Independent U.S. oil producer Continental Resources, (NYSE:CLR) has been at the forefront of America's booming shale oil production. The company's founder and CEO, Harold Hamm, has been an unabashed supporter of American energy independence, and a vociferous opponent of OPEC, the cartel of oil-exporting countries that currently produce about 40% of the world's oil.
Hamm's Continental Resources is facing a major challenge, with oil prices down more than half since last June. Nonetheless, the company reported a profit last year, and in its fourth quarter, when oil prices significantly declined. Even after rebounding 27% this year, Continental Resources' stock is down almost 40% from last year's high:
Is Continental Resources stock worth buying, or a value trap waiting to spring? Let's look closer.
Last year's profits, and Hamm's big mistake
Continental Resources showed a profit in 2014, and even in the fourth quarter as oil prices began plummeting. Hamm made the decision to cash in all of the company's oil hedges -- financial instruments that guarantee the company gets a certain price for crude oil -- last November, for $433 million. Here's what he said at the time (emphasis mine):
We view the recent downdraft in oil prices as unsustainable given the lack of fundamental change in supply and demand. Accordingly, we have elected to monetize nearly all of our outstanding oil hedges, allowing us to fully participate in what we anticipate will be an oil price recovery. While awaiting this recovery, we have elected to maintain our current level of activity and plan to defer adding rigs in 2015. This translates to a $600 million reduction in our 2015 capex budget, resulting in a revised 2015 capex budget of $4.6 billion, with 23% to 29% production growth.
Here's what oil prices have done since:
In short, Hamm sold the company's insurance against a further decline in oil prices for a one-time gain in the fourth quarter, leaving the company almost completely exposed to the worst oil price environment since the heart of the financial crisis.
Looking at 2015
Less than six weeks after saying that it would maintain the same level of rig activity in 2015, the company changed course in a big way, cutting projected average rig count for 2015 by 40% from 2014 levels, and slashing its non-acquisition capital expenditure budget from $4.6 billion to $2.7 billion. The company's guidance for production growth was also cut by 10% on the high side.
Frankly, it's a major concern when a company has to turn on a dime like that. I don't think it's too much of a stretch to say that Hamm sold off the flood insurance, then started buying sandbags a few weeks later. Today, West Texas Intermediate -- a common benchmark price for American crude oil -- sells for $51.75, a level that is actually profitable for a decent percentage of Continental's wells. Unfortunately, the company's aggressive growth in the Bakken comes at a price.
Without major pipelines to ship its product in, the company must pay a steep premium using rail to ship crude to market. The result is Continental's oil sells for less than WTI, and by a pretty wide margin. The company is expecting to collect between $7 and $10 less than WTI per barrel in 2015.
Debt, liquidity, and the big risks
This is the big risk to me:
Without a hedging program in place, the company has little wiggle room if oil prices stay down for an extended period. The company's production makes for pretty substantial cash flows, but aggressive expansion has seen the company spend far more than it brings in for years:
Yes... the company slashed capex by $2 billion -- and that will help -- but it's also selling its primary product at a substantial discount from prior years.That's just part of the risk. Global demand continues to grow very slowly, and an additional 800 thousand barrels of Iranian oil is likely to get added to the global supply this summer. In short, there are as many reasons to expect oil prices to stay as low as there are for them to increase. And that's a serious risk for Continental Holdings in the interim.
A coin toss at best
Hamm owns more than 70% of the company's stock, putting him in total control, and his decision to cash in the hedges last year makes me question whether he's a leader I would want wielding so much autonomy. That move will probably make for a much tougher 2015 than was necessary, but we won't know the full impact of the current oil market until Continental reports earnings on May 6.
Let's face it: Continental is likely in trouble if oil prices fall further, and not in great shape if they stay where they're at for a long time. The company has upside when prices eventually rebound, but so do plenty of less exposed oil producers.