E&Ps Using Hedging to Stabilize Stock Value

With gas prices tumbling fast and fundamentals decidedly bearish, producers have scrambled to lock in the highest wholesale rates available. Among others, Fort Worth-based independent XTO Energy Inc. said last week it has hedged 90% of its production through March 2002 at $4.30/MMBtu and has hedged 200 MMcf/d at $3.72 for the last three quarters of 2002. XTO is one among many independents who have touted their foresight in locking long-term rates when prices were considerably higher.

Pioneer Natural Resources, offering an overview of its operations and growth at a recent analysts' meeting, said it hedged about 60% of its North American natural gas volumes at prices above $4/MMBtu and anticipated hedging nearly 15% of its oil volumes. Conoco, which announced its second quarter earnings Monday (see related story), initiated a natural gas and crude oil hedging program with its Gulf Canada Resources acquisition and plans to lock in prices for about 85% of its acquired production through the end of next year.

Louis Dreyfus Natural Gas Co., headquartered in Oklahoma City, said its second quarter results were aided with $12 million pre-tax hedging gains from contracts covering 200 MMcf/d at an average price of $5.34/Mcf. The contracts continue through October 2001 and are currently approximately $1.95 over spot market prices.

Houston's Cabot Oil & Gas said its hedging program limited its exposure to falling natural gas prices in the second quarter. Cabot CEO Ray Seegmiller said the company's hedging program "consists primarily of a series of costless collar arrangements that are in place through October (with a $5.00 floor and $9.00 ceiling per MMBtu) and currently cover over 50% of the company's gas production.'' Seegmiller said Cabot realized $4.4 million in cash through its derivative positions in the second quarter adding $0.28 to the realized gas price.

For producers, hedging provides a way to help ensure their stocks hold some value in the volatile marketplace. "Given current natural gas storage data and economic conditions, we believe these hedges will help secure our goal of creating substantial value over the next 18 months," said XTO CEO Bob R. Simpson. "We remain bullish on gas. With the resumption of economic growth, natural gas will be a scarce commodity over the next decade."

Holding stock value will be ever more paramount if analysts' predictions come true. In the Salomon Smith Barney (SSB) "Exploration and Production Weekly" last Monday, analysts Robert Morris and Michael Schmitz noted that E&P shares had dropped for the ninth consecutive week "despite a rally late in the week," and added they expect to see "sharp weakness" in its coverage group, with an opportunity to increase exposure in large market-cap names like Anadarko Petroleum Corp., Apache Corp., Devon Energy and EOG Resources, and in the smaller-to-mid-caps like XTO, Chesapeake Energy, Stone Energy and Vintage Petroleum.

"Although the onset of some warmer temperatures and/or a severe hurricane through the Gulf of Mexico could provide some firming to natural gas prices this summer, we believe prices could approach $2.50/MMBtu this fall," said SSB. On average, they noted, E&P shares declined 2.2% last week, concurrent with 3.8% declines in West Texas Intermediate spot crude oil and 4.6% declines in composite spot natural gas prices.

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