8 Comments

Well argued, thanks

I'd add that for smaller companies the possible collateral requirements could be a barrier to large hedging programs

Expand full comment

Interesting post Andrew. Thanks. I do wonder why some of these smaller Oil E&P don't get taken private, hedge at current prices and just let the cash flow pay off debt and provide a nice return on a future debt free Co.?

Expand full comment

why would a company hedge their energy prices when they'll all be less than 1x levered by the end of this year??

Some energy companies will be DEBT FREE by next year and will have investment grade balance sheets. The need to hedge is to protect cash flows for companies that have levered balance sheets and/or are required to by their banks.

If a company does not have a levered balance sheet, then it should maintain its optionality to the upside w/o selling costless collars that destroy the upside

Expand full comment

I enjoyed your article. However, with all due respect (huge fan of your blog, first time commenting), I think that you should give some energy management teams a bit more credit. I think that if you checked out the transcripts on FANG / EOG, you'd see a really concerted focus on basing capital allocation decisions on through-cycle pricing (rather than spot or strip) and being highly focused on shareholder returns.

I appreciate the point on hedging. I think part of it is that for producers in the US, it is clearly exceptionally difficult to raise production (see HAL's recent earnings call, where they say, paraphrasing, "We're sold out" for the rest of the year), and I think that the supply-side of the energy equation is fairly favorable right now, and I would guess that they are simply reflecting that perspective in their hedging policies.

I'm a big fan of the mineral royalty plays (VNOM, KRP, STR, MNRL), some of which engage in hedging at current prices, and I think they're a pretty interesting group to look at if you have a value-oriented focus in energy. I think they're a uniquely situated set of companies that are really well-positioned to benefit from inflation and productivity growth in US energy. Plus, you're still getting a teens FCF yield.

Also, if I was making one pick in energy, I'd emphasize pipelines, even if pricing is a little rich right now...

Expand full comment

If you are going to invest in energy or any cyclical commodity business you have to get in the weeds. Watch management closely. If you are just bullish on oil (or coal or copper) in general then use futures to play it as tgerr is no risk of management squandering capital. I've been into energy for a while and the energy tourists are back because it has been working. The key in these cyclical businesses is to invest your capital in companies that have proven ability to weather cyclical downturns. That and stay away from companies where govts have massive stakes or have gone ESG crazy.

Expand full comment

I see your point, but investors who are not big firms willing to do activist takeouts don't really have any way to control for the risk you raise. I guess you could make marginal gains on M&A deals as they get announced as a regular investor, but holding these companies long in the hopes that they will attract M&A seems unproductive/risky, considering there's a pretty open conspiracy right now among world governments to prevent investment in oil/gas.

Expand full comment

Doesn’t Buffett ownership of OXY provide protection for both. Downside protection as Buffett buys if it dips since he believes in oil and he’ll ensure that management will act rational. Get the downside protection without hedging so the upside remains (unless he takes them out first).

Expand full comment

Nice follow up! I clearly have more to learn about examining the facets of risk.

Expand full comment