Continental Resources Exploits the Optionality in Its Portfolio
Harold Hamm, CEO of Continental Resources (CLR), has most recently been in the news because of his $995 million divorce settlement, which his wife is appealing. Far more interesting though, was Continental’s recent decision to remove all of its hedges on future oil production. Closing out the short positions in oil futures generated a one-time $433 million gain, while of course also leaving the company exposed to further drops in oil prices. However, CLR also cut back its planned 2015 capex budget from $5.2 billion to $4.6 billion. This highlighted the optionality that E&P companies possess, in that within limits they can decide not to produce oil from certain fields if prices aren’t sufficiently attractive. In those cases, rather than being long oil they have a position that looks more like a long call option on oil. As option traders will readily recognize, a long oil call option combined with a short oil position (through the hedges they had) creates a long put option on oil. In effect, CLR’s ownership of oil producing assets combined with its hedges has acted in part like a put option on oil. Harold Hamm said that they believe oil has to rise in price, and that’s a good enough reason to remove the hedges. But if they’re wrong, they can at least mitigate the situation by producing less. If you’re long options, a volatile market is usually good (it increases the potential value of your position). CLR is making full use of the volatility in oil by trading their effective long put option on oil. Harold Hamm’s divorce reminded me of someone who was just going through his third. Harold probably won’t see the humor in this at present, but this serial divorcer I’m thinking of had names for his three ex-wives: Half, Quarter and Eighth, denoting approximately what he was left with following each event in the unfortunate sequence.
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