Will Wildcatter’s ‘Naked’ Gamble on Oil Prices Pay Off? Continental Resources CEO Hamm Sells Hedges, Betting on Quick Rebound in Crude

By ERIN AILWORTH, GREGORY ZUCKERMAN and DANIEL GILBERT WSJ
Dec. 9, 2014 12:35 p.m. ET

Harold Hamm ’s willingness to make risky bets helped him build Continental Resources Inc. into the one of the biggest oil producers in North Dakota’s Bakken Shale and a symbol of the U.S. energy boom. But his latest gamble—a quick rebound in crude prices—is rubbing some investors and analysts the wrong way.

Mr. Hamm, who founded Continental and owns 68% of its shares, announced in early November that the company had cashed in almost all of its financial hedges that guaranteed it could sell millions of barrels of oil for about $100 apiece. The company said it had realized $433 million in cash from selling the hedges, some of which ran through 2016.

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“We feel like we’re at the bottom rung here on prices and we’ll see them recover pretty drastically, pretty quick,” Mr. Hamm said on a Nov. 5 call with analysts. He said the Organization of the Petroleum Exporting Countries was pushing down oil prices to slow America’s expanding energy output.

Now, removing the hedges, known in the industry as “going naked,” looks misguided even to some of the company’s fans, after the recent tumble for oil prices. The benchmark price for U.S. oil has continued to slide, falling from $81 in late October to $63.82 on Tuesday.

If Continental had kept the contracts that insured it against lower crude prices, it could have reaped $52 million more for its oil in November, according to a Wall Street Journal review of company disclosures. And it might have received $75 million more this month, assuming current conditions continue.

The Journal’s calculation of about $127 million in forgone revenue is similar to projections by several Wall Street analysts, and those projections would continue to rise in the coming months if oil prices remain below $96 a barrel.

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The company said it disagreed with the Journal’s figures but wouldn’t provide its own, except to say that after figuring in revenue it received for selling its hedges, it expects the “net negative effect” to be $25 million to $30 million in November and December. It sold nearly $1.2 billion of oil and gas in the third quarter and reported net income of $533 million.

“It was a bad move with terrible timing,” said Gregg Jacobson, a portfolio manager at Caymus Capital Partners LP, a $200 million Houston hedge fund manager that had about 4.5% of its portfolio in Continental shares as of the end of the third quarter. Though he thinks the hedging sale will prompt some investors to view the company as unusually risky, Mr. Jacobson said he remains a supporter because of its executives’ skill in finding and drilling for oil.

“In the long run, the stock will respond to how they perform in the field,” he said.

While shares of many U.S. energy producers have had double-digit percentage declines since oil prices began falling in late June, Continental’s stock has been hammered. Its shares, which closed up 7.2% at $36.18 on Tuesday, have fallen by more than half since the end of August, and more than 25% since Mr. Hamm disclosed on Nov. 5 that the company had sold the hedges.

Mr. Hamm said in an interview that he still believes his bet could pay off but that it might take as many as two years to tell. “You can’t condemn that as a bad decision,” he said. “You haven’t seen it play out.”

Companies like Continental can react quickly to market changes, he said, which gives them an advantage over OPEC’s members. The cartel is discounting “the resiliency of U.S. producers,” he said, adding that investors “need to look at Continental long-term.”

A wildcatter—he has called himself an “explorationist”—Mr. Hamm started the company that would become Continental in 1967 and first struck oil in 1971 in Oklahoma. More than two decades ago, he began focusing on exploring the then-little-known Williston Basin, which stretches from South Dakota to the Canadian province of Saskatchewan. Over time, his company became a leader in the Bakken formation in North Dakota, which has become one of the biggest oil fields in the U.S.

Continental produced nearly 35 million barrels of oil last year, almost four times what it was producing five years earlier. That growth has helped push U.S. oil output to more than 9 million barrels of crude a day, up from 5 million in 2008.

Though Continental has become a leader of the U.S. energy boom, it is unusual. Institutional and activist investors have curbed some of the risk-taking of wildcatters at other energy outfits, and few companies of Continental’s size remain controlled by their founders.

Continental said it had 5.2 million barrels insured in November and December at an average price of about $100.

When oil prices are falling, hedges—contracts that many energy companies buy to protect against declining prices by guaranteeing a minimum price for the oil and gas they produce—become much more valuable. Continental notes that several of its competitors aren’t hedged, including Apache Corp. , which has no hedges on the books in 2015. Apache said it does have some production insured through the end of this year.

Mr. Hamm isn’t the first energy executive to abandon hedges. Under the leadership of former CEO Aubrey McClendon , Chesapeake Energy Corp. dropped its natural-gas hedges in 2011, leaving it exposed to a dismal gas market and dealing with a cash crunch the following year.

‘It was a bad move with terrible timing… In the long run, the stock will respond to how they perform in the field’
—Gregg Jacobson, a portfolio manager at Caymus Capital Partners
Continental isn’t likely to face a liquidity crisis—its debt is smaller than many of its competitors at about 1.7 times its cash flow, according to S&P Capital IQ. And the company has $1.75 billion in unused credit, recent financial filings show.

“They’ve built such a good balance sheet, they have the luxury of making this gamble,” said Jason Wangler, an analyst for Wunderlich Securities, who called the move a speculative bet. “They left money on the table in the short term.”

Mr. Hamm, he said, is “the guy you’re investing in, as much as the company.”

Since selling Continental’s hedges, Mr. Hamm has lost about $4.4 billion of his personal fortune as Continental’s shares have fallen—a loss that could be compounded by Mr. Hamm’s divorce. A judge recently awarded the former Mrs. Hamm, Sue Ann Arnall, a nearly $1 billion settlement; she appealed that decision on Friday. Mr. Hamm now owns about $9.2 billion of company stock.

Some investors say Continental’s primary acreage in the Bakken and elsewhere renders the hedging decision less important in the long-term.

“Cash flow next year will be lower and more volatile, assuming prices stay under pressure,” said Joe Chin, an analyst at Obermeyer Wood Investment Counsel LLLP, an Aspen, Colo., firm that owned 340,000 Continental shares at the end of the third quarter. “But we remain confident about management’s ability to deploy capital.”

Write to Erin Ailworth at Erin.Ailworth@wsj.com, Gregory Zuckerman at gregory.zuckerman@wsj.com and Daniel Gilbert at daniel.gilbert@wsj.com

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