Oil Hedges Worth A Third Of Denbury’s Market Cap

Some E&P companies have a lot of their net worth tied up in oil hedges, and they’ll need to put those assets to good use to survive a difficult couple of years

Denbury Resources’ 2015/2016 oil hedges are now worth a third of its much reduced market cap, and while that’s the largest from among major exploration & production (E&P) companies, many of its peers have hedges worth more than 10% of their market cap as well. Now the question is how these valuable hedges can best be put to use.

“There are many possibilities, including partial monetizations, and the rational for the ‘why’ is simple: E&Ps face an increasingly bleak near-term future and may need to consider unorthodox liquidity levers to raise cash to ride out the low oil price storm,” write Sterne Agee analysts Tim Rezvan and Truman Hobbes.

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E&P companies with significant oil hedges

The reason for oil hedges’ outsized value is both because they are well into the money and because E&P firms market caps have plummeted. Neutral-rated Denbury Resources, for example, was trading above $18 last summer and is now at $7.53 – and that’s after a recent rebound. Gastar Exploration (Neutral-rated, $2.41), Oasis Petroleum (Buy-rated, $14.38), Carrizo Oil & Gas (Buy-rated, $47.40), Approach Resources (rated Underperform, $6.92), and QEP Resources (Buy-rated, $21.05) are all in a similar position with at least 10% of their market cap in oil hedges, according to the Sterne Agee report.

The question is what to do actually do with those hedges. Rezvan and Hobbes speculate that the oil hedges are probably at or near their maximum value right now, so continuing to sit on them isn’t a great option. Investors looking to invest in the E&P sector should pay attention to how the hedges are going to be used since it could give some companies a big survivability edge (similar to having a strong balance sheet).

Oil hedges also affect credit facilities

One other complication is that banks include oil hedges as assets when calculating credit facilities, which means that selling the options will restrict credit later in the year. The value of the oil hedges are discounted in the calculation, so the credit facilities won’t fall dollar-for-dollar, but it’s another factor that E&P management teams have to take into account. Credit facilities are expected to be sharply curtailed this year regardless when banks recalculate them before the second half, but a straightforward sale of oil hedges could exacerbate an already difficult problem.