Some E&P Companies Come Out on Top with Successful Hedging

Despite declining oil and gas prices, which have caused the petroleum industry to tighten its wallet, some small- and mid-sized E&P companies have hedged themselves into financial stability, according to a report from financial media outlet Forbes.

Forbes cites Houston-based Linn Energy, LLC as a case-in-point strategist. The company purchased put options through 2009 with the right to sell most of its oil production at $102 per barrel and all of its natural gas at $8.32 per million BTUs, both of which turned out to be "exceptional trades."

While more than a few of its contemporaries are either folding under $40 spot crude and $5 natural gas or locked into drilling costly wells under rig contracts signed when crude was riding high at $140 per barrel, independent oil and gas company Linn Energy has stayed a steady course. Rather than going bust over high-risk exploration and letting its cash flow float with spot prices, Linn takes the low-risk route, choosing to drill wells that require minimal capital expenditure and locking in margins several years out by hedging.

"We are a bird-in-hand company," Linn's VP of Investor Relations Clay Jeansonne told Forbes.

The report also notes that, unlike major oil companies, which can withstand a heavy blow from price volatility as long as their coffers are chock-full of cash, many firms will more than likely be forced to divest assets in order to strengthen their balance sheets. Analysts are keeping a close eye on hedge positions among small- to mid-cap E&Ps, as the companies face mounting pressure from lenders.

Linn certainly remained solid in such financial uncertainty, even sticking to its guns with $82 hedges when crude prices skyrocketed in July 2008. "If you stay true to your strategy, in theory, you don't take credit when prices go down and don't take criticism when prices go up," Jeansonne added. "We do believe we will be able to weather the storm particularly [well] because of our hedge book."

In a Feb. 2 report, Raymond James & Associates rated the company at "outperform." Analyst John Freeman added that Linn has "one of the best hedging profiles in the industry, with the potential to see profit-margin expansion in 2009."

The imminent question that exploration and production companies should consider answering as Linn did -- to hedge or not to hedge? -- just might provide the right amount of cushion needed to soften the fall from record-high commodity prices.