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Does Performance in Oil Stocks Correlate with Hedging Activity?

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US oil production continues despite fall in oil rigs

Over the past few years, US oil drillers were helped by an ample supply of funds from Wall Street investors. This paved the way for the US energy boom. Despite the prices of oil hovering at significantly lower levels compared to their 2014 value, an easy flow of money into energy companies has enabled US energy companies to circumvent liquidity issues and avoid a sharp fall in crude production.

The US rig count fell by ~53% compared to a year ago, according to data for the week ended June 12, 2015. However, 9.6 million bpd (barrels per day) were pumped throughout the United States during May 2015, the highest since 1970. Hedging by oil companies has helped as well.

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However, we can’t determine a clear relationship between hedging and stock returns. As you can see in the above chart, Denbury Resources (DNR) had significant hedges. But it experienced significantly greater losses compared to Kosmos Energy (KOS), which had a comparable percentage of crude oil production mix and employed significant hedges.

Similarly, SandRidge Energy (SD) and Devon Energy Corp. (DVN) both had relatively low levels of crude oil production and used hedging. But while SandRidge suffered an 83% erosion in its share price over last year, Devon Energy experienced a yearly return of just -16%.

Favorable funding environment supports oil firms

In spite of a slash in capital expenditures by oil companies and significant layoffs, institutional investors and private equity companies are investing in the energy sector. With interest rates still at historic lows, investors are on the hunt for good investments.

The energy sector has underperformed the S&P 500 Index so far this year, yet investors seem to be betting on a rebound in oil prices. They’re treating energy stocks as temporarily undervalued. The Energy Select Sector SPDR Fund (XLE) offered a year-to-date total return of -1.80%.

In the next part of this series, we’ll analyze the fundamentals of SandRidge Energy (SD).

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