Sometimes generating nearly 10 times as much money as the year before is still not enough.

That appeared to be the case Tuesday for MEG Energy, with shares of the oil sands producer falling as much as 3.7 per cent or $0.42 per share by midday trading on the Toronto Stock Exchange despite the company reporting a dramatic surge in cash flow.

MEG raked in $239 million in adjusted funds flow during its third quarter, representing a nearly tenfold increase from the $26 million generated during the same three months of 2020.

However, the windfall would have been even greater were it not for the substantial amount of production MEG had locked in at previously agreed upon prices late last year in a process known as hedging. The company incurred $66 million in total hedging losses during its third quarter, effectively leaving money on the table.

Nearly one third of its planned fourth-quarter production, or 29,000 barrels per day, is also locked into hedging contracts averaging US$46.15 per barrel. That price represents a discount of roughly 36 per cent relative to where Western Canada Select (WCS) crude oil was trading (US$62.76/barrel) on Tuesday shortly before noon eastern time.

Analysts, meanwhile, have largely supported the company’s hedging strategy given MEG’s substantial debt load.

“If we rewind to this time last year, MEG’s net debt would have been [roughly $3 billion],” George Huang, who covers the stock for Raymond James, said via email. “At that time, the strip pricing would have been in that ~US$45 range for 2021, so with that backdrop and the significant operating leverage of the business, I think it is fair to characterize the strategy as prudent.”

One year ago, MEG had a net debt to trailing funds from operations ratio of more than eight times, Huang said, meaning the company owed more than $8 in debt for every dollar it generated in cash.

“That hedging served to lock-in a part of the capital program required to sustain the business for 2021 and protect from severe swings in cash flows,” he said.

Desjardins Analyst Justin Bouchard echoed Huang’s view in a note to clients on Tuesday, writing that “at the time, we thought [hedging] was the right decision for MEG.” The company still faces headwinds for its fourth quarter results because of its hedging contracts, Bouchard wrote, “but then it’s done.”

“After one more quarter, MEG will be free and clear of [oil price] hedging, positioning it to maximize [free cash flow],” he wrote, concluding that is “certainly good news.”

MEG also increased its full-year production forecast for the third time since the start of 2021, with average daily output now estimated to be at least 92,500 barrels. The company is broadly expected to put those extra revenues towards debt reduction, with Travis Wood of National Bank Financial estimating MEG’s total amount owed falling to $1.7 billion by the end of 2022.

“Importantly, MEG has ample liquidity via an undrawn $800-million credit facility and a maturity structure with no notes due until 2025,” Wood said in a Monday evening note to clients where he raised his price target on the company’s stock by one dollar to $15 per share.

According to Huang at Raymond James, because “hedging should be viewed as a means of balance sheet protection, [then] as net debt on the balance sheet declines, the need to hedge forward cash flows decreases.”

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