2013 should be an interesting year for oil and gas in the United States. 2012 was disappointing, as results lagged expectations. There were several reasons for underperformance, but the main issue was differentials. Bakken differentials were the widest, as pipeline capacity was strained.
In 2013, Oil transportation issues should decrease. Additional pipeline capacity coupled with increased usage of the rails. EOG Resources (EOG) was the first to rail the majority of its Bakken crude. It was shipped to St. James for LLS pricing. Other Bakken producers sold its oil below WTI in 2012. EOG received an average of $10 more year over year.
There are a wide range of oil price estimates for 2013. Raymond James believes WTI will average $65/Bbl. It estimates a hard landing in China, continued macroeconomic issues in Europe, and weak demand in the United States. In response, OPEC will cut production. While these variables are possible $65/Bbl is unlikely. My estimate is $88/Bbl. Bakken differentials to WTI will tighten to $8/Bbl. Expectations are for significant volatility. WTI's low for 2013 will be short lived and bottom around $75/Bbl. This will be a buying opportunity.
|Type||2013 Average Price|
There are several reasons to be bullish the Bakken this year. Cost reductions should continue. Stimulation, trucking, and rig contracts will expire, and be signed at lower rates. Supply increases will decrease Proppant and chemical costs. Russian and Chinese ceramic proppant are significantly cheaper, so more can be used on completions. Completion times are improving. Continental (CLR) reports a 25% cycle time decrease. It has realized cost savings of $26000/stage since the first quarter of 2011.
Pad drilling decreases recoveries per well, but its Florida Alpha 6 well Eco-Pad offset this with better cost savings. 6 single wells took 201 days and had $29.3 million in costs. Florida Alpha was better at 128 days and $21.8 million for a 35% cost reduction. This compares to a 30% decrease in production from an 8 well pad. The comparison is imperfect using 6 and 8 well data. 6 well pad production would reduce this estimated to 23%. Continental is realizing savings through SWD wells and related infrastructure. It estimates savings of $2/Bbl for produced water and $2/Bbl for fresh water.
Cost savings are important, but differentials are the key. EOG managed to blow by estimates realizing oil prices above NYMEX. Other companies are beginning to follow suit putting additional resource on the rails. In 2009, 99% of all Bakken crude was piped. This decreased to 69% in 2011. 44% was piped as of September of 2012.
Upcoming pipeline projects by Enbridge Inc. (ENB) and Enbridge Energy Partners (EEP) are levered to the Bakken. Both are funding the Superior to Flanagan project. The most important expansion for EEP is its Sandpaper Project starting in Minot. Other rail expansions include the Bakken Berthold Rail and Philadelphia Rail JV. All of this will continue to improve differentials as more crude finds its way to the east, south and west. There are more projects planned, but these examples give an idea of the midstream expansions in process.
We will continue to see increased oil sales to the east and west coasts utilizing the rails. Phillips 66 (PSX) recently inked a five year deal for 50000 Bbls/day with Global Partners (GLP). This Bakken crude is destined for Phillips' Bayway refinery in New Jersey. Tesoro (TSO) is already railing Bakken crude to its refinery in Anacortes, Washington. Transportation is roughly $9.75/Bbl to Washington. Tesoro is talking about railing Bakken crude to Carson, California, which would cost $14/Bbl. This compares to $12.50/Bbl for Alaska North Slope or ANS. Bakken crude could continue to supplant Alaskan oil through 2013. EOG will continue to rail almost all of its Bakken crude the St. James. For every barrel of oil railed there is one less needing to be piped. This should aid in tightening Bakken differentials and more importantly decreasing volatility.
I have been bullish the refining sector since February based on differentials. The sector has outperformed with the mid-continent refiners leading the way. This area has had the lowest cost feedstocks. This should continue throughout 2013, as differentials shouldn't change much over the next 12 months. Companies like Tesoro and Phillips 66 are now getting exposure to Bakken crude. This may not be significant enough when compared to total barrels purchased, but it produces better margins. The table below lists refiners with a large exposure to mid-continent crude.
|Refiner||Market Cap||Price||1 year Target||Dividend|
Northern Tier Energy is one of my 2013 stock picks. It was once part of Marathon (MRO). Northern consists of a 74000 b/d refinery and Super America retail network. The St. Paul Park refinery gets its Bakken crude from the Enbridge North Dakota Pipeline system, which connects to Clearbrook. This crude travels south on the Minnesota pipeline to St. Paul. 49% of its throughput is Bakken, but 100% comes from northern mid-continent oil. This is important as this sells at a discount to WTI and is the most cost advantaged.
Northern Tier's price has run up significantly since its IPO, but still trades at fair value. At today's differentials, this stock will produce a large amount of income. Downside is limited unless Raymond James is right the world economy. If differentials widen, the current income will also provide additional growth. It is important to note that Bakken crude will always sell at a discount to WTI and Brent. This was a main point in my interview with Clarence Cazalot CEO of Marathon. It is lighter and sweeter than these two blends, but transport costs decreases its value. The approved refinery in Fort Berthold will only refine 13000 barrels per day. Tesoro's Mandan refinery was recently upgraded, but it only refines 68000 barrels per day. Even with significant expansions there will still be a large surplus of Bakken crude to be piped or railed to other areas. Wide differentials support this as seen in the table below.
These costs substantiate the use of Bakken crude throughout these regions of the United States. Using my differential estimates for 2013, these regions will benefit receiving Bakken crude by rail. My estimated Brent premium of $26/Bbl provides a $10 margin for crude railed to New Jersey. Margins are better in other areas. Northern Tier can purchase at more than $20 below Brent pricing. I think it is important to balance a portfolio with refining stocks if invested in oil exploration and production companies. This provides downside protection if the price of oil drops.
In summary, there are a significant number of catalysts in the Bakken for 2013. Bakken differentials should improve year over year helping Bakken oil producers. Costs should continue to decrease as well. Production increases will be seen from better well design, including the increased use of proppant and water. Refiners and pipelines will continue to pay down debt and improve balance sheets as significant cash flows are produced. In my next article of this series, I will cover Kodiak Oil and Gas (KOG). This is my top oil exploration and production stock for 2013.
Additional disclosure: This article provides estimates that may or may not be correct. Be careful investing, as there are no certainties. This is not a buy recommendation.