Head Full of Steam
Kodiak Oil & Gas (NYSE:KOG) began the year in an expansive mood, with capital expenditure waiting to be unrolled as the company initiated its own variation on the plug-n-perf methodology for successful fracking in its Polar well series, which saw their production numbers climb despite the introduction of 2 additional wells into the normal mixture of six they had traditionally drilled in each spacing, completion costs that were continuing to drop as completion times diminished into the 17-19 day range, and strengthening oil prices globally rose on the lack of Libyan production, closure of the gap between WTI and Brent, and the promise of a refinery and infrastructure shortfall for light sweet crude in the United States. The entirety of these forecast events has transpired for KOG, and the stock price has reached 52 week highs in the past months, only to be battered down sharply in the last two weeks, and as the last event in the list makes its presence finally felt.
Nowhere to Go
Refinery capacity in the United States and Canada, which will see the launch of the Keystone XL Pipeline in mid-January of the new year, has been relatively stagnant for the past year, while domestic oil production has surged to its highest levels since the 1980s. The infrastructure currently isn't in place to accommodate such a large volume of light sweet crude as this key variable hasn't expanded remotely in lockstep with the 65% production increase from the levels seen in 2011, and as such, will be hard pressed to handle an increase of this proportion in the near term.
The addition of the Redwater refinery outside Edmonton, Canada will come online in 2016, and relieve some of the pressure built up at Cushing, OK with its record supply of American crude, as well as minor expansions to existing capacity at locations across North America due to crude varieties and expanded production in Bakken and Eagle Ford plays as well as rising natural gas demands; however, the full distributive and price effects of this infrastructure addition will not impact the market until the pipeline and Redwater are completed.
A Price and Income Theory
The more immediate effects are being introduced amid a broad small and mid cap E&P selloff that has seen large, volume backed trading out of these types of companies and into larger, dividend yielding stocks with midstream capacity, natural gas and European exposure. The compensatory notes for these smaller oil producers are the well established hedges into 2014 most have taken great care to establish, as well as the Brent crude price, which is currently hovering in the $110 range, and the recent 5% that oil gained this past Friday. These latter two movements are indicative of the supply glut that will soon be released from Cushing, Oklahoma to the refineries on the gulf coast, and will provide large amounts of light sweet crude to global refineries and thus drive down the Brent price, as well as offering the potential for a higher price for light sweet crude to be realized which will drive domestic WTI prices upwards and can be collectively understood as the rationale behind the large positive movement in the WTI price.
Reading Mixed Messages
This series of mixed signals has many in the sector wondering about the near term future of KOG. The market capitalization of the firm, as a function of the stock price, is lower than it has been in the past 3 months, when crude was selling around $105-106 and Brent was above current levels; that said, the opposing momentum to what seems like a drastic reason to discount the KOG price is found in the increasing amount of oil coming out of a fixed acreage and the reduced cost of getting it out as the company continues to expand and implement its newest down-spacing techniques and attempts to further the gains made in their completion times and costs. These effects serve to almost offset each other, and while the near-term may see production numbers that fall short of market estimates as companies choose to drill and sell at higher prices on later dates, those higher prices are still trickling down the pipeline, as it were.
The key value proposition that allowed the price to reach $12.50 is still valid, and will be matched and surpassed in 2014 as WTI prices appreciate in the wake of increased refining capacity and infrastructure expansion.
Disclosure: I am long KOG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am not a CFA. The information and data presented in this article was obtained from company documents and/or sources believed to be reliable; however, it has not been independently verified, and thus the author cannot guarantee its accuracy. Please perform your own due diligence regarding investments, as I am not responsible for the investment decisions you make. Thanks for reading, and may the force be with you!