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Northern Oil and Gas, Inc. (NYSEMKT:NOG)

Capital One Securities 8th Annual Energy Conference Call

December 12, 2013 10:20 a.m. ET

Executives

Brandon Elliott - Executive Vice President, Corporate Development and Strategy

Unidentified Participant

[Abrupt start] And we will move, I haven't seen Northern, is Brandon here from Northern -- there we go. Had in mind the -- so Brandon come on up. Northern Oil and Gas will be our next presenter. Brandon Elliott, who is Executive Vice President of Corporate Development and Strategy, I think I got that right. Look forward to hearing a little bit about Northern. Thanks, Brandon.

Brandon Elliott

All right. Thanks, everybody. I appreciate Capital One for certainly giving us the time today. You are, I am sure at this point all familiar with the forward-looking statements and all the legal proceedings that say that anything we say can be used against us.

Little bit about Northern. We are a non-op company exclusively focused on the Williston Basin of North Dakota and Montana. With about 21 employees today we control 187,000 acres, produce just over 13,000 barrels of oil equivalent per day. Obviously, up in the Williston, a high percentage of that, 90% of that is oil. We are participating in about 20%-25% of all the Bakken wells being drilled. With our recent press release that we issued earlier this week, we indicated that we have added another 62 gross, or 9.5 net wells to production already in the first two months of this quarter.

We currently have a strong reserve base. Pretty good equity value and enterprise value as you can see, indicated here at the bottom. Couple of things we think you should care about when you are looking at Northern. It is a very strong, defensible, non-op position in one of the leading oil plays in the U.S. We are obviously laser focused on transactions in the basin. It's a basin where we have been since we started and have had with our co-founder, Mike Reger, a four generation advantage on the ground in this basin. So we clearly know where land deals are being done and where they are likely to be done in the future.

We have built on that early mover advantage into this current position. We have a very strong liquidity position to fund this growth moving forward. We choose to partner with leading operators in the basin. The operators in the basin today are really beginning to benefit from true developmental economics. We get the leverage as not only the tier one operators in the basin, do continue to improve with enhance completion design and techniques, but we also are going to benefit as let's say the tier 2 or tier 3 operators in the basin also begin to emulate those tier one guys and start to improve. That should provide Northern with a nice kind of mix advantage as we go over the next six to 18 months as the basin is really just in the beginning of this developmental economic phase.

Obviously, since we are exclusively focused on the Williston Basin, just a couple of slides on what we see going on there. This is a obviously a basin where the legal and regulatory environment in both North Dakota and Montana is ideally suited for the non-op business model. Of note recently, the rig count in North Dakota picked up from the levels we had seen in kind of the low to mid-180 rigs running to about 193 active rigs today. Producers continue to grow and expected to continue grow. We see production almost or basically nearing that 1 million barrel a day mark and we continue to see strong estimates for gross well spuds.

We think not only with the recent rigs that we have added but the rig efficiency that we have seen at times, not as much in the spring of this year, but as times where we see the number of wells drilled per rig starting to gain a little bit of ground as we continue to transition and put more and more of the rigs on pads. We expect that rig efficiency to gain and that should continue to drive gross well spuds going forward for us as well.

This just helps to illustrate that our leases have the ability to participate in wells and also it's not just the Bakken but the various benches of the Three Forks. So as down spacing and lower bench tasks begin to prove out the ultimate development plan for the basin, our inventory of drilling locations will likely rise significantly. Obviously, you are hearing from some of our operating partners talking about development plans with six to eight wells in the Bakken alone and obviously some numbers that are taking about even more than that, and that’s in a 1280 drilling unit. Plus you are also, as we begin to test some of the lower benches of the Three Forks, starting to hear some pretty robust numbers about the number of wells that we could see in the lower -- in the Three Forks benches to reach ultimate development.

Let me just talk a little bit about our business plan and our value proposition. In many ways, Northern is a pretty simple story because it's a pretty simple business plan, albeit a very profitable one. We continue to show strong return on invested capital and it's a business plan that has been very repeatable with a low headcount. Step one in that value proposition is obviously the acreage acquisition side. Our goal is to continue to buy acreage that is one step ahead of the drill bit or one step ahead of where the operators are headed to next.

We have really good visibility just because of the number of wells we participate on in the basin about not only AFEs but LOEs and can see, get a good read on where economics are headed in the basin. Today we are buying mostly acres that are held by production at the date we purchased them and also come in a lot of cases with AFPs already proposed on that acreage when we buy it. We manage to allocate our capital to those projects that we estimated to be greater than 15%, and we are still able to buy, as much as some people don’t believe it, we are still able to buy land at a significant discount to what the operators are paying for in the core of the play.

Where do our acreage opportunities come from? Obviously, smaller parties that are used to funding a one well at a time drilling proposal, that may own 4%, 5%, 6% of that well. All of a sudden those envelopes are now arriving with eight wells being proposed in a single envelope. That changes if you have got a checkbook that you are using to fund this, certainly changes the size, the need of your checkbook to fund that drilling. So we get calls from those people looking to unload either all or a certain portion of those wells in order for them to be able to afford to participate.

Obviously we continue to see non-op positions from companies that prefer to operate. I think as we move forward in the play now, you will likely continue to see those operating companies that either began or have a accumulated a decent non-op position in the book. Probably consider to liquidate some of those non-op positions and focus exclusively on the operating side. We continue to see some of those opportunities out there.

Kind of ties a little bit into the next bubble where you are seeing some larger operators seeking to consolidate their operated positions post-acquisitions. I think you saw it, Kodiak talk when they did one of their recent acquisitions, that they did pick up a non-op block. I think even they have traded out of a lot of those non-op blocks. We do a lot of trading with other operators, but we think as that process continues, you will start seeing some of those non-op blocks start to fall out. And then obviously you see some operators that look to sell down some of their working interest to keep a level loaded CapEx, CapEx plan and also to continue to reduce their risk.

This slide gives you an idea how we have done historically buying acres. Average prices for 2012 was just little over $1700 an acre for over about 17,000 acres. And you have seen that price a little over $1200 an acre for the first nine months of 2013 for a very similar acreage amount. It does kind of go to show that in the sweet spot of where Northern is able to buy acres, there is just not a lot of competition. We tend to compete in markets where there is not enough bodies in the room to really generate a bidding process, but kind of above that low side of the market where you can have small groups of investors be able to participate. So it is a good sweet spot. And despite those low dollar per acreage valuations, we are still able to buy those acres in the core of the play. So they are not cheap because they are outside the core, they are cheap because there is just not a lot of competition in that side of the market.

For 2013 we did increase our acreage acquisition budget when we announced the third quarter to buy an addition $10 million to approximately $30 million. Given the slight pickup, as I have kind of said on the previous slide, given the slight pickup we have seen in acreage deals in the market, and that is especially in what we consider our wheelhouse, which is acreage deals from a few million dollars to maybe $10 million to $20 million. Like I have said, they fit us because they are typically too small to attract retail bidding crowds but obviously big enough for some of the smaller players not be able to participate.

All those acreage deals have allowed us to assemble an acreage position that continues to set us up for growth in the future. You can see here the country breakdown of our acreage position. Obviously on the left in blue, with Mountrail, Dunn, McKenzie and Williams County making up a significant portion for us in North Dakota. The biggest portion of the Montana Richland County position is in an AMI with Slawson and it continues to show good IRRs. It's a good IRR project. It's not a project that’s going to knock your socks off with IP rates or EORs. That is a very good -- has got the potential, as costs continue to come down, to be a really good IRR return project for us.

Obviously the most important part of buying acreage is not just buying the acreage but buying acreage that add net well additions for us. So step two is really the authorization for expenditure of the AFE process. This chart shows you that not only are the operators in the basin active, if you look at the recent rig count with this group of pretty recognizable operators, could spend in excess of $10 billion on a run rate basis based on their rig count. So it's clearly a robust amount of drilling going on in the basin. Obviously not a surprise to many of you if you have listening to the presentations recently. Obviously continues to produce good returns for these operators so they are clearly going to work in the basin.

Importantly, and I think this gets missed a lot of times for Northern, in the lower right hand pie chart shows that activity levels are focused in areas where Northern has an acreage position. So while some have opined that Northern's acreage is not in the core of the play, based on this stat our acres are clearly in the core of where these leading operators are drilling. As you can see there, 84% of the rigs running in North Dakota in townships are ranges where Northern has acreage. So clearly shows you that our acreage position is not out in the hinterland to the play but where operators are running rigs currently.

You can also see, as I mentioned earlier in the gross well count numbers we released this week showing that we have participated in 122 gross wells just in October and November alone. That kind of gross well count and the associated spud counts that went along with those months are up from last year and continue to generate a strong pace of net well additions already here in the fourth quarter.

That AFE process has resulted in Northern currently producing from just over 1,700 gross wells, 143 net wells. Those 1,700 wells are nicely diversified across a group of operators you see here. Slawson, Continental, Hess and EOG making up just over 50% of our current producing wells. And you can kind of see the smattering of everybody else we participate with. Obviously well diversified and as I mentioned earlier, you decide on this page who might be a tier one operator, who might be tier two and who might be tier 3. The important part is, as we move over the next six to 18 months the improvement of all those guys as they migrate to best practices in the field, should bode really well for the kind of per well productivity that Northern could experience over that time period.

Step three in the process is obviously to grow reserves and production. The top of this page highlights our reserve valuation at the beginning of this year. The bottom right shows you how we have been able to grow those reserves over the last five years to currently 67.6 million barrels of oil equivalent as we began this year. We would like to also point out to you, if you value companies on a reserve base, because we are a non-op, we carry only about 2.5 years of drilling locations in our PUD bookings. This compares as you know to our operating peers that per SEC guidelines are allowed to include five years of drilling inventory. And this sometimes gets lost in the noise of the market, we have seen even sometimes some of our sell-side analysts who do know us pretty well, do NAVs and compares us with a group but fail to give an apples-to-apples comparison by either grossing up or grossing everyone else's PUD locations bookings down. So the good news is, is even some of those analysts that aren't very favorable on Northern right now are seeing their NAVs -- we saw one that was recently increase by about a little over 30%.

So I think we are just beginning to have the Street appreciate kind of what Northern has been able to generate and kind of the growth prospects going forward. Obviously we have been able to grow reserves and production while continuing to maintain very strong cash operating margins that are obviously comparable to the peer play peers in the basin and compare obviously very favorable to the rest as well. We think as the play moves in to a developmental mode, you could begin to see some of the positive leverage potential as we continue to grow reserves and production with really minimal, if any, increases to overall headcount which is already quite low.

So not only we have been able to grow at competitive margins, the model has been repeatable and sustainable at relatively low asset intensity levels. You can see here, three-year funding and development costs. And then in the lower left, compares asset intensity levels which is merely a measure of the cash flow we are able to generate from production accounting for those F&D costs over time, and also our reserve replacement numbers from 2010 to 2012 in the lower right hand graph.

Another measure of capital efficiency which we clearly pride ourselves on, try to continue to be better allocators of capital. Showing you how many dollars we are able to generate for every dollar we are adding to reserves over the past three years. This shows you that we have been able to, again, repeat this simple yet very profitable business plan for the last five years and nine months. With trailing 12-months EBITDA now just slightly over $260 million and trailing 12-month revenue numbers, as you can see, a little over $345 million in the left hand side of the chart.

With the time I have left, I will just briefly on kind of the financial overview and how we view our financial strategy as well. Obviously one of the most important aspects of a non-op is the liquidity position and it's obviously clearly valuable for Northern. It allows to continue to fund the growth we see ahead. We have indicated approximately $411 million CapEx budget for the full year of 2013. If you look at that trailing 12-month EBITDA number, indicate about $150 million of negative cash flow spend for this year. Obviously when you look at the, over $400 million we have available on our credit facility, we clearly have the necessary capital to fund our growth for this year and next. I will remind you that our credit facility has redetermination periods twice per year as is pretty common. It's been going up at about $50 million in each of the last couple of redeterminations. So we will have two more chances in 2014 to increase that facility giving us even more room and liquidity for next year to continue to fund our growth.

You can see here how our capital spend has shifted over the last several years and has moved from the acreage growth side of the play to the development of the acreage position with a little over 90% of our capital spend today focused on drilling. It's obviously down significant from the prior years closer to our funding.

We obviously maintain a hedge position to reduce our cash flow volatility and to protect that liquidity position I just mentioned. As you can see, we have got a little over 900,000 barrels per quarter of oil hedged at about $90 for 2014. We will continue to layer in 2015 hedges. You know when we see opportunities in the marketplace, it should continue to provide us a good base of that cash flow to fund the growth going forward.

We have been able to acquire the acreage position and generate the growth we have and yet trade at a pretty significant discount to our peer group in the basin. So obviously a discount that we hope to prove as unwarranted over time. As I mentioned earlier, even some of the skeptics out there are finding the need to raise the NAV valuations given our most recent performance.

So why should you consider Northern today? We obviously have a proven acreage acquisition model that is focused in an outstanding play in the U.S. We have incredibly deep generational knowledge of the land game in this area. We feel that we are the go to buyer of that non-op acreage that sits in our wheelhouse that I talked about earlier. And we are still able to add acres at a pretty significant discount to what the operators are paying in the basin.

We work with a very good diversified group of operators that are helping to drive our per well productivity. Per well productivity is something we talked about as we began 2013. We said it was something that would improve in the back half. I think you saw with our with our third quarter numbers the beginning of that sign of per well productivity as the rigs were moving back into the core, start to help us drive our results. And we obviously have visible growth potential ahead with extensive multiyear drilling inventory and the ability to continue to add acres and the right to participate in both the down spacing tests we see going on but also the Three Forks potential that is underway in the basin as well.

Thank you, guys for the time today and the interest. You can, obviously, we have got reconciliation for some of the numbers I gave you and I appreciate the time and interest in Northern.

Question-and-Answer Session

[No Q&A available for this event]

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