Kodiak Oil & Gas (NYSE:KOG) has an important milestone to celebrate. The company's 2014 spending budget that was announced yesterday contemplates - for the first time since the company entered the Bakken play - self-funded growth. Kodiak expects to finance its $940 million 2014 capital expenditure budget (which is allocated solely to Williston Basin oil and gas activities) essentially within its projected operating cash flow:
At the contemplated level of investment, Kodiak believes that operational cash flows should closely align with capital expenditures in 2014 based on the current commodity price outlook. The Company's cash flows are supported by an active hedging program. Kodiak currently has 2014 crude oil hedges in place on 26,150 barrels of oil per day at an average price of $93.29 per barrel.
The commitment to restrained spending is positive news for the stock as it demonstrates the company's ability to self-impose financial discipline and focus on operating efficiencies and strengthening its balance sheet.
Kodiak also provided updated production guidance for 2013 and 2014. The company alerted to a likely shortfall in production volumes during the current quarter due to unusually cold weather in North Dakota experienced in early December. According to the company, "the unexpected severity of the early season temperatures in North Dakota impacted the company's December 2013 production and the timing of ongoing completion operations." As a result, Kodiak now estimates its full-year 2013 production at ~29,200 Boe/d, slightly below its previous guidance of 30,000 Boe/d (slide below).
(Source: Kodiak Oil & Gas's December 2013 Investor Presentation)
The new guidance implies that the fourth quarter production volumes will likely be ~9% below the previous expectation. The shortfall is not a major concern per se as it appears that production volumes are essentially deferred due to delays in scheduled completions.
A bit more surprising is the company's 2014 production guidance that looks on the light side. Kodiak expects to average 42,000-44,000 Boe/d in sales volumes for the full year 2014. Of note, the estimate equates to 0%-10% growth over the previously estimated 2013 exit rate of 40,000-42,000 Boe/d (as shown on the graph above from the company's December presentation). On an annualized basis, the growth rate would equate to 0%-20% relative to the previously provided year-end exit rate guidance.
Given that production volumes during the fourth quarter are not lost but rather "deferred" into 2014, one would expect that the net effect would be: lower production in Q4 2013, but higher production in 2014, relative to the earlier projection.
The relatively low growth rates embedded in the guidance may have a simple explanation: the guidance may be conservative. Still, the slope of the Kodiak's production trajectory is something to be watched very closely as the company is transitioning into development mode and its operating regime is more reflective of the true drilling economics in the play.
As a pure play Bakken operator, Kodiak represents a unique "drilling economics laboratory" for investors to observe. The company has proven itself as an excellent operator and has vast and high quality acreage across the play. Given that the majority of the leases are already held by production, the company has the ability to focus on optimizing its development plan. With several density pilots underway, Kodiak is further along than many of its peers in accumulating a detailed understanding of what the optimal density pattern may ultimately look like. Kodiak has well-established completion designs that seem to have worked very well. Its corporate overheads are relatively low and spending outside of the drilling and completion operations is expected to be a small portion of the overall budget ($50 million). In this context, the company's production growth rate under its live-within-cash-flow capex in 2014 should provide an important indicator of what drilling returns in the better areas of the play might look like in full development mode.
Given the very steep initial declines in the deeper and over-pressured parts of the basin where Kodiak is drilling the vast majority of its wells, investment quickly converts into cash flow. As a result, one would expect that a company with truly high-return drilling economics will show high production growth rates, assuming spending equals to internally generated cash flow. So far, Kodiak's production growth has been spectacular. However, it has been in part driven by heavy outspending and does not represent a "clean" measure of economic profitability.
Operating Update and Guidance
In 2014, Kodiak expects to spend $890 million to the drill and complete approximately 100 net wells and $50 million for infrastructure build-out and small acreage acquisitions. The company has budgeted seven operated drilling rigs in 2014 and expects to continue to utilize one dedicated full-time, 24-hour completion crew, with access to a second 24-hour crew on an as-needed basis. Kodiak will also continue to participate in drilling activity on its non-operated acreage.
Kodiak expects to fund the 2014 CAPEX budget from existing working capital, operating cash flows, and availability under its existing revolving credit facility.
Kodiak also provided an update with regard to its three density pilots, commenting that the 12-well downspacing programs in the Polar and Smokey areas "continue to perform in line with production results from the company's earlier wells in the area."
- The 12 Polar area wells have reached a 120-day average of 618 Boe/d, which is on track with a 18-month payout.
- The 12 Smokey area wells have reached 60-days average of 627 Boe/d, with the wells drilled in the Middle Bakken averaging 738 Boe/d while the wells drilled in the Three Forks are averaging 517 Boe/d.
- Kodiak is currently completing the first of its four 4-well pads in its "super-density" unit to the east of the original Polar downspacing pilot. This 1,280-acre drilling spacing unit will ultimately contain eight wells in the Middle Bakken and eight wells in the Three Forks.
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