A Crude Season: Springtime Oil Play

Includes: KOG, MRO
by: Michael Kudrna

As spring continues and summer approaches, we tend to have new seasonal plays that begin to take effect. When we are finally able to leave our houses after a cold winter (very cold for me as I am in the Windy City), we tend to travel a bit more. With the increase in driving, gas prices tend to increase and peak around Memorial Day. This creates a higher demand for oil therefore the cost of crude tends to increase as well. However, this typically assumes the economy is at least growing. If the economy does not grow but unemployment numbers do, the demand probably will not be there. I will bet that we have six months of modest growth which, when combined with the higher crude prices from 2009, we could see many oil companies posting great earnings compared to last year. The time is upon us for a seasonal oil play and I believe I found one of the better small cap companies to benefit from these increased oil prices.

Kodiak Oil & Gas Corp (NYSE:KOG) is an independent energy company engaged in the exploration, exploitation, development, acquisition and production of natural gas and crude oil entirely in the western United States with revenues predominately from oil rather than natural gas. This makes KOG as close to an oil play as you can get which, ultimately, is what I am looking for. I have my refinery play in Marathon Oil (NYSE:MRO) already established with recent good news at the energy conference last week and expectations of around $40 PPS or more. KOG will be a new play I am going to build over the coming months.

September is when we anticipate 2nd quarter earnings to be released and if crude oil stays well above $80 per barrel, we could see enormous growth year over year and that should be reflected in a higher PPS. Oil demand may start to lower as fall and winter months approach hence my strategy to reduce my risk. More importantly, I question our economic growth later this year so if I keep that concern throughout summer, it will weigh heavily into my decision of selling or adding more KOG as time passes. If we do not feel more economic pain, 2011 looks to be a solid year as well for KOG. With that being said, let us dig into the details of KOG.

KOG reported 2009 revenues of $11,337,709 which is up from $6,964,790 in 2008. For 2009 revenues, $10,651,698 is from oil. KOG shifted focus to primarily oil based drilling and with crude prices expected to be over $80 a barrel for the year, we should see those revenues dramatically increase. To show you the difference from year to year, the average price per barrel that KOG was able to receive in 2009 was $58.35. EIA expects WTI prices to average above $80 per barrel this spring, rising to an average of about $82 per barrel by the end of the year and to $85 per barrel by the end of 2011. Some have actually predicted $90 which wouldn't be enjoyable at the gas station but we would more than make up for it in profits from KOG's PPS increase. That is obviously a drastic difference in 2010 which will show significant growth when earnings are released as the quarters progress.

2009 was a year of strong operations yet some growing pains in drilling. As expected in this industry, there were times when operations were met with some delay. This is a normal growing pain and with the experience gained, KOG will improve efficiency in the future. KOG recently added a Senior Operations Engineer which shows their commitment to improved efficiency thus resulting in increased production and improved cost controls for 2010 and beyond. This helps me believe KOG will meet the high growth expectations.

It is very important to note that KOG has no long-term debt at the moment. This significantly reduces any risk of not surviving in a struggling economy. KOG also expects 750% growth this year with a .57 five year PEG ratio while the average competitor has a PEG of 2. Analysts currently expect $.13 EPS for 2010 which I feel could be modest if we have a blowout 2nd quarter.

However, with any stock, we have some risk factors. Currently, KOG is attempting to establish a reserve-based revolving line of credit. It was said that it is not expected to be a concern on the conference call but if they do not obtain it, they might have to further dilute the stock to pay any unexpected bills that come up. I expect this concern to keep some pressure on the stock in the meantime. Management expects to have the line of credit locked up in 2nd quarter so look closely for any changes in that as problems obtaining this could put additional pressure on the stock.

The economic recovery will be a significant portion of how successful this seasonal play is with KOG. As we inch towards summer, demand for oil tends to increase therefore prices will as well. As prices increase, KOG can sell oil for more profit therefore meeting or exceeding current analyst estimates. With estimates expected to be over $80 a barrel for the year, I believe that unless we take a significant turn for the worse and job losses grow substantially, oil demand will be sufficient to net KOG the revenues it needs.

I will be building my position in KOG over the coming month. Under $3, I consider KOG a favorable risk/reward play. Upon building my core position, I will utilize my strategy of trading around it to lock in realized profits. If we see volatility in the PPS, which I fully expect due to frequent changes in oil prices, it will make it easier to lock in gains and buy back on dips. KOG should be able to report very strong 2nd quarter earnings in September/October due to the strong season so I’ll look to reduce my risk at that time. The economy is not overly strong and I have my concerns for later this year and next year but am bullish on the seasonal play in the meantime. Do your own homework to see if you agree with me and can tolerate the risk. Good luck out there.

Research made possible utilizing InfoNgen research tool

Disclosure: Author holds long position in MRO and KOG but positions can change at any time

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