Investing in small cap oil and gas isn't for everyone. Understanding the oil business is difficult enough, but unconventional production is a different business. Valuation is tricky for several reasons. Acreage is the most important. Valuing leaseholds can be difficult, as multiple operators can get a wide range of results. Poor well performance can be from something as easy as drilling outside the interval, or as difficult as using optimal types and amounts of proppant. Without access to well files, it is difficult to know why results can vary. In 2014, pad development will accelerate which should give us a better idea of where the best leaseholds are. The large volume of wells coming on line will provide a better idea of how areas will produce going forward. The skill of the operator is also important. Well data is very important in deciphering this. Well results must be logged and compared to other operators in the same area. Well design also comes into play, as an operator could have done a very nice job drilling and completing, but under utilization of water and proppant can cause a poor result. Management is also important, and in some cases is the top reason an operator underperforms. A company can beat production and revenue estimates, and still have a bottom line miss. If costs are not kept in check, we can see a stock get crushed at every quarterly conference call. These three variables, if accomplished, can make a small cap oil and gas name a success.
The above paragraph is over simplified, but it does provide a basic schematic to follow. With smaller companies, these variables are less complex. Large companies have hundreds of prospects all over the world. When an operator first begins its production ramp, just a few wells can make a big difference. So the timing of these results can significantly affect quarterly earnings. It is important to trust the analysts. Depending on the number of analysts, an investor can get a good idea of where most of the experts think revenues and earnings will be. Follow operational updates closely, as it will provide info on how time frames are for current completions.
There are several names in different plays I am bullish in 2014. In late 2013, I had said the oil names had gotten pricey, so it was important to take some profits. We have gotten our pullback, providing an opportunity to get into some names at a discount. Bakken stocks I like for 2014 are:
In addition to the above companies, I am also bullish Emerald (EOX). There are several reasons to like this operator. It continues to have great luck with slickwater fracs. Emerald's well results have been top notch, competing well with the best results in the area. Its acreage also has upside. Its core area is in northwest McKenzie County, which is not as good as northeast McKenzie County or the better fields in Mountrail. Its upside has to do with intervals. Continental's (CLR) work in the area is probably the top reason to like this area. Continental chose to do its tightest well spacing in play with its Wahpeton pad.
The map above shows four of Continental's initial large pad sites. The Wahpeton pad is located in northwest McKenzie County. The Rollefstad, Hawkinson and Tangrsud pads are all located near the Nesson anticline. These three pads have 320 acre or 1320 foot interwell spacing. The Wahpeton pad was much tighter at 160 acre or 660 foot interwell spacing.
As you can see in the above diagram, the Wahpeton pad tests 8 wells per interval. Four source rocks were targeted, from the middle Bakken to the third bench of the Three Forks. Continental probably has more well data than any other operator in the Bakken. Its choice to drill the tightest spacing to date (and most expensive pad) in this area shows confidence. Continental has alluded to Wahpeton as a success and its reason to pursue this spacing using three pads. Each pad is near the Hawkinson, Rollefstad and Tangsrud pads.
Geology may be the key to this area. It is unique in one interval, which is just beginning to be proven as its own unique source rock. This is much like two other areas in North Dakota. The first was in Sanish field, where the Sanish sands were found as an independent interval. The same could be said for the Pronghorn sands, which are located in Whiting's Pronghorn and Lewis & Clark prospects. A new interval has been defined in Whiting's Hidden Bench and Missouri Breaks prospects.
This is the reason for Whiting's big acquisition, shown in the map above. Oasis also made a large acquisition here. The interval of focus is the lower Bakken silt. This geology can be seen in the diagram below.
In Hidden Bench, the lower Bakken silt sits below the lower Bakken shale. There have been problems drilling this directly, so operators are fraccing into it. It is also important to note that this area has more possible locations from the middle Bakken and upper Three Forks than any other area in the Bakken. As you can see it is even more than Sanish field. It will take some time and activity to know how productive the area is, but the additional locations may prove more resource can be pulled northwest McKenzie than southwest Mountrail. There is no doubt Mountrail County wells are better from an individual location comparison, but at this time the Hidden Bench will produce 33% more locations. This isn't a great indicator of the number of possible locations after downspacing is complete, but it shows where the numbers are today. Triangle Petroleum also operates in this area. It has had excellent results in McKenzie County using very tight stages, and better source rock stimulation. It uses all the best including ceramic proppant. It manages these high well costs with its own completions business. This higher end well design has worked well in this area. Emerald's core Low Rider prospect is in this same general as Hidden Bench. Its geology should produce much like Hidden Bench, but more importantly both are prospective the lower Bakken Silt.
Emerald had a very good 3Q13. As usual its production numbers impressed, but more importantly it beat on the bottom line. The Street estimated EPS at a 17 cent loss. Emerald reported a loss of 13 cents. Although it beat, it still has a ways to go to being profitable. We are not buying earnings, but focusing on production growth as this will be what drives the stock. All of the wells drilled through Q3 are tracking at or above its model of 550 MBoe. Its first Excalibur well was above the model, while Emerald's two Hot Rod initially produced at its average. The Hot Rod wells' production was decreased due to a delay in lift installation. Emerald's EUR is quite low. My personal estimates for Emerald's wells are 600 to 700 MBoe, with the average being somewhere in the middle. Its best wells are probably higher than 700 MBoe, but again these are my estimates. I prefer the conservative approach to EURs. Decreasing estimates after the fact can create appreciable headwinds. Its second Excalibur well in production targeted the Three Forks. The result was quite good, and Emerald has planned more Three Forks wells in 2014. Some of its recently added acreage is prospective the Red River and is currently producing vertically. Emerald believes this may be an opportunity for horizontal development. It will continue to permit 7 well spacing, but believes it will downspace tighter in 2014. Four middle Bakken and three upper Three Forks is how Emerald plans to develop. This does not include any wells in the second through fourth benches of the Three Forks, the Bakken silt or Red River. To be clear, I don't know if the fourth bench is present here (probably not) or if the third bench is consistent through Low Rider. Also, the lower Bakken silt, as far as I know, is fracced into and not drilled directly. So I am unsure if this will translate into additional locations. It is present in both the northern and southern Low Rider. The Red River is somewhat of a wildcard, and this is why we haven't seen horizontal development. Some believe it can't function as a horizontal play, but we will not know this until development starts.
In January, Emerald announced the acquisition of 20,800 net acreages in North Dakota and Montana for $74.6 million in cash. 19,500 net acres were located in its Low Rider prospect. It had 350 Boe/d of production. This brought Emerald's total acreage to 85,000 net acres at closing. Since September, it has added 34,000 net operated acres. This also added three new operated areas to Emerald's portfolio. The first is in Richland County on the North Dakota border just south of the river. Richland County has reported significantly better well results from Whiting recently. By changing to its sand heavy frac design, it has increased initial production rates. The Easy Rider prospect is located in northeast Williams County. This is near the Nesson Anticline and been a very active area for Continental. Middle Bakken thickness has been excellent, although well pressures are a little lower. Lastly, it now has acreage in Billings and Stark counties. This is prospective the Pronghorn sands. All other operated areas currently support four middle Bakken and three upper Three Forks wells by Emerald estimates. The Billings and Stark counties leasehold will support three to four Pronghorn sands wells. Whiting is doing up to seven Pronghorn wells per section, so I would guess these will be estimated upward. In September, Emerald sold almost all of its non-op acreage. This moved approximately 27,000 net acres for $111 million in cash.
In Q3, it produced 1877 Boe/d. At the end of Q3, Emerald estimated it would produce 2300 Boe/d in Q4. At this time it estimated 2014 full year production of 3300 Boe/d. This production broke down quarterly in the table below.
Quarterly Production Estimates for 2014
|Quarter||Avg. Production Boe/d|
These estimates from the end of Q3 show a nice production ramp after selling its non-op acreage. This was a 106% production rate increase year over year and 67% exit rate increase for the same time frame. These numbers will increase if Emerald decides to bring on a fourth rig at year end. At the end of Q3, the 2014 capital budget was $182 million to drill 18 net operated wells. This compares to $127 million for 12 net wells in 2013. The 2013 numbers were set at a $10 million/well cost. I would guess Emerald will bring well costs down further this year, which could support additional wells at the same cap ex budget. Emerald stated its last few wells have trended below the $10 million mark. Management believes well costs in the low $9 million range is possible. Its first Three Forks well had costs in line with its middle Bakken. This is positive as the Three Forks is a little deeper than the middle Bakken. In 2014, $122 million will be spent in the Low Rider prospect. The remaining $60 million will fund the third rig, which will rotate to its other operated leaseholds. The 2014 land budget was estimated at $25 million.
Looking at well design, we have seen what Whiting and EOG Resources (EOG) have accomplished using multiple perf clusters per stage and cemented liners. To date, I am unaware of any operator using this design in a slickwater frac. Emerald and Liberty (bought by Kodiak) have both been very successful doing this, but we have had little info with regard to cemented liners. Emerald's slickwater fracs are using multiple perfs per stage. I do not have specifics on whether Liberty was using cemented liners or sliding sleeves in McKenzie County, but it would seem Emerald is able to get very good source rock stimulation without using cemented liners. Well design in the new operated areas will be much the same as the slick water fracs in Low Rider. In Billings and Stark counties, Emerald plans to change its completion style closer to what operators are doing there currently.
As of January, Emerald has two rigs drilling the Low Rider and still plans to add the third rig in April. Since Q3 earnings, it has drilled and completed 3.9 wells. It has 6.9 wells drilling, completing or awaiting completion in the beginning of 1Q14. In Q4 it averaged operated production of 2430 Boe/d. This was an increase of 103% year over year and 30% quarter over quarter. Emerald exited 2013 producing 2630 Boe/d.
It continues to impress with top notch well results. This is not the standard for early operators, but Emerald took good notes. I would guess it followed the earlier Liberty well results, and used this as a basis for development. Here are Emerald's results to date.
Emerald Operated IP Rates Boe/d
|Well||IP 30||IP 60||IP 90||Stages|
|Hot Rod 1-27-26H||661||562||650||34|
|Hot Rod 4-27-26H||530||490||34|
These are very good results, and look better when compared to other results near Low Rider.
Other Well Results In Low Rider
|Larsen 32-29 1H||Zavanna||678||35|
|Koufax 3-10 1H||Zavanna||662||35|
|Witt 34-27 1H||Zavanna||483||35|
|Martinez 36-25 1TFH*||Zavanna||557|
|Bunning 36-26 1H||Zavanna||745||35|
Emerald's middle Bakken results continue to outpace other operators in the Low Rider area. This is telling, as there are some very good companies for comparison. Both Triangle and Liberty have had good success in both northwest McKenzie and southwest Williams counties. The one Three Forks well drilled by Emerald produced in line with the wells by Zavanna and TRUE, but did so with significantly fewer stages. This isn't a large enough inventory to provide a quality comparison, but does shine some light on the economics of the area.
In summary, 2014 should be a good year for Emerald. The recent pull back has provided a unique buying opportunity. Analysts have been bullish as Global Hunter Securities upgraded Emerald Oil from Accumulate to Buy with a price target of $12.00 which is up from $10.00. Credit Suisse analyst Mark Lear initiated coverage with a $10.00 price target back in January. Emerald has just started its operated horizontal production ramp, and we already know it is a good operator. There is additional upside to its core acreage. Currently this area is being downspaced tighter than any other with respect to the middle Bakken and upper Three Forks. Emerald plans to drill four middle Bakken and three upper Three Forks per section. Using Whiting's current plans, it could more than double the number of locations per section. The main issue going forward is the bottom line. These smaller operators more times than not have difficulty managing this type of growth. This is especially true in the Bakken, where intervals are very deep and the weather is harsh. If management comes through and oil prices remain at these levels, Emerald will double over the next 12 months.
Additional disclosure: This is not a buy recommendation. The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, are not guaranteed for accuracy or completeness, do not reflect actual investment results, do not take into consideration commissions, margin interest and other costs, and are not guarantees of future results. All investments involve risk, losses may exceed the principal invested, and the past performance of a security, industry, sector, market or financial product does not guarantee future results or returns. For more articles like this check out our website at shaleexperts.com. Fracwater Solutions L.L.C. engages in industrial water solutions for oil and gas companies in North Dakota. This includes constructing water depots, pipelines and disposal wells. It also provides contracting services for all types of construction at well sites. Other services include soil remediation. Please contact me via email if you are interested in working with us. For more of my articles and other pertinent information on the oil and gas sector, go to shaleexperts.com.