With concerns about oil prices, wider differentials, and rising costs pushing down many oil and gas developers in high-growth areas like the Bakken and Niobrara, Oasis Petroleum (OAS) isn't exactly a unique situation. Relative to companies like Whiting (WLL) or Continental (CLR) I suppose you could call Oasis a "fast follower", but whatever you call it, the company has more than half a million acres in the Bakken. Oasis's acreage is company-operated to a very significant degree and a significant amount of that property is in the attractive McKenzie County in North Dakota.
Valuation is always an inexact science, and even moreso in the case of oil and gas companies. If you assume that double-digit differentials are temporary and that WTI oil prices won't drop back below $80/barrel, Oasis looks attractive on a NAV basis. Likewise, an EV/EBITDA approach would support the notion that a price in the mid-to-high $50's is reasonable today.
Big In The Bakken
There is no shortage of publicly-traded plays on the Bakken Formation in the Williston Basin. Larger independents like Whiting and Continental have been operating there for some time now, as have even larger players like Hess (HES) and Exxon Mobil (XOM). The appeal is straightforward - although the well costs in the Bakken are high ($8 million to $10 million and up), horizontal wells can offer recoveries in the neighborhood of 350K to over 600K barrels of oil (barrels of oil equivalent, or BOE) and attractive economic returns.
Oasis is still in a relatively young phase of its development in the Bakken, with proved reserves having grown from almost 80 million BOE at the end of 2010 to 228 million at the end of 2013. More important for investors today is the 515,000 net acres that the company controls, with over 80% held by production across North Dakota and Montana, including a substantial acreage position in McKenzie county. Although one of the bear arguments against Oasis thus far has been that a sizable percentage (more than one-third) of the company's acreage is "fringe Bakken" and unlikely to generate
the same appealing recoveries and returns, that seems a little harsh based on results seen to date.
Drilling activity is always subject to prevailing market conditions, but WTI prices of $80 and higher would suggest over 2,800 drilling locations across Oasis's acreage. With a relatively recent acreage acquisition that increased acreage by 49% for $1.5 billion, the company is looking at a self-reported drilling inventory of 17 years.
Driving Down Costs
On the subject of drilling, Oasis has done a good job of drilling and completing wells more economically. In the middle of 2012, it was costing the company around $10.5 million to drill a well, but that has fallen to $8 million as of the third quarter and management has talked about sub-$7 million well costs down the line.
There isn't anything particularly magical about the drilling program Oasis is using. Like Whiting, Continental, and many other Bakken operators, pad drilling has saved the company millions in drilling costs. Oasis also tries to learn from other companies' experience and be pragmatic about frac stages and the use of ceramic proppants or sand (spending more where the returns justify it, but not where they do not). Not so much like everybody else, Oasis has also made use of its own services operation (Oasis Well Services) to trim another half-million or so off of well costs.
Differentials, Poor Results, And Cost Control Are Just Some Of The Risks
Oasis has established itself as a credible Bakken operator, but that does not mean that management has de-risked the situation. Multiple issues can still impair the value of the shares and sour sentiment.
Differentials are a hot topic with Bakken and Niobrara operators, as weather, transportation, and refinery capacity issues have sent the differentials between Bakken crude and WTI back into the double digits. Comments from operators in the area suggest that 10% differentials are probably a good guesstimate for first quarter differentials, though increased rail capacity should keep them from going above $15/bbl for any sustained length of time. By the same token, though, any regulatory changes that restrict or reduce rail or pipeline access in the Bakken will hit those differentials.
Oasis still has to execute on its drilling and production operations. At least part of the recent weakness in the shares stems from a disappointing bench test for the lower Three Forks benches and management lowering its estimated recoveries from these wells by about 17%. Cost and capex guidance for 2014 were also higher than expected, offering a good reminder that cost containment is going to be important for these operators.
Estimating The Value
Management has been aggressive in acquiring acreage and using the company's balance sheet to fund it. Even with a debt-laden balance sheet, though, the company looks positioned for above-average debt-adjusted growth - below companies like Bonanza Creek (BCEI) most likely, but above the likes of Whiting.
I calculate a net asset value of $59.50 for Oasis. Of that total, $35 is from proved developed resources, with the remainder from risked projects (and then adjusting for the net value of debt, working capital, etc.). I believe the company's exploration program in the West Williston and East Nesson areas are worth a total of $45, with 60% of that from the former. Three Forks development, split across both West Willison and East Nesson is, by my estimation about one-third of the value of the exploration program.
As you might imagine, these estimates are sensitive to a range of estimates, including oil prices, differentials, well costs, and estimated recoveries. I am assuming that differentials decline back to the mid-to-high single digits over time, and persistent low-to-mid teens differentials would strip about $10 to $15 out of my NAV.
The Bottom Line
Trying to corroborate a NAV calculation with an EV/EBITDA approach is a little problematic, mostly as there aren't any consistent rules about what constitutes a "fair" multiple. I can say that running regressions of forward multiples to reserve life, estimated debt-adjusted production growth, and cash flow-based returns suggests a fair price of multiple of 7.0x based on where other oil and gas companies trade today. Using that multiple results in a target of $57.
Sell-side price targets on Oasis run from $46 to $67, and I guess I fall in the middle of that range. With a large collection of high-quality acreage and a demonstrated ability to achieve drilling success and lower drilling costs, I think Oasis is an undervalued Bakken player worth considering today.