- Black Ridge is an interesting Bakken/Three Forks shale play.
- This is a 100% growth rate company selling for book value.
- Management has set up the company for a period of hyper-growth.
Black Ridge Oil and Gas (OTCQB:ANFC) is a small energy company with holdings in the Bakken/Three Forks shale play in North Dakota.
At a market capitalization of $34 million and a share price of $.70, ANFC is in the category of a "penny stock." My blanket advice to investors is to avoid penny stocks like the plague, and avoid energy penny stocks even more.
There are exceptions to all investing "absolutes," and I seriously think that Black Ridge Oil and Gas is one of them.
So, here we go with some numbers background:
The wells in the sweet spot of the Bakken/Three Forks play have EURs (Estimated Ultimate Recoverable resources) of 600,000-800,000 barrels of oil equivalent. These wells cost from $6 million-8 million to drill and complete. Shale wells have a long life (30 years), but a very steep production decline. For example, first year production rates can decline 80%. That doesn't mean that 80% of the EUR is sucked out of the ground in the first year; it means that an initial production rate of 1000bbl/day could decline to 200 bbls/day at the end of the first year.
Now we need to understand who gets the money from this activity. Crude oil prices vary by quality, but average around $100/bbl today. About 20% is paid to the holder of the mineral rights, off the top, as a royalty, and another 11% goes to various taxing authorities. A $100 barrel of oil minus transportation, royalties, and taxes might net the producer about $65/bbl.
ANFC produced an average of 525 bbls per day for $3.9 million total revenue in the first quarter. So, ANFC was apparently realizing about $83 per barrel in the first quarter. Adding back in the royalty and apparently this nice Bakken light sweet crude was grossing something over $100/bbl. Light sweet crude, as in the Bakken should sell at a small premium to WTI (West Texas Intermediate)
Now about the business model:
Black Ridge Oil and Gas is much like a smaller version of Northern Oil and Gas (NYSEMKT:NOG) in that ANFC buys up leases and rights in very small amounts. For example, ANFC has holdings in about 300 gross wells, which nets out to the equivalent of six 100% owned wells. On any particular well drilled, that includes some ANFC acreage holdings, the company can decide to participate in the cost of the well and receive a pro rata share of the output, or to decline to participate, in which case it might be smart to sell the acreage to someone who will participate.
On page three of the Black Ridge Investor Presentation, we find that the company is in six net producing wells with another 1.9 net well in various stage of development. Due to the "flush" production of these new wells, the 1.9 could very well out-produce the six existing wells.
This is an interesting model in that ANFC can pick and choose which wells to fully participate in, and therefore, is diversified to an incredible degree.
The reason that this model works at all is the fact that North Dakota already had an "oil run" in the late 1940s and early 1950s, the result of which was that the mineral rights holdings is mixed up as though run through a blender. Therefore ANFC, and NOG before them, are the aggregators of these tiny bits of mineral rights and leases that the large operators don't have the time or inclination to nail down.
The company has no earnings, but is cash flow positive. The stock is selling at book value and one-half the PV 10 value based on proved reserves of 4.5 million barrels of oil equivalent. Using operating earnings minus interest as an approximation of cash earnings and using my special little valuation formula, the share price of ANFC should be $2-$3 today, mostly based on that 110% year over year growth rate .
Okay, now that we have some numbers to lean on, let's take a look at a typical sweet spot Bakken/Three Forks oil well. Someone thumbs up $8 million to drill and complete a well (another whole story in itself). About 19% of the EUR will be produced in the first year, or about 113,000 bbls; at the $83 price of above, this generates about $9.4 million cash in the first year. Now things get a little crazy; that first well generates enough cash in the first year to drill a second well and pay the interest on the first well's borrowed money. The remaining EUR of 487,000 bbls of the first well justifies borrowing for a third well.
It would be nice to have a lifetime for this bootstrapping process to play itself out, but these shale plays develop quickly and are overwith. This means that borrowed capital is required to accelerate the participation.
In 2013 the company was capital constrained and growing slowly. Today, $125 million in borrowing base has been secured, with $39 million deployed and $86 million still available for acquisition of acreage and well development.
Black Ridge Oil and Gas's top line, cash flow, earnings and proved reserves are a function of capital spending. Capital spending has increased by nearly 300% since 2011; 2013 was $32 million. Given the delay between spending and financial results, we could expect the 50% sequential quarter growth of the first quarter to continue or even increase in the second quarter. I'm expecting a very strong quarter when the company reports earnings later this month.
Small-cap energy companies can grow geometrically given adequate developmental capital. Company management feels that they have enough committed capital in place to sustain a 100% growth rate for the next three years and then a high, but sub-100% growth rate going forward.
If the stock price follows this same trajectory, ANFC is a high multi-bagger in three years.
I'm in the stock, but I need to remind readers that Black Ridge Oil and Gas is a very small company and the stock price will be volatile in the extreme. Do your own due diligence and be sure to read, and re-read, the company's investor presentation until you are comfortable with the risk implied in a micro-cap investment.
Disclosure: The author is long ANFC. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
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