Northern Oil and Gas: Benefiting From Bakken Non-Operator Model

| About: Northern Oil (NOG)

Its easy to love the Bakken. Barrels and barrels of oil with none of that lower margin natural gas getting in the way. As you may have guessed, it is big news in North Dakota, the fourth biggest state with respect to oil production, with a one billion dollar state tax surplus (and that is after the oil drilling tax break).

Oil production is increasing fast, only held up by overworked frack crews and little capacity to get the oil out of the state. Right now they are using trains and trucks. The good thing is that costs will decrease for these companies when we have suitable pipelines.

Leaders in this region are companies like Continental Resources (NYSE:CLR), with almost 900,000 acres and 21 rigs, and Hess (NYSE:HES) with a little over 600,000 acres and 15 rigs. Scanning the list produces plenty of names and a lot of potential. Those who follow the Bakken Formation know the names, but one company seems a little different.

When looking over the Credit Suisse (NYSE:CS) article "The State of the Bakken" from August 30, 2010, Northern Oil and Gas (NYSEMKT:NOG) sticks out like a sore thumb. Currently it has a market cap of 1.41 billion and a P/E ratio of 135, with a forward P/E of 28. NOG has 122,000 net Bakken acres, but the Credit Suisse report shows no operating rigs. Further study shows that it only has eight employees. This compares to Oasis' (NYSE:OAS) 55 employees and Brigham's (BEXP) 71.

NOG performs under a non-operator model. My initial reaction to this was one of apprehension, but as I looked deeper into its model I could see why its margins were better than its competitors'. By being a non-operator, it takes a minority position. The operator has control of the well but must absorb more of the costs. NOG only has to pay for its percentage of drilling costs, development and operating cost of the wells. The operator is responsible for its percentage of those costs, plus research and development, seismic, legal, and engineering departments, and will need a larger staff to complete all of those tasks.

This model has allowed NOG to increase margins by decreasing costs. Another important factor to its success is its leaseholds. Much of the acres NOG owns are in good locations such as Mountrail County. It has also picked good companies to partner with, including HES, CLR and EOG Resources (NYSE:EOG). It is participating in over 300 wells in the Bakken/Three Forks areas, with 91 gross wells currently drilling or completing. The success rate is 100%.

NOG is now in the process of expanding its exposure to a total of 760 net wells. It acquired an additional 38,800 acres in 2010 at an average price of $1,086 per acre. Currently the company has zero debt. Rig counts in the Bakken are expanding rapidly, with 164 rigs. Drilling is starting to go better as super-fracks are widely used. 80% of current NOG acreage is producing. In 2010, production increased 45%. This production is 96% oil.

Although I am not excited about hedging, it has 30% of this year's production hedged at $81 per barrel. This year it has planned to have 36 new wells spud. Its 2011 estimate is 6,500 BOE per day with respect to production, at an average well cost of $6.3 million. It also plans to continue purchasing acreage throughout 2011.

NOG seems they have benefited from being a non-operator. Its margins have been consistently better than most of its peers operating in the same area. This, coupled with its large growth in a short period of time, makes it a good investment long-term.

Disclosure: I am long NOG, BEXP.