Kodiak Oil and Gas: Exponential Production Growth

| About: Kodiak Oil (KOG)

Kodiak Oil and Gas (NYSE:KOG) has seen a meteoric rise over the past twelve months. Its 899 million market cap looks to be heading for a billion in the short term. So what is propelling this stock? It seems the Williston Basin has made an average company into an up and coming star. The Bakken/Three Forks area has made several CEOs look brilliant. The recent pullback looks to be an opportunity.

Kodiak currently has $140 million in cash and equivalent. Total assets are $370.7 million. In the Williston Basin, Kodiak has a lease position of 112000 gross acres. Of this position 69000 is net. There are a possible 320 locations in the Bakken/Three Forks. They have 34000 net acres east of the Nesson Anticline. Kodiak has an additional 35000 net acres west of the Nesson Anticline. The eastern Anticline position was their initial leasehold. This 69000 net acres occupies Dunn, McKenzie, Williams, Divide and Sheridan counties.

Much of Kodiak's success has been their ability to exponentially increase production. In 2008, Kodiak had a production of 300 barrels of oil per day. In 2009, that doubled to 600 barrels per day. The first quarter of 2010 Kodiak produced 1000 barrels of oil per day. The fourth quarter of 2010 they produced 2200 barrels per day when including acquired production. 2011 production is estimated to be 5500 to 6500 barrels a day, with early projected rig count being four long laterals and one short lateral. If estimated production for 2011 is in the middle of projections, at 6000 barrels per day, then production in three years will increase by 20 times 2008 production levels.

2011 capital expenditures for Kodiak is $190 million drilling and completion. 38 gross or 23.4 net total wells are budgeted. 28 gross or 18.4 net wells are operated by Kodiak. 29 gross or 16.7 net will be east of the Nesson, while 9 gross or 6.7 net will be west of the Nesson. $10 million will be invested in enhanced winter production, improving of product realizations, and to reduce LOE. The remainder has been set aside for possible acquisitions in the area. Kodiak is open to further increasing of its acreage if the price is right. Kodiak has increased its capital expenditures. 2009 cap ex was $27 million, 2010 was $75 million, and this year's estimate will be approximately $200 million.

Kodiak's position east of the Nesson Anticline in Dunn County has one operated rig. The second rig in this area is expected to be online by the end of the quarter. An un-operated rig is currently also running. This acreage is de-risked. West of the Nesson Anticline, one operated rig is running. This acreage is currently being de-risked.

The current estimate of locations for Kodiak is 316. With 1280 acre spacing, this is the estimate of total locations per county:

  • Dunn County ND-34000 net acres and 185 locations
  • McKenzie County ND-26000 net acres and 96 locations
  • Divide and Williams Counties ND-4000 net acres and 15 locations
  • Sheridan County MT-6000 net acres and 20 locations

Dunn County has the current five year lease terms with two to three years left on original leases. Long laterals here are estimated to produce 750 to 850+ MBoe. The economics here are $8 to $9 million in drilling and completion costs. Kodiak has 82% net interest at this location. There have been two recent transactions in this area. Enerplus (NYSE:ERF) made a purchase of $456 million and Williams (NYSE:WMB) spent $925 million.

The story of the Bakken seems to be new techniques in the area. Some of the competitors have started offset drilling with 160 acre spacing, and are getting decent results. Kodiak claims these changes are making decent production increases in the area. Kodiak states an increase in stages and ceramic proppant have helped. All of Its capital expenditures this year are going to be long laterals. Historically, comparing long to short laterals in the area shows a marked difference. In 2010, the first 30 days of production have 1170 Boe long laterals with short laterals producing 716 Boe. In the first 60 days long laterals 1073 Boe, and short laterals producing 603 Boe. The first 90 days have 972 Boe with long laterals, and short lateral producing 531 Boe. Kodiak has realized that investing more ($8-$9 millions) in long laterals is paying off as opposed to ($6-$6.5 million) short lateral economics.

West of Nesson seems to have variable net revenue interest. Completion and drilling costs are $8-$9 million. Estimated ultimate recovery is between 500 to 700 Mboe. In McKenzie County, Kodiak has a high working interest, with two wells drilled in the Bakken and awaiting completion of one on the Three Forks. A gas line is in place but awaiting hook-up. Smoky drilling will start sometime next quarter. In the Grizzly all wells are hooked to gas pipeline with big names (XOM, CLR, WLL) close by.

Kodiak seems to be doing all the right things. They maintaining adequate liquidity with a capital raise ($150 million), expansion of their borrowing base ($50 million), and a second lien facility ($40 million) to help provide liquidity going forward. Kodiak is hedged going forward to protect their current position. They should have enough cash to fund their entire 2011 capital expenditure program.

In summary, Kodiak seems well positioned going forward. With the recent pullback they could be a good buy. They should be able to draw enough income from current wells to cover upcoming costs. If done well, they will not have to cut shares to cover upcoming 2012 capital expenditures. Better well techniques and the rapid increase of production all bodes well for 2011 and beyond. Most important is the current draw out capacity and the investment in infrastructure to to get the oil out. This upcoming year is important; if management does a good job, investors could be rewarded handsomely.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in KOG over the next 72 hours.