These Beaten Down Bakken Bargains Are Great Buys

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 |  Includes: DNR, HES, QEP
by: David White

The market has fallen recently due to the EU credit crisis, the worrisome PMI data from China, and the failure of the U.S. Congress’ Super Committee to agree on the required budget cuts.

In the backdrop of that the U.S. has actually put out some positive economic data. For instance, the recent Initial claims numbers have been under 400,000 (Yahoo Finance). New home sales numbers were up slightly. Consumer confidence was up to 56.0 vs. a previous 40.9. Pending Home Sales surged 10.4% in October. ADP reported 206,000 private sector jobs were gained in November. The Durable Goods Orders ex Transportation were up 0.7% last week.China cut reserve requirements for commercial lenders. Many of the world’s major central banks acted in conjunction to increase liquidity worldwide. Overall there is no denying the tone has been good. On top of all this money managers want a rally to improve their performance for 1011.

With the U.S. markets mostly down on the year (IWN was $73.39 at the start and was at $61.52 at the Nov. 28, 2011 close), money managers want an end-of-year rally badly. With HFT trading constituting roughly 70% of the trading (and the major brokerages controlling a lot of that), they may be able to engineer a Christmas rally if the EU cooperates at all. To help them along, Q3 earnings have been generally good. The Bespoke Investment Group numbers from mid November indicate that 61.9% of the 2,197 U.S. companies that had released their earnings beat consensus analysts’ estimates. This should be enough to lift the U.S. markets if there are few external negative world economic and geopolitical events to push the market down. The hope for a new EU pact that will allow the issuance of euro bonds and/or the strong ECB buying of sovereign bonds may be enough to allow the market to rise for the next few weeks - a Christmas rally.

During the recent downturn a number of great Bakken oil stocks have been beaten down. These stocks are poised to rebound sharply upward in a Christmas rally. They are likely good long term investments at their current prices in any case. A long term investor should be able to buy them with low risk. A shorter term investor will have to deal with the risk of the EU credit crisis effects short term. A few of the Bakken developers’ stocks that are furthest from their one year analysts’ target prices are: Denbury Resources Inc. (NYSE:DNR), QEP Resources Inc. (NYSE:QEP) and Hess Corp. (NYSE:HES).

DNR is a leader in more than one field of oil recovery. On one hand it buys old oil fields, then it recovers more oil from them by using secondary (water floods) - if not already done - and tertiary (CO2 EOR) recovery techniques. The chart below of the Little Creek Field data gives an example of just how significant the secondary and tertiary recovery processes can be. Notably DNR has substantial CO2 resources with which to cheaply feed its tertiary recovery operations.

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As you can see above, the secondary and tertiary recovery processes can yield almost as much oil recovery as the primary recovery process. DNR estimates they have from 1.3B up to 10B barrels of recoverable oil with EOR in its two major development areas of the Rockies and the Gulf coast. DNR feels it has an advantage in knowing the approximate amounts recovered using primary methods in newly purchased fields for EOR. DNR estimates that it can grow EOR oil production from its 2010 level of 29,062 bopd at an average 13-15% CAGR to more than 100,000 bopd in 2020. On top of this the break even well head price for EOR plays is significantly lower than virtually all other plays. The chart below gives examples of the various well head prices.

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DNR feels the fiscal numbers show the EOR fields are going to be hugely profitable. DNR is trying to point out to the market this less flashy business sector is very flashy from a profit standpoint. Tertiary oil production now accounts for roughly half of DNR’s daily oil production.

Another DNR major growth area is the Bakken. DNR has approximately 200,000 net acres with approximately 300 million BOE of total potential. The Q3 2011 production was 9,976 BOE/d. The 2012E production is expected to be 12,7250-14,750 BOE/d. DNR seems to be getting the designs for its wells more “dialed in." The Q2 2011 average IP was 1,496 gross BOE/d. The Q3 2011 average IP was 2,197 gross BOE/d. The Q2 production rate was 7,626 net BOE/d. The Q3 production rate was 9,976 net BOE/d. This was a 31% sequential increase from quarter to quarter. With the new find by Continental Resources (NYSE:CLR) of multiple recoverable benches in the Three Forks formation, many of DNR’s estimates may need to be raised considerably. They haven’t put out this information yet, but a raise is almost certain.

QEP is one of the growing number of former natural gas oriented companies that are moving more into NGLs and oil E&P. It has 3.0Tcfe of proved reserves with a 15% four-year production CAGR. It has gathering and NGL extraction services (and infrastructure) for 1.37 Bcfpd of processing, and it has 2,239 miles of gathering pipelines. It markets natural gas, oil and NGL’s; and it owns gas storage. It has some of the lowest E&P costs for natural gas in the industry at $1.58/Mcfe vs. an industry average of $2.94/MCFE. It had Q3 2011 production of 768 Mmcfepd. QEP has a good record of growing production and reserves. The charts below illustrate recent performance.

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QEP still lists everything in Bcfe, but it is growing its production and revenues percentages that are derived from liquids. Through Q3 2011, liquids comprised 18% of total production. Plus liquids and fee-based revenues comprised 44% of total revenues. QEP expects liquids to comprise more than 20% of production by the end of 2012. I should note that the field services sector of the company has had a 24% CAGR over the last five years. It has a YTD Q3 2011 EBITDA of $233.1 million.

QEP has a wealth of opportunities to exploit. It has 1.32 million net acres in the Rockies and 640,000 net acres in the mid-continent and Texas/Louisiana. These properties include the Bakken/Three Forks, the Powder River Basin, the Pinedale Anticline, the Uinta Basin and the Vermillion in the Rockies. They include the Marmaton, the Tonkawa, the Woodford Cana, the Granite Wash and the Haynesville farther south. Many of these are oil plays and/or liquids rich plays. The table below has some of the relevant information about the plays. They should lead to significant oil production growth. Such has been the case so far, especially in the Bakken/Three Forks.

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HES is a large cap oil stock. As such its plan is more sedate. It plans to grow reserves and production 3-5% per year, and it plans to maintain an R/P ratio of about 10. It plans to reduce risk through geographical diversity. In fact it has achieved a large amount of geographical diversity. The table below shows just how diverse Hess production is.

Hess’ production is considerable at 371,000 boepd at the end of Q3 2011. Of this approximately 71% is oil and 29% is natural gas. Over the last five years it has achieved 5% CAGR in production and 7% CAGR in proved reserves. These are both impressive figures for a large cap oil stock, but what is more impressive is that they are likely to improve significantly in the near term. Hess has allocated 47% of its $7.2B capital and exploratory budget to unconventional oil developments (oil shale) this year. The chart below shows the approximate breakout.

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As you can see, approximately $3.4B has been allocated to development ventures in the Bakken, the Eagle Ford and the Utica. All of these are prolific oil shale fields. All should be tremendously productive for Hess. The various acreages probably give a good idea of the prospective future results. Hess has approximately 900,000 net acres in the Bakken with a 16 rig program. It has approximately 185,000 net acres in the Utica with a three rig program. It has approximately 100,000 net acres in the Eagle Ford with a three rig program. It has other unconventional oil developments worldwide, but the above are low risk, and they are the furthest along. The Bakken chart below is perhaps the best illustration of the current and expected results from these unconventional assets.

The predicted 50% CAGR per year from the Bakken is an excellent example of how prolific and lucrative this field has been and will be in the future. The general statistics for the Bakken for all companies are that 99% of drilled wells find oil, and 90% of drilled wells are commercially productive. This is much higher than the percentage for almost all conventional oil fields. It means margins will be better. The Utica and Eagle Ford are similarly prolific. All should be a huge boon to Hess in the coming years as development of these fields has just begun. Hess has many other conventional oil developments worldwide. One of the most exciting of these is a new discovery in offshore Ghana (the Tano Cape Three Points) which has 490 feet of net pay in Cretaceous aged clastic reservoirs. Hess plans to drill a minimum of three wells here in 2012. Hess also has a huge new natural gas discovery in offshore Indonesia (an area in which natural gas prices are more than double those in the U.S.). The gross resource of that field is estimated at 5 to 15 TCF. The list is much more extensive, but those are some of the highlights.

Hess also has a marketing and refining arm. The growth from that is much more sedate. However, Hess has been growing that consistently. Hess’ five year retail results are in the chart below.

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In sum Hess should grow a lot faster than it has been and with higher margins in the near future due to the prolific U.S. unconventional oil fields it has just recently begun developing. This is likely a sleeper stock that should give investors great returns over the next five to 10 years at least.

The table below shows some of the more important financial fundamental data for these stocks. The data are from Yahoo Finance.

Stock

DNR

QEP

HES

Current Price

$16.70

$32.00

$59.49

1 yr. Analysts’ Price Target

$24.90

$48.65

$84.73

Forecast 1 yr. % Price Gain

48%

52%

42%

PE

12.69

17.10

10.61

FPE

13.25

14.68

8.75

5 yr. EPS Growth per annum

24.30%

24.33%

11.89%

Mean Analysts’ Opinion

1.8

1.8

1.9

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All of these should provide substantial gains in the next year and in the near-term years to come. Each is solidly set up to do so. The market could crash due to the EU credit crisis or some other event, but these stocks should bounce back quickly if they follow a bad market down temporarily. The fundamentals of each of the companies is strong. If you invest with a 2-plus years time horizon, you should be handsomely rewarded. With emerging markets growth we are in the midst of a secular energy growth market. Solid growers in that market are almost certain to do well longer term. The above all fit that description.

In the short term, these stocks are in the process of bouncing off a near term low. If we get a Christmas rally (as we have been this week), they should all move substantially higher in the near term. If not, they may simply follow the market where ever it goes in the near term.

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