Bakken Update: What To Buy In 2012 Part III

by: Michael Filloon

Click here for Part I; Click here for Part II

In the first two parts of this series I covered a few of my favorite Bakken oil producers for 2012. Triangle Petroleum (NYSEMKT:TPLM) is my top pick followed by Oasis (NYSE:OAS) and GeoResources (NASDAQ:GEOI). The next two have little to do with production, but receive a portion of revenues from the Williston Basin. Flotek (NYSE:FTK) has started out the new year well. In my opinion, this is the best name in the fraccing fluids space. Frac fluids have been developed over the years by oil service companies that have performed and improved fracing. Market share of the frac fluid space is dominated by these big oil service companies:

  1. Schumberger (NYSE:SLB):35.6%
  2. Halliburton (NYSE:HAL):23.6%
  3. Baker Hughes (NYSE:BHI):11%
  4. Newpark (NYSE:NR):7.5%

Oil service companies are at an advantage as it markets its fluids when providing completion services. These companies continue to benefit from being a one stop shop. Outside of the top three players, there is a market share of 29.8%, in a $10 billion market. Given the growth of unconventional wells in the United States and abroad, this market should continue to grow. Flotek is also experiencing growth in its artificial lift and drilling technologies. Third quarter earnings were good, as it earned 35 cents/share versus the Street's estimate of 8 cents. The third quarter results caused analysts to almost double their full year earnings estimates. Year over Year revenue growth by segment was:

  1. Chemicals: 139.7%
  2. Drilling: 56.9%
  3. Artificial Lift: Flat

Year over year income growth by segment was:

  1. Chemicals: 131.6%
  2. Drilling: 138.7%
  3. Artificial Lift: 33.3%

Much of this growth has come from effective marketing, as Flotek has proven technologies that are seeing demand growth overseas. Focus should be on fluids, as this is why I think Flotek could be a "home run". The largest growth is coming from the Bakken and Niobrara plays. Its complex nanofluid micro-emulsifiers have been converted from a natural gas emphasis to liquids. I know nanofluids mean nothing to the average investor, but one variable makes them valuable. These fluids are green. This is important for two reasons. The first is the possibility of EPA regulations on components of fraccing fluids. I don't believe fraccing will be stopped, even for a short time as it would be too costly, but it may limit what can be put into the well. States are already moving on this, and I would guess others will follow suit. Even though most of the players in this space have green frac fluids, there would be a significant shortage, which would increase margins significantly. The second reason is public perception. Any company (including the oil producer) engaged in the use of chemicals in the fraccing process that are deemed harmful to drinking water stands to get negative press. Flotek is a great story, but more importantly it has growth. Its products are provided to a sector that is growing, while it continues to grow market share.

Basic Energy Services (NYSE:BAS) is another growth name in the Bakken. Worries of EPA regulations on fraccing has caused downward pressure on this industry. All aspects of oil service will continue to see demand. In my opinion, pressure pumping will continue to have the greatest difficulty of meeting demand. In 2003 the North American pressure pumping fleet had 2 million hhp. Earlier this year, that number had grown to 14 million hhp. Basic has 120+ pumping units with a total of 169000 hhp. In 2005, Basic had just over 40000 hp. In the third quarter of this year, Basic's completion and remedial services revenue was 45% of its total revenue. Other oil service companies are seeing these same increases in North American completion and production, as Halliburton saw a year over year increase in revenue from $1706000 to $2950000 in the third quarter of 2011.

In summary, both Flotek and Basic are positioned for growth. The increasing need for both frac fluids and pressure pumping services, should continue to push well costs higher. I believe both companies are positioned well and will outperform the majority of its competitors. If I am correct about the price of oil going higher, and Bakken crude's differential to WTI tightening, the Bakken could have a great year.

Disclosure: I am long FTK, OAS, GEOI, TPLM, BAS.

Additional disclosure: This is the third in a series of articles on oil production and service companies in the Bakken, that should outperform in 2012. This is not a buy recommendation.