Bakken Update: Poor Execution Is A Cause For Concern

by: Michael Filloon

The recent run up in the price of oil has been kind to the Bakken players. This has not just been the Bakken as the majority of oil producers have done well. Going into yesterday's earnings, there was some excitement as announcements of several small cap companies were due.

Kodiak (KOG) released bearish production numbers earlier this month. In "Bakken Update: Kodiak Production In The Face Of Adversity," I gave an overview of this production and an idea of why its numbers were so poor. Sliding sleeves were blamed for poor producing wells, but this seems to be only part of the problem. Kodiak made two large acquisitions in the vicinity of it Koala Prospect. This created its Polar Prospect (42000 net acres) and Wildrose Prospect (24000 net acres). Kodiak purchased a very good acreage, at a cost I believe to be below market value. The production of the wells drilled and completed by the previous operators were not as good as Kodiak's recent wells, and I would suspect depletion numbers were probably greater. Kodiak now has 137 gross or 60.2 net wells and over 157000 net leasehold acres. It now has six drilling rigs and six workover rigs. This growth has come at a price, as things have gotten much bigger and more complicated.

The earlier production numbers led us to believe Kodiak would miss earnings, as EPS estimates dropped from 12 cents/share to 9 cents/share since the announcement. Earnings came in much lower at a loss of 15 cents/share. The street's estimates had Kodiak's revenue at $59.86 million. Kodiak reported revenues of $55 million. Of Kodiak's loss, 8 cents/share was from unrealized derivative losses. Interest expense was also much larger, mostly due to the acquisitions. It totaled $18.9 million compared to $39 thousand in the same quarter in 2010. $11.5 million was related to costs associated with a stand by bridge loan that was not used but had to be expensed in the fourth quarter. Kodiak also had other deferred financing costs that when added to the $11.5 million totaled a loss of 7 cents/share. In summary, this miss was not as bad as it looks but it is worrisome.

Northern Oil and Gas (NOG) reported fourth quarter earnings of 21 cents/share on revenues of $53.24 million. The street estimated earnings of 25 cents/share on revenues of $55.06 million. Although Northern came in light, it has still shown impressive growth. In comparing its fourth quarter of 2010 to the same quarter in 2011 there were some improvements. Oil production increased 82%. The average sales price of crude oil increased by 21%. An increase in production costs of 83% was seen, but many other costs decreased. General and administrative costs reduced 5%, and DD&A decreased 8%.

The greatest impact on Northern's quarter was derivatives. It lost $2.7 million on settled derivatives and another $23.6 million on mark to market of derivative instruments. Derivative losses totaled half of Northern's fourth quarter revenue. It may have missed earnings but the effect of derivative losses pushed this stock back significantly, and could be a buying opportunity.

Magnum Hunter (MHR) reported fourth quarter earnings. Expectations were high as its earlier production update was much better than expected. Operations saw production increase in the Bakken, Eagle Ford and Marcellus. These numbers started a run in this stock, as investors believed Magnum would beat earnings. It reported revenues of $49.1 million with a loss of 5 cents/share. Estimates were for revenues of $45.99 million and a loss of 4 cents/share. Magnum missed on the bottom line but beat on the top line. The stock was down 7% on the news. This pullback was a bit extreme but considering the stock is up $1.50/share since January 26, it may be taking a short breather. Magnum's fourth quarter net loss widened to 46 cents/share.

This company has made some significant asset purchases in a short period of time. Because of this, as with any quick expansion, Magnum is having some growing pains. Non-cash and non-recurring charges were:

  • Impairment of proved of oil and gas properties of 17 cents/share.
  • Unrealized loss of derivatives of 16 cents/share
  • Non-cash compensation expense of 5 cents/share
  • acquisition related non-cash, non-recurring expense of 3 cents/share.

I would be careful with this company as it has gas dominated production. Magnum stated it will not be developing many of its natural gas liquids dominated projects until mid-2012. This is a bit worrisome as Magnum needs to increase liquids production significantly in a very short time. In the last three months of 2011 it had an average sales price of $48.50 Boe. In summary, I believe Magnum has a bright future if it executes based on short term increases in liquids production.

GMX Resources (GMXR) has had great difficulty since July of 2008. This company was trading for as high as $84/share, and now is valued at $1.82/share. 4Q of 2011 estimates had GMXR losing 7 cents/share on revenues of $27.75 million. It lost 12 cents/share on revenues of $26.1 million. GMXR's net loss to shareholders for the quarter was $1.39/share.

GMX Resources is a natural gas company that is trying to grow liquids production. Its recent purchase of 75000 Bakken/Niobrara acres is hoped to accomplish this. It is also trying to sell equipment and natural gas acreage for the purpose of subsidizing its new drilling program. The properties for sale were a $78 million impairment in the 4Q.

GMXR had several Bakken well results in the 4Q. Its two good well results were in McKenzie and Stark counties operated by Whiting (NYSE:WLL) and Slawson. These IP rates were 2694 Boe/d and GMXR has results on three of its wells 1436 Boe/d respectively. Its operated wells were not as good with IP rates of 450, 240 and 637 Boe/d. All three of these operated wells have workover rigs planned for this month. This is another small cap oil producer that is just beginning to get comfortable in a new leasehold. As I have said before, GMXR has been late to the party and probably spent too much on these acres. The average sales price for natural gas in the 4Q was $2.92/Mcf. When oil, natural gas and natural gas liquids are totaled, GMXR received a sales price of $5.12/Mcf. Costs were kept in check, as these were much lower year over year. In summary, I would be very careful with this name. It is significantly levered to natural gas, and if it does not execute we could see heavy losses throughout 2013 and 2014. Because this stock has consistently disappointed, I would stay away from this name as a long term investment.

Looking at these Bakken oil producers each has a different story with respect to its business. Kodiak is a Bakken pure-play operator that has just made a big move to become a major player in North Dakota. Northern is a pure-play non-operator that spreads out risk among several oil producers. Magnum Hunter is a play on the Bakken in both northwest North Dakota and Canada, but also has big interests in the Eagle Ford and Marcellus. GMX Resources is a late comer to oil production and is trying to save its business by moving to liquids in both the Bakken and Niobrara. All four of these companies did not execute in the 4Q (although one could argue that Magnum had a great quarter). One time items such as derivatives have weighed on 4Q results, but much of this is unrealized mark to market. All said these numbers will matter little as the price of oil continues to go higher in the short to intermediate term. It is still a good time to be invested in Bakken oil production.

Disclosure: I am long KOG, NOG. This article is not a buy recommendation