Kodiak Ready To Soar Above $10 In 2013

| About: Kodiak Oil (KOG)

By Morgan Smith

With gas prices going up almost daily, and experts and pundits both predicting no end in sight to price hikes, many are wondering if now is the time to invest in the oil and gas industry. The novice or amateur investor will think of Exxon Mobil (NYSE:XOM) or Shell Oil (NYSE:RDS.A) for investment options, but never consider the smaller independent companies.

The gas and oil that goes into your car or truck has to come from somewhere, and smart investors look to the source when deciding where to invest their money, and following the oil and natural gas coming out of the ground might just lead to a hidden jewel for a savvy investor. One potential jewel is discussed here.

Kodiak Oil & Gas (NYSE:KOG) is a Denver, Colorado-based independent oil and gas exploration company. Established in 1972, it operates in the Rocky Mountain region with holdings primarily in the Bakken Range in the Williston Basin in Montana, and North Dakota, and the Vermillion Basin of the Greater Green River Basin in Wyoming, Utah, and Colorado.

After several years of moderate performance drilling and bringing oil up and selling it, Kodiak last year made a series of acquisitions in the Williston Basin. These acquisitions put Kodiak in a strategic position to greatly increase its oil sales at a time when crude prices may be moving to a lengthy period of higher prices. Revenue, and most importantly, profits, could greatly increase over the next few years.

These acquisitions were completed in December, 2011, but the effective date was September, so the greatly increased revenue flow inflated the 2011 financial results. For the year-ended December 31, 2011, the company reported oil and gas sales of $120.0 million, compared with $31.0 million during 2010, a 287% increase over the previous year. This is due primarily to an increase in average daily production of oil from 1,259 barrels of oil equivalent (BoE) a day in 2010 to an average of 3,922 BoE per day for 2011. Much of the additional revenue went into restructuring debt, as well as equipment purchases and personnel hires.

But just owning the rights to the land where the oil may (or may not) be hidden is no guarantee of profits and success. The management of Kodiak has been in the business long enough to know that. Kodiak has purchased equipment and added personnel to drive this increase in oil production. It has increased employee count from 35 in 2010 to 74 at the end of 2011. Leasing and contracting for additional equipment and personnel to generate greater production has increased as well. All this additional activity resulted in a marked increase in oil production.

Much of this increased revenue was offset by the added expense associated with the acquisitions and the added equipment and personnel costs. Management also restructured debt and absorbed some expense in 2011 due to that. All this resulted in a net income of just $0.02 per common share. But this compares with net income losses in 2010, and 2009, of $0.02 per common share. Without the reduction in income per share caused by taking the entire $11.5 million in financing costs in the fourth quarter of 2011, together with other debt financing costs being amortized in 2011, the net income per share for 2011 would have been $0.09 per share. The company has positioned itself financially for a successful 2012 and beyond.

Looking at other companies operating in the same areas, Abraxas Petroleum (NASDAQ:AXAS) posted a gain of $0.07 a share in 2011 vs. a loss of ($0.05) a share in 2010. Abraxas operates primarily in the Williston Basin, as does Kodiak. But Abraxas is also involved in South Texas, Canada, and the Gulf Coast.

Northern Oil & Gas (NYSEMKT:NOG) is still another player in the Williston Basin. It reported 2011 income per share of $0.65, compared with $0.14 per share in 2010.

Of concern for Kodiak and other oil and gas exploration companies are the environmental and transportation issues that come with their operations. Waste water disposal and the cost of getting the oil to the refinery must be taken into account. Disposal of the water used in extracting the crude is expensive as well, and proper disposal of it must be taken into consideration.

Transportation costs and infrastructure must be considered as well. If the pipelines are filled with oil from Canada, for instance, then Kodiak and other companies can't move their oil. Trucking it is an alternative, but an expensive one. Kodiak therefore is directing considerable expenditures toward connecting to existing pipelines, and watching with interest the political machinations involving the Keystone Pipeline, as well as plans to improve pipeline capacity from Cushing, Oklahoma, to the Gulf refineries.

These companies have taken advantage of lower interest rates to finance mineral rights acquisitions and the purchase/lease of new equipment to generate more volume and reap the benefits of higher crude oil prices. If the price of crude continues to rise, these companies are positioned well to take advantage of the increases. Political instability in the Middle East will affect oil production and the continued industrialization of the Far East and Asian nations will require even more energy production, thus putting more pressure on the crude oil supply. Being in position to provide that much-needed crude oil over the next several years can drive up the value of smaller independent companies like Kodiak quickly.

I believe Kodiak management has moved to position the company to be able to be a strong provider of future oil and gas needs for the next several years.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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