Continental Resources Inc (CLR) has been an independent oil and gas exploration company since 1967, though the company only went public in May of 2007. It has reserves totaling 134.6 MMBoe, 77% of which are filled with oil (the rest with natural gas). 82% are located in the Rocky Mountains. Continental's reserves are concentrated in regions that have seen little attention from larger, publicly-traded companies because of the high cost of developing them. For this reason, the company has had years of developing unconventional reserves without competition. With high volatility, I believe the stock could see a large income stream as it strategically stores barrels of crude waiting for future price increases.
Aggressive Growth but how to Move the Crude?
Continental Resources expects massive second quarter growth because of its drilling campaign in the Bakken formation of North Dakota. The company has passed 100,000 barrels per day of oil (and equivalent natural gas) production for the very first time. That's up 11% from the first quarter and 76% from a year ago. It has finished the equivalency of drilling 43 wells for the quarter. This aggressive growth has helped the company increase its reserves to 610 million barrels in the last year which is a 50% increase.
How will they fair with this increase? While many energy companies like Continental struggle with the low natural gas prices, it has almost 70% of its output in oil at present. The company has a vision and is well on track to get there. Back in 2009, CEO Harold Hamm predicted that drilling in the Bakken region would enable the company to triple its production and reserves by 2014. He is way ahead of schedule but frustrations have hampered enthusiasm with a lack of pipeline capacity to bring the crude to market.
Should Shareholders be Disappointed?
Despite impressive growth, Continental investors have been disappointed in recent months because earnings have just not been up to par. Is this short sighted thinking? First quarter took a huge miss with net income coming in at 76 cents -- far short of the 85 cents estimates. Since then, shares are down 30%. The company's capital expenditures are running higher than anticipated with a projection for the year of 30% over what was originally estimated. Is this all bad? It could provide good fortunes for the company since its crude reserves have increased so much. If the price of oil goes up, the profits for the company will be rolling right behind. It is definitely way ahead of its production growth estimates. If it can reduce drilling and completion costs, it will be doing well.
This is a very volatile industry and Continental could be positioned very well for growth.
Other Movers from Bakken Shale
In the industry, crude oil must be moved from the wells to refineries to consumers. The market has created a number of different methods for this. Over water, barges and tankers are used and over land, pipelines, trucks and trains have been utilized. As an example, Tesoro Corporation (TSO) has decided to build a "pipeline on rails" to transport crude oil produced from its Bakken Shale acreage in North Dakota to its refinery in Anacortes, Washington. Eventually the project is slated to transport 30,000 bpd. On the water, there is Kirby, a barge operations firm. It transports crude oil from the Bakken Shale down the Mississippi River to 19 refineries in Louisiana. Pipelines by far are the most efficient method to transport crude oil and refined products. Pipelines are used to move crude oil from the wellhead to gathering and processing facilities and from there to refineries and tanker loading facilities.
Bakken Pipeline and Continental
ONEOK Partners is constructing the Bakken Pipeline which will be about 525 miles long pumping natural gas liquids from the prolific Bakken Shale play in North Dakota and Montana to the company's 50-percent owned Overland Pass Pipeline. The Bakken Pipeline will transport raw NGL's from ONEOK Partners' and third-party natural gas processing plants in a three-county area of western North Dakota to the Overland Pass Pipeline. Will this pipeline help Continental? While I am unfamiliar with the set up and contract, logic would tell me that the NGL portion of Continental's business could benefit but the crude side may not.
Analysts at Canaccord upgraded Continental Resources from "hold" to "buy" recently with a target price of $89.00 (from $83.00). Analysts have an average consensus price target of $89.31 which gives the company an upside of 25.1% from current price levels of $67.04. Why are they so bullish on a company that just last quarter investors were skittish with?
The Options Play
Looking at a weekly chart, this present down turn looks very similar to how the stock moves long term overall. This highly volatile stock is prone to long moves. Since I am expecting a turn around before the end of the year and a move back up, I am going to buy way out to December on an income play since the spread between costs are no different than the options in September.
- Buy a December 2012 call with a strike of '70' (priced at $6.80)
- Sell a December 2012 call with a strike of '75' (priced at $4.60)
- Net Debit to Start: $2.20
- Maximum Profit: $2.80
- Maximum Risk: net debit
- Maximum Length of Play: 5 months