Northern oil and gas (NOG) was trading for $32.69 on March fourth of last year. Since that time, the company has endured bad press, and a general misunderstanding of the way it does business. Poor Bakken differentials, higher costs, and worries of poor weather have also affected this name. I am not saying NOG was worth $32/share, but think there is value at its current stock price. On July 26th, we began to see a reversal. It is now above both the 50 and 100 day moving averages.
Wunderlich recently reiterated that Northern is a buy and increased its price target from $18 to $21. Global Hunter Securities also placed a buy rating on this stock with a price target of $27. Northern missed analyst earnings estimates by 2 cents, but the Street reacted bullishly. It posted earnings of 70 cents after derivative gains.
Northern increased its leasehold to 180000 acres, with 109000 net acres in developed, held by production, held by operations or permitted. It estimates 4000 to 6000 acres in its leasehold could expire in 2013. For clarification's sake, these acres are in areas seeing less development. This lack of development could continue for some time, as better areas will be targeted first. A very good example is approximately 15 miles north of Williston. Williston is in the deepest portion of the basin, but this area has not been pursued due to a high water content and lower pressure. This area is economic, as it is a shallow play which reduces costs. Given the economics of other areas, and worries about differentials and costs, the thickest areas of shale will be worked first. NOG understands that other better areas should take precedence.
Northern spent on average $2184/acre in the second quarter. It is important to note as a non-operator, Northern holds a significant working interest in its wells. In the second quarter, it averaged between 9% and 10% interest in those wells. Other non-operators such as Voyager (VOG) and Earthstone (ESTE) average a much lower percentage. This is what separates Northern from other investments. It completed 22.5 net wells in the first half of 2012, with a total of 44 estimated for the full year. Northern spent $25 million on acreage acquisitions in the first six months. It estimates spending another $25 million in the second half. This is $10 to $30 million less than previous 2012 estimates.
Northern's acreage is 90% oil, which is important. There has been a slow decrease in the percentage of oil estimated to be recovered in the Williston Basin. The reason is a change in production seen from certain areas. EOG Resources (EOG) explains this in its most recent presentation. Its Parshall Field acreage is 92% oil. Its Stateline (western Williams County) is 87% while northeast McKenzie County has 78% oil. This area has the highest gas production at 11%. The Three Forks also deviates in liquids production.
All things considered, Northern did well. Not only was the price of oil down, but differentials were greater. Before the effect of hedges, it realized an average oil price of $77.51. In the second quarter of 2011, this was $91.85. For the same time frame, Northern saw a decrease of 19% in the realized price of natural gas liquids. Oil differentials were $13.72 versus $7.42 for the same quarter a year earlier. These differentials were also highlighted by Marathon (MRO). Production expenses were higher year over year, but were down from the first quarter. Northern states this is from higher water disposal costs. This does make sense as year over year those costs have increased, but there has been a big drop over the past three months for other companies like Kodiak (KOG). Look for this expense to continue downward in the Basin.
In the first half of this year, Northern has AFEs of $8.2 million with respect to well costs. Going forward, this number will increase to $8.8 million. Northern Oil's proved developed reserves per well is 400000 Boe. I believe this number is conservative. This company believes it will continue to see increased LOEs. Northern believes this pricing will moderate soon along with drilling and development costs. Look for LOEs to pull back in the second half of the year. NOG also commented on a reduced number of rigs in the basin. The consistent theme of other producers has been a move to pad drilling, zipper fracs, walking rigs, etc. We should see a continued decrease of costs, more efficient drilling and completing of wells, and a tightening of differentials.
In summary, there are several reasons to be bullish on NOG. The stock is historically cheap on several metrics including price/cash flow and price/book. Costs are decreasing in the basin, and Bakken stock valuations are still low given the current price of WTI. I believe the second quarter differentials will improve, and am looking for an average of $11 in the third and $9 in the fourth quarter. Drilling and completion times are compressing. Water costs will continue to pull back, as infrastructure is catching up and there are a large number of trucks sitting. Right now the Bakken is not a bad place to be, given the fundamentals.
Disclaimer: This is not a buy recommendation.