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Michael Filloon, Split Rock (390 clicks)
Oil & gas, small-cap, research analyst, growth at reasonable price
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On August 8th, Continental (CLR) reported second quarter earnings and missed on both the top and bottom lines. The Street was looking for $559.2 million in revenue and earnings of 73 cents/share. Continental reported 68 cents/share on revenues of $523.39 million. Continental posted additional revenues of $471.72 on gains related to derivatives.

Two years ago, Harold Hamm announced Continental would triple production in five years. He now believes this will happen by early to mid-2013. Production for the second quarter of 2012 was 76% higher year over year and 11% better than the quarter before. Full year 2012 production growth has been increased between 57% to 59%. This was not a surprise to me as I have been documenting its results, which have been impressive in 2012. Continental has made a quick change to 30 stages. This isn't the only reason for increased production as it has been averaging between 50000 and 60000 barrels of water per 30 stage completions. This is an increase from 40000 to 50000 barrels seen in more recent 24 stage fracs. Continental is now using 2.7 to 3 million pounds of proppant, which is an increase from 2 to 2.2 million. This has helped to produce much better initial production numbers, but has also increased costs. Continental is shooting for 97% of its North Dakota Bakken to be held by production by year end of 2013. Right now it has 72% of this held by production. Continental has reduced its number of rigs in the Bakken from 26. Its current Bakken rig count is 19, of which 9 are ECO-Pad capable. It has 15 rigs in North Dakota and 4 in Montana.

As other Bakken companies are doing, Continental is reducing its number of rigs. Even with a lower number of rigs, Continental is still drilling as many wells. It has seen drilling times decrease by 30%. As acreage is de-risked, Continental is switching from its single well rigs to ECO-pad rigs. Currently, a little less than half of the number of rigs are ECO-pad. Continental decreases well costs by 10% using pad drilling. These variables are part of the reason for an increase in cap ex to $3 billion. Because drill times have decreased, more wells will be drilled.

Continental is also using cost increases as a reason. Looking at the first quarter, there has been some price relief with respect to oil services. Water costs have decreased significantly, and probably will continue to do so. Bakken pressure pumping is also cheap, and doesn't seem to have found a bottom like other plays. Much of this increase is probably due to additional stages and volumes of water plus proppant. This has increased production significantly, and why I believe these higher costs are a good thing.

On the first of the year, it had estimated the completion of 249 net wells in 2013 with a cap ex of $1.65 billion. Now that estimate is 330, and a cap ex of $3 billion which leads me to believe costs per well have decreased significantly when compared to the amount of production it is obtaining per well. Non-operated cost increases have also been seen, which is probably the reason Continental is trying to concentrate on higher working interest in its wells. Current well costs are $9.2 million, but this number reduces between $8.4 and $8.5. This compares to most recent estimates of $8.5 and $7.7 million. Its 20 stage fracs generally were in the $7.7 million range, and 24 to 27 stage fracs had well costs of $8.5 million. Continental's differentials in Bakken crude averaged $12.63, but had a high of over $18 in April.

Continental plans to drill 8 wells in the second and third benches of the Three Forks. Each bench will be tested equally at four per bench. Continental has been real aggressive with respect to expanding the play through additional pay zones. Its two wells had IP rates of 1396 and 1023 Boe/d. Burlington (COP) has also been working this bench. Keep in mind, Continental believes less oil will be recovered in the second, third and fourth benches of the Three Forks when compared to the middle Bakken and upper (first bench) Three Forks.

Another interesting point is Continental's Charlotte wells are in Banks Field just to the east of Kodiak's (KOG) wells in Poe. This is also good for Brigham (STO) and its Gunderson well in that same field. Denbury (DNR) and SM Energy (SM) also have acreage to the south of Banks Field. It is important to note that its Charlotte site will have four wells producing from four different pay zones. Since there are four pay zones we could see up to 16 wells per 1280 acre spacing. I used four wells per pay zone as this seems to be the number most companies are trying without getting communication between any of the wells. Hess (HES) is currently working on a twelve well pad. QEP (QEP) is also working on a ten well pad. These sites could prove up to 6 six middle Bakken and 6 upper Three Forks wells are possible. If that is the case, EURs will improve substantially.

Continental has done a great job of documenting costs. Here are those differences from over the past 12 to 18 months.

Continental Cost Increases
ServicesCost Increases
StimulationSlight Decrease
Scoria+30% Year Over Year
Drilling Rigs (Day Rates)+20% Year Over Year
Trucking+40% to +50%
Rental Tools

+30% to +40%

CementingFlat
Directional Services+10% to +15%

With respect to differentials, there are some very positive variables helping to tighten these numbers. At the low point in the second quarter there was a very high volume of oil going to Clearbrook. The addition of refineries being down, large volume of Canadian crude, and Syncrude units were running. On a positive note, Enbridge (ENB) reversed its Line 9 up to Montreal. This will run additional oil to Canada and the Great Lakes region. It has been using the rails to get oil to St. James like EOG Resources (EOG). The oil price in that area is quite high and helps to reduce differentials even by rail. By the first of the year the Seaway pipeline will increase oil transports from 150000 barrels/day to 400000.

In summary, Continental looks well positioned in the Bakken. It is doing a very good job of trying to get a handle on what the lower Three Forks will produce. It also has increased its leasehold to one million acres. I look for further upside going forward. Although it is spending more by the way of cap ex, Continental also is spending more on its wells and improving production.

Source: Bakken Update: Continental Ahead Of Schedule To Triple Production

Additional disclosure: This is not a buy recommendation.