Kodiak Oil & Gas (KOG) put in a healthy second quarter, and although its past performances are less than consistent, I think that combined with a relatively strong first quarter and an overall positive year in 2011, Kodiak is finally finding its feet. As a newer entrant to exploration and production, Kodiak faced more than its share of obstacles starting production during the worldwide recession, and that it's still here shows the underlying strength of the company. Looking ahead, Kodiak is just beginning to reap the rewards of its early play in the Williston Basin, and promises to start delivering shareholder returns by year end.
Big Players Moving In, Pushing Up Volumes
North Dakota oil production rose from 300,000 barrels per day in May 2010 to over 650,000 barrels per day in May 2012, with the steepest increases happening between June 2011 and June 2012. This period saw an amazing 71% increase in overall volume, and 594,000 barrels of this daily production is attributed directly to the Williston Basin.
Exxon Mobil (XOM) is one of the prime movers on the Bakken, more than doubling its Bakken production since it made an entry to the Williston in 2010 following its acquisition of XTO Energy. According to Exxon Mobil Vice President, Investor Relations David Rosenthal, Exxon Mobil brought 40 wells to sales in the first six months of 2012, twice the number of wells brought to sales in the same period of 2011. Exxon Mobil is a leader on the play, and this has both benefits and drawbacks to the smaller players.
Kodiak is suffering from higher lease prices brought on in part by its own bullishness in the Williston Basin, which contributed to the bullishness of other players. Kodiak's most recent acquisition, purchased in an online auction from the North Dakota Department of Trust Lands Mineral Division, cost it $7,148 per acre including lease and state sales fees. At these prices, marginally prospective acreage like that on which Kodiak made its start is no longer financially attractive, since a dry hole for a small producer is a loss of much needed capital. The good news for Kodiak is that now it is better established, these dry holes are not the disasters in waiting that they once were.
The massive production increases the Williston is seeing also result in lower costs to build out infrastructure, since more players can share in the costs. However, the rapid growth is stressing infrastructure to the point where costs are actually going up. This is impacting the price per barrel producers can realize; since there is a transportation bottleneck, crude from the Bakken is usually trading at a discount to West Texas Intermediate, and that discount can be substantial. For smaller players that can be a make or break difference.
Environment Ripe for Major Deals
QEP Resources (QEP) recently navigated a complex acquisition from multiple sellers for properties in Williams and McKenzie counties in a deal worth $1.38 billion. The deal adds 27,600 net producing acres to QEP's balance sheet, raising its total acreage in the Williston to 118,000. This puts it on the heels of Northern Oil and Gas (NOG), with 180,000 net acres, 109,000 of which were developed, held by production or operations, or were permitted at the close of the second quarter.
Black Hills (BKH) is one of the participants in the deal, as it will sell around 85% of its Bakken and Three Forks leasehold to QEP for $243 million. According to David R. Emery, Chairman, President, and CEO of Black Hills, the divestiture realizes the full potential future value that Black Hills estimated for the properties, and is in line with its strategic goal to focus on proving its reserve potentials.
QEP's deal is similar to a deal earlier this year between Magnum Hunter Resources (MHR) and Baytex Energy USA Ltd., in which Magnum Hunter purchased 50,414 net acres in a transaction valued at $311 million. Still, these two deals are small compared to transactions occurring on other liquids rich plays like the Niobrara. What I think is happening is a series of smaller transactions as a run up to potentially game changing mergers and acquisitions, in which smaller companies like Kodiak could see tempting takeover offers.
The Williston Basin is ripe for takeovers and acquisitions, given the sheer number of players currently participating in the area. According to the North Dakota Department of Mineral Resources, there are 41 operators with active drilling rigs at last count. As most of the best acreage is already leased up, players will be looking more and more towards joint ventures and acquisitions in order to expand operations. Those players who are not currently participating in the Williston boom will need to acquire current Bakken operators in order to gain a foothold. With its healthy production, expansive leasehold, and discounted market cap, Kodiak is a leading candidate for such a takeover, which could prove very rewarding to stockholders.
Kodiak is currently trading around $9 per share, with a price to book of 2.3 and a forward price to earnings of 8.5. For comparison, Northern is trading around $16 with a price to book of 1.8 and a forward price to earnings of 11.5, while Black Hills is trading around $34 with a price to book of 1.2 and a forward price to earnings of 15.4. QEP is leveling off after a recent spike, indicating that investors are not as enthusiastic for its long term Williston operations as might be expected; it is trading around $28 with a price to book of 1.5 and a forward price to earnings of 13.2. Exxon Mobil is trading around $87, with a price to book of 2.5 and a forward price to earnings of 9.9.
Though small and arguably disadvantaged, Kodiak is doing an excellent job raising production weighted on oil with limited resources. This is at least in part due to the supervision of CEO Tom Ward, an experienced oilman who knows how to shift a company's finances to the best possible advantage. Since the Williston is bursting at its borders due to the sheer number of operators, I think it is only a matter of time before a player who missed out on the land grab comes knocking for an acquisition. Since Kodiak is one of the most likely targets, I like its chances.