After an extended sluggish period, Kodiak Oil & Gas (KOG) is finally seeing a little investor appreciation. There are many reasons why this should be so, the most obvious being its competitive position on the Bakken, the hottest US play thanks to its oil weight amid continuing natural gas price stagnation. However, its recent numbers are what are really earning the firm attention. For the first nine months of the year, Kodiak's production averaged 20,000 boe per day. Compare that to an annualized rate that worked out to 600 boe per day as recently as 2009.
To further increase production, Kodiak is continuing its strategy of drilling multiple well pads, with two to four wells to a pad in nearly all cases. The addition of a second drilling crew beginning in October and expected to operate through year end will also advance Kodiak's drilling schedule considerably, since that addition effectively doubles Kodiak's drill rate. Paired with its continually decreasing drilling times and healthy drilling inventory, Kodiak is only at the foot of a steep production increase.
Its focus with multiple well pads continues to be in McKenzie and Dunn counties, areas where the firm regularly meets with impressive production numbers. According to Kodiak Chairman and CEO Lynn Peterson, "the well results from each of our operating areas through the fairway of the Bakken oil play continue to be robust and the results are very consistent between the areas…our work could lead to greater resource potential."
Kodiak's drilling expenses continue to remain competitive, averaging between $10 million and $10.5 million. At first glance this looks high considering past average well costs on the Bakken, but this average reflects the increase in costs due to increased competition for drilling resources on the play. With that in mind, it looks like Kodiak is doing an extremely good job at leveraging its small size for the best costs it can, while maintaining a success rate that helps offset the costs further. That is not to say, however, that Kodiak could not do better; Magnum Hunter Resources (MHR) is reporting per well costs of $6.9 million in North Dakota.
Yet these factors alone, important as they might be, don't explain how this small player gained 20% in the last two months alone. Kodiak's outlook already indicated its upward trajectory prior to its recent rise, which failed to keep its stock price steady over the volatile summer months. What's really fueling Kodiak is its position as a best buy for majors looking to get a better foothold on the Bakken.
The Consolidation is Coming, and Kodiak is a Front Runner
Exxon Mobil's (XOM) acquisition of Kodiak competitor Denbury Resources (DNR) is making waves on the northern plains, as its $2 billion valuation hints it might be the beginning of the anticipated first major round of consolidations in the over-crowded Bakken fields. Exxon Mobil will be paying Denbury $1.6 billion in cash plus exchanging two of its own fields, in the Hartzog Draw in Wyoming and the Webster in Texas, for the rights to 196,000 net acres in North Dakota and Montana. This will nearly double Exxon Mobil's total leasehold in the area.
Exxon Mobil's acquisition puts it on the same footing as EOG Resources (EOG) as far as total Bakken holdings. This must have EOG nervous, since the firm recently indicated that its new focus would be on the Bakken and other tight oil plays after forecasts indicating a plunge in natural liquid gas prices moved the firm to change up its strategy. Simply put, Exxon Mobil can bring more resources to bear on the Bakken than Denbury Resources ever could, which may raise personnel and equipment rental costs even higher in the near term.
There can be no question that consolidation on the Bakken is coming. The outer limits of the field are fairly known, and were recently tested once again thanks to reports commissioned by the state of South Dakota, which wanted to determine whether truly substantial future oil and gas growth was in its future - the answer of the reports was a resounding negative. North of the US Bakken in Saskatchewan, Canada, Bakken consolidation is already occurring, with producer Crescent Point Energy emerging as a play leader after several rounds of acquisitions to shore up its position.
Once the smallest producers and those producers not fully committed to the Bakken dispose of their leasehold, Kodiak is a logical choice for a merger or acquisition. The most likely buyers are the majors, and of these, Exxon Mobil's recent move puts it out in front. Exxon Mobil is suffering from its 2010 acquisition of XTO Energy, which gave it massive exposure to domestic natural gas. It makes sense that Exxon Mobil wants to belatedly hedge its bet with domestic oil, especially since the firm's own estimates indicate that US oil imports are peaking as domestic production expands.
Exxon Mobil could make any one of a series of deals on the Bakken to expand its holdings, but I think it is likely to start small as the company continues to hurt following its XTO acquisition. A Kodiak deal would register as a smaller deal for the largest US based oil company. Interest by Exxon Mobil could also spur its peers to acquisition, which could truly benefit Kodiak and its shareholders through garnering a price premium. That's something to look forward to.
Kodiak is currently trading around $9 per share, with a price to book of 2.5 and a forward price to earnings of 9.2. Magnum Hunter is trading around $4 per share, with a price to book of 1.4 and a forward price to earnings of 9.2. Denbury Resources is trading around $16 per share, with a price to book of 1.2 and a forward price to earnings of 7.3. EOG is trading around $112, with a price to book of 2.2 and a forward price to earnings of 17.6. Exxon Mobil is trading around $91 per share, with a price to book of 2.6 and a forward price to earnings of 10.5.
Even if an acquisition is not forthcoming, Kodiak has the leasehold, inventory, and momentum it needs to maintain stability and eventually prove itself with healthy returns. The only major red mark against it is its debt to equity, currently at 0.8. However, given its growth pattern, the high debt to equity is forgivable, and does not make Kodiak any less of a buy. I think Kodiak will reach the $12 to $13 level by 2014.