Kodiak Oil and Gas (NYSE: KOG) is one of the more volatile energy independents, which I think can be attributed to its status as a small cap, its limited drilling focus currently restricted to the Williston Basin, and its lack of a dividend, which consistently leads investors to dump Kodiak holdings to lock in gains. However, indicators are that this streak may be about to end, leading to solid gains for Kodiak in the near future.
Solid Growth Trajectory: It's in the Numbers
Kodiak's sales volumes continue to climb. Its preliminary numbers indicate that in the third quarter of 2012, Kodiak's average sales volume was 15,855 boe per day, over a 300% increase over the same quarter the year prior and a 25% increase quarter over quarter. Fully 88% of these sales volumes were in crude. This is fueling Kodiak's growth trajectory, as the company remains fully committed to an aggressive fourth quarter drilling and completion schedule.
Unlike some of its competitors which grew too quickly and now face the prospect of drilling in non-core areas in order to keep a leasehold active, Kodiak reports that most of its position is fully held by production. This will allow it to move its rigs to multi-well pads in the promising Polar and Smokey project areas by the end of this year. Kodiak plans to institute downspacing at 1,280 acre intervals in these areas once permitting is completed.
Drilling costs also continue to decline for Kodiak, a result both of drilling efficiencies and of improved infrastructure on the Bakken. According to Kodiak Chairman and CEO Lynn Peterson, the completion problems Kodiak experienced earlier this year have been "eliminated," and the company's new focus in multi-well pads and zipper fracking has reduced completion times overall.
Kodiak expects to close 2012 with an exit rate of 27,000 boe per day. This is a drop in a very large bucket, as total Williston oil output alone totals some 639,000 barrels per day. However, its consistent gains are encouraging, as is the improving natural gas price picture that could move Kodiak to flare less of its natural gas output and channel these resources into sales.
Competitor Successes Leading to M&A Environment
Kodiak competitor GMX Resources (NYSE: GMXR) is also becoming more efficient. GMX recently completed its first drilled well with oil-based mud in the Williston, reaching target depth in less than a month at a cost of $4 million. GMX is moving towards a focus on the Middle Bakken using plug and perf fracking to increase operating its efficiencies. After its recent $69 million East Texas asset sale, GMX is casting its eyes northward to Kodiak's territories on the Williston. According to GMX President Michael J. Rohleder, this asset sale will allow GMX to "focus on remaining near-term catalysts for our shareholders, which include higher daily oil production through improved completions, lower costs per well, and more wells drilled per rig per year."
Exxon Mobil (NYSE: XOM) is also moving north, seizing the opportunity to own oil rich Canadian shale in the Duvernay and Montnay formations from Celtic Exploration in a deal valued at $2.86 billion. These plays are easier for Exxon Mobil to enter than the relatively nearby Williston since Williston acreage is not only held piecemeal by hundreds of operators but is also nearly leased out. This is Exxon Mobil's biggest move into shale oil in one stroke so far, and indicates that the world's largest oil company might be preparing itself for further shale oil acquisitions. The Williston would be a sensible target for the firm, which has the resources to buy many of the smaller play operators outright - including Kodiak.
On the heels of Exxon Mobil's announcement, independent Halcon Resources (NYSE: HK) announced it would buy about $1.45 billion in Williston assets from Petro-Hunt. The deal encompasses some 81,000 net acres with average net production over 10,500 boe per day and proved reserves totaling 4.24 mboe. Halcon Chairman and CEO noted that the move is part of Halcon's goal "of building an oil company with a multi-year drilling inventory in several liquids-rich basins."
In the meantime, one operator decided that the Williston was no longer a top priority: Chesapeake Energy (NYSE: CHK). According to Petroleum News, Chesapeake quietly removed the Williston from its major plays sometime in the past few weeks, and a spokesperson confirmed that Chesapeake is not operating any drilling rigs in the Bakken. Chesapeake disclosed its interests in obtaining a development partner for the Williston back in 2011, but so far no interested parties are coming forward to work with the troubled independent.
The best scenario for Kodiak and GMX here would be a buyout, a scenario for which Chesapeake might also hope, at least for its Williston assets. As leases become tighter and the majors feel more confident in making big bets on shale oil, this is the most likely scenario for at least some lucky players. Kodiak looks very attractive in this context, since it largely avoids the complicated financial deals that discount Chesapeake and is not natural gas exposed like GMX.
Kodiak is currently trading around $9 per share, with a price to book of 2.4 and a forward price to earnings of 9.0. GMX is trading around $1 as it still struggles to recover from its dramatic 2008 slide into penny stock territory, weighted by its natural gas exposure. Exxon Mobil is trading around $91 per share, with a price to book of 2.6 and a forward price to earnings of 10.4. Chesapeake is trading around $20 per share, with a price to book of 0.9 and a forward price to earnings of 11.2. Finally, Halcon Resources is trading around $7 per share, with a price to book of 2.1 and a forward price to earnings of 11.0.
While it can't be denied that Kodiak is volatile, its earnings potential is far above the value placed by investors. What looks like another rough winter for natural gas prices can also benefit Kodiak, as the wary flock to oil heavy stocks. Following its current streak, I think Kodiak should break $10 by the end of this year, and represents a strong buy opportunity.