Update: What To Buy In The Bakken

Includes: CLR, COP, CRR, FTK
by: Michael Filloon

In my last article, I highlighted two Bakken companies that missed fourth-quarter production estimates. There were several reasons given, but as usual it has been slow going in North Dakota. Investors were bullish given the mild winter. Now obtaining equipment in the Bakken is slowing things. Although some companies have had a difficult time, others are doing quite well.

Continental (CLR) had a great fourth quarter from a production standpoint. More important, it accomplished this in a difficult quarter. Continental reported a year-over-year increase in production of 57%. Reserves grew 39%. Other bullish news from the S&P as it raised Continental's credit rating one notch. Continental's fourth quarter was strong as it pushed full year of 2011 production to 22.6 MMBoe versus Continental's estimate of 22.3 MMBoe. These numbers are great, but what has driven production growth? It would seem Continental has got a good grip on completions work. Continental had recently announced it would increase its average number of stages from 24.5 to 30. This has helped significantly. Continental recently reported IP (initial production) rates of several wells completed and producing in the fourth quarter. These reported rates were big improvements over past wells:

  1. Dvirnak 3-7H (Dunn County): IP rate of 831 Bo/d, 26-day IP rate of 738 Bo/d. 4 section spacing
  2. Dvirnak 2-7H (Dunn County): IP rate of 744 Bo/d, 26-day IP rate of 658 Bo/d. 4 section spacing
  3. Durham 1-2H (McKenzie County): 13384 barrels of oil were produced in December of 2011.
  4. Enzel 1-26H (Dunn County): 13219 barrels of oil produced in November and December of 2011
  5. Pletan 4-18H (Dunn County): IP rate of 1294 Bo/d, 26-day IP rate of 557 bo/d
  6. Mack 4-2H (McKenzie County): 24574 barrels of oil produced from October through December.
  7. Palmer 1-25H (McKenzie County): 18668 barrels of oil produced in November and December.
  8. Pletan 3-18H (Dunn County): 16665 barrels of oil were produced in November and December.
  9. Grande 1-18H (Dunn County): IP rate of 814 Bo/d, 83-day IP rate of 330 Bo/d
  10. Patterson 1-13H (McKenzie County): IP rate 929 Bo/d, 83-day IP rate of 614 Bo/d

These results are just for oil, so the rates are lower than that of Continental's press release. I used nonstandard time frames for initial production. By using as many days as possible, these numbers will give a better idea of depletion. As a point of comparison here are results from Jim Creek Field. The Dvirnak, Grande, and Pletan wells are all from Jim Creek Field. Here are other well results from this field in 2010:

  1. Kelly 2-2H: IP rate of 480, 26-day IP rate of 502 Bo/d and 83-day IP rate of 314 Bo/d
  2. Bonney 2-3M: IP rate of 1074, 26-day IP rate of 694 Bo/d and 83-day IP rate of 533 Bo/d
  3. Kelling 2-4H: IP rate of 163, 26-day IP rate of 130 Bo/d and 83-day IP rate of 259 Bo/d
  4. Medicine Hole 2-27H: IP rate of 1371 Bo/d, 26-day IP rate of 606 Bo/d, 83-day IP rate of 391 Bo/d
  5. Nadia 1-30H: IP rate of 759 Bo/d, 26-day IP rate of 238 Bo/d, 83-day IP rate of 206 Bo/d

Of the three wells completed in the fourth quarter of 2011 that had 26 days of production, the average rate was 651 Bo/d. The 26-day IP rate of the five wells completed in the same field in 2010 had an average of 434 Bo/d. If I remove the one well that looks to have had problems (Kelling 2-4H) this number increases to 510 Bo/d. It shows a decent improvement year over year in Jim Creek Field.

The two wells completed in the fourth quarter that registered 83-day IP rates had an average of 472 Bo/d. In 2010 the five wells completed in this field had an average 83-day IP rate of 340 Bo/d. Both of these numbers are important as Continental has historically had lower IP rates than its competition. It is important to understand that lower IP rates can still translate to higher EURs depending on how the well is drilled, completed and choked off. Looking at where these wells are located and how they are performing further out, does seem to show keeping pressure up in the well may not hurt longer term IP rates, as these numbers seem catch up to other wells that do not choke of initial production as much.

There are a couple of interesting variables with these results. The first is Dvirnak wells. Both were drilled from and Eco-pad and have four section spacing. Continental has said these wells will cut costs by 10%. It is tough to develop an exact figure, but these wells have historically cost $7.2 million versus non-pad costs of $8. I would expect these costs to increase as Continental starts doing more 30+ stage fracs.

Continental recently participated as a non-operator with Burlington (NYSE:COP) drilling the second bench of the Three Forks. This has been a hot topic, as it opens up the possibility of a substantial resource increase. The Sunline 11-1TF-2SH had an IP rate of 1464 Bo/d, and looks to be a commercially productive location. This well was 20 miles from Continental's Charlotte 2-22H. This helps to confirm Continental's assertion the second bench of the Three Forks is commercial throughout the basin. Obviously we will have to wait and see, but the fact other producers are working this part of the play is encouraging.

Another name that looks appealing here is Flotek (NYSE:FTK). For those that follow, you know I have been bullish this name since it came out with third-quarter earnings. Flotek posted 35 cents per share, beating analyst estimates of 8 cents. Much of this was due to the popularity of its green fraccing fluids, and the company did a very good job of switching over to liquids based resource.

Flotek has seen a recent and sudden pullback, but it is not alone. Oil service companies have been seeing a decrease in revenue from natural gas based work. Because the price of gas is so low, many companies have decided to decrease cap ex. The decreased demand experienced by Carbo Ceramics (NYSE:CRR) in natural gas plays translated to a fourth-quarter earnings miss. The street was looking for $1.70 and Carbo came in at $1.43. This miss in earnings was a drag on other companies associated with fraccing.

Flotek's stock took another hit when it released preliminary results for the fourth quarter of 2011. When compared to estimates this sell off may not have been warranted. Flotek reported:

  • 2011 Full-Year Revenue of $258 million
  • 2011 Fourth-Quarter Revenue $74.5 million
  • Improved Market Share
  • Full Year 2011 Gross Margins Above 40%
  • 2011 Fourth Quarter 42%

Analyst estimates for Flotek are:

  • 2011 Full-Year Revenue of $259.02 million
  • 2011 Fourth-Quarter Revenue of $76.03
  • 2011 Fourth-Quarter EPS of $.17

These numbers did not substantiate the abrupt pullback in share price. While the market is focusing in decreased demand for natural gas completion fluids, the investor should focus on the conversion from natural gas to liquids. Drilling rigs that are drilling for gas, will be moved to oily plays and provide further opportunity for companies with exposure to this type of resource. Flotek recently announced the doubling of capacity and increase of 150% storage of chemicals used in obtaining liquids based resource. The expansion of its Marlow facility was imperative to meet increasing demand for green fraccing fluids. Flotek also purchased land adjacent the facility as it believes further expansion will be needed.

In summary, Continental had a great quarter with respect to production in the Bakken. Increased utilization of its Eco-Pad system and increased stages should contribute to decrease costs and increase production. Although Continental might be considered expensive by current valuations, it may be cheap when growth is factored in the equation. Continental's 2012 guidance is for, on average, 40 operated rigs. This and $1.75 billion in 2012 cap ex, are estimated to produce 26% to 28% production growth.

Flotek is a growth story, and a play on green technology. Frac water contamination is becoming a topic of conversation in all of the unconventional plays of the United States. In North Dakota, the state has began changing the rules on reserve pits. These pits contain the flow back from the well. Last year in the Bakken, many of these pits flooded and contaminated areas near by. One way to decrease the chances of pollution is use biodegradable frac fluids.

Disclosure: I am long FTK, CRR.

Additional disclosure: This is an article on oil and gas related companies to be bullish going into 2012. It is not a buy recommendation.