Bakken Update: Reiterating A Short On Emerald Oil Which Is Down 99% Since The Call

| About: Emerald Oil, (EOX)
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Summary

Emerald's best well to date has a six-year payback using $60/bbl oil.

Although EOX's well design is quite good, geology is a limiting factor as its location is marginal at best.

The company's first producing well was excellent; it hasn't drilled a better well since.

Emerald has recently completed a well that produced 2,000 bbls of oil in nine months, raising the question as to whether this part of its acreage is viable.

With a market cap of just $6.44 million, this short call may be seen as late, but it is a reiteration of a short from November of 2014.

The drop in oil prices has caused issues for marginal operators throughout the US. Those late to the US oil land grab had to pay top prices for acreage outside the core. Many of those operators had to accumulate significant debt with the expectation oil prices would stay around $100/bbl. Most hedged oil and natural gas prices just in case prices pulled back. Many learned the hard way in 2008 when oil prices dropped quickly. Smaller operators with significant leverage almost went out of business. This motivated many to maintain large hedge books. This is one of the major reasons our current oil glut has lasted this long. Operators continue to produce and realize oil prices between $50 and $60/bbl. This has caused oil hubs around the world to swell. The question on everyone's minds is, "When will production finally decrease creating an equilibrium in supply and demand?"

Production decreases could be around the corner, as many operators have only been able to hedge about 50% of its barrels in 1H16. This means very few operators will be able to produce with oil prices at $30/bbl. Some will still be increasing production like RSP Permian (NYSE:RSPP) and Pioneer (NYSE:PXD). These Midland operators are in the sweet spot with very low costs. Since the majority of acreage across US unconventional plays are not economic at $30/bbl WTI, operators will have to decrease or stop completing wells. By H2, we have the same type of issue, only with lower realized prices and fewer hedged barrels. As hedges roll off, the expectation is for production to decrease.

There are a large number of operators in dire straits. This includes Bakken operators like Samson (NYSEMKT:SSN), Halcon (NYSE:HK), Triangle (NYSEMKT:TPLM), Comstock (NYSE:CRK), PetroQuest (NYSE:PQ), Gastar (NYSEMKT:GST), Approach (NASDAQ:AREX), Rex (NASDAQ:REXX), Bonanza (NYSE:BCEI), and Stone (NYSE:SGY). There are many others in threat of default. We have already lost companies like Magnum Hunter (OTCPK:MHRCQ), Penn Virginia (PVA), Goodrich, and Swift. The question isn't if we will see more companies go bankrupt, but how many. I doubt all of the names above will default, but it is possible a number of these do. This article pertains to Emerald (NYSEMKT:EOX) and the difficulties it faces. Being negative this name now may seem late, but this is a reiteration of an earlier call to go short a little over a year ago. November 12th of 2014, I wrote an article detailing headwinds for Emerald. The stock has fallen precipitously. After reverse stock splits, the stock was trading at the equivalent to $58.20/share. Currently, it trades for $1.13. This shows the importance of geology. If this is not good enough, it does not matter how good the operator is. After such a large move to the downside, many might think the trade is over. It is possible to get caught in a short squeeze, but there is a chance there could be more to go. To be clear, I am not stating Emerald will default. When we look at the name, there are still concerns that its best acreage will not be good enough even at $60/bbl crude.

(Source: Emerald)

The above map shows Emerald's acreage in green. The map also provides the acreage positions of other large ND operators. Oasis (NYSE:OAS), Whiting (NYSE:WLL), and Continental (NYSE:CLR) all have acreage around and near Emerald. To properly analyze its current leasehold, one needs to consider the geology and problems all operators will have in seeing economic results. Source rock depth is very important. Many of the best Bakken/Three Forks wells have been drilled in the deepest areas of the play. This is not always the case, but deeper horizontal generally have higher well pressures.

(Source: Continental)

The location of acreage is paramount to operators. Those with core acreage can focus on those locations until oil prices improve. If there is no core acreage, an operator could get squeezed in 2016. The beginning of this year could prove to be very difficult. When oil was at $100/bbl, companies were buying acreage well outside the Bakken core. This is true for many plays like the Permian and Eagle Ford. Now the most optimistic views see oil at $60/bbl next year. It is possible this could be the case for a long time, although I don't believe it. Operators having financial difficulties won't look that far ahead. 2016 is its worry. Others believe that oil prices could average below $40/bbl for the year. The truth is probably somewhere in the middle. $50/bbl oil won't do it in western McKenzie and Williams County. It also isn't good enough for Burke and Divide. Hedges should be considered, but most operators have very little in 2016 and are lucky to get $60/bbl.

(Source: Emerald)

Emerald's acreage is focused in west and southwest McKenzie County of North Dakota. It has additional acreage in northeast Richland County in Montana. There are additional, smaller acreage positions in Stark, Dunn and Billings counties. Its best acreage is in the northern part of its Mckenzie County core. Keep in mind when I say core, this is Emerald's core, not the Bakken's. Its smaller position in Billings and Stark target the Pronghorn Sands, which is unique to this part of the Bakken. It's not as deep, so well costs are lower, but we haven't seen huge results from this area when compared to Nesson.

(Source: Welldatabase.com)

The above map from Welldatabase shows all Emerald wells in ND with current production. In my last article, we went through EOX's production data which provided current issues to it being profitable when oil was higher than it was today. To give this operator a fair shot, we will be going over its most recent well results (2015 completions) to see how this data compares to older completions. This only gives us part of the data needed, as we have no way to track longer-term decline rates. That is always the difficulty in looking at newer well results. We do not know if a really good production history through 180 days will continue, and superimposing decline from other wells nearby isn't accurate either. We will also go over a few of its better wells, and see how long payback occurs.

The first well to discuss was its first. Pirate 1-2-11H was a very good result for its time and area. Emerald's use of slickwater in western McKenzie has been a good fit.

Date

Oil

Gas

Water

3/31/2013

4,465.00

3,825.00

15,720.00

4/30/2013

19,488.00

19,554.00

36,659.00

5/31/2013

14,943.00

15,413.00

23,916.00

6/30/2013

5,778.00

6,728.00

11,570.00

7/31/2013

7,402.00

6,728.00

11,241.00

8/31/2013

7,809.00

5,589.00

11,381.00

9/30/2013

6,278.00

3,806.00

8,515.00

10/31/2013

2,761.00

2,031.00

5,221.00

11/30/2013

9,246.00

9,043.00

12,786.00

12/31/2013

5,772.00

7,607.00

29,976.00

1/31/2014

8,262.00

11,053.00

18,957.00

2/28/2014

7,915.00

11,701.00

13,285.00

3/31/2014

7,324.00

7,936.00

14,240.00

4/30/2014

4,139.00

6,482.00

7,689.00

5/31/2014

2,016.00

2,270.00

16,107.00

6/30/2014

4,768.00

4,669.00

22,383.00

7/31/2014

7,929.00

7,355.00

20,970.00

8/31/2014

6,518.00

6,533.00

14,101.00

9/30/2014

6,412.00

7,275.00

13,341.00

10/31/2014

4,940.00

4,743.00

10,612.00

11/30/2014

4,104.00

3,736.00

10,100.00

12/31/2014

4,481.00

4,466.00

9,401.00

1/31/2015

3,856.00

4,196.00

8,167.00

2/28/2015

3,686.00

3,478.00

7,225.00

3/31/2015

968

1,210.00

2,680.00

4/30/2015

530

430

2,509.00

5/31/2015

1,773.00

1,303.00

4,638.00

6/30/2015

1,740.00

1,292.00

3,828.00

7/31/2015

2,079.00

1,546.00

3,595.00

8/31/2015

2,237.00

1,357.00

3,674.00

9/30/2015

2,527.00

1,864.00

5,705.00

(Source: Welldatabase.com)

It has produced 175,432 barrels of oil and 176,926 Mcf to date. Pirate 1 has produced for 33 months. This well was considered quite good for western McKenzie (not for the Bakken core). It used 246K bbls of fluids and 3.9M lbs of proppant. Pirate 1 was a 34-stage 9,000 foot lateral. When oil was selling at a much higher price, the payback times weren't as big of an issue. Today, this well is not economic. Using Emerald's last quarter oil and natural gas net of settled derivatives price, we have $37.65/bbl and $3.13/Mcf. This produced revenue of $7,158,792 in 33 months. Emerald D&C costs are now $7.5M. This number is a little deceptive as it has added four wells in Stark County.

WellDatabase Well Header Report

Report Generated: 1/6/2016 11:51:41 PM

First Prod Date

CUM Oil

CUM Gas

Field

Well Name

9/1/2014

88,701

37,411

HEART RIVER

LLOYD CHRISTMAS 4-4-9H

11/1/2014

98,382

54,203

GREEN RIVER

HARRY DUNNE 5-26-35H

8/1/2014

44,218

26,235

HEART RIVER

LLOYD CHRISTMAS 2-4-9H

8/1/2014

37,844

18,153

HEART RIVER

LLOYD CHRISTMAS 1-4-9H

These wells are at a vertical depth 1,000 feet less than Emerald wells in west McKenzie. This has helped to decrease wells costs. It has also seen a significant benefit from decreased water costs. This is important as Emerald slickwater fracs are water intensive. We see how difficult it has become for Emerald once we pull G&A, LOE and taxes. We would back out a little more than $4M from revenues of $7,158,792. The Pirate 1 well is considered one of Emerald's best wells, and using current economics, this well has produced approximately $3M and has a well cost of $7.5M. One thing to consider when looking at these numbers is its recent second-lien term loan and added pricing protection via puts. This added approximately $9/BOE to production costs. If we take production and use $60/BOE and $5/Mcf, revenues are $11,410,550 in the first 33 months. If we back out differentials, LOE, G&A and production taxes, the number decreases to about $5.25M. Pirate 1 is currently averaging 2,000 bbls of oil/month. Even if we don't account for decline rates, it will take another three years to reach payback. At that time, we would expect higher oil prices than $60/bbl, but it does not bode well.

One thing we always stress is to be up to date with current well production. We are always behind the curve on operator improvements to well design. This is because wells are kept in confidential status, so we do not see the results unless through presentations. It is possible Emerald has made some big improvements (Emerald did purchase some wells from Liberty, which is known for its top slickwater well design). To figure upcoming production, one needs to consider current well design, but this provides little by the way of production data. So we are forced to compare newer wells with less production data and model decline rates from there. As a general rule, most operators have improved decline rates. The big issue is where the well is drilled, as better producing wells have higher well pressures. This means more initial production is seen, and this means decline can be faster during the first year. An increase in decline by 10% isn't necessarily an issue to the operator if the well produces 150K more bbls of oil in the first 12 months, but we hear a lot about how decline rates are high near Nesson.

Emerald completed 14 wells in 2015. These wells are provided below:

WellDatabase Well Header Report

Report Generated: 1/7/2016 11:20:42 PM

First Prod Date

CUM Oil

CUM Gas

County

Well Name

5/1/2015

32,024

29,147

MC KENZIE

JOEL GOODSEN 7-32-29H

6/1/2015

39,994

30,016

MC KENZIE

GREG MARMALARD FEDERAL 3-28-33H

7/1/2015

20,657

27,307

MC KENZIE

NOONAN FEDERAL 3-18-19H

1/1/2015

46,605

40,182

MC KENZIE

TALON 6-9-4H

5/1/2015

25,761

23,766

MC KENZIE

DUDLEY DAWSON 7-2-11H

7/1/2015

22,803

26,005

MC KENZIE

CLARK GRISWOLD FEDERAL 3-17-20H

6/1/2015

26,360

24,165

MC KENZIE

JOEL GOODSEN 5-32-29H

3/1/2015

51,310

45,654

MC KENZIE

EXCALIBUR 6-25-36H

1/1/2015

1,988

59

MC KENZIE

CAMERON FRYE 2-36-25H

5/1/2015

34,601

31,923

MC KENZIE

JOEL GOODSEN 6-32-29H

7/1/2015

19,050

23,836

MC KENZIE

DUDLEY DAWSON 6-2-11H

3/1/2015

60,926

58,852

MC KENZIE

EXCALIBUR 7-25-36H

7/1/2015

15,783

7,619

MC KENZIE

ERIC STRATTON FEDERAL 5-36-25H

6/1/2015

37,844

37,146

MC KENZIE

DAGNY TAGGART 3-21-16H

(Source: Welldatabase.com)

None of these wells were spectacular. Excalibur 7-25-36H might be the best producing, a little less than 61K bbls/oil. Cameron Frye 2-36-25H is the most concerning as it produced just 2K bbls/oil over the course of the year. This was an 8,700-foot lateral with 50 stages. It differed from other EOX wells as it only used 36K bbls of fluids. This well used 3.3M lbs of proppant. There were two other wells permitted on this pad. One of these permitted wells has been cancelled since this result. Cameron Frye was the southernmost well drilled in 2015. It does create some skepticism as to whether these locations can produce. There has not been a lot of work done in this field to date.

(Source: Welldatabase.com)

These 14 wells produced 435,706 BOE over the course of last year. Each well averaged 31,122 BOE. Total water produced was more than double the volumes of oil.

Date

Oil

Gas

BOE

Water

Wells

1/31/2015

12,161.00

9,321.00

9,321

29,117.00

2

2/28/2015

5,600.00

4,764.00

4,764

15,361.00

2

3/31/2015

28,279.00

32,422.00

32,422

83,894.00

4

4/30/2015

30,103.00

24,312.00

24,312

61,463.00

4

5/31/2015

43,526.00

42,926.00

42,926

122,588.00

7

6/30/2015

65,061.00

59,974.00

59,974

171,989.00

10

7/31/2015

97,818.00

95,772.00

95,772

250,569.00

14

8/31/2015

94,985.00

84,391.00

84,391

203,027.00

14

9/30/2015

58,173.00

51,795.00

51,795

135,855.00

14

(Source: Welldatabase.com)

The above production data is for the 14 wells in 2015. It provides not only monthly production, but shows when wells were added.

(Source: Welldatabase)

Of the 14 wells, four were completed in Boxcar Butte. Three were in Moline and Mondak, with two in Sheep Butte. Just one well as drilled in Charbonneau and Pierre Creek.

(Source: Welldatabase.com)

As we would expect, the fields with more wells completed, produced more oil. Cameron Frye was drilled and completed in Pierre Creek.

(Source: NDIC)

The above map provides the locations of each field in question.

Name

Well Count

CUM Gas (MCF)

CUM Oil (BBL)

CUM Water

Avg. Oil/Well

BOXCAR BUTTE

4

157,818

155,696

367,807

38,924

MOLINE

3

85,235

92,985

229,968

30,995

MONDAK

3

74,781

93,621

224,623

31,207

SHEEP BUTTE

2

47,602

44,811

124,489

22,406

CHARBONNEAU

1

40,182

46,605

119,849

23,303

PIERRE CREEK

1

59

1,988

7,127

1,988

(Source: Welldatabase.com)

The above data doesn't tell the whole story, as it does not provide when the wells were turned to sales. If all wells started producing at the same time, it would be more accurate. It also does not show if any of the wells were shut in to complete adjacent wells. This also decreases producing days. Of these 14, the average number of producing months were five.

It is important to look at specific wells with respect to initial production. When looking at a number of wells, it is very difficult to judge decline rates when multiple locations are already producing. I have listed all 14 2015 Emerald wells below with both oil and natural gas production.

#1 JOEL GOODSEN 7-32-29H

Date

Oil

Gas

5/31/2015

10,442.00

11,310.00

6/30/2015

7,608.00

6,122.00

7/31/2015

4,132.00

3,777.00

8/31/2015

6,796.00

5,214.00

9/30/2015

3,046.00

2,724.00

(Source: Welldatabase.com)

#2 GREG MARMALARD FEDERAL 3-28-33H

Date

Oil

Gas

6/30/2015

13,860.00

12,227.00

7/31/2015

10,784.00

7,112.00

8/31/2015

8,013.00

5,828.00

9/30/2015

7,337.00

4,849.00

(Source: Welldatabase.com)

#3 NOONAN FEDERAL 3-18-19H

Date

Oil

Gas

7/31/2015

5,327.00

10,094.00

8/31/2015

9,186.00

11,623.00

9/30/2015

6,144.00

5,590.00

(Source: Welldatabase.com)

#4 TALON 6-9-4H

Date

Oil

Gas

1/31/2015

11,920.00

9,321.00

2/28/2015

4,979.00

4,761.00

3/31/2015

3,876.00

5,246.00

4/30/2015

4,053.00

3,091.00

5/31/2015

3,739.00

3,095.00

6/30/2015

4,233.00

3,348.00

7/31/2015

4,196.00

3,500.00

8/31/2015

6,456.00

5,249.00

9/30/2015

3,153.00

2,571.00

(Source: Welldatabase.com)

#5 DUDLEY DAWSON 7-2-11H

Date

Oil

Gas

5/31/2015

274

0

6/30/2015

5,101.00

5,724.00

7/31/2015

9,694.00

9,441.00

8/31/2015

4,667.00

3,552.00

9/30/2015

6,025.00

5,049.00

(Source: Welldatabase.com)

#6 CLARK GRISWOLD FEDERAL 3-17-20H

Date

Oil

Gas

7/31/2015

7,274.00

8,457.00

8/31/2015

9,774.00

10,447.00

9/30/2015

5,755.00

7,101.00

(Source: Welldatabase.com)

#7 JOEL GOODSEN 5-32-29H

Date

Oil

Gas

6/30/2015

249

571

7/31/2015

14,688.00

12,188.00

8/31/2015

5,725.00

7,609.00

9/30/2015

5,698.00

3,797.00

(Source: Welldatabase.com)

#8 EXCALIBUR 6-25-36H

Date

Oil

Gas

3/31/2015

10,392.00

9,289.00

4/30/2015

13,166.00

11,657.00

5/31/2015

6,192.00

5,661.00

6/30/2015

6,274.00

5,584.00

7/31/2015

5,007.00

4,312.00

8/31/2015

6,045.00

5,073.00

9/30/2015

4,234.00

4,078.00

(Source: Welldatabase.com)

#9 CAMERON FRYE 2-36-25H

Date

Oil

Gas

1/31/2015

241

0

2/28/2015

621

3

3/31/2015

202

10

4/30/2015

92

9

5/31/2015

184

8

6/30/2015

188

8

7/31/2015

162

7

8/31/2015

159

7

9/30/2015

139

7

(Source: Welldatabase.com)

#10 JOEL GOODSEN 6-32-29H

Date

Oil

Gas

5/31/2015

12,671.00

12,252.00

6/30/2015

8,522.00

7,191.00

7/31/2015

5,398.00

5,888.00

8/31/2015

6,923.00

5,503.00

9/30/2015

1,087.00

1,089.00

(Source: Welldatabase.com)

#11 DUDLEY DAWSON 6-2-11H

Date

Oil

Gas

7/31/2015

7,189.00

12,236.00

8/31/2015

7,507.00

6,092.00

9/30/2015

4,354.00

5,508.00

(Source: Welldatabase.com)

#12 EXCALIBUR 7-25-36H

Date

Oil

Gas

3/31/2015

13,809.00

17,877.00

4/30/2015

12,792.00

9,555.00

5/31/2015

10,024.00

10,600.00

6/30/2015

7,521.00

6,396.00

7/31/2015

6,672.00

5,817.00

8/31/2015

6,999.00

5,783.00

9/30/2015

3,109.00

2,824.00

(Source: Welldatabase.com)

#13 ERIC STRATTON FEDERAL 5-36-25H

Date

Oil

Gas

7/31/2015

7,704.00

4,795.00

8/31/2015

6,226.00

2,157.00

9/30/2015

1,853.00

667

(Source: Welldatabase.com)

#14 DAGNY TAGGART 3-21-16H

Date

Oil

Gas

6/30/2015

11,505.00

12,803.00

7/31/2015

9,591.00

8,148.00

8/31/2015

10,509.00

10,254.00

9/30/2015

6,239.00

5,941.00

(Source: Welldatabase.com)

To best assess the production data from these wells, the production dates need to be lined. This means each well's first month should be compared. This tends to clear up any confusion as to which wells outperformed. It will also help us to see if these newer wells are producing better than Pirate 1. The table below provides oil production in bbls by months of production. Well nine was a huge disappointment, and shouldn't be figured into the numbers as the well has turned out to be a failure. More importantly, it was the first well Emerald completed in this area. This field may not produce, which could mean some of its acreage is worthless.

Well

1st

2nd

3rd

4th

5th

6th

7th

8th

9th

1

10,442

7,608

4,132

6,796

3,046

2

13,860

10,784

8,013

7,337

3

5,327

9,186

6,144

4

11,920

4,979

3,876

4,053

3,739

4,233

4,196

6,456

3,153

5

274

5,101

9,694

4,667

6,025

6

7,274

9,774

5,755

7

249

14,688

5,725

5,698

8

10,392

13,166

6,192

6,274

5,007

6,045

4,234

9

241

621

202

92

184

188

162

159

139

10

12,671

8,522

5,398

6,923

1,087

11

7,189

7,507

4,354

12

13,809

12,792

10,024

7,521

6,672

6,999

3,109

13

7,704.00

6,226.00

1,853.00

14

11,505.00

9,591.00

10,509.00

6,239.00

(Source: Welldatabase.com)

Excalibur 7-25-36H may be the best of the group. It produced 60,926 BOE in seven months. This 8,900 foot, 25 stage lateral is a slickwater frac. It used 223,982 bbls of fluids and 3.8M lbs of proppant. Pirate 1 was an 8,900-foot, 35-stage lateral. It used 246,872 bbls of fluids and 3.9M lbs of proppant. The wells are similar, but Excalibur used less stages. Here is how the two compare over the first seven months of well life:

Pirate 1 (Emerald's First Well)

Date

Oil

Gas

3/31/2013

4,465.00

3,825.00

4/30/2013

19,488.00

19,554.00

5/31/2013

14,943.00

15,413.00

6/30/2013

5,778.00

6,728.00

7/31/2013

7,402.00

6,728.00

8/31/2013

7,809.00

5,589.00

9/30/2013

6,278.00

3,806.00

Totals

66,163.00

61,643.00

(Source: Welldatabase.com)

Excalibur 7 (Emerald's Best Well of 2015)

Date

Oil

Gas

3/31/2015

13,809.00

17,877.00

4/30/2015

12,792.00

9,555.00

5/31/2015

10,024.00

10,600.00

6/30/2015

7,521.00

6,396.00

7/31/2015

6,672.00

5,817.00

8/31/2015

6,999.00

5,783.00

9/30/2015

3,109.00

2,824.00

Totals

60,926.00

58,852.00

(Source: Welldatabase.com)

Although Excalibur is EOX's best well of 2015 (with respect to seven-month initial production), it is not good enough to be economic at $60/bbl oil. Emerald continues to try and beat production of Pirate 1, but not one well since its first has hit those numbers.

(Source: Welldatabase.com)

Since unconventional horizontal production began in the US, big changes have been made to well design. The number of stages and volumes of proppant are important, but there are subtle changes operators make to improve initial production rates. This could mean placing the lateral a few feet deeper, or the type of sand used. All plays have seen in better production rates when wells from the same section are compared. Many say the opposite which is not true, as comparing a core well to a marginal location is not a proper comparison. Comparing wells from differing source rock is also improper. Improved production rates have been seen even after wells have been drilled from a pad. After a pad is drilled, it decreases well pressures in future locations. Locations on the same section can also share resource, which basically means adjacent wells can share fractures. This means either well could produce the crude. This is why it is so impressive when newer wells out-produce.

The map above provides wells drilled and completed by Emerald in the same general vicinity of Pirate 1-2-11H. The above data provides 30- and 180-day IP rates. BOE 30 means barrels of oil equivalent produced in the first 30 days. BOE 180 is the same thing only over 180 days. Pirate 1 has a better 30 day than all but Caper 1. Caper 1 produced less resource over 180 days, as Pirate 1 had a lower decline rate. More concerning is the decreased production to the south. It's fairly obvious that Emerald's northern geology is better in the north when compared to the south. This wouldn't be as big of an issue, but the northern wells aren't that good. This isn't because EOX is a poor operator, just that it didn't do a very good job of picking acreage. From north to south, Pirate 1 is 12 miles from Dagny Taggart. 30-day total production decreased by 43%. If we move another 2 miles south, Greg Marmalard produced 30% less. Geology is not necessarily consistent. Well production can decrease significantly over just a few miles. This is what we are seeing with Emerald. As upside could be limited with respect to its leasehold. The production numbers on the map may seem quite good, but this is not just crude it also includes natural gas.

$60/bbl seems to be a foregone conclusion, but thanks to pricing protection via puts, this is the realized pricing EOX will see in 2016.

(Source: Emerald)

Emerald will not see $60/bbl oil for all production. 4Q15 production guidance is 4,700 to 5,000 BOE/d. This means Emerald would have approximately 2,000 BOE/d unhedged. These prices also do not include differentials. The can decrease price realizations by approximately $10 to $14/bbl. In 1Q16 and 2Q16, it is possible oil prices could average between $30 and $40/bbl. More importantly, we could dive into the $20s if we get bad news on the world demand (China). We think we see $60/bbl oil sometime in 4Q16, but do not think this will be the average. It is difficult to foresee much upside to $60/bbl for Emerald next year. Anything is possible, but a quick move back above $60 would take a significant move.

In summary, it is our belief the Bakken may have more headwinds in 2016 than other US unconventional oil dominated plays. Wider differentials and higher taxes make a difficult situation in the Bakken even worse. Although the Bakken core has some of the best wells in the country, the payzone is deeper. Infrastructure hasn't been built out as well as in the other producing states like Texas. These are just a couple reasons well costs are higher. Operators with core acreage should be fine in the upcoming quarters, but marginal players may have great difficulty. Operators like Triangle, Halcon, Oasis, and Emerald all have a significant number of marginal acres. It's difficult to say how each of these names will do, but we already have seen operator defaults like American Eagle (OTCPK:AMZGQ) and Magnum Hunter. For many operators it isn't a matter of if, it's a matter of when. Emerald may have more problems than other highly levered Bakken operators with poor acreage. None of its acreage would be considered core. In general, results in western McKenzie County are much like those in western Williams and Divide counties. Economics in Divide and western Williams are better because the source rock is at an approximate 1,000 feet less depth.

D&C costs are generally lower. Another issue is Emerald's well design. Its slickwater fracs are much like Liberty's. For those that are unfamiliar with Liberty (private operator), it is known for being one of the top slickwater producers. Both companies use huge volumes of fluids which increases well costs. The large drop in activity in North Dakota and Montana has reduced water costs and one of the reasons we have seen Emerald's well costs decrease. Emerald uses well over 200K bbls of fluids/well. Occidental (NYSE:OXY), Halcon , Whiting, Marathon (NYSE:MRO), Oasis, EOG Resources (NYSE:EOG), and Conoco (NYSE:COP) have all used these volumes, but only Emerald does it on every well. There is no doubt it improves returns, but many operators are unsure if the increased revenues offset additional costs from a payback perspective. The key issue Emerald has is lack of production improvement. It drilled and completed its first well in March of 2013. Not one of the wells it has drilled since has modeled to produce more resource. This includes wells drilled near Pirate 1.

More concerning are the results to the south. 30-day production decreases by 10% within a few miles. 10 miles to the south, we see production over the same time frame decrease by 30% to 40%. A little over 20 miles south of Pirate 1, Emerald had a failed completion. It is possible this acreage is not viable. In a nutshell, Emerald's geology is not that good. Although, it hedged 3,000 bo/d in 2016 at a WTI floor of $60/bbl, it may not be enough. Not only were these hedges added at a considerable cost, but also Emerald may need a higher oil price. Even its best well (Pirate 1) has poor economics. Using $60/bbl. WTI, this wells reaches payback in approximately six years. Although operators have decreased expectations, I don't think anyone would want to wait this long.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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