Why Whiting Petroleum Is Set For A Strong 2017

| About: Whiting Petroleum (WLL)

Summary

WLL was recently upgraded to a Buy with the potential to deliver strong upside in 2017 due to the possibility of higher oil pricing and lower costs.

WLL forecasts that it will be able to increase reserves by 40%, while costs will rise only 12.5% due to the deployment of advanced completion methods.

WLL’s total production expenses have declined over 41% in 2016 so far to $10.42/barrel as a result of better production efficiency, indicating better margins next year due to better pricing.

Better pricing will improve WLL’s revenue, which could lead to upside of 33% based on the company’s price to sales ratio.

Shale oil producer Whiting Petroleum (NYSE:WLL) is all set to benefit from an improvement in oil prices going forward as the company has managed to reduce its losses even in a challenging environment due to its cost control. In fact, driven by its focus on reducing costs, Whiting was recently upgraded by Stifel to "Buy" from "Hold" with a price target of $15. This implies a 25% upside potential as compared to the current levels.

In my opinion, the recent production cut decision undertaken by the OPEC and non-OPEC countries, which will create a supply deficit of close to 600,000 barrels per day next year, will prove to be a tailwind for Whiting. This is because due to the production cut, there will be a stark inventory correction in the oil market that will lead to oil prices of at least $60 per barrel next year. In this article, we will see how Whiting is placed to take advantage of a potential increase in the oil price.

High-quality acreage and enhanced completion methods have led to low costs

During the third quarter, Whiting had generated $151.31 million in cash from operating activities and exceeded its capital spending for the quarter by $66 million. Thus, Whiting was able to generate substantial free cash flow last quarter as it spent less capital, but the good thing was that the money was spent in the right areas with high-quality acreage.

For instance, Whiting completed 13 new wells in McKenzie County area of the Williston Basin with average initial production rates of 3,727 barrels of oil equivalent per day. The reason behind this high average rate in the McKenzie country is that Whiting utilized a longer frac design that allowed it to exceed the earlier 900 MBOE type curve earlier.

More specifically, the use of longer fracs has allowed Whiting to move a larger portion of its reservoirs into the high-pressure zone of the wells, which is why it was able to enhance output. Whiting needs to spend just $0.5 million more on completion for a 10,000 lateral length well to enhance output by 41%, as compared to a shorter lateral length well. As a result of such moves, Whiting Petroleum believes that it will be able to increase reserves by 40%, while costs will rise only 12.5%.

Due to the advanced completion methods, Whiting has managed to bring down its drilling times. The average time to drill a well from spud to spud in the Redtail area has been reduced to seven days, down 30% as compared to the drilling time in the third quarter of 2015. Additionally, during the third quarter, Whiting drilled a 1,280-acre spaced well in 2.75 days from spud to total depth, which is way lower than the average of 4.5 days from spud to total depth in the second quarter.

Apart from its completion methods, Whiting also is making its transportation more efficient. For instance, the construction of a new fresh water gathering system will lead to a reduction of around 75,000 truck trips per year going forward, therefore leading to lower costs.

Effect of lower costs on earnings and stock price

As a result of its efforts to enhance production and lower costs at the same time, Whiting has managed to lower its lease operating expenses. For instance, in the first nine months of the year, Whiting's lease operating expenses have declined 12.6% as compared to 2015 levels. At the same time, its exploration expenses also have gone down close to 55% as Whiting has focused on increasing production from specific areas.

As a result of the decline in the lease operating and exploration expenses, Whiting's total production expenses have declined over 41% in 2016 so far to $10.42 per barrel. In comparison, Whiting's average realized price per barrel this year has been $41.88, indicating production margins of over $31 per barrel. Thus, as the oil pricing scenario improves next year to an average of $60 per barrel, Whiting's production margins will increase significantly if it manages to hold on to its cost levels.

Driven by an improvement in its margins Whiting will be able to grow its bottom line substantially. This is evident from the chart given below:

Whiting Petroleum's Financial Summary

2014 A

2015 A

2016 E

2017 E

2018 E

Revenue ($ billions)

3.08

2.05

1.33

1.65

2.08

YOY Change

-33%

-43%

41%

26%

EPS

$0.53

$1.92

$(1.92)

$(0.65)

$(0.39)

Source: Guru Focus

As seen in the table above, Whiting is expected to turn in a huge loss this year as compared to last year. However, the company's bottom line will continue to improve going into the next couple of years, primarily driven by an improvement in the top line. Since Whiting is currently a loss-making company, in order to judge the stock price impact, we will be using the price to sales ratio.

Whiting's trailing twelve month price to sales ratio stands at 2.40. If the company manages to hold this price to sales ratio going into 2017, its market capitalization will increase to $3.96 billion as compared to the current market capitalization of $2.98 billion. Since Whiting has 246 million shares outstanding, a $3.96 billion market cap translates into a stock price of $16 per share, and this implies 33% upside in 2017.

Conclusion

Whiting Petroleum's focus on adding high-quality acreage and reducing operating expenses will lead to both top and bottom line improvements, especially as oil prices improve. As we have already seen, Whiting seems on track to deliver strong upside next year, which is why investors should consider remaining invested for more gains.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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