Bakken Update: Wider Differentials And Lower NGL Pricing Continue To Hurt Producers

by: Michael Filloon

The second quarter has shaped up to be an interesting time in the Bakken. Whiting Petroleum Corporation (NYSE:WLL) missed earnings, but did better on production than expected. The story was the same for Newfield Exploration Co. (NYSE:NFX), although results were much less levered to the Bakken than Whiting. Natural gas prices weren't the culprit, as differentials widened and natural gas liquids pricing also dropped off. Natural gas liquids were especially tough on companies, as most companies do not hedge. Without protection, the losses were especially hard.

Marathon Oil Corporation (NYSE:MRO) surprised at earnings with respect to the Williston Basin. It has pushed forward in the Eagle Ford increasing production by 50% compared to the first quarter. Woodford production was up 24%, but only 4.7% in the Bakken. Marathon announced it would be decreasing its number of rigs in the Bakken from 8 to 5 for the remainder of the year. It stated it may maintain this number through 2013 if oil and natural gas prices do not recover, or costs improve. This compares to 18 rigs in the Eagle Ford. Marathon is also reducing development of it Woodford and Niobrara plays. An interesting point made by Marathon on costs was its continued downward push on pressure pumping in the two northern basins.

Looking at the numbers, Marathon did give some very good information with respect to why we are seeing results that beat on production, but missed on margins.

Marathon Price Realizations

1Q 2012 2Q 2012 2Q vs. 1Q
U.S. Crude/Condensate($/Bbl) 97.28 88.68 (8.60)
U.S. NGLs($/Bbl) 51.55 40.54 (11.01)
U.S. Nat Gas($/MCF) 4.13 3.42 (.71)
NYMEX Prompt WTI($/Bbl) 103.03 93.35 (9.68)
Brent($/Bbl) 118.49 108.42 (10.07)
NYMEX Settle Nat Gas($/MMBTU) 2.74 2.22 (.52)

This is only a partial list of its price realizations, but it shows issues in the United States and how it affected the quarter. The most important number was NGL, as pricing was down more than 20%.

Denbury Resources Inc. (NYSE:DNR) saw production growth decrease this quarter. This was an effect of reducing its operated rig count. It noted a reduction in service costs and increased efficiencies as well. It was sheltered from decreased NGL prices, as it is only 2.5% of production, with most being in the Bakken. Denbury's realized oil price was down $7 on the quarter. Its tertiary oil production saw big improvements in differentials, which more than offset the Bakken. Bakken production sold at a $20 discount to NYMEX in the second quarter. This was up from $17 in the first. The majority of this difference was from NGL pricing. This year, Bakken differentials have varied from the low teens to upper 20s, but Denbury sees a positive move in the third quarter.

Average well costs in the Bakken for 2012 have been $10.5 million, but the most recent wells have averaged $10 million. Pad drilling and decreased oil service costs are the biggest factors. This is significant as Denbury had average well costs of $11 million last year and $10 million in the second half of 2012. Given the trend in pricing, it believes this will continue going forward. Differentials are expected to average in the low- to mid-teens, but large moves are still expected. Denbury is not looking to do floods in the Bakken at this point, although many have anticipated this since it acquired the acreage.

Hess Corporation (NYSE:HES) saw a big increase in production year over year, but more important was its crude oil rail loading system. During the second quarter, it shipped 29,000 barrels/day to higher value markets. Hess is ramping up its investment here, and this could have more to do with its ability to transport the crude than improvements seen in drill and completion times, or IP rates. Hess may have done the best job of decreasing well costs. Its 38 stage hybrid completions had a cost of $13.4 million. Its 34 stage sliding sleeve completions have averaged costs of $11.6 million. By the fourth quarter, Hess estimates these costs will be below $10 million. Its original well cost estimate, was $8.5 million/well.

The story remains the same for most of the operators in the Bakken. Difficult NGL pricing and oil differentials are pushing operators to find ways to decrease costs. Pad drilling, sliding sleeves and white sand are all good ways to achieve this, but more important is oil pricing. Companies like Hess are shipping oil to markets that have better differentials. We are seeing this in the refiners, as well as Tesoro Corporation (TSO), which has been shipping Bakken oil to its western refineries providing cheap feedstock. Costs should continue to decrease into 2013, but the key is differentials going forward.

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

Additional disclosure: Here is a list of my current portfolio: WNR, HFC, TPLM, BAS, NOV, FTK, RIG. This is not a buy recommendation.