Commentary: April 24, 2010

COMMENTARY: April 24, 2010

I remain enthusiastic about the Bakken. These are my observations at this point, to be updated over the next 24 hours based on feedback:

1. For investors, I think share prices of companies working in the Bakken are fair: neither over-valued nor under-valued. Folks have priced in recent events.  There has been a huge run-up in the past month, but I think the run-up is fair, and a new floor is being established. 

2. All things being equal, share prices will follow price of oil. The price of oil appears to be predominantly affected by: a) value of the dollar; b) strength of the global economy; and, c) hedge against inflation. The price of oil has recently trended with the value of the dollar. That will continue but the global recovery / supply and demand will start to play a bigger role. Investing in commodities is often a hedge against inflation.  Share prices are not being affected all that much by share dilution (BEXP, NOG).

3. Everything suggests that the price of oil now has a trading floor of $80 and will gradually trend up. I find it interesting that when oil spiked to $150 a year or so ago, gasoline prices at the pump were not a whole lot different then they are now -- maybe a buck/gallon more in some areas of the country, but folks seemed to manage it. That suggests to me that the price of oil could easily go to $100 by the end of the summer, 2010, without much effect on the economy.

4. If oil hits $100/bbl, a windfall profits tax (disguised as "cap and trade") is all but guaranteed. And, an additional windfall profits tax might be added. 

5. Energy companies in the Bakken are focused on oil and all oil companies have changed their focus from oil & natural gas to predominantly oil.  If the price of natural gas increases significantly, the share prices of all these companies will appreciate significantly.

6. I find it interesting that there has been a paucity of new wells being reported despite number of active rigs jumping to 109. I first noted this in April (this month). Yes, wells can remain on the confidential list for six months and six months ago we had significantly fewer than 109 rigs. However, companies are quick to announce the results if it's a good well. Some folks in the oil patch are opining that drillers are delaying completion of their wells. The Bakken wells are front-loaded (decline rates are horrendous) and the price of oil appears headed higher. If so, it only makes sense to hold off for the time-being in completing these wells. Think about it: in the first month, if a well produces 30,000 barrels and in the third month, the well produces 10,000 barrels, that's a difference of 20,000 barrels. At $80/bbl, 20,000 bbls represents $1.6 million. At $90/bbl, $1.8 million. The well can produce an extra $200,000 at the wellhead just by waiting for price of oil to increase from $80 to $90. Even if oil is not yet selling for $90/bbl, producers are writing contracts (hedging) for future delivery.

7. Backlogs to complete wells are due to fracking. I understand wells are now being scheduled as long as six months out to be fracked. If anyone has actual data, that would be appreciated. 

8. Capacity to ship oil out of the Bakken has caught up with production. North Dakota oil is on par with best ("sweet") oil and sells close to the price one sees on the business network crawlers. There should be little-to-no discount paid for Bakken oil due to transportation costs. 

9. Activity in the reservation was delayed two years compared to activity in the Sanish and Parshall (outside the reservation) due to bureaucratic delays in Washington, DC. Those obstacles have been removed and this year (2010) should be the year in which the reservation (think KOG) catches up. 

10. For folks living and working in western North Dakota, they are in the eye of the hurricane. It may seem calm to many of them, but surrounding them is unprecedented activity. Besides drilling, there is a huge backlog of fracking and companies are working to bring in more crews. There will be more pipeline laid this year, both for local production and for production coming out of Canada on its way to other parts of the US. Interestingly enough, there is even a refinery to be built (in the reservation) and there is a new natural gas gathering and processing plant to be built in eastern McKenzie County. I still think western North Dakota could look a lot like Tulsa, OK, before it's all over, except for the large population centers. The harsh winters and isolation will minimize long-term growth.

11. There was a suggestion some months ago that the center of activity would migrate to Minot for any number of reasons. It appears now that this migration might have been over-emphasized and may not be as great as predicted. Williston and Dickinson remain in the center; Williston more so. But I think Watford City is going to be an interesting city to follow. Stanley has more oil activity than Watford, but as the gateway to the national park, north unit, and being closer to the beautiful Killdeer Mountains (I just love "mountains" and North Dakota in the same sentence) suggests to me that Watford could be the growth story of the year.  Watford City is also the gateway to the western side of the reservation where a lot of activity is occurring.  "Eastern McKenzie County" is also where Oneck Partners is putting a new natural gas gathering and processing plant (CAPEX: $200 million through 2011).

12. It does without saying, but I will say it anyway, this will be the year of the multi-well pad. It will be interesting to see some head-to-head results and some Middle Bakken and Three Forks Sanish results from same pad. EOG and CLR seem to have the lead on multi-well pads.

13. Finally, how could a commentary not include a few comments about initial production (IP) numbers. People have complained that there is not a standard way of calculating IPs across the industry, and that some companies use methods that maximize ("exaggerate") IPs. It now appears that almost all companies are looking at methods to maximize their IPs. This is essential in the cutthroat world to raise capital. It appears that more and more companies will migrate to the initial 24-hour flowback. Having said that, I highlighted a company just a couple days ago that in its conference call said it would continue to use the average of the first 30 days. It spoke volumes to me when CLR said it would go to 24-hour flowback when reporting IPs of its wells.