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Sunday, January 16, 2011

The Importance of Profit Margins in the Bakken

Once in awhile it helps to step back and look at the big picture. The current boom in the North Dakota Bakken began in the 2006 - 2007 time frame.

It is now 2011.

Even the least productive Bakken wells drilled in 2008 and before have now paid for themselves (with some exceptions, I suppose -- more on that later).

Despite the horrendous decline early on, production tends to level off after a time, although continuing to decline at a slower rate. Most experts have opined that Bakken wells could produce for 20 to 30 years.

In addition, even the less productive wells hold the lease simply by continuing to produce. At some point more wells will be drilled in the same spacing unit and/or the original well will be re-fracked.

When I view corporate presentations, I often skip over the bar graphs showing past production and future production. I guess over the years, I have become numb to bar graphs, having seen so many. In addition, these bar graphs don't tell me anything I didn't already know.

What those bar graphs don't show is that a fair amount of that production no longer costs "anything" to produce.

So, what should an investor in the Bakken pay attention to among the larger, more established companies going forward (CLR, BEXP, WLL, OAS, KOG, NOG)? Profit margins.

As more and more of their wells get paid off but continue to produce, all things being equal, profit margins should increase.

Two things, of course, won't remain equal. One is the price of oil and the other is the rate of change in drilling.

CLR says they would like to double the number of rigs over the next 3 - 5 years. Significant increases in rigs will lower the profit margins. Most other Bakken companies plan to increase the number of their rigs but not to the same extent. BEXP said they would bring in one more rig in 2011. KOG will bring in a third rig. NOG has a unique business plan and it's profit margins should be more closely tied to the price of oil.

But wouldn't all companies benefit equally with increase in oil prices, or conversely, suffer equally with decline in prices? No. At the end of the day, it's how well these companies hedge their bets when drawing up contracts for future delivery. Did the Bakken companies see $90 oil a year ago when drawing up contracts for oil to be delivered six months later? For more on hedging see the FAQ tab above; when you get there, search "collars."

Oh, one other thing is not equal. Fracking. The smaller companies are at a disadvantage when it comes to scheduling fracturing or completing the well. But again, that discussion will have to wait another day.

For now, I need to go back and start looking at some profit margin statistics to be ready to compare them with the new numbers that will come out during earnings season. Here those numbers are.

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