Received As A Comment To An Earlier Post

The following was a comment to an earlier post ("array" fracking). One cannot easily search comments, so I wanted to bring the comment forward where it could be more easily found.

I like your comparisons of the forward looking PE's. I too don't understand why the market values these Bakken growth companies similar to XOM from an earnings perspective. The only logical explanation that I can up with is the perceived risk that the market must see in these Bakken companies.

Going with that assumption, I don't see risk in the reserve estimates, in fact I see significant upside for all the reasons that you state. "Array" fracking only adds the potential for upside. Early data points from these companies, both what they have stated publicly along with the data that one can see from the NDIC site are certainly positive indicators that we'll see an increase in EUR's as knowledge around the correct spacing evolves.

And then you look at the Lynn Helms discussion around the "gusher" NW of Watford City. Whether that turns out to be a step function in EUR's or not, it illustrates to me that there is the very real potential that a step function could occur in the near future. Certainly a huge financial incentive for the oil companies as well as the service companies to innovate.

There certainly is the risk around regulatory interference in fracking, which should be considered. And there are the macro economic risks that the price of oil could collapse. Hedging helps in the near term, but if prices stay low for too long the hedging won't provide indefinite protection.

I've also read some analyst who worry that the 'break even' point for Bakken oil is quite high. In my view, those analysts have it wrong. They are looking at current returns against current expenditures and concluding that the cost to produce oil is very high. The companies IRR numbers are very strong. If I could get 50%-80% IRR on every dollar I invest, I think I'd be extremely happy.

And then consider cost improvements, differential improvements and additional efficiency gains,and you start to really drive the bottom line figures which only drive the PE down or the share price up.

Up until this past year (or so), some of the Bakken-centric companies (particularly KOG) had outlandish P/Es, but now they seem to have swung to the other end of the continuum.

We may be seeing low P/E's for three reasons:

• most agree the Bakken-centric companies are priced to "perfection." Any glitch (regulatory, global economy, falling oil price, etc) and share prices will fall precipitously (based on history);
• everyone agrees one needs deep pockets to pay for these very expensive Bakken wells; pad drilling makes each well less expensive, but each pad becomes much more expensive; and, 
• relatively unknown to mutual fund managers and retail investors.

Two other thoughts:

• for growth, there are much better opportunities; many feel the "easy" money has been made in the Bakken; considering that one could have bought KOG for 60 cents/share several years ago, and that was before share dilution when additional shares were issued; and, 
• for value, there has been a noticeable turn to dividend-paying companies, which does not include many Bakken-centric operators. 

At least that's my 2 cents worth.

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