One Bakken Stock to Rule Them All

Kirk is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In a hole in the ground there lived oil.  Not a nasty, dirty, heavy oil, filled with bitumen and toxins, but a light, sweet, easy-to-refine crude, the kind that means really comfortable margins.  

In the Bakken and Three Forks shale formations of the Williston Basin, the oil boom taking shape is of historical proportions.  Finding exploration and production companies that are successfully finding oil is not that difficult.  Finding companies with the expertise, acreage and scale to generate fat bottom lines is more challenging.

Across the board in the Bakken, companies are ramping up production, which is keeping earnings results from being eye-popping as expenses are high.  Currently, production has not yet reached the halfway point, as only about 7,000 wells have been drilled out of 50,000-60,000 expected over the next decade.  Once enough productive wells have been added, companies will then start to see the ratio of expenses to income significantly improve.  When this happens, free cash flow and earnings will grow significantly.  

Among the players set to benefit the most from this oil boom is Continental Resources (NYSE: CLR). In easy to organize and understand SWOT fashion, here are some of Continental's key strengths, weaknesses, opportunities, and threats.

Strengths

  • Continental is the largest acreage holder in the Williston Basin, at approximately 1.1 million acres (including about 120,000 new acres purchased in November 2012), giving it significant scale of operations.
  • Continental is one of the most advanced "fracking" companies, with both a wealth of experience and technology.
  • Growth continues to be robust with quarter over quarter annualized production growth of 35%.
  • Approximately 40% of Continental's production comes from outside the Williston, primarily Oklahoma, giving it important diversification.
  • The company's balance sheet is exceptionally strong with ample cash and lines of credit, as well as assets exceeding liabilities by more than $2 billion, allowing it to press forward with an aggressive growth plan.

Weaknesses

  • Transporting oil out of the Williston Basin to refiners is still constrained and causes margins to be compressed. (This week, ONEOK Partners, L.P. announced it will not go forward with an expected pipeline to transport oil out of the Williston, further lengthening the time frame of when the company will realize fuller value for its oil.)
  • As with any oil company, the effect of hedging decisions can greatly impact earnings.
  • The financial statement is complex and includes significant compensation to executives, which some might find excessive.

Opportunities

  • Expenses have moderated, after a shortage of frack sand and other materials drove costs up in previous quarters, making earnings estimates for 2013 of $3.20/share appear very achievable.
  • If transportation for oil by pipeline out of the Williston Basin improves, margins per barrel of oil could improve up to $20, adding up to $200 million to Continental's bottom line at next year's expected production.
  • Continental has started using recycled water and cleaner fracking fluids, which should garner it goodwill and gradually widen margins.
  • The company could be able to acquire more acreage from smaller drillers or partial well interests as an operator over time.
  • Natural gas capture could add significant revenue to results, as capture equipment is put into place by 2015 in order comply with EPA requirements.
  • International oil demand continues to drift upward, which will lead to greater revenue over time.  
  • An eventual domestic economic recovery would generate wider profits as the United States is still heavily oil dependent.
  • Continental has the ability and potential to acquire smaller players with complimentary properties.  In North Dakota, Kodiak Oil and Gas (NYSE: KOG) has adjacent and proximate acreage to Continental's, as well as a market cap at a digestible $2.2 billion.
  • Continental is also a potential take-over target by larger players such as Exxon (NYSE: XOM), which recently bought a Williston Basin competitor of Continental's.

Threats

  • The biggest threat to all of the companies using hydraulic fracturing to bring up oil would be if the EPA or other government put a stop to the practice.  While this is not likely based upon recent policy by the EPA, it is not an impossibility.
  • With transportation using over half of all oil, a major breakthrough in battery technology leading to large market share increases for electric and hybrid vehicles combined with a mass shift to natural gas for larger vehicles could reduce top and bottom lines for Continental. 
  • Execution risk due to management hubris.

My take on Continental is that as infrastructure improves and oil demand increases, if Continental can continue to execute, then the company has a very attractive future. 


Kirk and clients of Bluemound Asset Management, LLC own shares of Kodiak Oil and Gas.  Neither Kirk nor Bluemound clients plan any transactions in the next 3 trading days in the mentioned company's securities. Opinions subject to change at any time without notice. Follow Kirk on Twitter @KirkSpano, http://bluemoundam.com or http://AmericanResourceBoom.com. The Motley Fool owns shares of ExxonMobil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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