In Bakken Oil Boom, Oil Hunters Diverge on Strategy

NEW YORK ( TheStreet) -- References to oil rig workers sleeping in the beds of their pickup trucks in McDonald's parking lots have become synonymous with the oil boom of North Dakota.

However, all acreage is not created equal in the oil and gas exploration and production (E&P) business, and that's becoming a much more important investing dictum -- and dividing line for E&P stocks -- in one of the biggest U.S. oil booms in history.

Recent earnings from a wide swath of E&P companies operating in North Dakota show how quickly and broadly strategies to tap the North Dakota play are diverging. Crude oil prices have moved up significantly this year from what was already attractive pricing for E&Ps in 2011. However, costs in North Dakota continue to be a headwind for many E&P companies. Even if costs per well in the North Dakota Bakken have reached a peak between $9 million and $10 million, the costs are not declining.

As E&P stocks continue to ride the crest of high oil prices, it becomes more important for energy stock investors to weigh potential reward from North Dakota drilling versus too much reliance by any one E&P on what remains a high cost play.
More and more U.S. oil is coming from North Dakota, but energy stocks may be getting too much credit for the boom relative to the costs.

"The bloom is off the rose. The land grab is over," said Sterne Agee analyst Tim Rezvan.

Chesapeake Energy ( CHK), the poster-child for the U.S. oil and gas acreage land grab, revealed in its recent earnings that some of its Williston acreage in North Dakota had been a disappointment and it was redirecting assets, chasing E&Ps like Whiting Petroleum ( WLL), which has operated in "sweet spots" within the North Dakota oil play.

"We drilled a couple of wells up there and we're not crazy about what we found to date, so kind of recalibrating there ... And I suspect the western part of our acreage, which kind of abuts where Whiting is operating, will probably work out fine," Chesapeake CEO Aubrey McClendon said.

Other sizable E&Ps with acreage across the U.S. are simply pulling out of North Dakota for the time being because of high costs leading to inferior returns relative to other regional assets.

EOG Resources ( EOG) and Occidental Petroleum ( OXY) both cited the high costs of operating in the Bakken as reason for redirecting capital in 2012.

EOG noted in its earning call that even though it has a built-in advantage in the Bakken with a transport system that reduces cost relative to peers, it is still de-emphasizing this play in the current environment.

"In the North Dakota Bakken, we continue to achieve consistent results, and the play contributed to the 13% total liquids growth realized in our overall Rocky Mountain operating area in 2011 over 2010," the company said. "We're reducing our Bakken rig count in 2012 because a majority of our acreage is now vested, and we, therefore, expect 2012 volumes to decline a bit. Some analysts have recently noted that Bakken economics may be less than stellar for many companies."

EOG says it doesn't just have a transport advantage but the highest well reserve rate in the Bakken. Yet EOG is clearly betting that with its leases now secure -- it doesn't need to drill to maintain drilling rights -- there will be a better time in the future to capitalize on the Bakken at a higher return potential.

"This is a heated basin in servicing and water disposal costs and companies with a longer term view, like OXY or EOG, with other levers to pull can go elsewhere," said William Butler, Stephens analyst. "EOG was one of first in the play and they don't need to push inventory," Butler said.

Occidental Petroleum, which pegged costs per well in the Bakken at $8 million to $8.5 million -- slightly below some industry estimates of $9 million to $10 million -- said on its earnings call that the Bakken costs are, "still too high for what you get relative to our other projects...So we've cut back."

Occidental gave two Permian basin examples for comparison purposes. Completed well cost in the Wolfberry can range from $2 million to $2.5 million, while in the Bone Spring, costs can range from $6 million to $7 million per well.

"Occidental really doesn't have scale in the Bakken, and it's one of the most return-oriented companies among E&Ps. Plays like California remain more lucrative for them," added Brian Youngberg, analyst at Edward Jones. "It doesn't mean they abandon North Dakota, but when you look at the cost pressures and where the returns are, it's better for them to show their flexibility," Youngberg said.

Longer-term, Occidental Petroleum has the flexibility to move in any direction it wants with North Dakota, according to Butler. The company could sell its North Dakota acreage and focus on its higher-return plays, or it could ultimately consolidate smaller operators in the Bakken at a later date.

For EOG, the Eagle Ford opportunity remains a much more economic play than the Bakken given current costs. "It just makes more sense to focus there," Youngberg said.

The shying away from the Bakken by some of the larger, independent E&Ps raises the issue of risk in the North Dakota pure-plays. EOG and Occidental can wager that they will ultimately receive a higher return for their Bakken oil when costs trend down.

For the companies operating in the North Dakota sweet spot, like Continental Resources ( CLR) and Whiting Petroleum, higher risk has led to higher returns but the smaller hand to play in terms of acreage diversity remains a threat, analysts say.

It remains a tight market, but for those with the best acreage drilling will continue, though increasingly operational efficiencies will come into play.

"High oil prices have been a big part of the trade even as logistical issues plague the basin. We won't see higher costs from here, but now the question is, 'Can you get drilling efficiencies to bring costs down?'" Butler asked. "With many of the names there are high expectations priced into shares," the analyst added.

Stephens analysts' note that among the North Dakota plays, Whiting Petroleum has underperformed Continental Resources, and it has slightly more diverse holdings to propel its shares.

"We would focus on Whiting. Like Continental, it is mostly Bakken, but it has assets in the mid-Continent and Texas. Yes, it's a Bakken proxy, but it hasn't enjoyed the extended run of some of the other names, and it just beat and raised on production, and has more room to run."

A prime example of the Bakken battleground stock issue is QEP Resources ( QEP). Stephens rates QEP as one of its best ideas in the E&P space, and cites its diversified approach.

Stephens likes that the company can reallocate assets from the uneconomic Haynesville dry gas basin. "QEP can emphasize North Dakota more in 2012 and is still cheap in our eyes," Butler said.

The beauty of the Bakken boom remains in the eye of the beholder, though. Sterne Agee's Rezvan sees a different scenario in QEP's decision to move to North Dakota in 2012, and downgraded the stock on Thursday to a sell after a 20% rise in February.

QEP had delayed development in the North Dakota Williston basin due to high costs last year, and now is ramping the play only a few months after saying it was uneconomic. Rezvan doesn't want to assume the risk of what this shift in strategy could mean.

What has changed since QEP last decided to hold back on North Dakota amid the high costs? The price of crude oil was $90, as opposed to as high as $107 on Thursday, and even as costs remain at a peak, wells are being completed more quickly in North Dakota. "My concern is that they are ramping even though well costs have not come down and that indicates they don't have other places to go," Rezvan said.

Rezvan argues that while crude oil prices have trended upward since last year, the biggest driver in re-ramping the Williston is a lack of repeatable resource plays for liquids, more so than absolute returns. "Many other operators with Williston exposure are re-deploying capital to other onshore liquids plays in 2012 because of inferior returns. We believe QEP lacks the inventory depth to do so itself," the analyst wrote.

The QEP story is one that indicates the rapid maturity and reliability of North Dakota as a resource base, but also the potential for E&P -- and energy stock investor -- over-reliance on it relative to valuation.

"They have other liquids plays, but some are very gassy with some liquids. With few repeatable resource plays in development mode outside the Williston Basin, a play the company recently delayed ramping because of cost issues, we believe QEP is likely to underperform our E&P coverage group over the rest of 2012. The QEP trade has done well and valuation has been brought into line," Rezvan wrote.

-- Written by Eric Rosenbaum from New York.

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