My Favorite Oil Plays

Created by EQUITIES Magazine

In a few months, it will be time to look at natural-gas plays. Right now, the storage amounts are astronomical and will hold prices below $4. Natural gas is a regional play—and with new shale-gas reservoirs coming in with profitability above $4, it’s hard to make a case for much pricing pressure until we get below normal reserves. One key issue for natural-gas valuation is usually trades related to British thermal unit content. For example, divide the oil price by six to get the Btu equivalent in natural gas. At these prices, natural gas is a steal from a Btu perspective.

But in the short term, oil is the energy play. It’s priced worldwide and delivered worldwide. Its price is determined on the auction trading floors every day. Pricing pressure comes when excess daily reserves drop below 2 mm barrels a day. Right now, we have 4 mm to 5 mm of excess capacity. But that spare capacity is coming down fast with OPEC reigning in exports, Mexican exports continuing to wither, and canceled drilling projects staying offline.

My favorite domestic oil plays come from the Bakken Shale in North America. The Bakken Shale is an oil-bearing shale present in North Dakota, Montana, and Canada. The U.S. Geological Survey estimates that 3.65 billion barrels of recoverable reserves are present.

The Bakken Shale has continued to attract investment from exploration and production companies because the industry shifts capital during price downturns to places that will earn a better return relative to other higher-cost areas.

The big players in the Bakken Shale are Continental Resources Inc. (NYSE: CLR), EOG Resources Inc. (NYSE: EOG), Whiting Petroleum Corp. (NYSE: WLL), Devon Energy Corp. (NYSE: DVN), Rosetta Resources Inc. (NASDAQ: ROSE), and XTO Energy Inc. (NYSE: XTO). Of these players, Continental and Whiting are the best pure plays and should be bought on pullback.

However, I like the small-cap players better. My favorite is Brigham Exploration Co. (NASDAQ: BEXP). Brigham Exploration has 308,000 net acres in the basin, and company officials said during a recent conference call that the Bakken Shale play is economically attractive to develop at an oil price as low as $40 per barrel. That is the key metric in the Bakken Shale—being profitable under $50 oil. My forecast is for $65 to $75 oil over the next year, which means this new oil produced is highly profitable.

Service costs have also fallen in the Bakken Shale as drilling activity fell in North America. Brigham representatives said that costs were down 20% to 30%, and they expect that decline to reach 40% later in 2009.

They also said in August that Brigham’s Anderson 28-33 well had produced 2,154 barrels of oil equivalent in its first 24 hours in operation, which was more than the 2,021 barrels of oil equivalent that another well, the Strobeck 27-34, had produced in its first day last month.

Brigham officials said that the strong results from the two wells have them also looking toward late August or early September when the third well is due and to mid-September for another well. This well, named Figaro 29-32, could be “particularly important” because it is in a “largely undeveloped area.”

Shares of Brigham had been battered over the past year, falling from a high of $14.50 last September on rising debt concerns and falling oil and natural gas prices. But with these new wells, earnings per share will double in 2010 if they stay on this track. My target is $15. And there is another important play underneath the Bakken Shale—the Three Forks-Sanish

Lynn Helms, director of the state Department of Mineral Resources, said recent production results from 103 newly tapped wells in the Three Forks-Sanish formation show many that are as good or better than some in the Bakken Shale, which lies two miles under the surface in western North Dakota and holds billions of barrels of oil.

Companies have reported that some Three Forks-Sanish wells were recovering more than 800 barrels daily, considered decent by Bakken Shale standards. The Three Forks-Sanish formation is made up of sand and porous rock directly below the Bakken Shale. But geologists don’t know whether the Three Forks-Sanish is a separate oil-producing formation or whether it catches oil that flows from the Bakken Shale above.

State and industry officials are conducting a study to determine whether the Three Forks-Sanish is a unique reservoir. Results from the study could be ready later this year, officials said. It already is spurring some speculation that the state has billions of barrels more in oil reserves.

“Eventually, it could equal the Bakken, which is remarkable, and that’s an understatement,” Helms said.
Promising production results from the Three Forks-Sanish could mean that companies that come up empty in the Bakken Shale could use existing leases to drill in the same area for Three Forks-Sanish oil

Stay tuned.

By Tobin Smith
Tobin Smith is the founder of ChangeWave Research.