As the old saying goes, "you need to spend money to make money." Bakken-focused Kodiak Oil & Gas (NYSE: KOG ) is taking that saying to heart by making a very big bet on the Bakken this year. In fact, when you consider that the company's entire enterprise value isn't much more than $4 billion, what I'm about to tell you will seem especially large.
What's interesting, though, is that many investors will miss the fact that Kodiak just upped the ante on its big Bakken bet by about 25%, which is a lot considering it was pretty large already. The announcement was tucked in at the very end of the company's press release announcing its second-quarter production results. The company said:
In conjunction with the anticipated drilling and completion schedule in the second half of the year, the July 2013 acquisition, combined with the contemplated transactions affecting our working interest in its operated units, we are increasing the estimated full year capital budget to a range of $950 million to $1 billion. This budget contemplates approximately 100 net wells being completed in 2013.
Initially, Kodiak was expecting to spend about $775 million this year in capex to drill 75 net wells. That was a slight boost from last year's $750 million capex budget, though the company did end up spending a total of $810 million last year. Kodiak has steadily boosted this year's planned capex, and as recently as last month it was expecting to spend about $900 million to drill 83 net wells:
That being said, a billion dollars to drill 100 wells is a lot, but there have been a couple of major changes since the year started, which has caused the company to shift into a higher gear. First, Kodiak made a large $660 million acquisition, which caused it to add $50 million to this year's budget. More recently it would appear that the company isn't done buying, as the press release pointed out that Kodiak is contemplating transactions that would affect its interest in operated wells, which would suggest it's working to buy out one or more of its partners. This leads me to the final change since the year began: Oil prices are much higher, as the WTI-to-Brent spread has narrowed from $20 a barrel this past February to recent levels, which have reduced that spread to next to nothing. That means Kodiak and its Bakken peers are earning more for each barrel of oil produced, which is what would appear to be the driving force behind the company's decision to spend additional capital this year.
Further, high oil prices, when combined with drilling efficiencies, is a terrific recipe to boost the bottom lines of Bakken producers. That's one reason Kodiak sees fit to boost its spending to take advantage of these higher profits, though it won't benefit as much as some of its peers. For example, Oasis Petroleum (NYSE: OAS ) has slashed 23% off its drilling costs over the past year to get its well costs down to around $8 million, while Kodiak's are around $10 million. That's enabling Oasis to drill the same number of wells this year with $111 million less capital. Higher oil prices make the return on the capital being spent that much better.
Overall, oil companies are getting much better at drilling the Bakken, which is really having an impact on returns. Continental Resources (NYSE: CLR ) , which is the top driller and producer, was able to shave 73 days and $7.5 million off the costs of drilling six wells by moving to multi-pads. That's a 36% cycle time improvement, which is improving the company's returns when oil is over $100 from a 50% rate of return to an even better 60% rate of return.
Kodiak has been been improving its well costs and average drilling days, though it's not yet to the level of Continental or Oasis. Overall, the company has improved well costs from $12 million all the way to $10 million this year while it's planning on slicing more than 10 days off its average drilling days. Significant cost reduction when combined with higher oil prices will really pad Kodiak's bottom line, which will go a long way in funding the company's bigger its Bakken bet this year. While I can't say for sure if this will indicate that Kodiak will report blowout quarterly results on Aug. 1, it would seem to indicate that the company is getting a great return on the money its spending this year.
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