Bakken Warning Is a Spoiler: Protect Your Portfolio

The federal government recently published a safety alert, warning that oil produced in the Bakken region is more flammable than traditional crude benchmarks. The announcement came after a string of rail accidents involving Bakken crude resulted in explosions, raising serious concerns regarding public safety.

In order to prevent such mishaps, the Department of Transportation has advised railroad operators to remove hazardous materials and gases from Bakken crude before transporting it. Fearing that this might inflate rail transportation costs and impact oil supply, shares of Kodiak Oil & Gas  (NYSE: KOG  ) , Continental Resources  (NYSE: CLR  )  and Oasis Petroleum  (NYSE: OAS  )  were sold by investors and speculators. What should be your next move? Let's find out.

Root of the problem
Bakken crude is known for its hydrocarbon-rich composition and high calorific value. The North Dakotan crude benchmark is generally lighter than other heavy crude benchmarks, making it easier to refine and convert into popular petroleum products like gasoline and diesel. The problem, however, lies with its mode of transportation.

Federal agencies stated that transporting Bakken crude is unsafe without the proper removal of hazardous materials and gases from liquids. Pipeline operators have the required infrastructure to test liquids and remove hazardous gases from them. However, railroad operators – which collectively transported about 70% of the crude produced in the Bakken region last November – lack such infrastructure.

The obvious solution would be to retrofit railcars so that minor accidents don't result in explosions. But the solution, unfortunately, isn't that simple.

Gordon Delcambre, a spokesperson of the Hazardous Material Safety Administration, believes that it will take at least a year for federal regulators to order railcar upgrades. Even after the regulation is introduced, the retrofitting of all the railcars operating in the Bakken region will take another 10 years while incurring up to $5 billion in costs.

With the option of retrofitting cars seemingly unfeasible, I believe that the federal authorities are left with only two options.

1) They can permit the unrestricted transportation of Bakken crude via rail. Meanwhile, rail operators can build the required infrastructure to separate gases from liquids. This move will jeopardize public safety.

2) They can introduce stringent regulations to ensure public safety. However, the movement of Bakken crude via rail maybe permitted only after hazardous gases have been removed from liquids.

If the federal authorities go with the second option and limit rail transportation, Bakken oil producers won't be able to move about 30% of their product to the market. This can result in a supply glut in North Dakota, and consequently, oil prices in the region will decline. So, top oil producers in North Dakota are exposed to a great deal of risk.

Susceptible to Bakken downfall
In case of a supply glut, I believe Oasis Petroleum, Continental Resources and Kodiak Oil will be severely hit. All three companies have made large investments in the region, with a primary goal of increasing their Bakken oil production.

Oasis Petroleum, for example, spent about $1.52 billion last year to increase its North Dakotan acreage by 51.3%. With about 492,000 acres of leased land, management expects to boost its overall production by about 22%. In addition, the company is spending $1 billion annually to consistently grow its production in the region.

Similarly, Kodiak Oil & Gas is also betting on the North Dakotan oil boom. The company currently owns about 192,000 acres in the region, and is investing $1 billion every year to increase its acreage. On the back of its recent $660 million worth of asset acquisition, management aims to hike its overall production 20% by the end of fiscal year 2013.

On the other hand, Continental Resources is the largest oil producer in North Dakota. With 1.2 million acres of leased land, its Bakken oil production stood at 94,500 barrels of oil equivalent during the previous quarter – representing 67% of its total production. Management has earmarked $2.5 billion for fiscal year 2014, to drill 120 wells in the Bakken region and hike its overall production by 28%.

Final words
From what I understand, if federal agencies introduce stringent regulations to ensure public safety, Bakken oil transportation via rail can suffer over the short-medium period. Keeping that in mind, investors might want to avoid investing in Oasis Petroleum, Kodiak Oil, and Continental Resources due to their huge exposure to North Dakota.

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Comments from our Foolish Readers

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  • Report this Comment On January 17, 2014, at 1:17 PM, RealityCounts wrote:

    What's Hedging, then? Is Hedging irrelevant?

    The Bakken Region has the most desirable crude sought by refiners, is that not true?

    Once the EPA publishes an opinion or a warning, do think the aforementioned CEO'S collectively ignore those warnings? I don't think so...

    By today, you know what Canada thinks of our lack of inertia in 'New Energy Initiatives' let's call them- that, in most people's opinions, should be fueling one of the greatest 'Boom Cycles' our two Countries have ever seen, all thanks to our own natural resources.

    Of course, we can stay mired with YOUR opinions while Americans continue to pay the Middle East and others a paltry few Billion $$$ in effective taxes every week-all the while back-door funding Terrorism in Middle East rogue states. Yeah, don't kid yourselves-nor us, your readers...

  • Report this Comment On January 17, 2014, at 2:06 PM, BuzzVestor wrote:

    Hi RealityCounts,

    I really don't see how your comment is constructive in any way. You mentioned refiners, while the basis of this speculative article is how a potential supply glut can impact Bakken oil producers.

    Regarding hedging, as far as I can recall, Kodiak had about 60~62% hedged positions. So, what happens to the remaining ~40% production?

    And I agree with you, the U.S should become self reliant on its energy needs. But to do that, it can push for pipeline projects rather than putting the lives of its taxpayers at risk.

    So, if you have something constructive to add/discuss, it'd be great !

    Thanks for reading

    Author

  • Report this Comment On January 17, 2014, at 2:11 PM, Ruth wrote:

    I know most of you think that the Keystone pipeline is not being built. False !!!!. The Federal Govt. can only regulate if it crosses the Canadian border. The construction of the segment from Cushing OK to Baker MT. has been going on for a couple of years. The piece from Cushing OK to Houston is already completed and is starting up right now. Completion of the part to Baker Mt. will allow a lot of Bakken crude to go by pipeline.

  • Report this Comment On January 17, 2014, at 5:27 PM, bfrancis73 wrote:

    I can't stand motley fool……contradicting articles by someone who doesn't have a clue and a bunch of ads

  • Report this Comment On January 22, 2014, at 7:20 AM, scottorado wrote:

    Piyush, To say that "Bakkan crude oil is hydrocarbon rich" is an incredibly stupid statement. You should change your name to "Master of the Obvious" Furthermore to say that "oil produced in the Bakkan region is more flammable than traditional crude benchmarks" shows that you are just as ignorant as the regulators in the federal government. Bakkan crude with an API gravity 36-40, is heavier and therefore has LESS light ends than West Texas Intermediate @38-41 degrees, and many others. WTI is THE US MAIN BENCHMARK traded on Nymex. Other common crudes like Louisiana Light Sweet or Tioga Sweet are 42-45. With many others even more volatile, with even higher quantities of the dissolved gases methane CH4, Ethane C2H6 or Propane C3H8. Butane C5 and all other hydrocarbons are liquid at standard temperature(60 degrees) and pressure(1 atmosphere) Crude produced from the Bakkan and Three Forks Shales are "sweet" & are NOT hazardous. You can drink it, It has medicinal qualities, think Vaseline.

    Sour crude from Venezuela with Hydrogen Sulfide gas over 1% is hazardous.The current administration is anti petroleum because they believe the global warming hoax. They always try to put a negative spin on anything to do with God given.petroleum. Its now a "fossil fuel" Such a stupid old fashioned idea you know. And hydraulic fracturing is now FRACKING with a K, synonymous with f__king. What milarky!

    Trust me the oil companies, railroads & pipeline companies WILL find a way to get their production to market. It's only appropriate that you are posting on the "Fool's Website".. Did you front run this stupid article by getting short? This chart looks bullish to me, bouncing off the weekly 50sma, converging with old resistance now support.

    As they say in the patch, "Keep it turning to the right!"

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