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4 Areas Kodiak Oil & Gas Investors Must Watch

http://www.fool.com/investing/general/2012/12/11/4-areas-kodiak-oil-gas-investors-must-watch.aspx

Arjun Sreekumar
December 11, 2012

With the end of the era of "easy oil," energy companies like Kodiak Oil & Gas (NYSE: KOG) have increasingly turned toward locations that are harder to reach and harder to drill in its quest for the black gold. North American shale reservoirs have been especially popular.

While these unconventional plays offer unparalleled rates of production, they often carry high – sometimes prohibitively high – operating costs. Take North Dakota's Bakken Shale, for instance.

While the vast and expansive play is responsible for one of the biggest oil booms in decades, the costs to drill and complete a Bakken well routinely exceed $10 million. In addition to equipment costs, labor costs in North Dakota have risen dramatically over the years, adding further pressure on companies to find ways to reduce expenses.

Bakken operators like Enerplus (NYSE: ERF), Oasis Petroleum (NYSE: OAS), Northern Oil and Gas (NYSEMKT: NOG), Whiting Petroleum (NYSE: WLL), and many others are constantly experimenting with ways to cut their costs. Some commonly employed methods include switching between long and short laterals, varying the number of fracturing stages, using a technique called "down-spacing," which reduces the spacing between wells, and various other techniques.

Kodiak is no stranger to these methods and has made substantial progress in reducing its operating expenses, especially this year. In fact, in order to explore Kodiak's cost-cutting measures, as well as numerous other crucial factors affecting its future, I created a premium research report on the company. Hopefully, the report should help investors get a better picture of the company's future. It includes opportunities, major risks, crucial areas to watch, and a closer look at the company's management.

The following is an excerpt from the report that addresses four key areas investors should watch. It's just a sample of one section, but I hope you find it useful.

Four Key Areas You MUST Watch
Following Kodiak's operational and financial progress is easier than with most energy companies, many of which tend to have diversified holdings across North America. By contrast, Kodiak's producing portfolio is exclusively in the Bakken. With that said, be sure to keep an eye on the company's progress in terms of four major indicators of operational and financial health: production rates, cost-cutting measures, cash balance and credit facility situation, and hedge situation.

Production
Kodiak is shooting for 27,000 barrels of oil per day by the end of 2012, so be sure to follow the company's updates on new wells, especially in McKenzie, Williams, and Dunn counties in North Dakota.

Judging by initial production rates, Kodiak is one of the best oil producers in the Bakken. And with the company aiming for a higher number of fracking stages for the remainder of the year, initial production rates and estimated ultimate recoveries should continue to move higher. Kodiak may also have some of the most desirable acreage in the Williston. For instance, its results from the Koala well in McKenzie County were some of the best seen in the entire basin.

Cost-cutting measures
One aspect that Kodiak continues to focus on is reducing operational expenses. The cost of drilling and completing wells in the Bakken is extremely high, often twice the cost in other up-and-coming plays like the Mississippi Lime. Therefore, minimizing costs and maximizing efficiency is crucial for Kodiak, as the company seeks to fund itself primarily through its operating cash flow.

From an operational perspective, significant progress has been made in both drilling and completion. The company currently has an eight-rig count, up from three just a year ago. Drilling days per well have also been reduced to five days, representing a meaningful three-day reduction. As the new drilling crews continue to become more familiarized with the idiosyncrasies of each well, such improvements are likely to continue.

In terms of completion, the company is making solid progress by using innovative techniques, such as cemented liners. This is a completion technique that involves cementing the liner throughout the horizontal wellbore, which has the benefits of greater wellbore stability, greater control of fracture initiation, as well as improved well serviceability.

Kodiak is also seeing meaningful reductions in the time taken to complete a well. Drilling crews have managed to complete two well pads in eight to 10 days by using "zipper fracs," a hydraulic fracturing technique made possible by microseismic fracture mapping. This allows adjacent wells to be fractured in sequence and maximizes the area of exposed reservoir rock.

The company has made significant progress, especially since the third quarter of 2011, in lowering its lease operating expenses, which are the costs incurred maintaining and operating property and equipment on a producing oil and gas lease.

Through efficiency improvements in water handling, Kodiak has managed to bring these costs down to the $5-$6 range per barrel, and management expects further reductions in lease operating expenses going forward. Also, the company's shortened drilling times are a major cost-saver considering that rig burn rates are as high as $100,000 per day.

The block of acreage in Williams county is not nearly as productive as Kodiak's other acreage, yet the company still expects an internal rate of return of 20%, assuming completed well costs of $7 million-$7.5 million and ultimate estimated recovery of roughly 300,000 barrels. This is a good sign because it shows that even its worst-performing wells are easily economical at current oil prices, thanks in part to significant reductions in well completion costs.

Overall, Kodiak continues to see improving efficiencies in its drilling projects, which has led to a meaningful decline in spud-to-rig-release drilling times. Through a combination of operational efficiencies and cost-cutting initiatives, Kodiak's completed well costs for operated wells are now between $10 million and $10.5 million. If the trend of recent cost reductions continues, the company expects to reduce well costs by an additional 5%-10% over the second half of the year and early 2013.

Cash balance and credit facility sit