Oil pump jack in the snow

Image source: Getty Images.

Bakken shale-focused producer Oasis Petroleum (OAS) rewarded investors handsomely last year. The company rode the crude oil rally for most of the year before breaking away in the late fall:

OAS Chart

OAS data by YCharts.

Fueling that sharp rebound was a transaction that set up the company to grow at an accelerated rate over the next few years, even at lower oil prices. As a result, the company expects to deliver robust production and cash flow growth this year, which could fuel even more gains in the stock as long as oil prices don't falter.

What went right last year?

Oasis Petroleum took a very cautious approach entering 2016. The company set its drilling budget at $200 million, which was 57% lower than it spent in 2017, and roughly matched anticipated cash flows at $35 oil. That lower spending rate meant that the company would not be able to drill enough wells to keep its production from declining. Initially, the company expected output to fall from 2015's average of 50,477 barrels of oil equivalent per day (BOE/D) to a range of 46,000 to 49,000 BOE/D in 2016, or down 6% at the midpoint. Compared to larger Bakken Shale rivals Continental Resources (CLR) and Whiting Petroleum (WLL), that was a very modest decline; Continental initially expected its production to fall 10%, while Whiting Petroleum forecast a drop of 14%.

Oasis Petroleum, however, beat those expectations due to stronger well performance and lower costs. That led the company to increase its full-year production guidance to between 48,500 and 49,500 BOE/D by the second quarter, before boosting guidance again in the third quarter to a range of 49,300 to 50,000 BOE/D, without adding any money to its drilling budget. Instead, the company took advantage of higher oil prices to generate free cash flow, which it used to strengthen its balance sheet as total debt fell $100 million by the end of the third quarter.

Oasis Petroleum used its strong balance sheet and surging stock price to acquire 55,000 net acres in the Bakken from SM Energy (SM -2.92%) for $785 million in October. Oasis was able to buy the acreage because SM Energy needed the cash to acquire more land in the Permian Basin. The deal added 12,400 BOE/D of production while increasing Oasis' drilling inventory by 25%.

Aerial view of a drilling rig in the Bakken shale

Image source: Hess.

What needs to happen in 2017 to keep the momentum going?

As a result of its drilling momentum last year, and the SM Energy acreage acquisition, Oasis Petroleum expects to ramp up its drilling activities in 2017. The company intends to double its rig count in the Bakken this year to four, as long as oil is above $50 per barrel, while planning to add a fifth rig next year. These rigs put the company on pace to deliver a compound annual production growth rate in the mid-teens through the end of next year, and absolute production growth of 65% by the end of 2018 when factoring in the SM Energy transaction.

That is a compelling growth rate, especially for the Bakken, where drilling returns are not quite as high as some of the other shale plays. It compares very favorably to Continental Resources, which sees its production in the Bakken rising 26% from its 2016 exit rate to its 2017 exit rate.

However, it is worth noting that on an apples-to-apples basis Continental Resources' companywide production will only increase 4% this year, though that is on a production base more than three times Oasis'. Furthermore, Continental's plan requires $55 oil, and half of its well completions will come from the higher-return STACK and SCOOP plays of Oklahoma.

Another comparable is global oil giant Hess (HES 0.10%), which sees its Bakken production averaging between 95,000 and 105,000 BOE/D in 2017. At the midpoint, Hess' Bakken output would be up 5% from its fourth-quarter average rate of 95,000 BOE/D.

Clearly, Oasis is growing at a compelling rate this year for a Bakken producer, which alone should continue its momentum, especially considering that the stock still sits 75% off its all-time high. However, the company could make up more lost ground by pushing its costs down and well productivity up, so its drilling returns can rival those of the Permian Basin or STACK and SCOOP plays. That would enable the company to grow even faster, which would certainly catch the eyes of investors.

Investor takeaway

Oasis Petroleum enjoyed quite a run last year, as the company's ability to cut costs and improve well productivity put it in the position where it could restart its growth engine at lower oil prices. As that growth materializes this year, it should provide the stock with the fuel needed to continue its recovery. Meanwhile, if the company can get a combination of even higher oil prices and a further improvement in drilling returns, it would have enough lighter fluid to ignite another big rally in 2017.