Kodiak Oil & Gas (NYSE: KOG) has spent billions to build out a premier position in the Bakken Shale. A good portion of that spending has been fueled by debt as the company has significantly outspent its cash flow. To date the company has racked up $1.55 billion in senior notes to go with another $600 million drawn on its revolver. That leaves the $5 billion company with just about $500 million in liquidity.
Some read that and might think that Kodiak is in a precarious position. However, that is simply not the case as Kodiak's cash flow is actually now starting to catch up to its spending. If everything goes according to plan, 2014 could be the year that Kodiak runs at a break-even pace. Once that happens, Kodiak has the potential to really fuel some compelling future returns.
Kodiak has often been criticized for spending more money on its wells than some of its peers. With capital so precious, cheaper wells enable a company to drill more wells for less money. However, over the long term what's even more important is a company's ability to produce more oil out of existing wells. Kodiak chose to take the long-term approach when it decided to use ceramic proppants instead of less expensive raw frac sand. It's a move that as time goes on should really serve it well.
The main selling point of ceramic proppants like those produced by CARBO Ceramics (CRR) is the higher estimated ultimate recoveries. According to CARBO, ceramics could lead to a 30% improvement in estimated ultimate recoveries. That's a significant increase in the amount of oil recovered, which will also increase the return on investment for the producer.
For example, in comparing returns of Bakken producers we'll take a look at top dog Continental Resources (CLR). It spends about $8 million per well, which is estimated to ultimately produce about 603,000 barrels of oil equivalent. At $100 oil, that's more than a 60% rate of return. It's solid returns like those that have fueled Continental's rise to the top.
Kodiak on the other hand has well-documented well costs that are well above that, currently in the $9.5 million range. However, thanks to ceramics and its location in the basin, Kodiak is estimated to ultimately produce anywhere from 650,000 to 850,000 barrels of oil per well. At $95 oil that yields internal rates of return in a range of 54% to 84%. Those increased recoveries make Kodiak's wells very valuable, especially in a day where $100 oil is likely here to stay.
It's easy to take a quick glance at the numbers and consider Kodiak a sub-par Bakken player with its higher well costs and limited liquidity. However, that would mean missing out on the fact that Kodiak chose to pay up to build a premium position, which should prove to be more valuable over the longer-term. Combine that with the possibility that the company could be run at cash flow break even next year, while still growing at a decent clip and Kodiak is a pretty compelling oil growth story. It's a company that could surprise a lot of investors over the coming year.
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