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Continental Resources' Rally Hasn’t Fully Played Out

By Lennox Yieke – Feb 22, 2014 at 3:00PM

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Continental Resources stands to benefit from the high oil price environment.

Continental Resources (CLR 0.04%) has had one of the most spectacular rallies in the oil and gas sector in recent years, riding on the production resurgence in the U.S. industry. In the past decade, its stock has gained well over 500%, edging out bigwigs such as ExxonMobil (XOM 0.67%) and Chevron (CVX 1.50%), which made gains of about 130% and 165% respectively over the same period. Naturally, this tremendous growth has made Continental Resources a darling among growth-oriented investors.

Continental Resources recently allayed fears that production was topping off -- driven of course by decreased volumes in the overall upstream industry. It announced that it grew production by 39% in 2013 to 49.6 million barrels of oil equivalent (BOE). The Bakken-focused driller also announced that its proven reserves grew by 38% in the past year, justifying its exploration spending and signaling more production in coming years.

Naysayers are retreating back to their cocoons in view of the continued uptick in crude oil and natural gas prices. Last year, prices moved lower, dampening the profitability forecast for exploration and production players such as Continental Resources, whose profits are a close function of crude oil prices. Now, however, oil prices have started picking up. More notably, the data is now more consistent, and it looks as if a sustained higher price environment could be in the cards.

March natural gas futures rallied 11% Wednesday to settle at $6.149 per million British Thermal Units, their highest settlement in over five years. Naturally, the uptick in natural gas prices has also lifted crude oil prices. Oil futures also topped $103 a barrel, reaching a four-month high.

Continental Resources has a healthy production profile, with crude oil being 71% of total production in 2013 and byproducts (largely natural gas) making up the rest. As such, it is in a unique position to gain from rising oil and natural gas prices.

Riding on strong tailwinds of the overall industry
In the short term, high crude and natural gas prices will be sustained by the cold weather, with new weather forecasts calling for continued cold weather in the next couple of weeks. However, in the long run, high prices will be sustained by continued pressure from big players in the oil and gas sector. This signals an opportunity for Continental Resources to ride on the tailwinds.

Natural gas storage levels are about 34% lower than last year and 27% below the five-year average. As supply thins, the control that oil players have over pricing mechanisms increases. Furthermore, the high demand has placed immense pressure on the transport infrastructure, which doesn't match domestic production volumes to start with. This is likely to be priced into the overall price of oil and natural gas going forward.

Although leveraging controls over supplies to sustain high prices isn't exactly an ideal practice, it is the only card left.

For the most part, major oil companies have financed their operations during the years after the U.S. production resurgence externally through debt and equity. Unfortunately, increased volumes suppressed prices for a long time, leading to thinner margins for explorers and producers. Because of this, most companies were unable to make enough profit to both expand and reward providers of capital at the same time. This explains why most oil companies are divesting non-strategic assets to generate cash. Occidental Petroleum Corporation (OXY 1.29%), for instance, recently announced its plans to sell a $1.4 billion stake in the largest natural gas field in North America, the Hugoton Field. The sale is a part of its efforts to boost its quarterly dividend and share repurchase program. The board also announced that it had increased its dividend from an annual rate of $2.56 per share to $2.88 per share, bringing the yield to 3%.

Final thoughts
The path taken by Occidental is a familiar one as far as oil majors are concerned. Similar deals have been made before as Big Oil tries to shift its focus to core areas and, in the process, generate enough cash to reward providers of capital. With this in consideration, the entire industry is thereby likely to court any measures that can sustain the current high prices. Oil majors want to generate enough profits to finance operations and reward providers of capital at the same time -- the asset sales can't hold forever.

If the higher prices are maintained, Continental Resources is poised to gain because, unlike most of its peers, it has a narrower focus, working only in select areas as opposed to taking a wider approach. In consideration of the increase in Continental Resources' proven reserves (increased 38% in past year), higher prices are likely to sustain its rally. Similarly, the move to further its SCOOP play in Oklahoma is timely. In the past year, the company grew its SCOOP reserves from 63 million BOE to 215 million BOE, a 214% jump. Higher prices will increase its ability to squeeze out more profits from these reserves, setting up a new growth pillar. Despite currently trading intimately close to its 52-week high, Continental Resources' rally hasn't fully played out; there is still more upside.

Lennox Yieke has no position in any stocks mentioned. The Motley Fool recommends Chevron. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

ExxonMobil Stock Quote
ExxonMobil
XOM
$110.54 (0.67%) $0.73
Chevron Stock Quote
Chevron
CVX
$181.03 (1.50%) $2.67
Continental Resources Stock Quote
Continental Resources
CLR
$74.27 (0.04%) $0.03
Occidental Petroleum Stock Quote
Occidental Petroleum
OXY
$69.11 (1.29%) $0.88

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