In search of exploration and production shale plays

Author: Tyler Kocon, Split Rock Private Trading

Covestor models: Bakken Shale, Equity Rotation


Disclosure: Long QEP, TPLM

There has been a vast amount of information disseminated in recent memory pertaining to the Bakken and other United States energy deposits. These definitive areas of American land have become some of the most active places in the entire country.

The relative explosion of shale oil and natural gas exploration has fortified populations in the cities and towns that inhabit these shale deposits. Cities like Williston, North Dakota,  have experienced such a rapid influx of population that houses are being sold before they are even being built.

The infrastructure literally cannot contain the excitement that the general public has for this burgeoning resource. Likewise, the topic of infrastructure applies very consistently to the resource themselves. We have lamented in the past about the lack of pipeline and other related transport infrastructure among the most popular and sought after U.S. shale deposits.

The lack of infrastructure is most notably in the Williston Basin area. However, the infrastructure in the basin is only as important as the amount of resource being produced. Therein lies the trickiest issue of the Bakken shale oil deposit. The fact of the matter is that the entire area is limited by one enormous and unchangeable factor. There is only so much land to go around, and only so many companies that can participate.

This is one of the main reasons why I have decided to hold a significant portion of the Bakken Shale investment model in exploration and production companies. 

These companies provide value to investors on two separate fronts. First, these are the companies that will benefit most from an appreciated oil price environment and the continued improvement of technology lowering drilling costs at the wellhead. Secondly, these companies may provide even more value to investors through their exclusive portfolio of acreage and land ownership throughout the various basins.

Land ownership in these areas can be a tricky process, yet simply holding these acres (regardless if any actual drilling or production activity is taking place) can provide investment opportunity in itself.

Recently, there have been a series of acreage acquisitions that have taken place involving companies participating in the Bakken space that has renewed some interest in potential takeovers or purchases as a way to enter such a landlocked and exclusive operating area.

The main transaction of this type was announced recently between QEP Resources (QEP), which agreed to purchase 27,600 net acres in the Bakken for $1.38 billion. Overall, this translates to a whopping average net acre price of $50,000 per acre. While this acreage may seem aggressively overpriced at this rate, consider what QEP actually purchased.

A significant portion of this acreage is located in parts of Williams and McKenzie counties, two of the best counties in the basin in regards to average daily oil production. Furthermore, the acreage they assumed contains an estimated 125 million BOE of recoverable reserves of which an estimated 90% are oil or liquids based hydrocarbons which fetch much higher prices than their predominantly natural gas reserve mixture. That being said, these 125 million BOE could easily return over $10 billion (assuming oil prices remain above $90 per barrel) throughout the course of the operation. Not bad.

All of this information provides an honestly good case behind holding some of the smaller, more pure play Bakken exploration and production companies. Companies like Triangle Petroleum (TPLM), and other small-cap exploration and production companies are held in the Bakken and U.S. Energy Shale SMA because they have proven their competence as wonderful operators of their Bakken acreage.

In addition, their market cap and acreage mix make them incredibly attractive buyout targets for some of the larger and more cash-heavy oil companies looking to establish positions in the Bakken or other U.S. shale deposits but may have been late to the party. For example, a company like Triangle Petroleum with a market cap of approximately $326 million is technically worth less than a quarter of what QEP paid for the aforementioned acres in their recent acquisition.

That being said, TPLM has roughly 83,000 net acres dotting across McKenzie and Mountrail counties in North Dakota as well as some acreage in several locations in Montana, according to the company’s most recent 10-K report.

Based on QEP’s price of $50,000 per acre, TPLM’s acreage alone could roughly be priced out at just over $4 billion. These may be pipe dreams, but it is clear to see just how much potential these exploration and production companies hold. It is a mixture and combination of all of these facts that make the E&P companies such an integral part of the Bakken and U.S. Energy shale portfolio.

In the end, regardless of a buyout or not, these companies provide value in a traditional and straightforward manner. These are the companies that are physically pulling the oil and natural gas from the ground, and will continue to do so for as long as the shale stays ripe and plush with America’s most precious commodity.

Performance discussed is net of advisory fees. Also, any investments discussed in this presentation are for illustrative purposes only and there is no assurance that the adviser will make any investments with the same or similar characteristics as any investments presented. The investments are presented for discussion purposes only and are not a reliable indicator of the performance or investment profile of any composite or client account. Further, the reader should not assume that any investments identified were or will be profitable or that any investment recommendations or that investment decisions we make in the future will be profitable.