After Earnings Report, What's Next for Kodiak?

Bakken-focused oil and gas junior Kodiak Oil & Gas reported fourth-quarter results on February 28 that missed Wall Street's estimates for both revenue and earnings.

But looking past the quarterly highlights reveals a company that has made impressive progress in increasing its reserves, production, and cash flow over the past year. In addition, major reductions in production and lease operating costs point to a management focused on financial discipline.

In the months ahead, Kodiak will be moving forward with two new pilot programs, the results of which will have massive implications for the company's development strategy in the Williston Basin going forward.


Reduction in well costs
Over the course of 2012, one of the most distinguishable trends among oil and gas exploration and production companies was an overarching focus on reducing production costs. Kodiak was no exception.

Thanks to a meaningful reduction in spud-to-rig release days, which the company said were down to the low 20s for a typical well, and other improvements, Kodiak saw a 15%-20% reduction in well costs over the year. The company says its current well costs range from $9.7 million to $10.2 million, with drilling accounting for about a third of that cost, and completion accounting for the balance.

Different operators in the Williston Basin have reported drastically different well costs, due mainly to factors such as the location of their acreage, its depth, and bottom well pressures, as well as to variations in the completion procedures used.

For instance, Whiting Petroleum , which reported some exceptional well results in the fourth quarter, said its well costs are currently running in the range of $8-$8.5 million. And Continental Resources may have even lower well costs, saying in its most recent earnings conference call that an "impressive well pad" costs the company under $8 million per well.

However, given that the majority of Kodiak's acreage is located in the deepest part of the Williston Basin and is characterized by lower pressure windows, its reported well costs appear quite reasonable. Over the remainder of this year, the company expects a further 5% decline in well costs through further efficiency gains.

Falling LOE and improving infrastructure
Commensurate with its priority of slashing costs, the company made major progress in reducing its lease operating expenses (LOE), which refer to the costs of operating and maintaining property and equipment on producing leasehold acreage. For the full year 2012, LOE came out to $31.7 million, or $6.04 per BOE, which represents a 30% decrease per BOE compared to the previous year.

The main drivers of the reduction in LOE were major improvements in water disposal costs, which are the largest component of LOE, and the improved availability of trucking and wastewater disposal facilities. Over the course of the year, Kodiak drilled four saltwater disposal injection wells, which -- in addition to lowering LOE -- reduced the company's dependence on third-party providers of wastewater solutions.

In addition to improved water handling and disposal, Kodiak also reported major improvements in the region's infrastructure. Currently, the company is building pipeline infrastructure in its Polar project area and, going forward, expects a substantial increase in the total quantity of oil it moves via pipeline.

Crude shipments via rail also expanded in 2012, with the company estimating that the region's 16 rail facilities are currently moving between 400,000 and 500,000 barrels per day. With roughly 80% of Kodiak's oil moving via rail, the company benefited greatly from access to markets where oil trades at a substantial premium to West Texas Intermediate (WTI).

New completion procedures
After noticing potential communication between wells during fracture stimulation procedures in the latter half of December, the company made the decision to modify its completion procedures.

CEO Lynn Peterson explained further:

Based upon our new observations, we decided to [shut down] all producing wells within the immediate vicinity of completion operation of new wells. With this approach we are seeing a positive response from the shutting wells once they are returned to production. Which leads us to believe that we are initiating new fractures into the old well bores and finding new reserves. While this procedure has resulted in a delay of some production, it is our view that this approach will help us prudently manage the reservoir and enhance our expected long-term results.

If there is significant communication between wells, it could have an impact on the quantity of oil the company can expect to ultimately recover, as well as implications for its estimate of proven reserves.

New pilot programs
To explore this issue further, the company will be implementing two pilot programs. The logic behind these programs is to evaluate the impact of closer well bore spacing over a larger acreage and get a better understanding of communication between intervals.

The two pilot programs will involve drilling six wells each in the Middle Bakken and Three Forks formations. Currently, Kodiak has three rigs drilling in its Polar project area, and one rig up and running in its Smokey project area. 

In the Polar project, the company expects to begin completion operations by the middle of the year, while in the Smokey area, it will be commencing completion operations throughout the year and has plans to fully develop the acreage. 

The knowledge and experienced gleaned from these two pilot programs, which account for a third of Kodiak's operated drilling program, will have a major influence on its future development strategy, the company said.

While Kodiak Oil & Gas is a dynamic growth story with tremendous promise, it remains highly leveraged to the Williston Basin. To get a better understanding of the opportunities and risks facing this oil and gas up-and-comer and to see if Kodiak is currently a buy or sell, check out our brand-new premium research report on the company.

The article After Earnings Report, What's Next for Kodiak? originally appeared on Fool.com.

Fool contributor Arjun Sreekumar has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. 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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