Rising Costs Drive Acquisitions in US Oil from Shale Boom
07/14/2014 5:29 pm EST
The acquisition today in the oil and gas sector makes one company the biggest producer in the Bakken and Three Forks formations, but for the US oil boom, in general, MoneyShow’s Jim Jubak thinks it also sums up the industry’s biggest problem.
This deal summarizes the big problem in the US oil boom.
Today Whiting Petroleum (WLL) announced that it would acquire Kodiak Oil and Gas (KOG) at a premium of just 5% over Kodiak’s average share price for the last 60 days. Given that Denver’s Kodiak is one of the 10 largest oil producers in some of the most productive areas of North Dakota and Montana, the question is, why is the premium so low?
The answer is pretty simple: Like a lot of the smaller producers in the US boom, Kodiak’s capital spending budget has been growing faster than its cash flow. In fact, this year Kodiak had planned to cut its drilling budget in order to bring capital spending back in line with cash flow. The company had estimated that it would complete 100 wells this year, even with the lower budget, but that would require a continued drop in the cost per well to $9 million from $10 million in 2013 and $12 million in 2012.
The deal will make Whiting the biggest producer in the Bakken and Three Forks formations with production of 107,000 barrels of oil equivalent a day. Whiting also holds leases on 120,000 acres in Colorado’s Niobrara basin, one of the more promising geologies for new exploration and development in the United States. The combined company will hold leases on 855,000 acres after the deal.
Kodiak shareholders are getting a relatively small premium in the all-stock deal but Whiting will also take on $2.2 billion in debt. Not that Whiting is exactly swimming in cash either. The company has put more into capital spending than it has seen in cash flow over the last three years. The company was planning to spend $2.7 billion on drilling and other capital costs in 2014, about the same as in 2013.
In fact, the key to the deal is the two companies’ belief that by combining operations, they’ll be able to cut costs by $1 billion over the next five years.
Bulking up should also enable the combined company to increase its borrowing since the combined company will have the production and potential reserves to attract a larger group of lenders. The deal values Kodiak at about $43 for every barrel of oil equivalent in proved reserves.
The market has voted in favor of this logic with shares of Kodiak up 4.78% today and Whiting’s stock up 7.69%.
Some of the enthusiasm results, I think, from a sense that this deal, which keeps these two smaller oil producers independent, provides more future value for shareholders than an acquisition by one of the big oil companies such as Royal Dutch Shell (RDS), Statoil (STO), Exxon Mobil (XOM) or BP (BP) that have been on the prowl in U.S. oil and natural gas geologies. An acquisition by a international major would dilute the pure shale play represented by smaller exploration and development companies.
The deal also signals that we’re likely to see even more acquisitions in the near term as companies that had tried to bulk up run head on into the capital-spending wall. After all in 2013 Kodiak and Whiting had both added acreage in the Bakken in two deals for $600 million and $260 million, respectively.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I managed, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund shut its doors at the end of May and my personal portfolio is now in cash. I anticipate putting those funds to work in the market over the next few months and when I do I’ll disclose my positions here.