A U.S. Oil Stock Outhustling the Majors

A Good Prediction Comes to Pass–and Reasons for Hope Ahead

Saudi Arabia in the Dakotas?

A U.S. Oil Stock Outhustling the Majors

In December, I wrote in Cabot Wealth Advisory that I saw oil and gas prices experiencing a “Goldilocks” rally in 2011–that is, prices wouldn’t get too hot or too cold. They’d be just right, from an energy investor perspective, to generate strong profits while not being too damaging to the fragile economic recovery. I wrote that crude prices would crest over $100 in the spring–and they did, at $114 at the start of May–but that fears of European debt troubles would cap a rally, as would the aim of OPEC to not kill demand from their best customer–the U.S.–by getting too greedy. (Read the December issue here.)

Oil prices have come down significantly from the spring peak: The benchmark oil contract in New York ended June at $95, up 26% from the price one year earlier. I wrongly predicted gasoline would average $4 a gallon on Independence Day–it was $3.62 nationally, according to the Department of Energy–but considering many pundits spent much of the first part of the year all but guaranteeing gasoline would be $5 a gallon by now, I’m feeling pretty good about being closer to the mark with my prediction.

What do I think the rest of the year holds? Probably more of what we see now, with oil ending the year not too far from its current price and gasoline ending the year a little cheaper. But predictions are a tricky business and it’s almost certain there will be a lot of volatility between now and New Year’s Eve, thanks to the inevitable geopolitical worries, followed by hurricanes and, come December, cold snaps.

In the next few weeks, part of the oil price volatility will come from the release of 30.64 million barrels of oil from the U.S. Strategic Petroleum Reserve. The Department of Energy just awarded bids to buy that oil one week ago and the influx of oil should lower prices at the gas pump starting in August. Personally, I think that’s a good thing for our economic recovery: Just as rising gas prices clip consumer spending, falling gas prices will help.

According to an analyst at the Federal Reserve, which has yet to release official June figures, June’s gas prices effectively fell 7%. Combine that with the fact that people are spending a smaller percentage of their incomes on debt obligations than they have in 16 years and you can see the middle class feels less financial pressure and is thus more apt to spend. Those are reasons to feel good about the economy. I’m not saying the economy is great, but it’s looking better than we’ve been hearing lately.

One more reason to feel optimistic: Based on the projected 2011 price-to-earnings ratio of the S&P 500 Index, stocks are at their lowest price since 1985, at just 13.6 times expected earnings–and keep in mind, we already know that corporate earnings have been better for the first half of the year. I’ll make one more prediction: Provided Congress and the Obama administration take care of the debt ceiling problem in the next week or so, I see the back third of the year posting another strong stock rally, similar to the great bull run we saw last September-December. This pattern–of stocks waffling for the summer then rallying strongly to end the year–was par for the course in the middle of the last decade as we recovered from the bursting of the dotcom bubble.

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While I’m on the subject of predictions, let me shift to some wildly exciting–and controversial–divining underway about a huge domestic oil field prospect you may have heard of: the Bakken. The Bakken is a rock formation in the Williston Basin, which is a geological area that covers North and South Dakota, the eastern third of Montana and part of the abutting Canadian provinces. Geologists have known since the 1950s that the Bakken contains oil, but they believed there wasn’t much that could be recovered.

It’s only been in the past few years that technological advances in the oil industry have made extracting crude oil from the Bakken realistic. These advances–in 3-D imaging of rock formations, fracturing technologies, proppant (to prop open the rock to expedite oil flow) and, most importantly, in the ability to drill horizontally for great distances deep underground–mean the Bakken is now responsible for 5% of U.S. oil production. The 113 million barrels produced last year isn’t much in the grand scheme of the United States’ total oil demand of 5.25 billion barrels a year, but it’s still a potent resource.

And the Bakken has the potential to produce much, much more. As technology improves and understanding of the Bakken evolves, so does the belief in how much oil sits waiting to be pumped. The U.S. federal government just dramatically raised its estimate to 4.3 billion recoverable barrels in the Bakken–that’s a significant amount of oil, and makes the Bakken one of the largest oil fields discovered in recent decades. But it looks like the federal government estimate could actually be very low: North Dakota’s state resource agency issued a meta-study–a study of studies–which found that over the past three decades, various geologists have estimated far more oil may be in the ground in the Bakken, from 132 billion barrels to 413 billion barrels!

Understand, these are hotly disputed numbers in the industry. But if true, the Bakken would all but solve the problematic America-OPEC dynamic by providing the U.S. nearly 80 decades of oil supply at current consumption rates. Saudi Arabia, by comparison, has about 270 billion barrels of oil in its reserves. Even if oil prices experience a pullback, it won’t appreciably alter an inevitable fact: the Bakken is destined for a huge amount of investment.

A controversial U.S. government geologist, Leigh Price, posited the fantastical estimate that the Bakken holds 413 billion barrels of oil. Unfortunately, Price died of a heart attack in 2000, without ever publishing his numbers. In the years since, another scientist saw Price’s data and concluded Price may be more right than wrong (although even Price didn’t speculate that more than half of that 413 billion barrels would be recoverable).

An early believer in Price’s data–and my stock pick for this issue–is Brigham Exploration (BEXP). Brigham was a small wildcatting firm that began buying up leases in the Williston Basin in 2005 after it analyzed Price’s research, which had been circulating among oil circles since his death. Brigham already held 302,000 acres by the time the U.S. Geological Survey began revising its older and much smaller estimates of the region’s oil reserves. Now the company has 378,100 acres in the region, primarily in North Dakota and Montana, placing it eighth for acreage holdings in the Williston behind oil majors including ExxonMobil (XOM), ConocoPhillips (COP) and Hess (HES).

So why not pick one of those companies instead? Because Brigham has been outperforming competitors in generating stronger-producing wells!

Over the past five quarters, the company’s average well outproduced the average of 18 competitors in the area by 120%. Over that time only two competitors have had quarters where their average well outproduced Brigham’s average. One of those, Denbury Resources (DNR), only drilled one well versus three by Brigham in the comparable period (the first quarter of 2011). The other, Newfield Exploration (NFX), drilled just two when Brigham drilled eight, in the first quarter of 2010. That production efficiency makes the company’s motto, No Oil Left Behind, seem appropriate.

At 31 a share, Brigham is trading at a reasonable 21 times Wall Street consensus expected 2011 earnings of $1.44 a share (and that is well below what I project the company will generate in 2011). I told subscribers to Cabot Global Energy Investor, the newsletter of which I am chief analyst and editor, about Brigham in early June and we added shares under 28. Subscribers are up 12% on the position today, but at 31, BEXP still looks like a great buy, even if the Bakken won’t enable us to leave OPEC behind us for good.

All the best,

Brendan Coffey
Editor of Cabot Global Energy Investor

Editor’s Note: You could buy BEXP and hope for the best, or you could check out Cabot Global Energy Investor to see Brendan’s latest recommendations on this and other top picks in the energy sector. Learn more now!


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