This undiscovered Bakken play could be hugely profitable next year and double from current prices.
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Image I. The Bakken Formation
The formation is named after Henry Bakken, the former owner of part of the land where the formation was discovered. In 1951 oil was discovered in the region, however due to difficulties recovering the oil it has not been a focus for exploration until recently. Bakken oil is light sweet crude with an API gravity of 32 to 40 degrees. Current estimates of total oil in the region are approximately 24 billion barrels, however only part of that is recoverable using currently available drilling techniques.
Oil production in the Bakken has grown rapidly over the past several years, contributing tremendously to US production growth. In 2005, less than 3,000 barrels of day came out of the region. By 2012, the region produced nearly 550,000 barrels per day. In March of 2012, North Dakota was the second most productive state in the US, surpassing Alaska. The chart below shows oil production in North Dakota alone, with rates increasing as rapidly as 6% per month. Many market participants expect this strong growth to continue as companies make investments in developing previously undrilled land in the region.
Image II. Fracking Process
The fluid used in fracking is typically a solution of water and chemical additives that aid in the creation of the fractures in some way. Hydraulic fracturing was first used in the 1940’s to access reserves of oil and gas previously available. The majority of new wells drilled today utilize fracking technology.
Norstra Energy Inc. is an oil and natural gas exploration company based in Texas and operating primarily in Montana. Norstra has interests in the southern Bakken-Alberta Fairway in the central part of western Montana. The company is targeting a horizontal Bakken drilling program to bring the prospect from exploration to production.
Image II. The South Run River Bakken Prospect Site
Total potential oil production in the region could be as high as 10-15 million barrels of oil per square mile.
Drilling and Production Plans
Table II. NORX Production Forecast 2013 - 2015
The initial build-out of the first well will be financed through a proposed convertible bond. Norstra will be able to finance future wells with production revenues if the initial well is successful, on-time, and produces oil at a rate which is within the range of estimates. In this scenario, no additional financing will be required. If there are delays or issues with production, particularly in the first few wells, additional financing may be required.
The company plans to consider additional land acquisitions which would likely require additional financing. In the meantime, our projections suggest the Company should reach cash flow positive status sometime in 2014.
Glen Landry, President and CEO
Dallas Kerkenezov, CFO
Norstra Energy is an exploration company with no current revenues or cash flows. Prior to generating any revenue, the company must successfully drill new wells in a previously untested area of the Bakken. In the broader Bakken area, the presence of oil is well established. However, there is risk to the presence of oil in the proposed drilling area. Additionally, there is risk in the execution of the drilling and fracking process even once the presence of oil has been established.
According to our projections, Norstra should be able to finance subsequent drilling through revenues from the initial well. However, if the first well is unsuccessful, additional financing will be required. In that case, should Norstra fail to receive sufficient financing in a timely manner, the company will not be able to bring new productive wells online as rapidly as originally projected. This will impact both the amount of time needed to achieve positive cash flow as well as overall valuation. Even if Norstra is able to successfully develop some wells, failures in one or more of the first few wells could significantly delay profitability and increase financing needs.
Fracking has become quite controversial due to the potential for environmental impacts. Opponents are concerned about the potential for fracking water, which typically contains chemicals, to contaminate drinking water. Some of these chemicals may be radioactive and/or known human carcinogens. These risks were highlighted in a film entitled “Gasland” released in 2010. In addition, there is concern that the fracking may increase the occurrence of earthquakes. For these reasons, there is debate over legislatively restricting fracking practices. A law passed in 2005 called the Bush / Cheney Energy Bill exempted drilling companies from disclosing the chemical composition of fracking water. This is seen as a loophole in the Safe Water Drinking Act of 1974. There is significant lobbying to close this loophole, and to enact steps to restrict fracking activities such as those proposed by Norstra. Any government regulations restricting fracking activities could impact Norstra’s financial situation.
In our view, all of these risks are consistent with firms of Norstra’s size and standing and we believe that the Company’s positioning, strategy, and favorable seismic data will enable it to succeed utilizing its less risky horizontal drilling strategy versus the deep wells drilled by several major oil companies in the region in the 1980’s.
VALUATION AND CONCLUSION
In our view, NORX offers investors the opportunity to invest in what we would consider a relatively undiscovered and potentially lucrative Bakken play, given its site in Montana. Moreover, favorable and abundant seismic data, utilization of horizontal drilling, and a conservative approach could enable NORX to produce nearly 250,000 barrels of oil in 2014 with two producing wells beginning in 2014. As a result, meaningful upside potential exists if management can meet its timetable and our preliminary forecasts of $5.6M in net income. Our price target of $2.00 reflects a reasonable 14x P/E on our preliminary 2014 net income estimates, and represents a double from current levels. Therefore, we rate these shares Speculative Buy.
Table III. Preliminary Projected Income Statement
Recent Trading History For NORX
Senior Analyst: Robert Goldman
Rob Goldman founded Goldman Small Cap Research in 2009 and has over 20 years of investment and company research experience as a senior research analyst and as a portfolio and mutual fund manager. During his tenure as a sell side analyst, Rob was a senior member of Piper Jaffray's Technology and Communications teams. Prior to joining Piper, Rob led Josephthal & Co.'s Washington-based Emerging Growth Research Group. In addition to his sell-side experience Rob served as Chief Investment Officer of a boutique investment management firm and Blue and White Investment Management, where he managed Small Cap Growth portfolios and The Blue and White Fund.
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