HOUSTON. The View from. Bakken Takeover Targets

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1 The View from HOUSTON Energy Prospectus Newsletter: The View from Houston May 7, 2013 Issue: 72 By: Dan Steffens, President Dan Steffens is the President of Energy Prospectus Group (EPG), a networking organization based in Houston, Texas. He is a 1976 graduate of Tulsa University with an undergraduate degree in Accounting and a Masters in Taxation. Mr. Steffens began his career in public accounting, becoming licensed as a CPA in After four years in public accounting, he transitioned to the oil & gas industry with the bulk of his time (18 years) spent with Amerada Hess Corporation (HES). He served as the Hess United States E&P Division Controller from 1994 to INSIDE THIS ISSUE 1 Bakken Takeover Targets 3 EPG Upcoming Events 4 Sweet 16 Growth Portfolio 6 Small-Cap Growth Portfolio 7 High Yield Income Portfolio 9 EPG Disclaimer Seek and ye shall find. At EPG we are seeking out the best energy stocks and we bring those companies to the attention of our members. Our Sweet 16 is poised to do great things this next year. With crude oil prices rebounding, what can we expect these next few months? First quarter results are pouring in and we are doing our best to keep our forecast models up-to-date. So far, all of our model portfolio stocks have reported strong results with most of them topping my forecast models. Crude oil prices have rebounded since the last newsletter and the North American natural gas market continues to tighten, with storage now over 100 Bcf below the 5-year average. If commodity prices hold near current levels, our favorite companies should do quite well this year. Bakken Takeover Targets When oil & gas reserves are cheaper on Wall Street than average finding & development costs, it just makes more sense for the large-cap E&P companies to take over the smaller companies. In fact, many small-caps are built with that idea in mind. You may recall that EPG members recently did quite well on sales of two former Sweet 16 Growth Portfolio companies Brigham Exploration (BEXP) and 1

2 GeoResources (GEOI), whose CEO s were clearly looking for buyers. I think the Bakken is now ripe for another round of takeovers this summer and several companies in our model portfolios are prime targets. Continental Resources (CLR) EOG Resources (EOG) Kodiak Oil & Gas (KOG) Oasis Petroleum (OAS) Whiting Petroleum (WLL) Triangle Petroleum (TPLM) SM Energy (SM) During my last three years with Hess Corp. (HES), I was on a business development team tasked with looking for undervalued targets with assets that were a good fit for Hess. Believe me, there are teams of analysts doing it for all of the largecaps. In fact, in a mature region like North America, an aggressive acquisition strategy is the fastest way to grow a company. Just look at the history of Apache Corp. (APA), Anadarko Petroleum Corp. (APC) and Devon Energy (DVN). All three of them grew rapidly through a series of mergers with smaller E&P companies. A Bulls Eye is clearly on the Bakken The growth of the Bakken oil formation has been incredible. In a presentation late last year, Mark Papa, CEO of EOG Resources (EOG) said, "... there are only two meaningful oil plays in the United States - the Bakken and the Eagle Ford. I will argue that the Permian Basin is now right up there, thanks to horizontal drilling technology. As a result of North Dakota s good fortune to have most of the Bakken within its borders and its strong support for the industry, the state is now the second-largest oil producer in the U.S. after Texas. It also has a near zero unemployment rate and you can make $20/hour working at a burger joint. The U.S. Geological Survey (USGS) recently updated a geology based assessment of the Williston Basin. The USGS now estimates there are still 7.4 billion barrels of oil, 6.7 trillion cubic feet of natural gas and 0.53 billion barrels of natural gas liquids that can be recovered from the Bakken and Three Forks formations using today s technology. Continental Resources (CLR) CEO Harold Hamm thinks the recoverable volumes are triple what is in the new USGS report. Even Harold s higher number is less than ten percent of the estimated oil in place, so we can expect the industry to be harvesting oil from this region for several decades, at least. This is the kind of thing the majors should be all over, which is why I believe they have teams of analysts looking for ways to get them a large stake in the play. Since almost all of the good acreage is leased, the only way to get a meaningful position is to go out and buy a company that holds it. Figure 1 just shows the Williston Basin in the United States. It does extend up into Canada. We won t know for decades who s right about the total oil & gas that will be recovered, but it is now crystal clear that North Dakota contains a massive amount of valuable hydrocarbons. The recent improvements in horizontal drilling and multi-stage fracing have made shale oil & gas, that was previously thought to be sub-economic to produce, incredibly profitable. America is producing more than 7 million barrels of oil a day, the highest volume since 1992, according to figures released by the U.S. Energy Information Administration. The U.S. is now forecast to overtake Figure 1 2

3 Saudi Arabia as the world's top oil producer in just a few years thanks to rapid production growth in the Bakken, Eagle Ford and Permian Basin. Note that Texas and North Dakota are leading the way, not just because they hold the best resource plays, but because they support the energy business. You d think bankrupt states like California and New York would notice and get more supportive of the only industry that can save their economies, but that is a subject of another article. The map below shows how blessed we are with shale resources. I sure am glad to be living in Texas where the economy is booming. The Bakken Petroleum System covers over 9 million acres. It is an unconventional oil resource deposited during the Devonian and Mississippian periods. It is a selfsourcing petroleum resource that has up to 35% organic content. The Bakken extends from the eastern edge of the Williston Basin in North Dakota to the Bakken Fairway in northwest Montana and north into Canada. The western boundary of the Bakken is defined by the Rocky Mountain Thrust Belt. The Bakken Formation remains remarkably consistent from the Nesson Anticline (discovered by Amerada Hess Corp. in 1950) on the eastern edge to the western boundary in northwest Montana. The Bakken does extend up into Canada, where PetroBakken Energy Ltd. (PBKEF) has drilled hundreds of successful wells. This newsletter is brought to you by: Figure 2 Just to give you an idea of the recent valuations being placed on the Bakken / Three Forks play, QEP Resources (QEP) recently purchased 27,000 acres in the Williston Basin for an estimated $40,000 per undeveloped acre, a new record. It is mind-boggling to me that any acreage is that valuable. Former Sweet 16 Growth Portfolio company, Brigham Exploration was one of the first companies to prove that horizontal drilling and multistage fracing could generate outstanding financial results from the Bakken. Brigham was followed by the medium to larger companies moving in. Companies like Whiting Petroleum (WLL), Oasis Petroleum (OAS), Northern Oil & Gas (NOG), Kodiak Oil & Gas (KOG) and Continental Resources (CLR), are smaller players that are now becoming takeover targets based on their cheap market cap valuations and significant undeveloped proven acreage. The big boys have already started to make their move: Exxon Mobil (XOM) moved into the Bakken when they took over XTO Energy in XTO Energy is now a wholly owned subsidiary of Exxon. Exxon added to their stake at the end of last year in a deal that included $1.6 billion in cash and additional working interest considerations. Apache Corp. (APA) entered the Bakken with a big acquisition of 300,000 Bakken acres in Montana. Statoil ASA (STO) bought Brigham and its Bakken acreage for $4.4 billion. Some EPG members made a ton of money on that deal. 3

4 It is just natural for the large companies to take over the development of the Bakken. They have the capital and the large technical teams needed for a job of this size. It will take over 100,000 wells to fully develop the Bakken / Three Forks and more capital than I can imagine; good news for our favorite onshore drillers, Helmerich & Payne (HP) and Unit Corp. (UNT). In my opinion, Kodiak Oil & Gas (KOG), Oasis Petroleum (OAS) and Triangle Petroleum (TPLM) are the most likely takeover targets because they are pure plays on the Bakken / Three Forks. Continental Resources (CLR) may actually be in play because of the much publicized divorce of the company s founder and CEO. EOG and Whiting Petroleum (WLL) have a lot more going on than just the Bakken, so they may just sell their stake in the play or become a buyer themselves. SM Energy (SM) holds over 160,000 net acres in the Bakken / Three Forks and I would be thrilled to see them sell it and use the money to accelerate development of their Eagle Ford acreage. In my opinion, the best way to play this as an investor is to spread the risk. A takeover of any one of the Bakken players mentioned above will draw more attention to the valuations of the entire pack. Disclosure: I have long positions in CLR, CRZO, DNR, ENRJ, EXXI, GPOR, GTE, MIND, MMP, MWE, NFX, PMG. TO, PBKEF, TGA and UNT. I do not intend on buying or selling any securities mentioned in this newsletter within 72 hours of the publication date on page one. I am not receiving compensation from any of the companies mentioned in this newsletter. See the DISCLAIMER on the last page of this newsletter for more details. Sweet 16 Growth Portfolio Prior to the date of this newsletter, six of the Sweet 16 companies (DNR, HP, KOG, RRC, SM and WLL) had reported strong first quarter results. Denbury Resources (DNR) closed on the acquisition of producing properties in the Cedar Creek Anticline area from ConocoPhillips late in the quarter. They will report a significant increase in production during the second quarter. DNR deserves to trade at a much higher multiple than where it stands today because it has very long-lived crude oil reserves. Helmerich & Payne (HP) continues to pump out solid earnings and cash flows from operations. Their FlexRigs are in high demand in all of North America s shale plays as they are perfect fits for drilling multiple horizontal wells from pads. HP is much more than a drilling company. Companies that engage HP quickly discover that in addition to the world s best drilling equipment, they are getting a first class engineering team to help them reduce drilling time and lower their costs. 4

5 they continue to meet or exceed my production forecasts. SM Energy s Eagle Ford Production Whiting Petroleum (WLL) is the top oil producer in North Dakota. Every time I take a hard look at this company I shake my head in disbelief at the share price compared to its peers. First Call s target price is $60.72, which would certainly be a welcome move for shareholders, but I think it deserves a much higher price. In addition to being a leading company in the Bakken / Three Forks, Whiting has a tertiary recovery project (CO2 flood) in West Texas that is ramping up to 9,000 BOE per day (mostly oil) and their Redtail prospect in the Denver Basin is getting great results in the Niobrara A and C Kodiak Oil & Gas (KOG) is on-track to increase production by more than 80% this year. I m expecting the company to increase production each quarter, but really ramp it up sharply during the second half of this year after Spring Breakup. KOG should have a very impressive yearend reserve report. As I mentioned in the opening article, KOG is near the top of my list as a prime takeover target. Range Resources (RRC) is the only gasser in the portfolio. All they do is just keep beating my production forecast quarter-after-quarter. If I m right about natural gas prices pushing up to $5.00/mcf by yearend, RRC should make a heck of a run down the stretch. SM Energy (SM) has posted the most impressive first quarter results so far. The stock is trading at just over 4X my current cash flow per share forecast for this year. They reported much better than expected production from their Eagle Ford wells and they are having strong drilling results in the Permian Basin. They have a nice block of acreage in the Bakken, which I wish they would sell since the rate of return on their Eagle Ford and Permian Basin wells is better. I have raised my Fair Value Estimate to $93.70/share which is just 5X CFPS. In my opinion, it has a shot at a much higher multiple if Sweet 16 Growth Portfolio Company Name BONANZA CREEK ENERGY Primary Product Stock Symbol Share Price 5/3/13 EPG Fair Value Estimate Percent Undervalued OIL BCEI $36.15 $ % CARRIZO OIL & GAS OIL CRZO $25.85 $ % CIMAREX ENERGY OIL XEC $74.03 $ % CONTINENTAL RESOURCES DENBURY RESOURCES INC. OIL CLR $80.58 $ % OIL DNR $17.88 $ % EOG RESOURCES OIL EOG $ $ % ENERGY XXI OIL EXXI $23.33 $ % GULFPORT ENERGY CORP OIL GPOR $53.40 $ % HELMERICH & PAYNE Services HP $61.75 $ % KODIAK OIL & GAS OIL KOG $7.92 $ % OASIS PETROLEUM OIL OAS $34.26 $ % RANGE RESOURCES GAS RRC $74.43 $ % ROSETTA RESOURCES OIL ROSE $42.60 $ % SM ENERGY GAS SM $61.76 $ % UNIT CORP. Services UNT $43.00 $ % WHITING PETROLEUM OIL WLL $45.38 $ % 5

6 Small-Cap Growth Portfolio Company Name Primary Product zones. If I were advising a major looking to jump into the Bakken, I d be telling them to make a hard run at Whiting. Each share of WLL represents over 3.1 boe of proven reserves based on the company s 3rd party reserves report. This is what I mean when I said that oil is a lot cheaper on Wall Street these days. Stock Symbol Share Price 5/3/13 EPG Fair Value Estimate Estimated Undervalued APPROACH RESOURCES OIL AREX $25.30 $ % COMSTOCK RESOURCES GAS CRK $15.55 $ % ENERJEX RESOURCES OIL ENRJ $0.61 $ % EVOLUTION PETROLEUM OIL EPM $9.97 $ % GRAN TIERRA ENERGY OIL GTE $5.65 $ % MITCHHAM INDUSTRIES INC Services MIND $14.56 $ % OSAGE EXPL & DEV OIL OEDV $1.38 $ % SARATOGA RESOURCES OIL SARA $2.20 $ % SWIFT ENERGY OIL SFY $13.05 $ % TRANSGLOBE ENERGY OIL TGA $8.17 $ % TRIANGLE PETROLEUM OIL TPLM $5.65 $ % expect this risk adverse market to pay up for what these stocks are worth anytime soon. Investors just don t want to deal with the unknowns of doing business in Columbia and Egypt these days. But crude oil trades on a global market and I believe it is wise to have international exposure in a balanced portfolio. They both have rock solid balance sheets with very little debt. Investors with a longer term outlook should be accumulating these two on the dips. Three of the companies in the portfolio have reported first quarter results. We will be updating our forecasts models within days after they report earnings and we will update all of our detailed company profiles later this month. Approach Resources (AREX) reported first quarter production inline with my forecast. The company is driving down their completed well costs and the initial results from their stacked wellbore pilot program in their Pangea horizontal Wolfcamp shale play are encouraging. The first two stacked wellbores were completed with initial rates of 705 Boe/day and 843 Boe/day. By stacking wellbores AREX expects to increase recoverable reserves per well. As you can see in the map above, AREX has a lot of running room in the Permian Basin with over 2,000 identified horizontal drilling locations. I believe this is going to be a significant turnaround year for Comstock Resources (CRK). I The Sweet 16 is our Mid-Cap Growth Portfolio. These companies were selected because they have very strong production and proven reserves growth locked in. It is nice that they report solid earnings quarter-after-quarter, but the real value of any E&P company is their proven reserves plus their growth potential. Small-Cap Portfolio Our Small-Cap Growth Portfolio is a group that I believe has what it takes to grow into solid mid-caps. In fact, it can be argued that Gran Tierra Energy (GTE) and TransGlobe Energy (TGA) are already there. I m keeping these two Calgary based companies in the small-cap portfolio, but I don t 6

7 listened to their quarterly conference call and there was definitely a more upbeat feel to the call. Comstock will close on the sale of their Permian Basin assets to Sweet 16 member Rosetta Resources (ROSE) in the 2nd quarter and book a $250 million gain on the sale. The company should report about $3.00 earnings per share for the second quarter. This sale will shore up the company s balance sheet and allow them to focus on their Eagle Ford shale development program. Comstock is the most leveraged company in the small-cap portfolio to increasing natural gas prices. Swift Energy (SFY) had a good first quarter with cash flow per share of $1.63, slightly above my forecast due to strong realized oil & gas prices and increasing production. Earnings per share beat my forecast by $0.04. Management announced that they are working on a joint venture for their Eagle Ford acreage that should be closed in the 3rd quarter. I am now expecting Swift s production to dip a little in the second quarter, and then accelerate into year-end. If you want a small-cap that will get a major boost from increasing natural gas prices, you should take a hard look at my forecast model for SFY. Terry Swift, CEO of Swift Energy commented, Swift Energy delivered strong operational results during the first quarter. Our refined drilling and completion techniques in the Eagle Ford shale and the strong performance of our base production in Lake Washington resulted in higher than forecast production volumes. We re encouraged by our progress so far this year. Near term, our focus remains on improving performance, cost efficiencies and results throughout our active operational areas. We are also taking steps to introduce new, high value opportunities to our operations through horizontal drilling in the Louisiana Wilcox, horizontal drilling in the Southwestern Colorado Niobrara and Subsalt exploration in South Louisiana. Finally, as demonstrated by the sale of our Brookeland field, we will be looking at monetizing assets we control that are not a focus of our operations to bring forward unrecognized value in our portfolio. After listening to the Denbury Resources (DNR) first quarter conference call, I am now convinced that the Delhi Field Tertiary Recovery Project in Louisiana will reach payout late in the third quarter. This means that Evolution Petroleum s (EPM) net revenue interest in the field will increase from 7.4% to 26.5%. EPM reports first quarter results this week. High Yield Income Portfolio Our Income Portfolio is focused on finding energy sector stocks, bonds and MLP units that offer high yield with a reasonable level of risk. The MLPs in the portfolio have a track record of increasing their distributions to unit holders yearafter-year, which is a great way to stay ahead of inflation. Keep that in mind as you look at the chart. The annual yields for the MLPs are based on their current distributions to unit holders, not expected future distributions. It is a good idea to check each MLP s website and look at their distribution history before investing. The seven I ve selected are all expected to increase distributions this year. Last week I added SeaDrill Limited (SDRL) common stock to the portfolio and I dropped Evolution Petroleum 8.5% Series A Pfd stock (EPM-PA) because I think they will call their preferred soon after the Delhi Field reaches payout. I also decided to drop the Magnum Hunter Resources Corp. Pfd stock (MHR-PD) until we see some resolution of their accounting issues. Gastar Exploration, Ltd. (GST) reported first quarter results that beat both the First Call earnings per share estimates and my forecast model. I am still recommending that cautious investors stick with their preferred stock (GST-PA), which I believe will continue to drift up to the par value. I am also considering adding GST to our Small-Cap Growth Portfolio. High Yield Income Portfolio Primary Stock Share Estimated Company Name Product Symbol Price Annual Yield 5/3/13 PETROBAKKEN ENERGY LTD OIL PBKEF $ % GASTAR EXPLORATION - Pfd GAS GST-PA $ % SEADRILL LIMITED DRILLER SDRL $ % LINN ENERGY (Upstream) MLP LINE $ % VANGUARD NAT RES (Upstream) MLP VNR $ % HI CRUSH PARTNERS MLP HCLP $ % HOLLY ENERGY PARTNERS MLP HEP $ % MAGELLAN MIDSTEAM PARTNERS MLP MMP $ % MARKWEST ENERGY PARTNERS MLP MWE $ % PLAINS ALL AMERICAN PIPELINE MLP PAA $ % PLAINS ALL AMERICAN PIPELINE MLP PAA $ % 7

8 I am expecting a strong first quarter from PetroBakken Energy Ltd. (PBN. TO and PBKEF). They ve already announced that first quarter production averaged 49,078 barrels of oil equivalent per day ("boepd") (82% light oil and liquids), a 4% increase over the fourth quarter of First quarter funds flow from operations exceeded what I had in my forecast model. Unless there is a big drop in the price of crude oil, PetroBakken has more than enough cash flow to pay their monthly dividends. PetroBakken also announced they will be changing the company's name to Lightstream Resources, Ltd. in a couple months. Since the Cardium is quickly becoming their top area of production this name change makes sense, plus it may bring some attention to a grossly undervalued common stock. Final Thoughts First quarter results are pouring in on a daily basis. This keeps me very busy updating forecast models and profiles. April was a fantastic month for the Energy Prospectus Group. We picked up over 60 new members from Value Forum. My trip to Scottsdale and then on to Las Vegas was fantastic. I made a lot of new friends and some valuable contacts. Life is all about networking and interdependence with our fellow human beings. By working together we can all achieve so much more and have a more rewarding life. The reason the Kevin and I formed EPG back in 2001 was to help our members make money. I believe that if you focus on helping others achieve their goals that you have a better chance of reaching your own. I am encouraged by the rebound last week in crude oil prices and I see the North American natural gas market continue to tighten. So far, I have not been disappointed by first quarter results from any of our portfolio companies. It sure feels like things are setting up for a strong second half of this year for the energy sector. Thank you for your support. Keep an eye on the macroenvironment, but look closely at the details before you invest in anything and good luck! Dan Steffens, President Energy Prospectus Group 8

9 EPG Disclaimer The analysis and information in this newsletter and the reports & financial models on our website are for informational purposes only. No part of the material presented in this NEWSLETTER and/or reports on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed herein constitutes a solicitation to purchase or sell securities or any investment program. The opinions and forecasts expressed are those of the PUBLISHER (Energy Prospectus Group, a division of DMS Publishing, LLC) and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. Investors should always consult an investment professional before making any investment. Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results. Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the PUB- LISHERS, editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided. The analysis provided is based on both technical and fundamental research and is provided ''as is'' without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed. The information contained in the NEWSLETTERS is provided by Energy Prospectus Group, a division of DMS Publishing, LLC. Employees and affiliates of Energy Prospectus Group may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. PUBLISHER will indicate whether he has a position in stocks or other securities mentioned in any publication. The disclosures will be accurate as of the time of publication and may change thereafter without notice. Index returns are price only and do not include the reinvestment of dividends. The S&P 500 is a stock market index containing the stocks of 500 large-cap corporations, most of which are US companies. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill Energy Prospectus Group 9