Northern Oil versus Brigham Exploration Company

Someone in the comments asked me why I was short Northern Oil versus (say) Brigham Exploration Company.  Brigham is another highly valued Bakken play.  Yahoo reports Brigham as having a 97 times PE ratio.

Northern Oil is – as previous posts have made clear – not an exploration and production company.  It buys acreage and it participates in wells drilled by other people on that acreage.  Its only skill – its only reason for existence – is choosing which acres to buy and managing their ownership position.  That is why it manages to be a $1.6 billion company with only 11 staff.  The staff don't do anything except buy and manage an acreage ownership position.

Well here is list of completions from the most recent 8K.

RECENT COMPLETION HIGHLIGHTS

The following table illustrates first quarter 2011 completions in which Northern Oil has participated with a working interest.

WELL NAME		OPERATOR		COUNTY/STATE		WI		IP/BOEPD *
JEANIE 25-36 #2H		URSA		MCKENZIE, ND		54.58%		1,185
HOVDEN FEDERAL #1-20H		SINCLAIR		DUNN, ND		45.72%		1,325
BORSETH #15-22 1H		URSA		MCKENZIE, ND		39.55%		2,015
BANDIT #2-29H		SLAWSON		MOUNTRAIL, ND		26.25%		959
NIELSEN #1-12H		CONTINENTAL		DIVIDE, ND		24.25%		857
VONA #1-13H		CONTINENTAL		DIVIDE, ND		20.31%		921
ERNEST SCHARCHENKO #34-33H		MARATHON		DUNN, ND		17.57%		400
MUSKRAT FEDERAL #1-28-33H		SLAWSON		MOUNTRAIL, ND		12.83%		1,453
ZI PAYETTE #10-15H		ZENERGY		MCKENZIE, ND		12.50%		1,323
HOLTE #1-32H		CONTINENTAL		WILLIAMS, ND		12.50%		933
GEORGE TANK #151-96-10C-3-3H		PETRO HUNT		MCKENZIE, ND		12.35%		902
ALMER 31X-6		XTO		WILLIAMS, ND		11.14%		388
BROWN 30-19 #1H		BRIGHAM		MOUNTRAIL, ND		9.25%		2,240

2

CROWFOOT #35-3031H		EOG		MOUNTRAIL, ND		8.38%		330
COWDEN #5404 13-35H		OASIS		WILLIAMS, ND		7.65%		1,594
EN-HEINLE #156-94-2536H-3		HESS		MOUNTRAIL, ND		7.29%		950
VIXEN FEDERAL #1-19-30H		SLAWSON		MOUNTRAIL, ND		6.70%		2,218
HELEN 11X-05		XTO		WILLIAMS, ND		6.64%		917
BENNY #1-13H		CONTINENTAL		RICHLAND, MT		6.25%		232
NORWAY #1-5H		CONTINENTAL		MCKENZIE, ND		5.14%		1,429
ROUND PRAIRIE #10-1819H		EOG		WILLIAMS, ND		4.82%		1,900
MILLER #44-11H		WHITING		WILLIAMS, ND		4.12%		1,144
BUD #1-19H		CONTINENTAL		WILLIAMS, ND		3.70%		1,983
KOSTELECKY 31-6H		FIDELITY		STARK, ND		3.60%		1,343
PROWLER #2-16		SLAWSON		MOUNTRAIL, ND		3.44%		1,145
HODENFIELD #15-23H		AMERICAN		WILLIAMS, ND		2.38%		1,400
EN-TRINITY #154-93-2833H-1		HESS		MOUNTRAIL, ND		2.28%		750
MCD #11-29H		FIDELITY		MOUNTRAIL, ND		2.08%		430
PAYARA # 2-21H		SLAWSON		MOUNTRAIL, ND		2.03%		1,148
MUIR #1-7H		CONTINENTAL		DIVIDE, ND		1.75%		671
MICHAEL STATE 31X-16		XTO		WILLIAMS, ND		1.19%		271
OUKROP #34-34H		FIDELITY		STARK, ND		1.17%		262
CLEARWATER #23-3025H		EOG		MOUNTRAIL, ND		1.08%		250
LYNN #19-20-29H		FIDELITY		MOUNTRAIL, ND		0.81%		1,251
SATTERTHWAITE #43-1H		WHITING		MOUNTRAIL, ND		0.70%		1,478
EN-WILL TRUST B #157-94-2635H-3		HESS		MOUNTRAIL, ND		0.54%		320
FORT BERTHHOLD #152-94-13B-24-1H		PETRO HUNT		MCKENZIE, ND		0.52%		1,135

_____________

There are a bunch of things to notice.  Every single well is in North Dakota.  That is not surprising - the "sweet spot" in the Bakken is in North Dakota.  We know that Northern has been buying its large acreage in Montana and buying small plots in North Dakota - but all the drilling is on those small plots.  (The large Montana acreage might one day be valuable but they paid not very much for it - and as far as the current drilling is concerned the Montana positions only pad the acreage numbers.)

The second thing to note is how variable these wells are.  Only three wells have an initial flow of above 2000 barrels per day.  Ten wells have an initial flow below 500 barrels per day.

The third thing to note is that - as per all Northern releases - no decline data is given.

Lets contrast this to Brigham Exploration (BEXP) who have published a summary of their Williston Basin North Dakota results.  BEXP averages greater than 2850 barrels per day initial flow.  The average of Brigham is above the highest achieved by Northern Oil.  Brigham has multiple wells that flowed above 5000 barrels per day initially.

Moreover Brigham does not have a single well with an initial flow below 1000 barrels per day.

Further Brigham published flow rates averaged over the first 30 days and the first 60 days.  Declines are massive.  Initial flows averaged 2858 barrels per day. Average of the first 60 days is 826 barrels of oil per day and those averages include very high initial flows.

Whatever: it is clear that Brigham's results are much much better than Northern and that Brigham deserves a premium valuation.  All things equal these results suggest that Northern's acreage position is inferior to Brigham despite Northern being entirely focussed on acreage.

Decline rates are massive at Brigham - albeit from high initial flows.  We do not know the decline rates at Northern but the initial flows are much lower.



John

A postscript is warranted. Brigham Exploration was acquired. It was a good call...

When senior executive pay becomes parody: Transocean edition

Transocean awards bonuses to senior management at least in part based on safety.  That looks honorable to me.

But as the WSJ reports:

Transocean Ltd. had its "best year in safety performance" despite the explosion of its Deepwater Horizon rig that left 11 dead and oil gushing into the Gulf of Mexico, the world's largest offshore-rig company said in a securities filing Friday.  

Accordingly, Transocean's executives received two-thirds of their target safety bonus. Safety accounts for 25% of the equation that determines the yearly cash bonuses, along with financial factors including new rig contracts. 

The payout contrasts with that for 2009, when the company withheld all executive bonuses after incurring four fatalities that year "to underscore the company's commitment to safety."

I want to express my view about the obligation of shareholders to hold management accountable and the problems in corporate law and practice that make that difficult (eg staggered boards) but sometimes you need to just look in wonder at where we have got to.



John

Northern Oil's expanding share count

I had to double-take when I wrote this.  Over the past two years Northern Oil has had about 60 million dollars of revenue.  It has issued roughly three quarters of a billion dollars worth of stock at current prices.

Think about that for a while - then read the detail.

Details details details...

Here is the share count for Northern Oil for the last 8 quarters

2009 Q4     34,120,103
2009 Q1     34,392,103
2009 Q2     36,691,195
2009 Q3     36,769,195
2009 Q4     43,911,044
2010 Q1     44,932,331
2010 Q2     51,079,143
2010  Q3    51,596,849
2010 Q4     62,129,424

Shares outstanding have risen by 28 million which at current market prices is about three quarters of a billion dollars.  Share count has risen every quarter.

Regular issuance is dilutive of the interests Northern Oil shareholders.  It is hard to justify the current stock price if this issuance keeps up.

Many of these shares were sold to the market for cash.  However shares were also issued for lots of other purposes.

Warren Buffett observes that when a company issues shares it is selling a little bit of itself.  If it sells shares for acreage it is selling a little bit of the company in exchange for that acreage.  If the acreage is better-than-average it might be worth it.  But when a company is issuing shares at this rate the quality of assets acquired for those shares should be subject to scrutiny.

As noted - this company often buys acreage for shares.  The land manager (presumably someone important in making that decision) is a 23 year old.  He is probably on top of it.

However shareholders should keep abreast of the reasons management issue stock.  To help I have  (without further comment) reproduced below the section on stock issuance in the 10K.



John






NOTE 6     PREFERRED AND COMMON STOCK


The Company’s Articles of Incorporation authorize the issuance of up to 100,000,000 shares.  The shares are classified in two classes, consisting of 95,000,000 shares of common stock, par value $.001 per share, and 5,000,000 shares of preferred stock, par value $.001 per share. The Board of Directors is authorized to establish one or more series of preferred stock, setting forth the designation of each such series, and fixing the relative rights and preferences of each such series.  The Company has neither designated nor issued any shares of preferred stock.


In 2008 optionees exercised 260,000 stock options granted in 2006 and 2007, resulting in cash proceeds to the Company of $933,800.  A tax benefit of $425,000 related to fully vested stock option awards exercised was recorded as an increase to additional paid-in capital


In February 2009, the Company agreed to issue 92,000 shares of Common Stock to three employees of the company as compensation for their services.  The employees were fully vested in the shares on the date of the grant.  The fair value of the stock to be issued was $261,280 or $2.84 per share, the market value of a share of common stock on the date the stock was obligated to be issued.  The entire amount of this stock award was expensed in the year ended December 31, 2009.


On February 27, 2009, the Company closed on a revolving credit facility with CIT Capital USA, Inc. (“CIT”).  As part of obtaining this credit facility agreement the Company entered into an engagement with Cynergy Advisors, LLC (Cynergy).  As part of the compensation for the work performed on obtaining the financing, Cynergy received 180,000 shares of restricted Common Stock of the Company.  The fair value of the restricted stock was $475,200 or $2.64 per share, the market value of a share of Common Stock on the date the financing closed.  The fair value of this stock was capitalized as Debt Issuance Costs and is being amortized over the amended term of the financing.


On April 3, 2009, the Company acquired leasehold interests in North Dakota. The total consideration paid for this acreage was 49,092 shares of restricted common stock.  The fair value of the restricted stock was $224,879, or $4.58 per share, the market value of a share of Common Stock on the date the leasehold interests were acquired.


In June 2009, the Company completed a registered direct offering of 2,250,000 shares of common stock at a price of $6.00 per share for total gross proceeds of $13,500,000.  The Company incurred costs of $813,237 related to this offering.  These costs were netted against the proceeds of the offering through Additional Paid-In Capital.


On October 26, 2009, the Company deposited 41,989 shares of common stock in a specially-designated shareholder account that had been previously-created to hold shares of our common stock represented by certificates that appear in our stock transfer records but were known to have been cancelled and their underlying shares transferred between July of 1987 and August of 1999.  An aggregate of 58,268 shares of our common stock are held in the specially-designated shareholder account, which, following a substantial review of all available historical stock transfer records, the Company concluded represents the maximum number of shares of our common stock that could potentially be released to shareholders who may be able to establish a valid claim to such shares due to previously unrecognized issues with the Company’s stock transfer records.  These shares are considered issued and outstanding and are included in the total number of shares outstanding disclosed on the cover page of this report.


On November 4, 2009, the Company completed a registered direct offering of 6,500,000 shares of common stock at a price of $9.12 per share for total gross proceeds of $59,280,000.  The Company incurred costs of $2,972,027 related to the offering.  These costs were netted against the proceeds of the offering through Additional Paid-in Capital.


In November and December 2009, the issued 79,005 shares of common stock related to the purchase of leasehold interests in North Dakota. The fair value of the stock was $890,859, the market value of the Common Stock on the date the leasehold interests were acquired.


In November 2009, the Company issued 50,000 shares of Common Stock to two employees of the company as compensation for their services.  The employees were fully vested in the shares on the date of the grant.  The fair value of the stock issued was $457,500 or $9.15 per share, the market value of a share of common stock on the date the stock was issued.  The entire amount of this stock award was expensed in the year ended December 31, 2009.


In December 2009, the Company issued 100,000 shares of Common Stock to two executives of the company as compensation for their services.  The executives were fully vested in the shares on the date of the grant.  The fair value of the stock issued was $970,000 or $9.70 per share, the market value of a share of common stock on the date the stock was issued.  The entire amount of this stock award was expensed in the year ended December 31, 2009.


In December 2009, the Company issued 41,670 shares of Common Stock to the Company’s outside Directors as compensation for their services.  The Directors were fully vested in the shares on the date of the grant.  The fair value of the stock issued was $404,199 or $9.70 per share, the market value of a share of common stock on the date the stock was issued.  The entire amount of this stock award was expensed in the year ended December 31, 2009.


In December 2009, a Director of the Company exercised 100,000 stock options granted to him in 2007.  The exercise of these options was completed through a cashless exercise whereas the company repurchased 52,061 of common shares to issue the common shares related to this option exercise.


In January 2010, the Company agreed to issue an aggregate of 4,000 shares of Common Stock to two employees of the Company.  The shares were fully vested on the date of the grant.  The fair value of the stock issued was $50,280 or $12.57 per share, based upon the market value of one share of the Company’s common stock on the date the stock was obligated to be issued.  The entire amount of this stock award was expensed in the year ended December 31, 2010.


In January 2010, the Company agreed to issue 1,000 shares of Common Stock to a consultant of the Company.  The shares were fully vested on the date of the grant.  The fair value of the stock issued was $12,320 or $12.32 per share, based upon the market value of one share of common stock on the date the stock was obligated to be issued.  The entire amount of this stock award was expensed in the year ended December 31, 2010.


In March 2010, the Company issued 10,287 shares of Common Stock as part of an acquisition of leasehold interests in North Dakota. The fair value of the stock issued was $99,475 or $9.67 per share, based upon the market value of one share of common stock on the date the leasehold interests were acquired.


In March 2010, pursuant to employment agreements the Company issued an aggregate of 50,000 shares of Common Stock to executives of the Company.  The shares were fully vested on the date of the grant.  The fair value of the stock issued was $664,500 or $13.29 per share, based upon the market value of one share of common stock on the date the stock was obligated to be issued.  The Company expensed $307,331 in share-based compensation related to the issuance for the year ended December 31, 2010.  The remainder of the fair value was capitalized into the full cost pool.


In April 2010, the Company entered into an underwriting agreement to sell 5,750,000 shares of common stock at a price of $15.00 less an underwriting discount of $0.60 per share for total net proceeds of approximately $82.8 million, after deducting underwriters’ discounts.  The Company incurred costs of $300,000 related to this offering.  These costs were netted against the proceeds of the offering through Additional Paid-In Capital.


On June 14, 2010, the Company issued 382,645 shares of Common Stock as part of an acquisition of leasehold interests in North Dakota.  The fair value of the stock issued was $5,360,856 or $14.01 per share, based upon the market value of one share of common stock on the date the shares were registered with the SEC for resale, which is the date the leasehold interests were acquired.


On June 18, 2010, the Company granted 14,167 shares of Common Stock related to acquisitions of leasehold interests in North Dakota.  The fair value of the stock granted was $238,006 or $16.80 per share, based upon the market value of one share of common stock on the date the leasehold interests were acquired.


 On July 13, 2010, the Company granted 31,206 shares of Common Stock related to acquisitions of leasehold interests in North Dakota.  The fair value of the stock granted was $451,551 or $14.47 per share, based upon the market value of one share of common stock on the date the leasehold acquisitions were agreed upon.


On July 14, 2010, the Company granted 444,186 shares of Common Stock related to acquisitions of leasehold interests in North Dakota.  The fair value of the stock granted was $6,529,534 or $14.70 per share, based upon the market value of one share of common stock on the date the leasehold interests were acquired.


In July 2010, pursuant to an employment agreement the Company issued 5,000 shares of Common Stock to an employee of the Company.  The shares were fully vested on the date of the grant.  The fair value of the stock issued was $69,250 or $13.85 per share, based upon the market value of one share of common stock on the date the stock was obligated to be issued.  The entire amount of this stock award was expensed in the year ended December 31, 2010.


In November 2010, the Company entered into an underwriting agreement to sell 10,292,500 shares of common stock at a price of $20.25 less an underwriting discount of $0.81 per share for total net proceeds of approximately $200.1 million, after deducting underwriters’ discounts.  The Company incurred costs of $392,795 related to this offering.  These costs were netted against the proceeds of the offering through Additional Paid-In Capital.


In November 2010, the Company issued 153,075 fully vested shares of Common Stock to the executives and employees of the Company as compensation for their services.  The fair value of the stock issued was $3,497,764 or $22.85 per share, the market value of a share of common stock on the date the stock was issued.  The Company expensed $1,235,429 in share-based compensation related to the issuance for the year ended December 31, 2010.  The remainder of the fair value was capitalized into the full cost pool.


Restricted Stock Awards


During the years ended December 31, 2010, 2009, and 2008,the Company issued 1,058,000, 361,330 and 20,000, respectively, restricted shares of common stock as compensation to officers, employees, and directors of the Company. The restricted shares vest over various terms with all restricted shares vesting no later than December 31, 2013. As of December 31, 2010, there was approximately $13.2 million of total unrecognized compensation expense related to unvested restricted stock. This compensation expense will be recognized over the remaining vesting period of the grants. The Company has assumed a zero percent forfeiture rate for restricted stock. 

The guy in charge of purchasing acreage at Northern Oil

Northern Oil is not a traditional oil exploration and production company. It has a simple model. It buys part shares in acreage in the Bakken shale. It waits until the major holder develops the acreage and it pays a proportion of the development costs and receives a proportion of the revenue.

That allows it to be a 1.6 billion dollar company with only 11 staff.

The only expertise it brings to the table is buying acreage. And they buy it at a wide scatter of prices.  They have paid $2500 or more an acre for some small (and presumably productive) lots. For example they paid $2500 an acre for 1748 net acres in Williams and McKenzie County of North Dakota during 4q 2010. They have paid less than 250 an acre for some very large lots. In the last quarter they purchased a 50% working interest in approximately 14,538 net acres in Richland County Montana for less than $250 an acre in the same quarter. In that case the acreage was purchased from the operator (Slawson) and presumably the operator had better-than-average intelligence as to the quality of that acreage.

The supporters of the stock value the stock based on acreage owned. This is obvious enough because you most certainly would not want to value it against current earnings or current revenue.

Given that acreage purchase is the whole reason for owning Northern Oil and believing the Northern Oil story it is worth following the people who manage acreage purchase. Betting on Northern Oil is above all betting on those people.  Northern Oil after all buys acreage in a scatter of prices almost all below $3000 an acre with large purchases below $250 an acre but is valued by the market at about $8600 per acre.  The acreage buying is the driver of incredible (market) value.

So without further ado I will tell you that the Land Manager of Northern Oil is Mr Kruise Kemp. Kruise Kemp has been hanging around the courthouses of Montana swooping on land where leases have expired without ever being drilled. An old article in the Billings Gazette describes the process and says how lease holders in Montana look in envy on the lease holders of North Dakota because in North Dakota the land often gets drilled whereas in Montana leases expire without ever seeing the drill bit. To quote:

Kruise Kemp is no stranger to the courthouses of northeastern Montana. The land manager for Minnesota-based Northern Oil & Gas said there are several buzzing with the land men just like Richland County's. 

Many of those speculators are looking to "top lease," meaning their sniffing out existing oil leases that are just about to expire in hopes of swooping in to strike up a new deal just as the clock runs out. 

In these parts, Montanans, some with leases that went untapped, have looked in envy toward North Dakota where drilling rigs have cropped up like knapweed the last couple years. There are 138 rigs punching holes through the shale in North Dakota. Here, there is only a handful. 

Kemp said the state of North Dakota had provided oil companies with a wealth of services including online field data that made it easy to setup. And drilling rigs attract other drilling rigs. It's a safe assumption when you see other rigs active in your area that you're going to hit something. Having so many rigs drilling in one area puts pressure on companies to permit as many wells as possible before moving on. 

But now companies are turning to Montana to further define the productive area of the Bakken. Working with two other companies, Northern launched a new 3,000-acre project in Richland County this month and has two others nearby.

You see Northern is buying the land where the drills aren't. Of course this makes it cheap. It could be cheap for a reason - the drills not being there because it is not really all that good land. Or it could be that Northern Oil is really great at finding cheap acreage that really is super-prospective.

Well as investors we can't directly know. We don't see the seismic and we are not there with the drill bit.  

All we have to go on in the people. And so I present to you a picture - a couple of years old - of Mr Kruise Kemp.

He played golf for Montana State and was a business school graduate (no particular honors) in the spring of 2010.  A nexus search identifies him as 23 years old.

So what qualifies Kruise Kemp for such a senior role in a 1.6 billion dollar company? Well it is not his finance degree. But Kruise is steeped in the oil industry in Montana. His father owns or controls a couple of oil companies. (I can find their names but not much detail about them.) His late grandfather was also an oilman.

Northern Oil has also done many related party transactions to buy acreage.  If the company is buying acreage from directors then I guess it is incumbent on the land manager to vet those purchases. Kemp is the man with that job.

We view Kemp's age and business degree (rather than say a major in geology or reservoir engineering) with skepticism. Then again we own Google. That is one of the greatest companies in history and it was started by (very bright) people in their 20s. Steve Jobs was 16 when he was introduced to Steve Wozniak and Apple was the result.

It could be that Montana State University business school has produced one of the world's great 23 year old oil-industry entrepreneurs. Might be. As a Northern Oil shareholder that is one of the things you are betting on.

John

Northern Oil related party statements

From the 10K - presented without comment

NOTE 7 RELATED PARTY TRANSACTIONS 

The Company has purchased leasehold interests from South Fork Exploration, LLC (“SFE”) pursuant to a continuous lease program that covers specific agreed upon sections of townships and ranges in Burke, Divide, and Mountrail Counties of North Dakota where SFE previously acquired leasehold interests on the Company’s behalf and is authorized to continue to acquire additional acreage within the proximity of the originally-acquired leases. This program differs from other arrangements where the Company may purchase specific leases in one-time, single closing transactions. In 2008, the Company paid a total of $815,100 related to previously acquired leasehold interests. In 2009, the Company paid a total of $501,603 related to previously acquired leasehold interests. In 2010, the Company paid a total of $5,000 related to previously acquired leasehold interests. Because each lessor separately negotiates its own desired royalty, SFE’s over-riding royalty interest varies from lease to lease. The Company is receiving a net revenue interest ranging from 80.25% to 82.5% net revenue interest in the acquired leases, which is net of royalties and overriding royalties. SFE’s president is J.R. Reger, the brother of the Company’s CEO, Michael Reger. J.R. Reger is also a shareholder in the Company. 

The Company has also purchased leasehold interests from Montana Oil Properties (“MOP”). In 2008, the Company purchased leasehold interests from MOP for a total consideration of approximately $5,160,824. In 2009, the Company paid MOP a total of $63,234 related to previously acquired leasehold interests. In July 2010, the Company paid MOP a total of $269,821 for leases and reimbursement costs pertaining to two separate wells in Mountrail County, North Dakota. MOP is controlled by Mr. Tom Ryan and Mr. Steven Reger, both are relatives of the Company’s Chief Executive Officer, Michael Reger. 

The Company has also purchased leasehold interests from Gallatin Resources, LLC (“Gallatin”). In 2008, the Company purchased leasehold interests from Gallatin for a total consideration of approximately $22,109. In 2009, the Company paid Gallatin a total of $22,223 related to previously acquired leasehold interests. In 2010, the Company paid Gallatin a total of $15,822 related to a previously acquired leasehold interests. Carter Stewart, one of the Company’s directors, owns a 25% interest in Gallatin. Legal counsel for Gallatin informed the Company that Mr. Stewart does not have the power to control Gallatin Resources because each member of Gallatin has the right to vote on matters in proportion to their respective membership interest in the company and company matters are determined by a vote of the holders of a majority of membership interests. Further, Mr. Stewart is neither an officer nor a director of Gallatin. As such, Mr. Stewart does not have the ability to individually control company decisions for Gallatin. 

The Company has a securities account with Morgan Stanley Smith Barney that is managed by Kathleen Gilbertson, a financial advisor with that firm who is the sister of the Company’s president and Director, Ryan Gilbertson.

All transactions involving related parties were approved by the Company’s Board of Directors or Audit Committee.

The marvellous Wall Street capitalization machine: Northern Oil edition

Northern Oil has its defenders and the defenders tend to point to one thing only – the value of Northern Oil's acreage.  After all you would never buy Northern Oil based on its current revenue or its current profit.  Here are the quarterly numbers (you will need to click for full detail):

(The company notes the 3c per share loss in the fourth quarter was after oil hedging losses.  The loss was also after an extra depletion charge.)

Anyway its pretty hard to justify Northern Oils $1.6 billion market cap based on these quarterly numbers.  We are talking approximately 35 times revenue – and well over 100 times earnings (on their numbers – numbers which I believe are inflated).

To justify the market cap you need to assume that soon-to-be-developed acreage is worth a fortune.  And the defenders do just that.  For example Canacord Genuity (a major promoter) in its daily note (23 March 2011) led with this:

Investment recommendation 

We are reiterating our BUY rating and thesis based on Northern Oil’s acreage quality and relative growth potential. The company's core competency is lease acquisition, and we remain encouraged by its ability to accelerate acreage acquisition and development activities. In our view, the recent bearish sentiment and associated sell-off are overdone. We remain very comfortable with our assessment of the Bakken, oil and gas accounting and Northern Oil’s valuation. We view this weakness as a buying opportunity given precedent transactions and the company’s proven ability to organically acquire acreage at accretive levels.

Investment highlights

 From our constructive stance, we believe the bulls would argue that Northern Oil trades at a ~17% discount (EV/EBITDAX) to its closest peers (BEXP and OAS) and that the recent Linn Energy transaction (CXO/LINE valued at +$12,700 per acre, NOG valued at ~$8,600 per acre) more than underpins its fundamental valuation. The LINE and NOG metrics are adjusted for production at $100,000 per boepd. The bears point to depletion accounting and corporate governance concerns.  While oil and gas accounting is complex, we are very comfortable with our assessment of Northern’s business model, reserve accounting and oversight controls and balances.

The key here – which I highlighted – is that the company is only valued at $8,600 per acre compared to some recent transactions at $12.600 per acre.

That would be good if we were comparing apples with apples (or acres of identical quality).  We can however find a good scatter of acreage prices.  The Feburary 25 edition of Rocky Mountain Oil Journal gives a Bakken state of play.  This is what they said about North Dakota auctions by the State in 2011:

Aside from the oil and gas numbers, North Dakota also set numerous lease records for 2010. The state held four land sales during the year, selling 164,848.38 acres for a total of $311,238,786.60. This translates into an eye-popping per-acre average of $1,888.03. The Mar. 10, 2010 sale was particularly memorable, with 53,274.97 acres being sold for $158,099,211.75, representing an unbelievable per-acre average of $2,967.60.

Note that a $1,888 average is “eye popping” in a trade magazine.  The March auction was “ unbelievable” at $2,967.

I run out of adjectives for Northern Oil's market cap at $8,600 an acre.  But that is Wall Street – buy it at sub $3000 an acre, put it in a company and have pension funds buy it from you (when you sell your stock) at $8,600 an acre.  Everyone is happy!

But hey – why use average auctions when we have Northern's own numbers?  When you read these numbers remember that well spacing is typically about 1 per 600 acres to 1 per thousand acres with the lesser spacing being more common.  Quoted from the 10K:

The following describes some of our larger acquisitions during the fourth quarter of 2010: 

Williams and McKenzie Acreage Acquisition 

In December of 2010 we acquired approximately 1,748 net acres for $2,500 per net acre in Williams and McKenzie Counties of North Dakota. All of the acreage consists of non-operated tracts that are not subject to specific exploration or development agreements. Several operators have been permitting and drilling wells in close proximity to the acreage, and we expect development of our acreage will commence in 2011. 

Slawson Exploration Lambert Prospect 

In December of 2010 we acquired a 50% working interest in approximately 14,538 net acres for total consideration of $1,737,483 in Richland County, Montana. Slawson will be operating the prospect and all drilling and future acquisition costs will be shared pro-rata with Slawson based upon our proportionate working interest in the prospect. This prospect is in close vicinity of Elm Coulee, and considered an extension of the Southwest Big Sky project, which is also operated by Slawson. 

BLM Sale

In December of 2010 we purchased 720 net acres from the Bureau of Land Management for $875 per net acre in Richland County, Montana. The acreage lies within a selected township that recently experienced a successful test well targeting the Bakken formation, but is not subject to specific exploration or development agreements. 

Miscellaneous Acreage Acquisitions 

In November 2010 we purchased 506 net acres for $2,000 per net acre in a single spacing unit in McKenzie County, North Dakota. In December 2010 we purchased 506 net acres for $1,500 per net acre in a separate spacing unit in Richland County, Montana. As of December 31, 2010, the McKenzie County, North Dakota well was awaiting completion and the Richland County, Montana well was spud. In December of 2010 we purchased 322 net acres for $1,775 per net acre in Mountrail County, North Dakota, of which 235 net acres is estimated to spud during the first quarter of 2011.

Now the first acquisition (William McKenzie) is 1748 acres (two or three wells at standard spacing) at $2500 per acre.  These will be drilled this year - and they were purchased at about the mid-price for Bureau of Lands sales in 2010.  You would expect them to be ordinary acres. It is a bit adventurous the the stock market to value this at $8600 per acre but it is at least in line with industry norms.

But the second acquisition (Slawson Exploration Lambert Prospect) was very different.  It was a 50 percent interest in net 14,538 acres (call it 7269 acres net for Northern) for $1,737,483.  That is $239 an acre.  And they did not buy it from a dupe part - they bought it from Slawson who operates and will continue to operate those acres.  The operator was willing to sell these acres for $237.  It looks awful rich to value them at $8,600 per acre for these acres.

The BLM sale was at about a third the cost of the average BLM sale during the year - and that was at a competitive auction.  $875 per acre in a competitive auction is not chump-change but it is about 10 percent of the market-cap per acre the company trades at.

Wall Street - the capitalization machine

Wall Street capitalizes future earnings.  The price of a stock now is the market estimate of what cash it can generate for investors in the future.  Sometimes Wall Street is really dismal and the price of stocks is much lower than the value of the same businesses would sell for in a private transaction.  (That is when Warren Buffett likes to buy stocks.)  Sometimes Wall Street values stocks far more than independent industry transactions.  At that time businesses wanting to sell rush go to public.

Boone Pickens when he purchased oil stocks famously said that it was cheaper then to "drill for oil on the floor of the New York Stock Exchange" than it was to drill out in the field.

Northern Oil stock is the anti-Boone-Pickens transaction.  The company buys acreage at as low as $237 an acre and have the AMEX value it it at $8600 and have lots of Wall Street's Finest Analysts tell you that is cheap compared to comparable transactions.

Thanks - but I am still short.



John