July 14, 2014 3:57 pm

Whiting / Kodiak: Bakken black?

For shale producers, bigger does not automatically qualify as better

North Dakota, home to Fargo. But that is not all. These days the state is as famous for its shale oil as it is for film thrillers. However, Whiting Petroleum’s $6bn all stock purchase of Kodiak Oil & Gas came with its own surprise: no premium. Kodiak shareholders have been offered a 2 per cent discount to Friday’s closing price and will end up owning 29 per cent of the new company. Whiting probably could not afford much more. Given that neither side has enough operating cash flow to develop their respective reserves, this combination will require cost cutting.

According to Credit Suisse, growth in oil production has peaked at both of these explorers. Kodiak has plenty of reserves on its books, but needs to spend money to develop them. So-called “proved undeveloped reserves” account for 61 per cent of Kodiak’s total reserves. For most US exploration and production companies, that figure is under 50 per cent. So Kodiak needed funding to keep pumping up production.

Step forward next-door neighbour, Whiting. However, Whiting hardly offers a new well of cash. By 2016, its own net debt is likely to have doubled from last year to $3.8bn as its spending tends to exceed cash flow. So it needs to find money to spend on both Kodiak’s reserves and its own. That means cuts are on their way. That funding situation might explain why both companies trade on forward cash flow multiples – adjusted for debt – about 5.7 times, roughly a fifth below the sector average.

Together the new merged company would become the largest oil producer in the Bakken region of North Dakota, ahead of Continental Resources, producing 107,000 barrels of oil daily. Today, the merged company would account for about 11 per cent of production there. Bigger does not automatically qualify as better in this case. No surprise there.

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