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Avinash Gandhi

CLR AT A GLANCE

P/E ► 301 VERY HIGH EV/EBITDA ► 34.6 VERY HIGH ROA ► 1.7% AVG ROE ► 2.3% AVG Debt to Equity ► 1.27 AVG Current Ratio ► 1.13 AVG Interest Coverage Ratio ► 3.39 AVG

 

 

 

 

 

 

Continental Resources had its initial public offering in May of 2007, and its stock price has more than tripled since then. Continental's engineers have been using high-end extraction techniques for nearly a decade, giving them an established knowledge of the intricacies of technologies like horizontal drilling - a boon in a market where record-high oil prices have made such expensive techniques cost-efficient. The majority of its reserves, around 77%, are filled with oil^[1], giving the company more exposure to oil prices than to natural gas prices, which have also trended upwards, but to a much lesser degree. These reserves, located primarily in the Rocky Mountains, are also mostly unconventional, meaning they can produce well but are dependent on high-cost drilling techniques - risky to hold in the event that oil prices drop, as the company's margins, which have been over 50% for the last three years, would collapse. Continental competes with other onshore E&P companies like Cabot Oil & Gas, XTO Energy, Unit, Forest Oil, Equitable Resources, and Cimarex Energy Co.

Business and Financials

Continental Resources has been an independent oil and gas exploration company ince 1967, though the company only went public in May of 2007. It has reserves totaling 134.6 MMBoe, 77% of which are filled with oil (the rest with natural gas). 82% are located in the Rocky Mountains, and the rest are distributed between the Woodford Shale and other mid-continent and Gulf Coast fields.

Continental's reserves are concentrated in regions that have seen little attention from larger, publicly-traded companies because of the high cost of developing them. For this reason, the company has had years of developing unconventional reserves without competition, developing a skill set that has come in handy in the high oil price environment that has been evolving since the middle of 2007. With oil prices at record highs, oil companies are all scrambling to ramp up production, and are willing to use expensive extraction techniques to get at difficult-to-access reserves; Continental's experience allows to use these techniques at lower cost and higher efficiency.

Though CLR has seen steady revenue and income growth.^[2]

Trends and Forces

Continental's Focus on Oil Rather than Natural Gas Means it is More Exposed to Fluctuating Oil Prices

Out of Continental's total reserves in 2007, 77% were filled with oil.^[4] This means that the price of oil is the key determinant of whether the company will turn a profit. Since the middle of 2007, oil prices have been trending upwards, to record highs; on the 21st of May, 2008, for example, oil traded at $134.10 per barrel^[5], after averaging around $20 during the 1990s.^[6] Most other onshore American E&P companies focus on natural gas production, making them dependent on highly volatile natural gas prices. Natural gas prices have also trended upwards, but from $4 during the '90s to around $10 in May.^[7][8] Oil prices have increased by over a factor of six, while natural gas prices have increased by a factor of two and a half, making CLR a greater beneficiary to rising petroleum prices than most other North American onshore explorers.

Continental's Position in Younger Oilfields Allows it to Offset a Decreasing Reserve Life Caused by Growing Production

CLR has 12.1 years worth of oil in its reserves, assuming it doesn't add any more reserves to its holdings and it keeps production at 2007 levels.^[9] The company, however, has a huge incentive to ramp up production, as there is no guarantee that future oil prices will be so lucrative; this would decrease CLR's reserve life. Fortunately for the company, its properties are in some of the most potentially lucrative fields in North America: the Bakken field covering areas in Montana, North Dakota and Saskatchewan was reported by the U.S. Geological Survey to contain over 400 billion barrels of oil, though some estimates range as high as 900 billion, dwarfing Saudi Arabia's largest oilfields. ^[10] This gives the company a high likelihood of successfully exploring for new reserves. Furthermore, the American onshore drilling market is in a decline, as most conventional reserves have been depleted over the last 40 years. Having entered these younger oilfields earlier than most other onshore American E&P companies, Continental was able to pay lower lease prices and start exploring earlier, giving it an advantage over future competitors.

The Success of Continental's Drilling Strategy Relies on High Oil Prices

Up until 2007, Continental was a private corporation, and so was able to focus on developing high-end extraction technologies and crew expertise in ways that public E&P companies couldn't because oil prices were low and so returns on such techniques weren't as high. The company went public at a time when oil prices were on their way to record highs, giving the company the advantage of a decade of unconventional drilling experience. While many of Continental's reserves are in large, high-output fields, they are also relatively unconventional formations - they require expensive, unconventional drilling technologies like horizontal drilling and enhanced extraction techniques to produce. In the Red River fields of the Rocky Mountains, for example, the company has over 50% of its reserves, and has already drilled 235 horizontal wells, versus just 18 conventional, vertical wells.^[11]

Legislation Supporting the Development of Renewable Energy Threatens the Long-Term Strength of Hydrocarbons in the U.S.

Whether it’s because of the desire for energy independence, the rising price of oil, or fears of climate change, public opinion has turned away from petroleum, and is driving government policy changes that encourage the adoption of alternative fuels. Environmentalists have been calling for a shift to renewable energy for years, and though the river of change is running slow, it is running deep. The Energy Independence and Security Act of 2007 is the first step towards a grander series of changes. By forcing automakers to achieve 35 mpg by 2020 and setting a Renewable Fuel Standard of 36 billion gallons of biofuels in 2022^[12], the Act has potential to get the ball rolling to greatly reduce American dependence on hydrocarbons.

Already, 26 states across the country have adopted Renewable Energy Standards to increase the share of renewables in their energy mixes, while both Democratic candidates for President have pledged to reduce carbon emissions 80%, to below 1990 levels by 2050.^[13][14] While the Republican candidate isn't so tough on climate action, he still supports a strong cap-and-trade system. In emerging markets like China and India, the drive for economic growth supersedes environmental concerns, but CLR sells all its petroleum to the U.S. companies, a changing American environmental and energy legislation landscape would be disastrous to its business without the development of some effective carbon sequestration technology.

Competition

With all of its reserves on land, Continental competes with other U.S. onshore E&P companies.

• Cabot Oil & Gas - Cabot abandoned its offshore operations in favor of developing 1.616 Tcf worth of natural gas reserves across the U.S., in locations like Kansas, Oklahoma, Texas, West Virginia, the Rocky Mountains, and Canada.^[15]
• XTO Energy - XTO is an onshore E&P company operating in Texas, Louisiana, and the Rockies with approximately 11.29 trillion cubic feet equivalent in its reserves.^[16]
• Unit - Aside from its midstream pipelines and oilfield services operations, Unit has reserves of 514.6 Bcfe in New Mexico, Oklahoma, Arkansas, Louisiana, and Texas, of which 82% are natural gas.^[17]
• Forest Oil - Forest Oil operates 2.1 Tcfe of reserves around the world.^[18]
• Equitable Resources - Aside from its natural gas pipelines, storage, and utilities businesses, Equitable Resources operates 2.7 Tcfe of reserves in the Appalachian Basin.^[19]
• Cimarex Energy Co - Cimarex's reserves contain 1.4 Tcfe of petroleum, of which 1.1 Tcf is natural gas; the company drills in Texas, New Mexico, Oklahoma, Kansas, Wyoming, and Louisiana.^[20]

References

1. ↑ CLR 2007 10-K, Page 4
2. ↑ CLR 2007 10-K, Page 50
3. ↑ CLR 2007 10-K, Page 2
4. ↑ CLR 2007 10-K, Page 4
5. ↑ Reuters: "Oil surges over $134 on supply woes, weak dollar"
6. ↑ Oil Prices Chart
7. ↑ http://www.secureourenergy.com/images/10.jpg
8. ↑ Energy Prices Data, Accessed May 7th, 2008
9. ↑ CLR 2007 10-K, Page 2
10. ↑ Wealth Daily: "The Bakken Oil Field: The Oil Find That Trumps Saudi's Biggest Oil Field"
11. ↑ CLR 2007 10-K
12. ↑ WhiteHouse.gov, Fact Sheet: Energy Independence and Security Act of 2007
13. ↑ CNN Election Center: Issues: Environment
14. ↑ Washington Post: "A Green(er) Obama"
15. ↑ Reuters: Full Description: Cabot Oil & Gas Corp
16. ↑ Reuters: Full Description: XTO Energy Inc.
17. ↑ Unit Web Site: Operations Map
18. ↑ http://sec.gov/Archives/edgar/data/38079/000104746908001938/a2183054z10-k.htm FST 2007 10-K, Page 4]
19. ↑ EQT 2007 10-K
20. ↑ XEC 2007 10-K
21. ↑ CLR 2007 10-K, Page 2, found using a conversion factor of 1 bbl to 5.6146 cubic feet
22. ↑ Reuters: Full Description: Cabot Oil & Gas Corp
23. ↑ Reuters: Full Description: XTO Energy Inc.
24. ↑ UNT 2007 10-K, Page 9
25. ↑ http://sec.gov/Archives/edgar/data/38079/000104746908001938/a2183054z10-k.htm FST 2007 10-K, Page 4]
26. ↑ EQT 2007 10-K
27. ↑ XEC 2007 10-K
28. ↑ XTO 2007 10-K, Page 12