1 Stock to Play the Bakken Shale

The Bakken shale is arguably the most famous unconventional oil play in North America. Ever since new drilling technologies unlocked the play's potential, companies from all around the world have been rushing in to get a piece of the action.

One small-cap oil producer has a commanding position in the Bakken relative to its size, and its recent production results look very promising. Could this up-and-comer be one of the best ways to play the Bakken?

The biggest oil story in decades
Before I talk about the company, let's talk about the Bakken and why it's so important. Spread out across North Dakota, Montana, and parts of Canada, the Bakken formation is one of the most prolific shale plays ever discovered in North America. According to a 2008 study by the U.S. Geological Survey, it could contain reserves totaling 3.6 billion barrels of recoverable oil.

While that's a stunning number already, some say these figures are far too conservative. A director at the North Dakota Department of Mineral Resources recently placed estimates between 10 billion and 14 billion barrels of oil.

And Harold Hamm, a longtime veteran of the oil industry and CEO of Continental Resources (NYS: CLR) , another company with significant operations in the Bakken, is even more bullish on the play. Having dubbed it "America's Saudi Arabia," Hamm estimates that the Bakken and Three Forks reservoirs collectively hold 20 billion barrels of recoverable oil.

A massive boom in North Dakota
The play has already yielded such vast quantities of oil that it's managed to propel North Dakota to become the second-leading oil producing state in the country. Surpassing Alaska in March for this honor, it trails only Texas. The Bakken boom has brought down unemployment in North Dakota to an enviable 3% -- significantly below the national average -- and the state now runs a large budget surplus.

The state's growth story has been made possible largely by technological advances, including hydraulic fracturing -- or fracking -- and horizontal drilling. These techniques have helped unleash the potential trapped within rock formations like the Bakken. The resulting boom has attracted not only domestic players, but also international companies such as Norway's Statoil (NYS: STO) , which entered the play through its acquisition of Brigham Exploration.

Now let's get back to the Bakken producer I mentioned at the start, and look at why it might be a great way to invest in the play's potential.

Rockin' in the Bakken
The company is Kodiak Oil & Gas (NYS: KOG) and its as much a Bakken story as any oil producer out there. Its operations are largely focused on drilling for oil in the Williston basin, where it has amassed 157,000 acres. Perhaps more importantly, the company has nearly de-risked all of this acreage, which means that from here on out, it will be engaged primarily in low risk developmental drilling.

While second-quarter results won't be out until Aug. 2, recently reported preliminary results are encouraging. Sales volume grew 20% from the previous quarter, averaging around 12,700 barrels of oil equivalent per day. And for the first two weeks of July, net production averaged between 17,000 and 18,000 boe per day as the company inches closer to its year-end target of 27,000 boe per day.

Financial situation
While Kodiak has been growing production at a rapid clip, capital expenditures have been on the rise, as well. The company does have a sizable funding gap and has been outspending cash flow by quite a lot. But from what I can tell, it's also carefully watching costs. It recently decreased the spacing between its Bakken wells -- a practice known as downspacing -- which has yielded significant cost savings for companies like EOG Resources (NYS: EOG) .

For 2012, Kodiak's capital spending budget is $585 million, with the bulk of it dedicated to drilling and completing wells. The company plans on funding its aggressive drilling operations through cash flow and liquidity alone, after raising a large amount of capital through a senior note issuance and a stock offering last November.

Final thoughts and things to keep an eye on
Overall, Kodiak appears to be in a solid position. It's got around 800 net drilling locations in some very attractive acreage, most of which has already been de-risked. With seven operated rigs currently up and running and two non-operated rigs drilling, it expects all areas to be held by production by the end of next year.

But while there are many factors working in Kodiak's favor, the biggest risk is falling oil prices. Due to its small size, it's more vulnerable to a collapse in oil prices compared to larger players in this space. However, to offset this risk, Kodiak has hedged a large part of its production for the year at higher West Texas Intermediate (WTI) spot prices. When the company reports earnings Aug. 2, keep a close eye on the hedge situation, along with the cash balance and operated rig count.

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The article 1 Stock to Play the Bakken Shale originally appeared on Fool.com.

Fool contributorArjun Sreekumardoes not own shares of any companies listed above.Motley Fool newsletter serviceshave recommended buying shares of Statoil A. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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