Continental Resources Upgraded: What It Means for Others

Continental Resources  was bumped up to investment grade by Moody's last week. While the Oklahoma-based company's strong financial position is attributed to its growing crude oil production from the Bakken shale play and the Anadarko Woodford, it's also good news for fellow Bakken operators, Kodiak Oil & Gas and Whiting Petroleum .

Another reward for Bakken investors
One of the largest operators in the Bakken shale play, Continental announced last week that the credit rating agency upgraded the company's senior unsecured rating to Baa3 from Ba2. Management directly attributes the upgrade to its growing successes in the Bakken and the recently discovered SCOOP play, along with a "disciplined capital sourcing enabling a strong credit profile." From an investor standpoint, this is what I'm looking for.

Handsome returns
Not surprisingly, shareholders have been rewarded handsomely with a market-beating 84% in the last two years. Delving deeper, how exactly did Continental Resources manage these returns? And, more importantly, how can other companies emulate Continental's success?

CLR Chart

CLR data by YCharts.

The secret behind Continental's growth: Cost discipline
One of the major factors behind the company's success is a well-balanced approach to growth. Despite being the largest leaseholder in the Bakken with 1.2 million net acres at the end of the third quarter, Continental has, by far, the best well economics in the region. That means the company not only aims for outright growth in production volumes but it seeks to do so in the most efficient manner possible. Despite its huge reserves, Bakken is an expensive region to operate. The cost of a completed well is critical to a company's cash margins. Continental's costs averaged $8 million per completed well in the third quarter, lower than the industry average of $9.2 million in the first half of the year. For 2014, Continental is targeting to further drive down costs to $7.5 million per completed well.

Kodiak Oil and Gas, on the other hand, is averaging between $9.2 million and $9.5 million per completed well. However, in the last quarterly earnings call, Kodiak's management seemed confident of pushing down costs to $9 million and below in future. Also, Kodiak is currently working on two wells that are going to be in the $7.5 million range. Whiting Petroleum, however, has been much more impressive, finishing off its Bakken wells in just $7.5 million.

Speaking of margins, Continental enjoyed a cash margin of $59 per barrel of oil equivalent, or Boe, in the third quarter, while for Kodiak it was $71 per Boe. This is mainly because of a different oil-gas mix rather than any deficiency. In any case, these margins are solid.

Bigger than we thought!
However, newer and more advanced technology is also increasing the life of the reserves. The Lower Three Forks formation in the Bakken was considered to contain 24 billion Boe of recoverable reserves. However, these estimates have been revised upward to 32 billion barrels of recoverable oil last year. This is why I see long-term potential in these Bakken players, provided their capital management is sound.

Are the debt levels too high?
This leads us to the next point: How much debt do these companies carry? At a debt-to-equity ratio of 116%, Continental's debt levels aren't exactly low. But Moody's seems to think otherwise, and rightly so. These are oil companies whose investment periods span decades. And given that Bakken isn't exactly inexpensive to drill, I'm not surprised why the cheaper form of capital is a little high. Continental is aiming to triple production volumes by 2017 from current levels. That's definitely ambitious, but given the way this company operates in one of the hottest shale plays of North America, it sounds plausible.

On the other hand, Whiting Petroleum has a debt to-equity ratio of just 75%, while Kodiak is a little higher at 192%. Again, I'm not concerned, as Kodiak is definitely one of the most successful growth companies in the oil and gas space in the last five years.

Foolish takeaway
Both Whiting as well as Kodiak are rated Ba2 by Moody's -- in other words, their credit ratings are just below investment grade. However, as these companies mature and stabilize, they should likely be bumped up to investment grade status. In the meantime, long-term investors in these companies should witness solid returns in 2014 and beyond.

More advice from The Motley Fool
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Fool contributor Isac Simon has no position in any stocks mentioned. The Motley Fool recommends Moody's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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