Dakota oil: Persia on the Plains?

By Jon Markman

Western North Dakota and western Pennsylvania, by which I mean the middle of nowhere, are on track to become the center of the universe for energy companies over the next few years as geologists, speculators and attorneys battle for control of two of the most important and unusual oil and gas finds of the past three decades.

Before the battle is fully defined and winners are awarded the spoils, there's plenty of time for investors to make low-risk bets that could generate great returns over the next few years. There are even cheaper opportunities north of these two hot spots, in the Canadian tundra of Saskatchewan and New Brunswick, which share the same rich rock formations but have yet to attract as much interest.

It may be a little hard to believe that these forlorn areas -- far from the glamorously derrick-dotted plains of Texas, Oklahoma and California -- could yield the sort of riches that attract the diamond-studded-cowboy-hat crowd, but energy exploration has never exactly gone hand in hand with the tourist trade. So put on your mukluks and parka, get out your atlas and prepare for a visit to the Bakken and Marcellus shales.

Going deep

Let's start with western North Dakota, which some in the energy business are now calling Persia on the Plains.

Ramshackle wheat and alfalfa farms up there happen to lie atop the juiciest zone of the underground Bakken Formation, which stretches across 200,000 square miles of Montana and Saskatchewan as well. The heart of the Bakken, which contains three layers of shale that formed when the area was covered with relatively deep ocean, is about 2 miles down.

The rock was initially discovered as an oil source in the mid-1950s, but with extremely low porosity and permeability, it was impossible to exploit fully with conventional drilling techniques when oil was going for less than $50 a barrel.

In recent years however, horizontal drilling and "fractionation" extraction techniques -- invented in U.S. labs and developed in fields from Russia to Argentina -- have opened the formation, and its output is expected to expand exponentially so long as oil prices remain above $60 a barrel. Experts figure it will yield 270 million to 500 billion barrels of oil over its lifetime, which could make the roughly 60 billion barrels of oil of the famed North Slope of Alaska look like a child's mud puddle.

The interest has grown only recently as major producers such as EOG Resources (EOG, news, msgs) of Houston have announced major finds, making the folks who finance these sorts of high-risk ventures think they've got another huge winner on their hands.

It wasn't long ago that so-called unconventional fields were considered uneconomic. Now these underdogs are the center of the show, as the unconventional Barnett Shale in Texas has unleashed gushers of cash for early developers, as has the Pinedale Anticline area of Wyoming, developed by Ultra Petroleum (UPL, news, msgs).

Just to give you an idea of how this can affect a stock, back in 2001-03, one of my energy-biz sources, David Anderson of Palo Alto Investors, was regularly talking about Ultra's potential. At the time, it was just another $2-a-share energy stock that had a hard time convincing investors it could make much of its large stake in unconventional acreage. Now that it's up something like 4,000%, nobody's skeptical anymore. All an exploration company has to do now to demand multibillion-dollar valuation is announce a legitimate claim to 20,000 acres in the Barnett, Fayetteville and now Bakken shales.

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That's essentially what Continental Resources (CLR, news, msgs), has done: The Bakken player went public at $14 a share last May and has more than doubled, putting its market capitalization more than $5 billion. Showing its marketing savvy, it has the words "unconventional exploration" as a big headline right on its Web home page. And like most energy companies of its type, it's probably still dirt cheap, pardon the expression, trading at a price-to-earnings ratio of 10 on 2009 estimates despite income growth that's likely to top 22%.

Other major drillers in the Bakken are Brigham Exploration (BEXP, news, msgs), Whiting Petroleum (WLL, news, msgs), St. Mary Land & Exploration (SM, news, msgs) and tiny Northern Oil and Gas (NOG, news, msgs). Earlier this week, Northern Oil saw its shares shoot up 6% in a day after announcing its fifth discovery as a minority partner on a Bakken project -- in this case a well in the remote badlands of Dunn County, N.D., population 3,000. In a sure sign of boom times, that news was worth $15 million to shareholders before the well has produced any oil.

Keystone opportunities

A thousand miles to the east and south, unconventional is also the billion-dollar term for the Marcellus Shale formation of Pennsylvania that has helped to send the shares of Range Resources (RRC, news, msgs) to $68 from $4 in the past five years and Chesapeake Energy's (CHK, news, msgs) shares to about $48 from $8. The play here is on natural gas, an energy source once burned off at the source as a nuisance and which now powers a fifth of U.S. electrical power plants and an increasing number of cars and trucks. A Jefferies analyst told newspapers recently (subscription required) that although the stocks have done well, "to say the market has fully captured the potential is laughable."

The government officially calculated the Marcellus potential at 1.9 trillion cubic feet of gas in 2002, but experts today say new extraction and measurement techniques put the formation's total yield as high as 168 trillion cubic feet, which is about seven years' worth of total U.S. demand. Contrast that with the Texas' Barnett Shale -- which has shot in the past half-decade from absolute insignificance to its status as the premier gas field in the U.S. -- and you can see why the woods and hollows of coal country are swarming with bolo ties and money clips these days.

Continued: Crossing borders, courting risk

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