Why Bakken Shale Stocks Will Continue to Get Crushed

Bakken shale stocksBakken Shale stocks have been hit the hardest as crude oil prices decline - with one down as much as 57% in the last three months.

West Texas Intermediate (WTI) has dropped 38% since June. That price slump has caused oil stocks like Exxon Mobil Corp. (NYSE: XOM) to dip 10% over the same period.

But Bakken Shale stocks have suffered steeper declines:

  • Continental Resources Inc. (NYSE: CLR) operates in both the North Dakota and Montana portions of the Bakken. As of 2012, CLR owned more than 1.1 million acres of land in the Bakken territory. CLR is down 52% since September.
  • Whiting Petroleum Corp. (NYSE: WLL) has one of the largest acreage positions in the Bakken and is the second-largest oil producer in North Dakota. Its stock is down 57% since September.
  • EOG Resources Inc. (NYSE: EOG) controlled approximately 90,000 acres in the Bakken area at the start of 2014. In the past three months it's slipped 14%.

And these Bakken stocks will continue to underperform into 2015. You see, the low oil price only exacerbates three major issues that Bakken Shale stocks already face...

Bakken Shale Stocks Issue No. 1: The Cost of Fracking

Fracking has been the main driver behind the U.S. oil production boom, but it's also very expensive.

Because getting the oil out of the ground this way is so pricey, it raises the breakeven point - the point at which oil companies start to lose money for drilling oil. According to Bloomberg, Bakken Shale oil has a break-even point of $73.72 per barrel.

Fracking isn't exclusive to the Bakken. In fact, fracking companies across the country are getting crushed because of declining oil prices.

But other U.S. shale formations like the Eagle Ford in Texas have much lower break-even points. They remain profitable all the way down to $50 per barrel, due to lower average transportation and drilling costs.

"Projects like those in the Bakken make perfect sense when oil prices are above $100 a barrel," said Money Morning's Global Energy Strategist Dr. Kent Moors, who has more than 35 years of experience in oil and gas policy. "At those levels, economies of scale take over and improve profit margins. The higher production volumes offset the higher operating costs."

That has not been the case in 2014, of course, with oil down around $65 a barrel.

And there are two other factors that weigh on companies operating in the Bakken...

Bakken Shale Stocks Issue No. 2: Expensive Transport

After Bakken Shale oil has been extracted, it must be transported.

The most popular way of shipping crude oil in the United States is by rail. From 2008 to 2013, oil shipped by rail in the United States skyrocketed from 9,500 to 407,642 carloads. That's an increase of 4,191% in five years.

But rail transportation is very expensive for oil producers. It costs $5 per barrel to move oil via pipeline. It can cost between $10 and $15 per barrel to move it by rail.

Fracking in the Bakken Shale

The Bakken Shale is a shale rock formation spanning 200,000 square miles. It stretches from parts of Montana, North Dakota, Saskatchewan, and Manitoba.

Bakken Shale oil has contributed heavily to America's resurgence in oil production. To remove oil from the shale rock, drillers use a process known as hydraulic fracturing or "fracking."

The fracking process involves blasting shale rock with a liquid mixture of water, chemicals, and sand. Fracking became popular in the 2000s and is widespread in the Bakken.

Bakken production reached 1.19 million barrels per day in November. The U.S. Energy Information Administration expects that to hit 1.22 million by the end of December. By comparison, total U.S. production is expected to hit 9 million barrels a day in 2015. That means the Bakken alone will account for more than 13% of all U.S. oil output.

Approximately 70% of Bakken oil is moved by rail. So why are oil companies choosing the more expensive route?

It's because sufficient pipeline infrastructure does not yet exist to support booming production.

The U.S. pipeline system is only about 57,000 miles long. The rail system is roughly 140,000 miles long. Major delays in projects like the Keystone XL pipeline, plus complete cancellation of projects like the $2 billion Freedom Pipeline, have made oil companies even more reliant on rail transport.

Distance also makes Bakken oil transport expensive. Much of U.S. oil is shipped to Louisiana, where the majority of refineries are located. For companies drilling in Southern Texas, that's less than 700 miles. But Bakken companies must ship all the way from Eastern North Dakota - more than 1,800 miles.

Finally, the last factor weighing on Bakken Shale stocks is the quality of the oil coming from the Bakken.

Bakken Shale Stocks Issue No. 3: Combustible Bakken Oil

A study by The Wall Street Journal this year found that Bakken oil is considerably more combustible than other types of oil.

The researchers measured the oil's vapor pressure. Higher readings mean the oil is more susceptible to explosions during transport.

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The Bakken oil routinely had a vapor pressure over 8 pounds per square inch (PSI), but was often much higher. Sometimes the Bakken oil read as high as 12 PSI. The same study found that the crude oil found in Louisiana had an average vapor pressure of 3.3 PSI.

Those elevated levels call for increased safety precautions - boosting cost yet again.

And that's not all. Trying to fix these problems with Bakken oil could significantly slow down production and transportation. That's another major headache for Bakken stocks that are already suffering.

"Clamping down on rail transport could thwart the growth of oil output and slowing oil trains could affect the rail industry's ability to move freight around the country," the report stated.

The Bottom Line: Avoid major Bakken Shale stocks while the price of oil remains at such low levels. But you don't have to avoid the energy sector altogether.

As a matter of fact, Money Morning's Global Energy Strategist Dr. Kent Moors has been targeting a different area of the energy industry. It's presenting an excellent profit opportunity right now, and unlike crude oil, the prices here are going way up...



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