What could be worse than watching an oil patch investment get drilled daily as crude prices drop?

Perhaps only the prospect of the company in question continuing to pursue an ambitious, and increasingly expensive, growth agenda.

During its analyst day on Sept. 18, Aggressive Portfolio recommendation Continental Resources (NYSE: CLR) provided a wealth of data on its big positions in the Williston Basin as well as SCOOP (South Central Oklahoma Oil Province.) It also claimed to have discovered an oily layer of rock above its current Woodford Shale target in the SCOOP that could produce richer returns than the better known formations pioneered by Continental.

Source: Continental’s analyst day presentation

But tapping this newfound resource will cost money, and unfortunately the news came at a time when skittish investors were particularly susceptible to sticker shock. When they learned that the company would spend $4.55 billion this year — $500 million more than previously forecast — followed by $5.2 billion next year, the stock dropped 8% in a single day. And then it kept dropping, so that as of Thursday the price was down 17% from a record high set not quite a month earlier.

The extra money will go toward delineating and developing the new Springer Shale prospect within SCOOP, where Continental expects to recoup drilling cost for a typical well in as little as a year. It will also pay for enhanced well completions in the Bakken, typically using twice as much sand and other proppant as a year ago, that are expected to increase both immediate well productivity and the ultimate volume of recovered crude.

The problem is that the ultimate recovery is currently unknowable, while the increased spending will tax cash flow in the here and now, postponing the eagerly awaited turning point at which the company can pay for its capital spending out of profits and without adding to its $6 billion of debt.

It’s a hard tradeoff to accept at a time when falling oil prices remind investors that the future isn’t guaranteed to be rosy.

Continental didn’t reassure the skeptics with updated Bakken data that suggested it had about eight years of so of drilling, at it current pace, before running out of the inventory of wells more productive than the current assumed average for the play. The company did increase its estimate for the ultimate resource recovery in the Bakken, but once it exhausts the inventory of locations in its sweet spot it may face a long slog of drilling only modestly rewarding wells on the remainder of its acreage to get out everything it can. And who can guarantee that oil prices or other circumstances will continue to reward this enterprise?

No one, which is why the prospect of spending an extra $1.15 billion this year and next so troubling to some. The flip side is that no one can be sure that the rapidly evolving fracking technology won’t unlock more oil than is now supposed sooner, and ultimately cheaper.

Continental is set to grow production 27% to 30% this year and as fast again in 2015. Subsequent growth will depend, in part, on the decline rate of the wells drilled in the past, and the long-term performance of new stimulation techniques and well spacing strategies.    

Given the uncertainties of modern prospecting for oil and gas, investors have to be willing to extrapolate much from limited data and judge the track record of the people making the promises. Fortunately, the record of Continental CEO Harold Hamm is as good as they come, as reflected in the sixfold appreciation of the shares over the last five years.


Source: Continental’s analyst day presentation

Multi-billionaire Hamm bought nearly $5 million worth of Continental’s stock Monday to remind the world that he does not lack for confidence, adding a shade of frosting to his 68% majority share of the corporate pie.

And if the company’s borrowing requirement just went up at least it’s borrowing cheaper than ever given the historically low interest rates and its recent investment grade credit rating.  

We urged investors to cut their position in half on April 24 a little bit above the current price, and those who did not are still up 60% in the 19 months since we recommended buying Continental. And nothing that’s happened recently has made us regret either the original pick or the subsequent suggestion to sell half of that stake. If you never lightened up, consider doing so on the next bounce. But we’ll give Hamm every benefit of the doubt so long as he keeps delivering on his promises. If he does, the stock should get back to its winning ways before too long.

Cabot Oil & Gas (NYSE: COG) is already at that breakeven cash flow point Continental is still chasing, yet has lost 4% since our March of 2013 recommendation, proving that cash flow isn’t everything. But free cash flow and rapid production growth make for a winning combination in the long run, and Cabot is still forecasting an output increase of 28% to 34% this year and 20% to 30% in 2015.

That top end of this year’s guidance is down from 41% before last week, because Cabot is still experiencing pipeline constraints as midstream partner Williams (NYSE: WMB) tries to keep up with its needs. Another overhang is the discounting of the Marcellus gas relative to the prices elsewhere in the country as a result of inadequate long-range transport option, a situation that’s not expected to materially improve for another year or two.

Yet Cabot’s gas wells in northern Pennsylvania’s Marcellus sweet spot for dry gas are so productive that they too can recoup the entire drilling cost within a year. And that’s if Cabot gets $3 per million British thermal units (mmBtu) for its gas, its minimum forecast for 2014 and about 75% of the price on the NYMEX. At the full NYMEX price of $4/mmBtu, a typical Cabot Marcellus well pays for itself in six months or so. But midstream infrastructure constraints in the Marcellus have Cabot investing more in its oil drilling within the Eagle Ford.  The company recent added 30,000 acres to its position in that play with a purchase worth $210 million, and will add a fourth rig to its drilling fleet in the South Texas basin.

Cabot shares, which initially lurched lower on news of the reduced third-quarter guidance this week, soon reversed. The company has been propping up its share price by repurchasing 2.7 million shares over the last two months. It’s the sort of luxury one can afford when profits from old wells are paying for the new ones, which are in turn recouping that investment quickly.

The fact that Cabot has not paid off for us so far doesn’t mean it won’t, and at these levels the potential reward on this financially secure, well-hedged value play far outweighs the risk of further losses. Buy COG below $42.50.

Gastar Exploration (NYSE: GST) is a poster child for the sort of small, speculative and leveraged exploration and production stock that’s fared worse than most in this correction. It’s now down 31% from its June peak and 19% just since Sept. 15, when it revealed plans for a secondary offering.

Yet, as with Continental’s borrowing, the additional capital will be applied to a promising exploration program that has so far exceeded expectations, so that the equity issuance could, in fact, prove to be in the best long-term interest of shareholders. We suggested readers sell half their initial stake in April 6% above the current reduced price, and even those who failed to act on that opinion have seen a 22% return since the December pick.

Gastar is making impressive progress on developing its Hunton Lime acreage, where wells can be drilled relatively cheaply, while its positions in the Marcellus (and the Utica Shale below it) could produce big upside down the road, especially if natural gas prices rise. We’ll be watching closely for a near-term opportunity to buy back the partial stake we recommended selling in April at a further discount.