Whiting Petrol and Kodiak: Should You Invest in American Oil and Gas?

Source: Thinkstock

Recently we learned that the largest Bakken shale oil company, Whiting Petroleum (NYSE:WLL), plans on acquiring Kodiak Oil And Gas (NYSE:KOG) in an all-stock transaction whereby each Kodiak share will be exchanged for 0.177 Whiting Petroleum shares. While this is being advertised as an acquisition, it is probably better to describe it as a merger, as Kodiak shareholders aren’t realizing an enormous premium to the current share price.

Nevertheless, the managements of both companies are confident that the deal will be accretive and beneficial for shareholders of both firms in the long run. The reason for this is that the companies are both major players in the Bakken shale region in North Dakota, one of the booming oil producing regions in the United States. The combined company will be able to share technology and geological research that can allow for the combined entity to produce more oil at a lower cost. The combined company will also be substantially larger, and this will give it easier access to the capital markets so that it can expand even further.

As we have been seeing for a few years now, companies that specialize in hydraulic fracturing, or fracking, in areas such as the Bakken shale region have been performing incredibly well. The fracking boom has led to a plethora of companies growing their oil production rapidly, and this has driven investor enthusiasm. A deal such as this one is indicative of the bullish sentiment in the American oil and gas sector, and it leads us to consider the merits of making a similar investment.

While the American oil boom story is a compelling one, we have to realize that it is well known, and generally the market is bullish on American oil producers, meaning that there aren’t many investors left to buy. For instance, analysts are almost unanimously bullish on Whiting Petroleum, and they believe the stock can rise to $88 per share from today’s share price of $78 per share despite the fact that the stock already trades at 24 times trailing earnings.

Analysts see significant earnings growth in the near term despite the fact that much of the company’s growth is behind it and despite the fact that the company’s earnings depend on the oil price, which could easily decline.

Similar stories exist for the other major American oil producers, especially if they operate primarily in one of the booming shale regions such as the Marcellus shale region or the Eagle Ford shale region. But investors need to heed the aforementioned concerns. Furthermore, investors need to consider the fact that there is growing criticism of hydraulic fracturing given the rise of scientific literature linking earthquakes to the practice.

So what should investors do with their Whiting Petroleum or their Kodiak Oil and Gas shares? Management provides a relatively simple and compelling case for the potential to create value through synergy, and this could create an excellent trading opportunity. But I think for many of the larger shale oil companies — say, those companies larger than $1 billion — Wall Street already knows the story, and unless you are an industry expert, you should probably stick to ETFs.

One relatively unknown ETF exists that is devoted to fracking companies — the Market Vectors Unconventional Oil and Gas ETF (NYSEARCA:FRAK), although this is an illiquid fund that might be difficult to sell quickly if you need to. Another fund to consider is the SPDR S&P Oil And Gas Exploration and Production ETF (NYSEARCA:XOP), which owns shares in many of these companies but which also gives you exposure to companies that produce oil abroad and to companies that use more conventional oil extraction methods.

I think this latter fund will give you exposure to oil and gas prices with sufficient exposure to the growing American oil sector to generate excellent returns. The fund’s 14 percent year-to-date return speaks for itself.

Disclosure: Ben Kramer-Miller has no position in any of the stocks or funds mentioned in this article.

More From Wall St. Cheat Sheet: