Micro Cap Energy: High Risk, But High Return

By Eric Fox | May 19, 2009 AAA

Investors who take a chance on micro cap stocks can either reap huge rewards or lose their shirts by investing in higher risk play. Investing in this area is a tempting strategy, but it is not for everyone.

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It's hard to believe that less than a decade ago some of the household names in the exploration and production sector, including Southwestern Energy (NYSE:SWN) and XTO Energy (NYSE:XTO), were small cap names. Investors who bought these companies in the early days were rewarded greatly for their research. Several micro cap names, currently in the early stages of development, may represent home run stocks for investors who have the stomach for this type of higher risk investing. Although most of these stocks are up strongly since the market bottom in March 2009, they still have much room to run to get back to 52-week highs. (Read more in our Oil And Gas Industry Primer.)

Northern Oil & Gas (NYSE:NOG) is headquartered in Wayzata, Minnesota, a town that is not exactly known for being the epicenter of the energy industry. However, Northern Oil & Gas performs just fine for a company with acreage next door in North Dakota. The company has 70,000 net acres and, like so many other operators, targets the Bakken Shale, an oil bearing shale that is becoming very popular in the industry. The company just reported a loss in the quarter due to lower production and realized prices for crude oil. Northern Oil & Gas just secured a $25 million credit line and believes it is fully funded to develop its acreage in the Bakken Shale.

Kodiak Oil & Gas (NYSE:KOG) is active in the Williston Basin, which targets the Bakken Shale, and in the Green River basin in Wyoming, where the company is developing the Baxter Shale. The company is jointly developing its acreage with Devon Energy (NYSE:DVN), a larger exploration and production company with extensive North American assets. Joint development is a common strategy for smaller companies in the sector that may lack the financial and other resources to develop properties on their own. Kodiak drilled four wells with Devon Energy in 2008, but is delaying completion until prices recover. Kodiak just issued equity in a secondary offering and raised $7.15 million with which to develop its properties. The company reported a loss in the first quarter of 2009, but had no debt. (For more, read Become An Oil And Gas Futures Detective.)

Rex Energy (Nasdaq:REXX) has 65,000 net acres in the Marcellus Shale in Pennsylvania and will commit 70% of its $49 million capital budget to this area in 2009. Rex Energy recently had its borrowing base of $80 million reaffirmed by its lenders. This means that the banks investigated the company's reserves in the context of a future price of oil and gas and decided to maintain the previous credit line. Rex has to pay a higher interest rate, but it presently has only $5 million borrowed.

Bottom Line
The micro cap stocks of today may one day become the large caps of tomorrow, with the key obviously being picking the right ones. Investors can start the search by focusing on micro caps that aren't overly leveraged, with properties in well-known resource basins that are being developed by their larger cap peers. (For more, see Fueling Futures In The Energy Market.)

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