Split Rock's Guide To Bakken Investing

This nationally recognized shale energy investment firm has a plan to leverage low oil and its small town style for economic gain. Since Starting Split Rock Trading & Wealth Management in Duluth, Minnesota, the company has become a Bakken staple.
By Luke Geiver | July 27, 2015

Tyler Kocon can’t see drilling rigs from his Duluth, Minnesota, office window. In a long day’s drive, Kocon, portfolio manager and co-founder of Split Rock Trading & Wealth Management LLC, can barely make it to the fringe of the Bakken shale play where oil wells and drilling rigs litter the landscape much like the shipping vessels that dot Lake Superior only minutes from Kocon’s office. The office view and the long drive haven’t stopped Kocon and his small team from becoming a nationally recognized shale energy investment firm. “In today’s day and age, we can manage money from Smalltown, USA,” Kocon says. In 2011, Kocon and Mark Cool launched Split Rock’s North American Shale Energy separately managed account (SMA) offering, soon followed by a hedge fund also focused on the shale industry. Both offerings have performed well since their inception and drawn investors from the Midwest, East Coast and internationally. Formed after the great recession of 2008-‘09, the Split Rock team has navigated market fluctuations since, including rig count contractions and increases, and oil price volatility.  Through their Williston Basin road trips, investment strategy changes and constant interaction in the greater shale energy industry, they’ve lived the Bakken story from their northern Minnesota headquarters much as any Houston-based operator would.

Now, armed with a gifted, North Dakota-grown market analyst and five-years experience the Split Rock team believes it can leverage low oil prices and  its small-firm status to help investors from around the world understand the same prosperous view Kocon sees every day from his Duluth office.

Early Work, Lasting Lessons
The first industry pullback Cool and Kocon experienced during their careers as money managers happened in 2003 during the tech bubble. The second came during the 2008 financial meltdown. Following the second pullback, the duo decided to branch out on their own and apply a conservative approach to money management. “We went from having over 1,000 clients each to having 300,” Cool says. “About the same time we launched our firm [2010], we started getting news of what was happening in North Dakota.”

Oil and gas production activity was high and generating buzz on a national scale. The duo’s early enthusiasm for creating a Bakken-linked product offering wasn’t just about oil production activity or their desire to be connected to a growing industry. When the team looked at other investment options that would expose a portfolio to the successful firms growing in the Bakken, only the big investment shops offered large cap names like Chevron or Halliburton. The wildcatters, pure-plays and midstreams responsible for much of the Bakken’s fast rise, were not offered, a facet of the investment industry that provided the niche opportunity for the team.

“We are not your typical Wall Street firm that invests in the energy space,” Kocon says. “Large firms are too big to effectively play in this space as they tend to push around pieces of these smaller shale players as they enter or exit positions. We are small enough that we can enter and exit these names without disrupting the market. As such, we can focus on the large as well as small names that truly comprise the U.S. shale space.”

According to Kocon, the large firms can’t buy or identify a name they feel has incredible acreage or tremendous growth opportunity because doing so would push that individual company stock around. On the flip side, those same large firms can’t exit or sell stock in a company because doing so would drive the price of that stock for sale down. Because of that, the Split Rock team is quick to explain it is nimble and small enough to not affect the stock price either way. “We are very much fine letting people know we are a small firm,” Kocon says.

The early positioning of the company in the shale energy investment space made it a strong option for investors. It also exposed the team to the ups and downs of the shale world. After only three months of managing its NASE fund, the team knew it had to diversify itself from exploration and production companies linked to commodity prices. Since then, the company has run its portfolio with other energy-related investments comprising roughly 80 percent of the entire fund. The vast majority of the clients work with the team on a discretionary basis, meaning Cool and Kocon have 100 percent discretion to invest client money if it fits into their respective risk tolerance ranges.

No matter where the company is looking to in the shale industry—from the Permian to the Wattenberg or the Bakken—the team has adopted and practiced a lesson it believes will pay dividends now and in the future. “We manage our portfolios for the downside,” Cool says. “The upside will take care of itself. We have some exciting names in there but we are not trying to hit a homerun all at once with the portfolio and we will settle for base hits.”

Last year, the company’s index—a measure of the changes and performance of stocks in a portfolio that represent a portion of an overall market (energy)—was up 26 percent. This year, in the down market, it is only down 2 percent, a number both Cool and Kocon say investors are happy with. The team has learned that East Coast investors are misinformed about the Bakken and that many looking for shale-based investment options are turning to Split Rock. Although most of its upper Midwest investor clients contract the team to manage all monetary assets, East Coast investors are using the team to specifically manage shale-related energy assets based on the knowledge and track record of the team.

View From Split Rock
Trips to western North Dakota combined with an obsessive analytic effort into the shale energy industry weren’t enough for Cool and Kocon. Two years ago the team enlisted the help of a Michael Filloon, a Fargo-based industry analyst who has established a large following on several investor-related websites. In his early days performing industry-related research, Filloon became frustrated with analysts who were high on certain firms without supporting information why. “People were saying they loved this company because of this or because of that and they would say the numbers looked good and everything was going to be great and then they would miss on earnings or their revenues were down,” Filloon says. “I would say what is going on?”

Not agreeing with that uninformed approach to investing,  Filloon began researching individual well files to track production results based on completion design. “I would see a huge variance between one operator from another even if they were a couple of miles apart,” he says. Since he first began publishing or posting his views on well completion design and the resulting production totals, Filloon has been recognized by his peers. “I’ve been lucky enough to have a lot of people support my work,” he says. Those people certainly include Cool and Kocon, who now utilize Filloon’s insight to explain the industry to clients and to drive future investment decisions.

Filloon-based research tells the team that oil prices will dip once again this year. Kocon believes oil inventories, already high, will push the price of oil down later this year, especially if Iran begins to sell into the market again and offshore oil off the coast of Africa hits the market. “We are bearish on oil. We are a little worried about inventories,” he says. The fact that the shale energy industry hasn’t, too date, rolled over as some expected, also adds to the sentiment that inventories will remain high for the next several months, Filloon says. “Our outlook is we are going to be in more of a w-recovery. We have hit a low and we will probably come back and hit that low again,” Kocon says.

Managing a shale basin portfolio can be a tough pitch at times, Cool says. “When we put out subscription information, people sometimes scratch their heads and wonder why we are even in this space,” he says. The company is currently in a holding pattern on most Bakken-linked producers, as the subscription shows. The team is focused on reentering the Bakken in six to nine months and  investing in several names it wasn’t able to get into the last time the Bakken was on the rise. In fact, the team isn’t afraid of the lower oil price environment.

According to Kocon, the supply and demand curves will correct themselves eventually. The decreased rig count and wells a waiting completion will eventually come online and create a short-term dip in oil prices again, but at some point that will go away and create a tipping point for increased production. “The market is such with the supply and inventory that we could see some pretty huge swings,” Filloon says. “But, when things become a little more transparent, the good names start to look really good.”

Good names for Filloon are those that are located in the core areas of a play, such as the Nesson anticline or Sanish and Parshall fields of the Williston Basin.

Cool believes that as oil prices slump again, bigger names with better balance sheets will purchase acreage that was left to expire by worse-off companies unable to hold leases by production.

Despite the hold pattern they are currently explaining to current clients, the team is certainly excited for the future. “If you can withstand this low period and you have the risk tolerance, there will be an incredible amount of opportunity in the future,” Kocon says. The optimism is linked to Filloon’s analysis of completion designs and the fact that many companies are now deploying highly productive designs that yield more oil than ever before. The positivity is also linked to the simple fact, Kocon says, that the oil is in place for the taking and demand is showing no signs of staggering. Combine all of that with the potential that certain players can or will purchase acreage previously unavailable to add to growth runways, and Bakken producers, in particular, look highly attractive for the future.

Right now, it isn’t fun to talk about oil prices, he says. “People sometimes ask us why they shouldn’t invest in tech or healthcare instead. In reality, this is the time you want to be adding too or getting in the space. This is so cliché and you hear it all the time: Buy and hold. That is very true in this space.”

The Split Rock team may not truly know where oil prices will lead the shale energy industry, but regardless the price of oil, the team has investment strategies that will yield positive outcomes, Kocon believes. The future viewed from Duluth could be one worth watching, based on the team’s outlook. “If you enter now it [oil] is going to go lower, but the rewards down the road will be great.”

Author: Luke Geiver
Editor, The Bakken magazine