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Why Shorts Think Northern Oil Can Go Lower

Northern Oil and Gas had been a hot play on the Bakken shale, but its stock has plummeted nearly 40 percent over the past six weeks after a number of controversial reports.

Even with Northern Oil's stock stumble, shorts (and there are a lot of them, with nearly half its outstanding shares sold short) think it can go lower.

Among the reasons:

—Northern Oil is a reverse merger, and reverse mergers (doesn’t matter if they’re Chinese or American) are always a red flag.

—Questions about aggressive accounting. In his blog, for example, John Hempton of Bronte Capitalpoints out that Northern Oil’s depletion allowance—an estimate number tied to the amount of oil reserves used up—is much less than a bigger peer’s.

—For most of its life Northern Oil has used the same dinky Salt Lake City accounting firm that represented the shell it merged into. They call themselves a "local CPA firm." Only now, with the year ending December 31, is it switching to a big four firm—Deloitte.

—Saving the best for last: There are questions about possible related parties—in this case, the way Northern Oil offloads some of its wells to an entity called Ashwood Resources.

According to one of three critical reports on Northern Oil by Melissa Davis on TheStreetSweeper.org, Ashwood was formed by “a future cosmetologist…barely old enough to order a cocktail at the time.”

Davis, a former colleague of mine while we were both at TheStreet.com, also links to a document that shows the official contact person for Ashwood is none other than Brittany Reger, the wife of Northern Oil CEO Michael Reger.

On Northern Oil’s conference call earlier this week, Reger didn't dispute Davis' reporting; he even acknowledged that his wife works for Ashwood as an independent contractor “to process the massive amounts of paperwork” associated with wellbores purchased from Northern Oil.

He adds: “We haven't done anything wrong. This was not a related-party transaction. We believe we execute the most potent ground game in the Bakken play, and this PR issue has no bearing on our ability to participate in successful wells or otherwise execute our business plan.”

Maybe, but it still gets us back to that sniff test.

I contacted Northern Oil yesterday. I actually talked to them and emailed them a list of questions. I was told they'd get back to me. So far, they haven't.

Questions? Comments? Write to HerbOnTheStreet@cnbc.com

Follow Herb on Twitter: @herbgreenberg

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