Sunday, March 22, 2015

Analysis of SandRidge Energy

“Degrees of ability vary, but the basic principle remains the same: the degree of a man’s independence, initiative and personal love for his work determines his talent as a worker and his worth as a man.” – Ayn Rand


Please read the disclaimer here: Enjoy the article, bitches!

Hey, I hope you guys have been doing awesome. I’ve been putting off writing about the oil investments I made for the Greedy Dragon portfolio as I only recently learned about the industry. Not unlike a horny 19-year-old choosing which hooker to bang in some brothel, my analysis was all over the place. But to really know how much I learned about the industry, I guess I need to put pen to fucking paper and write an organized analysis of an oil producer. With that said, let’s get down to business.

Updates on the Greedy Dragon portfolio: It has been a busy week for the Greedy Dragon portfolio. I took a position in Northern Oil & Gas and added to my position in Comstock Resources. I also sold my stake in Kumpulan Fima and Tifa Finance as well as the rest of my position in Uranium Participation Corp.

I bought SandRidge energy a few months back at $1.85 per share. The stock is currently trading at $1.64 per share. SandRidge Energy is a U.S. oil & gas company that primarily conducts exploration and production activities in the Mid-Continent area with the Mississippian formation being a key target. Most of the wells drilled in 2014 were horizontal wells. The following information in this paragraph is taken from the company’s 2014 Fourth Quarter Earnings Update presentation and 2014 fourth quarter earnings call transcript that I got from Seeking Alpha. The company aims to get the cost per lateral/well down to $2.4 million by the second half of 2015 from $3 million in 2014 (which is itself down from $3.6 million per lateral in 2012). The company has already realized savings of $250,000 of the $600,000 per lateral savings target at the end of February.  The company is seeing an increase in its Mississippian type curve estimated ultimate recovery (EUR) to 484,000 barrels of oil equivalent (BOE) from 380,000 BOE previously. The increase is due to higher natural gas and natural gas liquids EURs while the EUR for oil remains the same at 118,000 barrels. According to this website, “a production type curve is a representative production profile of a well for a specific play and/or area”. There was also an 8% increase in oil initial production (IP) and a 14% increase in natural gas IP. To get a better picture of the company’s 30 day IPs, cumulative production, EURs and 1st year decline rates, please refer to slide 7 of the Q4 earnings update presentation. At the target lateral cost of $2.4 million and the new type curve, SandRidge believes that new wells could generate an internal rate of return of 30% (the return will be lower if you include around $250,000 for saltwater gathering infrastructure per well) at flat $50 oil and $3.50 natural gas.

I don’t know if the company will be able to achieve its well cost target this year. I hope that they do. But I have to say that there are a lot of exciting things going on in the industry such as multilateral wells and long laterals. As oil producers become more experienced with those drilling techniques, there’s definitely potential for lower cost and/or more productive wells. It must be pretty fucking awesome being in charge of attaining a satisfactory return on the drilling program by deciding which drilling locations to develop and the types of wells to drill. I imagine it’s kinda like ordering a sandwich at Subway. Hmm, meatballs and steak mixes pretty well together. Maybe I should add some of that chipotle sauce and see how it goes…       

To estimate SandRidge Energy’s finding and development (F&D) cost, I divided the total cost incurred in 2014 for oil and natural gas property acquisitions, exploration and development by 2014 extensions and discoveries of proved reserves. This gives me a F&D cost of about $9.30 per BOE. The higher end of the company’s 2015 guidance on its cost of production is at $18.10 per BOE (the sum of per BOE lifting costs, production taxes and total G&A costs). So, the total cost to find, develop and extract their reserves comes up to $27.4 per BOE. Based on the lower end of SandRidge’s production guidance, excluding the effects of derivatives and assuming the company realizes current price levels less guided differentials for its production, it would get around $22 per BOE. Note: I’m assuming that the NYMEX Natural Gas price and Henry Hub price is the same.

The lower end of the company’s 2015 production guidance was for 9 million barrels of oil, 4 million barrels of natural gas liquids and around 15 million BOE of natural gas. All of Sandridge’s estimated oil production for 2015 is hedged and most of its liquids are hedged (The company’s hedges for 2015 cover 10.164 million barrels of oil; NGL barrels hedged at 3:1 ratio to oil). However, a significant portion of the production is hedged with 3-way collars. Unlike a 3-way in the bedroom, a 3-way collar isn’t all that hot when the price of oil dropped as significantly as it did. Of course, I would rather have a 3-way collar than no hedge at all, but it’s not optimal. Anyway, based on my calculations the company’s hedges will allow it to realize $79.93 per barrel for its oil in 2015. In my calculations, I assume that oil prices will remain constant at $45.72 (Friday’s WTI crude oil closing price). I also assume that all the oil swaps will be applied before the 3-way collars are applied to determine the hedged price. While oil is expected to make up only 32.14% of the company’s estimated production in 2015, it should be the largest contributor to revenue.

The company’s debt of $3.195 billion as at December 31, 2014 is also quite a large amount. But the debt only starts maturing from 2020 onwards which gives the company some time to deal with its debt.

One of the issues with horizontal wells is the steep decline in production rates. SandRidge’s new type curve for its Mississippian wells show first year declines of 80% and 62% for oil and natural gas production rate respectively. According to the earnings call transcript on Seeking Alpha, the CEO said “I will say that at the start of the year, if you just halt the drilling altogether for the whole company, we’re on a 35% exit-to-exit decline.” I’m not particularly worried about the company running out of places to drill new wells to sustain production. According to the company’s 2014 Q4 presentation, the company has 3,212 future drilling locations in the Mississippian formation, 401 future locations in the Chester formation and 147 future locations in the Woodford formation. SandRige intends to develop 182 gross laterals in 2015. I’m more worried if oil prices stay at these low levels for a prolonged period of time as that could result in the company having fewer drilling locations that are economically viable.

Note: I don’t know if each drilling location will translate into a new well or new wells. I just don’t know enough about the industry yet.

I know that there’s still a lot of stuff I need to learn about the O&G industry. And frankly, I’m fucking psyched! It’s like when I was a kid playing pokemon. Every new fact I learn about the industry is like encountering a new pokemon that I want to catch. Thank you for reading. Take care and stay rational. 

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