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SandRidge Mississippian Trust I (SDT) is a trust formed to hold interest in approximately 160 horizontal development wells drilled (or to be drilled) in the Mississippian formation consisting of approximately 49,600 gross acres of land. (Source - SDT 10K)

SDT has 28M units outstanding, of which 7M are subordinated units owned by SandRidge (SD) and SandRidge only receive distributions if the trust generates enough cash flow to pay its primary unit holders a set threshold distribution.

The Subordination threshold is as follows:

 Subordination ThresholdTarget DistributionActual Distribution
4Q2011$0.51$0.64$0.82
1Q2012$0.52$0.65$0.79
2Q2012$0.56$0.70$0.79
3Q2012$0.59$0.74$0.73
4Q2012$0.58$0.73$0.68
1Q2013$0.59$0.74 
2Q2013$0.61$0.76 
3Q2013$0.61$0.76 
4Q2013$0.61$0.76 
1Q2014$0.62$0.78 
2Q2014$0.66$0.83 
3Q2014$0.70$0.88 
4Q2014$0.72$0.90 
1Q2015$0.67$0.84 
2Q2015$0.62$0.78 
3Q2015$0.58$0.73 
4Q2015$0.54$0.68 
1Q2016$0.52$0.65 
2Q2016$0.50$0.63 
3Q2016$0.48$0.60 
4Q2016$0.46$0.58 

Of the 160 wells to be drilled, as of September 30, 2012, 131 have been dilled and are producing.

As of SDT's last 10-K, the trust has proved reserves of 8,315M barrels of oil and 66,254 MMcf of natural gas. Adjusted for 2012 production of 511M barrels of oil and 4,351 MMcf of natural gas we can determine the trust has 7,804M barrels of oil and 61,903 MMcf of natural gas remaining.

Using current market values of $85.98 for oil and $3.55 for Natural Gas, we can determine the future cash flows of the trust have a value of $671M in oil and $220M in Natural Gas for a total of $891M (down from $1.031B as reported in its 10-K). Using the adjusted future production cost estimated in SDT's 10-k of $50M, we can assume the future cash flow of the trust to be roughly $841M over the life of the trust.

One thing we have yet to account for is the value of its hedges (which are not part of the future cash inflows or PV-10 calculation in the 10-K). SDT has oil swaps and natural gas collars for most of its production through 2015.

Oil - Price Swaps   
YearMBblAvg PriceMarket PriceValue
2012114$104.15$85.98$2,071.38
2013488$102.07$85.98$7,851.92
2014541$100.94$85.98$8,093.36
2015468$101.07$85.98$7,062.12
     
Natual Gas - Collars   
YearMMBtuCollar Price*Market PriceValue
2012201$5.00$3.55$291.45
2013858$5.00$3.55$1,244.10
2014937$5.25$3.55$1,592.90
20151010$5.50$3.55$1,969.50
*My conservative estimate given the range listed in the most recent 10Q
     
  Total Value $30,176.73

Add these hedges to the future cash flows and we can expect $871M over the life of the trust. Approximately $31.10 per unit given a stable oil and natural gas price post 2016.

Trust documents show the trust will dissolve on December 31, 2030; however given the nature and production life of horizontal rigs, the distributions will be uneven and skewed toward higher distributions in the preliminary years.

Given the hedges in place and the successful completion of 131 of the 160 wells, I believe at minimum the subordination threshold distributions will be maintained and predict distributions equal to 95% of the target distribution. 2012 trust distributions were $2.99 per unit. I conservatively estimate future distributions to be 95% of the target distributions and peak in 2014 then decline through the end of the trust in 2030.

 TargetEstimate
2013$3.03$2.87
2014$3.38$3.21
2015$3.01$2.86
2016$2.45$2.33

Remember - these projections are minimally impacted by price change through 2016 because of the hedges.

At $17.40 per unit, SandRidge Mississippian Trust I is undervalued. Based on a total future distribution of $31.10, you can anticipate a total return of 78% over the life of the trust.

Given the nature of the distributions and the fact that you can anticipate a return of investment of $11.27 over the next 4 years, your adjusted basis at that point would be $6.13 for a future cash flow of 19.83 given current pricing. (223% return over the final 13 years of the trust)

Important assumptions:

  1. Stable Oil Price of $85.50 per barrel
  2. Stable Natural Gas Price of $3.55 per Mcf
  3. Proved Reserves of SDT do not decrease
  4. SandRidge fulfills its obligation to drill the remaining 29 rigs

Potential impact of market price change:

Scenario 1

Assumption: Oil at $70 per barrel, Natural Gas at $2.50 per Mcf

Using the 7,804M barrels of oil and 61,903M Mcf determined above, we can assume future cash flows of the trust have a value of $546M in oil and $155M in Natural Gas for a total of $701M. Using the adjusted future production cost estimated in SDT's 10-k of $50M, we can assume the future cash flow of the trust to be roughly $651M over the list of the trust.

Adjusting for hedges as follows:

Oil - Price Swaps   
YearMBblAvg PriceMarket PriceValue
2012114$104.15$70.00$3,893.10
2013488$102.07$70.00$15,650.16
2014541$100.94$70.00$16,738.54
2015468$101.07$70.00$14,540.76
     
Natual Gas - Collars   
YearMMBtuCollar Price*Market PriceValue
2012201$5.00$2.50$502.50
2013858$5.00$2.50$2,145.00
2014937$5.25$2.50$2,576.75
20151010$5.50$2.50$3,030.00
*My conservative estimate given the range listed in the most recent 10Q
     
  Total Value $59,076.81

Add in the value of the hedges and future cash flows will be roughly $710M, 25.36 per unit of which $11.27 will be conservatively returned over the next 4 years, leaving 14.09 to be returned over the final 13 years of the trust. Using an adjusted cost basis in 2016 of $6.13, these price assumptions would yield 130% return over the final 13 years of the trust.

Scenario 2

Assumption: Oil at $105 per barrel, Natural Gas at $4.50 per Mcf

Using the 7,804M barrels of oil and 61,903M Mcf determined above, we can assume future cash flows of the trust have a value of $819M in oil and $279M in Natural Gas for a total of $1,098M. Using the adjusted future production cost estimated in SDT's 10-k of $50M, we can assume the future cash flow of the trust to be roughly $1,048M over the list of the trust.

Adjusting for hedges as follows:

Oil - Price Swaps   
YearMBblAvg PriceMarket PriceValue
2012114$104.15$105.00$(96.90)
2013488$102.07$105.00$(1,429.84)
2014541$100.94$105.00$(2,196.46)
2015468$101.07$105.00$(1,839.24)
     
Natual Gas - Collars   
YearMMBtuCollar Price*Market PriceValue
2012201$5.00$4.50$100.50
2013858$5.00$4.50$429.00
2014937$5.25$4.50$702.75
20151010$5.50$4.50$1,010.00
*My conservative estimate given the range listed in the most recent 10Q
     
  Total Value $(3,320.19)

Add in the value of the hedges and future cash flows will be roughly $1,045M, 37.32 per unit of which $11.27 will be conservatively returned over the next 4 years, leaving 26.05 to be returned over the final 13 years of the trust. Using an adjusted cost basis in 2016 of $6.13, these price assumptions would yield 325% return over the final 13 years of the trust.

Conclusion:

In either scenario or at current market prices, I would gladly pay $6.13 for the trust on January 1, 2016 and that is all but guaranteed given the hedges in place, current price, and distributions over the next 4 years.

Source: Understanding SandRidge Trust I