Understanding SandRidge Permian Trust

Dec.11.12 | About: SandRidge Permian (PER)

SandRidge Permian Trust (NYSE:PER) is a trust formed to hold interest in approximately 1,405 oil and natural gas wells drilled (or to be drilled) in the Permian Basin located in Andrews County, Texas, consisting of approximately 17,500 gross acres of land. (Source - PER - 10K)

SDT has 52.5M units outstanding, of which 13.125M are subordinated units owned by SandRidge (NYSE:SD) and SandRidge only receives 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 Threshold Target Distribution Actual Distribution
1Q2012 $0.42 $0.53 $0.55
2Q2012 $0.44 $0.55 $0.58
3Q2012 $0.47 $0.59 $0.57
4Q2012 $0.49 $0.61 $0.62
1Q2013 $0.51 $0.64
2Q2013 $0.53 $0.66
3Q2013 $0.56 $0.70
4Q2013 $0.58 $0.73
1Q2014 $0.61 $0.76
2Q2014 $0.63 $0.79
3Q2014 $0.65 $0.81
4Q2014 $0.66 $0.83
1Q2015 $0.64 $0.80
2Q2015 $0.61 $0.76
3Q2015 $0.56 $0.70
4Q2015 $0.54 $0.68
1Q2016 $0.53 $0.66
2Q2016 $0.52 $0.65
3Q2016 $0.51 $0.64
4Q2016 $0.50 $0.63
1Q2017 $0.49 $0.61
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Of the 1,405 wells to be drilled, as of September 30, 2012, 932 have been drilled and are producing.

As of SDT's last 10-K, the trust has proved reserves of 20,750M barrels of oil and 7,710 MMcf of natural gas. Adjusted for 2012 production of 1058M barrels of oil and 280 MMcf of natural gas we can determine the trust has 19,692M barrels of oil and 7,430 MMcf of natural gas remaining.

Using current market values of $85.54 for oil and $3.44 for natural gas, we can determine the future cash flows of the trust have a value of $1.684B in oil and $26M in natural gas for a total of $1.710B (down from $1.848B as reported in its 10-K). Using the adjusted future production cost estimated in PER's 10-k of $140M, we can assume the future cash flow of the trust to be roughly $1.57B 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). PER has oil swaps for most of its production through 1Q2015.

Oil - Price Swaps
Year MBbl Avg Price Market Price Value
2012 290 $102.20 $85.54 $4,831.40
2013 1289 $102.84 $85.54 $22,299.70
2014 1411 $101.75 $85.54 $22,872.31
2015 303 $100.90 $85.54 $4,654.08
Total $54,657.49
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Add these hedges to the future cash flows and we can expect $1.625B over the life of the trust. Approximately $30.95 per unit given a stable oil and natural gas price post 2016.

Trust documents show the trust will dissolve on March 31, 2031. 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 932 of the 1405 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 $2.32 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.

Target Estimate
2013 $2.73 $2.59
2014 $3.19 $3.03
2015 $2.94 $2.79
2016 $2.58 $2.45
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Remember - these projections are minimally impacted by price change through 2016 because of the hedges.

At $17.30 per unit, SandRidge Permian Trust is undervalued. Based on a total future distribution of $30.95, you can anticipate a total return of 79% over the life of the trust.

Given the nature of the distributions and the fact that you can anticipate a return of investment of $10.86 over the next 4 years, your adjusted basis at that point would be $6.44 for a future cash flow of $20.09 given current pricing. (212% return over the final 14 years of the trust).

Important assumptions:

  1. Stable Oil Price of $85.54 per barrel
  2. Stable Natural Gas Price of $3.44 per Mcf
  3. Proved Reserves of PER do not decrease
  4. SandRidge fulfills its obligation to drill the remaining 473 rigs

Potential impact of market price change:

Scenario 1

Assumption: Oil at $70 per barrel, natural gas at $2.50 per Mcf

Using the 19,692M barrels of oil and 7,430M Mcf determined above, we can assume future cash flows of the trust have a value of $1.378B in oil and $19M in natural gas for a total of $1.568B. Using the adjusted future production cost estimated in PER's 10-k of $140M, we can assume the future cash flow of the trust to be roughly $1.257B over the life of the trust.

Adjusting for hedges as follows:

Oil - Price Swaps
Year MBbl Avg Price Market Price Value
2012 290 $102.20 $70.00 $9,338.00
2013 1289 $102.86 $70.00 $42,356.54
2014 1411 $101.75 $70.00 $44,799.25
2015 303 $100.90 $70.00 $9362.7
Total Value $105,856.5
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Add in the value of the hedges and future cash flows will be roughly $1.363B, 25.96 per unit of which $10.86 will be conservatively returned over the next 4 years, leaving 15.10 to be returned over the final 14 years of the trust. Using an adjusted cost basis in 2016 of $6.44, these price assumptions would yield 134% return over the final 14 years of the trust.

Scenario 2

Assumption: Oil at $105 per barrel, natural gas at $4.50 per Mcf

Using the 19,692M barrels of oil and 7,430M Mcf determined above, we can assume future cash flows of the trust have a value of $2.068B in oil and $33M in natural gas for a total of $2.101B. Using the adjusted future production cost estimated in PER's 10-K of $140M, we can assume the future cash flow of the trust to be roughly $1.961B over the life of the trust.

Adjusting for hedges as follows:

Oil - Price Swaps
Year MBbl Avg Price Market Price Value
2012 290 $102.20 $105.00 ($812.00)
2013 1289 $102.86 $105.00 ($2,758.46)
2014 1411 $101.75 $105.00 ($4,585.75)
2015 303 $100.90 $105.00 ($1,242.30)
Total Value ($9,398.51)
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Add in the value of the hedges and future cash flows will be roughly $1.952B, 37.18 per unit of which $10.86 will be conservatively returned over the next 4 years, leaving 26.32 to be returned over the final 14 years of the trust. Using an adjusted cost basis in 2016 of $6.44, these price assumptions would yield 308% return over the final 14 years of the trust.

Conclusion:

In either scenario or at current market prices, I would gladly pay $6.44 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.

SandRidge Permian Trust primarily has oil assets. If you are looking for more exposure to natural gas assets, take a look at SandRidge Mississippian Trust I (NYSE:SDT). You can also review my analysis of the company. Note that both are priced around $17.25 and will return over $10 to shareholders over the next 4 years. Following the time period where these trusts have their production hedged, PER will give you predominant exposure to fluctuations in oil prices whereas SDT will give you exposure to both oil and gas price fluctuations.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.