On February 28, SandRidge Energy Inc. (SD), a domestic energy producer that has been facing shareholder demands to oust its chief executive officer and other board members, reported a loss for the fourth-quarter of 2012. SandRidge's loss narrowed to $302 million or $0.63 per share, from a loss of $389 million or $0.97 a year earlier. Further excluding one-time costs, including asset impairments and losses from hedging contracts, the company beat Wall Street estimates by about $0.03.
SandRidge's revenue increased to $1.4 billion from $373.8 million a year earlier. Sales of oil and gas increased by 51 percent, to $500 million, due to increased output from its Mississippi Lime formation assets in Oklahoma and Kansas. Production increased 61 percent to 9.8 million barrels of oil equivalent. The company lowered its 2013 production forecast 13 percent to 34.3 million barrels of oil equivalent due to previously announced Permian Basin asset sales that occurred in 2012.
TPG-Axon Capital Management LP, which owns 33 million shares of SD, or about 6.71% of the company, making it the third-largest shareholder, has pressed SandRidge for changes and has asked other shareholders to join with it to remove the board of directors and fire CEO Tom Ward. The story is very familiar to what has happened with Aubrey McClendon and his ouster at Chesapeake (CHK). The two Oklahoma City-based energy companies have far more than recent shareholder dissent in common. In 1989, McClendon co-founded Chesapeake with Ward.
Further, in the wake of poor performance by both companies that complaining shareholders attribute to excessive risk-taking and generally sloppy governance, their assets and the companies in whole have become sale candidates. SandRidge maintained its forecast for $1.75 billion in capital spending in 2013, and indicated that it would fund its 2013 drilling requirements with the $2.6 billion it generated from the sale of 225,000 of its Permian Basin acres.
Production expenses rose to $13.67 per barrel of oil equivalent from $13.20 a year earlier, with the company indicating that the increase was primarily related to recently acquired offshore properties. Ward noted that average costs should improve as SandRidge concentrates on drilling in the Mississippi Lime formation, because its drilling expenses are generally lower there.
The market did not respond positively to these results, despite the reported numbers apparently being in-line to better than expected. Shares fell substantially in the immediate response to these results. Part of the reason for the fall may have been the increased average cost per barrel of oil equivalent, though other reasons likely include the reduced estimates for 2013. These estimates should have already been lowered by analysts in anticipation of the reduced production resulting from the Permian Basin asset sale.
SandRidge has also developed multiple royalty trusts, including the SandRidge Permian Trust (PER) as well as the SandRidge Mississippian Trust I (SDT) and SandRidge Mississippian Trust II (SDR). These trusts performed poorly over the last several quarters and so far in 2013, as production levels declined at faster rates than initially anticipated, and as wells also produced a higher mix of gas compared to oil than originally projected and produced.
Since SandRidge has stated a commitment to concentrate on drilling in the Mississippi Lime formation, it should be anticipated that the company will continue to ramp up wells that will relate to the two Mississippian trusts. Unitholders are entitled to receive 80 percent of the net proceeds from sales of hydrocarbons extracted from the targeted Mississippian interval. Most of the wells related to these trusts were initially estimated to be drilled by the end of 2015, but die to past and continuing accelerated drilling, it now appears likely that the related wells will be completed by the end of the first-quarter of 2014.
Over the course of the drilling program, rising production should fuel significant distribution growth, but this is being countered by the faster than expected decline rates and greater gas percentage. Moreover, once SandRidge completes its related well developments, output should likely drop sharply in the following year and then stabilize to a milder decline rate. The most beneficial potential tailwind would be increasing natural gas and oil prices, which many unitholders probably anticipate. Nonetheless, trust distribution estimates also anticipated higher oil prices.
SandRidge structured its trusts to protect unitholders from energy commodity price volatility and production rates in the early years of its life cycle. The trust hedged about 70 percent of projected oil and gas production through 2014, and potentially a greater amount if production actually comes in lower than initially estimated. Production may be better than anticipated due to the accelerated drilling program, or less than expected due to accelerated decline rates.
SandRidge also subordinated about 12.5 million units of SDR, or about one-quarter of the trust, such that if the trust's quarterly distribution falls 20 percent short of the targeted rate, those subordinate units must relinquish a portion of their distribution in order to distribute to the other unitholders.
The recent decline to hit SandRidge and its trusts is not terribly surprising in light of its reduced oil production, but the degree to which units and shares have fallen does appear to be an overreaction. Total production from all of SD's Mississippi Lime wells was 29 percent oil in 2012, compared to a November estimate of 35 percent, with the other 71 percent being less profitable and lower priced natural gas and petroleum liquids. Therefore, SD and its trusts should have increased sensitivity to natural gas prices going forward.
Disclosure: I am long SDR.