SandRidge Energy, Inc. Q1 2009 Earnings Call Transcript

May. 8.09 | About: SandRidge Energy, (SD)

SandRidge Energy, Inc. (NYSE:SD)

Q1 2009 Earnings Call

May 8, 2009 9:00 am ET

Executives

Tom Ward - Chairman and CEO

Dirk Van Doren – CFO

Matt Grubb – COO

Analysts

David Heikkinen - Tudor, Pickering, Holt

Brian Singer - Goldman Sachs

Joe Allman – JP Morgan

Shannon Nome – Deutsche Bank

Jeff Robertson – Barclays Capital

Dave Kistler - Simmons & Company

Operator

(Operator Instructions) Last night, the company issued a press release detailing SandRidge financial and operating performance for the first quarter of 2009 and also filed the 10-Q. If you do not have a copy of the release, you can find a copy on the company's website, www.SandRidgeEnergy.com. Also, you can sign up for all new releases to automatically be sent to you and this is located under the Investor Relations tab.

Now, for our forward looking statement, please keep in mind that during today's call, the company will be making forward looking statements, which are subject to risks and uncertainties. Actual results might differ materially from those projected in these forward looking statements. Additional information concerning risk factors that could cause such differences is detailed in the company's filings with the SEC.

Today's presentation will include information regarding adjusted net income and adjusted EBITDA or other non-GAAP financial measures. As required by the SEC rules, reconciliation of the most directly comparable GAAP measures are available on our website under the Investor Relations tab.

Now let me turn the callñ over Chairman and CEO, Mr. Tom Ward.

Tom Ward

Welcome to our first quarter conference call. We also have on the call today Dirk Van Doren, CFO and Matt Grubb our COO. I will have a few brief remarks and will turn the call over to Dirk to discuss our financial results.

Today we announced that we have signed a letter of intent to sell our Piñon Midstream assets for $200 million and assigned a PSA to sell our East Texas deep rights for $60 million. While the sale of the Midstream assets will net us $200 million in proceeds up front it could be valued up to as much as $500 million over the next four to five years if the purchaser exercises its option to contribute to further Midstream infrastructure expansions under the terms of the transaction.

This transaction has always been negotiated in a circular fashion. We would determine how much cash we propose to raise versus the fee to move the gas. After having negotiations with multiple parties we’ve chose the lower cash price and the lower fee structure.

When combined with our earlier $265 million preferred offering and our $110 million common offering we will have exceeded our goal of raising $550 million of capital needed to grow our low fining cost production in the Warwick thrust and fill a Century plant in 2010 and 2011. This capital raise and the additional CO2 treating capacity from Century will set us up to exceed 550 million cubit feet of gas a day of net production in 2012. This will be a 72% increase to our Q1 2009 production of 319 million cubit feet of gas a day.

SandRidge started contracting our operations in September 2008 with our announcement at the Lehman Brothers conference that we were going to reduce our operated rig count from the then 47 rigs we had running. Since that time we’ve been working to ensure that our balance sheet would remain strong in an ever darkening financial world.

Not only did we move our operated rig count down to our current five rigs from 47 but also cut our budget from $2 billion to our current guidance of $500 to $700 million in 2009. We are currently operating at the lower end of our CapEx budget while also executing over $550 million of equity type transactions and hedging between 75% and 85% of our 2009 and 2010 production at 842 and 770 per Mcf respectively.

SandRidge has one of the premier reservoirs in North America developed in the Warwick thrust of the West Texas Overthrust and today can generate mining costs of less than $1.00 per Mcf as our costs continue to move down. We are now drilling wells for $2.2 million that cost over $3 million one year ago.

Not only are costs coming down but the amount of gas we are finding per well in the Warwick thrust continues to increase and now is up to an average of 7.5 Bcf per well of total gas which about 3 Bcf is methane. We do not see any large reservoir in the US with the ability to generate this low of finding cost.

Our company was producing 20 million cubit feet a day in mid 2006. We could not grow our asset base and stay within cash flow. We have since then raised an equal amount of equity and debt. However, 2008 was a debt year and that had to be followed by this year’s equity raise in order to shore up our balance sheet and facilitate developing our world class reservoir. We’ve now completed the hard work and can expect to reap the rewards of a healthy balance sheet coupled with the great assets.

We also have announced a drilling deal with a private company to bring forward reserves in the Piñon field. This anticipated 75 million of drilling will generate approximately 19 million carried interest drilling net to SandRidge that is additive to our CapEx budget. In other words, it brings forward reserves that we could not get to for many years. The 75 million of drilling capital at fully funded will generate approximately 50 Bcf of reserves. We will continue to explore opportunities to bring forward value by evaluating up to 125 of addition outside drilling capital in the next few months.

With pricing support in 2008 we were able to aggressively hedge our natural gas production through 2010 at attractive prices. We carefully considered hedging further out but continue to believe the market will correct itself before the 2011 timeframe. With that said, we have remained un-hedged in 2011 and beyond.

We remember a time like this in 2001 when others decided to hedge historically low prices and paid the price in later years as prices and service costs rebounded. Our goal has always been to pick a price near $8 Nymex to hedge into and that has not changed.

We do believe that we have entered into a new phase of natural gas development in the US with the high finding cost producer will be challenged with an obsolete model. As the large shale plays continued dominate every producer is going to have to look at their inventory and see if they can compete. At SandRidge we have the resource that can compete with any other reservoir in the US and our low finding cost will help us to succeed in an environment where $6 to $7 gas may be a long term solution versus when an earlier $9 to $10 world of natural gas could be envisioned.

Even though we see and can live in a $6 to $7 environment we believe the market will overshoot to the upside to allow us to hedge in 2011 as the drilling ramp up from shale plays will not be able to answer quickly enough the loss of production from today’s rig count decline. We believe in the product that we product and believe that clean burning natural gas will become the preferred energy source in the future.

The United States is currently utilizing about 20% of our natural gas electrical generation capacity. When already have the infrastructure in place through the electrical grid and our supply questions have been answered by the new large reserves have been discovered in the last few years. I believe this work is under way and the people of our nation will support this change.

I’m very pleased with the operation of this company and proud of our employees and the management team for the hard work and our accomplishments during the last nine months to prosper in a time of trial. These efforts will be born out over the next few years as we finish our century plan and grow the West Texas overthrust.

I’ll now turn the call over to Dirk.

Dirk Van Doren

I will focus on a few financial highlights, our current financial position and our projections. Our internal model proved to be very reliable as EBITDA for the quarter was $158.7 million and total debt ended the quarter at $2.4 billion. As we have mentioned in previous calls and at our investor meting in New York in March, as we slow down our drilling and capital expenditures there is going to be a significant amount of cash coming out of the business. During the quarter we experienced about $99 million of working capital leave the business. Today we are seeing almost no cash burn in the business.

Turning to capital expenditures we had GAAP expenditures of $297 million and $53 million that was accrued at year end 2008. This is why the statement of changes shows capital expenditures of $350 million. We use GAAP numbers in our internal model and we expect capital expenditures in the current quarter and the second half of the year to be dramatically lower. Hence we are still comfortable with or capital expenditure guidance being in the lower half of the $500 to $700 million range.

We’ve had a few questions on our tax rate and guidance of 0%. Our recent asset impairments generated a large deferred tax asset. Given the current commodity price environment and the requirements per recording a deferred tax asset we do not perceive realizing that asset during 2009. However, as we generate taxable income we will realize and reduce the tax asset but our tax rate will be zero until we can eliminate the asset. If commodity prices were to recover and the taxable income were to rise we would reduce that asset quicker.

Moving to the capital structure. We announced on April 21 that our revolving credit facility was essentially re-determined with no change in the size of the facility or covenants. For some color behind the process it went extremely well and thank the 26 leading institutions for their support. Given our current planned asset sales, our drilling program and our hedges we see no issues today with the fall re-determination which should occur in September/October timeframe.

We’re in compliance with all our covenants at the end of the quarter and our revolver balance on May 5th was $555 million. Since our last conference call we have been busy adding to our basis swap book for 2011 and 2012. Since the last call we have built positions up to 93 Bcf in 2011 at $0.46 an increase from 21 Bcf at the end of February and started a 2012 position of 26 Bcf at $0.67. The lower price in 2011 can be explained that now have about 33% of our basis at $0.33 in the Houston ship channel because of firm transportation in that direction.

For 2009 the financial mission is to create financial flexibility for the next two years via hedging to protect cash flow, complete asset sales, raising some capital and reducing leverage. We’ve been very busy so far in 2009. Each of these transactions in our financial plan is a small bite and when taken in aggregate it creates a clearer picture for investors to understand how we can navigate through the weak commodity price environment.

At the investor analyst meeting in March we stated that total debt at year end 2009 would be $2.1 billion and based on our achieved and planned transactions we should achieve that goal by the end of the second quarter, two quarters ahead of plan. From a liquidity standpoint we should have almost $800 million of availability on our line by the end of the second quarter.

Looking forward to our conference schedule, we are attending the UBS Energy Conference on May 20 in Austin, Texas, the Deutsche Bank Energy Conference in Miami on May 28th and the RBC Energy Conference in New York on June 2nd.

That ends our prepared remarks. We can open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Heikkinen - Tudor, Pickering, Holt

David Heikkinen - Tudor, Pickering, Holt

Thinking about the transactions in East Texas first versus North Louisiana, any thoughts about further deep right sales or a mark of value of this sale versus what you have in North Louisiana.

Tom Ward

I’m not sure what the market would be like in North Louisiana right now as some other wells are being drilled very close to that acreage. I can’t say that it’s going to be better or worse then East Texas. We felt comfortable with knowing that in our capital raise that we would use the capital that we have to drill West Texas Overthrust versus our [inaudible] acreage so that’s why we moved forward with the sale of East Texas.

David Heikkinen - Tudor, Pickering, Holt

Why East Texas versus North Louisiana just because of wells being closer to your acreage in North Louisiana or it’s a better option.

Tom Ward

I think that there is maybe more development around the wells in East Texas and there are still more unknowns and maybe more upside in Louisiana site.

David Heikkinen - Tudor, Pickering, Holt

The midstream letter of intent any thoughts around timing of getting everything signed and closed.

Tom Ward

We’re still holding to the close in the second quarter.

David Heikkinen - Tudor, Pickering, Holt

On the Piñon field and your Warwick well results coming in at $2.2 million how much better can that get or is that an optimal level now?

Tom Ward

I think it’s pretty optimal.

Matt Grubb

That same question was asked to me last quarter and didn’t think it could get any better. At that point we were at $2.4 million. We kind of finished ’08 at $2.8 million and at the height of that activity last summer it was about $3.3 million so its come down 34% since the high. A lot of that cost savings, the $1.1 million from $3.3 to $2.2 million about half of it’s from a high pressure pumping services and steel in our costs. The rest of its spread over about 70 different items on our AFE.

I think we’re getting to the point we’re probably bottoming out and we are continuing to negotiate pretty hard with our service providers to lock in some of these costs on a longer term basis. I’m a little surprised its gotten this low but I think we’re certainly very pleased with it and we’ll try to do better but I’m just not hopeful that we can.

Tom Ward

This has a lot to do with having rigs running in the Permian basin versus other places that are more active. The Permian operators are able to maybe glean a little better from the service companies that are already in the area.

David Heikkinen - Tudor, Pickering, Holt

On the pipe inventory build in the first quarter how much more delivery do you have, how far does that get you into 2009 and 2010 and do you continue building inventory?

Matt Grubb

We are not continuing to build inventory at this point. Our budget has gone from over $2 billion to $500,000 to $700,000 so we actually ahead of time bought pipe for that large budget and now we have enough pipe to really service us through the end of this year and probably most all of 2010.

Operator

Your next question comes from Brian Singer - Goldman Sachs

Brian Singer - Goldman Sachs

How are you thinking about the next few years in terms of financing the growth you’re projecting through 2012, how sensitive is that to the broader market views on capital spending versus cash flow and natural gas prices should they go higher or lower?

Matt Grubb

I’m not quite sure of the broader markets view but the way we’ve got our internal model run is now moving forward. We’ve got a significant amount of gas hedged next year at $7.70. This morning the 2011 strip is at $7.10, we have no hedges out there but right now we don’t need any external capital from now going forward and that gets us through ’12.

Brian Singer - Goldman Sachs

Any new data points on the Frog Creek?

Tom Ward

No, really what we’re focusing on is the wells that we have drilling are within the Piñon Warwick thrust and really even going into the first half of ’10 the vast majority of drilling will be just to fill the Century plant which will be all in the Warwick. We have multiple years on our leases and in fact most of the Frog Creek acreage that we look at is HTP and so we can wait on that for some time really focusing on filling the Century plant with low, low fining costs.

Operator

Your next question comes from Joe Allman – JP Morgan

Joe Allman – JP Morgan

Could you talk about recent well results in the Warwick thrust?

Tom Ward

The Warwick thrust continues to be in-filled development wells even though they might be, all the wells come in at around average three million a day IP and that has about 55% to 65% CO2 and our average has moved up to 7.5 Bcf per well. It’s a statistical model that really hasn’t varied any since the last time we visited other than the [EWars].

I do continue to go up and our CO2 content is a little bit less then we anticipated even six months ago. No changes in the Warwick thrust other than the ultimates continues to get just a little bit better as we drill in some of the thicker portions of the Warwick down to the Southwest portion of the field.

Joe Allman – JP Morgan

No surprises positive or negative based on recent results?

Tom Ward

We’ve moved up our ultimate so I think its positive on two fronts. You have a little less CO2 and a little more production.

Joe Allman – JP Morgan

Do you plan on keeping the five rigs for the rest of the year?

Tom Ward

Actually we’ll move, we kept a rig in East Texas for a little while longer to hold a couple of leases and will probably move down to four and then just determine when we start to ramp up. Right now we anticipate not ramping until first quarter ’10.

Joe Allman – JP Morgan

With the lower costs that you’re seeing what impact does the lower cost have on the capital needed to fill the Century plant?

Matt Grubb

We’re going to drill about 55 Warwick thrust wells this year so we’re basically going to save just a little over $1 million a year there. Then we’re going to go up to 175 wells next year. If we can maintain the cost savings it will be significant that’s pretty simple math there.

Joe Allman – JP Morgan

The CapEx for 2009 you’re looking to spend closer to the $500 million then the $700 million.

Tom Ward

We’re trending towards the lower side of the guidance.

Joe Allman – JP Morgan

When the Century plant opens do you expect to have that filled up fairly soon upon that starting up?

Tom Ward

We won’t have on day one, flipping the switch and be full but we’ll be switching over from our legacy plants into Century and then drilling into it.

Joe Allman – JP Morgan

You would expect to see a decline in the legacy plants?

Tom Ward

Yes, we’ll move from Legacy into Century and then fill all plants together throughout the year.

Joe Allman – JP Morgan

Any kind of number on the decline in the Legacy plants?

Matt Grubb

Our Warwick thrust wells decline at about 13.5% a year. That’s kind of the decline that you’re looking at. They’re all high CO2 wells going through all the plants.

Tom Ward

Why you would move over from three Legacy plants to Century is that you have better efficiency in the new plant. We should gain about 10% efficiency.

Operator

Your next question comes from Shannon Nome – Deutsche Bank

Shannon Nome – Deutsche Bank

Can you give us any sense of what the accompanying gather ‘c’ structure will be with your midstream position?

Tom Ward

I can’t today but will be able to do that when we sign our purchase to sell agreement which will be, I don’t think it will be we’ll close in second quarter so you shouldn’t have to wait too long.

Shannon Nome – Deutsche Bank

Would you say that the terms had or had not degraded much from recent expectations?

Tom Ward

We’ll be lower then our guidance.

Shannon Nome – Deutsche Bank

Lower on the costs?

Tom Ward

We had a $200 to $300 million range that we’re looking at. We chose to take a $200 million range and we had guided towards a $300 million up front with higher fees. Fees will be lower then our analyst presentation on March 3rd.

Shannon Nome – Deutsche Bank

Can you discuss any risks that you see to the extent there are some around the Okc phase one startup timing? Can you also run us through how that CO2 tax credit thing works and how fungible that would be?

Tom Ward

On timing we’re still saying second quarter 2010, there’s no change in our timing on the plant. Everything is going along fine. As far as the tax credit that’s now law and so there is a $0.53 per Mcf tax credit for every Mcf of CO2 that goes through the plant and into sequestration. We would receive 75% of that and Okc would receive 25%.

Shannon Nome – Deutsche Bank

Given your tax status is that something that, how do you accrue value for that?

Tom Ward

Even if the IDCs were taken away from us then we still would not be a tax payer going into the future. Those tax credits would be fungible for us to place with other people who would need them.

Operator

Your next question comes from Jeff Robertson – Barclays Capital

Jeff Robertson – Barclays Capital

A question on the Midstream deal, the capital you said that could be worth up to $500 million to SandRidge is that through just a capital spending burden being born by your partner versus what you all would have to spend to expand the system?

Matt Grubb

Yes, that’s true. We would get $200 million up front on the initial sale and then what we project is to build out the system to load Century and grow our production on the WPO and Piñon field. I would get spent up to $300 million in the next four or five years. We could offer that to the purchaser for sales under similar terms of this initial transaction.

Jeff Robertson – Barclays Capital

The drilling deal you talked about can you talk a little bit more about the terms around that. I think you said $19 million of carries.

Tom Ward

25% carry through the tanks.

Operator

Your next question comes from Dave Kistler - Simmons & Company

Dave Kistler - Simmons & Company

On the basis hedges that you added in 2011, 2012, can you just discuss your thought process on laying those on at this point and going out that far my perception is that that’s where you guys see potentially one of the bigger areas of risk in the future.

Tom Ward

I think we see basis as process contract basis as also contracted. There are two ways to look at this as we go out into 2011 that there’ll be less drilling done in 2009 and 2010 and you could have basis narrow as you get gas on gas competition decreases. However, if prices move up you’d also have basis expansion and so what we usually try to do and what we’ve done in the past is we try to hedge basis at low prices and try to hedge our swaps at higher prices.

Dave Kistler - Simmons & Company

A housekeeping issue on the Midstream sale here, obviously taking a lower upfront payment impacts the gain on sales. From a tax perspective can you give us any color on that?

Matt Grubb

Right now we’re thinking a $35 to $40 million loss on that. We took all this into consideration when making the decision to take the lower money and the lower fees.

Dave Kistler - Simmons & Company

On the transaction that you did for $75 million and a follow on one that you’re looking at doing, you indicated in your comments that the first one adds about 50 Bcf of reserves. If I’m just doing simple math off of $2.2 million per well is that a fair way to then look at the number of wells and the reserves added per well?

Matt Grubb

There’s a couple things in that question, on the carry you’re looking at 25% carry on $200 million that’s basically $50 million and you’re looking at Warwick $1.00 funding costs in Mcf that’s about 50 B’s.

Dave Kistler - Simmons & Company

You mentioned the potential for a follow on deal like that. Can you talk about what that does as far as total number of wells that you’re going to drill and whether or not you might even use some of that to step out of the Piñon a little bit?

Tom Ward

We would not use that to step out of Piñon. Its really just to bring forward, we don’t have unlimited reserves in Piñon but we have a considerable reserves of a backlog of drilling that we can’t get to in a normal realized timeframe that we all want to live with. What we’re trying to do is just bring forward reserves that we can’t get to in the next few years. It is limited to only Piñon and we have not looked at any projects yet to bring in a partner outside of Piñon.

We do not have any projects that have been done outside of the one that we’ve mentioned. However, we just said that we might evaluate more up to that amount the $200 million.

Operator

Your next question comes from Joe Allman – JP Morgan

Joe Allman – JP Morgan

In terms of filling up the Century plant you indicated that you’re going to be taking some gas from the Legacy plants. What kind of volume per day would you expect to take from those plants to assist in filling up the Century plant?

Matt Grubb

Theoretically you could take it all. This Century plant phase one is expected to have capacity of 400 million a day. By mid year this year we should be moving at 350 million a day to Legacy plants. We should have enough volume there to substantially load Century when it comes on.

Joe Allman – JP Morgan

Was it your original intent to take the gas from those Legacy plants and help to fill the Century plant or is it because of the financial situation in the market that has caused you to shift your plan here?

Matt Grubb

With our commitment to Okc with the better efficiencies and lower costs of operating Century your first Mcf of ICT gas should go to Century.

Joe Allman – JP Morgan

That was your plan all along to do that?

Matt Grubb

That has been our plan all along, yes.

Joe Allman – JP Morgan

In 2010 let’s assume strip pricing do you think can you spend within cash flow and fill the Century plant or you think you need to outspend cash flow in 2010?

Tom Ward

We’ll be outspending cash flow in 2010 that’s why we have done the deals we’ve done this year.

Dirk Van Doren

Keep in mind that obviously we’re going to have a ton of room on our line and we’ll just use the line a little bit to make it back end.

Tom Ward

Everything we’ve done up to date was to be able to weather through at today’s strip. We won’t have any issue with moving forward to balancing in ’11 or ’12.

Operator

We have no further questions in queue. I would like to turn it over to management for closing remarks.

Tom Ward

No other remarks other than to say thank you for joining us today and we look forward to our next call.

Operator

Thank you for your participation in today’s conference. This concludes the presentation you may now disconnect and have a wonderful day.

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