In July 2013, SM Energy (SM) announced that it engaged an advisor to market all of its properties in the Anadarko Basin, which includes the company's Granite Wash interests. The marketing process is anticipated to take approximately six months.
SM Energy has a well diversified portfolio of assets. SM Energy targets primarily the Eagle Ford and Wolfcamp shale in Texas, the Bakken/Three Forks formations in the Williston Basin and the Frontier formation in the Powder River Basin.
SM's Balance Sheet
SM does not have any debt problems currently. With an estimated cash flow (annualized) at approximately $1.2 billion and long term debt at $1.6 billion, the company's D/CF ratio stands at 1.36x. So I believe that the majority of the proceeds from the potential sale will not be utilized to reduce the debt, but will most likely fund the development of the company's projects.
Which property will be the beneficiary of these funds? Well, SM Energy has significant production from its South Texas properties and a growing production from the Bakken/Three Forks formations in North Dakota. The company's acreage in the Powder River Basin is natural gas weighted. So I believe that SM will direct the proceeds to its least developed acreage which is located in East Texas.
During Q2 2013, SM Energy increased its acreage position in East Texas to approximately 195,000 net acres from the previously announced 150,000 net acres. This indicates the company's strategic expansion into that region. These properties are located primarily in Washington, San Jacinto, Walker, and Polk Counties, Texas.
According to the latest quarterly report, SM's plan is to drill test wells on this acreage targeting the Eagle Ford and Woodbine formations in H2 2013. The production from this acreage will most likely be heavily oil and liquids weighted as the drilling results of the neighboring companies have demonstrated thus far.
For instance, Halcon Resources (HK) and Crimson Exploration (CXPO) drill in the same area. Halcon's acreage is located primarily in Brazos, Burleson and Grimes Counties, Texas while Crimson's assets are located in Madison, Houston and Grimes Counties, Texas. Halcon's and Crimson's oil-weighted drilling results from this region are shown in my article here.
A more oil-weighted production is what SM Energy desperately needs because it has a balanced commodity mix currently comprising only 50% oil and liquids. So this is an additional reason for me to believe that East Texas will be the primary beneficiary of these funds, once the sale in the Anadarko Basin is completed successfully.
Deals In The Anadarko Basin
Can this sale have a material impact on SM Energy's production, changing the current balanced commodity mix? To find this, I'll estimate first how much money SM Energy can milk from its Anadarko Basin cow. To make an accurate estimate, I'll check out the details from the major deals of the area:
1) In May 2013, Laredo Petroleum (LPI) sold its acreage in the Anadarko Basin in Western Oklahoma and Texas to EnerVest for $438 million to raise capital for its drilling activities in the Permian Basin. Laredo sold 104,000 net acres that produced approximately 9,600 boepd (~6% oil) and had proved reserves of 28.5 MMboe (~5% oil).
Since the completion of that sale, Laredo's stock has risen significantly and its steep rise reminds me of Miller Energy's (MILL) stock. Miller Energy Resources is an underfollowed E&P company and you can hardly find an article about it at the online publications. I spotted Miller Energy Resources at ~$3.7 in March 2013. The stock has risen 90% lately and lies at ~$7.06 today. My articles about Miller Energy Resources are here and here.
Actually, Miller's amazing return joins the big returns from Surge Energy (OTCPK:ZPTAF) and Rock Energy (OTCPK:RENFF) which I also recommended in the first half of 2013, when there were not any online articles about them. Both Surge Energy and Rock Energy were under-followed and under-appreciated. Since then, Surge Energy and Rock Energy have hit a return of 100% and 90% respectively. My articles about these two companies are here, here and here.
2) In 2012, Unit Corporation (UNT) acquired assets from Noble Energy (NBL) that include approximately 84,000 net acres primarily in the Granite Wash, Cleveland, and Marmaton plays in western Oklahoma and the Texas Panhandle, for $617.1 million in cash. The proved reserves of the properties were 44 MMboe and the production was 10,000 boepd.
Pro forma this acquisition, Unit doubled its acreage in the Granite Wash Texas Panhandle core area, by adding approximately 25,000 net acres in this highly prolific liquids-rich fairway in the Anadarko Basin.
3) In 2012, Apache (APA) acquired privately held Cordillera Energy Partners for $2.85 billion. This acquisition more than doubled Apache's holdings in the Anadarko basin, adding proved reserves of 71.5 MMboe and 18,000 boepd (53% oil and liquids) of production. Cordillera had 254,000 net acres in the Granite Wash, Tonkawa, Cleveland and Marmaton areas of western Oklahoma and Texas.
Apache has been drilling in the Anadarko basin for more than 50 years but it had no horizontal wells in the area before 2009. Since then, things has changed a lot and today it gets more than half of its daily output in that region from horizontal wells and the use of hydraulic fracturing.
It must also be noted here that Apache overpaid for this acreage as shown at the table below. The transaction metrics of Apache's deal were the highest ones among all the area deals of the last two years although Cordillera's production was not heavily oil-weighted.
4) In June 2013, BreitBurn Energy Partners (BBEP) acquired Whiting Petroleum's (WLL) interests in the Postle and North East Hardesty oil fields, along with associated midstream assets, located primarily in the Oklahoma Panhandle, for $860 million. The sale includes the related gathering and Dry Trail plant processing facilities, oil delivery pipeline, 60% interest in the 120-mile Transpetco-operated CO2 transportation pipeline, CO2 supply contracts and certain crude oil swaps. Whiting's assets produced 7,640 boepd (98% oil and liquids) and had proved reserves of 44.2 MMboe.
5) In April 2013, Midstates Petroleum (MPO) acquired producing properties as well as developed and undeveloped acreage in the Anadarko Basin in Texas and Oklahoma for $620 million. The assets were sold by Panther Energy, Red Willow Mid-Continent and LINN Energy (LINE). They hold 36.4 MMboe proved reserves (66% oil and liquids) and produce 8,000 boepd (67% oil and liquids), expanding Midstates Petroleum's acreage position by 140,000 net acres.
6) LINN Energy was a buyer in late 2011 when it acquired oil and natural gas properties located in Ochiltree and Lipscomb Counties, Texas and Ellis County, Oklahoma for $220 million. The production of these assets was 2,700 boepd from 170 producing wells, the proved reserves were 10 MMboe (45% oil) and the total acreage position was 44,000 net acres.
The following table helps us visualize better the transaction metrics of the deals above:
UNT - NBL
WLL - BBEP
LINE - MPO
Doing The Math To Find The Price Tag
The company's assets in Anadarko Basin span a total area of 56,000 net acres. SM Energy does not provide the proved reserves associated with this acreage. Currently, these assets yield about 9,000 boepd comprising 75% natural gas. Since this production accounts for around 8% of the company's total production in Q2 2013, I will assume that the proved reserves associated with this acreage is approximately 8% of the company's total proved reserves of 293 MMboe (53% oil and liquids). Thus, the acreage for sale holds approximately 23.44 MMboe.
Using the average metrics of the deals above, I get the followings:
1) Per production: 9,000 boepd X $89,534/boepd = ~$806 million
2) Per Proved Reserves: 23.44 MMboe X $21.29/boe = ~$499 million
3) Per acre: 56,000 net acres X $6,441/acre = ~$361 million
To minimize the valuation gap among the different results, I'll use the average price which is $555 million.
To appraise SM's properties as accurate as possible, I will also take into consideration their commodity mix. Excluding Laredo's deal, the properties of the aforementioned deals had either an oil-weighted production or a balanced commodity mix. Since SM's acreage for sale has a natural gas weighted production, I will discount the average estimate above by 10%, bringing my final appraisal down to $500 million.
My Take Away
1) SM Energy's CapEx for 2013 is approximately $1.65 billion. Based on this CapEx, the company's full-year 2013 updated production guidance is approximately 48 MMBOE, and represents production growth of approximately 30% year-over-year.
Meanwhile, the proceeds from the pending sale can hit $500 million or even surpass this threshold depending on the buyer and the market conditions. This amount is one third of the total annual CapEx for 2013 and can obviously play a major role in SM's production growth in 2014.
2) SM Energy owns properties with significant oil and liquids potential in South Texas (145,000 net acres prospective for Eagle Ford), North Dakota (81,000 net acres prospective for Bakken/Three Forks), and East Texas (195,000 net acres prospective for Eagle Ford/Woodbine). If the proceeds are directed to these properties (which is very likely), the oil and liquids portion of the total production can substantially increase in 2014.
Assuming SM Energy does not sell its assets in the Anadarko Basin at a fire sale price, it has high odds to receive approximately $500 - 550 million. If this scenario comes true, SM Energy will be a totally different company in 2014 compared to 2013, and the growth seekers must put it on their watch list.