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The huge amount of oil and natural gas found in the onshore U.S. has provided growth to a number of oil and natural gas explorers and producers. SandRidge (SD) is one such oil and natural gas explorer and producer based in Oklahoma. The company has its core operations in the Mississippian Lime region. While in our previous article we discussed how SandRidge is focusing on achieving operational efficiency, in this article we will delve deeper to find out how the company is focusing on the development of the Mississippian Lime. In addition to its operations in the Mississippian Lime, SandRidge has built significant infrastructure for the extraction of oil and natural gas from this region.

Searching more bounty in the Mississippian Lime

SandRidge continues to invest in its Mississippian Lime asset to increase its production. The Mississippian Lime, which stretches from Kansas through northeastern Oklahoma, is the name given to the rock formation from which oil and natural gas can be extracted. The company has an acreage position of 1.9 million in the Mississippian Lime and has around 22 running rigs and 900 horizontal wells.

The company plans to focus primarily on Woods, AlfaAlfa, Grant, Comanche, Barber and Harper counties with net acres of 615,000 within the Mississippian Lime. SandRidge named these six counties as the "development" or "project areas," as they are major oil and natural gas producing counties in the region.

With around 166 wells operating in the project area, SandRidge has received encouraging results from these wells. The initial production, or IP, from these wells has been increasing over the years, as illustrated by the chart below. IP of wells is a metric used to estimate the total available resources from a well. The company's average IP rate in these areas has increased from around 231 barrels of oil equivalent per day, or Boepd, in 2010 to around 377 Boepd this year.

(click to enlarge)

Source: SandRidge

Will the "stack" pay?

One of the potential growth drivers for SandRidge is the "stack pay" in the project area. Stack pay are multiple geological zones that are capable of producing oils. The company has already dug eight wells in the stack pay. The following diagram shows the stack pay in the project area. The colors in the two diagrams correspond with each other. As can be seen in the diagram, the stack pay consists of five zones. These are Chester, Upper Mississippian, Middle Mississippian, Lower Mississippian, and Woodford.

(click to enlarge)

(click to enlarge)

In a recent data released by SandRidge, it was found that the Upper Mississippian is as productive as the Middle Mississippian. As can be seen from the diagram the Woods, AlfaAlfa and Comanche counties constitute a significant portion of the Middle Mississippian. The company plans to drill around 40 wells in the Middle Mississippian by the end of this year.

One of the potential zones in the stack pay is the Woodford layer. The Woodford is the lower most layer in the stack pay and lies below the Mississippian Lime. According to a study by the U.S. Geological Survey in 2010, there is an estimated 400 million barrels of undiscovered oil in the Woodford shale. The Woodford shale lies in large areas of Oklahoma State, where the company operates, so it's probable that the company might find large oil reserves in the Woodford layer of the stack pay.

Are the operating costs in a downward trend?

Year

2010

2011

2012

Revenue ($ million)

931.74

1415.21

2730.97

Operating Income ($ million)

6.79

420.01

325.2

Operating margin

0.73%

29.68%

11.91%

Source: Yahoo finance

Looking at the table above, we believe the operating margins should improve during this year. This is because of the significant advantages the company has in the Mississippian Lime. Since SandRidge has already drilled around 900 horizontal wells and 14,000 vertical wells in the Mississippian Lime, the cost of drilling wells in the stack pay will reduce since the well drilling infrastructure already exists. This well drilling infrastructure consists of a saltwater disposal system and the electrical arrangement.

A significant component of the well drilling infrastructure in the Mississippian Lime is the saltwater disposal system. SandRidge has put a proper saltwater disposal system into place. The amount of water cut in the Mississippian Lime wells is more than 90%. Water cut implies the volume of water coming out from a well as a percentage of the total liquid produced. By the end of this year, the company would have invested around $650 million in the salt-water disposal infrastructure. SandRidge disposes around 865,000 barrels of water through 850 miles of pipeline on a daily basis. This results in cost savings since the company doesn't have to use trucks to dispose of the salt-water.

Also, SandRidge has created its own power system with around 750 miles of electrical lines and six substations with access to 100 megawatt, or MW, of power. This independent electric power system is required to operate the company's electrical submersible pumps to extract oil from the wells. The independent power system assures an uninterrupted power supply during well operations.

This infrastructure has helped bring down the cost per well from $3.5 million per well during the second quarter ending in June last year to around $2.95 per well during the second quarter ending in June this year. This could be attributed to the existing infrastructure for well drilling, giving SandRidge a cost advantage over its competitors and adding to its margins.

A major player in the Mississippian Lime is Devon (DVN). The company has a net acreage of around 650,000 in the Mississippian Lime. It currently operates around 15 rigs in the region and plans to drill around a total of 350 wells by the end of this year. During the second quarter ending in June this year, the company had 10 wells, which have a 30-day IP averaging around 840 Boepd. Devon realized a cost of $3 million for each well drilled during the quarter, which is close to the cost realized by SandRidge. A key difference is that while SandRidge is focusing on the Middle Mississippian, Devon is focusing more on the production from the Woodford shale.

Another company, Chesapeake (CHK), which is into oil exploration and production, also has major leases in the Mississippian Lime. Chesapeake, along with Sinopec, has acreage of 850,000 in the region. With a strong focus on exploration and production, the company is divesting more of its non-core assets. In August this year, Chesapeake sold its natural gas gathering and processing assets in the Mississippian Lime to SemGroup. During the second quarter ending in June this year, it realized an average production of 126,000 Boepd. With a greater focus on production and exploration, we expect that Chesapeake would try to increase productivity from its wells in the region.

Does the stock have potential?

Company

Enterprise Value/Revenue, or EV/Revenue

Enterprise Value/EBITDA, or EV/EBITDA

Devon

3.09

6.12

Chesapeake

2.1

5.79

SandRidge

1.72

4.79

Source: Yahoo finance

The table shows that SandRidge's EV/Revenue multiple is lower than the competitors. One of the factors is that the market is significantly discounting the potential of its Mississippian Lime asset. The results shared by the company show that the Mississippian Lime has plenty of energy resources left in it. Additionally, the company is yet to exploit the reserves in the Woodford region of the stack pay. With its high acreage position in the Mississippian Lime, we believe that SandRidge will be able to provide more growth in the future.

Also, the EV/EBITDA of the company is attractive compared to Devon and Chesapeake. We believe that SandRidge will continue to have an attractive EV/EBITDA because of the reducing cost of its wells in the Mississippian Lime. With well-drilling infrastructure in place, the company has been able to consolidate its operations in the Mississippian Lime and gained cost advantage over its competitors. Going forward, the company will be providing growth to its investors because of its formidable position in the Mississippian Lime and the cost advantages it has over its competitors.

Source: Why SandRidge Is One Solid Oil Stock To Buy

Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Madhu Dube, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.