From an operating standpoint, the quarter appears weak, with the Mississippian production increasing sequentially only 1% and average IP rate per Mississippian well in the third quarter being lower by 19% relative to the second quarter and lower by 7% relative to the first quarter. Results of testing productive potential in additional pay zones were mixed. Notably, the initial three wells completed in the Woodford Shale came in at non-commercial rates or watered out.
While SandRidge's press release implies that the company is on track to meet or slightly exceed its operating and financial guidance for the full year 2013 (production guidance for the year was increased by ~1%), capital outspending relative to internally generated cash flow leaves many questions open with regard to the true magnitude of value creation in the company's Mississippian Lime operation.
The leadership and Board changes that SandRidge went through earlier this year did not translate into a balanced budget for 2014 or accelerated debt repayment. The company announced a $1.5 billion capital spending plan for 2014 (net of estimated ~$300 million of joint venture carries), which means that outspending will continue into the next year. To put the planned capex in perspective, SandRidge generated discretionary cash flow of $235 million during the third quarter and $593 million during the first nine months of this year.
In light of the aggressive budget, the company's guidance for an 8% overall production growth (the company uses a 12% "organic, as adjusted for the Permian sale" growth metric) and 8% oil production growth in 2014 underwhelms and raises renewed concern regarding well performance and the company's ability to use capital efficiently.
Annualizing SandRidge's Q3 2013 Adjusted EBITDA of $252 million and using $6.61 price per share, the stock is currently trading at ~6.1x multiple of the company's run-rate Adjusted EBITDA. While not totally unreasonable if compared to the peer group, the multiple is certainly on the high side, given that the company's current production is dominated by recent-vintage wells and therefore is characterized by a steep base decline rate.
While SandRidge's liquidity remains ample, supported by the $920 million of cash on hand and an undrawn credit facility, the company's leverage nonetheless remains elevated. At the end of the third quarter, SandRidge had outstanding ~$3.2 billion of senior notes and $0.8 billion of convertible preferreds.
During the third quarter, SandRidge operated an average of 22 rigs in the Mississippian play and "delivered 104 Mississippian wells with an average 30-day IP of 307 Boe per day." By comparison, the company's average 30-day IP rate in the Mississippian was 377 Boe per day in the second quarter and 330 Boe per day in the first quarter. While IP rates provide imperfect correlation to drilling economics, on the surface well performance seems to have deteriorated in the third quarter despite the company's strategy to focus its drilling effort within select, more productive areas.
While the average rig count during the third quarter represents a 15% reduction from the second quarter and 31% reduction from the first quarter, the company still outspent its internally generated cash flow during the quarter by ~$90 million and used up estimated ~$90-$100 million in JV carries.
Despite the significant outspending, the company's Mississippian production averaged 47.9 MBoe/d in the third quarter, which represents a sequential increase of just 1%, a substantial slowdown from the 20% sequential growth during the second quarter and 10% sequential growth in the first quarter (the slide below). It is also worth noting that despite the reduction in the number of rigs running, the number of wells "brought on" during the third quarter is only slightly lower than during the previous two quarters: 104 wells during Q3 compared to 111 wells during Q2 and 109 wells during Q1. Clearly, weaker well productivity is the primary driving factor behind the slowing production during the quarter.
The Mississippian Lime is a highly statistical play and some variability in average well results from quarter-to-quarter is to be expected. Besides, the company's press release states that production from 12 high-volume wells was deferred during the quarter due to production outperforming gas infrastructure capacity. Importantly however, the weak quarter-on-quarter growth in Q3 vividly highlights the challenge of offsetting steep production declines from existing Mississippian wells in SandRidge's portfolio, even when using significant amount of drilling capital.
In the context of visibly weaker average well results during the quarter and poor sequential growth, the company's comment in the press release is truly surprising:
James Bennett, SandRidge's Chief Executive Officer and President, commented, "Over the last couple of quarters, we have pursued several key themes operationally - being more efficient with our capital, consistent Mississippian production growth, reducing our costs, and identifying new opportunities. We believe we are hitting the mark on all of these. Through successful high grading efforts and operational improvements, we have increased Mississippian production from the second quarter even while reducing our rig count by 15%, again delivering more production for less capital…"
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