SandRidge Energy (NYSE:SD), the sponsor of SandRidge Mississippian Trust I (NYSE:SDT), this morning filed the 2013 annual report on Form 10-K for the Trust. The report contains yet another significant downward revision to the Trust's proved reserves (which I first warned about in my detailed article in July 2013 - the article focused on poor well performance as a risk factor to the Trust's reserve estimates). The downward revision should not come as a particular surprise to investors, given the abysmal oil production volumes posted by the Trust over the past two quarters.
Reserve Report Analysis
The downward revision of the previous reserve estimates impacted both oil and natural gas reserves:
- Oil reserves revised down 22%;
- "Wet" natural gas reserves revised down 22% (NGL reserves down 6% and dry gas reserves down 25%).
Oil represents ~22% of the total remaining proved reserves, which is unchanged from year end 2012.
Based on my analysis, using a flat pricing assumption of $95 per barrel WTI and $4.50 per MMBtu Henry Hub, crude oil still accounts for more than half of the total PV-10% value of the Trust's proved reserves (56%, based on my model).
During 2013, SandRidge brought on production 16 new wells in which the Trust holds an interest, bringing the total number of the Trust's Mississippian horizontals to 161.
While the downward reserve revision may reflect a worse-than-anticipated performance of the wells brought on production in 2013, it clearly also reflects a material downward revision for the Trust's wells that were on production as of year-end 2012 driven by the actual performance.
Based on my calculations, the latest reserve report implies that the Trust's wells, on average, are now expected to have oil EURs of less than 80 MBo, which compares to 107 MBo suggested by SandRidge's year-end 2012 Mississippian type curve.
As a reminder, this is a second in a row significant revision of the Trust's proved reserves estimate. At the end of last year, the Trust's oil reserves were revised down by a dramatic 52% from the year-earlier estimate, while "wet" natural gas reserve estimate was reduced by over 10%.
Net Asset Value Considerations
At the end of 2013, the PV-10% value of the Trust's proved reserves stood at $174.4 million, using the 2013 SEC price assumption. Using this PV-10% estimate as a starting point, I arrive at the following NAV range (based on an assumed 10% required rate of return) for the Trust's units:
(Source: Zeits Energy Analytics).
The illustrative NAV analysis above indicates that the Trust's current price per unit implies a moderate premium (~10%-20%) to the underlying NAV-10%.
Given the nature of the risks involved (the Trust does not pay lease operating costs, does not have debt, has minimal overhead, and does not engage in future E&P activities), the Trust's current price per unit appears to adequately reflect the underlying NAV (of course, assuming no further performance revisions to the reserves). The implied "IRR to maturity" is in high single digits, which, arguably, is in line with what the market has required of similar investment vehicles.
Risks Remain, Both To Downside and Upside
The shape of the Mississippian decline curve remains a significant uncertainty to the units' price.
A flattening, relative to the current type curve, of the decline trajectory in the later phase of the wells' life - which is certainly a possibility - could lead to better-than-expected recoveries. Moreover, such flattening would improve the risk profile of the Trust's future cash flows and potentially result in reduced required rate of return, which represents a highly impactful valuation variable for the units. Higher commodity prices and persistently low interest rate environment would also have a positive impact on the units' valuation.
On the negative side, despite the two major adjustments to the reserve estimates, the risk of additional downward revisions cannot be ruled out either (particularly given the poor track record of the Trust's sponsor and its outside reserve engineers in predicting the performance of a very large sample of wells within the sponsor's core operation).
Disclaimer: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.