Yesterday after the close, SandRidge Mississippian Trust II (NYSE:SDR) announced quarterly distribution and operating results for its first quarter of 2014 (the three months ended March 31, 2014 which reflect production revenues for the period from December 1, 2013 through February 28, 2014).
The report is disappointing - production volumes were lower-than-expected:
- Average daily oil production dropped 17.0% quarter-on-quarter (to 174 thousand barrels, including ~7.3% NGLs, from 212 thousand barrels, including ~7.0% NGLs, during the prior period).
- Average daily natural gas production declined 8.9% sequentially (to 1500 MMcf from 1,665 MMcf during the prior period).
- Distributable income declined 13.9% quarter-on-quarter.
The press release quoted three factors contributing to the result:
- well performance;
- fewer development wells brought on production during the period;
- intervals of reduced production due to severe winter weather conditions.
The 17% decline in oil production volumes is highly disappointing given that the Trust's development program is ongoing. While SandRidge Energy (NYSE:SD) has reduced the pace of drilling on the Trust's behalf, the 6.9 new wells that were brought on production during the quarter (which compares to 10.7 wells during the prior period) represents a meaningful addition to the portfolio.
Perhaps most notable in this context is the admission in the press release that well performance was among the factors that contributed to the operating result.
While it is difficult to calculate with precision what the production volume would have been without the 6.9 new wells that were added during the quarter, I "guesstimate" that the sequential decline for the portfolio would be in the ~25% range. In terms of its natural decline trajectory, the Trust appears to perform similar to its sister trust, SandRidge Mississippian Trust I ("SDT"), which serves as a valuable "type curve laboratory" for Mississippian Lime wells.
SDT finished drilling new wells three quarters ago. SDT's portfolio is now in natural decline and is providing real-time data on how production from a portfolio of Mississippian Lime wells might perform once the development program is completed. As a reminder, SDT posted 26%, 21% and 22% sequential quarterly declines in average daily oil volumes during the three quarters that followed the end of the development drilling.
On a combined basis, the two trusts (SDR and SDT) represent a very broad well sample consisting of approximately four hundred producing wells. Therefore, it would be incorrect to dismiss the steeper-than-expected production declines based on unfavorable well location.
The Trust's press release did not quantify the magnitude of the severe weather impact on the quarter's production volumes. Hopefully, the Trust's production volumes will strengthen during the next quarter and help restore confidence in the type curve. In the meantime, the Trust's well performance is a concern. A flattening of the Trust's production profile is needed to support the reserve estimates and valuation.
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