SandRidge Mississippian Trust II - Calculating The Q2 2016 Dividend

| About: SandRidge Mississippian (SDR)


We calculate the expected upcoming May dividend for SDR similarly to my earlier CHKR article.

Because the May dividend relates to production from December 2015 through February 2016, an accurate estimate can be made based on expected production declines and known price declines.

After reading this article, you will know what oil trusts are and how to calculate their dividend with relative accuracy.

Lastly, we apply the same estimating technique for production relating to March through May 2016 (for Aug 2016 Dividend) according to a range of potential prices.

An oil trust such as SandRidge Mississippian Trust II (NYSE:SDR) owns royalty interests in active oil fields. Each quarter it produces some revenue based on how much oil it sells and the price it sells it for. However, proceeds are not paid out until approximately three months later to allow time (I presume) for accounting and sale settlement. Thus to estimate the next quarter's dividend, we must estimate the parameters of price and production for the most recently passed quarter. That is, for the May 2016 dividend, we must look at production from December, January, and February. This presents a great opportunity for precisely calculating the next dividend, as the price is now historical data, and the oil fields themselves deplete in largely predictable way.

Let's look at SDR specifically. Looking at the three most recent 8-Ks from Jul15, Oct15, and Jan16, we see production was (88, 80, 1,189, 366), (70, 70, 1,084, 321), and (51, 64, 981, 279) for the production periods of Mar15-May15, Jun15-Aug15, and Sept15-Nov15 respectively where the units in are Oil MBbl [thousands of barrels of oil], NGL MBbl, Gas MMcf [million cubic feet], and total mboe [thousands of barrels of oil equivalent], which adds the three categories to give total production in units of "oil equivalent." Notice that in mboe, there is a decline rate in production of 12% [(366-321)/366] and then 13% [(321-279)/321]. Looking at just oil, production declined by 20% [(88-70)/88] and then 27% [(70-51)/70] whereas for gas, production declined just 8.8% [(1,189-1,084)/1,189] and then 9.5% [(1,084-981)/1,084]. We also see that in the most recent quarter, 51 of the 279 mboe is actual oil. According to filings, there should be no new drilling, and it appears from the three most recent quarters at least that the rate of decline is accelerating. However, we can do calculations for a few potential production decline amounts.

Next we must estimate the prices at which oil and gas were sold over the last three months. While the price depends a lot on quality and location, the relative price change in SDR's oil and gas should reflect the relative price change in market prices more generally. If we approximate that production is constant throughout each 3 month production period, then the average price per barrel received should be proportional to the 90-day moving average at the end of each quarter. However, because the price of oil has been steadily declining, the average price realized should be higher than the 90 day average because there was relatively more early production than later production. However, the same should be true for the previous quarter too, so simply taking the ratio of the 90 day averages from the previous quarter to this one should account for this effect as well as accounting for the difference between what the Trust can sell it for and what the general market prices are. One further complication is determining exactly what percentage of revenue comes from each of the three products -- oil, NGL, and gas -- that it sells. Thankfully, the prices of these commodities have moved together within the margin of error from the method I introduce in the next paragraph.

I was unfortunately unable to find a 90 day moving average for oil or gas on the internet that lent itself to calculations, so instead I used averages from ETFs that are designed to track the price of oil. However, these only give prices for weekdays as the ETFs only traded then, and different ETFs differ by as much as 5% in their price change over the past 3-6 months. Over the last 3 months as of February 19th, the United States Oil Fund LP (NYSEARCA:USO) has dropped by 34.36% and iPath S&P GSCI Crude Oil Total Return (NYSEARCA:OIL) has dropped by 39.03%, according to Google Finance. Both of these ETFs track oil price, but the ratio of the 60-weekday average from December 1, 2015 to February 17, 2016 has changed by 32% for USO, and only 29% for OIL. Of course, USO tracks prices in the United States only rather than worldwide. It is a similar story for gas. The United States Natural Gas Fund, LP's (NYSEARCA:UNG) 60-trading-day moving average has dropped by 25.6% over the same period.

As a conservative estimate, we can thus assume at least a 25% drop in sales price, and a 10% decrease in production. A more liberal estimate would probably be a 30% reduction in sales price, and a 15% reduction in output. Finally, once profit is calculated, we must subtract 1.2 million for quarterly trust expenses, which the trust has consistently deducted for at least the past three quarters. Given that the trust had a royalty income of $4.938 million last quarter, if we estimate a 25% drop in sales price, and a 10% drop in production, we arrive at a prediction of $3.3 (4.938*0.9*0.75) million in royalty income for the upcoming dividend. If we use a 30% reduction in price with a 15% reduction in production, the royalty income would be $2.9 million. If this were the end of the story, then we would expect a total distributable income of between $1.7 million and $2.1 million, which divided over 37.29375 million shares gives a distribution between $0.046 and $0.056.

However, there is both worse and better news. For the upcoming distribution, one month's worth of production is protected by oil hedging contracts established when the trust was formed, but that expired at the end of 2015 (remember the production period for the May dividend is December, January, February). However, this will completely disappear by the August dividend, and to make matters worse, approximately one quarter of the current shares will transition from being subordinated units to regular shares. Subordinated shares are shares that only receive a dividend if the total distributable income is above some certain threshold. Because of lower than expected oil production and prices, the subordinated shares have not received any dividend in recent history. However, they will convert into regular shares in April and start receiving a dividend in August, presumably for production attributable to April and May, but not March before becoming completely regular shares for the November dividend. Once the subordinated shares become regular, the total number of regular shares will go from 37.29375 million to 49.725 million, for 4/3 as many shares, making the payout ¾ as much.

As the price of oil has fallen and the hedge contract sizes have increased over the last three quarters, the trust's income from derivative settlements has increased from $2.5 million, to $2.7 million to $3.1 million. That means the settlements made approximately $1 million a month, which we can add to the trust's total distributable income for the February dividend. Because the price of oil was lower in December than previously, but since it is unknown exactly what volume was hedged relative to previous months, I would estimate a range $0.8 million-$1.2 million for proceeds from derivative contracts. Then, the total distributable income could range from $2.5 million (1.7+0.8) to $3.3 (2.1+1.2) million for a distribution between $0.067 to $0.088. Based on my previous experience with oil trusts, I have low expectations, and expect the dividend to be towards the low end at approximately seven cents.

Lastly, I have created a table to predict the August dividend based on production of March, April, and May based on potential changes in price and sales volume this coming quarter as compared to price and volume disclosed in the most recent February dividend for production from September, October, and November 2015. Thus, if there we use a 10% production decline rate, production for August will actually be 81% that for February.

Table showing the proportion of Royalty Revenue attributable to the trust in the February Dividend that will be attributable for the August Dividend

Oil and Gas 90 Day Average Price. Percentage Change from
December 1st to May 1st

Quarterly Production Decline Rate




































*For this quarter, the 90-day oil price has fallen 30% since December 1st.

Click to enlarge

The following table then gives the expected dividend payout corresponding to each of the scenarios with only 37.29375 million shares receiving dividends rather than 49.725 million. Note that this assumption is wrong, and each payout should be multiplied by ¾ to get an accurate estimate. If prices stay exactly the same for the next three months, then we would be in the range of a 90-day average decline between 30 and 40 percent since the 90-day average on December 1, 2015. With an expected depletion rate of 15% (0.72 of original production) each quarter, the dividend would be around 3-4 cents in August [See table below].




































Click to enlarge

Overall, these calculations agree with the estimates Daniel Moore has given of nine cents in May, and five cents in August [in his analysis of February 2016]. However he cautions "that [in the] best case the Trust can earn $0.05 per unit … [And this] distribution level is not without significant risk." I personally expect a lower distributions of seven to eight cents in May and three to four cents in August (given constant prices over the next 3 months for the August estimate).

If SDR does pay four cents a quarter, for a payout of 16 cents a year, after five years, the stock would pay out approximately 86 cents, and only $1.72 after 10 years. I do not have experience to estimate whether the rate of extraction will continue to decay at 13% a quarter. If it does, then the price of oil and gas would have to double every 5 quarters to maintain a constant dividend. Even if this decay rate only lasts one more year, oil will have to rebound towards its original price just to keep the profit constant for this year. And of course, the trust has a large fixed cost of operation. If the price of oil halves from $30 to $15 as some predict, the dividend will go from five cents to zero because every quarter the trust pays $1.2 million in expenses.

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