SandRidge Energy (SD) released first quarter earnings on May 3, reporting net income of $0.04 cents per share. Its earnings report also revealed record oil production for the company of 3.4 mmbbls, with peak production of 99 mboe per day just before the earnings report. I think this is a sign of SandRidge's recent growth and an indication of good things to come.
Expect SandRidge's CEO Tom Ward to be in the news in coming weeks, and perhaps not in a positive light. Ward was co-founder and former President of Chesapeake Energy (CHK) until 2006, when he resigned from Chesapeake and bought a stake in Riata Energy, which later became SandRidge. Ward ran the hedge fund that is currently under scrutiny with McClendon from 2004 until his resignation.
Growth Through Acquisition
SandRidge recently completed the acquisition of Dynamic Offshore Resources, LLC. It was a quick move by SandRidge, considering Dynamic's first IPO was just completed in January 2012 and the first reports of the acquisition by SandRidge came mere weeks later, on February 1.
Not only was it a quick move, but it is a good one. SandRidge previously indicated its intentions to double its oil production, and the acquisition of Dynamic gives it near-instant access to 62.5 mmboe. As throughout its short operating history, SandRidge focused on shallow and on-shore drilling. So Dynamic made sense as an acquisition, considering over half of its resource base is in shallow water, at depths of 300 feet or less.
SandRidge's expertise is centered on shallow drilling because this method is accessible and cost effective, but as others rush in to the plays that SandRidge discovered, SandRidge will be forced to go deeper to find its profits. I think SandRidge's best bet for expansion is to move into more complex plays and pursue experience through acquisition.
SandRidge was one of the first energy companies to begin a transition into oil and liquids ahead of the natural gas boom and resulting oversupply. Its early moves allowed it to acquire its current position in the Mississippian formation at an average of just $200 per acre; the current valuation is around $4,236 per acre, which makes this a stunning coup for SandRidge. SandRidge attributed its 33% increase in oil production in the first quarter primarily on its plays in the Mississippian and the Permian. In the Permian Basin, SandRidge has interest in 225,000 acres on which it is operating 12 rigs. SandRidge is indicating that it intends to drill 759 wells on the Permian in 2012.
Similar to Chesapeake, SandRidge divested some of its assets in the Permian, although it is doing so selectively and is not looking to exit the play wholesale, a mistake Chesapeake is ready to commit. In 2011, SandRidge gained $696 million through sales of properties in Bone Spring, Avalon, and Wolfberry in the Permian. Despite the divestiture, the Permian still represents 40% of SandRidge's proved reserves, with 187 mmboe, and 30.4% of its daily production. SandRidge is competing on this play with Occidental Petroleum (OXY) and Apache (APA) primarily, although other presences on the play include Exxon Mobil (XOM), Chevron (CVX) and ConocoPhillips (COP).
SandRidge is also focusing on the Mississippian shale in Kansas and Oklahoma, with 8,000 drilling locations identified on 1.7 million net acres. Although one of the smallest energy companies by market cap, SandRidge is responsible for almost half of the horizontal wells in the formation.
According to the Oklahoma Geographical Survey, the number of active rigs in the state reached 180 in 2011, close to the all time high of 200 in 2008. However, there was a major difference: In 2008, most rigs were targeting natural gas, and now the target is oil. Still, most of the reserve capacity in the Mississippian formation is gas, and not oil; the Oklahoma Geographical Survey reports that on a barrel of oil basis, gas production is four times higher than oil production. This is a challenge that SandRidge will need to overcome as the industry waits for gas prices to edge higher.
The Oklahoma Geographical Survey also concludes that Chesapeake remains the most active driller in the state, with pads across the state and an 8% share of all drilling. Somewhat humorously given Chesapeake's current struggles, the Survey also notes that other operators "are much more focused in their drilling", and names SandRidge and Devon Energy (DVN) as the next most-active drillers. SandRidge competitor EOG Resources (EOG) is also working on the Mississippian formation, but is doing so from the southern end of the formation in western Texas County. All of this indicates that eventually, SandRidge will need to drill deeper to continue competing with these experienced companies.
Devon is particularly active in the Woodford shale in the Anadarko Basin. In the first quarter, it averaged 271 mcfe per day and 13,000 boe per day from the Woodford. Exxon Mobil is also moving into shale gas, running 65 wells on the Woodford and gearing up to finish 130 wells per year.
SandRidge's working interest agreement with Repsol E&P (OTC:REPYF), which was enacted in January 2012, grants Repsol a 25% non-operated interest in SandRidge's Mississippian acreage in exchange for cash up front and a share of development costs, up to $750 million over the next few years. This deal allows SandRidge additional liquidity, though limited, while minimizing the risk inherent in shouldering 100% of development costs.
As of the close of 2011, 96% of SandRidge's income derived from revenue from oil wells. By taking a contrarian approach to resources investment beginning with its decision to transition to oil in 2008, SandRidge ensured that it would be able to add to its resource base at reasonable prices.
SandRidge intends to fund its capital expenditures within cash flow by 2014, an admirable goal and one that should shore up shareholder confidence, as SandRidge's current debt to equity ratio is far above industry average, standing at 1.4. This offsets SandRidge's value ratios, as it has an ordinarily attractive price to book of 1.8 trading around $7 per share. For comparison, Anadarko Petroleum (APC) also has a price to book of 1.8 trading around $72, and Occidental comes in close at a price to book of 1.9 trading around $90. Chesapeake's volatile stock is trading at a price to book of 0.8 at around $17, though given its current situation this attractive price comes at considerable risk.
Overall, SandRidge is a small energy stock with big potential. So far it is proving almost prescient about changes that are impacting the entire industry. As a result, SandRidge is not suffering losses due to depressed gas prices as much as some of the other regional and domestic producers. Its debt to equity sounds a note of caution, though that is one of only a few things not to like about this particular stock.