New York Mercantile Exchange (NYMEX) natural gas futures rose this week, closing on May 18 at $2.74 mmbtu, good news for small growth energy company SandRidge Energy (SD). Despite a move towards offsetting punishing U.S. natural gas prices with increased liquids production, SandRidge is still reliant on dry natural gas, which makes up well over half of its total production on a barrel equivalent basis.
SandRidge CEO Tom Ward said earlier this year that SandRidge will have no rigs working in 2012 for natural gas. This means that any revenue derived by SandRidge from the commodity in 2012 will be coming from the current supply it has in storage. In my opinion, this puts SandRidge among the few energy companies making a sincere effort at erasing the current natural gas oversupply that is contributing to the price depression, and earns the company a strong checkmark for corporate responsibility.
Staking Future on the Mississippian
The Mississippian Formation has been well explored where it underlies the state of Oklahoma, but the so-called Mississippian Extension takes that play up through the northern border of Kansas. As this extension is further explored, players are realizing the potentials and looking to build up their acreage before land prices skyrocket. SandRidge is among the early arrivals. Out of the 68 horizontal wells it drilled in the first quarter on the Mississippian, 55 were in Oklahoma and 13 were in Kansas, making SandRidge's total wells drilled here 297. It now has five wells producing in Kansas.
According to SandRidge CEO Tom Ward (video), "drilling on the midcontinent started … about five years ago in North Dakota. As oil prices have moved up, we have started to drill more - and the places we can drill today happen to be in the central portion of the U.S." Ward calls (video) SandRidge the leader of the Mississippian play, and notes that for SandRidge, the Mississippian has the highest rate of return for the company. SandRidge anticipates (video) that peak production on the Mississippian will not occur until 2019, which leaves the company positioned for skyrocketing growth.
On the southern reaches of the Mississippian, SandRidge will be competing with Devon Energy (DVN), which as of the close of 2011 held 230,000 acres in northern Oklahoma encompassing Mississippian Lime and the Woodford shale. Range Resources (RRC) is also competing for acreage here, and plans to devote a significant portion of its 2012 expenditures towards horizontal drilling on the Mississippian. Beleaguered Chesapeake Energy (CHK) has holdings on the Mississippian on the Kansas side, but the cash-strapped company can't afford to drill the play until its outlook improves.
According to the Kansas Corporation Commission, which tracks intent to drill statewide, intents were up sharply in April, at 611. This compares to 473 in March and 551 in February. So far in May, 412 intents have been filed, which does not promise a record but does indicate that interest in the Mississippian Extension remains strong.
The Kansas Geological Survey is supportive of hydraulic fracturing in the state, as evidenced by the statement it released earlier this year. The statement reiterates previous research, which found that if hydraulic fracturing is related to induced earthquakes, it is only because the activity is occurring in areas that were primed to have an earthquake in the future, even without the fracturing. Between this and the Kansas Corporation Commission's generous considerations regarding temporary well abandonments, Kansas is doing all that it can to encourage exploration and production efforts in the state.
Lack of Infrastructure the Major Hurdle
One important consideration in Kansas is the relative lack of infrastructure to transport crude oil out of the state. There are currently only nine pipeline companies licensed to handle intrastate oil movement in Kansas. One of these companies, Plains All American Pipeline LP (PAA), announced earlier this year plans to construct a 274 km pipeline from Alva, Oklahoma to the hub at Cushing, Oklahoma. This falls just under 400 miles short of the northwestern border of Kansas, which represents the furthest rich of the Mississippian play in the state. This could be troublesome for SandRidge s plans to move further north and west as it follows the play. However, as Plains All American indicated that the pipeline will exist mainly to service SandRidge's needs, extension should be possible.
Although Plains All American indicated that it is open to extending the pipeline as demand warrants, the lack of infrastructure means that this play will experience growing pains. Already, the hub at Cushing is sitting on an enormous glut due to a lack of infrastructure to move crude further south where much of the nation's refining capabilities are located. This glut is forcing down oil prices, even as demand remains relatively strong. A similar scenario further north could spell the end of the Mississippian Extension even before peak production is reached - which would be a disaster for SandRidge.
Fortunately, it does appear that the will and the capital to improve infrastructure is primed to catch up to the nascent midcontinent oil boom. Infrastructure on the Bakken is expected to be able to support 750,000 barrels a day this year, after the Bakken experienced the kind of explosive growth that companies on the Mississippian are hoping for. On May 17, a much needed pipeline reversal out of Cushing to the Gulf coast was finally completed. After technical tests, the first pumping began at noon Cushing time on May 19, and is expected to reach 150,000 barrels per day within the week.
Oil production in Kansas could benefit from a pipeline project planned by Canadian company Enbridge (ENB) in a partnership with U.S. company Enterprise Products Partners LP (EPD). As planned, the pipeline would cross through Kansas and Missouri on its way down to the Gulf coast from Canada. Pipeline companies may be playing it safe for now by waiting to see what production numbers from the Mississippian will be once they approach the peak, but should be careful that they don't wait so long that the oil producers don't follow the example of Cabot Oil & Gas (COG), which isn't afraid to form joint ventures to operate its own infrastructure.
SandRidge is currently trading around $6, with a price to book of 2.1 and a forward price to earnings of 18.0. This is extremely favorable compared to its peer Cabot, which is trading around $34 with a price to book of 3.4 and a forward price to earnings of 37.3, while entering oversold territory. Range Resources, though a strong company, is also significantly overpriced, at $61 with a price to book of 4.1 and a forward price to earnings of 39.0. Competitor Devon is trading at a more reasonable price to book of 1.1 and a forward price to earnings of 8.9 at $61. Finally, Chesapeake's stock continues to be pummeled, trading around $14 a share at a price to book of 0.7 and a forward price to earnings of 7.7.
With its strong position on the Mississippian and history of well-timed strategic moves, SandRidge might not be a mid cap stock for long. Its current price is a value proposition for those able to hold on to shares during the company's growth stage.