Natural gas supplies rose by lower than expected amounts earlier this month, causing a brief 15% price rally in futures. Among those bullish on natural gas prices is T. Boone Pickens, who is predicting that $3 price levels will be seen by next summer. These moves are beneficial for SandRidge Energy (SD). Although 91% of its reserve mix is weighted towards oil, SandRidge could still benefit from a rise in gas prices, especially as its smaller size skews investor perception of where its revenues are generated. Additionally, just 53% of its reserves are developed, and a substantial portion of the undeveloped 47% is gas rich; an upward move in gas futures resulting in increased profit margins could spur SandRidge to move back towards natural gas development and production on these leases.
Since there are potential gas locations on its Mississippian holdings, an area of primary focus, such a move would fit in with the company's overall strategy. This overall strategy includes double digit annual EBITDA growth and a goal of funding capital expenditures largely within cash flow, key indicators for value investors. To achieve this, SandRidge is looking for oil growth for now, both on the Mississippian and elsewhere. Dynamic Offshore Resources LLC, a subsidiary that SandRidge acquired earlier this year, announced an acquisition of its own late last week. The company purchased 74 wells on about 185,000 acres on the Gulf Coast, with current production of about 3,000 boe per day, in a deal valued around $50 million. While 3,000 boe per day will not double SandRidge's daily production, which it hopes to do, it is a step in the right direction.
Speculation on a New Merger
The oil industry is talking about a recent announcement by First Titan Energy concerning a possible merger. First Titan is indicating that an unnamed established oil and gas company with multiple plays in the U.S. approached First Titan about a possible merger. Depending on specifics, such a deal could be very beneficial for First Titan, which is an early stage oil and gas company. According to First Titan, it plans to focus on "new discoveries of oil and gas in the North American corridor." How it will do so successfully is open to question, considering that at the end of the first quarter the company had just $57,096 cash on hand, and was in danger of losing its reporting status with the Securities and Exchange Commission.
First Titan's resources are limited to working interests in five oil wells, one each in Louisiana, Texas, and Alabama, and two in Oklahoma. What all of this indicates is that whichever company approached First Titan about a merger, the company is almost certainly very small; a larger player like Anadarko Petroleum (APC) with cash on hand would be discussing acquisitions rather than mergers. Two publicly traded companies that might have an interest in merging with First Titan come to mind, SandRidge and its competitor, Kodiak Oil & Gas (KOG).
Kodiak's focus on the Williston Basin is an adequate business plan for a company of its size, but as it and its peers continue breaking production records in North Dakota the infrastructure needed to bring that oil and gas to market is stressed beyond capacity. This is leading to speculation that Kodiak will need to reconsider its single focus, since continued revenue growth depends on saleable resources. Rather than idle its wells and contract workers, it could make more sense for Kodiak to attempt a small scale drilling project elsewhere. Partnering with First Titan, which owns the small scale leaseholds that Kodiak might be after in such a plan, would make sense in this scenario.
SandRidge is another possibility, if only because its debt to equity ratio is rising to the point where further debt puts the company in danger of an overleveraging that would damage its already low stock price and tenuous credit ratings. A merger with First Titan could allow SandRidge access to new drilling territory without tipping the balance on its debt load. Additionally, SandRidge's recent subsidiary announcement regarding Gulf Coast acquisitions is part of a larger series of hints that the company is pivoting towards this area. Most recently, the company indicated in a presentation that it was pursuing "opportunistic acquisitions of producing properties at less than 2x cash flow." In this context, First Titan has exactly the resources and benefits that SandRidge might be looking for. For its part, it appears that First Titan needs such a merger for its own survival, which could result in extremely lucrative terms for its partner.
Mid-Continent Successes Outstrip the Competition
For a company of its size, SandRidge is rewarding investors with some amazing accomplishments. Many of these derive from its activities on the Mississippian. From June of 2010 to June of 2012, SandRidge has increased its production on the play from less than 1,000 barrels per day to over 28,000 barrels per day with just 25 rigs operating. This indicates a focus on efficiency, which is part of the reason that SandRidge's cost per well is lower than average, at $3.2 million per well, compared to up to $4.5 million for Chaparral Energy.
Though streamlined, the well costs on the Mississippian are far higher than the well costs on the Permian, which SandRidge reports average out to just $643,000 per well. However, lower daily production rates on the Permian, at 53 boe, are commensurately lower than the Mississippian, at 275 boe. Nevertheless, SandRidge is maintaining its position as one of the most active drillers on both of these plays as it drives to increase its margins to meet its goals - and impress investors.
SandRidge is currently trading around $6 per share, far below its true value if CEO Tom Ward can continue the company's growth trend. However, though Tom Ward engineered SandRidge's switch into oil (which is a major contributor to SandRidge's current 1.9 debt to equity ratio), I believe that SandRidge is being discounted for Ward's relationship to Aubrey McClendon, CEO of beleaguered Chesapeake Energy (CHK), which unlike SandRidge has no plan for growth other than divesting to make its debt obligations.
With a price to book of 2.0 SandRidge is not cheap even at its discounted price, but its potential to meet its growth targets does much to offset this relatively high price, especially considering that investors are jumping in to Cabot Oil & Gas (COG) at a price to book of 3.7, which is completely out of line with Cabot's growth potential. SandRidge is not perfect, but I think that it does look like a short-term winner.