Headlines focused on SandRidge (SD) management have missed a more fundamental issue which may...

Headlines focused on SandRidge (SD) management have missed a more fundamental issue which may lead to further share weakness, Josh Young writes: Well performance is much worse than expected. Permian Trust (PER) results were so bad that cash was pulled from subordinated unit distributions to fund minimum common unit distributions, which means SD's interest in the asset is generating less cash flow than expected.
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  • The Lawman
    , contributor
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    Alert: Trust Update
    by Elliott H. Gue


    After yesterday's close, Focus List holdings SandRidge Permian Trust (NYSE: PER) and SandRidge Mississippian Trust II (NYSE: SDR) announced their quarterly distributions for the three months ended Feb. 28, 2013.
    Investors responded bullishly to view SandRidge Mississippian Trust II's results, while units of SandRidge Permian Trust sold off. But a closer examination of the announcements suggests that SandRidge Permian Trust's difficulties will prove temporary, while SandRidge Mississippian Trust II appears to have shaken off some of the concerns surrounding the productivity of its underlying acreage.
    SandRidge Permian Trust
    SandRidge Permian Trust announced a quarterly distribution $0.512 per unit, a more than 15 percent decline from the $0.603032 per unit that the trust disbursed in the preceding quarter. Even more discouraging, the trust generated just $0.472 per unit in cash available for distribution--$0.04 below the subordination threshold outlined in its prospectus.
    Under the terms of the trust agreement, SandRidge Permian's 13.125 million subordinated units--all of which are owned by sponsor SandRidge Energy (NYSE: SD)--will take a haircut on their payout to ensure that common unitholders receive the minimum distribution target. Accordingly, subordinated unitholders will receive $0.353 per unit for this three-month period, while common unitholders will collect $0.512 per unit.
    The trust's hydrocarbon production fell 12.6 percent sequentially from 390,000 barrels of oil equivalent (boe) in the three months ended Nov. 30, 2012, to 341,000 boe this quarter. Natural-gas output held steady at about 95 million cubic feet, while volumes of crude oil and natural gas liquids tumbled by 13.1 percent.
    This sharp decline in production occurred despite the SandRidge Energy drilling 16.6 more developmental wells than in the prior three-month period. At the end of February, the sponsor had sunk 508.3 of the 888 wells required by the trust agreement.
    Although SandRidge Permian Trust's distribution and hydrocarbon output disappointed, these weak results reflect the timing of well completions and unfavorable pricing trends at the hub in Midland, Texas--temporary challenges that don't call into question the quality of the underlying resource base.
    In fall 2012 and early 2013, surging oil production in the Permian Basin combined with local takeaway constraints to swing the Midland hub into an oversupply, widening the price gap with West Texas Intermediate (WTI) crude oil delivered to Cushing, Okla. (We discussed this trend at length in the Dec. 13, 2012, installment of Energy Investing Weekly, Mind the Differentials.)


    Source: Bloomberg
    Although the spread between WTI-Midland and WTI-Cushing had contracted from a record high of $16 per barrel in December 2012 to less than $1 per barrel by the end of February 2013, this price differential averaged more than $7 per barrel over the three months covered by SandRidge Permian Trust's distribution. This spread had averaged roughly $4 per barrel over the three months ended Nov. 30, 2012, and $1.60 per barrel over the three months ended Aug. 31, 2012.
    To worsen matters, the swaps and options in SandRidge Permian Trust's hedge book are based on WTI-Cushing, providing scant protection again weak WTI-Midland prices; the trust's average oil-price realization fell by about 8 percent sequentially during the quarter, eroding its distributable cash flow by $6.87 million.
    Had hydrocarbon prices remained flat over this period, SandRidge Permian Trust's cash flow would have come in $2.3 million higher. In other words, lower realized oil prices reduced investors' quarterly distributions by about $0.045 per unit.
    Fortunately, these headwinds have abated. Two months into the trust's next reporting period, this critical price differential has shrunk to less than $0.30 per barrel, while WTI-Midland prices have increased by about $7 per barrel from the prior quarter.
    At the same time, the decline in oil volumes attributable to SandRidge Permian Trust doesn't reflect a problem with the underlying resource base. Of the 59.6 developmental wells that SandRidge Energy sank over these three months, more than half didn't come onstream until February--that is, more than 30 wells contributed less than one month of production.
    These drilling and completion delays date back to late 2012, when the sponsor reduced its rig count in the area of mutual interest to three units from six. Although the number of drilled wells rebounded in the most recent three-month period, that most of these sites weren't completed until February suggests that delays remain a problem.


    Source: SandRidge PermianTrust Filings
    In SandRidge Permian's first several quarters as a publicly traded entity, the number of drilled wells that had yet to be completed in the area of mutual interest averaged about 18 at the end of each three-month reporting period. This backlog ballooned to 29.5 wells on Nov. 30, 2012, and dipped slightly to 24.2 sites at the end of February 2013. Management has emphasized that this backlog should improve over time.
    The disappointments of the trust's most recent reporting period also set the stage for a big rebound in hydrocarbon production this quarter; the more than 30 wells that came onstream in February should bolster output significantly, offsetting the natural decline rate of older wells. Growing oil production and improving price realizations should translate into significant distribution growth in the next quarter.
    Take advantage of the recent pullback and buy SandRidge Permian Trust under $19.90 per unit.
    26 Apr 2013, 05:41 PM Reply Like
  • Bob Curtin
    , contributor
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    Didn't the original article by Josh Young have a big enough impact on SD? Why the need to point out an article that was posted a little more than 3 hours ago? If the stock is up on Monday will you post another comment about the comment about the stock? Why not also point to an article that highlights TPG's evaluation for balance.


    Seeking Alpha normally does not in effect double post articles. It seems a little odd to be piling onto SD.
    26 Apr 2013, 05:41 PM Reply Like
  • lolhammer
    , contributor
    Comments (267) | Send Message
    Very meta. How about we now post an interview with josh young to show his reaction to the seeking alpha article about the original article he wrote for seeking alpha. The stuff in his article isn't new one was priced in anyhow.
    29 Apr 2013, 07:32 AM Reply Like
  • Wall-Invest
    , contributor
    Comments (541) | Send Message
    I'm curious why the article glosses over a 12% decline in volume. Even for newer wells that seems like a massive decline. And while new completions didn't come on until quarter end, they had the full quarter's production from wells brought on the quarter before. So what's the real decline in volume? Closer to 15%? 17% Worse?


    Inquiring minds (and unit holders) want to know!
    29 Apr 2013, 09:59 AM Reply Like
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