Mississippian Oil Play: Another Setback?

Includes: APA, CHK, DVN, ECA, RDS.A, RDS.B, SD
by: Richard Zeits

There is hardly another horizontal oil play in North America that would have caused so much controversy and polarized opinions as the Mississippian Lime. In the latest development this week, an Associated Press article (which was widely re-printed by regional and oil & gas-related publications) reported another high-profile departure from the play by a major exploration company. According to AP, Royal Dutch Shell's (RDS.A, RDS.B) spokesman confirmed that the company is selling off its vast 600,000-acre Mississippian Lime position in nine Kansas counties, including 45 producing wells, after the company's strategic review concluded in July that the assets do not meet its targets. The acreage is located in Barber, Harper, Kingman, Pratt, McPherson, Sedgwick, Sumner, Rice and Reno counties in Kansas.

Mississippian Lime Play Limits (Per SandRidge Energy)

Shell's acreage includes areas that would be considered part of the play's "traditional core" (acreage in Barber, Harper and Sumner counties adjacent to the Kansas-Oklahoma state line) as well as areas located in the play's "extension" to the north (including McPherson, Rice, Reno, Pratt, and Sedgwick counties). Shell's departure continues the consolidation trend in this enormous play, with activity clustering around select areas that are better understood from a geophysical perspective, have demonstrated higher rates of drilling success, and have critical mass of production infrastructure.

Shell's decision follows retrenchment by several other heavyweight exploration peers who had initially accumulated massive acreage positions on the Kansas side of the play.

SandRidge Energy (NYSE:SD), the most active driller and largest leaseholder in the Mississippian Lime, has substantially curtailed its initial plan to ramp up its drilling program in the play to 45+ rigs and is currently running 22 rigs instead. SandRidge has made it clear that "holding" acreage is not a priority for the company and certain (and potentially very substantial) parts of its acreage position - which currently stands at 1.9 million net acres - may be left to expire undrilled. As SandRidge has focused its capital allocation to a six-county area (map below), many of its leases in the play's northern extension may end up released.

(Source: SandRidge Energy September 2013 Investor Presentation)

Similar to SandRidge, Chesapeake Energy (NYSE:CHK) seems to have limited its focus primarily to the better delineated portion of the play in northern Oklahoma, and, following the formation of a joint venture with Sinopec, seems unlikely to increase capital allocation to drilling activity in the extension area in the near term. In fact, Chesapeake has recently released some of its leases in the play due to expirations.

(Source: Chesapeake Energy's February 2013 Investor Presentation)

Earlier this year, after almost a year of active but unsuccessful marketing of a Mississippian Lime Joint Venture and following several mixed test results, Encana Corporation (NYSE:ECA) designated its ~320,000 net Mississippian Lime acres in Kansas for sale. In July, Encana followed with a decision to divest its remaining acreage in Osage County in Oklahoma, including seven producing wells.

(Source: Encana Corporation)

Apache Corporation (NYSE:APA), which had leased a large 580,000-acre position in northern Kansas and Nebraska (map below) and initially spoke with enthusiasm about the multiple-objective potential the area had to offer, has kept a surprisingly low drilling profile in the area.

(Source: Apache Corporation)

In general, a disappointingly low number of horizontal test wells have been drilled in central and northwestern Kansas since the play took off in 2010. The map below shows that the vast majority of horizontal wells (producing wells are shown with black dots and spud wells are shown with purple dots) drilled during the past four years is concentrated within a very limited area in the south-central part of the state, while exploratory effort in the extension area has been scarce.

In aggregate, it appears that over 3 million acres of Mississippian Lime leases in Kansas that were assembled by various operators in frenzied leasing campaigns during the 2010-2012 period may end up largely untested during their primary terms, with much of those lands likely coming available for new leasing in the near future.

While the sheer amount of acreage that was leased in the play may impress, it is important to keep in mind that monetary loss to operators from relinquishing their acreage undrilled is in fact quite moderate. With lease bonuses in the extension area of the play often running at $150 per acre or less, leasing a half a million acre position may cost a large operator less than $100 million, including transaction costs. This explains the relative ease with which companies part with their leaseholds once they determine that drilling economics fall below corporate return thresholds.

It is also worth noting that joint venture transactions (the highly lucrative promoting business that has become a major source of income and almost an addiction for North American operators), have potential to cover, often by a very high factor, the cost of leasing and testing a large block of acreage. Proceeds received from JV monetizations in the play by just three operators - SandRidge, Chesapeake, and Devon - approach $3 billion in aggregate. This figure alone vastly exceeds all losses to all operators across the play from lease expirations.

  • SandRidge raised $1.5 billion in cash and drilling carries in their two JV transactions, with Repsol and Atinum;
  • Chesapeake Energy received $1 billion in cash from selling an interest in a Mississippian Lime JV to Sinopec;
  • Devon Energy (NYSE:DVN) raised $2.5 billion in cash and drilling carries in a "Five Emerging Plays" Joint Venture with Sinopec, which included Mississippian Lime ($0.5 billion allocated to Miss Lime for the purposes of this discussion).

While the extension area may have lost, at least for the time being, the sponsorship of several important operators, drilling activity in the play's core, including southern Kansas counties, has continued unabated. Kansas well statistics through June (the latest month available) show a healthy pace of growth in total production volumes and the number of wells being turned in-line.

The departure of several significant participants is certainly disappointing news for the Mississippian Lime. However, the process is only natural for a play that has an areal extent of over 17 million acres. The Mississippian needs to consolidate and establish a firm track record of success before it can attract a new wave of external capital and start growing again.

Disclaimer: Opinions expressed in this article by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity. This article is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned in the text and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.