Betting the House on this One Play Offers a High Risk, High Reward Scenario

SandRidge Energy is betting it all on the Mississippian-Woodford trend as it divests Gulf assets for a loss.

Jan 28, 2014 at 11:06AM

Sometimes acquisitions don't work out as planned. For example, SandRidge Energy (NYSE:SD) purchased Dynamic Offshore back in 2012 for approximately $1.3 billion, but due to a corporate shakeup, SandRidge recently decided to sell those assets for about $1.1 billion ($750 million in cash and the abandonment of $370 million in liabilities).

In other words SandRidge was able to effectively throw $150 million down the drain, but it did get to keep a 2% overriding royalty interest in two blocks of the Gulf Coast. The royalty interest allows SandRidge to benefit from future developments while spending nothing going forward.

The best part of this news comes from what SandRidge plans to do with that cash: management plans to use its $2 billion in liquidity to grow Mid-Continent production. By focusing on the Mid-Continent, SandRidge was able to raise its 2014 organic production growth estimate to 26% from 12%. That is a colossal revision upward and justifies why SandRidge was willing to take a small hit so it could focus on the bigger picture.  

Keep in mind that output will be down in 2014 versus last year because of divestitures, making organic growth essential. 

More cash more rigs
With its additional cash SandRidge Energy is going to increase its rig count in the Mid-Continent. Three extra rigs by the second quarter of 2014 will allow SandRidge to bring 30 more gross wells online. SandRidge Energy's average rig count in the Mid-Continent last year was 25, and that will grow to 29 by the end of 2014. Investments in the Mid-Continent could be very lucrative, as SandRidge expects 37% output growth this year.

SandRidge's divestments have put all the weight on its Mid-Continent assets, as its investments in Texas are now just a small part of its operations. By admitting that the Gulf wasn't going to be a major source of growth, SandRidge is able to focus on strong organic growth from a play it knows best.

So why is SandRidge focused on the Mid-Continent?
SandRidge's Mid-Continent assets are located in the Mississippian-Woodford Trend along the Kansas-Oklahoma border. The Mississippian-Woodford Trend houses a stacked play with multiple layers, much like the Bakken-Three Forks region in North Dakota.

To get an idea of what the Woodford could potentially hold, SandRidge is going to utilize 3-D seismic imaging in Grant County, Okla. 3-D seismic images, combined with production rates from appraisal wells it just completed, will paint a clearer picture of just how much recoverable resources are within reach.

After divesting assets in the Permian Basin and the Gulf of Mexico, SandRidge is betting everything on this play. While it projects overall output to rise by 37%, liquids production could trump that by growing 52%, providing a better production mix if management can meet its own guidance.

Emerging growth story
Devon Energy (NYSE:DVN) isn't going to let SandRidge have all the fun. Classified by Devon Energy as an emerging growth story, the Mississippian-Woodford trend has been steadily adding to Devon Energy's output.

In the first quarter of 2013, the region was producing a paltry 3,000 barrels of oil equivalent per day (boepd) for Devon Energy. 2013 saw Devon Energy bring 350 wells online in the Mississippian-Woodford, which should boost output to a year-end level of 15,000 boepd. 

By accessing the stacked regions of the play, Devon Energy thinks it can keep growing potential drilling locations, which stand at around 1,000. This play accounts for just 2% of Devon Energy's overall output, but that doesn't make it any less important. Plenty of upside can be generated through continued investment in the area and by bringing more wells online that tap into the bench parts of the play.

As better techniques unlock the full potential of each bench, companies like Devon Energy and SandRidge Energy will be able to access the most lucrative benches, such as the liquid-rich Woodford.

Foolish conclusion
So far results have been strong coming out of the Mississippian-Woodford trend, but it is still an emerging play. Plenty of infrastructure will need to be completed, from pipelines to water-treatment systems, within the next few years. This could mean that there still is plenty of low-hanging fruit in regards to reducing well completion costs, offering upside to exploration and production, or E&P, players in the region.

A sharp increase in guidance is always a good thing, and it seems that the Mississippian-Woodford trend is where SandRidge is going to find the most growth. By betting the bank on just one play, investors will have to wait and see if this is SandRidge Energy's golden goose.

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Callum Turcan has no position in any stocks mentioned. The Motley Fool owns shares of Devon Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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