Between 2009 and 2010, there were two big horizontal drilling plays of the future. One was a multi-layered play in a proven oil-producing region; the mid-continent. The other play was a risky gambit way up in North Dakota.
Many put hopes on the former, thinking the multi-layered play in a proven geography would be the safer choice. A litany of well-known companies rushed in: Shell, Chesapeake Energy (NYSE:CHK), Apache (NYSE:APA), and a few others. Fast forward to today, all three of those operators have since deserted this play, while that shale up in North Dakota ended up being the biggest, most profitable oil discovery since Prudhoe Bay. These three companies left the Mississippi Lime for the same reasons: Low returns, better returns in other places, and high barriers to entry thanks to the quantity of saltwater in the formation.
The shale that worked is, of course, the Bakken. The play that didn't work is less well-known now: The Mississippi Lime. So, what happened? Much of the Mississippi Lime wasn't all that profitable. There were a lot of 'dud' wells and returns on most acreage was sub par. There are now only a few operators left in this increasingly lonely play.
But the one company that has been the most diligent and steadfast in the Mississippi Lime is also the one that ended up making it all work out. I'm talking about SandRidge Energy (NYSE:SD), which now has over 2 million acres in this play. SandRidge recently changed its entire management suite, trading a wildcatting philosophy for a value-building one. The company has worked hard to improve well profitability, grow production in the sweetest spots, and finally secure its balance sheet.
There are several ways that SandRidge has finally turned the Mississippi Lime into a play that works, but the above chart is the best way to illustrate it. After years of shaky profitability, management has raised ultimate recovery rates and reduced drilling costs to the point where its average well in the Mississippi Lime now has an internal rate of return, or IRR, of 64%.
An IRR of 64% is not great. Such rates do not come close to rivaling the Eagle Ford or Bakken, which generally provide IRRs of 100% or greater. But SandRidge's rate is respectable. Usually a 20% IRR is seen as the minimum. Even at oil prices of $80, SandRidge will achieve almost twice the minimum rate. Even better, management sees well costs coming down to $2.7 million in three years, which will boost IRRs to 79%.
Last year, SandRidge had to take on a lot of debt to fulfill contractual obligations to its former CEO and founder. In addition, all that land acquisition cost a lot. This is why SandRidge has over $3.7 billion in debt, which is quite a lot considering the company's $3.2 billion market cap.
The new management team made sure that the company would be able to fund its growth operations and ensure continuity of operations for the long term. That meant refinancing debt and moving maturity dates out as far as possible, even if that meant paying a higher interest rate. No senior notes are due until 2020, giving SandRidge plenty time to grow cash flow and really start monetizing the Mississippi Lime. Management has a 3-year plan to grow production by 25% each year.
As you can see, SandRidge has made the Mississippi Lime work. Production is now moderately profitable, with more upside as well costs continue to decline. While the company has quite a bit of debt, it is now all secured, and maturity dates are far enough away that management should be more than able to deal with that debt when it finally comes due. If the Mississippi Lime works, so too will SandRidge.
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