After listening to SandRidge Energy Inc.'s (NYSE: SD) fourth-quarter conference call, one thing became abundantly clear to me: This is a company that was built for $90 oil. With that oil price in the rear-view mirror, and no signs that we'll see it again any time soon, it suggests SandRidge Energy might not be around for too much longer. Now, that doesn't mean I think the company is going bankrupt, but it is becoming obvious that SandRidge's assets might be better off inside a larger entity with deeper pockets.
A billion too much on the balance sheet
SandRidge CEO James Bennett told listeners on the company's conference call that its $3.2 billion in debt was "high, relative to our asset base." However, its intention all along was to grow "the cash generation ability of our asset base to get in line with the balance sheet." That was clearly something it could do at $90 oil, but now that oil is in the $50 to $60 range, it's "less easy to do," according to Bennett. In fact, Bennett admitted that if the current oil price was the new normal, the company would "probably want to remove $1 billion of debt from the balance sheet."
This tells me SandRidge Energy clearly wasn't built to handle low oil prices, which means it wasn't built to last. While there was a general consensus that the oil prices would stay elevated for years, that doesn't mean the company shouldn't have taken actions to really strengthen its balance sheet when oil prices were high to ensure its survival if prices collapsed.
No ability to self-fund growth
In addition to having a balance sheet that wasn't built for $50 oil, the company's asset base also isn't ideal for a low oil price. That's pretty clear given the fact that the company can't self-fund its capital program at the current oil price.
On the call, SandRidge noted that it was cutting its capital spending plan from $1.6 billion last year to just $700 million this year. That capital is expected to deliver 6% production growth in 2015. However, that $700 million is still too high, as the company is outspending its cash flow by several hundred million dollars. It plans to bridge the gap by selling $200 million in non-core assets while also using its $180 million cash position as well as tapping its $900 million credit facility.
To make matters worse, the cash flow the company does have coming in this year will drop substantially next year as its oil and gas hedges roll off. The company currently has 92% of its liquids volumes hedged this year, or 10 million barrels of oil, at around a $90 oil price. However, next year, its hedges cover just 4 million barrels of oil, meaning its cash flow will drop substantially if oil prices don't pick up.
That makes an already bad situation worse as the company's production will likely drop next year if it chooses to invest within its meager cash flow. In fact, Bennett pointed out on that call that if the company "halted drilling altogether for the whole Company, you're on a 35% exit-to-exit decline" rate for production. This suggests the company needs to pump hundreds of millions of dollars into new wells each year just to keep its production flat. The problem is that it won't have the cash it needs to do this if oil prices stay where they are. So, the company might not even be able to self-fund maintenance capital at $50 oil to keep its production from slipping, let alone deliver any growth.
It's becoming clear that SandRidge Energy wasn't built to last, as it clearly hasn't been built to withstand $50 oil prices for more than a year or two. So, if oil prices don't start to meaningfully recover, the company might have to take some dramatic steps to either reduce its debt or find a deep-pocketed suitor. Otherwise, the company runs the risk of running itself in the ground, as its liquidity will dry up quickly if it keeps drilling itself deeper into debt.