What's Going On With SandRidge Energy?
Mar. 16, 2015 5:21 AM ET | 2 comments | About: SandRidge Energy, Inc. (SD)
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Summary
Capital expenditure slashed by 60% in 2015.
Production will be challenged by naturally high declines.
Management will consider hedging if WTI reaches $70.
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SandRidge Energy (NYSE:SD) is one of the biggest victims of the steep decline in crude oil prices. Since July 2014 shares of SandRidge have dropped by over 75%. The reason for such a big drop is that SandRidge bet heavily on the Mississippi Lime horizontal play.
While the Mississippi Lime at first seemed promising, it turned out to be one of the more marginal shale plays, not least because of the high saltwater content in the reservoirs. Nevertheless, SandRidge held on and doubled down on the Mississippi Lime, building out an extensive saltwater disposal system and adding to acreage. And just when the company's engineers seemed to have 'cracked' the code, crude oil prices collapsed.
SharpCharts
This chart shows SandRidge's precipitous decline. Judging from the price action, some people obviously believe that the company is in trouble. This article will take a look at SandRidge's production and capital expenditure guidance for 2015. This article will also try to provide a "big picture" view of the company.
Some thoughts on capital expenditure
In 2015, capital expenditure will be reduced by 60%, from $1.6 billion in 2014 to just $700 million in 2015. This includes a reduction in the rig count from 35 down to just seven. This steep reduction was brought about by necessity as much as it was value preservation. Long story short, SandRidge is running out of cash by which to spend in excess of its cash flow. Yet, at the same time, lower oil prices are sharply reducing the company's cash flow by which to operate in the first place. Compound that lack of capital with a high decline rate which necessitates constant drilling just to keep production flat, and SandRidge's dilemma becomes apparent.
Data by Morningstar
This chart is a good depiction of what SandRidge is facing. The company has been burning through cash, and at this burn rate, SandRidge will soon run out of cash. Does the company have other liquidity options? Yes. Will the company face a liquidity crisis in 2015? Very unlikely. However, I still believe that the cash burn rate is a real problem.
Before moving on to 2015 guidance, let's first go over the company's liquidity options. While SandRidge is indeed running out of cash, the company renewed its revolving credit line at $900 million, nearly all of which remains undrawn. Management plans on selling another $200 million in 'non-core' assets. Although we don't yet know what those assets are, I would guess that the 'non core assets' refer to the company's Permian holdings and, potentially, the company's interest in its royalty trust. In any case, an additional $200 million in cash would bolster the company's balance sheet considerably. More on that later.
Cash flow guidance
Courtesy of SandRidge Inc. Investor Relations
In 2015, about half of SandRidge's liquids production is hedged in 2015. Notice that another 41% is hedged in three-way collars, but WTI has dropped well below the 'floor' price. SandRidge must therefore accept strip pricing for that portion of crude oil production. The swaps were taken some time in 2013, and provide a realized price of over $92 per barrel. Also, these hedges are concentrated in the first half of the year. Hedge protection drops off sharply in the latter part of 2015.
All that considered, SandRidge still expects about $550 million in EBITDA in 2015. Interest expense should be $200 million. That leaves only $350 million for capital expenditure, with a capex program of $700 million for the year. The remaining $350 million-$400 million will have to come from cash, asset sales or a draw on the credit line.
Despite substantially outspending cash flow, $700 million in capex will not keep production growing for long. While management expects a modest 6% year-on-year growth rate in 2015, the 4Q 2015 exit rate will be some 15% lower than that of last year. As you might imagine, it will be very difficult to keep production flat in 2016 with this level of capital investment. Production declines will further diminish EBITDA.
Conclusion
The bottom line is that SandRidge should be OK in 2015, and the company has no debt coming due until 2020. However, there will be significant challenges in 2016 when the hedges roll off. Production may also be very challenged in 2016. In 2014, SandRidge made significant progress in reducing its drilling and completion costs. Management hopes to repeat that process in 2015.
In the latest conference call management said that it would consider hedging once again if WTI reached $70 per barrel. I believe that statement is a clue as to where SandRidge needs the oil price to be in order to operate within its cash flow. While shares are down below $1.50, I believe there is still downside if WTI does not recover to the $70 vicinity by next year.
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