On April 17, onshore-focused SandRidge Energy Inc. completed two transactions that further transform the Oklahoma City E&P company. First, it closed its somewhat surprising, $1.275-billion acquisition of privately held Dynamic Offshore Resources LLC, gaining its first assets on the Gulf of Mexico shelf. And, it took public its third yield instrument, SandRidge Mississippian Trust II (NYSE: SDR), for net proceeds of $638 million.
When asked how he juggles two significant closes on top of one another, chairman and chief executive officer Tom L. Ward says matter-of-factly, "It's just what I do. I work quite a bit; the company is like my hobby."
These deals allow SandRidge to kick into even higher gear its burgeoning Mississippi Lime play in the Midcontinent, where SD was one of the first movers. For this, and deftly transitioning to an oilier portfolio, then backstopping the heavy spend with two newly public royalty trusts—and two joint ventures with international companies, Ward is Oil and Gas Investor's Executive of the Year for 2011.
Ward graduated from the University of Oklahoma in 1981 with a bachelor's in petroleum land management, and after running his own concern for a while, he co-founded Chesapeake Energy Corp. with friend Aubrey McClendon in 1989.
SandRidge's growth comes at a cost. Critics cite the company's high debt-to-capital ratio of about 53%. SandRidge's budget for this year is $1.85 billion; the company already spent $570 million in the first quarter. Its joint venture in the Mississippi Lime, signed late last year with Spanish firm Repsol, is funding drilling carries on part of this. Repsol paid $250 million upfront and will pay $750 million over the course of three years in the form of a drilling carry for roughly 365,000 acres. A September 2011 deal with Korean investor Atinum Partners Co. Ltd. also funds some drilling.
At press time the company had 22 rigs working in the Midcontinent after accumulating 2 million acres there in the past two years, and 12 rigs operating in the Permian's Central Basin Platform. SandRidge claims a deep inventory of 7,000 net drilling locations in each region. Production is nearly 57% liquids.
Oil and Gas Investor talked with Ward about his plans to increase production 38% this year, with a goal of doubling the company by 2014, going from 24 rigs in the Mississippian to 45.
The company unveiled two barnburners recently in Alfalfa County, Oklahoma, that flowed 2,200 and 4,000 barrels a day.
Investor You've always been an onshore guy, so the market was caught off guard when you picked up Dynamic. Why are you straying far afield, strategy-wise ?
Ward I look at us as a very focused company. We have two good areas to work in (the Permian Basin and Mississippi Lime).We bought the Gulf of Mexico, but we are not looking to grow it. We'll spend enough there each year, about $200 million, to keep production flat. Cash flow from the Permian and the Gulf are for drilling the Mississippian, which is our big growth engine, and the one generating the best returns—70% to 100%.
Investor Weren't you surprised by the market's reaction?
Ward No. The market was surprised about our earlier acquisitions in the Permian and Mississippian too, and they turned out to be positive. I look at my job like this: today's investors have a three-month time frame, but my time is three years out. If I do what I say I am going to do, the stock will take care of itself. My time frame is good.
I get branded a maverick, but I see myself differently. I see us taking low-risk, conventional bets, founded in science, in old oil plays that can be expanded with horizontal drilling and fracing. We're drilling vertical and horizontal wells in the Mississippian and Permian, and buying producing oil in the shallow-water Gulf. In my opinion that's not very risky. If that makes me a maverick, I'll wear that hat.
Investor What about costs offshore?
Ward If you can buy oil for under $50,000 per flowing barrel, you can make money. Offshore operating costs are just another factor you need to put into your bid costs. If we can make an inexpensive acquisition on a dislocation in the market, we'll do it.
Investor You were a first-mover on switching to an oil focus.
Ward We did a U-turn in the middle of 2009. When I bought the company in June 2006 we were over 95% natural gas and in 2008, we were still a gas company with just one asset, Pinion Field in the West Texas Overthrust. We had to start over from scratch.
Through 2007 most big companies were moving abroad to look for oil and gas, but starting in 2007, there was an influx coming back. That's when we decided it'd be difficult for a young company like ours to compete for capital, and we saw low gas prices coming.
By the time we went to the board in February 2009, oil had deteriorated to $39 and gas was $2, but we got approval to start making oily acquisitions.
Today, we are in two oil plays that have a rate of return of 70% to 100%. There's no way those gas plays would have made that kind of return. If what we believed would happen with gas happened, the company would have struggled to survive—yet today, three years later, we are thriving. So we made that call.
Investor What's your plan for the Overthrust?
Ward We still have Pinion Field, but we are not drilling it, and we have a lot of leases there we'll let expire. We are open to selling it down the road when gas prices go higher…
Investor When do you think that will be?
Ward Basically the main reason we have sub-$4 gas is the warm winter, and then we put another 1 Tcf of gas into what was already an over-supplied situation. But I believe that by spring of next year, we could see gas prices double, getting back to $4. The gas rig count is going in the right direction and utilities are switching from coal. Supply and demand will react. When gas goes back to $4, then you'll have Powder River Basin coal coming back.
Investor While keeping your West Texas gas assets, your first new oil acquisition was also in the Permian Basin.
Ward We looked there because that was the largest area of oil production onshore the U.S. I have always loved sandstones and limestones, but we chose to go into shallow, low-risk conventional carbonates there. Wea invested about $2 billion in the Permian to buy assets from Forest Oil and Arena Resources. We've grown our net production out there from essentially zero to over 35,000 BOE a day, with 12 rigs running now. We'll drill over 750 wells there this year. In the past two years our reserve growth (proved and PUDs) is 150 million barrels with a PV-10 of $2.7 billion.
Investor But ironically, last year you sold your Wolfberry and Bone Spring/Avalon assets. That was $465 million, but now, any regrets?
Ward Oh no. We kept the highest rate-of-return reserves and got a good price for those other assets. We had to come up with funds to bridge the deficit between cash flow and capex. Everything we do here is on a three-year plan, to double oil production from 2011 to 2014, based on growth in the Mississippian and the other two staying flat. It's all about the Mississippian.
Investor How did you come to focus on that?
Ward Where others saw a lot of water production, we saw oil. It's a very large stratigraphic trap that I'd worked on my whole career with Chesapeake, so I knew it pretty well. The Mississippi Lime sits below the Chester and the geology is similar to the Sahara area where Chesapeake was the most active driller and making very good wells. We are just north of that. We got in early—I think the average price we paid is $200 an acre for our 2 million acres.
Since then we've sold 550,000 and bought another 50,000…we ended up selling interest for $2.3 billion in JVs and the two royalty trusts, so net net, we've averaged $4,300 per acre in sales for something we paid $200 for, from 2009 to 2011.
The challenge is to stay within inventory and not buy so much we can't handle it. Leasing there was like running around finding manna or gold nuggets—you could spend too much capital before the play developed, so we cut ourselves back, actually.
Investor How big can this get?
Ward Our actual return has been around 135%—we think this is the highest-return oil play in the U.S. It is difficult for a shale play to compete with a carbonate, and this covers more acreage than the Bakken or Marcellus. And we have 7,000 locations. This is the most exciting time in our short history. The play grows daily.
Investor How does it look on the Kansas side?
Ward We've drilled 23 wells and our results there were even better than in Oklahoma, and better than our type curves. But there are only nine wells producing there so far, in Harper County, compared to 119 in Alfalfa County on the Oklahoma side.
Investor How did the Atinum JV come about?
Ward We met them through Tudor, Pickering. Then we met with Repsol too. Both deals came through and we enjoy working with both of them. Atinum is more a silent, financial partner, while we deal more closely with the people at Repsol. We'd like to sell about 250,000 more acres in Kansas, but we're in no hurry. We'd like to keep our inventory at 15 years.
Investor It's a big call on money.
Ward We are fully funded this year. As our EBITDA (earnings before income tax, depreciation and amortization) increases, we will be fully funded now and could be for next year. Our debt-to-EBITDA is improving. I don't look at the debt-to-equity ratio, I look at debt-to-EBITDA. We are at over three times and we'll be over two times next year. We were up to five times in 2009. If you rely on natural gas for your revenue, it's a problem. We're not alone, but as our ratio improves we'll move back to normal.
We've hedged over 80% of our oil volumes this year. The only hurdle to our three-year goal is if oil prices go down, which is why we hedge so aggressively.