Will SandRidge's Bet Pay Off?

Will SandRidge's Bet Pay Off?

Unlike many of its competitors, which are focused on high-growth, unconventional oil and gas plays such as the Bakken and the Eagle Ford, SandRidge Energy has focused the bulk of its resources on the Mississippi Lime play -- a shallower, lower-growth resource play. Will the company's strategy pay off?

SandRidge in the Mississippian
Though SandRidge still maintains operations in the Gulf of Mexico, the company's main area of focus is the Mississippi Lime, a vast carbonate oil play that spans parts of Kansas and Oklahoma. Tom Ward, SandRidge's founder and former CEO, was a big believer in the play's potential, and led the company to amass a large position relatively early on.

This year, roughly three-quarters of SandRidge's total drilling and completion capital expenditures will be directed toward its drilling program in the Mississippian, where it commands a whopping 1.9 million net acres. Meanwhile, other energy companies have quietly backed out of the play.

Energy companies exiting the Mississippian
Take Royal Dutch Shell , for instance. As part of a strategic review of its North American shale oil and gas assets, the Hague-based oil giant recently put all of its 600,000 acres in the Kansas portion of the Mississippi Lime up for sale. Shell's reasoning behind the decision is twofold -- first, these assets simply aren't generating the kind of returns Shell is looking for, and second, the company has better opportunities elsewhere.

Similarly, Chesapeake Energy , another company that was initially optimistic about the Mississippian, sold a 50% interest in a large chunk of its Mississippian acreage to China's Sinopec earlier this year. While the terms of the deal were quite disappointing, with Chesapeake selling its acreage at less than a third of the price it had previously estimated the land was worth, the company needed the cash desperately and was willing to take whatever it could get.

SandRidge's unique advantages
But these companies' departures from the Mississippian don't necessarily bode ill for SandRidge. That's because SandRidge has numerous advantages in the play that these companies didn't have, including its deep knowledge base of the play, the existence of multiple pay zones across its vast acreage, and its existing infrastructure within the play.

In 2011 and 2012, the company invested heavily in both electrical and salt water disposal infrastructure, which offer both improved economies of scale and a lower cost structure. Results from recent quarters suggest these investments are already paying off handsomely, as the company's new wells required roughly half the spending on salt water disposal as wells brought online a year earlier.

In addition, SandRidge reckons that up to five zones within its Mississippian leasehold may feature what's known as "stacked pay potential," meaning that there are multiple pay zones within a single play that can be accessed by drilling at varying depths. This is important: Not only could it significantly boost recovery rates, but it could also significantly increase the value of the company's reserves and therefore the value of its acreage.

The bottom line
Even though breakeven costs in the Mississippi Lime are generally higher than those in plays such as the Eagle Ford and the Bakken, SandRidge has done a great job of leveraging its knowledge base and existing infrastructure in the play to grow its production at double-digit growth rates while still maintaining a more or less flat level of capex.

The company's low cost structure and unique infrastructure advantages in the play allow it to generate a roughly 45% internal rate of return on its wells at current strip pricing. If SandRidge can continue to lower operating expenses in the play through further well site redesign and pad drilling efficiencies while growing liquids production much faster than total production, it just might be able to unlock the full value of its Mississippi Lime assets.

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The article Will SandRidge's Bet Pay Off? originally appeared on Fool.com.

Fool contributor Arjun Sreekumar owns shares of Chesapeake Energy and SandRidge Energy. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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