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Prem Watsa / Fairfax File 10% Ownership Position On Sandridge – Some Notes from Conference Call To Help Determine Why

November 11, 2010 | About:

I wrote earlier this year about Sandridge Energy a couple of times:


My thesis was that as existing shareholders became fed up with the massive dilution they had experienced and realized that this company was not going back to $60 per share in the near or medium future that there would be continued selling. In addition as Arena shareholders received Sandridge shares after their company was acquired I also expected a fair bit of selling as Sandridge is much different than the Arena company they had invested in.

In other words, I envisioned a scenario where there was a lot of selling being done by shareholders no longer interested in what the actual value of the company was. And I think that selling has likely played itself out at this point.

This week Fairfax filed on an increased position in SD indicating that they still believe in the company transition to oil. I tend to like SD at $5 a share as well believing that there is upside at current commodity prices and potential for massive returns if natural gas prices recover as SD has a very large natural gas inventory.

So why is Prem and company interested in Sandridge ? Here are some key points from the recent conference call that might help with that and also provide some industry insight from Tom Ward:

A Large New Play for Sandridge

Our timely move to oil is now expanding with the Horizontal Mississippian play in the Mid-Continent. This oil plays fits us perfectly, as it's in an area we know well, it's large, shallow, inexpensive to drill and has a tremendous amount of vertical well control. We've been quietly and patiently building our acreage position, and we have now amassed over 400,000 acres with the goal of leasing at least 500,000 acres by the end of the year.

We are moving from drilling our first well in January to having five rigs in the play today and plan to further expand the 10 rigs in early 2011 as we drill over 100 wells in the coming year. To give you an understanding of the success to date that we've had in the play, we've posted all of the wells we've drilled along with our drilling cost. The 30-day peak rate, the 30-day rate and the last 30-day rate. Based on results to-date from our wells and others, we're achieving 100% rates of return and we've increased the pro-well estimated ultimate recovery range to between 300 Mboe to 500 Mboe.

Considering reservoir certainty, drilling economics, infrastructure and available services, we believe this play competes with the very best oil plays in the United States.

Expect No Rebound in Natural Gas until Haynesville Rig Count Drops

We've chosen to stand apart from the crowd. When natural gas prices moved against us, we did not keep drilling gas wells but actively acquired oil properties. We have kept our gas assets awaiting a more advantageous gas environment when they will again be very valuable. However, we do not see an end to the difficulties in the natural gas markets until the Haynesville rig count diminishes. I do believe when that happens, natural gas prices will rebound substantially and investors will benefit from the upside of our natural gas assets. In the meantime, we are well positioned and actively drilling high rate of return oil wells.

Challenged on A Capital Raise

Duane Grubert - Susquehanna Financial Group, LLLP

And then on the new capital raise, a more cynical person might think, gee, the auction for your Wolfberry and Bone Spring stuff might have been done sooner than the January-type PSAs that you're talking about. And again, a suspicious view would be stepping up the program and raising capital ahead of those auction results might be because you're worried about the auction results. How would you respond to that?

Tom Ward

Well, we don't have any results. The data rooms are still open. So I don't know, we could have preempted if we would have cared to, but I think we'll have a better outcome by going through the whole process. We're selling oil assets in an oil market instead of trying to sell gas assets in a depressed market. So I tend to be pretty optimistic -- what the offering does for us is give us tremendous flexibility. If you really -- I believe that the Mississippian play is a unique play today, one of a handful of plays I've ever been in that I think can change a company. And the reason I believe that is because you can control your cost. With the high-pressure frac-ing really being the main culprit, we're seeing in other areas that costs are tripling or more in what it takes to complete a well. And I just like being able to control our own services and then have the vertical well control to really know how hard to field can be is, is that has over 30 years of production history and it's the carbonate. So those things make me very, very bullish on the Mississippian so what the preferred does is it gives us more time to look and drill Mississippian wells and determine how we want to sell our excess acreage. We made it very public that we have more acreage than our company is going to be able to take care of. And I think that in the next year, you'll be able to see us not only monetize the assets that we're talking about in the Bone Spring and the Wolfberry, but now we'll have time to get the maximum amount that we think we can out of the Mississippian. And only time will tell us if how successful we are with that, but I believe that it might -- I won't say it's the best play in the United States, but it's got a rank very close if it has a scale that I think it does.

Challenged on Why 2011 Growth Not More Robust

Richard Tullis - Capital One Southcoast, Inc.

Just looking at 2011 guidance at this point, I guess you're estimating about 59,000 barrels a day after what you plan to sell. And I guess that's about what you averaged in the third quarter as well. I'm just trying to reconcile the growth expectations for next year given the amount of capital that you're dedicating. I guess, why not a more robust growth rate?

Tom Ward

Well, we're growing in oil and letting gas decline. I think we're maybe unique in this that we look at the two commodities as totally separate. And while everybody combines them in MMboe, obviously the revenue from one is much greater than the other. So whenever you combine everything together and project growth, you can say you're not growing but obviously, your revenue is much better by growing oil and letting gas decline, it's really that simple.

My Thoughts

I admire Tom Ward in that he saw a big problem last year when his company had a future completely dependent on natural gas and made some very unpopular moves to address the problem. He had a shareholder base that could recently remember a $60 share price which was due to $10 natural gas. With the amount of debt he had something had to be done before his natural gas hedges came off and his company was in trouble producing natural gas at $4.

I had bought a few shares around $4 and sold when it got up to $5.70 a couple of weeks ago. I find this company very difficult to value with all of its moving parts, dilution, new production so I can’t make it a high conviction investment. I do think that if natural gas does rebound in the next couple of years that Sandridge has tremendous upside.

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