March 1, 2012

SandRidge Energy makes its move in Kansas oil

OKLAHOMA CITY – One day last month, a worker on a skid-steer loader was jackhammering concrete on the partially demolished roof of a building across the street from SandRidge Energy’s headquarters.

OKLAHOMA CITY – One day last month, a worker on a skid-steer loader was jackhammering concrete on the partially demolished roof of a building across the street from SandRidge Energy’s headquarters.

SandRidge CEO Tom Ward, glancing out from a top floor conference room, wondered aloud about the risk the guy was taking.

That’s ironic.

Ward appears to be one of the kings of risk-taking, making bets bigger than almost anybody else in the oil and gas industry. One of his big bets is to buy 2 million acres of oil leases in Oklahoma and Kansas to become the biggest single player in the state’s oil boom.

But Ward, like the guy across the street, sees it differently: He’s actually playing it safe, if aggressive, and – he won’t say this himself – perhaps just a bit smarter than everyone else.

SandRidge is the biggest player in Kansas in a movement to ramp up oil production using horizontal rigs and other expensive technology. There are also sizable presences by Chesapeake Energy, Shell Oil, Devon Energy, and a number of large in-state and out-of-state independent producers.

If this works out as hoped, Kansas will see 100,000 new jobs, Ward said, enough to make the departure of the roughly 2,000 Boeing jobs “look paltry.”

The company is ramping up production from zero in the area 18 months ago to 35,000 barrels of oil and oil equivalent a day. They moved from 11 rigs in 2011 to 26 rigs in 2012, and will have an expected 55 rigs by the end of 2014.

The company has six drilling rigs in Kansas, and more in Oklahoma, drilling horizontal wells 24 hours a day, seven days a week in a layer of limestone laid down in the Mississippian period more than 320 million years ago.

The company has operations in other places, but Ward is clear: Those areas provide cash, but the growth is in their Mississippian acreage, two-thirds of which is in Kansas.

“It is the future of the company,” he said.

Risk taker

Ward was 23 when he met Aubrey McClendon in 1983 and the two ambitious young producers decided to join forces and in 1989 formed Chesapeake Energy.

Chesapeake saw tremendous success and growth through the 1990s, as well as tremendous difficulties that nearly sank the company. McClendon was CEO and Ward was chief operating officer.

The flamboyant McClendon still heads Chesapeake, the biggest player in shale gas across the country. Ward retired from Chesapeake in 2006, by most accounts an amicable split.

But, Ward said, he got restless immediately, despite a lengthy list of charity projects, and started SandRidge.

“It was hard, both times,” he said. “You don’t have the people in place, don’t have much technology.”

He bought a Texas natural gas company and then another. In 2007 Ward hired industry veteran Matt Grubb as his second-in-command, a position he still holds.

The company saw skyrocketing growth from its acquisitions. Grubb said it rose from zero at the beginning of 2006 to 235 million cubic feet of gas per day in 2007 when it went public as one of the year’s hottest IPOs. It hit $32 a share on the first day of trading and soared over $60 in 2008 as energy prices shot up.

Then the economy crashed and energy prices crashed with it. That got Ward and Grubb thinking about the future.

Oil and gas industry executives are used to ups and downs, but Ward and Grubb also saw something else: Gas drillers had had incredible success over the last decade finding shale gas in places such as Pennsylvania, Texas and Louisiana.

So, they decided to get out of gas as much as possible and into oil because they thought oil prices would come back, but gas would not.

So, in spring 2009, they placed their first bet-the-company wager: They began divesting hundreds of millions of dollars worth of gas assets and buying oil assets.

On-land oilfields, they said, were out of favor at the time, so they got a great deal on assets in the Permian Basin in west Texas.

In 2010 and 2011, they made their second big bet: spending $400 million to buy the mineral rights to 2 million acres across the Mississippian formation.

They were right. Oil is back over $100 a barrel, while gas is still below a punishing $3 per million BTUs.

“Given the chance would every gas company make the same decision? Heck, yeah,” Grubb said. “They’re all trying to get into oil now. The problem now is it’s almost too late. Those opportunities are almost gone.”

A safe bet

It provides insight into Ward’s character to see his thinking process on such a bet.

To Ward and Grubb, getting into oil and getting into the aging oilfields of northern Oklahoma and southern Kansas was perfectly reasonable, even though no other big companies were doing this.

Since the early 1990s, Kansas had been the exclusive province of hundreds of small and medium-sized companies based in Wichita and the many smaller towns spread across the oil patch. They were drilling 5,000 wells a year, year after year. There are well over 100,000 wells in Kansas.

The fact that there is oil in the Mississippian formation has been thoroughly known and exploited for decades. The problem with the Mississippian is that it is filled with salt water, 10 times as much water as oil, and dealing with it is expensive.

What’s new, Ward said, is that oil is over $100 a barrel. That makes large-scale horizontal drilling more cost-effective than vertical wells.

The secret to the system is not the horizontal well or the fracking, although those are crucial to getting the volume of oil needed. It’s the water injection wells needed to get rid of all that water immediately.

“If you had the belief the you could move 3,000 barrels of water a day and get 200-300 barrels of oil with it day, and could do it over a large area, you would be inclined to invest the tens of millions of dollars upfront to put in a water disposal system,” Ward said. “That’s what we did.”

He also trumpets the company’s use of older, smaller equipment that is no longer popular with the bigger companies.

Drilling and finishing a horizontal multi-stage hydrofracked well in Kansas costs $2 million to $3 million, five to six times the cost of a conventional vertical well, but the additional cost is more than worth it if oil stays at $90 or $100 a barrel, he said.

All in all, it sounds reasonable:

The oil was known to be there. The geology was well understood. The technology was perfected. The equipment was relatively inexpensive and available.

The only variable was the price of oil, and they believed that it would stay high for the foreseeable future. Grubb said they need $40-a-barrel oil to get a return.

To them, they could take the sure thing and struggle to reap a small reward. Or they could take a large, but managed risk, in an attempt for an enormous win. To them, the choice was obvious.

“The way I look at it is, if I have to get from me to you and there’s a river, I’m going to get wet no matter what, so I better dive right in and get it over with,” Ward said.

Ambition for Mississippian

But will Mississippian oil be an enormous win?

That’s still up for debate, as everyone involved in the Kansas oilfields reminds those who ask.

Ward said the company is still evaluating the exact potential of what it bought. The company said the wells in the Mississippian yield an average of 275 barrels per day over the first 30 days. Production over the life of the well, he said, has been raised from initial estimates of 250,000 barrels to 450,000 barrels.

He didn’t break out the Kansas wells, but said they are performing as well as the Oklahoma wells.

Those are some powerful numbers. But it’s important to remember that SandRidge is a public company, and Ward must be a bit of a promoter.

He has already sold about 500,000 acres of his Kansas acreage to international investors at a 2,100 percent profit, according to the company, and expects to sell another 250,000 acres.

Many in Kansas remain privately skeptical that Ward can get what he says he can get. Worse, they say, by throwing all that borrowed money around, SandRidge has upset the well-developed relationship between the small-time Kansas drillers and the landowners.

It will take five or 10 years for landowners to lower their asking prices back to what the economics of the play really justify. In the meantime, the Kansas mom-and-pop exploration companies have to work existing leases, look somewhere else or do something else.

Nationally, analysts and investors also remain skeptical about Ward’s promises. The company’s stock price plummeted after that 2008 crash and has mostly remained below $10 a share since then, despite the plethora of charts showing rising revenue and reserves. The stock closed Wednesday at $8.67.

Ward is used to skepticism. He said he hears from Kansans about every day telling him he is overspending for Kansas oil.

Ward maintains that the land sales, and the company’s recent purchase of a large play in the Gulf of Mexico, are really to generate the cash needed to develop the Mississippian acreage in the five-year lifespan of the leases.

You can tell people what you are doing and why, but they still are afraid of something new, Ward and Grubb said.

“When you are first mover, people are always skeptical,” Grubb added. “People are, like, ‘Why are you doing that when nobody else is doing it?’ ”

“They’ve been skeptical about everything we’ve done,” Ward said of the assets he’s bought over the years. “That’s why they’re cheap.”

Ward, who had to rush off to another meeting, said goodbye to his visitor, but as he did he gave a glimpse of a gambler who thinks he already has won.

“The next time you come visit us, you’ll say congratulations,” he said.

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