|Letter to Shareholders from SD. |
Worth reading if you have a SD position. One comment - I wasn't aware SD is 96% oil. I thought they were more like 70%/30%. With the recent sell off, I have established a substantial position in shares and short puts. This will allow me to play bearcat's bob SD game on monthly income.
Fellow Shareholders, Upon completing our transformation from natural gas to oil in 2010, we took additional bold measures in 2011 to further ensure our ability to deliver increased shareholder value in 2012 and beyond. We have purchased $400 million of leases in the Mississippian Oil Play, which stretches from northern Oklahoma to western Kansas, securing two million acres(1) in an area we believe generates the highest rate of return for horizontal drilling in the U.S. today and will be the primary driver of growth for the company going forward. We are also the most active operator in the play, drilling nearly half of all wells drilled to date. Our drilling success has been transformative for our company and will be an ongoing source of growth for the future.
Every action we take, including our pending acquisition of inexpensive oil and cash flow through the purchase of Dynamic Offshore Resources, LLC (DOR), is meant to improve our ability to develop our Mississippian holdings and to fulfill our three-year growth strategy. By the end of 2014, we expect to increase our annual EBITDA(2) to more than $2 billion, while also providing annual double-digit production growth, lowering our total debt to EBITDA ratio and funding our capital expenditures within our cash flows. Through the DOR acquisition, the offering of two royalty trusts (with a third pending), two joint ventures with international partners and the sale of non-core assets, we have established the groundwork necessary to reach our goals. Our achievements over the past 12 months have positioned our company in such a way that I am more energized about the future of SandRidge than ever before.
Believing oil prices would rebound more quickly than natural gas and ultimately provide a more stable revenue stream for the company over the long-term, we made the decision in late 2008 to change our focus to oil. Our decision to move quickly in this direction enabled us to acquire a tremendous base of oil assets at prices significantly lower than would be possible in today’s market. Moreover, our focus on low-cost, shallow, carbonate formations enables us to achieve some of the highest rates of return in the industry. Wells drilled into shallow carbonates require lower horsepower equipment for drilling and low pressure pumping equipment during the completion process—both of which are plentiful and readily available. SandRidge also owns 31 drilling rigs, which help keep our costs low and our rates of return high.
We currently have more than 7,000 net potential horizontal drilling locations identified on our Mississippian acreage, targeting vertical depths of 4,000 to 7,000 feet. An average horizontal well costs $3.2 million(3) to drill, produces 456 thousand barrels of oil equivalent (Mboe) and provides an internal rate of return of approximately 98 percent(4). We drilled 167 horizontal wells in the Mississippian in 2011 and expect to drill 380 horizontal wells this year, using an average of 26 active rigs.
Because of its exceptional economics, our Mississippian acreage has been a remarkable source of value creation for the company. We acquired two million acres of leasehold for a total investment of $400 million or roughly $200 per acre. In 2011, we monetized approximately 500,000 acres through three separate transactions—two joint ventures and one royalty trust—for a total of $1.83 billion. A second royalty trust is expected to raise another $500 million. Together these transactions will have raised $2.33 billion in non-debt capital, giving an implied value of $4,236 per acre to these properties. With nearly 1.5 million acres remaining under our control, we have the potential to sell an additional 250,000 acres and still retain a portfolio of locations large enough to support a robust 12 to 15 year drilling program.
Our second core area, the Texas Permian Basin, also provides access to shallow, permeable carbonate reservoirs that can be reached quickly and at a low cost. The company owns 225,000(5) acres of leasehold in the Permian Basin, where approximately 7,600 potential future drilling locations have been identified across the Central Basin Platform. Targeting multiple formations, these wells are drilled to depths between 4,500 and 9,000 feet, cost an average of $643,000 to drill, produce an average of 58 Mboe and provide an internal rate of return of approximately 80 percent(4). SandRidge drilled 803 vertical wells in the Permian Basin last year and we expect to drill more than 750 wells in 2012.
Non-Debt Capital Raises
Through the aforementioned joint ventures and royalty trusts and the planned sale of non-core assets, we have raised $3.2 billion(6) in non-debt capital, enabling SandRidge to begin 2012 with approximately $1 billion in liquidity. In September, we completed a $500 million joint venture with an affiliate of Atinum Partners Co., Ltd, one of the Republic of Korea’s top investment firms. Atinum received non-operated working interests in approximately 113,000 net acres in the Mississippian for which SandRidge received $250 million in cash and will receive an additional $250 million in the form of a drilling carry.
We followed the Atinum JV with a $1 billion joint venture in December with a subsidiary of Repsol YPF, S.A., a leading energy company headquartered in Madrid, Spain. At the closing of the transaction, Repsol received non-operated working interests in approximately 364,000 net acres in the Mississippian for $250 million in cash and an additional $750 million in the form of a drilling carry. Combined, these joint ventures raised $1.5 billion in non-debt capital for the company, essentially all of which will be used to develop our Mississippian acreage.
We closed two Royalty Trusts in 2011—the SandRidge Mississippian Trust I (NYSE: SDT) and the SandRidge Permian Trust (NYSE: PER). These entities are business trusts formed to own royalty interests in producing wells and in development wells to be drilled within areas of mutual interest. The Trusts were conveyed royalty interests by SandRidge, which entitles them to receive a percentage of the wells’ net revenues without being burdened by drilling or operating expenses. Monetizing these interests enables us to accelerate the development of our oil properties and, in turn, increase the company’s value.
We launched SDT in April to a very positive reception, enabling us to increase the size of the offering, which priced at the top end of the expected price range. SandRidge Mississippian Trust I owns royalty interests that entitle it to a percentage of the proceeds from production on wells drilled in the Mississippian formation on approximately 42,000 net acres. SandRidge received net proceeds of $337 million from the offering (before offering expenses) and currently has a 32.7 percent beneficial ownership in the trust(7).
The initial public offering of PER successfully launched in August. SandRidge Permian Trust owns royalty interests that entitle it to a percentage of the proceeds from production on wells drilled on approximately 15,900 net acres in the Permian Basin. SandRidge received net proceeds of $581 million from the offering (before offering expenses) and currently has a 30.5 percent beneficial ownership in the trust(7).
We have also divested several non-core assets through planned sales totaling $696 million. These properties included the Bone Spring and Avalon reservoirs and the Wolfberry assets in the Permian Basin, 23,000 net acres in Lea and Eddy counties in New Mexico and over 23,000 net acres across several counties in East Texas.
We have several options remaining to raise additional capital in the future, as needed. Our nearly 1.5 million acres in the Mississippian give us an inventory of drilling locations that would take more than 15 years to complete. Selling an additional 250,000 acres through joint ventures could provide additional capital, while reducing our drilling inventory to a more manageable 12-15 years. In addition, we can divest other non-core assets as well as our remaining common units in the royalty trusts.
Our ability to transform into a company that now derives approximately 96 percent of its revenue from oil wells has been greatly enhanced through our acquisition of producing properties inexpensively in areas that have fallen out of favor with the rest of the industry. In late 2009 and 2010, for example, as others were moving quickly toward shale plays, we were able to acquire 149 million barrels of oil equivalent (MMboe) of proved reserves and 16,100 barrels of oil equivalent per day (Boepd) of production at significantly reduced prices.
Similarly, as companies have retreated from the Gulf of Mexico, the purchase price of assets in this area has become more attractive, enabling SandRidge to acquire 25 Mboepd of production and 62.5 MMboe of proved reserves for less than $1.3 billion in cash and stock through the acquisition of Dynamic Offshore Resources, LLC (DOR). Approximately 50 percent of both production and proved reserves consist of oil and are located primarily in water depths of less than 300 feet. The acquisition will be immediately accretive to our earnings and should contribute significant free cash flow in excess of the annual drilling and recompletion capital budget. The valuation at which we are able to acquire these properties is consistent with our plan to triple EBITDA and double oil production while lowering our debt to EBITDA ratio.
2011 was an extremely successful year operationally for SandRidge as we increased proved reserves, adjusted for asset sales, by 11 percent to 471 MMboe. The increase reflects the divestment of 123 MMboe and represents a reserve replacement ratio of 303 percent. Oil reserves, adjusted for asset sales, increased 17 percent to 245 MMBbls. Oil production grew 60 percent in 2011, adding to a 16 percent increase in overall production to 23.4 MMboe.
Throughout our transition to oil, SandRidge has made bold, decisive moves that have provided stability and growth during a time of worldwide economic uncertainty. We are now well positioned to achieve our three-year objectives of annual EBITDA greater than $2 billion, annual double-digit production growth, reducing our total debt to EBITDA ratio and becoming a company that can continue to grow while living within cash flow. Moreover, our demonstrated ability to achieve high rates of return through our drilling program, capture value on our oil and natural gas assets and opportunistically acquire production and proved reserves at below market prices enable us to generate higher revenues and deliver increased value to our shareholders.
I would like to thank our board of directors for their expertise and counsel, our talented employees for their superior performance and our shareholders for your belief in the future of our company. SandRidge Energy is stronger than it has ever been, with greater prospects for the future than at any other point in our history.
Tom L. Ward
Chairman and Chief Executive Officer