Sunday, April 4, 2010

Another Nat Gas Company Moving Towards Oil

As Nat Gas prices continue to plunge due to strong supplies from shale plays and low demand from industry, nat gas producers like Chesapeake (CHK) and now SandRidge Energy (SD) make bigger moves into oil drilling. To a major extent they are victims of their own success. The major success in shale drilling by the founders of CHK which now include the CEO of SD has led to much higher gas production even as demand lagged in 2009.

Today SD announced the purchase of Arena Resources (ARD) which mainly focuses on oil production in the Permian Basin in Texas for $1.6B. This marks a major shift for SD into oil that the CEO claimed at a conference a few months back was '10x more profitable to drill for then gas'. Guess that should've signaled to the markets that SD was going to make such a move.

Recently CHK announced that they were moving more drilling resources towards oil and away from nat gas. The April Investors Presentation shows a goal of 20% oil production and a probable drop of roughly 10% of rigs drilling for nat gas. Even with this they expect huge growth in production that is undoubtedly not helping prices. With oil being a global commodity that has benefited from Asian demand and a lack of any new cheap production, its actually surprising that this move didn't happen sooner. Nat gas still remains a domestic commodity tied completely to US demand which has lagged due to low industry demand.

Stone Fox has remained negative on nat gas companies as supplies had remained high and demand low. Its interesting that this deal takes place as supplies have finally come back within the 5 year averages and the US economy is showing signs of picking up. Last week the ISM index hit 59 showing signs of accelerating demand. This is definitely not the type of deal that signals a top or turning point in the price ratio between oil and gas, but it does strike us as buying the higher priced commodity. As more and more explorers makes similar moves, the prices are likely to revert closer to normal ratios.

Details on the deal:

  • Arena shareholders will receive stock and cash consideration valued at $40 per share of Arena common stock based on SandRidge's April 1 closing price. This represents a 17% premium for Arena shareholders. SandRidge will issue 4.7771 shares of SandRidge common stock and pay $2.50 in cash for each share of Arena common stock
  • The transaction uniquely positions SandRidge as one of the largest producers of West Texas conventional oil and gas. The oil opportunities will come primarily from drilling and development of shallow, low risk reservoirs located on the Central Basin Platform ("CBP"), a part of the Permian Basin in West Texas. The CBP has produced over 13 billion barrels of oil since the 1930s. The combined company will have over 200,000 net acres in the Permian Basin and 5,700 identified locations to drill primarily in the shallow San Andres and the Clear Fork formations. Additional upside exists with down spacing and future secondary and tertiary potential. SandRidge also owns low risk natural gas properties in the Pinon Field, and significant exploration opportunities in the West Texas Overthrust.
  • transaction to be accretive to 2011 cash flow per share.

Disclosure: No position.

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