SandRidge is an Oil Company.
In 2010, SandRidge Energy successfully completed its transformation from a company that was focused primarily on natural gas two years ago to one that will derive approximately 80 percent of its 2011 revenues from oil and dedicate essentially all of its 2011 drilling budget to oil. Shifting to oil was viewed by many as a contrarian move; however, we believed it natural based on the increasing divergence between the relative values of natural gas and oil. We can now look back and see that we not only made the right call on commodities, but we did so on a scale that transformed our company.
Oil and natural gas are traditionally compared on an energy equivalency basis using a ratio of six thousand cubic feet of natural gas (Mcf) to one barrel of oil (Bbl), or six-to-one (6:1). On a valuation basis, however, with natural gas prices currently hovering around $4.00 per Mcf and oil in the $100 per barrel range, the valuation ratio is approximately 25:1. One barrel of oil is now worth the same as 25 Mcf of gas, making oil a significantly more valuable commodity. As the supply and demand fundamentals for oil remain robust, we are convinced the valuation ratio will remain high and our focus on oil production will provide a stronger, more secure revenue stream for the company.
Proven Shallow Carbonate Reservoirs Mean Low Cost
Controlling costs is the key to success in our oil drilling program. By pursuing shallow, permeable carbonate reservoirs, we are able to drill wells quickly and at a low cost. Shallow carbonate targets mean lower horsepower requirements for drilling and low pressure pumping equipment during the completion process. Since most of the industry has moved to deeper, tighter rock formations, which have higher horsepower requirements for hydraulic fracturing, the low pressure equipment we need is plentiful and readily available. In addition, we also own 31 drilling rigs, providing the flexibility to move on and off site quickly. As a result, our drilling costs have not increased appreciably since early 2009, and we do not expect significant increases going forward.
In addition to our emphasis on low costs, we also look to drill in areas with decades of proven production. The Central Basin Platform of the Permian Basin, for example, has been actively drilled since the early 1900s and has produced more than 13 billion barrels of oil. Reserve estimates based on decades of production history indicate the area still contains substantial amounts of oil in multiple reservoirs. Our focus on cost control in proven low risk reservoirs, combined with an aggressive hedging program, enable SandRidge to lock in exceptional rates of return.
Permian Basin Oil
In late 2009, we acquired properties in the Central Basin Platform of the Texas Permian Basin from Forest Oil. We followed this up with the acquisition of Arena Resources in July 2010. These two transactions provided SandRidge with 149 million barrels of oil equivalent (MMboe) of proved reserves and 16,100 barrels of oil equivalent per day (Boepd) of production—75 percent of which is oil. Our total investment of less than $1.9 billion is now worth approximately $3.8 billion(1) clearly illustrating our ability to execute and enhance value in our core areas.
The largest portion of our 2011 drilling budget will be dedicated to the Central Basin Platform where we expect to drill more than 800 wells using 16 rigs, making SandRidge the most active driller in this oil rich region. A majority of our wells are drilled to depths of 4,000 to 8,000 feet, and are often completed in multiple zones, with the San Andres and Clear Fork being the primary targets. The average well costs approximately $760,000 and takes four to eight days to drill, depending on the formation being targeted. These wells are expected to produce an average of about 83,000 Boe per well and achieve a 90 percent rate of return(2).
Horizontal Mississippian Oil
Our second core area is the horizontal Mississippian play in Northern Oklahoma and Southern Kansas. We are excited about the potential of the Mississippian formation with its shallow carbonate reservoirs and decades of production history. Our early and aggressive entry into this play enabled us to keep our lease costs under $200 per acre, which is in stark contrast to the entry cost of many of the recent, more high-profile plays now prominent in our industry, where acreage costs have been 10 to 100 times higher.
Horizontal wells drilled in the Mississippian formation reach a total vertical depth of about 6,000 feet and are then drilled another 4,000 feet horizontally, at a cost of $2.7 million(3) per well. With more than 17,000 vertical wells drilled in this area over the last 30 years, we believe the Mississippian has significant scale. Accordingly, we ex-pect to reach 900,000 to 1 million acres of leasehold, which represents the largest land position of any operator. We have identified more than 3,400 potential drilling locations in the Mississippian formation and expect to drill approximately 135 horizontal wells this year using 12 rigs. We expect ultimate recovery to range from 300,000 to 500,000 Boe per well and, based on current commodity prices, these wells to provide a 120 percent rate of return(4).
Not Just Oil: Significant Natural Gas Upside Remains
SandRidge has approximately 8,000 natural gas drilling opportunities across Oklahoma, East Texas, the Gulf Coast, the Gulf of Mexico and in the West Texas Overthrust. However, as our oil rich assets produce the highest return on our drilling capital, we have drastically curtailed our natural gas drilling to the point where we do not expect to drill any new gas wells this year. When natural gas prices reach an appropriate level, our extensive asset base provides a tremendous opportunity to either increase natural gas production or use these gas assets as a source of capital.
Oil Hedges
We continue to actively hedge and lock in cash flows on our high rate of return oil projects. For 2011, we have over 75 percent of our estimated production hedged at prices just over $86 per barrel for oil and $4.69 per Mcf for natural gas. We have an additional 20 million barrels of oil hedged through 2013 at an average price of $91 per barrel and we continue to hedge aggressively as oil prices, currently around $100 per barrel, continue to improve.
While hedging our production at current commodity prices allows us to lock in revenues, it is our ability to control our drilling costs that makes our hedging program work. Because we have some certainty about our future drilling costs, we are comfortable hedging two to three years of future production, locking in positive revenue and returns.
Increased Oil Production Equals Increased Shareholder Value
The changes we have implemented over the last two years have made this an exciting time for SandRidge. With the transformation to oil essentially complete, we now have an exceptional platform of conventional assets with predictable production curves that we are able to drill at a low cost, resulting in high rates of return. Our two sizable oil plays in the Central Basin Platform and the horizontal Mississippian formation provide a large inventory of high return oil drilling opportunities with decades of known production history.
At a time when oil is in high demand worldwide and is progressively becoming more difficult to find and produce, SandRidge increased oil production last year by 155 percent over 2009. In 2011, we expect to further increase our oil production by another 66 percent over 2010. When considering the current valuation ratio of oil to natural gas, our ability to substantially grow our oil production clearly enables SandRidge to generate higher revenues and deliver increased value to our shareholders. When combined with our ability to quickly capture value on our natural gas assets should prices improve, our successful transformation to oil has put SandRidge in an extremely positive position for the future.
I would like to recognize the expertise and counsel provided by our board of directors, the leadership of our senior staff and the superior performance of our talented employees, whose combined efforts made the transformation to oil possible. Thank you to our shareholders for offering the ultimate vote of confidence through your continued faith in the future of our company. The hard choice to move away from natural gas in early 2009 is now paying dividends as the company is poised to deliver tremendous growth in 2011 and beyond.
Tom L. Ward
Chairman and Chief Executive Officer
(1) Based on NYMEX strip prices as of February 7, 2011, with hedging adjustments.
(2) Based on NYMEX strip prices as of February 14, 2011 and a type curve estimated ultimate recovery of 83,000 Boe.
(3) Includes capital expenditure allocation for water disposal facilities.
(4) Based on NYMEX strip prices as of February 14, 2011 and a type curve estimated ultimate recovery of 409,000 Boe.