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SD Q1 2011 results


rijk
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good operational results

 

not sure what to make of financial results, $267 million unrealized derivative loss (Q1 oil & gas revenue is the same figure)...

 

- how are derivative results calculated?

- regarding Buffett's suggestion to Burlington to not hedge their diesel costs, wouldn't this apply to SD also, especially since they apparently are a low cost producer?

 

regards

rijk

 

 

http://finance.yahoo.com/news/SandRidge-Energy-Inc-Reports-prnews-1416744902.html?x=0&.v=1

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Guest VAL9000

Hi Rijk,

 

I'm speaking a bit out of turn here as I'm not really familiar with the oil business, but here are my thoughts:

- The derivatives are probably hedging instruments used by SD to lock in profits for the oil they pull out of the ground.  If this is the case, when oil goes up (as it did in a big way in Q1), the derivative instruments will drop in value.  The idea is that SD will bring in excess revenue when the oil is sold at high spot prices, so the instruments are offset by those profits.  Alternatively if oil drops and they're losing money on the spot price, the derivatives will increase in value which offsets that loss.  The value of the derivative is likely a mark-to-market on the hedge.

- I would adjust the BNSF/SD analogy to get a different result.  SD's main product is oil.  BNSF's main product is transportation.  BNSF doesn't hedge oil, but they do hedge transportation fees by offering long term shipping contracts to their customers.  These agreements are signed today but priced out over many months or years.  In that view, BNSF's contracts and SD's hedging activity are very much aligned.  SD not hedging oil would be like BNSF only offering transportation at spot prices.

 

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thanks val9000,

 

let's take an example... cost 30, hedge price 80 and spot price 100

 

what happened in Q1 is that SD recorded -20 because oil increased while they hedged at 80?

 

what will happen in the future is that SD will record +70 (assuming spot price stays the same)?

 

i thought it would make more sense from a matching perspective to record 50 when the oil is sold.....

 

in any case, it looks like the Q1 derivative loss will return like a future profit????

 

regards

rijk

 

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Keep in mind that nat gas went from $14 to $4, where is sits today. Oil also rapidly dropped to $45 during 2008 from $140. SD would likely be bankrupt were it not for the nat gas hedges. I need to listen to the call, but I hope we have hedged a chunk of oil out 3 years or so over.

 

Cost are fixed, debt is high, and rates of return exceed 100%. Why not hedge a bit in this jittery environment.

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Guest VAL9000

let's take an example... cost 30, hedge price 80 and spot price 100

 

what happened in Q1 is that SD recorded -20 because oil increased while they hedged at 80?

 

what will happen in the future is that SD will record +70 (assuming spot price stays the same)?

More like what happened in Q1 is SD recorded a loss for all of its future oil delivery.  If it cost x to enter into these contracts on Jan 1, then it would have cost (x - $267mm ) to enter into the same contracts on April 1 - because the market price of oil is that much higher.  Hence they show the loss on the books.

 

i thought it would make more sense from a matching perspective to record 50 when the oil is sold.....

Designating derivatives as a hedge is a GAAP thing.  It's optional.  If you designate them as a hedge then the mark to market bypasses the income statement (records directly in shareholder's equity) and is eventually netted out in the period when the hedged transaction takes place.  From SD's annual report:

 

We have not and do not plan to designate any of our derivative contracts as hedges for accounting purposes and, as a result, record all derivative contracts on our balance sheet at fair value.

 

in any case, it looks like the Q1 derivative loss will return like a future profit????

Yeah sorta.  The oil is going to be delivered at the contract price regardless of how the contract is valued on the books.

 

I would ignore the fluctuations in these instruments and instead look at the future net profit locked in by the hedge.  Also ensure that the volume of contracted oil and the amount they can really produce are aligned.

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Guest VAL9000

Thanks for the props Myth.  I don't frequent other boards.  I'm a sometimes poster on SSW's Yahoo Message Board, but other than that I'm very web silent.  Posting actively here is a first for me and it's been a lot of fun.  The members of this board are a bright bunch and I get a lot out of everyone's posts.

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thanks again val9000, your explanations make sense...

 

i wonder why SD hasn't opted to designate their derivative contracts as a hedges, when the only reason to enter into these contracts is to lock in the profit when prices are favorable, i.e. derivative losses should be matched with future oil profits

 

looks like the market doesn't ignore derivative results, SD continues to slide while other oil companies are more stable (today)

 

regarding Buffett's Burlington comment, even though SD's expertise is oil, i would think that their expertise is more focused on oil exploration and production versus trading a commodity, my understanding was that Buffett's point was that nobody can accurately predict commodity prices and that therefore it doesn't make much sense to dedicate resources to hedging. i understand the cost/price preditability/stability arguments, however, Buffett's argument seems to be that hedging activites do not necessarily provide value to shareholders....

 

regards

rijk 

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GAAP is its own little beast. Im sure they have good reasons for how they choose to account for things. Either way I just focus on cash flow, and capex.

 

I think SD is down because it ran more than any other oil company. Even down 30%, its still up 100%.

 

With regard to hedging in general I think you have to look at Ward's argument and the other side of the coin. When you have massive amounts of debt, you really dont want to be at the mercy of oil traders and global economic whims. As I said prior. No hedged gas, and a bankrupt or taken under company. $87 seems low, but its light years away from the $60 and $70 we were getting last year.

 

Buffett said that basically it all evens out overtime, and by hedging inputs you sometimes win and sometimes loss. Over the long term you loss because of transaction costs. It makes sense for consumer of resources but isnt gospel and doesnt really address this situation (debt and covenants generally require hedging, banks want to be paid regardless of the price of oil).

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Guest VAL9000

 

regarding Buffett's Burlington comment, even though SD's expertise is oil, i would think that their expertise is more focused on oil exploration and production versus trading a commodity, my understanding was that Buffett's point was that nobody can accurately predict commodity prices and that therefore it doesn't make much sense to dedicate resources to hedging. i understand the cost/price preditability/stability arguments, however, Buffett's argument seems to be that hedging activites do not necessarily provide value to shareholders....

 

I agree with Myth's response and will add:

SD is better at E&P, which is why they don't trade, they hedge.  The difference is that if you know you're going to sell at $87 then you can produce for $40 or whatever their net costs are.  If instead you're delivering at $50 or $60 then your approach to the meat of the business, the E&P part of the business, will change accordingly - $40 may be too expensive.  It's because they can't predict the price of oil that they hedge.

 

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re: hedging  When price of the underlying asset is inflating, hedgers will miss out on some of the upside. There are industry players who have the testicular fortitude to be more discretionary with their hedgebooks (ie Devon was unhedged last year for the longest time... except they do nat gas. We all know how that worked out). The SandRidge guys aren't/can't afford to be market timers, which is fine with me.

 

If you take Ward at his word, SandRidge's CBP and Mississippi assets still generate decent IRRs at $60 crude (provided they can drill and hold all their leases). And their more recent contracts were initiatied at ~$100 delivery price. Not too shabby.

 

The "miss" is due in part to the surprisingly long and harsh cold front that hit Texas earlier this year, in part due to analysts' modeling a flat revenue progression from quarter to quarter this year vs. the company's ramping up from a lower base... Again, a good enough explanation.

 

All in all, an okay quarter if you ask me. What matters here on out seems to be when/how Ward & Co will raise the money.

 

Drill, baby, drill.

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Drill, baby, drill.

 

This is the first time I have seen this line and not cringed lol.

 

In retrospect I should have taken more off the table. SD is a bit high on a cash flow basis, but very low on a net assets basis (but just about every oil company is). What I like about this team is they understand present value like no other. They are working extremely hard to bring as much of that production forward as possible. I loved the line about the $1 billion dollar Trust if possible, and like the fact that equity appears off the table. Hopefully debt is too.

 

It will be interesting, for now I plan to hold. Also very interesting comments about Eagle. A CHK JV will also be interesting. Drill baby drill.

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Nothing go straight up, but this correction is fierce especially on oil stocks.

 

But once they figure out how the 12 cap ex will be funded, we will be fine.

The math is actually pretty straight forward, with 24 rigs (average) in 12, they can do a few 300 millions worth of royalty trusts annually. 300 millions = 42k acre. And they have 1million acres. I do realize there is drilling cost. But for 7B EV, we are not paying much for rest of the co and the natural gas assets! And once those trusts are formed, cash flow to the company will be quite amazing.

 

 

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