At the end of December, SandRidge Energy Co. (SD) estimated that it held 1.3 trillion cubic feet equivalent of natural gas reserves. Of that amount, 52% was estimated natural gas reserves and the rest was oil. Today the company changed that calculation when it announced that it would merge with Arena Resources, Inc. (ARD) in a transaction worth about $1.6 billion in cash and stock.
SandRidge’s action runs counter to the current drive by oil companies to increase their natural gas holdings. Think Exxon Mobil Corp. (XOM) paying $40 billion for XTO Energy (XTO), one of the largest natural gas companies in the US. The merger will add nearly 60 million barrels of oil to SandRidge’s current reserves of about 105 million barrels, pushing the natural gas to oil portion of assets down to about 41%.
That’s a big shift in focus, but it is one that SandRidge has been following consistently throughout 2009. The company’s oil reserves grew from about 43 million barrels in 2008 to more than 105 million barrels in 2009, capped by SandRidge’s $800 million acquisition of natural gas and oil properties from Forest Oil Corp. (FST).
That deal was partly funded by a secondary issue of 26.6 million new shares of SandRidge common stock. The company also issued $450 million worth of unsecured 8.75% senior notes and completed a private placement of 6% convertible perpetual preferred stock to raise another $200 million.
The merger with Arena will be paid for with 4.7771 new shares of SandRidge stock and $2.50 in cash for each share of Arena stock. The price represents a premium of 17% to Arena’s closing price of $34.26 on last Thursday. The cash portion of the deal will cost SandRidge about $95 million. The company did not say how it would raise the cash, but look for more new shares because SandRidge had less than $8 million in cash at the end of 2009.
A major portion of SandRidge’s operations come from secondary and tertiary recovery in the Permian Basin, including CO2 injection. The company captures about 140 million cubic feet per day of CO2, of which it sells 104 million cubic feet to a division of Occidental Petroleum Corp. (OXY) and Chevron Corp. (CVX). It uses the remainder in its own operations.
The price of crude oil has run way past its traditional 6:1 spread against the price of natural gas. SandRidge wants to capitalize on that growing differential as much as it can. Crude oil now fetches about 20X the price of natural gas. For a smallish ($1.6 billion market cap) energy company with most of its assets in natural gas, that differential could have been fatal to SandRidge.
To the company’s credit, it moved quickly to line up acquisitions and financing to help it bulk up to a project market cap of $6.2 billion if shareholders and regulators approve the deal with Arena. A little more than a year ago, SandRidge looked like a possible takeover target. That it has turned that around testifies to the soundness of both its strategy and its execution.
Of course SandRidge shares are down today, almost 4.5% so far, and volume is already 5X daily averages. But the share price has risen from the intraday low as investors see the value of the deal.
