The Radical Shift SandRidge Energy Inc Investors Probably Didn't See Coming

Over the past several years,SandRidge Energy Inc has invested billions of dollars to become an oil-focused growth company. The plan was working, and at one time, 80% of the company's Mississippian-shale cash flow came from oil, thanks in part to the company's growing oil production and the fact that oil prices were much higher than natural gas on a barrel of oil equivalent basis. However, in 2015, SandRidge Energy will return to its natural gas roots in part because of a natural phenomenon found within its wells in a shift most investors probably never saw coming.

Turning on the gasThe dramatic drop in the oil price over the past year is forcing Sandridge Energy to make some changes. One of the most dramatic moves the company made was to cut its spending, halting its growth plans. The company is cutting its capex plan from the $1.6 billion it spent last year to just $700 million in 2015, as it's dropping its drilling rig count from 19 all the way down to seven. This will result in meager production growth of 6%, which is well below the former plan of 20%-25% production growth.

What's interesting about the company's plan is the fact that its 6% growth rate will really be weighted toward natural gas, as we see on the following slide.

Source: SandRidge Energy Inc Investor Presentation.

From that slide, we can see that the company's oil production will actually be down 2%-12%, while its NGL production will be up 8%-35%, and natural gas production will be up 9%-14%. This is despite the fact that the company isn't necessarily targeting natural gas, as it will be drilling the same types of wells in the same region as it did last year.

The only thing the company is doing differently is high grading its development program to focus on drilling its most compelling prospects. These prospects just happen to contain a bit more natural gas than some of its other prospects, but that's not the only reason gas production will surge next year.

It's all about the geologyThere's actually a natural explanation for how the company can drill the same type of wells in the same general locations and see its oil production slip while its gas production surges. It has to do with the geology it will be drilling into, which is detailed on the following slide.

Source: SandRidge Energy Inc Investor Presentation.

There are two things I want to draw your attention to from this slide. First, by high grading its capital program in 2015 to focus on its best prospects, SandRidge Energy plans to drill wells that are expected to deliver 27% higher estimated ultimate recovery, or EUR, which is the amount of oil and gas a well is expected to produce in its lifetime, than wells drilled in 2014. This is because SandRidge will not only be drilling fewer wells this year, but the ones it does drill will be the best prospects because of the higher EURs. It just so happens that one of the reasons the EURs of these wells are higher than last year's wells is because they contain more recoverable natural gas.

The other thing I want to point out that is driving SandRidge's natural gas growth in 2015 comes from the first-year decline rate of its wells. The slide above notes that the wells it plans to drill this year have a first-year decline rate of 80% for oil and 62% for natural gas. Those decline rates are pretty typical for wells the company drills in its core region from prior years.

The key here are those legacy wells, as thegas production from those wells hasn't declined as steeply as the oil production. This is giving the company a gassier base, making it much easier for the company to naturally grow gas production, as gas has less of a legacy production decline to overcome.

Investor takeawaySandRidge isn't focusing on growing natural gas production this year because of low oil prices. Instead, that growth is largely a funcion of geology. Not only do SandRidge's best prospects contain more recoverable natural gas, but the company's legacy natural gas production doesn't decline as steeply as oil production does. It's why SandRidge Energy is seemingly making a radical shift back to natural gas when that shift is actually being caused by the geology where SandRidge drills.

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Matt DiLallo owns shares of SandRidge Energy. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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