- SandRidge is one of the heavily-leveraged oil and gas companies have seen their shares recover sharply quickly as oil prices continue recovering.
- This is due to the fact that oil prices dictate whether or not they remain liquid or go bankrupt.
- SandRidge is one of the safer investments in this category.
Nearly all oil and gas companies have tumbled in the melee of what has been one of the worst selloffs in the energy sector in recent memory. Oil and gas prices have been cut by half over the past 12 months, and the stocks of companies operating in the space have followed suit, falling by a comparable margin. But, there are a few notable oil and gas stocks that have suffered a worse fate than their peers. These include Seadrill (NYSE: SDRL ), BreitBurn Energy Partners (NYSE: BBEP ) and SandRidge Energy (NYSE: SD ), all down by more than 70% during the period.
Oil prices are, however, currently undergoing one of the most sustained recovery periods, with prices up by almost 10/bbl over the past one month.
They say a rising tide lifts all boats. This seems to be true in the case of oil companies. All the 3 biggest losers, as well as some oil majors, have surged by big margins over the last couple of days as the market continues to be express enthusiasm that the current upsurge is not just another sympathy rebound, but is here to stay.
BBEP Price Change
Source: CNN Money
SDRL Price Change
Source: CNN Money
SandRidge Price Change
Source: CNN Money
Some oil majors as well have been benefitting from the oil upsurge. PetroChina (NYSE: PTR ), China's largest O&G company, has seen a huge resurgence lately, helping it to finally leapfrog Exxon Mobil (NYSE: XON ) as the world's largest energy company.
Seadrill, Breitburn and SandRidge have been hammered more than their peers primarily because of their heavy leverage which places them at high risk of suffering bankruptcy if oil prices remain depressed. I'm one of the guys in the bullish camp that believes that the oil rally is set to continue.
A lot of the current recovery in oil prices has been fuelled by falling inventory levels. And a lot of it can be chalked up to the ''bad boy'' role that major oil powers such as Saudi Arabia as well as OPEC have played over the past couple of months. Saudi Arabia has persistently been telling the world that it would no longer play its traditional role of acting as a swing producer that has helped stabilize prices by jacking production whenever prices ebbed and cutting it when they raced higher. The country has even been repeatedly saying to all who cared to listen that oil prices would remain depressed for a long, long time.
OPEC has not been helping matters much either, and joined the fray by making a declaration late last year that it its member countries would not cut production even if oil prices plunged to as low as $20/ barrel. Mind you back then oil prices were still a respectable $70/barrel. It's not hard to see why OPEC has been so recalcitrant. Just like Saudi, OPEC has traditionally acted as stabilizing force on oil prices, albeit much more effectively due to its huge clout and market share. Oil demand and supply tends to be very inelastic, and even small changes in demand or supply can cause huge price swings. OPEC has usually intervened whenever the oversupply was as low as 1%-2%. But, the organization's role of trying balance things out has largely worked against it--OPEC's global market share has plunged from 50% in the 1980s to just 33% currently.
With nobody to control the forces of supply and demand, oil prices plunged to as low as $40/barrel. Many western producers could no longer drill profitably at that level and cut down production or shut down wells altogether to lower their operational costs. U.S. oil inventories fell and rig count declined. According to renowned oil investor, Boone Pickens, one of the major signs that an oil bottom is not far off is when U.S. rig count falls by a large margin. U.S. rig count has been shown to have a very positive correlation with oil prices, with a major reduction in rig count being followed by a big rally in oil prices, with
little time lag. By the time Mr. Pickens was speaking in December, rig count was down by as much as 180 and by March the rig count fell to a 4-year low .
In February, OPEC secretary general made a declaration that oil prices would rebound to $200 or more, though he did not give a specific time frame. If this had come from somebody else, it would have been taken as just another of the many off-the-cuff remarks about oil prices that we have been hearing from all quarters. OPEC has remained true to its word and has even increased production. with the organization producing 30.72 million barrels of oil per day during the month of March, a good 800,000 barrels higher than the February reading. OPEC members are highly reliant on oil, with oil revenue accounting for 80%-90% of the GDP of many member countries. It appears that OPEC's hardline stance was primarily meant to force western producers to cut their production, and it seems to have worked. Despite OPEC's non-conformity, oil prices have continued recovering, suggesting that the claim that global oil demand is rising could be true.
Why I Prefer SandRidge to its Peers
SandRidge's performance is highly sensitive to oil prices, and it's hardly surprising investors have been fleeing from the company in droves as oil prices continue to plunge. SandRidge simply needs oil prices to recover quickly due to its high leverage.
Source: SandRidge Investor Presentation
SandRidge's long-term debt load has grown almost 10 times over the last five-year period, to $3 billion currently. SandRidge of course borrowed all those billions a few years back to expand its drilling operations when oil prices were very favorable. Even though the company's management declared during its last earning s call that it finished the year with $1 billion in liquidity, close to $900 million of that is attributable to the company's credit facility. The big consolation for its investors, however, is that the company's credit line was reaffirmed during the spring redetermination, so there is little risk of the company suffering a liquidity crisis any time soon.
Now that oil prices are rising, SandRidge will be in a better position to drill its way out of debt. The company's returns usually dip below 10% when oil prices are below $50; rise to 20% when it's around $60 and shoots above 40% when prices hit $80 per barrel. I would say that $60/barrel is the minimum required for the company to stay out of danger of getting into a liquidity crisis, and were are pretty close to that level.
I don't have the models for BBEP and SeaRidge. I'm however, concerned about BBEP's worrying debt track record. The company fared really badly back in 2009 when oil prices plunged and its borrowing base was cut by its financiers leaving it with a mere $43 million in liquidity. The company seems to have been going down that road this year since it had already used up $2.3 billion of its $2.5 billion credit facility leaving it with little room to wiggle. This forced the company to turn to less-than-ideal cash sources, when it received a $1billion investment from EIG Global Energy Partners in the form of debt and equity to help it pay down its credit facility. BreitBurn later cut down its dividend payout by half, barely two months after another 50% cut, to preserve cash.
Meanwhile, Seadrill has heavy leverage of $13 billion on its books and was recently forced to suspend dividends altogether. Although the company is, arguably, in a stronger financial position than Seadrill, its debt load is simply excessive meaning it might take longer to return to business as usual and reinstitute the dividend.
This promises to be a bumpy ride for SandRidge investors due to the high short interest in the company's shares. You can expect the company's shares to trade down by huge margins every time oil prices dip slightly and to trade up every time there is a rally. But, in the long run, I believe the company and its investors will come out on top.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More. ) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.