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On the Money: Mississippi Learning

So far, the Mississippi Lime’s been a bust. But that could change

Jody Chudley is the author of The Punchcard Portfolio, a value-oriented newsletter with a focus on Canadian oil and gas stocks

Aug 13, 2014

by Jody Chudley

The Play

There have been a handful of tight oil and gas plays that have hit the scene in the past five years that have exceeded almost all expectations. The Mississippi Lime is definitely not one of them. It’s a huge, mostly oil-rich reservoir fed by the Woodford Shale formation that is located across north-central Oklahoma and Kansas, and ranges from depths of 4,000 to 6,000 feet deep. In 2009 and 2010, it was the target of a huge land grab that involved both large and small oil companies, and during that mad rush the acreage values in the play soared.

It’s more or less been downhill from there. The first nasty surprise was that the play was considerably “gassier” than expected. With oil production being significantly more valuable per barrel of oil produced, that lower than expected oil content greatly changed the economics of the play. Additionally, the total volume of hydrocarbons that can be recovered per well turned out to be less than originally estimated. That combination is about the worst one imaginable.

That wasn’t it as far as bad news went, either. The play also produces enormous amounts of water, which requires a significant investment in water handling and water disposal facilities. This greatly increases the cost of adding production and also slows down the time between drilling and production. Those high costs don’t leave much room for error, and they drove many large leaseholders like Shell and Encana out of the play entirely. The market has also given up on the Mississippi Lime, and the shares of smaller companies focused on it are hurting. But that could create an opening for bold investors, because there has been some recent news about improved well results from the Mississippi Lime that might portend considerable upside.

The Picks

SandRidge Energy (NYSE:SD)
One-year return: 43.8%

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SandRidge was the original player in the Mississippi Lime, with the company accumulating more than two million acres. It was also the company that first tipped the market off to the fact that wells in the play were not measuring up to expectations. As you might expect, shares of SandRidge have suffered.

But recent results are beginning to create some reason for optimism. SandRidge has changed its approach in a couple of ways that seem to be improving well economics in the Mississippi Lime. First, the company is narrowing its focus, and instead of trying to operate across the entire two million acres it’s targeting six “focus areas.”

Additionally, SandRidge has been able to improve productivity of its wells by introducing artificial lift and has reduced its well costs by improving its ability to handle water. It’s going to take some time for SandRidge to win back the confidence of the market, but if its results in the Mississippi Lime keep improving, it’s a company with a lot of leverage to the market revaluing this play.

Petro River Oil (OTC:PTRC)
One-year return: -76.3%

onthemoney_story2

While its share price is only a nickel, Petro River Oil actually has a market capitalization of $40 million, so it isn’t truly a “penny stock.” Still, owning shares in this company is pretty far out there on the risk spectrum, so only a small position would be appropriate. There are a couple of reasons that Petro River Oil interests me. The first is that it has a lot of exposure to the Mississippi Lime. With its recent acquisition of Spyglass Energy Group, Petro River has more than 190,000 acres in the play. That is huge leverage compared to its size if this play has a revaluation.

Petro River has also been consistent in its message that it will be bringing in a joint venture partner to help fund the development of its big acreage position. The announcement of a good deal with an experienced provider of capital could put this little company on the map. It’s hard to know with these little companies whether they are talking a good game or they really have something interesting. Still, the involvement of the former head of the national oil company of Venezuela (PDVSA) as part of the Petro River leadership team does add some credibility in this case.

The Postscript

This is a classic risk-reward proposition. Yes, the Mississippi Lime has been a dud so far, and the shares of the companies most exposed to it have suffered. But we’ve seen technology turn previously fallow fields into highly profitable plays time and time again, and the Mississippi Lime could prove to be another example of that. Then again, it could be what it appears to be right now – a major disappointment. And so, you have to be willing to endure the downside if you’re going to bet on the upside. But make no mistake: the upside’s there.

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