Sanchez Energy (ticker: SN) issued common shares in its December 2011 initial public offering at $22 per share. The shares opened for trading on December 15, 2011, at $18.42 per share. Since the stock reached a low of $16.96 during trading on January 13, 2012, SN’s share price rallied as much as 48.8% reaching $25.23 per share during trading on February 24, 2012.
This is significant because the company’s shares are now trading above the $22.00 IPO price, giving SN the ability to raise equity capital (if needed) without diluting its shareholders by issuing shares below the IPO price. Sanchez is beginning a year filled with catalysts, as it initiates the development of its Marquis and Maverick prospects which account for 61% and 29% of its Eagle Ford acreage position, respectively, and the continued development of its Palmetto prospect (10% of Eagle Ford position).
It’s widely known that big fields do get bigger. Case in point are the recent announcements by Marathon Oil (ticker: MRO) and EOG Resources (ticker: EOG) about their Eagle Ford positions. The announcements have the potential to offer a long-term valuation catalyst for SN’s shareholders. Marathon Oil, Sanchez’s drilling partner in its Palmetto prospect, plans to test the Palmetto acreage for down-spacing to 60-acre and 40-acres spacing units. SN owns 9,400 net acres in Palmetto, and using a spacing estimate of 120-acres, the company projects owning 75 net un-risked drilling locations.
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If Marathon’s down-spacing program is successful at 60-acres, SN’s un-risked drilling location projection more than doubles to 157 net un-risked drilling locations and at 40-acres SN would have 235 net un-risked drilling locations. Additionally, the company’s reserves in the Palmetto would increase (SN’s mid-point EUR range in the Palmetto is 600 MBOE), implying a higher valuation for SN’s reserves which traded on March 9, 2012 at $247 per BOE versus $38 per BOE in EnerCom’s small-cap peer group.
We note that Marathon is not the first company to experiment with down-spacing in the still relatively “young” Eagle Ford shale play. EOG Resources initially evaluated its Eagle Ford acreage on 130-acre spacing units, before further study of the shale and the drilling of down-spaced wells led the company to determine a range of 65-acre to 90-acre spacing units would be optimal for hydrocarbon recovery. EOG estimates its down-spacing will increase its recovery of oil in the Eagle Ford to 6% from 4%.
SM Energy (ticker: SM) also tested the Eagle Ford for down-spacing but with mixed results. The company recently completed the testing of two down-spaced pilot wells at 72-acre spacing, each with more than six-months of production data. Results from the first well suggest 72-acre spacing would reduce EURs by 30%, with data from the well suggesting optimal spacing of 100-acres; 72-acre spacing was optimum for the second well, with data suggesting a range of 72-acre to 100-acre spacing units across SM’s acreage (similar to EOG’s conclusions).
Two of the Eagle Ford’s largest acreage holders, EOG at 572,000 net operated acres and SM at 149,000 net operated acres, recently concluded that current spacing is too wide and spacing should be reduced to optimize hydrocarbon recovery.
What does this mean for Sanchez? The results of EOG and SM’s spacing tests suggest down-spacing could apply to SN’s entire acreage position. The company’s Eagle Ford acreage spans from Zavala County, Texas (Western Eagle Ford) to Fayette County (Eastern Eagle Ford), a range more similar to that of EOG’s, whereas SM’s entire Eagle Ford position lies in Webb, Dimmitt and LaSalle Counties (Western Eagle Ford), meaning EOG’s spacing results probably provide a better comparison for SN’s optimal spacing.
We estimate reducing spacing to 78-acre units (mid-point of EOG range) from 120-acre units will increase SN’s potential drilling locations to 1,167 net un-risked drilling locations from 750 net un-risked drilling locations (company’s current estimate based on 120-acre spacing). We note that the increase in reserves due to down-spacing could potentially be a positive for the company’s liquidity, allowing Sanchez to increase its borrowing base (SN currently has no zero debt and no plans to set-up a credit facility) or issue equity based on expected share price appreciation, allowing it to increase production over the near-term.