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Sanchez Energy Says TMS Economics Adding Up

As Sanchez Energy Corp. prepares to drill its first well in the Tuscaloosa Marine Shale (TMS), executives are hoping it will do more than just add to the delineation of the play; they're expecting it to make money.

"We're as high as ever on the TMS," CEO Tony Sanchez told analysts during an earnings conference call. "...[W]e expect to start our first [operated] well probably no later than May...I think it's a basin that's going to add tremendous upside to our prospects."

And that well will be a moneymaker if COO Chris Heinson gets his way. "It's well known that the TMS is a technically challenging environment to drill, and we've been working the technical design of our wells for a period," Heinson said. "...[W]e're not just trying to drill wells for the sake of appraising the acreage. We actually believe we have a good shot of making money on our very first well. So we've spent a lot of time and effort designing the well."

Sanchez executives have also looked closely at the wells that have gone before in the TMS, particularly the ones that turned out to be disappointments. Landing a well in what's known as the "rubble zone" is to be avoided.

The rubble zone isn't actually a real zone, Heinson said. It's a highly fractured area that lies just above the Richland Sand. "People have gotten themselves into trouble when they have tried to land above that Richland Sand because of the rubble zone; [there's] just no telling how far it may extend vertically in the section. So some operators who were trying to avoid it ended up intersecting highly fractured zones when they landed north of that Richland sand."

Sanchez has participated in one non-operated TMS well that was expected to be completed Sunday. Units are forming around where the company has acreage, Heinson said. "What's a little bit difficult to predict because there is a fairly extensive land process around the unit formation, is when those operators will actually drill. But we've seen the most amount of activity in and around Wilkinson County where we actually have a fair amount of acreage. That's going to be a highly active area, so we expect to see quite a bit of non-op [activity]."

The company has 40,000 net leasehold acres in what it thinks is the core of the TMS. CEO Sanchez said the company is not planning any large-scale acreage swaps in the play. However, operators are working together to try to form as many contiguous units as possible. "...[W]hat we've seen is sort of the core of the TMS is collapsing down into a much narrower window," he said.

CFO Michael Long said when Sanchez began looking at the TMS, executives estimated what returns would be with a $15 million well cost and estimated ultimate recoveries of (EUR) of 500,000-600,000 boe up to 800,000 boe. "...[W]e're looking at returns at those high capital costs in the 17% to low 20%," he said. "So once we got our hands around that, we figured that's a positive return from an appraisal well, and we started to look at the TMS under a development scenario. And because of its leverage to oil prices and the high IP rates, you can get those returns kicked up pretty quick with the reduction in costs."

For instance, he said, a $10 million well with a 600,000 boe EUR would generate at $90/bbl oil a 50% rate of return. "If you go up to 800,000 bbl, you're looking at anywhere from 75% to well over a 100% rate of return," he said. "If you use those book ends to make a judgment on the play -- which is the way we looked at it -- we started to get really comfortable with the potential that the TMS has."

The company is confident it can bring costs down in the TMS like it did in the Marquis area of the Eagle Ford, where its first two wells cost $16 million and then $15 million; now Sanchez is drilling wells there for less than $9 million. "So we've got experience in dropping well costs from that kind of a magnitude to something substantially lower," Long said.

"So I think that the prize is there. We think that if the technical challenges are solved, that the TMS is going to be offering very competitive rates of return to what we’re drilling over in the Eagle Ford. We're not prepared to make a decision yet, and we probably won't make a decision to go into full-scale development until we have a number of wells under our belt. But all the pieces are in place to turn that TMS into a huge play."

For the fourth quarter, Sanchez adjusted net income was $11.5 million, an increase of 611% over the year-ago quarter. Adjusted net income for the full year was $33.2 million, an increase of 351% over 2012. For 2013 the company had revenue of $314.4 million, an increase of 629% over 2012.

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