After One Mississippi Lime, Two Mississippi Lime the question is what will transpire by the time the count hits Three Mississippi Lime in 2013. Rest assured, the game is afoot in the Midcontinent’s Mississippi Lime play, which in 2012 exhibited the same rig count acceleration common to unconventional plays at similar development stages historically.

The question for 2013 is whether rig count, now at smore than 70 units, rises at the 2012 rate, or whether the rate of growth flattens for idiosyncratic reasons involving some of the play’s operators.

Datapoints that argue for a rig count increase in 2013 include announcements of incremental program expansions by Range Resources Ltd. (NYSE: RRC) and Devon Energy Corp., (NYSE: DVN) who combined represent 29% of Mississippi Lime rig employment, and how fast Chesapeake Energy Corp.’s (NYSE: CHK) $1.02 billion all-cash joint venture with China Petroleum & Chemical Corp. (Sinopec) will accelerate drilling.

Chesapeake is currently running 8 rigs in the Mississippi Lime. Curiously, the Sinopec joint venture, which provides Sinopec with half of Chesapeake’s 850,000 net acre Mississippi Lime holdings, does not include a drilling carry—a first for the large joint ventures that have dominated unconventional development domestically.

Of additional note, the size of the acreage exchange between Chesapeake and Sinopec, at 50%, is larger than representative joint venture deals between foreign investors and U.S. independents that typically involved 25% to 30% of holdings. Furthermore, the Chesapeake/Sinopec joint venture came in at $2,400 per acre, significantly lower than the $7,000+ per acre Chesapeake had been projecting in its corporate presentations after it announced its intent to pursue a Mississippi Lime deal more than a year ago. It also marks the second sale that fell below Chesapeake's expectations after Chesapeake divested acreage in the Permian Basin during the fourth quarter 2012, suggesting the balance of negotiating leverage has shifted away from cash-strapped Chesapeake and that shift may include a large ramp on behalf of the company and its JV partner in 2013.

More Than Two To Tango

There is no doubt joint ventures are playing a major role in efforts to develop the Mississippi Lime. Sinopec previously inked a $2.2 billion joint venture agreement with Devon in January 2012, including a $1.6 billion drilling carry that would underwrite Devon’s costs for drilling in five major “emerging plays,” including Devon’s 600,000 net acres in the Mississippi Lime. At the end of the agreement, Sinopec would own 30% of Devon’s total acreage in those plays, including 145,000 acres in the Mississippi Lime, mostly in Noble, Pawnee, and Payne counties in the oil rich zone southeast of the Nemaha Ridge in Oklahoma. The drilling carry is expected to run through 2014.

Specifically, Devon projects injecting $1.2 billion in capital into the Mississippi Lime in 2013 and will drill 300 operated wells and participate in another 100 wells operated by others. In 2012, Devon drilled 60 wells on its Mississippi Lime acreage. The company is running 15 rigs in the play targeting both the Mississippi Lime and the underlying Woodford shale and may increase that number to 20 rigs by year end as the company develops a sophisticated reservoir model to solve the petrophysics and improve results.

The 800-pound gorilla in the play, SandRidge Energy Co., (NYSE: SD) represents more than 40% of rig employment and was largely responsible for the big increase in drilling activity that the Mississippi Lime experienced in 2012. SandRidge is no stranger to the JV model, having inked a $1 billion deal with Repsol–YPF at the end of 2011 and an August 2011 $500 million joint venture with South Korea’s sovereign wealth fund, Atinum Partners Co. Ltd. Those deals provided SandRidge $1.5 billion in drilling carries, part of which underwrote the company’s 2012 drilling ramp in the Mississippi Lime.

However, SandRidge faces distractions that may impact the intensity of activity levels in 2013. SandRidge management is involved in a nasty public fight with major shareholder TPG-Axon over issues that include outsized debt, a steep capital spending hurdle, and a curious set of transactions between the company and senior management that have led to conflict of interest accusations.

Oily Sweet Spots

The Mississippi Lime stretches northwesterly from the central Oklahoma/Kansas border to the western Nebraska panhandle, underlying approximately 17 million acres. While an active leasing campaign is under way in western Nebraska, where Apache Corp. is a major leaseholder, most Mississippi Lime production originates along the Oklahoma/Kansas border with a sweet spot along the north/south trending Nemaha Ridge, a subsurface geologic feature that effectively divides the play in two.

In general, the Mississippi Lime is oilier to the east of the Nemaha Ridge, especially as the play moves south into Oklahoma, but tends to be gassier west of the Nemaha Ridge.

Most activity is focused in 20 counties in Oklahoma and Kansas with a special emphasis on Kay, Grant, Alfalfa, and Noble counties in north central Oklahoma. Besides Chesapeake Energy Corp. and SandRidge, other large operators include Devon Energy Corp., and Royal Dutch Shell, Plc. (NYSE: RDS), which holds 600,000 acres. The play gained some recent cache with Range Resources’ announcement that it will increase rig count from 2 to 5 units in 2013 and the Midstates Petroleum Co. Inc. (NYSE: MPO) $650 million purchase of the acreage owned by play-originator Eagle Energy Production LLC in August 2012.

At first glance, the Mississippi Lime is attractive. The play features low well costs, exceptional well control from 17,000 vertical legacy wells, a good foundation of installed infrastructure, thanks to decades of drilling, and a liquids-heavy production profile—all of which argue for development to expand.

Furthermore, well costs hover in the low $3 million range, production is relatively shallow at less than 6,000 feet, and operators can employ abundant standard drilling rigs to bore horizontal laterals of 4,000 to 5,000 feet versus the technology rigs used elsewhere, which keeps cost low. Estimated ultimate recoveries (EURs) are roughly 150,000 barrels of oil equivalent with 1.5 Bcf of natural gas, with initial production rates in the 300 barrels of oil per day range over nearly 1,300 horizontal wells to date. In terms of cost and production, the Mississippi Lime compares favorably with the Wolfberry vertical play in the Permian Basin, though the Mississippi Lime averages a higher natural gas component.

Hitting a Mississippi Lime well in a core sweet spot produces internal rates of returns of more than 50%, ranking the best of the play high in comparison with other liquids rich developments domestically. Range recently reported a couple of wells producing more than 1,000 BOE per day along the Nemaha Ridge.

But it is what is happening outside the sweet spots that will determine how Three Mississippi Lime works out in 2013. News from SandRidge in late 2012 that production was more gassy than oily, plus an acknowledgement of rapid depletion in the oil component of production, coupled with a subsequent drop in EUR estimates per well, increased concerns about SandRidge specifically, and about the extent of the play in general. With more than 2.3 million gross acres and 30+ employed rigs, SandRidge is the play’s leading character at the moment.

Separately, the play produces enormous quantities of water that require additional infrastructure in the form of water handling and disposal facilities that can delay getting production to market while adding cost. Operators are now employing 3D seismic to map faults and fractures and avoid high volume water infiltration into producing zones. To date, the industry has drilled one saltwater disposal well to service five to six oil producing wells. SandRidge is experimenting with installing electrical submersible pumps to improve oil recoveries and claims it can reduce the number of disposal wells to producing wells from 1 to 6 currently to as low as 1 to 10 in the future.

These are solvable issues as the industry moves through the unconventional development cycle of delineation, optimization and ultimately resource harvest.

In other words, the Mississippi Lime is as challenging at this stage of development as most unconventional play developments, although the play is actually a conventional carbonate trap formation which operators are exploiting through unconventional drilling techniques.

The play will pass from delineation to optimization for most operators in 2013 with a small group of operators moving to the resource harvest phase of the cycle. Petrophysical studies, more operational experience over a broader aerial extent in 2013 and foreign investment will move the play forward as the count winds down on Three Mississippi Lime. That argues for rig count to grow further in 2013 although, judging from headlines in regards to a couple main players, maybe not as fast as it grew in 2012.

Contact the author, Richard Mason, at rmason@hartenergy.com.

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