SandRidge Permian Trust Risk Outweighs Potential Reward of Higher Oil Prices

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1 SandRidge Permian Trust Risk Outweighs Potential Reward of Higher Oil Prices SandRidge Permian Trust units (PER) fell from $4.50 on the ex-distribution date in November 2015 to an all-time low of $2.01 in mid January Since reaching the all-time low, the unit price rallied 35% to close at $2.72 on 1/29/16, the day after a distribution announcement of $0.19 per share. PER is now estimated to be trading in a fair value range consistent with a $40 per barrel price of oil over the next 5 years, assuming proven reserves are not impaired. This report provides a fundamental analysis of the Trust to provide investors a foundation for assessing the current fair value of PER shares. After reaching an all-time low of $2.01 in mid-january 2016, Sandridge Permian Trust (PER) shares rallied over 35% to close at $2.72 on 1/29/2016. The rally was supported by a distribution announcement of $0.19 per unit after hours on 1/28/2016. For multiple reasons, including the depressed market price of oil and the recent conversion of subordinated shares into common, the distribution level is not sustainable in the future. These factors, as well as risks associated with the virtual certain bankruptcy of SandRidge Energy (SDOC), the Trust well operating partner, make assessing the current fair value of the Trust shares a challenge. This report provides a fundamental valuation assessment of the SandRidge Permian Trust given the continued high risks faced by the Trust. Distribution Performance Review SandRidge Permian declared a common unit distribution of $0.19 in a press release on January 28, Overall earnings for the 8 th quarter in a row did not cover the Trust subordination threshold. Distributable income on a fully diluted basis was $0.14 per share, and subordinated unit holders did not receive a distribution. Since inception the Trust has paid out 79.1% of the target common distribution

2 level projected in the IPO prospectus, but recently the distribution level has been on a rapid downward trajectory. Although depressed oil prices are a major factor in the decline, it is not the only factor. Distribution levels are also falling because of poor well performance relative to initial estimates and expiration of lucrative derivative contracts during the year. Both of these issues, plus the upcoming expiration of common shareholder subordination protection, weigh on the future distributable income the Trust will be able to produce. SandRidge Permian Trust Earnings Performance Analysis During the last quarter, production volume was 231 MBOE, less than production in the previous quarter by 10.8% (the November distribution primarily reflects Sept-Nov production). The production level was down 31.6% compared to the same production quarter in 2015.

3 Trust distributable income was $7.54M in the most recent quarter, a decline of 23.5% quarter over quarter. Lower production and realized price declines account for the large drop in Trust earnings. The decline in volume continues to be faster than expected based on the age of the Trust wells and a typical production decline curve for wells in the Permian Basin. The steep decline is a red flag. The question becomes, has SandRidge Energy curtail production due to depressed prices, or is there well impairments that will reduce long-term production of the Trust? The PV-10 published in the Trust 10-K in March should provide useful insight on this risk. Drilling Completed Drilling was completed by SandRidge (SD) during the 4 th quarter of Based on the completion date, the conversion of subordinated shares took place on January 1, The Trust made clear in their results press release on 1/28/2016 that beginning with the May 2016 distribution the protection that common unit holders have experienced since IPO will end. Currently unit holders can expect the May distribution to drop to $0.07 per share as the common share count increases to 52.5M and oil prices remain at depressed levels. Trust Derivative Contracts Highly Favorable Oil Hedges have Expired Without the advantage of very favorable $100 per barrel oil hedge contracts that were in place in 2013

4 through early 2015, the realized price levels at the Trust declined significantly in the past two quarters. The realized price of oil per barrel fell to $43.84 per barrel in the last quarter, a decline of 12.6% quarter over quarter. Overall, realized price levels across all products delivered by Permian fell 12.53% over the past quarter to $39.17 per BOE. NGL prices stabilized in the quarter (10.0% of production), while natural gas prices (only 5.2% of production) were heavily depressed. Market & Realized Trust Pricing Trends In the graph below you can see the trend in average spot market prices for crude oil, NGL and natural gas during the past year and the last production period. Prices for oil and natural gas products fell during the September to November production quarter, while NGL prices were stable. All three product prices were sharply below year earlier levels. The weighted average realized price for crude oil at the Trust was $43.84 per barrel in the September to November production quarter.

5 As seen in the graph below, the $39.17 price per BOE of overall production in the last quarter was substantially lower than previous production quarters, but does show signs of slowing in decline rate. Indications are that the upcoming quarter should establish an intermediate low and possibly a longerterm low point for realized price levels. As of the beginning of February 2016 investors can expect a sharp decline to about $30 per BOE for the Permian Trust product mix in the distribution expected in May of Thereafter, realized price levels are expected to gradually recover. Current Oil Price Forward Expectations Since the price level of crude oil is such a critical component in determining the fair value of the Permian Trust units, the following graph has been created to help investors visualize the current expectation for crude oil prices through the end of 2020, and how the expectations have changed over the past 180 days.

6 The very rough winter for the oil sector has materialized as I suspected in previous articles. Now the market is beginning to price in, but only marginally, the impact of the inevitable decline in production that will likely pick up pace in the second half of I do not expect a dramatic oil price spike in 2016, as $40 oil is the price point that will force maintenance only operation across the industry, and there is a major storage excess that needs to be worked off. However, by this time in 2017, the futures curve is very likely to be back into the position it was in August of 2015, with a front-month spike very likely in the making. The longer that bare bones capital spending budgets are kept in place by many oil and gas operators, the more dramatic the price spike in the next several years is likely to become. Updated PV-10 In the Trust 10-K published in March 2015, the 2014 year end PV-10 was supplied which showed a per unit value of $8.29. This value reflected, as of 12/31/2014, the expected distributable cash flows from the estimated remaining proven reserves held by the Trust, discounted at 10%.

7 Adjusting for recent production of 1064 MBOE during the 4 quarters of 2015, the PV-10 is estimated to have declined in value to approximately $7.55 per share. At the recent traded unit price of $2.72 on 1/29/2016, the Trust is currently trading at a PV-10 multiple of 0.36 times. The PV-10 is now over one year old and uses estimates of market price levels which are far above the current market price levels for the oil and gas products sold by the Trust, over double the current market price for both oil and NGL. The price levels for oil and NGL production, which are 95% of Trust reserves, no longer are in line with current market price level expectations. The natural gas price used in the estimate is also above the current market. Based on a price level review only, investors assessing the current market price of Permian Trust shares should expect the traded price to be at a deep discount the most recent PV-10.

8 The PV-10 will be updated when the Trust releases its annual 10-K, expected at the end of February. Fair Value Estimation of Permian Units In order to gauge the fair value of the Permian Trust units against the backdrop of depressed and volatile energy prices and other risks, investors should assess the potential distributions they will receive through the end of life of the Trust. This report utilized this type of forecasting model, and discounts the expected distribution stream to a present value to arrive at a fair market value estimate for a Trust share. The model utilizes the forward NYMEX price curve for oil and gas products through year end 2020, and thereafter grows price levels at 2.5% per annum. The estimated price levels received for oil and gas products are adjusted for delivery based on the average differential which is typically realized by the Trust. The model uses a product mix of 86.1% oil, 9.3% NGL and 4.6% gas, in-line with the most recent Permian Trust PV-10. When the expected price and product mix assumptions are combined with the expected production rate of remaining proven reserves held by the Trust, the distributions each quarter a unit holder can expect through the end of life of the Trust ($6.48 in total from May 2016 through 2031 at current expected prices) can be forecast as shown in the graph below (see the blue line). Note that the upcoming May distribution is expected to be $0.07, 63% less than the current February distribution of $0.19. The May distribution will be the first after the subordinated shares convert to common on January 1, 2016.

9 Including the production on which the February 2016 is based, the Trust has depleted 38.31% of its reported proven reserve estimate. Total remaining proven reserves are estimated at 10,792 MBOE. Based on this model, at the closing price level of $2.72 on 1/29/2016 the implied rate of return on a Trust unit if bought and held to termination is 12.60%. If you expect a 10% return, a fair price level for a PER common unit is $3.15 up to the February 10 th ex-dividend date. After the ex-dividend date the valuation estimate at a 10% DCF estimate falls to $2.96 per unit. The model distribution valuation is substantially below the PV-10 primarily due to the forward product price expectations in the forecast. In the distribution model, the average realized oil price over the next 5 years is $37.50 per barrel, or about $43.50 before delivery and production taxes. Sensitivity of Trust Unit Price to Oil Price Changes Does a 12.60% implied rate of return give an investor a fair return if they purchased a Permian Trust unit today at $2.72? The price is definitely far lower than it has been at most any time in the Trust history; but, is the price fair given the balance of risks present in the market today and more specifically risks with the Trust itself? To help investors assess this question a price sensitivity table has been prepared

10 which shows how the valuation model changes if the implied forward price of oil rises or falls from its current market level. As you can see in the table below, the Trust is valued at $2.64 per share when forward oil prices are assumed to average $40 per barrel over the next 5 years and thereafter increases by 2.5% per annum through the Trust end of life. If you believe that oil prices are the primary risk facing Permian Trust shareholders, and that $40 per barrel is a longer range market floor, then the current traded price of the Trust is a favorable investment opportunity. The opposite is true if you think prices will be lower. My personal assessment of the oil market is that the $40 level will mark the lower range for future oil prices and that the balance of risk are to the up-side, not down-side. Changes in oil price levels although a major factor, however, are not the only risk that investors need to weigh in their assessment of the fair value of the units at the present time. SandRidge bankruptcy threat raised Distribution disruption risk grows Previous reports have highlighted the risk that SandRidge Energy, the Trust well operator, my enter bankruptcy protection and potentially disrupt distributions and future returns to Trust shareholders. Although a separate legal entity, SandRidge Energy s financial misfortune can cause problems for Trust shareholders and should not be overlooked as a risk in pricing the shares for investment.

11 During the 3rd quarter of 2015, SandRidge Energy underwent voluntary debt restructuring which left the company in a stronger liquidity position, almost $1B in cash, by re-structuring $925M of its outstanding senior unsecured debt. The company also ceased all preferred dividends at the time. The changes provided the company financial strength in the form of much lower on-going interest charges and elimination of the need to refinance a large portion of its debt until 2022 (in exchange for major existing shareholder dilution and dividend cessation). The hope by SandRidge management was that the changes would allow it to ride out the decline in energy price levels. However, since the time of re-structure market oil and gas prices declined much further than anticipated. The decline now means the debt covenants on its secured line of credit will very likely be triggered in the company April creditor reserve impairment review. Additionally, reports are that SandRidge has been required by regulators to shut down seven wells in Oklahoma and reduce wastewater injected into at least 40 wells more due to earthquakes being experienced in the area linked to SandRidge wells. This settlement at best means reduced production in this area (note Permian assets are in Texas, not Oklahoma). Currently SandRidge Energy (SDOC) shares trade in the over the counter market at $0.03 per share, signaling that the shares are essentially worthless. The issue for the SandRidge Permian Trust is at what point liquidity may dry up at SandRidge Energy, potentially jeopardizing payments made between the Trust and SD. There is also the likelihood that well maintenance to keep production levels at the levels previously estimated to be recoverable will be foregone to preserve cash. The risks associated with the financial troubles being experienced at SandRidge Energy currently are ones which SandRidge Permian investors must assess how they might impact the value of the assets held by the Trust in the future. My personal opinion is that The Permian assets have good long-term value; however, the risk of short-term impairment in some way is growing in likelihood. Bottom Line - Risk Outweighs Potential Reward Individual investors should assess what they believe the fair value of the Trust units is at this point based on their risk tolerance and forward expectations for oil prices. My opinion on the Permian Trust is that the fair market value, ex-dividend on February 2016 should be based on a $40 to $50 oil price for the next five years, which is a value of $2.64 to $3.55 per unit based on my valuation model. The oil market over the next year is going to tighten, and I believe it will move back toward the $50 per barrel mark by year end or early Thereafter, geopolitics will likely determine if it remains in this range for many years as the Saudi s have implied in public discourse, or pressure due to conflict in the region ultimately disrupts supply to the extent that the world heads back to $100 oil or even higher. At this point, I don t see any reason to pay up for such an outcome given the inventory level worldwide. However, should such a spike materialize, SandRidge Permian unit holders given the Trusts oil heavy production mix would be big beneficiaries. However, the two major risks highlighted in this report, the fast pace of production decline and the SandRidge bankruptcy risk, weigh on the units in market trade. Because these risks are elevated at the present time, I believe the shares should be avoided. The $2.00 floor price will be tested if a binary event such as a distribution suspension, even if viewed as temporary, is triggered by a messy SandRidge

12 bankruptcy. Additionally, I want to see the upcoming PV-10 report for the Trust to get a better understanding of whether the Trust wells have been impaired significantly for a reason other than price over the past year. Daniel Moore is the author of the book Theory of Financial Relativity: Unlocking Market Mysteries that will Make You a Better Investor. All opinions and analyses shared in this article are expressly his own, and intended for information purposes only and not advice to buy or sell.