When building a portfolio of master limited partnerships in the energy patch, this one should be at the top of the list, notes Elliott Gue of Energy and Income Advisor.
The largest upstream publicly traded partnership by market capitalization, Linn Energy (LINE) went public in early 2006, and has grown into the eighth-largest independent oil and gas producer in the US.
Over the past six years, the limited liability company has expanded its reserves to 5.1 trillion cubic feet of natural gas equivalent, of which oil and natural gas liquids (NGL) account for 45%. Although the firm’s asset base spans oil- and gas-producing acreage in California, Texas, Oklahoma, Kansas, North Dakota, and Michigan, one commonality unites these properties: their low operating costs and reliable production profiles.
Given its size and scale, Linn Energy can pursue ambitious organic growth opportunities, such as its horizontal drilling and hydraulic fracturing program in the Granite Wash and its joint venture with Anadarko Petroleum (APC) at the Salt Creek field in Wyoming
Linn Energy has amassed about 30,000 net acres and identified an inventory of more than 600 high-probability drilling locations in the Granite Wash, a liquids-rich basin in the Midcontinent region that contains at least eight productive zones.
With the price of natural gas likely to remain depressed for at least the next two to three years, Linn Energy and other operators two years ago shifted their focus from deep-lying gas-bearing deposits to liquids-rich formations.
However, the rapid decline in NGL prices in the first half of 2012—a downturn that was particularly pronounced at the oversupplied hub in Conway, Kansas—compressed profit margins in the region. Although Linn Energy aggressively hedges its oil and gas output, the relative immaturity of and lack of liquidity in the NGL futures market present an impediment to hedging this exposure directly.
In this situation, the firm’s strong presence in the Granite Wash proved its worth. Linn Energy responded to deteriorating NGL prices by shifting its drilling activity to target the oil-rich Hogshooter, a shallower formation within the Granite Wash.
On September 28, Linn Energy announced that the nine horizontal wells that the firm drilled and fractured in the third quarter boasted an average initial production rate of 1,983 barrels day of crude oil per day and 3.4 million cubic feet of natural gas per day. These results correspond with flow rates from the three Hogshooter wells that the limited liability company drilled earlier this year.
The upstream operator plans to drill about 20 horizontal wells in the Hogshooter this year. We expect this drilling program to continue apace in 2013.
We’re also bullish on Linn Energy’s joint venture with Anadarko Petroleum in Wyoming’s Salt Creek play, a mature oil field that the two partners will seek to exploit through carbon dioxide injection. The project’s operator estimates that about 20% of the field’s reserves were extracted during primary production.
Water flooding—an enhanced recovery technique that involves pumping large volumes of water into a mature field to artificially increase reservoir pressure—is estimated to have produced another 25% of reserves. With an estimated 1 billion barrels of oil in place, tertiary production methods could boost the end recovery rate.
Thus far in 2012, the upstream MLP has closed two major deals with BP (BP), one of the markets most motivated sellers.
On February 27, Linn Energy announced the $1.2 billion purchase of BP’s 600,000 net acres in Kansas’ Hugoton Basin. This property is home to more than 2,400 long-lived wells that produce an average of 110 million cubic feet per of natural gas equivalent per day, about 63% of which is natural gas and 37% of which are NGLs. These wells exhibit an annual decline rate of about 7%. BP had also identified an inventory of about 800 high-probability drilling locations, providing plenty of potential upside.
About four months later, the two sides announced that Linn Energy had agreed to pay $1.025 billion for BP’s gas-producing assets in the Jonah Field, located in southwest Wyoming. The transaction covers the international oil company’s working interest in 260 operated wells that produced an average of 80 million cubic feet of natural gas equivalent per day, as well as non-operated wells with average net production of about 65 million cubic feet of natural gas equivalent per day. The roughly 12,500 net acres involved in the deal contain an estimated 1.2 trillion cubic feet equivalent in resource potential.
Not only are these deals accretive to distributable cash flow without additional drilling and development, but Linn Energy’s return on investment will only increase when the price of natural gas recovers. Moreover, Linn Energy has hedged 100% of expected production from these properties for several years into the future, taking advantage of higher prices down the futures curve.
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