The Contrarian Energy MLP

With natural gas prices falling, we've seen several companies try to move their portfolios more toward liquids. Vanguard Natural Resources (NASDAQ: VNR  ) is going in the opposite direction. What does this company see that the others don't? Let's look at this company bucking the industry trend and see what it means for investors.

You say goodbye (to gas), and I say hello
The best way to understand the contrarian approach of Vanguard is to look at Chesapeake Energy (NYSE: CHK  ) . Before the natural gas boom, Chesapeake had gobbled up millions of acres in these emerging shale plays. Then, when natural gas prices sank in 2012, the value of these assets tumbled and the company struggled to service its debt load. So Cheaspeake has gone to great lengths to change its drilling strategy toward a more liquids approach, which is starting to pay off. Chesapeake has increased its liquids produciton by more than 41,000 barrels of oil equivalent in 2012.

Then you have Vanguard. Before 2011, the company was highly leveraged to oil production in mature, proven fields and was producing only 35% natural gas. With so many companies looking to offload their gas assets based on current prices, Vanguard has been a buyer. In 2012, it purchased more than $760 million in assets from both Antero Resources and Bill Barrett in the Arkoma, Piceance, Wind, and Powder River basins. The combination of these two purchases increases Vanguard's natural gas production to about 65% of total production in 2013.

Why does this make sense? Simply put, the purchase price. These assets were purchased when the market value for natural gas was at its near lows, so the price to produce from them is much lower. Lease operating expenses for Vanguard dropped from $17 per Boe in the fourth quarter 2011 to just over $9 per Boe at the end of 2012. This means the company generates a return at lower natural gas prices. 

Echoes of another MLP?
Since the end of the previous quarter, Vanguard has come to an agreement with Range Resources (NYSE: RRC  ) to purchase $275 million of producing assets in the Permian Basin. This would make for just over a billion in purchases over the past 12 months. According to the company's most recent conference call, that pace may not slow either. Vanguard's management hinted that it expects to close on as many deals as in 2012, potentially even more.

Its pace of acquisitions is reminiscent of another exploration and production MLP: Linn Energy (NASDAQ: LINE  ) . With such a similar appetite for acquisitions, it makes it a little less surprising that Vanguard has stated that it's considering a move similar to Linn's spin-off of LinnCo (NASDAQ: LNCO  ) . This move not only allowed Linn to generate a large chunk of capital to fund some of its investments, but it also gave the company a vehicle for institutional investors to invest in the company. As of right now, Vanguard's management believes that it can fund most of its acquisitions through more conventional methods. In the event that it plans to start going after larger acquisitions, the company may need some other form of investment vehicle. Unless institutional investors start to warm up to the idea of investing in an upstream MLP, Vanguard management believes that it could pursue a structure very similar to to the Linn/LinnCo relationship.

What a Fool believes
Vanguard is a unique investment. Its contrarian approach may have seen absurd only a year ago, but it could work based on the prices it has paid for its assets. What also is very interesting about Vanguards approach is its preference to take non-operating stakes in certain plays. More than 40% of the company's budget relies on other operators. The issue with these types of ventures is that the company has less control of the drilling schedule, but it helps to keep its operational budget lower so the company can dedicate more of its operational cash flow to its distributions. At a distribution yield of 8.8%, this MLP certainly needs a healthy cash flow.

Just because Vanguard's approach is almost the opposite of Chesapeake's, that doesn't necessarily mean one is wrong and the other is right. Both strategies can be profitable, if executed correctly. To learn more about Chesapeake's approach fo the upstream energy space and its potential, you're invited to check out The Motley Fool's brand new premium report on the company. Simply click here now to access your copy, and as a bonus, you'll receive a full year of key updates and expert guidance as news continues to develop.


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  • Report this Comment On March 12, 2013, at 1:21 AM, cdb5556 wrote:

    I seem to remember an investment truism...something about buying low and selling high?

    (long VNR)

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