Can LINN Energy Grow Its Way out of Its Current Mess?

Photo credit: LINN Energy

So far, 2013 has been a year to forget for LINN Energy (NASDAQOTH: LINEQ  ) and its investors. The company has struggled with historically low natural gas liquids, or NGL, prices, its once promising Hogshooter oil development program in Texas turned out to be a dud, and let's not forget that it's currently being informally investigated by the SEC. To make matters worse, its transformational deal with its affiliate LinnCo (UNKNOWN: LNCO.DL  ) for oil-rich Berry Petroleum (UNKNOWN: BRY.DL2  ) has been delayed and could potentially fall through.

Add it all up and LINN Energy continues to pay out more than it earns, which isn't a sustainable business practice. In fact, so far this year the company has paid out $38.5 million more than it earned. This means that 11% of its current distribution is being funded from sources other than current cash flow. If LINN's deal for Berry does fall through, will it still be able to grow out of its mess?

What we do know is that closing the Berry deal would quickly solve LINN's problems because it would bring its distribution coverage ratio up to 1.16 times in the fourth quarter, instead of the projected 0.95 times LINN would have without closing the deal. Should the deal fall through, LINN does have some intriguing internal opportunities that it could pursue to climb its way out of its current hole of having a low distribution coverage ratio. Let's take a closer look at two of these options.

The Mississippi Lime
On its conference call with analysts LINN mentioned that it has some prospective acres in the Mississippi Lime which it's pursing a joint-venture agreement to develop. The partner would carry a portion of LINN's drilling costs and would potentially drill 15 horizontal wells in the Mississippi Lime over the next two years. In addition to that, the company has about 450,000 acres in the Anadarko Basin which could hold similar potential for joint-venture deals.

The Mississippian is an area that SandRidge Energy (UNKNOWN: SD.DL  ) has been aggressively pursuing due to the high rate of return of its oil-heavy development opportunities. In fact, at current prices, SandRidge can produce a 50% internal rate of return in the Mississippian despite the fact that 55% of the production out of the Mississippian is natural gas. That's because the oil content is high enough and the well costs low enough to really drive its returns. SandRidge's success in the play bodes well for LINN's opportunities to also target this high-growth, high-margin play.

The Wolfcamp/Spraberry
Another potential high-growth opportunity in LINN's current portfolio is the Wolfcamp/Spraberry portion in the Permian Basin. LINN believes that it has about 25,000 net acres; it's currently working with its partners to drill four non-operated horizontal wells later this year. If all goes according to plan, LINN can ramp up its development efforts later this year. Further, if the Berry deal does close, LINN would double its acreage in this prospective play.

LINN mentioned in its earnings press release that increased horizontal drilling activity by the industry leads it to believe that it too will find success here. In fact, Pioneer Natural Resources (NYSE: PXD  ) is reporting unbelievable numbers using horizontal drilling to target these plays. In one of its horizontal Wolfcamp wells, the company produced 140,000 barrels of oil equivalent in about six months. A typical vertical Wolfcamp or Spraberry well took 30-35 years to produce that much oil. This is why LINN is watching industry peers like Pioneer to see if it makes sense to pursue moving more of its capital toward horizontal Wolfcamp wells.

Final Foolish thoughts
While losing the Berry deal would certainly hurt LINN, it does at least have some high-return internal options it could pursue in order to make up its distribution shortfall, even if it needs to shut off its acquisition machine for a while to continue dealing with the SEC. LINN Energy might be down right now, but given some of its interesting internal options, it's certainly not out.

Not only that but as a consolidator of mature assets LINN has the potential to gain from the record oil and natural gas production that is revolutionizing the United States' energy position. However, it's not the only company that will win, which is why finding the right plays while historic amounts of capital expenditures are flooding the industry is the only thing that will pad your investment nest egg. That is why it might be worth it to you to check out the Motley Fool's comprehensive look at three energy companies that are really set to soar during this transformation in the energy industry. To find out which three companies are spreading their wings, check out the special free report, "3 Stocks for the American Energy Bonanza." Don't miss out on this timely opportunity; click here to access your report -- it's absolutely free. 

Read/Post Comments (3) | Recommend This Article (4)

Comments from our Foolish Readers

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  • Report this Comment On August 10, 2013, at 8:49 AM, JustMee01 wrote:


    Linn's not exactly in a happy place at the moment.

    Understandably, you neglected the gas projects. They're so unsexy...

    There are two new drilling programs that will bring significant growth in the future on the ex-BP properties. One rig is operating in the Hugoton, while a second is now running on the Jonah field.

    Gas may be poorly priced at the moment, but unlike the unconventional plays you outline, these conventional wells will be steadily contributing to production for a very long time. There are a lot of conventional proven undeveloped reserves to unlock in both fields.

  • Report this Comment On August 12, 2013, at 11:17 AM, road2perdition wrote:

    It is time for all to realize that the LinnCo-Berry deal of 1.25 shares for each share of Berry is dead in the water. If anyone else still believes that it is going to happen, I have three quarters that I will give you for a dollar.

  • Report this Comment On August 12, 2013, at 2:25 PM, sept2749 wrote:

    I think LINE/LNCO are in a pickle! They have the SEC taking a look and various law firms looking to file suits. How long can they continue to pay out more then they take in. The share price is around 23 and change and I don't see it coming up for a long time. It's not like next week the SEC is going to say that LINE is just fine. This whole thing is going to take time to play out. I would only buy back in ( I sold my shs.) when this mess is finished. The distributions were great and I miss them but I didn't want to risk the $$$ I had built up.

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