For investors of LINN Energy (NASDAQ: LINE ) , 2013 has been a terrible year. Informal SEC investigations regarding both its accounting principles and its complicated, dragged-out acquisition deal involving its holding company LinnCo (NASDAQ: LNCO ) and Berry Petroleum (NYSE: BRY ) have also contributed to shares plummeting 25% this year alone.
For LINN Energy to regain investors trust, it needs to do one thing and one thing alone: Produce oil and gas efficiently. Let's check in with how that effort is coming to see if LINN can leave the baggage from 2013 behind.
Generating cash is king
There is a cardinal rule for all master limited partnerships that you must have a distribution coverage ratio greater than 1. It sounds fancy, but it just means you can't give more cash out to your shareholders than what you take in. If you just miss this mark once in a while, it's not the end of days, but you certainly shouldn't get in the habit of it. Unfortunately for LINN, it has violated that cardinal rule for two straight quarters, and it anticipates it will continue to miss that coverage ratio of 1 for the next two quarters.
Another thing to note about LINN is that the company hedges 100% of its production, which is a true rarity among exploration and production companies. Even today, LINN's upstream MLP peers only have about 71% of their total production hedged. This means that the total amount of revenue the company brings in is very predictable, which is exactly what an MLP is looking for when determining distribution payments.
Using LINN's projections as a guide, we have a rough idea of how much it plans to produce, and we know that the price it will get is pretty fixed because it is hedged. So there is only one variable that can throw cash generation out of whack, and that is how efficiently it can produce oil and gas and keep costs under control.
Playing to LINN's other strength
LINN gets a lot of credit for being an "acquisition specialist" because it always seems to be looking to buy assets. What many investors seem to overlook, though, is that it is also very good at taking those assets and finding ways to squeeze efficiencies out of the drilling process. The best example of this is in the two regions where it has the largest drilling activity: the Granite Wash play in Western Oklahoma and the Permian Basin in Texas. So far this year, LINN has been able to bring its well completion costs in the Granite Wash down 11% to about $8 million per well, which puts its costs very much in line with the top driller in the region, Apache (NYSE: APA ) .
What is probably more important, though, is that its Permian Basin per-well costs have dropped by 15% compared to 2012. This is especially critical because of both the recent $500 million purchase in the Permian as well as the large acreage it could pick up as part of the Berry Petroleum deal. As LINN builds know-how in the Permian, it will be able to translate those operational efficiencies to these new assets, which should enable the company to generate a better return on these long-life, mature assets.
What a Fool believes
There isn't much investors can do when it comes to SEC informal inquiries, and there is still a little uncertainty regarding the Berry acquisition that is out of LINN's hands. For the company to really take control of its future (and get that coverage ratio back up to where it should be), it will need to focus on keeping costs down. It appears that from an operational standpoint, it is doing a very commendable job in its core regions. If LINN can translate this operational efficiency to its newer assets like the Green River Basin and the Jonah field, then it should be in a pretty good position, Berry deal or not.
Let's face it: We like LINN for that 11% distribution
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