How LINN Energy Saved its Distribution this Quarter

LINN Energy drilling in the Granite Wash. Photo credit: LINN Energy

LINN Energy (NASDAQ: LINE  ) and its affiliate LinnCo (NASDAQ: LNCO  ) reported a pretty solid quarter. Of course, that's just my opinion. Which is something investors need to keep in mind when looking at earnings releases and the commentary that follows, while the numbers are real, our interpretation of them can sometimes be very different.

That's why I've always been very fond of the quote, "if you torture the data long enough, it will confess to anything," which is loosely attributed to British economist Ronald Coase. We're always looking for an angle that will confirm our bias. My bias is pretty clear, especially when scrolling down to the disclosure section that notes I own both LINN Energy and LinnCo. I want to see the good in the numbers because it makes me feel better about my decision to invest in this business.

That said, I really did try to find something wrong with LINN Energy's quarter. But, truth be told, I was pleasantly surprised as the results exceeded my own muted expectations. The fact that it didn't have a shortfall in meeting its distribution really surprised me.

One of the reasons LINN was able to do this was its ability to cut its total operating expenses by 7% on the quarter relative to its guidance. While cutting costs can provide a nice boost to income, these aren't long-term drivers. What is a long-term driver is LINN's ability to get more out of the wells it drills.

This is where LINN really saved its distribution this quarter, and hopefully for more quarters to come. LINN's first quarter results were marred by poor performance in the Hogshooter wells it was drilling in Texas. The company shifted gears and moved its drilling rigs to the Mayfield area of Western Oklahoma. That move really paid some big dividends this quarter.

The company has now drilled a dozen wells which had an average initial production rate of 3,800 barrels of oil equivalent per day. These were very liquids rich at 74% and cost the company about $7.9 million to drill. Just to put those numbers into some context, we'll take a look at Continental Resources (NYSE: CLR  ) and its wells in the SCOOP play of Oklahoma.

Continental Resources is spending about $9 million per well in the oil window, which are about 75% liquids. Its three most recent wells produced average initial production of 1,850 barrels of oil equivilent per day. At current prices Continental is seeing a rate of return just over 40%. While those returns aren't quite as high as it sees in the Bakken, it's good enough for Continental Resources to earmark a quarter of its 2014 capital budget on the play. All this to say, LINN Energy seems to have found a very rich spot to drill and sees the potential for 100 more wells in the Mayfield area.

If LINN's Mayfield wells performed poorly it could have affected LINN's ability to pay its distribution. However, its success suggests that it's starting to find its footing. Looking further ahead, LINN Energy has interesting potential in the Permian Basin that could lead to further strengthening of its distribution.

Much of the company's acreage in the Permian is prospective for horizontal drilling of the Spraberry and Wolfcamp intervals. The shift to horizontal drilling has been a game-changer for companies like Pioneer Natural Resources (NYSE: PXD  ) . CEO Scott Sheffield noted on the company's last conference call that in six months one of its horizontally drilled wells produced 140,000 barrels of oil equivalent. A vertical well would have taken 30 to 35 years to produce that much oil. That's why Pioneer Natural Resources is leading the charge to develop the play through horizontal drilling.

This is a shift that LINN Energy is just beginning to undertake. The company is participating in four non-operated wells and has plans to drill its first operated well by early next year. Success here will make it much easier for LINN to at least keep its distribution steady, if not grow it in the future.

The bottom line here is that LINN Energy drilled its way to a safer distribution this quarter. The potential is there for LINN to keep it up in the future and to accelerate its growth with its ability to continue to acquire. That's why I still think LINN is a solid play and its distribution still looks rock-solid to me.

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Read/Post Comments (6) | Recommend This Article (3)

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  • Report this Comment On November 01, 2013, at 12:17 PM, timmnsa wrote:

    I was pleasantly surprised by Q3 report, too.

    Plus, there is this morning's announcement by LINE/LNCO that the SEC advised "no further comment" on Amendment # 6 to the revised Form S-4 regarding the stalled merger with Berry.

    Should be an interesting conference call next Wednesday.

  • Report this Comment On November 01, 2013, at 1:03 PM, LeKitKat wrote:

    Matthew

    As an analyst with a major investment company, maybe you could contact the company and ask if they plan to disclose distributable cash and coverage ratio. It's normally in the supplemental quarterly release on the website but was conspicuously absent this Q. I emailed them but they don't respond readily to questions from the general public

  • Report this Comment On November 01, 2013, at 2:33 PM, zorro6204 wrote:

    First they did disclose DCF and coverage, it's just not called that anymore. Hey, blame the SEC, not LINE! And . . . educate yourself a little on the background here before commenting? Anyone following LINE knows what the score is there.

    Second, yesterday I emailed IR with a question on Berry, they emailed me back within the hour, gave me a phone number and invited me to call. I did and they picked up right away and spoke to me for nearly five minutes. So . . . maybe try a little harder?

  • Report this Comment On November 01, 2013, at 3:01 PM, zorro6204 wrote:

    If this posts twice, it was a glitch. Anyway, to the above person, anyone following LINE with the least attention knows that they did disclose DCF and coverage, it's just done in different language, and for that, blame the SEC, not LINE.

    As to them not readily responding to the public, yesterday I emailed them a question about the Berry deal. Within an hour they emailed back a phone number and invited me to call. I did, they answered, and we spoke for several minutes. I would call that "readily responding", and then some.

  • Report this Comment On November 01, 2013, at 4:05 PM, TMFmd19 wrote:

    @LeKitKat - Zorro6204 is right, the names is different because LINN is actually an LLC not an MLP. New term to know is: "Excess of net cash provided by operating activities after distributions to unitholders and discretionary adjustments considered by the Board of Directors"

    I wrote about it here: http://www.fool.com/investing/general/2013/10/29/linn-energy...

    That said, the coverage ratio was just above 1.0 as LINN earned $2 million more than it paid out.

    I've reached out to LINN before and both times they got back to me within an hour or so.

    Matt

  • Report this Comment On November 02, 2013, at 1:44 AM, zorro6204 wrote:

    Uh, Matt, I hate to correct you, you're more right on most things than others around here, but the fact that LINE is an LLC has nothing to do with the language in the release or the S-4. Matter of fact, it has nothing to do with anything really, it's just that an LLC doesn't require a dummy corp as a general partner. Tax wise and operationally, its the same thing as an LP. Nobody uses LP's anymore, but it's not significant.

    Anyway, history lesson on LINE and "DCF". Before the Barron's and Hedgeye attacks, LINE never presented "distributable cash flow" in its earnings releases, just something called "adjusted EBITDA", which I never found very useful. You could always derive DCF, because they disclosed coverage in the conference calls, but that meant you had to back into maintenance capex, and they never gave any color on how that was calculated. Someone pointed out they did present a condensed calc of DCF in a presentation once, but it was not common practice.

    Then the attacks came, and when LINE released Q2 earnings, they included a reconciliation to DCF, and took some time to explain maintenance capex, and how it was derived. The first S-4 also included DCF calcs, from the Q2 release.

    Then, apparently, the SEC chimed in and made them alter and then (again apparently) drop "adjusted EBITDA", it was nowhere to be found in the Q3 release. Instead the SAME DCF NUMBER they previously provided was derived starting from the GAAP cash flow statement. This ultra confusing presentation, out of step with the rest of the upstream space, is brought to you courtesy of our stupid government, thanks very much civil servants.

    Presumably LINE is now stuck with this mess, the only result of the BRY deal besides legal fees, unless somehow the LNCO/BRY gap can be closed before the deal peters out. Maybe we'll hear more on that quarter next week.

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