Right now is a good time to be in upstream MLPs. These partnerships typically buy long-lived assets, hedge production out for at least a couple years to lock in the cash flow, and distribute that cash to unit holders. Assuming a stable regulatory environment, upstream MLPs need two things: Availability of mature oil and gas assets for sale and a friendly debt market.
A common argument among bears is that high rates would prevent additional acquisitions for upstream MLPs, and that they would therefore be stuck with old fields and precipitously declining production. Because these partnerships never explore and rarely drill for new hydrocarbons, they must acquire acreage to grow production and distributions.
The party continues
After hitting a yield of 3% in September, 10-year treasury notes have recovered and yields have retreated back down to 2.5%. Historically speaking, that's a pretty low rate. It looks like upstream MLPs, for now, will have a good environment for deal-making.
Plenty to pick from
Right now, many upstream MLPs are "on the hunt" to acquire properties, and there's ample opportunity to buy. Why? In short, because many operators are pouring capital into shale oil. For example, between 2007 and 2012, operators have raised $500 billion in capital for the shale. And a majority of that, $297 billion, came from asset sales. In a nutshell, many operators are selling their mature US properties to raise capital and develop assets in the Eagle Ford, Bakken and others. This has flooded the market with exactly what upstream MLPs are looking for, and they are often buying for very reasonable prices.
Linn Energy (NASDAQ: LINE ) is the biggest name in this space and most obvious place to start despite the current uncertainty surrounding it.
Linn has a huge asset base in the Permian Basin of over 100,000 acres. The Permian was also the site of its most recent acquisition, where Linn picked up an additional 6,250 net acres, 300 more wells to drill, 4,800 barrels equivalent of production per day and 30 million in reserves. While management estimates a reserve life of 17 years, there are another 24 million potential barrels attainable through waterflooding, which would surely add much life to those reserves.
Consider for a moment the economics of this deal: With an oil price of $100 per barrel and a Henry Hub price of about $4 per thousand cubic feet, we use a weighted average and get revenue per BOE of $77.20.
We then subtract the $15.00 per barrel of operating costs and get margin of $62.20 per barrel. That's nearly $300,000 in margin per day. Assuming the average well operates 340 days per year, we get about $101 million per year: a breakeven of 5.2 years. That's a pretty good setup. Linn will be producing in the Permian for a long time to come.
Linn's recent quarterly results showed a lot of progress, especially from its recent acquisition. Best of all, going by what the company used to term Distributable Cash Flow, or DCF, Linn should once again be able to fully cover its distribution. Linn currently yields 10.3%. While the overhang of an informal inquiry by the SEC still remains, the worst of that seems over. Linn is worth wading into.
Then there's BreitBurn Energy Partners (NASDAQ: BBEP ) , another bigger name in this space. And you couldn't be blamed for liking it. BreitBurn was formed in the late 80's on the premise that there was a lot more oil in the US than previously thought. And BreitBurn has had a secure coverage ratio for awhile now. This year, the partnership is slated to hit the high end of its coverage target of 1.1 to 1.2 times distributions.
While not as big as Linn, BreitBurn has pulled off some noteworthy acquisitions. The largest of which was its deal with Whiting Petroleum (NYSE: WLL ) in the Oklahoma panhandle. Production from this deal will be over 80% oil with a reserve life of 13 years. Using the same parameters, this $860 million deal has an estimated payback about as long as Linn's Permian deal: 5.3 years. Perhaps most valuable is the CO2 flooding experience BreitBurn will get from these operations, which management can use on other properties.
BreitBurn's assets are pretty diversified. Its biggest production areas are the gassy Antrim shale in Michigan, various basins in Wyoming and now, the more oily Oklahoma panhandle assets. BreitBurn also has significant oil assets in Kern County, California, the Permian basin and a few others. This partnership yields a generous 10%.
Thanks to stabilizing interest rates and continued abundance of supply, the upstream MLP model of acquiring to grow is safe and sound for now. These names will be able to continue acquiring mature properties, many of which have significant opportunity to be further developed through enhanced recovery methods. Linn and BreitBurn are two of the better, if not the best, acquirers in this space.
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