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The announcement of a possible deal to lift sanctions on Iran sent Brent crude prices down by $2 on Monday. Many experts believe that supply risks in Libya and Iraq, coupled with refineries already operating at full capacity, will put a floor under Brent crude. Nevertheless, investors have read the events of this weekend as a sign to broadly make for the exits.
This has created a set of opportunities in oil names that operate in conventional basins and employ enhanced oil recovery techniques such as water flooding and CO2 injection. These names have a very low cost of production and will therefore not be threatened even if oil prices drop substantially.
Take a look at this chart above from a Denbury Resources presentation, which compares the profitability of CO2 injection to some of the hotter shale plays. To be reasonably profitable, the better Bakken wells require $68 oil, Eagle Ford wells require $76 oil and wells in the Mississipian require $87 oil. Amazingly, CO2 injection names are profitable with oil prices as low as $50. This article will look at 2 enhanced recovery names which operate in the lowest cost environment and whose prices have pulled back.
Prime acreage MLP
In the U.S., locations with the lowest production cost tend to be in mature basins. Perhaps the most prolific of these geographies are West Texas and Southern California, both of which have been producing oil since before the Second World War. California is particularly attractive because oil there fetches Brent Crude pricing, while mid-continent oil sells for West Texas Intermediate, the latter of which is significantly lower in price.
Linn Energy (NASDAQOTH: LINEQ ) is a great way to play both basins while collecting a substantial income. Linn currently has over 100,000 acres in the core of the Permian Basin, and will have 160,000 when its acquisition of Berry Petroleum is complete. In California, Linn will also be adding substantially to its acreage thanks to the Berry transaction. In fact, after the transaction, Linn will be the fifth biggest producer in California. In both states Linn drills from very established basins, such as Sunset-Midway in California and Wolfberry in Texas, which carry among the lowest production costs in the country. Linn will be profitable even with lower oil prices. Best of all, shares of Linn currently yield 9.66%, and the company hedges its production out for five years, making Linn a great way to build income.
Water flooding, where the producer injects water into a reservoir to push out the oil, has kept America's oil producing basins active for much longer than originally expected. Mid-Con Energy Partners (NASDAQ: MCEP ) is a pure water flood, pure oil production play. Operating in Oklahoma, Mid-Con enjoys high margins from conventional production in a mature geography.
This chart above, more than anything else, illustrates the margin advantage Mid-Con enjoys over its gassier peers. Like Linn, Mid-Con only produces from mature, well-developed acreage. With an EBITDA margin of $68 per BOE, Mid-Con's business will not be disrupted by anything the Iran agreement may lead to. Mid-Con has come down in price by over 15% in the last 30 days on the company's decision to focus capital expenditure on water injecting equipment, which has delayed production increases. A general sell-off in oil stocks is also to blame for Mid-Con's pullback. Like Linn, Mid-Con is a high-yielding MLP. Mid-Con now yields 9.15%. This is another solid income opportunity.
Whether the Iran deal will significantly affect oil prices remains to be seen. If oil comes down significantly, deep-water production and the more marginal shale plays will be affected first. But by focusing on enhanced recovery operators, we can lessen the risk of falling oil while still picking up companies whose stocks have been beaten down. That is a win-win.
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