Risk isn't easy to quantify. In fact, financial advisor Carl Richards has noted that "risk is what's left over when you think you've thought of everything else." LINN Energy LLC (NASDAQOTH: LINEQ ) and LinnCo LLC (NASDAQOTH: LNCOQ ) investors learned that firsthand in 2013, as the biggest risk came from negative comments by a web-based financial media company that were then regurgitated by Barron's. No one saw that coming, just like few will see what roadblock LINN Energy and LinnCo might hit in 2014. That said, what once was a big risk for LINN Energy and LinnCo appears as if it will no longer pose as much of a problem in 2014.
Outside of what's said in the financial media, one of the biggest risks that LINN Energy and LinnCo faced in 2013 was the impact that the price of natural gas liquids, or NGLs, had on cash flow. While LINN Energy hedges 100% of its oil and gas production out four to six years on average, it doesn't hedge its NGL volumes. That can have noticeable impact on its cash flow, as these prices can swing wildly. For example, in the first quarter LINN Energy realized $33.38 per barrel for its NGLs, which was well under the $40.21 it realized in the first quarter of the prior year. That only got worse as the year wore on.
By the third quarter its NGL volumes only fetched $31.35 per barrel, which is a pretty big deal for a company that projected NGL production this quarter of up to 32,850 barrels per day. That is just 1,000 barrels per day less than its projected oil production, which is why NGL prices can have a big impact on its cash flow each quarter. In fact, one of the main reasons why LINN expects to deliver such a great fourth-quarter is because NGL prices have actually started to increase. Because of this, it now sees excess cash flow 5%-10% above what it distributes to investors.
However, it isn't rising NGL prices that are causing this big risk to abate in 2014. Instead, it's the closure of a deal for Berry Petroleum, as a bulk of Berry's production is oil. The fact that Berry Petroleum was guiding for 2013 oil production of about 32,500 barrels per day is huge to LINN, as it virtually doubles LINN's daily oil production. Overall, 80% of its production this year is oil, which is up from just 66% in 2009. Last year alone Berry grew oil production by 20% as it chose to invest only in the development of crude oil.
Because LINN Energy is getting a lot oilier, its exposure to NGL price volatility won't be as pronounced. Further, the addition of Berry's oil rich growth opportunities will enable LINN to shift more of its capital to oil growth instead of pursing more volatile NGL volume growth.
A good example of the importance of oil-focused growth as opposed to liquids-rich growth was seen at fellow MLP BreitBurn Energy Partners (NASDAQ: BBEPQ ) . BreitBurn really focused all of its capital into oil-rich growth, enabling it to grow its liquids production by 94% while also growing its Adjusted EBITDA by 46% over the past year. Overall, BreitBurn Energy Partners liquids production has moved from 45% of total production to 61% of production. However, liquids is a pretty loose term here, as just 5% of BreitBurn's total production is NGLs, with high margin oil making up 56% of its production. That's why BreitBurn had a much easier task growing its distribution coverage ratio in 2013 than LINN Energy.
Bottom line here is that one of LINN Energy's biggest known risks is slowly evaporating. Its deal for Berry Petroleum basically doubles its oil production, which will mute the impact of NGL price volatility in 2014. Further, by adding Berry's oil-rich drilling locations, LINN can follow fellow MLP BreitBurn Energy Partners in plowing more of its capital into oil-rich growth in 2014 to further mitigate the impact of NGL prices. While that doesn't mean LINN Energy isn't without risks, one of its biggest is slowly fading away.
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