1 Important Number LINN Energy, LLC Investors Might Have Missed

Photo credit: Linn Energy, LLC

LINN Energy (NASDAQ: LINE  ) and LinnCo (NASDAQ: LNCO  )  recently reported pretty strong fourth-quarter results. That report was filled with all sorts of numbers, including 2014 guidance that some investors didn't like. However, because so many investors were focused on guidance, it was easy to miss the improvements LINN Energy made to its proved reserves last year.

Why proved reserves matter
Proved reserves are the oil and gas that an energy company is fairly certain it can to produce under current technology and economic conditions. For investors in LINN Energy or LinnCo this is a really critical number to keep an eye on each year. When we invest in either company, we are buying a piece of those proved oil and gas reserves.

Further, when LINN Energy or LinnCo make a deal to acquire oil and gas assets, it's the proved reserves that matter most as those reserves are what will fuel the income paid to investors. If those assets are later found to be weaker than expected it poses a problem for LINN Energy. The company would then need to spend more capital to replace those reserves so that it can keep production flowing and growing.

A closer look at this year's number
Last year LINN Energy was able to grow its proved reserves by 34% to 6.4 trillion cubic feet equivalent, or Tcfe. Overall, 34% of LINN Energy's reserves are oil, 47% are natural gas and the final 19% are NGLs. In 2012 the mix was 24% oil, 54% natural gas and 22% NGLs. The key here is that we're seeing a solid reserve mix that made a big shift toward oil thanks to the company's deal to buy Berry Petroleum.

LINN Energy usually sees the biggest addition to its proved reserves by acquiring those reserves. Last year the company's deal with LinnCo for Berry Petroleum, as well as its purchase of assets in the Permian Basin, added 1.6 Tcfe to the company's reserves, which is what provided most of the company's reserve boost last year.

That said, the purchase of reserves weren't the only additions to LINN's reserves last year. As the following table shows, there were a lot of moving parts when it comes to LINN Energy's proved reserves.

Proved Reserves Table (Bcfe)

   

Proved reserves at December 31, 2012 

4,796

Revisions of previous estimates due to price

52

Revisions of previous estimates due to PUD SEC 5 year rule

(109)

Performance revisions

(100)

Purchase of minerals in place

1,610

Sales of minerals in place

(73)

Extensions, discoveries and other additions

527

Production

(300)

Proved reserves at December 31, 2013

6,403

Source: LINN Energy fourth-quarter earnings release

 

Photo credit: LINN Energy

Last year LINN Energy removed 109 Bcfe of reserves due to a 5 year SEC rule as well as another 100 Bcfe due to poor performance. Of the two, the downward revisions due to performance is an area that could be a concern. As I mentioned before, when LINN Energy buys an asset it's buying proved reserves, and for the company to find out that it didn't acquire the reserves it once thought existed could cause problems down the road. However, in this case the 100 Bcfe of performance revisions is pretty small and was actually a combination of the company adding in about 200 Bfce of reserves at its Hugoton and Green River assets, while 300 Bfce of reserves came off the books at its Granite Wash assets. Overall, this number is much better than the 340 Bcfe the company dropped from its books last year.

The other important number on the table above are the 527 Bcfe of reserve extensions, discoveries and other additions, which represent a very positive development for the company. These additions are a direct result of the company's $1.17 billion drilling program last year that saw the company complete 559 total wells. This organic growth was more than enough to offset the company's production last year and represents a very strong 123% organic reserve replacement ratio.

When we net everything out LINN Energy saw significant improvement in the makeup of its proved reserves from 2012. That year the company needed to remove 94 Bcfe from its reserves excluding production and acquisitions. This year, however, the company's reserves actually rose by 370 Bcfe with those same exclusions. That's the direction we want to see its reserve going, especially given the fact that LINN Energy does spend capital to grow organically.

Investor takeaway
Last year LINN Energy saw its reserves head in the right direction. The company's drilling program enabled the company to replace 123% of its production, while its acquisition program boosted its production replacement ratio to 660%. Bottom line here is that LINN Energy has plenty of oil and gas in the ground to keep its production and distribution both flowing and growing.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 10, 2014, at 10:57 AM, rlp2451 wrote:

    This is all well and good - as long as prices remain high. Several factors influence reserves estimates, but crude oil and natural gas prices are particularly important. Higher prices typically increase estimates (positive revisions) as operators consider a broader portion of the resource base economically producible, or proved. Lower prices, on the other hand, generally reduce estimates (negative revisions) as the economically producible base diminishes.

  • Report this Comment On March 12, 2014, at 1:24 AM, Dwightfish wrote:

    Could you possibly comment on the precipitous drop in price today for Linn?

  • Report this Comment On March 12, 2014, at 11:43 AM, TMFmd19 wrote:

    @dwightfish - I didn't see any news. One can only guess but my assumption is that someone bearish on the company said something negative about it.

    Matt

  • Report this Comment On March 13, 2014, at 9:48 AM, LAVol wrote:

    "The key here is that we're seeing a solid reserve mix that made a big shift toward oil thanks to the company's deal to buy Berry Petroleum."

    I agree that long term this shift is a positive. But, short term, not so much. Due primarily to the dramatic decline in natural gas storage, natural gas prices will very likely remain well above the 5-year average for the next 18-24 months. So, LINN will benefit more from the natural gas reserves than from oil in the near future.

    --Former Nat Gas Exec.

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