Earlier this week Linn Energy (NASDAQ: LINE ) announced that it made a deal with Devon Energy (NYSE: DVN ) which would include a swap of its 70,000 net acre position in the Granite Wash Play in the Texas and Oklahoma panhandles in exchange for Linn 896,000 dry-gas producing acres in five separate locations. On the map below, acreage acquired by Linn is marked in beige.
Here is a breakdown of the acreage Linn will receive:
|Current Well Count||Decline Rate|
As you can see, almost half of both the acreage and production Linn will receive is in the Rockies. Since, right now, oil offers much higher returns than does gas, one might wonder why Linn is trading its oily assets away like this. The reason Linn is doing this swap is to lower its overall decline rate: As a master limited partnership, or MLP, Linn's goal is to maximize cash flow and return that cash flow to shareholders.
One of the biggest concerns of any MLP is how much is needed to spend in order to maintain production levels in any given oilfield. "Maintenance capex" comes right out of distributable cash flow. Generally, the higher the decline rate, the higher the maintenance capex will be. Therefore, properties with higher decline rates, even if growth prospects are promising, tend to be inappropriate for an MLP portfolio.
When compared to some of Linn's other assets and recent trades, the 14% decline rate in this new Devon acreage seems quite high. For example, in California and the Permian, the decline rates are low-to-mid single-digits for much of Linn's acreage. Recently, Linn also swapped Permian shale acreage for gassy acreage in the Hugoton Basin which has an average decline rate of just over 10%.
However, while Linn hasn't disclosed decline rates of its Granite Wash acreage, other drillers in this play typically report an initial decline rate of between 50% and 80%; much higher than that of the acreage Linn is acquiring.
The Granite Wash has been a disappointment for Linn. Back in 2012 and 2013, disappointing well results in this shale play led management to de-emphasize the region. For example, in 2013 management devoted 38% of its capital budget to the Granite Wash. In 2014, however, spending was cut to just 11% for this region.
Devon probably thinks it can do better in the Granite Wash, and frankly, I also believe that it can. As an upstream MLP, Linn's expertise is in exploiting mature fields. Devon's expertise, however, is in shale oil. In its newly acquired acreage Linn sees over 1,600 total future drilling opportunities, 600 of which are in areas already drilled by Devon. Conversely, Devon likely sees additional shale opportunities in drilling areas missed by Linn. That's how this deal is a win for both parties.
Linn's acreage swap with Devon is part of a larger plan to reduce capital intensity in its operations, thereby freeing up capital and increasing the partnership's distribution coverage ratio. Devon, for its part, got a good deal on shale acreage which it believes it can successfully develop. Those long Linn Energy should look forward to next quarter's conference call, as we will get better information on just how much this deal effects the distribution coverage ratio and possible future distribution growth.
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