A Deeper Look at BreitBurn Energy Partners, L.P.’s Second Quarter Results

BreitBurn Energy Partners' (NASDAQ: BBEP  ) made a lot of headlines last week with its announcement that it was acquiring QR Energy (NYSE: QRE  ) in a unit-for-unit merger. However, that was far from the company's only news as it also reported second quarter results. Let's take a closer look at how the company did this past quarter.

Photo credit: Flickr/Paul Lowry 

Drilling down into the numbers that matter
In the second quarter, BreitBurn Energy Partners produced 3.4 million barrels of oil equivalent, or BOE. That's 38% higher than in the second quarter of 2013. It's also 5% above the 3.2 million BOE the company produced just last quarter. Higher valued oil and natural gas liquids production was especially strong as the company produced 2.2 million BOE of liquids this past quarter, which was a quarterly record for the company.

The company's oil and gas production yielded $52.7 million of distributable cash flow on the quarter, which is 9% higher than last year's second quarter. However, distributable cash flow did fall quarter-over-quarter as BreitBurn Energy Partners produced $60.3 million in distributable cash flow last quarter. Because of the slip in cash flow, the company's distribution coverage ratio also slipped from 1.0 times last quarter to 0.86 times in this quarter. While that's something that might concern investors, it's not the first time this has happened. Further, the company believes its 2014 capital plan should increase the ratio in the second half of this year. This is a metric investors always need to watch closely.

What went wrong
One reason why the company's coverage ratio was off this quarter was because it spent an abnormally high amount of money on maintaining its production in the Permian Basin. Because of its issues in the basin, BreitBurn Energy Partners provided lower than expected production guidance for the second half of the year. Needless to say, this is an area that may have caught investors a bit off guard.

The company's problems in the basin stem from an acquisition it made late last year. BreitBurn Energy Partners noted last quarter that it was having trouble with that asset as a number of the wells it acquired were offline when it took over. Further, the company had more trouble this quarter as it experienced a high number of pumping and tubing equipment failures from these wells. The company noted that of the 77 wells it acquired, 48 of them have had failures since February. This forced the company to spend 15% more to maintain production from its wells in the quarter, which cuts into distributable cash flow. BreitBurn Energy Partners doesn't expect these issues to continue as it has redesigned the manifold equipment in the wells that had failed.

Looking ahead, BreitBurn Energy Partners has a new plan for its position in the Permian Basin. The company now plans to transition its drilling program in the basin from drilling vertical wells to one focused on drilling horizontal wells. It sees that switch yielding better economics and being a much more efficient use of its capital. As the map below notes, the company has a pretty concentrated position in the basin to pursue this new strategy.

Source: BreitBurn Energy Partners Investor Presentation (link opens a PDF

There's just one problem with the switch--production from horizontal wells decline rapidly. BreitBurn Energy Partners is aware of this and is committed to implementing a horizontal well program in an MLP friendly manner; however, that won't be easy. Fellow MLP LINN Energy (NASDAQ: LINE  ) tried to do the same thing, but ended up giving up on its horizontal program as the decline rates were really tough to combat. Because of this, BreitBurn Energy Partners might be better off joining LINN Energy by cashing in on its horizontal opportunities and selling them instead, as the company certainly does have hidden upside in the basin.

Investor takeaway
Overall, the second quarter wasn't the greatest showing for BreitBurn Energy Partners as the company's operations in the Permian Basin really aren't performing up to expectations. However, the company is making some big moves to improve as it is shifting its drilling program horizontally and acquiring QR Energy in a transformational deal. While these are bold moves only time will tell if these are the right moves for the company. 

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