The Best Oil and Gas MLP in America Just Hit a Grand Slam

As part of a series exploring the upstream (oil and gas producers) MLP industry, I named Breitburn Energy Partners the best upstream MLP in America. This is because Breitburn Energy Partners is the fastest growing upstream MLP, and its management team -- masters of disciplined and accretive acquisitions -- is high quality.

From 2011 to 2013 Breitburn made $2.1 billion in acquisitions, and the pace is accelerating with $1.2 billion worth of purchases coming in the form of two major deals in 2013. Breitburn Energy Partners has a 15-person team devoted to scouring America for high-quality, already producing, low-decline assets that can grow its distributable cash flows and its distributions. In 2013, it examined 400 potential buyout candidates before selecting its Permian basin bolt-ons and the Postle oilfield in Oklahoma. 

The Postle field is an enhanced oil recovery project, where CO2 is pumped into the wells, maintaining pressure and production. Breitburn Energy Partners expect little to no production decline for several years, and this purchase emphasizes the partnership's shift toward higher-margin liquids.

The Permian assets consist of 300 drilling locations on the Wolfberry shale, estimated to hold 18.3 million barrels of oil equivalent. Currently, only 93 locations are in production at an average cost of $7/barrel. This means Breitburn's Permian acreage is not just highly profitable, but it also has a large growth runway ahead of it.

Breitburn Energy Partners was guiding for $600 million in 2014 acquisitions, and today it announced a grand-slam deal that puts that guidance to shame. 

$3 billion deal makes Breitburn the largest oil-focused MLP in America
On July 24, Breitburn Energy Partners announced it was acquiring QR Energy for $1.67 billion in cash and stock. Including QR Energy's class C convertible units, the deal is worth $3 billion, which is 400% above Breitburn Energy Parners' acquistion guidance for the year.

QR Energy unit holders will receive 0.9856 Breitburn units for each unit of QR Energy they hold. This represents a 19% premium to QR Energy's recent closing price and will come as welcome relief to QR Energy investors, who have seen their units trade at 40% discounts to the value of their oil and gas assets.

However, the news gets better for everyone involved, because QR Energy just reported preliminary Q2 blowout results, proving Breitburn Energy Partners made the correct decision in acquiring it.

QR Energy just reported:

  • Production of 20,264 barrels/day, up 17.6% from Q2 2013.
  • Adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) of $69.6 million, up 14% year over year.
  • Distributable cash flow (DCF) up 24.6%.
  • Distribution coverage ratio improved from 0.9 to 1.1.
The biggest reason QR Energy unit holders should be happy with this acquisition is because QR Energy would have had a very difficult time growing its distribution without this buyout. 
 
QR Energy recently announced it was planning on raising its capital expenditure budget by 82% to focus on expanding existing oil producing assets, rather than seeking further accretive acquisitions, as it had done with $1.4 billion in purchases since its IPO.
 
This was likely because QR Energy's unit price was trading at such a discount that making accretive acquisitions by issuing equity would have been very challenging. Meanwhile, QR Energy was facing a 20% dilution cliff, a result of buying out its general partner, a deal that put a stop to horrendous dilution of up to 10% per quarter. While the deal was immediately 7% accretive to DCF, the upcoming dilution would have threatened the security of QR Energy's distribution and made future distribution growth all but impossible -- thus, QR Energy's decision to invest in increased production, the only growth avenue available to it.
 
However, with this deal, QR Energy investors trade an MLP with little to no growth prospects for units in the fastest growing, and now second largest oil and gas MLP in America. 
 

Source: Breitburn Energy-QR Energy acquisition investor presentation, July 24, 2014, page 6.

Thanks to QR Energy's 20,264 barrels/day of production, Breitburn Energy Partners will now be a $7.8 billion MLP with 57,300 barrels oil equivalent production per day and reserves of 323 million barrels of oil equivalent. This means this acquisition will increase Breitburn Energy Partners' production by 55% and its reserves by 51%. The deal also raises Breitburn Energy Partners' liquids mix from 60% to 67%.

Distribution growth for everybody
The best news from this deal is that it represents distribution growth for investors in both Breitburn Energy Partners and QR Energy. Breitburn has announced that it intends to increase its distribution $0.07/year upon the close of the acquisition, expected in Q4 2014 or Q1 2015. This represents a 3.5% distribution increase for Breitburn, and 5% growth for QR Energy unit holders. This raise comes on top of the 4.7% distribution raise Breitburn just announced after reporting its own record-breaking quarterly results.

Foolish takeaway
Breitburn Energy Partners just hit a grand slam with an accretive acquisition that ensures many years of secure and growing distributions for both it and current QR Energy investors. With a safe and growing 9.3% forward yield paid monthly, Breitburn Energy Partners represents the best upstream MLP in America and should be on every long-term income investor's radar.

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