LINN Energy LLC (NASDAQ: LINE ) has grown tired of battling the declining rate of oil and gas production within its portfolio. These battles with its decline rate have made it tough for the company to grow its cash flow, which is why its distribution to investors hasn't grown in more than two years. Now, the company is changing tactics by taking a new approach to fight its decline rate. As the company switches to its new approach it is in a period of transition as it is in the process of jettisoning $4-$5 billion of high-declining assets and replacing those with $4-$5 billion of low-declining assets, which represents nearly 20% of the entire company. With so much movement within its portfolio, there are a few things LINN Energy's management wants investors to know about this transition.
The end game
The first thing CEO Mark Ellis wants investors to know is where LINN Energy expects to be after all of the portfolio reshuffling is complete. On the company's second quarter conference call he said:
Completion of all the announced transactions, including the intent to sell the Granite Wash and Cleveland assets and the sale or trade of the remaining Midland Basin assets in the Permian, is expected to reduce our capital expenditure run rate by $300 million to $400 million and lower the company's estimated annual decline rate to approximately 15%. This transactional asset rotation is expected to result in a more stable base business and sets the stage for future growth.
Progress so far
With that stated goal Ellis wanted investors to know that the company is making good progress on its plan. On that same conference call he said:
Early in 2014, we laid out a clear strategy for portfolio improvement, which included maximizing the value of our Midland Basin assets in the Permian. One of the alternatives outlined in this strategy, was a trade of some or all of our position in the Midland Basin for long-life mature producing properties. While asset trades are typically challenging to accomplish at the end of May, we were pleased to announce an asset trade with ExxonMobil.
The ExxonMobil trade didn't exactly win favor with investors because LINN traded its oil assets in the Midland Basin for ExxonMobil's natural gas in the Hugoton Basin. However, the trade actually increased LINN Energy's production by a net 73.4 million cubic feet of natural gas equivalent per day and increased distributable cash flow by $30-$40 million. On top of that the production gained is only expected to decline 6% per year, which is a lot less than the production it traded to ExxonMobil. These benefits, however, were only the beginning.
Becoming a better operator through consolidation
Another reason why LINN Energy is reshuffling its portfolio is so that it can become a stronger operator and reduce its costs in key basins like the Hugoton Basin. Ellis said as much when he noted that, "As we continue to grow the company and consolidate larger positions in certain core areas, we expect to continue to improve our operating efficiency."
This is why it wasn't surprising to see the company follow up the ExxonMobil trade by acquiring the Hugoton Basin positions of both Pioneer Natural Resources (NYSE: PXD ) and Devon Energy Corp (NYSE: DVN ) . As a result LINN Energy was able to consolidate its way to become the top producer in the basin:
Looking ahead, we shouldn't be surprised to see LINN Energy look to consolidate more of its core operating areas when the opportunity arises as the larger scale could reduce costs. This would enable LINN to make higher profit margins, which would give it more cash to pay distributions to investors.
Two things to know about the distribution
LINN Energy's management team also wanted to make one thing clear when it came to the current level of the company's distribution. Mark Ellis noted:
Obviously, what you have seen us do this year is creating an awful lot of stability for the distribution going forward and building an outstanding platform of assets on which to grow upon.
What we can glean from that insight is that the company's distribution is becoming much more stable, meaning that any worries about a future distribution cut are quickly fading away.
Unfortunately that doesn't necessarily mean the distribution is heading higher anytime soon. According to Ellis the company still has work to do before it will be in the position to grow its distribution:
We still hold to the premise that distribution growth really for us comes through accretive transactions and looking forward with the stability that we've created this year, great platform for growth, we think the market is going to be there for additional transactional activity, that's really what's going to drive distribution growth in the future for us.
So, before investors see another distribution increase, LINN Energy needs to finish trading away its Midland Basin assets and sell its Granite Wash asset. Once those transactions are complete the company's next deal could be the one that finally moves the needle to boost the company's distribution.
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