I've spent a lot of time this year drilling down into several publicly traded upstream MLPs. The business model is fairly straightforward: These companies buy proved reserves, hedge the current production out for several years, and then distribute nearly all of the income to investors. It's a model that delivers high yields to investors along with slow and steady growth, all while being less risky than a traditional oil and gas company, as both exploration risk and commodity volatility have been mitigated.
That being said, an upstream MLP is only as good as the reserves it has in the ground. That's why I've looked closely at the reserves of LINN Energy (LINE +0.00%) while also breaking down those of BreitBurn Energy Partners (BBEP +0.00%). Today, I want to do the same with Vanguard Natural Resources (NASDAQ: VNR).
Vanguard, which went public in 2007, has now made 18 acquisitions totaling about $2.8 billion. These acquisitions have expanded the company's geographic and commodity diversity. The deals have also enabled the company to grow its distributions by 45% since its IPO while stabilizing cash flow to the point where it can pay its distribution monthly. Because the company doesn't expend capital to explore for oil and gas, it depends on the reserves it has purchased to fuel that distribution. With that as a backdrop, let's take a closer look at those reserves.
Today, about 60% percent of Vanguard's reserves are natural gas which is down from 100% at the IPO. However, as you will see, the company has made a significant shift in recent years toward natural gas, which at one time was just 35% of production. Vanguard has been going in the opposite direction of both LINN and BreitBurn, who have both been active in acquiring oil-rich assets as well as devoting a majority of capex to drill on oil-rich acreage. Only time will tell which strategy will prove to be the best one for investors.
Despite being gas-heavy, Vanguard has amassed 175 million barrels of oil equivalent reserves. As you can see on the map below, the company has operations that span across several states:
Source: Vanguard Natural Resources Investor Presentation
Arkoma Basin
At 38% of total reserves, the Arkoma Basin dominates the company's reserves. This gas-heavy asset was acquired in June of last year from Antero Resources and includes gas properties in the Woodford Shale and Fayetteville Shale. The company paid $428.5 million for the assets which produce about 10,600 barrels of oil equivalent per day. What's important here is that just 55% of the acreage is proved developed, meaning that Vanguard has plenty of room to grow production here to offset declines elsewhere within its portfolio.
Permian Basin
The next largest portion of reserves is the company's Permian Basin assets which were recently boosted by an acquisition from Range Resources. The $275 million deal brought the Permian to 28% of total reserves. These assets tilt toward oil which is about 51% of the total, while being mostly at 85% proved developed. What's great about these assets is that the reserve to production ratio is about 20 years while still leaving a lot of room to the upside from drilling opportunities. Upstream MLPs thrive on these types of low-decline assets with just enough upside to grow production to at least offset natural production declines.
The Rockies
Another recent acquisition, this time from the Bill Barrett Corporation, added a large reserve position in the Piceance Basin as well as smaller reserves in both the Powder River and Wind River Basins. The company was able to take advantage of cheap natural gas prices to pick up these inexpensive gas-heavy assets. In doing so Vanguard added 25.7 million barrels of oil equivalent reserves in the region, which are about 96% natural gas. The structure of the deal leaves a lot of future upside to natural gas as Vanguard's working interest increases over time.
Big Horn Basin
The last major reserve basin is the oil-rich Big Horn Basin. These reserves consist of 22.7 million barrels of oil equivalent of reserves and consists of about 83% oil. This is an excellent low-decline asset that has been producing oil and gas for decades.
Additional reserves
In addition to the reserves mentioned, Vanguard does have several smaller reserve basins, including reserves in South Texas, Mississippi, and the Williston Basin. These are mainly high-margin oil assets and represent less than 10% of the company's overall reserves. These cash flow assets can be further built up by making bolt-on acquisitions with the Williston Basin being a prime place as producers look to unload mature assets to free up cash to reinvest to higher growth assets.
Adding it all up
When you look across Vanguard's portfolio you will first realize that a majority of the company's largest reserves were just acquired within the past two years. What the company has done is take advantage of the dip the price of natural gas to scoop up cheap natural gas reserves. If the price of natural gas does rise over the next few years these reserves could be worth substantially more, which could lead to additional upside in the form of distribution increases.
