So far, 2013 has been a year to forget for LINN Energy (NASDAQOTH:LINEQ) and its investors. The company has struggled with historically low natural gas liquids, or NGL, prices, its once promising Hogshooter oil development program in Texas turned out to be a dud, and let's not forget that it's currently being informally investigated by the SEC. To make matters worse, its transformational deal with its affiliate LinnCo (UNKNOWN:LNCO.DL) for oil-rich Berry Petroleum (UNKNOWN:UNKNOWN) has been delayed and could potentially fall through.
Add it all up and LINN Energy continues to pay out more than it earns, which isn't a sustainable business practice. In fact, so far this year the company has paid out $38.5 million more than it earned. This means that 11% of its current distribution is being funded from sources other than current cash flow. If LINN's deal for Berry does fall through, will it still be able to grow out of its mess?
What we do know is that closing the Berry deal would quickly solve LINN's problems because it would bring its distribution coverage ratio up to 1.16 times in the fourth quarter, instead of the projected 0.95 times LINN would have without closing the deal. Should the deal fall through, LINN does have some intriguing internal opportunities that it could pursue to climb its way out of its current hole of having a low distribution coverage ratio. Let's take a closer look at two of these options.
The Mississippi Lime
On its conference call with analysts LINN mentioned that it has some prospective acres in the Mississippi Lime which it's pursing a joint-venture agreement to develop. The partner would carry a portion of LINN's drilling costs and would potentially drill 15 horizontal wells in the Mississippi Lime over the next two years. In addition to that, the company has about 450,000 acres in the Anadarko Basin which could hold similar potential for joint-venture deals.
The Mississippian is an area that SandRidge Energy (UNKNOWN:SD.DL) has been aggressively pursuing due to the high rate of return of its oil-heavy development opportunities. In fact, at current prices, SandRidge can produce a 50% internal rate of return in the Mississippian despite the fact that 55% of the production out of the Mississippian is natural gas. That's because the oil content is high enough and the well costs low enough to really drive its returns. SandRidge's success in the play bodes well for LINN's opportunities to also target this high-growth, high-margin play.
Another potential high-growth opportunity in LINN's current portfolio is the Wolfcamp/Spraberry portion in the Permian Basin. LINN believes that it has about 25,000 net acres; it's currently working with its partners to drill four non-operated horizontal wells later this year. If all goes according to plan, LINN can ramp up its development efforts later this year. Further, if the Berry deal does close, LINN would double its acreage in this prospective play.
LINN mentioned in its earnings press release that increased horizontal drilling activity by the industry leads it to believe that it too will find success here. In fact, Pioneer Natural Resources (NYSE:PXD) is reporting unbelievable numbers using horizontal drilling to target these plays. In one of its horizontal Wolfcamp wells, the company produced 140,000 barrels of oil equivalent in about six months. A typical vertical Wolfcamp or Spraberry well took 30-35 years to produce that much oil. This is why LINN is watching industry peers like Pioneer to see if it makes sense to pursue moving more of its capital toward horizontal Wolfcamp wells.
Final Foolish thoughts
While losing the Berry deal would certainly hurt LINN, it does at least have some high-return internal options it could pursue in order to make up its distribution shortfall, even if it needs to shut off its acquisition machine for a while to continue dealing with the SEC. LINN Energy might be down right now, but given some of its interesting internal options, it's certainly not out.