LINN Energy (NASDAQOTH:LINEQ) and its affiliate LinnCo (UNKNOWN:LNCO.DL) reported a pretty solid quarter. Of course, that's just my opinion. Which is something investors need to keep in mind when looking at earnings releases and the commentary that follows, while the numbers are real, our interpretation of them can sometimes be very different.
That's why I've always been very fond of the quote, "if you torture the data long enough, it will confess to anything," which is loosely attributed to British economist Ronald Coase. We're always looking for an angle that will confirm our bias. My bias is pretty clear, especially when scrolling down to the disclosure section that notes I own both LINN Energy and LinnCo. I want to see the good in the numbers because it makes me feel better about my decision to invest in this business.
That said, I really did try to find something wrong with LINN Energy's quarter. But, truth be told, I was pleasantly surprised as the results exceeded my own muted expectations. The fact that it didn't have a shortfall in meeting its distribution really surprised me.
One of the reasons LINN was able to do this was its ability to cut its total operating expenses by 7% on the quarter relative to its guidance. While cutting costs can provide a nice boost to income, these aren't long-term drivers. What is a long-term driver is LINN's ability to get more out of the wells it drills.
This is where LINN really saved its distribution this quarter, and hopefully for more quarters to come. LINN's first quarter results were marred by poor performance in the Hogshooter wells it was drilling in Texas. The company shifted gears and moved its drilling rigs to the Mayfield area of Western Oklahoma. That move really paid some big dividends this quarter.
The company has now drilled a dozen wells which had an average initial production rate of 3,800 barrels of oil equivalent per day. These were very liquids rich at 74% and cost the company about $7.9 million to drill. Just to put those numbers into some context, we'll take a look at Continental Resources (NYSE:CLR) and its wells in the SCOOP play of Oklahoma.
Continental Resources is spending about $9 million per well in the oil window, which are about 75% liquids. Its three most recent wells produced average initial production of 1,850 barrels of oil equivilent per day. At current prices Continental is seeing a rate of return just over 40%. While those returns aren't quite as high as it sees in the Bakken, it's good enough for Continental Resources to earmark a quarter of its 2014 capital budget on the play. All this to say, LINN Energy seems to have found a very rich spot to drill and sees the potential for 100 more wells in the Mayfield area.
If LINN's Mayfield wells performed poorly it could have affected LINN's ability to pay its distribution. However, its success suggests that it's starting to find its footing. Looking further ahead, LINN Energy has interesting potential in the Permian Basin that could lead to further strengthening of its distribution.
Much of the company's acreage in the Permian is prospective for horizontal drilling of the Spraberry and Wolfcamp intervals. The shift to horizontal drilling has been a game-changer for companies like Pioneer Natural Resources (NYSE:PXD). CEO Scott Sheffield noted on the company's last conference call that in six months one of its horizontally drilled wells produced 140,000 barrels of oil equivalent. A vertical well would have taken 30 to 35 years to produce that much oil. That's why Pioneer Natural Resources is leading the charge to develop the play through horizontal drilling.
This is a shift that LINN Energy is just beginning to undertake. The company is participating in four non-operated wells and has plans to drill its first operated well by early next year. Success here will make it much easier for LINN to at least keep its distribution steady, if not grow it in the future.
The bottom line here is that LINN Energy drilled its way to a safer distribution this quarter. The potential is there for LINN to keep it up in the future and to accelerate its growth with its ability to continue to acquire. That's why I still think LINN is a solid play and its distribution still looks rock-solid to me.
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