Oil and gas companies like LINN Energy (LINE +0.00%) and BreitBurn Energy Partners (BBEP +0.00%) have a big issue to overcome. Each year production from the legacy wells these companies own declines. That puts both in a tough spot because even ast wells are declining investors expect the distributions they receive to increase. So how do these companies overcome this challenge?
A closer look at the problem
According to CFO Jim Jackson, BreitBurn Energy Partners' investors can expect to see the company's portfolio of wells to decline by a 10% range annualized over the next five years. That means a well that is producing 100 barrels of oil per day this year will, on average, only produce about 90 barrels of oil next year, and less oil the following year.
This is why companies like BreitBurn and LINN focus on oil and gas assets with very low decline rates, given that some shale wells can see production declines upward of 75% or more in the first year. One of the attractions in acquiring Berry Petroleum (NYSE: BRY) for LINN Energy and its affiliate LinnCo (NASDAQ: LNCO) is the low 15% decline rate of Berry's assets. In a world of massive decline rates, 15% is seen as a low-decline asset that's an excellent fit for a master limited partnership like LINN.
In order for these companies to grow the payout to investors, both need to grow production to more than offset the decline, as well as any lost income from commodity price volatility or rises in costs. To do this both companies invest to drill new wells or work on existing wells to keep production steady.
Maintaining the flow
This is where the development program comes into play. BreitBurn's program is designed to achieve a low-to-mid single-digit growth rate. Meanwhile, LINN Energy is gearing for a bit higher organic growth rate of 8%-10% this year. The two companies could invest less money to just maintain production, but they are taking advantage of higher oil prices to shift more production to higher margin oil.
The main purpose of these programs is to simply maintain production to serve as a base for the distributions. The real growth will come by way of acquisitions. However, investors still do need to watch these development programs closely.
BreitBurn's development activities are now focused on California and Texas. Last quarter, the company completed 54 total wells and another 19 workovers. That added incremental net production of 2,730 barrels of oil equivalent per day. California is an especially important asset because it's a very mature field that still has significant amounts of oil in place, yet still possesses a low decline rate. That enables BreitBurn to better maintain production and even grow it to offset declines elsewhere.
LINN Energy's development program is more focused on the midcontinent area and the Permian Basin. This year, LINN has focused on the Hogshooter interval of the Granite Wash in Oklahoma and the vertical development of the Wolfberry trend in the Permian Basin. However, after closing the deal for Berry Petroleum it will be the fifth largest oil producer in the state and can then join BreitBurn and focus more development dollars on low-declining California oil.
Investor takeaway
These development programs are critical to maintaining the large distributions paid to investors. Earlier this year LINN's program fell short, which hurt its distribution coverage ratio. Investors need to keep an eye on how both companies spend development capital, because it could impact future payouts. Unlike most other MLPs, these two companies face an uphill battle each year to replace declining production from legacy wells. So far both have done admirably, which is why neither distribution is in danger of declining anytime soon.
