BreitBurn Energy Partners LP (BBEPQ) announced today that it has acquired oil and gas properties in the Midland Basin that are adjacent to its existing operating area. The master limited partnership is paying $50 million in cash along with another 3.4 million in common units for 3,700 net acres that are prospective for horizontal drilling. That works out to just over $100 million for an asset that's producing about 600 barrels of oil equivalent per day. However, this deal isn't about today's production, but rather focused on tomorrow's growth.
Drilling down into the deal
The acreage BreitBurn Energy Partners is acquiring is in Howard County, Texas, one of the company's core operating areas in the region.
Once completed the deal will boost the company's acreage position in the Midland Basin by more than 20%. It will also add 32 potential horizontal drilling locations to the company's inventory as well as the potential for at least 160 laterals on multiple benches, which means that the company can drill wells into several different formations because the oil layers here are stacked like pancakes. That represents a lot of future drilling opportunities for the company that it can use to organically grow its payout to investors.
The new growth plan
In commenting on the deal, CEO Hal Washburn noted:
This prospective acreage dovetails nicely with our existing Howard County acreage and greatly enhances the horizontal development program in the Permian that we announced last quarter. In addition, our expanded, contiguous footprint will provide us with greater flexibility in our ongoing discussions with potential operators and financial sponsors to create more "MLP friendly" assets from our horizontal program.
This is where the deal differs from the company's previous acquisitions as it's not focused on current cash flow but on organic growth potential. The plan BreitBurn Energy Partners announced last quarter will see it transition to a horizontal well program in the Permian Basin to improve its returns. As part of that transition it planned to expand its acreage position to increase its scale in the play, which was accomplished in today's deal. Over time the company will use this acreage to drill high returning wells that it hopes will grow its distribution to investors at a higher rate.
However, there is just one problem with horizontal drilling in the Permian Basin, and that's the fact that the production decline rate is pretty steep. This is why we've seen LINN Energy LLC (LINEQ) reverse course on a similar horizontal development plan. Over the past year LINN Energy has actually been shedding its acreage in the Midland Basin, where production declines by about 35% per year, and exchanging it for assets providing a mid-teen decline rate. LINN Energy simply could not grow production fast enough to move its bottom line because it had to spend a lot of money just to maintain its production.
This is a potential future problem for BreitBurn Energy Partners as well. That being said, the company is looking outside the box for an "MLP friendly" way to develop its acreage, which includes finding potential operating partners or financial sponsors. This would allow the company to benefit from the growth of horizontal drilling but with less of the headache from the decline rate. If it works it would enable the company to use high-growth horizontal drilling to fuel a faster growing payout to its investors.
BreitBurn Energy Partners' latest deal is a pretty big departure from its previous focus on buying proved production. It's betting big that it can develop this acreage, as well as its own acreage, in an MLP-friendly manner. The fact that the much larger LINN Energy tried this and gave up is a pretty big warning sign that BreitBurn Energy Partners will need to be very creative as it develops this acreage. This is certainly something investors should keep a close eye on as LINN Energy spent a lot of money to develop its horizontal acreage and still wasn't able to grow its distribution to investors.