The seemingly unstoppable sell-off in oil prices is having an ugly effect on BreitBurn Energy Partners L.P.'s (NASDAQ:BBEP) unit price. As the following chart illustrates, those units have sold off, which sent the company's yield up to an attention-grabbing 20%.
When a yield gets that high it suggests that investors don't think the company's current payout rate will continue for very much longer. That's actually quite the opposite of what is indicated by the company's own recent actions, as BreitBurn Energy Partners just raised its distribution a few weeks ago by 3.5% after closing the largest deal in its history. While the move alone doesn't mean the current payout rate is safe, it does suggest that a cut isn't currently at the top of the company's agenda.
Why BreitBurn Energy Partners thinks its payout is safe
BreitBurn Energy Partners views its current oil hedges as a source of stability for the cash flow it uses to pay its monthly distributions. As the following chart notes, 71% of the company's production in 2015 is protected by hedges that are much higher than current commodity prices.
The company views these hedges as adequate protection to endure any short-term oil market meltdown, much like what we are seeing today. These hedges provide enough near-term cash flow certainty that the company can maintain its dividend even when the energy market goes haywire, considering it has ample time to adjust to these conditions. However, the lower oil prices fall, and the longer they stay at lower levels, the higher the risk that the company will one day have no choice but to reduce its payout increases.
When it might have to cut
At this point, there does not appear to be any near-term risk of a distribution cut. Not only does BreitBurn Energy Partners have solid hedges in place for 2015, but the company does have some optionality heading into 2015 when it comes to its capital spending program. Over the past few years, the company has tried to balance organic growth with maintenance spending. However, having just taken over QR Energy, the company now has more flexibility to high-grade its capital budget and only invest in its best and highest returning projects. Because of that, the company should be able to do more with less money, providing it a little bit more flexibility to maintain its distribution in lean times like the industry is seeing now.
That said, the company can't endure lower oil prices forever without cutting its payout, as its oil hedges really begin to drop off in 2017. So my best guess is that if oil prices remain depressed at current levels, or worse, for another six months, the company will reduce its distribution at that time. BreitBurn Energy Partners would likely need to reduce its payout by 25% at that time -- however, it could cut deeper if it plans to use the cash flow it would be saving to buy back units or debt.
There is a lot of fear in the energy markets these days because no one knows how low oil prices will go, nor for how long prices will remain depressed. This uncertainty is causing reactionary sell-offs in oil-related stocks, as investors fear the worst. In the case of BreitBurn Energy Partners, investors are afraid of an immediate distribution cut, even though that remains highly unlikely, at least for the next few quarters. A quick rebound in the oil market would make these worries go away.
Matt DiLallo has no position in any stocks mentioned. The Motley Fool recommends BreitBurn Energy Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.