Last week an explosion at an ExxonMobil (NYSE:XOM) refinery in California resulted in a portion of that refinery being shut down. The explosion rocked the state's already limited refining capacity as another refinery was already shut down due to planned maintenance. At one point 17.5% of the state's refining capacity was out of commission, which is a problem for large oil producers in the state, including LINN Energy LLC (NASDAQOTH:LINEQ).
The incident highlights a risk that investors need to keep an eye on. As LINN consolidates is position in key producing basins, like southern California, it's also consolidating its risk as its putting greater reliance on key customers to take its oil and gas. That customer concentration risk could cause problems down the road if a key refinery or pipeline is out of commission for an extended period of time.
The California conundrum
On LINN Energy's fourth-quarter conference call CEO Mark Ellis took a brief moment to update its investors on its relationship with the ExxonMobil refinery. He said that,
We felt compelled to update you a little bit on this incident. At this point in time LINN Energy has approximately 23,000 barrels a day sold in to that refinery. We understand the capacity is about 155,000 barrels a day. I would tell you at this time we're not really sure what the impact if any will be to us as result of this incident. But also let me assure you that we have a number of contingency plans in place to deal and mitigate with these types of impacts and we'll obviously be actively working on those over the next several days. Once we get a better feel for what's going on at the refinery and the impact, we'll be able to provide more updates.
As Ellis notes LINN currently sells 23,000 barrels of oil per day to this one refinery, which is 32% of the company's total daily oil production of 71,900 barrels per day. So, suffice it to say but this is a big chunk of its total oil output. As Ellis notes the company has a number of contingency plans for incidents such as this, however, those plans could be hampered by the other refinery closure as well as the ongoing labor dispute that refining industry is dealing with at the moment. While the dispute hasn't caused plants to shut down, it's a risk as so far 9 refineries that account for 13% of the country's refining capacity have been affected. If the strike widens further and results in capacity being constrained it would limit LINN's options as other producers will be looking for takers for their displaced oil as well.
One more risk to watch
While LINN's California operations could be affected by this refinery issue, it's not the only area where one customer handles a lot of LINN's production. That's because ExxonMobil isn't even the company's biggest customer. That distinction goes to Enbridge Energy Partners L.P. (NYSE:EEP) which accounted for 13% of LINN Energy's total oil and gas sales last year. LINN actually specifically called out its relationship with Enbridge as being a risk in its annual report. The company said that,
For the year ended December 31, 2014, sales of oil, natural gas and NGL to Enbridge Energy Partners, L.P. accounted for approximately 13% of the Company's total production volumes. If the Company were to lose any one of its major oil and natural gas purchasers, the loss could temporarily cease or delay production and sale of its oil and natural gas in that particular purchaser's service area. If the Company were to lose a purchaser, it believes it could identify a substitute purchaser. However, if one or more of these large purchasers ceased purchasing oil and natural gas altogether, it could have a detrimental effect on the oil and natural gas market in general and on the volume of oil and natural gas that the Company is able to sell.
So, if a major oil or gas pipeline is damaged or a refinery is out of commission for an extended period of time it could have a detrimental impact on LINN's production and cash flow. The big risk here is that this could cause LINN Energy to miss production and cash flow guidance in a quarter, which could lead to its units selling off.
The key takeaway for LINN investors
All that being said, one thing investors need to realize is that these issues do tend to be temporary in nature and are very unlikely to impact the long-term outlook of the company. That's why investors should watch when these risks rear their ugly head as the short-term sell-off could very well offer a compelling long-term buying opportunity.
Matt DiLallo owns shares of Linn Energy, LLC. The Motley Fool recommends Enbridge 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.