Breitburn Energy Partners L.P. (NASDAQOTH:BBEPQ) made a bold move last year to bolster its oil portfolio as it acquired QR Energy to become the largest U.S. based oil-weighted upstream master limited partnership. The move appeared to backfire when oil prices promptly plunged; however, that might not be the case as Breitburn can still make a lot of money on oil even at current prices. Furthermore, the company has a significant opportunity to drive its operating costs lower, which would improve its oil-fueled cash flow.
The upside to weak oil prices
Breitburn knows falling oil and gas prices are a risk to its business. It highlighted the threat in its annual report:
Oil, NGL and natural gas prices and differentials are highly volatile. Recent declines in commodity prices, especially steep declines in the price of oil, have adversely affected, and in the future will adversely affect, our financial condition and results of operations, cash flow, access to the capital markets and ability to grow. A decline in our cash flow could force us to further reduce our distributions or cease paying distributions altogether in the future.
The downside of depressed oil prices on the business has been on full display this year as the company cut its distribution twice by 50%.
That being said, the company noted in the report that there is actually a downside to high oil prices, and therefore an upside when prices plunge. That upside stems from the fact that service and operating costs drop when oil prices fall.
Historically, higher oil and natural gas prices generally stimulate increased demand and result in increased prices for drilling equipment, crews and associated supplies, equipment and services. Although commodity prices have steeply declined recently, we believe that the costs associated with drilling have not declined as rapidly.
This cost situation suggests that Breitburn's present costs should come down, which would boost its cash flow.
Starting to turn
The company's more recent first-quarter report did note that Breitburn's operating costs are trending down. The company said lease operating expenses had fallen by 9%, from $21.77 per barrel of oil equivalent in the fourth quarter to $19.71 in the first quarter. In addition, the company's general and administrative costs fell from $28.1 million in the fourth quarter to $25.3 million this past quarter.
Some of this decline is due to Breitburn wringing out some synergies from the QR Energy merger. As CEO Hal Washburn said in the company's first-quarter press release, "the integration of QR Energy is going smoothly and our teams are doing a great job continuing to drive down both lease operating expenses and general and administrative costs."
Still, oil prices are down about 50%, so the company has a long way to go on costs. While those costs aren't likely to drop by 50%, CFO Jim Jackson noted at an investor conference last year that the last time oil prices plunged during the financial crisis, "we saw our operating costs drop by almost 20%." So, management should be able to wring out additional expenses from its costs structure beyond merger synergies and the cost reductions it pushed through over the past quarter. Its ability to do that would boost cash flow and take some of the pressure off the company's balance sheet.
It has been a rough year for Breitburn Energy Partners as plunging oil prices hit its oil-focused business. However, there is a bright side to falling oil prices: reduced costs. Breitburn's expenses did indeed drop last quarter, but history suggests the company has further moves to make, which would offer upside if it can capitalize on these cost savings.