The past year has been a trying one on LINN Energy LLC (NASDAQ:LINE). The steep drop in oil and gas prices caught LINN, and the industry as a whole, completely off guard. It forced the company to take a number of actions that are painful in the short-term, but should strengthen the company over the longer term.
It's that long-term vision that seems to always be front and center in LINN Energy's planning as the company has always had a vision for what it wants to do next to improve. One improvement it has sought to make was to secure private capital funding for growth-oriented drilling, which is why it recently finalized a 5-year commitment for $500 million in capital via its DrillCo alliance. With those funds the company plans to drill wells in emerging areas that carry a bit more risk, but with that risk a higher reward. Here's a look at one area where the company might use those funds first.
Looking toward the future
As LINN Energy continues to comb through its acreage portfolio across the U.S. it is looking for new opportunities to unlock value and has uncovered four promising locations, which are detailed on the map below.
Some of these areas are where LINN owns acreage that could eventually be sold or traded while others offer opportunities for the company to acquire additional acreage to drill via its two new strategic alliances. One area in particular that has caught LINN Energy's early attention is the Ruston/Terryville area of Louisiana. It's an area where it sees a lot of potential, which is why it's already drilling test wells with another partner. If those wells are successful this is an area that could be developed in the future using funds from the DrillCo agreement.
Testing, testing, 1...2...3...
LINN's management team actually spent some time discussing this area on its last conference call after an analyst asked about its joint drilling program. The analyst asked,
[...] would you mind discussing your joint program in Lincoln Parish? I believe you're drilling a vertical well there, near where Memorial Resource Development Corp (NASDAQ:MRD) has had a lot of success ... what zones are you testing, and really what kind of what is your plan for the area?
That particular asset was acquired by LINN Energy in its $2.3 billion deal for Devon Energy's non-core natural gas assets. It's actually detailed on the map below from Memorial Resource Development as Devon Energy's acreage.
As that map notes, Devon's former acreage is in the pink color and is spread across the map including right next to that area where Memorial Resource Development is successfully drilling in the Terryville Complex in Lincoln Parish, Louisiana. In fact, Memorial Resource Development has been so successful that it's earning top-tier returns from its consolidated position with an internal rate of return, or IRR, in excess of 200% at current commodity prices.
In discussing its position in response to the analyst's question LINN Energy's COO Arden Walker said,
[...] we're drilling the first vertical well out there to basically test the different intervals, the different targets for horizontal development. As you know, we have a pretty good position out there. We have roughly 25,000 net acres in the general vicinity ... We're in the process of this first vertical well [that] will set us up for potentially a couple of additional horizontal wells later this year. We won't have production on those horizontal wells until likely December time frame. But we like the play. We watched the offset operators have some very good success out here. We think it's a pretty exciting area for us. And so, we're doing an analysis. This is an area that we acquired from Devon back in the fall. And so, it's new for us. We're trying to get up to speed on it, and trying to do the technical work to set ourselves up for success. But it does look very interesting, and if we can get some more results of some of the offset operators, we think it could be very good for us.
As Walker points out this is a new area to LINN Energy, but one it is very excited about. However, that newness adds development risk for LINN, which appears worthwhile as Memorial Resource Development has seen that higher risk pay off with some really robust returns. That balance of risk and return is really in the sweetspot of the DrillCo agreement because it takes initial risk off of LINN's shoulders. Further, these are returns that would easily fit the return hurdle for the DrillCo agreement, which requires an IRR of just 15%. That's why this area appears to be a potential good first use of the DrillCo capital.
LINN Energy is expecting to drill two horizontal wells on its acreage during the second half of this year, and if the results are as promising as those enjoyed by Memorial Resource Development, then it's possible LINN will begin to spend even more money on future development. What will be interesting to see is if LINN pays for that development out of its own account, or if it makes use of its new DrillCo strategic alliance for the funding. Either way, this is certainly a play worth watching as it has very compelling potential for the company.
Matt DiLallo owns shares of Linn Energy, LLC. The Motley Fool owns shares of Devon Energy. 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.