"Those who do not learn history are doomed to repeat it." -- George Santayana
We can learn a lot from history. When we're aware of what happened in the past, we can at least be prepared if the same thing happens again. For LINN Energy LLC (NASDAQOTH:LINEQ) investors, the lesson from the past that we should learn is the early history of Apache Corporation (NYSE:APA). That's because both companies share an eerily similar path taken early in their history, which could point to what lies ahead for LINN Energy. For that lesson, we need to go all the way back to 1981.
A walk down memory lane
For the oil industry, 1981 was one of the high points of a rather dreary decade. The price of crude averaged more than $35 a barrel that year, or $92 adjusting for inflation, leading to strong profitability. In fact, industry profitability was so strong that the U.S. had enacted a windfall profits tax on industry profits the year before.
This scenario led investors to look for ways to maximize any tax advantages they had available. One such advantage, though not widely used at the time, was the master limited partnership, or MLP, structure.
This is where Apache Petroleum Corporation, as it was known at the time, enters our story as it was the first to take full advantage of this structure by creating the first publicly traded MLP in 1981. In doing so, it gave investors access to a vehicle that had the liquidity and opportunity for price appreciation of a stock, but with the tax advantages of a partnership.
That structure, however, didn't really produce the intended results:
The culprit was the price of oil, which soon collapsed into the mid-teens. That collapse, which when coupled with a tax reform that wiped away some of the tax advantages of MLPs, led Apache to completely abandoned the MLP structure in 1987. In its place, investors were offered the ability to exchange their units for shares of either Apache Corporation or a newly created entity called Key Petroleum Corporation. Those who chose Apache would own a pure exploration and production company that is the foundation of Apache today.
History is mirroring the past
Longtime LINN Energy investors will notice something eerily familiar with Apache's history. LINN Energy, like Apache, also led in the creation of a new wave of publicly traded MLPs when it went public in 2006, though technically LINN Energy is a limited liability company, or LLC, and not an MLP. Still, the similarities in the stories are striking, especially considering the fact that we're now in a period similar to 1987, when oil prices have collapsed yet again.
As such, it raises the question of whether LINN Energy might also now be doomed to follow in the footsteps of Apache and abandon the structure it has championed for the past several years.
While collapsing oil prices were only part of the equation that led Apache to abandon the structure, the other side of that equation is at play here, too. Even though there isn't yet talk of any changes to the tax code, we can't dismiss the fact that one of the key advantages of the MLP structure is the tax-advantaged income, which LINN Energy no longer offers investors after recently suspending its distribution.
As such, the structure is now, at best, just underutilized -- while it is, at worse, also a burden. I say that because the tax burden itself could grow due to the fact that the company is repurchasing its bonds at a discount to par value, which could cause some investors to be on the hook for tax liabilities. In other words, there's really no point for LINN to remain an MLP if it's not going to take advantage of the structure.
While such a drastic change like this might sound like the end of the world, that might not be the case -- if, again, we look at Apache's own history. As the following chart shows, Apache's stock price has vastly outperformed the market since it made the switch, suggesting that such a move by LINN Energy might also benefit investors over the long term.
LINN Energy clearly didn't learn from Apache's past mistakes as it has found itself repeating them by being on the wrong side of another collapse in the price of oil. As such, it might have no choice but to follow Apache out of the MLP structure if conditions don't improve. That said, given Apache's history since abandoning the MLP structure, this is a case where being doomed to repeat history might not be so bad.