Wednesday, February 20, 2013

Linn Energy: A bizarre definition of distributable cash hides really clapped out assets

The last post explained just how bizarre the definition of EBITDA/distributable cash is at Linn Energy. This bizarre definition of EBITDA in my opinion allows a zany and unsustainable level of distributions to be paid and hence attracts investors.

This stock is sold on the yield.

I think you should buy shares on the underlying assets and not a running yield.

So it is worth looking at what the underlying assets are.

Here from the last 10-K is a disclosure on the number of productive wells owned:


Productive Wells
The following sets forth information relating to the productive wells in which the Company owned a working interest as of December 31, 2011.  Productive wells consist of producing wells and wells capable of production, including wells awaiting pipeline or other connections to commence deliveries.  “Gross” wells refers to the total number of producing wells in which the Company has an interest, and “net” wells refers to the sum of its fractional working interests owned in gross wells.  The number of wells below does not include approximately 2,500 productive wells in which the Company owns a royalty interest only.
Natural Gas Wells
Oil Wells
Total Wells
Gross
Net
Gross
Net
Gross
Net
Operated (1)
3,8892,9253,8703,5787,7596,503
Nonoperated (2)
1,8433691,6282073,471576
5,7323,2945,4983,78511,2307,079
(1)
The Company had 12 operated wells with multiple completions at December 31, 2011.
(2)
The Company had no nonoperated wells with multiple completions at December 31, 2011.



The previous year the total was not dramatically different - this from the 10-K for the year ended 2010:


Productive Wells
The following table sets forth information relating to the productive wells in which the Company owned a working interest as of December 31, 2010.  Productive wells consist of producing wells and wells capable of production, including wells awaiting pipeline or other connections to commence deliveries.  “Gross” wells refers to the total number of producing wells in which the Company has an interest, and “net” wells refers to the sum of its fractional working interests owned in gross wells.  The number of wells below does not include approximately 2,700 productive wells in which the Company owns a royalty interest only.
Natural Gas Wells
Oil Wells
Total Wells
Gross
Net
Gross
Net
Gross
Net
Operated (1)
3,7512,7073,3463,0887,0975,795
Nonoperated (2)
1,7173421,5721753,289517
5,4683,0494,9183,26310,3866,312
(1)
Ten operated wells had multiple completions at December 31, 2010.
(2)
Three nonoperated wells had multiple completions at December 31, 2010.


They would have averaged about 3,170 net productive gas wells and 3,520 net productive oil wells. The average total productive wells would have averaged about 6,700.

And here from the form 10-K is the average daily production.


The following sets forth information regarding average daily production, average prices and average costs for each of the periods indicated:
Year Ended December 31,
2011
2010
2009
Average daily production:
Natural gas (MMcf/d)
175137125
Oil (MBbls/d)
21.513.19.0
NGL (MBbls/d)
10.88.36.5
Total (MMcfe/d)
369265218


They produced 175,000 Mcf/d of natural gas and 21,500 barrels of oil per day with another 10,800 barrels of natural gas liquids.

The total gas equivalent is 369,000 Mcf/d of natural gas.

Lets do some division. The oil wells produce 21,500 barrels of oil per day from an average of 3,520 wells. This is an average of 6 barrels per day.

There are going to be an awful lot of wells that produce less than two barrels per day.

The gas wells produce 175,000 Mcf/d of natural gas from 3,170 wells. This works out at 55 Mcf/d in gas. At a $3 gas price these wells are producing - get this - $165 in natural gas per day. Presumably these wells are also declining...

Fortunately they also produce 10,800 barrels of natural gas liquids per day. That is 3.4 barrels of liquids (at about $45 a barrel as an estimate).

I have a few questions of management:

Question 1

How many of the much-vaunted wells produce less than $100 gross revenue per day? Oh, that $100 needs to be before hedging!

Question 2

How many wells were shut down or went out of production in each of the last five years because the flow rates were so low the wells became non-economic?

Question 3

What is the right level of maintenance capital expenditure for wells with flow rates this low? How does this level of maintenance capital expenditure differ from the maintenance capital expenditure used for calculating distributable amounts?

High valuations for clapped-out assets

This company sports a premium valuation for very old and very run-down-low-production wells.

I believe this premium valuation is because people see the (high and attractive) dividends not the (clapped-out) underlying assets.

The fact that the dividends are - at least in part produced by financial engineering not cash flow (as per the last post) is besides the point. This company buys and manages clapped out oil and gas properties and maintains a perception of asset backing. After all the MLP is issuing large numbers of units and they are selling both dividends and the perception of asset backing. Telling a good story about run-down assets is necessary.

The long term future of Linn Energy: Who would normally own the wells?

These wells are valuable. A well flowing 3 barrels per day still generates $70-100 thousand a year of gross revenue. There is only a small fraction of that left after production taxes and maintenance. Someone has to fuel and maintain the nodding-donkey oil pump after all. And someone has to drive the truck around to collect the oil.

This is gritty work. Apart from anything these fields are laden with environmental problems - because typically the pump is pulling up a barrel of oil and fifty barrels of salt water per day. The salt water needs to be disposed of. And the oil collected and spills dealt with.

So you are under no illusions this what a typical unit producing one barrel per day (and 150 barrels of salt water) looks like check out this video from You Tube.




What you own if you own Linn Energy is simple. It is thousands of these things.

But lets get back to the natural owner of this well. I know the guy. Sun burnt but would be far more sun burnt without the hat. A pick-up truck. Dog and a shot-gun in the back. Political views well to the right of mine.

You have to admire this guy - he is a self-reliant individual who works without much corporate overhead. Has nobody to blame when the electric motor burns out than himself. And he works hard. Real hard.*

This assets owned by Linn Energy are not normally the sort of asset owned by a 14 billion dollar enterprise valuation listed entity. They are owned by the red-necked, gun-toting self-reliant individual who works hard and does not mind getting his hands dirty.

When this MLP runs out of cash to distribute it is likely to be dismantled and the assets will be sold to those those fine people with their politics, dogs and shotguns. Assets like these tend to find their natural owners.

In liquidation I seriously doubt if there will be anything like enough to make whole the $7 billion owned to the banks and other lenders. If you are Linn Energy debt-holder beware.

Something substantial for the residual equity holders? Surely you must be joking?



John

*Please understand I am not mocking the natural owner here. If my (non-existent) daughter married him I would be pleased for her even if social conversation at Christmas dinner was awkward. I have far more respect for that-type than I have for many financial or CEO types...

6 comments:

Bruschettaboy said...

I think these days that character would be the natural operator/contractor of the well. The natural owner would be a suburban OKC lawyer or surgeon with a slightly too wide smile, a new-model BMW and a lot of investment blogs bookmarked. The conversation at Christmas dinner would be a little bit easier but you might like him somewhat less.

Don Petty said...

What you say about the lack of profitability makes sense and is showing up in the 10-Qs and 10-Ks. LINE has made more Net Income from the realized gains on derivatives used for hedging plus asset sales, than from their core operations of oil and gas development and production, a lot more. I haven't gone through and done a complete analysis, but I would estimate that between 65% to 75% of their Net Income has come from those gains, rather than from its core operations.

My question is: If the assets are not worth what was borrowed to purchase them with, why would the banks make the loans in the first place?

Mark T said...

"If the assets are not worth what was borrowed to purchase them with, why would the banks make the loans in the first place?"

That surely is the perenniel question for Bankers....

Nemo Incognito said...

To be fair it wasn't commercial lenders, it was the index zombies of the high yield market.

Anonymous said...

The fresh wells have very high initial decline rates. These old wells might be able to go on for a lot longer. Much longer if the price goes up, but companies can't book the reserve now. Is the claim here that the acquisitions were done at inflated prices? If not why should NAV be negative?

Anonymous said...

Let the ponzi continue -
http://finance.yahoo.com/news/linn-energy-buy-berry-petroleum-122019335.html

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