Linn Energy is Going Whole Hog

By Matthew DiLallo - August 1, 2012 | Tickers: APC, APA, BP, CHK, LINE | 0 Comments

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Linn Energy (NASDAQ: LINE) recently reported a 76 percent increase in production, which led to a 21 percent increase in adjusted EBITDA.  However, their distribution coverage ratio slipped to 0.97 times due to significantly lower than expected NGL prices.  The company has hedged its oil and natural gas production out until 2016 and 2017, respectively.  The good news for investors is that they expect the coverage ratio to get back up to a safer zone of 1.1 to 1.2 times as they shift their drilling focus and as their previously announced acquisitions begin to fully impact the bottom line.

To combat those low NGL prices the company, which has plans to allocate fifty percent of their total capital spending to the Granite Wash play, has decided to go whole hog to drill one specific zone in the play, the Hogshooter zone.  The company currently has eight operated rigs and has shifted them all to now drill Hogshooter wells; it plans to drill a total of twenty wells by the end of the year.  The reason for the shift is that the average Hogshooter well is much oilier and therefore much more profitable.  Take a look at the following two charts from their latest earnings presentation:

As you can see in the first chart, these Hogshooter wells produce 72% oil vs. 30% from the average liquids-rich Granite Wash Well.  Because of the value of oil, this leads to a 71% uplift in revenue, which is why Linn is moving the rigs to drill in this zone.  Linn’s has now completed three wells, and they’ve seen initial production of 2,500 Bbls/d of oil and they expect initial production of 1,700 Bbls/d of oil from the wells they drill going forward.  The company believes these wells will produce a meaningful shift in their production mix and increase their cash flow.

Linn’s not the only one finding success in the Hogshooter.  Chesapeake (NYSE: CHK) recently announced that two of their wells in the play are producing 80% oil and a combined 8.400 barrels of oil equivalent per day.  They have 30,000 net acres in the play that they can either drill on or because of the value they could sell to pay down their large debt burden.  Another company finding success in the play, Apache (NYSE: APA),has seen its first two wells produce rates exceeding 2,000 barrels of oil per day.  Apache is planning to drill an additional 10 wells in this oil-rich play.

With stubbornly low natural gas prices, companies are increasingly turning to NGLs and oil in an effort to stay profitable.  Thanks to their hedging program, Linn is in much better shape than most of its peers.  They are using this to their advantage to continue to pick up assets from some of their cash strapped peers.   

So far this year, they’ve acquired $2.2 assets from BP (NYSE: BP) in two separate transactions.  The Hugoton field in Kansas is 63% natural gas and 37% NGLs, while the Jonah field in Wyoming tilted a bit more to gas at 73% natural gas and 27% liquids.  BP, of course, has been selling a lot of assets due to the disaster in the Gulf of Mexico.  Linn had also acquired a 23% joint venture interest in Anadarko’s (NYSE: APC) Salt Creek enhanced oil recovery project, which is also in Wyoming.  Because they hedge 100% of their production as soon as they acquire an asset, they are looking to develop more low risk upside from projects like the Hogshooter to provide additional value to their unit holders. 

Now What?

I continue to like Linn Energy and have recommend writing October $35 puts for my virtual portfolio, the “No Drip, No Mess” Portfolio.  With shares trading closer to $40, these puts are likely to expire without us picking up the shares.  We’ll reevaluate our options after expiration, but given their stable cash flow and operational excellence, this is a company I want to earn income from for a long time.

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