The Energy IPO that’s Perfect for your IRA

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Do you like to pay taxes? I sure don’t, though I probably wouldn’t mind them as much if they were simpler to understand. I like living in a safe country with paved roads and all the other benefits that come with paying taxes. Still, the more I pay in taxes now the less money I’ll have compounding my way to a retirement.

To ensure more of your money is compounding for you instead of in the government’s coffers it’s smart to open an IRA and fill it with solid investments. Few businesses are as solid as the Master Limited Partnership; however, owning one of those in an IRA can be a waste and could even result in owing tax. If you only have a retirement account you can leave these tax-advantaged businesses off your radar.

That’s a shame because one company that’s elected to be treated as a partnership for U.S. federal income tax purposes is the one energy company I want to own. That company, Linn Energy (NASDAQ: LINE), is one of the largest independent oil and gas companies in the U.S. and it is focused on the development and acquisition of long-life, low-decline onshore oil and gas assets. In a nutshell they buy up older producing properties from E&P companies that need the capital to pursue other opportunities. These properties produce excellent and stable cash flows, which Linn returns to their unit holders each quarter.

The assets that they own are different from the strategy of a traditional MLP that typically will own midstream assets like pipelines and processing facilities. Enterprise Products Partners (NYSE: EPD), for example, owns more than 50,000 miles of natural gas, NGL, crude oil, refined products and petrochemical pipelines. Place all those pipes end-to-end and you’d go around the world two times. They also own enough natural gas storage capacity to fuel a small city for a year. Nearly 80% of these assets are fee-based, making them very stable cash flow generators. Like Linn they send a good chuck of this cash flow back to unit holders each quarter.

Why Linn Energy?

While the exploration and production business is fraught with risk and volatility, Linn has taken the steps necessary to ensure more stable returns. They have a balanced production base of 45% oil and NGLs and 55% natural gas. And their 15,500 producing wells have an estimated 18 year reserve-life index. To ensure they don’t run out of gas someday they have a substantial inventory of low-risk drilling locations and they have an excellent acquisition track record. Finally, they are 100% hedged through 2016 to ensure cash flow stability.

It’s their hedging philosophy that really sets them apart from both their C-Corp peers. As an aggregate, that group -- which includes Range Resources (NYSE: RRC) and Southwestern Energy (NYSE: SWN) -- are just 44% hedged this year, 22% next year and by 2016 they are not hedged at all. Southwestern Energy is slightly above average at 47% hedged this year and 33% hedged next year. Range, on the other hand, has hedged out 80% of their projected production for the second half of this year for both oil and gas and have some hedges in place for next year as well. No one hedges as much for as long as Linn Energy. Of course if commodity prices skyrocket they’ll not see the upside; but you don’t invest in Linn for commodity price exposure, you invest for income security.

Now About that IRA

That income security is why you’d want a company like Linn in your IRA. For many, though, the K-1 and the potential of owing “unrelated business income tax (UBIT)” is a turn-off and a reason why many shun the company. Their management team has realized that this problem is plaguing would-be investors and they’ve come up with an innovative solution.

Enter LinnCo (NASDAQ: LNCO), which is structured as a C-Corp, making it a perfect fit for your IRA.  This new publicly traded company will have but one purpose: to own shares of Linn Energy. Investors in LinnCo will receive a 1099 for tax purposes instead of a K-1, making it very IRA-friendly. 

Written in the prospectus leading up to the IPO it says that, “LINN believes that this structure will appeal to investors that would like to invest in a dividend-paying oil and natural gas exploration and production company, but currently do not invest in LINN units because of UBTI consequences and more onerous tax reporting requirements.” Furthermore they state that, “while LINN has been one of the most active energy-focused master limited partnership equity issuers in recent years, we believe that expanding the investor base to include institutions, individual retirement accounts and tax-exempt investors will provide LINN with equity-raising opportunities significantly beyond its current capacity.”

If you’ve ever considered owning Linn but have held off because of the K-1 concerns, you now have your chance to invest in this exceptional business without all the hassles. You’ll still be entitled to that great dividend, less between 2% and 5% that they’ll accrue for the tax liability. That’s why I think this energy IPO is a perfect fit for your IRA.


latimerburned owns shares of Linn Energy, LLC and Enterprise Products Partners L.P. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Enterprise Products Partners L.P. and Range Resources. 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. If you have questions about this post or the Fool’s blog network, click here for information.

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