What’s the Opportunity with Linn Energy?

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

Treasuries are yielding less than two percent and that bank account of yours, you’d be lucky to earn half a percent.  Investors are starved for yield and are looking for it in all the wrong places by bidding up the prices of bonds to such heights that the fall from those levels will be quite painful.  What if there was an asset that offered the stability of a bond but actually had the potential to grow that payout over time?  That's not a mirage but the opportunity that lies ahead for investors in Linn Energy (NASDAQ: LINE) and its publically traded subsidiary LinnCo (NASDAQ: LNCO)

Linn Energy is organized as an LLC which makes the company a tax advantaged asset for investors.  This also means you’d get a K-1 instead of a 1099 at tax time.  That does create a bit more paperwork for investors which is why the company recently sent LinnCo to the public markets.  LinnCo only invests in units of Linn Energy and as a C-Corp the company sends shareholders a 1099.

Investors have a choice to make as to which Linn is best for their portfolio but a general rule of thumb is that LinnCo is best for your IRA while Linn Energy would be a better fit in a traditional brokerage account.  As you discover the exciting opportunities ahead for investors you’ll see why you’d want the company in your portfolio. 

The Opportunity

Linn Energy is the ultimate second hand shopper taking mature producing oil and gas wells out of the hands of their E&P peers and turning them into black gold gushing cash flow machines.  An example of this was seen earlier this year as the company raided beleaguered oil giant BP (NYSE: BP) in two separate purchases.   In February, it spent $1.2 billion to buy the Hugoton Field in Kansas and then in June it bought the Jonah Field for another $1.025 billion.  Both fields were immediately accretive to distributable cash flow for Linn and enabled BP to fix the gaping hole in the balance sheet from the Gulf of Mexico disaster.  It also provided Linn with additional inventory of future drilling locations as well as opportunities to invest in increasing the production at several currently producing wells.

Over the past decade the company has spent about $10 billion in 54 separate acquisitions of mature oil and gas assets.  Its goal is to continue to consolidate the industry by snapping up mature oil and natural gas assets and then locking-in that cash flow by hedging the production of these newly acquired assets for the next four to six years.  This has provided stable and growing cash flow which it has been distributing to its investors.

That distribution likely will keep growing because in addition to buying mature assets and turning them into cash flow machines, the company has at least four major opportunities to create value for its owners:

  1. Enhanced Oil Recovery –Back in April, Linn signed a joint venture agreement with Anadarko (NYSE: APC) on its Salt Creek CO2 flood in Wyoming.  In exchange for a 23 percent interest in the field, Linn will be investing $600 million over the next three to six years.  Not only does the asset offer stable cash flow, but it provides Linn with a world-class operator with extensive EOR experience as a partner.  The education and experience gained will enable Linn to potentially transfer this technology to its existing asset base as well as assets it could potentially acquire in the future.
  2. Organic Growth – Linn has a large inventory of low risk and liquids rich development opportunities across its portfolio.  Recently it has been targeting the Hogshooter formation of the Granite Wash which has a very high oil concentration.  Linn has hundreds of other drilling locations it can drill for many years to come.
  3. Half trillion dollar E&P market place – Linn currently accounts for half of the $31 billion MLP/LLC upstream market but that market is just a fraction of the nearly half trillion dollar upstream E&P market.  Not only can Linn continue to pluck mature assets from its E&P brethren, but it has the financial firepower and the scale to buy an operating company if the right opportunity came along.
  4. Natural gas prices – Despite a strict hedging strategy, Linn has retained significant upside to benefit if commodity prices recover.

Bottom Line

Linn is a different kind of oil and natural gas company.  By focusing on maximizing the cash flow of more mature assets and organizing the company in a tax advantaged structure it is able to pay investors an annual distribution of more than seven percent.  That payout should continue to rise as the company pursues the ample opportunities I’ve just outliined.  You don’t need to go chasing yield in the bond market, you can do much better by investing in Linn’s secure and growing business.

latimerburned owns shares of Linn Energy, LLC. The Motley Fool has no positions in the stocks mentioned above. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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