Some have said that LINN's hedging is no different that what other MLPs engage in. While that may be true, the nature of reporting the cost of those hedges by LINN appears unique among 30 MLPs in the sector, and THAT is what has the SEC seeking a (voluntary) explanation from management.
Here is the essence, according the MF:
"Upon further scrutiny, it appears that Linn Energy’s use of non-GAAP accounting may be more company than sector specific. One of the issues involves the cost of hedging against future fuel price drops, which involves using derivatives like put options. While Linn Energy reported the $583 million spent on derivatives to hedge against fuel price drops in their GAAP financials, they did not recognize it in their non-gaap DCF. Linn Energy proclaims the costs of derivatives as a capital investment rather than an expense. This has allowed Linn Energy to offset $0.50 per unit in order to cover last year’s distribution. According to HedgeEye, Linn Energy is the only MLP out of 30 that does this."
LINE has always disclosed all of it's hedges and how it accounted for them. Expensing options only adds volatility to the DCF to such and extreme degree that it would be completely incompatible and useless by destroying its hedging value.
For four months short hedge funds have been claiming this is accounting irregularity, the claim is proven wrong, and there has never been any shareholder who would desire to change the accounting or reporting. It's old news. The expensing of options is lousy accounting -much worse than present practice. And saying is again and again doesn't make it new!
The difference between LINE and other E&P companies is the size of it's hedge position not it's accounting.
Obviously other MLPs have not felt the need to engage in the same reporting practice, and their DCF has not shown undue volatility.
Perhaps that is merely a matter of scale of hedge positions, as you suggest that is where LINN differs from the other E&P companied.....
Would it then be fair to speculate that other MLPs in this sector, if they engaged in 100% hedges out to 2017, would likewise modify their reporting practices?
Is then the issue then not really whether hedging, at such a grand scale, is in the best interests of the
company and its shareholder....and that the accounting practice for the costs of such extended hedges are reported using generally agreed upon practices of accounting?
To understand correctly what you are saying they expensed the $583 mm for GAAP purposed but capitalized it for the DCF calculation. Is the $583mm total or annual. Seems whether the SEC accepts that or not, that's a big number that impacts cash, and the distribution coverage. And they are over spending cash flow on growth capex, believe it was to the tune of $300mm in the first half of this year. This is beginning to remind you of the creative accounting at Enron, probably an overstatement. The longer this goes on, the more anxiety and lower unit price. Not saying it is, obviously the hedges are protecting cash flow for a few more years, and seem well worth it. But the numbers may be not reflecting real dist coverage.
It is my understanding they also claimed Breitburn was doing the same thing. Which is it? Breitburn, of course, blew away their earnings, almost covered their distribution and is now predicting 1.4 to 1.5 coverage of their distribution as their Whiting acquisition is fully integrated. What's the difference. It seems it is almost exactly what Linn is doing. Bottom line - you can't trust anything coming out of Hedgeye as they are liars.
I doubt others will do this. Since they haven't before. Now that this is seen as a grey area. You won't see any other MLP jumping on board. They haven't before so why now. Using dirty hedges and puts is what made Linn different. But we shall see how the SEC sees this. If it was straight forward I would of thought the SEC would of signed off on this sort of action already.
That's it in a nutshell. LINE has taken the position that a long term hedge should be amortized over the life of the hedge rather than being expensed. that makes sense. that is also probably the reason that major financial institutions have repeatedly stated that the accounting issue was overblown. Everyone capitalizes the cost of drilling wells. Why shouldn't the 'capitalize" other long term assets?
Yes, that seems reasonable (and perhaps even with precedent among other business), but it appears to be a non-standard practice among MLPs in oil/gas.
It appears that the worst case scenario for LINN, if it were asked to follow accounting procedures used my other MLPs, is it wold have about 0.50/sh less distributable cash. That would reduce the payout to about $2.40/sh, and would imply a 10.4% yield at its current market price.
yet, the shares have historically traded at a 8% yield. That implies that the market has either 1) overreacted, with fair value being closer to $30, and/or 2) perceives other risks of disclosures linked to the SEC informal inquiry.
By the way, none of this is especially contingent on the Berry acquisition. For all practical purposes, the shares of LINE trade as though Berry acquisition will not occur.