Linn Energy (NASDAQ: LINE) has been incredibly volatile in 2015. The company's units have been up more than 35% at various points in the year, but right now, units are up just under 3%. Here are three things Linn could do to push its unit price back to those heights and beyond.
1. Start using DrillCo
One of Linn Energy's strategies has been to seek out private capital to fund growth. So far this year, it has successfully netted $1.5 billion in private capital. One piece of that private capital is the company's $500 million DrillCo venture, which provides the company with capital to drill wells without spending money from its own balance sheet.
So far, Linn has yet to use any of this money as it is searching for the right opportunity to invest the capital. One opportunity it could pursue is to use DrillCo to drill wells on the company's remaining 6,600-acre position in the Midland Basin. When asked on the company's first-quarter conference call about using this acreage position for DrillCo, CFO Kolja Rockov said that while it was continuing trade dialog, the company also has "a number of different development opportunities now that we can pursue the value on that," with DrillCo being one option.
Putting DrillCo to work either drilling on its Midland Basin acreage, or at some other spot, could provide a boost for the unit price since this is no-cost growth for Linn Energy.
2. Make a deal using AcquisitionCo
Linn's other private capital funding vehicle is its AcquisitionCo venture, which provides it with up to $1 billion in equity capital for acquisition funding. It is a vehicle that, with leverage and Linn's contribution, provides the company with a war chest of upwards of $2.5 billion for acquisitions.
Using this vehicle to make a deal could drive Linn's unit price higher as it provides relatively low-cost growth with lots of upside. Rockov noted on the first-quarter conference call that the company plans to use AcquisitionCo to acquire assets that might not be a perfect fit for Linn Energy's low production decline business model. Instead, the company will use AcquisitionCo to acquire a company earlier in its life cycle, then as the decline rate of the acquired assets moderates, Linn can drop those down into its own portfolio, meaning built-in growth for the company.
3. Using its buying power to acquire a rival
The intention behind AcquisitionCo is to buy assets or companies that don't currently fit within a low-decline MLP business model, such as an asset based on horizontally drilled shale wells. That leaves all other acquisition opportunities open to Linn to buy for its own account. The company has said that its preference is to use equity to make acquisitions in this environment, and one really compelling opportunity would be to acquire smaller upstream MLPs in a unit-for-unit exchange. That would fit with recent trends as the upstream MLP sector has seen a lot of consolidation in recent months, with three notable deals over just the past few months.
One MLP that looks like a perfect fit for Linn is Legacy Reserves (NASDAQ: LGCY). The upstream MLP is already operating as many of the basins as Linn, as Legacy has core areas in the Rocky Mountains, Permian Basin, and the Mid-Continent. In addition to that, Legacy Reserves has a relatively strong balance sheet, which means an acquisition wouldn't negatively impact Linn's credit metrics.
Another reason Legacy Reserves looks like a compelling fit is because the company has a solid position in the Permian Basin, which Legacy has noted would be best developed in a DrillCo. In fact, the company said it has the potential to spend $500 on initial projects over the next few years, which just happens to be what Linn has available on its own DrillCo. Acquiring a company like Legacy Reserves would make a lot of sense for Linn Energy, as it could improve its balance sheet and its opportunity set, which could also boost the company's unit price.
Linn Energy's unit prices have been quite volatile over the past year. However, by using its private capital or making an acquisition, Linn Energy could excite investors, which would push the unit price higher.
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Linn Energy LLC (NASDAQ: LINE ) and its financial holding entity LinnCo (NASDAQ: LNCO ) have taken it on the chin over the past year. Obviously, the primary culprit was the rout in the oil market. The price of crude oil fell from about $100 per barrel at its 2014 peak to roughly $45 per barrel at its 2015 low. As a upstream exploration and production company, Linn was hit extremely hard.
Things got even worse a couple weeks ago when Linn stock fell double-digits after the company announced a major secondary unit offering. Linn sold 16 million units at an average price of $11.79 per unit. This is well below where Linn was trading just a few months ago. In fact, Linn shares exchanged hands at $30 this time last year.
Still, Linn had good cause to conduct this offering now. Here's why Linn's transaction made sense, and why better days might lie ahead for the embattled oil and gas producer.
Getting some relief
Linn took on significant debt as a result of its $4.3 billion acquisition of Berry Petroleum, $1.8 billion of which was the assumption of Berry's debt. With oil and gas prices getting slammed and a debt-heavy capital structure, Linn needs some flexibility. Linn could use any relief on its existing Berry credit facility it can get, because it's essentially maxed out.
Linn's Berry credit facility has a borrowing base of $1.4 billion, but as of the end of last year, there was less than $1 million of available borrowing capacity. That's exactly what it's getting with its secondary offering. The transaction will raise approximately $181 million in net proceeds to repay debt under the company's existing credit facility, which was primarily incurred to repurchase Linn and Berry's senior notes.
On the surface, it seems questionable for Linn to offer units that yield 10% to retire less-costly debt. It doesn't appear to make sense to incur a near-term cash burn when the company needs as much cash as possible during the oil and gas downturn. But other considerations might be in play. For instance, reducing debt could improve Linn's position with creditors. Linn did have approximately $10.4 billion in debt at the end of last quarter after all.
Meanwhile, things appear to be improving
The unit offering aside, Linn's situation does seem to be improving. The company's oil and gas production grew 2% last quarter, even though it cut capital spending by a whopping 65%. This implies Linn's shifting focus toward higher-quality assets with lower rates of decline is working as management had hoped.. Linn also saved a significant amount of cash by slashing its distribution by 57%. Linn has taken an ax to its spending as a result of the oil crash, including its reductions in distributions and its capital budget. Fortunately, these spending reductions appear to put Linn on firmer footing. The company expects to fund its 2015 distributions and oil and gas capital spending entirely from internally generated cash flow.
In addition, Linn has strong hedging policies in place to help insulate it against further deterioration. Linn entered into additional oil swaps earlier this year, which mean the company is now hedged 80% of its 2015 oil production at an average price of $91 per barrel. Moreover, Linn is fully hedged on its natural gas production at an average price of $5.12 per MMBtu..
Separately, the price of oil has recovered significantly from last quarter. West Texas Intermediate is back to nearly $60 per barrel, meaning the current quarter's results could improve from the preceding three-month period.
The Foolish takeaway
The bottom line for investors is that while markets typically punish companies for selling new units, reducing debt is a good strategy for Linn Energy. Excessive debt can force a company into dire straits, which was a real concern for exploration and production companies when the price of oil collapsed. Selling new units is costly as well, but the company can always cut its distribution again if conditions deteriorate further. Meanwhile, Linn got some much-needed debt relief, as its current Berry credit facility is maxed out. And, if the oil market stabilizes, Linn's operations could continue to improve from here.
Tell me, just how much have you lost with Line.
Seeing Saudi Arabia beat its head against the wall has been so fun that now Iraq’s petro-military apparatus has decided it, too, wishes to flood the world’s oil market with fresh supply and bring U.S. shale producers to their knees.
To put this in terms Iraqis may grasp: Please do. Texans will meet you in the street with yellow roses.
Short of giving away a city to Islamic State (as it did last weekend), Iraq could hardly do anything less in its own interest. It will cost Iraq money it doesn’t have — and can’t easily borrow. So the gambit to boost production by 800,000 barrels a day won’t last, and won’t matter. Ultimately, the drama will highlight why the price of oil is likely to stay near where it is for now, and drift lower over time.
Here’s why: U.S oil production is edging back into the money. With Brent crude LCON5, +4.47% around $65 a barrel and West Texas Intermediate CLN5, +4.28% at $60, world prices are high enough to make most U.S. production profitable, according to recent analyses by both Rystad Energy and Goldman Sachs.
And this may be conservative: Oil’s collapse last fall was fueled partly by data from North Dakota’s state government suggesting the average break-even point for Bakken shale is in the low $40s.
Rumble seat: 2015 Corvette Z06 convertible(3:44)
The 2015 Corvette Z06 convertible could become a future collectible for car enthusiasts, WSJ’s Dan Neil says. Photo: Mike Finkelstein
That’s why the drop in U.S. rig counts has stalled. Last week’s Baker Hughes statistics showed only three fewer rigs than the week before, after a 60% one-year drop, with three net new land-based rigs. U.S. production is still higher than a year ago, and a game-changing 80% higher than in 2008. Moreover, the cost of shale production is still dropping.
For all the that the Saudis have “won” because Brent has gained about $10 a barrel since January, it’s still as much as $20 cheaper than it was in November 2014 when the Saudi plan became clear. The U.S. production drop hasn’t occurred, and investment is stabilizing. Some win.
At the same time, no OPEC producer has done much to undo their chief cost disadvantage — political instability and lack of individual freedom. It may sound abstract, but buying-off oppressed populations is expensive.
Since Arab states boosted social spending after the 2010 Arab Spring, the effective break-even on oil that props up regimes is extremely high. It costs only a few dollars a barrel to get the stuff out of the ground, but last year Goldman Sachs estimated Iran’s total break-even cost at $133 per barrel. Russia’s is $107, Iraq’s is $101. And so on.
OPEC’s endgame — push oil to $40, freeze U.S. supply, and wait for oil to hit $90 or $100 again — can’t work. There’s no place on that spectrum where OPEC covers its overhead — and it would have to cut capital spending, making OPEC less competitive and relevant, while making local politics even more volatile and unstable. Ask Iraq how smart that seems in Ramadi just now.
This is good news for oil stocks with U.S. exposure. A crude-price consensus would spark deal-making, as companies like Exxon Mobil XOM, -0.13% or Chevron CHV, -0.42% snap up rumored targets such as Anadarko Petroleum APC, -0.29% and Chesapeake Energy CHK, +0.21% And $60 crude still spurs U.S. producers to become more efficient, hastening the day when U.S. crude costs $50 or $55 on average to produce.
Crude around $60 is also good environmentally. Pump prices around the national average of $2.77 give people $50 to $100 of incentive a month to buy more-efficient cars — and there’s evidence that prices of many eco-friendly cars are falling. Yet speculative fossil-fuel ventures such as the offshore Alaskan drilling the Interior Department approved May 12 are likely to stay uneconomical.
A “goldilocks” price for oil is low enough to nurture consumer spending on everything else, and high enough for oil producers and shareholders to make money. It’s also low enough to make Nissan Motor NSANY, -0.95% 7201, +0.12% keep pushing down the cost of electric-powered Leafs, as Hyundai Motor 005380, +1.28% is doing with Sonata hybrids. Ideally, natural gas also stays cheap enough to sustain pressure for tax incentives for wind and solar electricity that, along with regulation, slash coal use.
Oil cheap enough to apply pressure on everyone to be more efficient and to force policymakers to keep thinking green, while high enough to make the effort worthwhile, is the goldilocks price. That’s close to where oil is now. Which has little to do with the Saudis, and nothing to do with Iraq.
What's your point? Do you think you're telling us something we don't imagine could happen? Anything could happen. So tell me what is your point?
Are you looking for someone to join you in your misery? You sold for a loss, time to move on.
The U.S. is about to change the global LNG market forever.
When the first tanker carrying liquefied natural gas from shale fields leaves the Sabine Pass terminal in Louisiana in December, it will turn consumers into traders with more bargaining power. That will transform a market dominated by long-term contracts into one where spot trading gains prominence, similar to crude oil.
Since the first LNG cargo went to the U.K. from Algeria under a long-term contract in 1964, buyers opted for guaranteed supply because the fuel was scarce. That’s changing because gas from the Eagle Ford and other fields will transform the U.S. into the third-biggest exporter by 2020. Spot trading will probably account for almost half of transactions by then, from 29 percent last year, and LNG is poised to overtake iron ore as the most valuable commodity after oil.
“We see the U.S. as a major contributor to the development of the LNG spot market as the volumes start to ramp up,” Jamie Buckland, head of investor relations at GasLog Ltd. in London, which owns 22 LNG tankers, wrote in an e-mail May 14. “There should be a lot more flexibility and you could see some buyers of U.S. volumes selling product on to others.”
Last week, the Energy Department gave Cheniere Energy Inc. final approval for the nation’s fifth major export terminal at Corpus Christi in Texas, which will ship the fuel from 2018.
Companies including Tokyo Gas Co. have said they will seek to profit from buying and selling U.S. cargoes that, unlike those on most current contracts, aren’t tied to a destination. Cheniere, the operator of Sabine Pass, expects the U.S. to produce 74 million metric tons of LNG by 2020. That’s about 22 percent of expected global output by 2019. Only Qatar and Australia will produce more.
Significant U.S. exports will likely boost prices, currently at about $3 a million British thermal units, Energy Aspects Ltd. said in a report for UniCredit SpA on Tuesday. U.S. gas may converge toward European levels, now at about $7 a million Btu, the analysts said.
U.S. natural gas will play an important role in connecting Pacific and Atlantic markets, Shigeru Muraki, an adviser at Tokyo Gas, said at a conference in Kuala Lumpur on Tuesday. The company is expanding its investment in shale gas production in the U.S. as a natural hedge for LNG, he said.
Suppliers are now signing deals going as short as two or three years rather than 20 years, according to Charif Souki, Cheniere’s chief executive officer.
Long-term contracts will be eroded amid new supply coming from Australia and the U.S., Dubai Mercantile Exchange’s CEO Christopher Fix said at the conference in Kuala Lumpur.
LNG trade will exceed $120 billion this year, overtaking iron ore as the second most valuable commodity after oil, Goldman Sachs Group Inc. said in a March report. LNG is gas cooled to minus 160 degrees Celsius (minus 256 degrees Fahrenheit) so it occupies 600 times less space.
Spot and short-term LNG trades are defined by the International Group of LNG Importers in Paris as deals lasting four years or less. They accounted for 16 percent of all transactions in 2006 and that share may expand to 45 percent by 2020, according to Alan Whitefield, a senior associate at Sund Energy AS, a consultant to the industry.
The total LNG market will expand 40 percent by 2019, from 2013 levels, according to the International Energy Agency in Paris.
“What will make it a more interesting market is when gas starts being exported from the U.S., because then it becomes really like a commodity market,” Marco Dunand, the CEO of Mercuria Energy Group Ltd., said in an interview last month in Lausanne, Switzerland. “If you have constant supply coming from a terminal, then it becomes a liquid commodity.”
The new U.S. supply will also help link regional markets, said Ann-Elisabeth Serck-Hanssen, acting senior vice president of marketing and trading at Statoil ASA in Stavanger, Norway.
“We as a trading organization make our living from margins, so it both opens up opportunities and ties the different producing regions closer together,” she said by phone May 13. “If you believe a good market is a liquid market, this is positive.”
The better companies will adjust to the new norm. We will see who the winners and losers are eventually. For me, i'll take my chances with Linn. As i said before, i'm not selling for a loss.
Continental Resources (NYSE:CLR) founder and CEO Harold Hamm knows a thing or two about the oil market. He has made himself more than $10 billion by finding and producing oil in the U.S. Because of his ability to turn oil into wealth, when Hamm speaks about the oil market, it is worth it for those also seeking oil-fueled riches to pay attention. Here is a summary of his latest thoughts on the oil market.
Harold Hamm started off his thoughts regarding the current state of the oil market on Continental Resources' first-quarter conference call:
We are living today in historic times as world markets are recalibrating and the pace of North American energy renaissance as demand expands to equal supply. Continental has been a leader in this renaissance. I'm pleased to tell you that we have adjusted to this new market condition and we are well-positioned for success in this environment.
Hamm calls the times we are living in "historic" for the world energy market. That's because for the first time in decades, the oil market is no longer controlled by the Middle East. Instead, that control is being ripped away by North American energy producers, with Hamm's Continental Resources leading the charge.
He would go on to note that his company is pushing down costs as it "adapted quickly and decisively to the new price environment"; it can now produce more oil for less money spent. Overall, the company is drilling farther, faster, cheaper, and more efficiently than ever before. It's a trend not seen just at Continental, but being furthered by most other U.S. independent oil companies.
Because this trend is real and gaining momentum, the industry is pushing for change, particularly for the lifting of the U.S. oil export ban.
The time is now
Hamm noted that:
Continental has been working hard with other industry leaders to lift the U.S. ban on crude oil exports. The current environment [of] world energy markets perfectly illustrate why this should happen, and I'm highly optimistic we'll get this done this year. Senators and Congressmen are becoming knowledgeable around this issue and the fact that the ban is a 1970s-era relic of the Nixon price control administration that directly contradicts our commitment to free-trade.
Hamm and many of his industry peers, including Ryan Lance, CEO of ConocoPhillips (NYSE:COP) and Scott Sheffield, CEO of Pioneer Natural Resources (NYSE:PXD), have been very vocal in their push to have the export ban lifted. In fact, both ConocoPhillips and Pioneer Natural Resources have already found ways to skirt around the ban as Conoco has exported some of its Alaskan oil while Pioneer is exporting a minimally refined ultra-light oil. Still, all three men want a complete end to the ban because it is hindering the growth of the oil boom.
Hamm then noted a key reason the ban is becoming a logistical issue in the U.S.:
It is becoming widely recognized that sufficient refinery capacity does not exist in America today to process American light sweet crude oil from shale plays such as the Bakken, and we, the producers, are subject to a steeply discounted value as a result. Success in getting the ban lifted will benefit the United States immensely in terms of energy development and security, jobs growth or trade balance, and consumer stability of gasoline prices in the future. The time has come for this change.
We can see the price disconnect he is referring to in the chart below:
WTI Crude Oil Spot Price Chart
WTI CRUDE OIL SPOT PRICE DATA BY YCHARTS.
What Hamm is suggesting is that by allowing U.S. oil companies to export oil, it would close the gap between the global oil benchmark, Brent, and the U.S. oil benchmark, WTI. That would give U.S. oil companies a bit more cash to drill more wells and produce more oil, therefore further loosening OPEC's grip and providing more stability to the oil market, and providing a boost to global energy security.
Hamm is such an outspoken critic of the export ban because the only real beneficiary OPEC, which has destabilized the oil market time and gain. That's why he recently went on CNBC to say that OPEC's decision to flood the market with oil will backfire because it will be the catalyst to open up the floodgates to U.S. oil exports.
Hamm pointed out that OPEC "used predatory pricing to cut the price of oil down to nothing where they think we can't make it, but I think they've almost guaranteed us an outlet to world markets." That's because U.S. oil companies have instead proved they can make it in a low oil price environment because of how rapidly costs have fallen. Now, U.S. oil producers are ready to pounce and become the leaders in the global oil market just as soon as they can export freely.
Harold Hamm doesn't see the dramatic drop in oil prices over the past year being a cause for concern, but instead it marks a historic shift. U.S. oil producers proved they can change on a dime and dramatically cut their costs. Now, they're poised to unleash their own flood of oil on the market as soon as the U.S. ends its archaic export ban. Clearly, Harold Hamm is quite optimistic about the future of the U.S. oil industry.
As he usually does each quarter, Halliburton Company (NYSE:HAL) President Jeff Miller recently provided investors with his company's view on the oil market. Last quarter, he provided a clue on when the oil market might turn. This quarter his comments seemed to indicate that when the turn comes, it could lead to a significant change in America's role in the oil market. Here's a breakdown of his comments.
The demand response
Miller led off his comments by detailing the supply and demand picture. He noted that,
Over the past several months global demand expectations for 2015 have been consistently revised higher now calling for an increase of over 1 million barrels per day including recent upward revisions for both US and Europe.
One of the reasons the oil market went into a tailspin was because demand for oil was weaker than expected last year. This was due to a combination of persistently high oil prices along with slowing economic growth. Now that oil prices have been lower for several months that's leading to incremental demand for oil. It's an encouraging sign for the oil market as higher demand tends to lead to higher oil prices.
The supply surprise
Miller then turned his attention to the other side of the oil market: Supply. The other factor contributing to the oil price crash last year was the fact that supply growth was more robust than expected. This led to a glut of oil on the market and a deep downturn in oil and gas activity. Miller noted that in terms of supply,
[...} we're all watching US production levels very closely given the volume expansions that took place throughout 2013 and 2014. Recently monthly production estimates have been encouraging, however, showing significantly lower production growth and actually projecting oil production to be flat to down in the major basins.
Miller notes that once robust U.S. oil supplies are now showing a significant slowdown. This is due to the fact that oil companies are really pulling back on new wells. In fact, in Core Labs' earnings release it pointed out that just to keep production flat in the Bakken Shale of North Dakota oil producers need to drill 115 wells per month. However, in February only 42 new wells were completed, which is leading to a slump in production from the play.
In addition to a noticeable slowdown in U.S. production growth, international oil production from non-OPEC producers is also coming down. Miller calls this "an overlooked positive factor." In fact, he pointed out that by, "comparing the IEA forecast exit rate for 2015 against 2014, key non-OPEC contributors are expected to decline."
The combination of stronger than expected demand along with much slower than expected supply growth is expected to lead to a more balanced oil market in the future. That said, Miller did note that, it could be months or even quarters before we do finally reach equilibrium.
When balance is restored
Still, the very fact that balance is beginning to be restored to the oil market is a positive for energy companies, as well as their investors. In fact, Miller sees very positive signs for the North American oil market's future based on how it has reacted during the current downturn. Miller pointed out that,
[...] it is our view that North America will continue to be the most adaptable market in terms of addressing well economics through both efficiency models and technology uptake. One way to look at it is that the US unconventional business is now the lowest cost, fastest to market incremental barrel of oil available in the world today.
Said another way, the unconventional shale market has become the new swing producer in the oil market. This, in a sense, replaces Saudi Arabia as the swing producer as American producers have brought their costs down to such a level that they can ramp production up or down to very quickly respond to changing oil prices. It's really a potential game-changer for the oil market as it has broken OPEC's control over oil prices. That's why it has turned its focus on controlling its share of the oil market instead of swinging into action to cut production when oil prices collapse.
Halliburton's President sees the oil market improving to the point where it's very close to reaching equilibrium. However, as important as that is in the near-term for oil producer profits, what's even more important is that this downturn has demonstrated how quickly the U.S. oil market can respond to changes in oil prices. So, in the future when oil prices recover there will likely be a very dramatic uptick in U.S. oil production leading to a real gusher of profits for oil producers due to how much they've been able to cut their costs over the past year. It's a significant change that will only make America's oil production more important to the global market in the years ahead.
Natural gas currently trades just under $2.50 per million British thermal units (MMBtu). If we look back on the long term chart of natural gas, the time spent under $2.50 has historically been limited. Over the past 15-years, each of the four times the commodity spent time below $2.50, it followed with a rebound back above $6.
Also, with coal still representing the majority of fuel used to generate electricity, there are forthcoming new Environmental Protection Agency rules that will force power companies to switch from coal to natural gas as early as this summer, creating instant demand for natural gas.
Finally, perhaps the greatest energy trader of all-time and self-made billionaire, T. Boone Pickens, has recently said he thinks we will see $6 natural gas again.
T. Boone Pickens at the annual Milken Institute Global Conference in Beverly Hills, Calif., on April 30, 2013. Photographer: Patrick T. Fallon/Bloomberg via Getty Images
If Pickens is right, and natural gas bounces back to levels last seen just over a year ago, many small and mid-cap natural gas stocks are in position to triple, by returning to levels these stocks traded when natural gas was last $6.
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Last week Linn Energy (NASDAQ:LINE) (NASDAQ:LNCO), made its second private equity deal in the last few months. This time, in a deal with its original founding investor, Quantum Energy Partners, Linn will create a joint venture entity named AcqCo, short for "Acquisition Co." AcqCo will receive initial funding of $1 billion by Quantum Energy Partners, which will acquire oil and gas properties with the help of Linn Energy. Linn will get an initial working interest of between 15% and 50%, depending upon how much Linn contributes.
AcqCo provides a degree of acquisition flexibility that no other upstream MLP has, but this deal does come with a price tag. From comments I've read on articles on Seeking Alpha, there seems to be a handful of questions remaining about this deal. This article will attempt to address some of that uncertainty and put some perspective on this deal. Instead of quoting the press release verbatim, this article will focus on and summarize the key concepts.
Source: Linn Energy Investor Relations Notes: (1) Subject to final documentation (2) Board of Directors of AcqCo will comprise of five (3) Working Interest (4) General and Administrative expenses.
This chart explains the basics of the new joint venture. So let's start with the basics, and put some questions in the 'parking lot' as we go along (I'll answer those 'parking lot' questions later).
First of all, AcqCo will start off being 100% owned by Quantum. If AcqCo and Linn make an acquisition, Linn could fund as little as 15% of the deal or as much as 50% of the deal and achieve a corresponding working interest.
This gives Linn a good deal of additional flexibility. In the past, Linn would simply have to acquire on its own for 100% of the working interest. Going forward, Linn can make big acquisitions but will now be able to 'digest' those acquisitions piecemeal as appropriate, which I believe is a big advantage.
One question investors may have is whether these new acquisitions will be initiated by Linn or Quantum and AcqCo. Let's put that question in the 'parking lot' and continue on with the deal specifics.
Once the property is acquired, Linn will have the same managerial control on the acquired property as it would on all properties it owns. In other words, Linn will be the operator. In exchange for management services, AcqCo will reimburse Linn for all general and administrative costs, and will take distributable cash flow profit according to its working interest.
That more-or-less sums up the basic tenets of the deal. So, how does Quantum benefit from this? Why bother putting out a billion dollars just to get part of the working interest on assets? Why pay out G&A expenses? Why wouldn't Quantum just acquire the property themselves and drill on it?
Well, in order to manage the acquired properties, Quantum would have to hire technically capable employees and management to do so. Unfortunately for Quantum, most talented employees and managers are already out working for someone else. That's where Linn Energy comes in. The basic deal is quite generous to Linn, in my opinion, and that only shows how highly this private equity firm values Linn Energy's management and employees. Quantum could have picked a wide array of companies to work with, including other upstream MLPs. Instead, Linn Energy got the nod. I think that says a lot about Linn.
Now back to the 'parking lot'. Who will initiate the acquisitions? Will it be Linn's choice, or Quantum Energy's decision? From the press release, I really don't know, but the press release verbiage does give a hint:
Subject to final documentation, Quantum has agreed to initially commit up to $1 billion of equity capital to fund acquisitions and development of oil and natural gas assets. LINN will have the ability to participate in all acquisition opportunities with a direct working interest ranging from 15 percent to 50 percent.
This seems to suggest that Quantum will the one initiating the acquisitions, and that Linn will have the "ability to participate" by investing and building up working interest. We might get some further color on that question during the first quarter earnings results call. Personally, I hope that Linn Energy will be the decider and initiator, as they are the ones with the managerial expertise and the acquisition experience.
Of drop-downs and return hurdles
Notice a few other things on the above chart. Specifically, the potential for further drop downs to Linn. In other words, AcqCo (and Quantum, which owns 100% of AcqCo) will have the option to dispose of assets and drop those assets down to Linn at anytime. Who will initiate the drop downs? Linn or Quantum? That question can be answered quickly, so let's not even bother with the 'parking lot' on this one. Take a look at the following verbiage.
Upon the sale of any assets within AcqCo, LINN will be given right of first offer to acquire those assets.
That pretty much answers this question. AcqCo will make the decision to dispose of its assets, which is not too surprising, and Linn will have the right of first refusal.
Here is another part of the official press release I would like to quote, because it isn't reflected in the above chart.
Additionally, after certain investor return hurdles are met, LINN will have the ability to earn a promoted interest in AcqCo.
Basically, this line means that, after Quantum hits a 'certain' rate of return, Linn will have the opportunity to acquire a greater working interest in AcqCo and the properties, which AcqCo owns. This kind of language echoes the deal between Linn Energy and DrillCo by which Linn would earn a greater interest in the property after DrillCo hit a return rate of 15% or greater. I think that this part of the AcqCo deal really reflects what Quantum wants out of this: A chance to acquire mature oil and gas producing properties and get a guaranteed return out of it. Partnering with the management and employees of Linn Energy is, in my opinion, a really good way of doing so.
The one question remaining from this portion of the deal is "What is the 'return rate' Quantum is looking for before Linn gets a chance to increase its ownership stake?" Unfortunately, we still don't know that. Nevertheless, this deal will afford Linn a good amount of additional flexibility in future acquisitions. The joint venture will also allow Linn to separate financing from the timing of acquisitions, giving Linn more funding flexibility.
Putting it all together
Linn's deal with Quantum Energy Partners is neither a 'poison pill' nor a 'deal with the devil' in which Linn is giving up a significant portion of its equity or cash flow in which to procure some short-term funding. Instead, this deal is all about adding more options by which Linn can acquire. Not only that, the terms of this deal say a lot about Linn's management in general. It seems that the flow of upstream MLP acquisitions has more or less halted, either because sellers are not willing to lower their asset prices according to the drop in WTI, or buyers don't have the available liquidity at the moment. Whatever the case is, I believe this joint venture with Quantum gives Linn another tool in its box.
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