Thursday, December 18, 2014

Linn Energy: A Shale Play Challenged at $55 Oil

Linn Energy (LINE) (LNCO) traded closed below $10 a unit on December 15, 2014, marking both a 52 week low, and lows not experienced since the December 2008 financial crisis.  During the 2008 crisis, oil reached a bottom in the $35 range, whereas currently we are just reaching the $55 per barrel range.  Why is the panic so much more acute today than the time period politically labeled as the “Greatest Recession since the Great Depression?”  Are we entering an even bigger Depression?  That question I may have an opinion, but will not attempt to answer in this article.  What I will provide readers is a clear nuts and bolts view of why there is a run on the Linn Energy units, and why as the market approaches $55 oil per barrel on the front-end of the curve, the investor sentiment is warranted. 
The big issue facing common unit holders of Linn Energy is the over-extended financial structure of the business, i.e. financial leverage.  While Linn Energy is well hedged with favorable $90 oil derivative contracts for the next several years of production, the reassessment of the value of its proven reserves is expected to severely stress its financing capacity in the very near future.  In addition, even with the hedge program, the drop in oil price will still place a burden on cash flow to pay distributions while continuing to maintain a steady capital expansion program.  If drilling is constrained for any period of time at Linn Energy, the current high oil production rate will decline rapidly given the characteristics of the proven undeveloped reserves that Linn Energy owns (light oil, high concentration of NGL and Natural Gas).  The cost structure of the company makes the oil production “cliff” a particularly onerous problem.  Based on an assessment of the financial position of the company contained in this article, investors should expect a radical down-sizing, or even complete elimination of the $.24 monthly distribution level which is currently a 28.76% yield.