There are worse things than being an oil and gas producer in era of crashing commodity prices. Being an oil and gas producer whose shareholders want yield would be one.
On Friday, Linn Energy a producer with oil and gasfields across the US, said it would more than halve its 2015 capital spending budget to $730m. It cited both lower oil and gas prices and a reduced asset base. Linn is one of the rare producers structured as a master limited partnership, a tax-efficient vehicle that funnels nearly all cash flow to shareholders through distributions. MLPs have thrived in a low returns environment. But they need to generate enough cash flow to keep the dividend humming.
Even with the capex savings, Linn slashed its distribution to shareholders by nearly 60 per cent. That keeps the so-called coverage ratio — cash flow per share vs distribution per share — stable. Full coverage is important because financing the dividend through either debt or equity offerings is expensive and unsustainable. The assumptions underlying Linn’s revised cash flow numbers are equally important. It expects a Nymex crude oil price of $60 per barrel (it is about $50 now) and natural gas of $3.50 per million cubic feet. Investors remain sceptical — Linn’s share price implies an annual yield still above 10 per cent.
Producers structured as MLPs, such as Linn, are an anomaly. More than 90 per cent of the aggregate enterprise value of MLPs comes from energy logistics companies (so-called midstream and downstream). The allure of MLPs is not just that they distribute cash, but that those distributions grow steadily over time. So Linn has not totally abandoned growth. It also announced a $500m drilling joint venture with the lending affiliate of Blackstone, whereby the fund puts up all the cash and earns a preferred return. Public shareholders love monthly distributions but patient capital, like Blackstone’s, looks like it will win biggest.
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