- Natural gas in US storage is roughly -50% below its norm after a colder than normal winter of 2013-2014.
- LNG exports are expected to start in late 2015. This should put upward pressure on natural gas prices, even before LNG exports start.
- Both BBEP and VNR will benefit greatly from higher natural gas prices in the long term.
- VNR has a proved reserves distribution of 66% natural gas and 34% liquids. BBEP has a proved reserves distribution of 40% natural gas and 60% liquids.
- Both VNR and BBEP have made significant acquisitions recently which should be nicely accretive to their distributions in the future.
BreitBurn Energy Partners LP (NASDAQ:BBEP) and Vanguard Natural Resources LLC (NASDAQ:VNR), which acts as an LP for tax purposes, are both energy limited partnerships with high percentages of natural gas production and reserves. As of the close on Friday April 25, 2014, VNR paid an 8.22% annual distribution/dividend; and BBEP paid a 9.78% annual distribution/dividend. VNR also has 7.875% Series A Cumulative Redeemable Perpetual Preferred Units which trade under the symbol (VNRAP). VNR has 7.625% Series B Cumulative Redeemable Perpetual Preferred Units which trade under the symbol (VNRBP). If you are worried about your dividend, you can consider one of these. VNR has 1.8 Tcfe (about 300 million Boe) of proved reserves. Of these reserves 66% are natural gas and 34% are liquids. 60% are proved developed producing.
BBEP has approximately 214.3 million Boe of proved reserves. BBEP's reserve mix is 53% oil, 7% NGLs, and 40% natural gas. Its production mix is 51% oil, 6% NGLs, and 43% natural gas. 81% of BBEP's reserves are proved developed.
Yes, both of these companies have their natural gas production well hedged. However, their unhedged portion will be likely to provide greater income with higher natural gas prices. Plus the new hedges they lay on for future years will be at higher and higher prices as natural gas prices go up.
BBEP has 72% of its natural gas hedged at $4.95/mmbtu for FY2014. It has 74% hedged at $4.94/mmbtu for FY2015. It has 54% hedged at $4.32/mmbtu for FY2016. It has only 24% hedged at $4.44/mmbtu for FY2017; and only 2% hedged at $4.15/mmbtu for FY2018. As an example, Henry Hub January 2018 futures are currently priced at $4.662/mmbtu. This price is already significantly above BBEP's current FY2018 hedges. Further there is good reason to believe that US natural gas prices, which closed at $4.647/mmbtu on the Nymex on April 25, 2014, will continue to rise over the next several years. Some experts are expecting prices to rise to the $5-$7/mmbtu range relatively quickly.
Critics point to the huge amount of newly available natural gas in the US through new unconventional drilling in shale formations; and they decry the above estimate of $5-$7/mmbtu. However, the hard cold facts argue strongly against these critics. The reality is that for many producers natural gas is not profitable to explore and develop unless prices are consistently over $5/mmbtu. For this reason we have seen the number of US drillers for natural gas decrease dramatically in recent years. Even long after the natural gas price low of approximately $1.90/mmbtu in the spring of 2012, the US natural gas dedicated rig count decreased to 323 for the week of April 25, 2014 versus 366 in the year ago week. This doesn't bode well for a flood of new natural gas production near term; and current production will decay over time. Anyone familiar with typical production decay curves will know this. Replacement of decayed production is not happening fully in many companies; and it will not until prices rise more stably over $5/mmbtu. This reality firmly supports the thesis for a price rise to the $5-$7/mmbtu range.
Many will also say that the colder than normal winter of 2013-2014, which led to the recent price rise, was a one-time event. However, there are multiple longer-term factors which should push the price of natural gas upward. There is the dearth of natural gas drilling mentioned above. There is the coming LNG export demand and its expected rapid growth. This is expected to grow to 15.2-17.2 Bcf/d by 2020 and 33.1-35.1 Bcf/d by 2026. The export of natural gas to Mexico via new pipeline capacity is planned to increase significantly in the next several years from 2.0 Bcf/d in 2013 to approximately 4 Bcf/d in 2015. GTL (natural gas to liquids such as gasoline and diesel) and CNG (compressed natural gas for transportation refill stations) demand is expected to increase from almost 0 to 1.3 Bcf/d for GTL and 1.8 Bcf/d for CNG in 2018. Power generation demand and demand for ammonia fertilizer manufacturing are both expected to increase by approximately 1 Bcf/d yearly. All told this all amounts to a huge increase in demand. Admittedly the supply is also forecast to increase; but those increases will be at a much slower rate. The current forecast is for a supply increase of about 1.5 Bcf/d per year according to VNR.
For readers interested in VNR's natural gas hedges, the chart below shows them.
These are priced lower than BBEP's hedges. Plus VNR is more fully hedged further out. Hence it will take longer for VNR to phase in new, higher priced hedges as the price of natural gas likely goes up in the near future. However, a much higher percentage of VNR's proved reserves are natural gas (66% versus 40%). Therefore VNR should see more substantial write ups in the value of its natural gas proved resources than BBEP, even if it does not get to phase in higher natural gas hedges quite as early as BBEP.
Readers should realize that VNR's current hedges on natural gas are at lower prices per mmbtu than BBEP's hedges. Therefore VNR should have more upside profitability in the future due to larger increases in hedging prices obtained. Plus VNR should have higher profitability gains due to its much higher percentage of natural gas reserves and production than BBEP. All told VNR's future looks very bright; and BBEP's future looks a lot brighter than many had been thinking.
BBEP has already been doing well. BBEP's annualized distribution was $1.88 per unit for Q4 2012. It is already up to $1.99 per unit ($0.1658 per unit per month) for the second monthly payment of Q1 2014 -- a 9.78% annual distribution/dividend. Further BBEP completed its $302 million Permian Basin acquisition on December 30, 2013. Therefore the cash flow from that acquisition will be accretive to distributions for Q1 2014 and beyond.
BBEP's distribution coverage ratio in Q4 2013 was 0.93x. However, this was not as bad as it sounds. BBEP had a distribution coverage ratio of 1.31x in Q3 2013. A good part of the reason for the lower distribution coverage ratio for Q4 2013 appears to be the large impairment charge of $54,000,000 in Q4 2013. The impairment charge for Q3 2013 was only $361,000. If one posits that the impairment charge will be much less in Q1 2014, that should help to raise the distribution coverage ratio for Q1 2014 (and beyond).
When you add the cash flow from the Permian Basin acquisition, this should put BBEP easily higher than a 1.0x ratio. If you add a further benefit from higher natural gas prices in Q1 2013, one might think the distribution coverage ratio will be even higher. Remember 26% of BBEP's natural gas production is unhedged for FY2014. This portion of VNR's natural gas revenues should benefit directly from higher natural gas prices.
VNR should also be on the upswing. Natural gas prices were demonstrably higher in Q1 2014. They spiked to roughly $6.50/mmbtu at their highs in Q1 2014. The average price was over $5/mmbtu for Q1 2014. This is a huge increase over an average price of less than $4/mmbtu in Q4 2014. Even though only 15% of VNR's natural gas production is unhedged for FY2014, a huge move upward in price for Q1 2014 should add nicely to both the top and bottom lines, especially when you consider that 64% of production for Q4 2013 was natural gas.
Further the Pinedale/Jonah deal completed on January 31, 2014. This added 847 Bcfe (765 Bcfe using SEC figures) of proved reserves to VNR's total (about +80% to proves reserves or +75% using SEC figures). The production from these assets was 113.4 MMcfe/d for Q4 2013. About 80% of this production was natural gas. Therefore higher natural gas prices are just that much more important to VNR now; and the additional production and reserves will be that much more accretive to Q1 2014 distribution monies. Consequently VNR's distribution coverage ratio for FY2014 was raised to a midpoint value of 1.12x. This may not seem that great; but it is a vast improvement over the 0.88x distribution coverage ratio for Q4 2013. VNR should have a bright future with higher natural gas prices likely coming in the next few years.
Admittedly both VNR and BBEP may have experienced some operational problems due to the abnormally cold winter this year. Any impacts from the winter will be sure to be delineated in the Q1 2014 quarterly reports from each company. Whatever the actual results for Q1 2014, it should still be clear at that time that each company is very healthy when you consider all of 2014 (and beyond). Each has added significant production for Q1 2014; and each saw a significant improvement over prior natural gas price forecasts for Q1 2014. With the great distributions/dividends each has, each is a buy.
The two-year chart of VNR below provides some technical direction for this trade.
The slow stochastic sub chart shows that VNR is overbought. The main chart shows that VNR is in a mild uptrend. Given the information reviewed in this article, it seems likely that uptrend should continue for some time. VNR could pull back in the near term, especially if oil prices fall.
Many think oil prices are artificially elevated due to the trouble in the Ukraine. Therefore an eventual pullback in oil prices seems likely. The overall market could also pullback considerably after five plus years of a bull market. For this reason it may be a good idea to wait for VNR to be less overbought. Alternatively investors may wish to average into VNR over the course of the next year.
The two-year chart of BBEP below provides some technical direction for this trade.
The slow stochastic sub chart shows that BBEP is near overbought levels. The main chart shows that BBEP is in a mild uptrend. However, it probably does not have as much upside potential as VNR at this time. It did not recently practically double its proved reserves at a very low price as VNR did. BBEP is still a buy though. The fundamentals are good, and BBEP should be able to find more deals to make in 2014. These should help it grow its distribution further. Averaging into BBEP over the course of 2014 may be a good strategy. It is likely a good stock to own.
Both BreitBurn Energy Partners LP and Vanguard Natural Resources have five star CAPS ratings (strong buy ratings). Analysts give BBEP a mean recommendation of 1.8 (a buy) and VNR a mean recommendation of 2.1 (a buy). It is hard to find significant negatives about either stock. Both are stocks that income investors will want to own for their hefty distributions/dividends. Both stocks may also see stock price appreciation over time. Both should benefit from the likely increase in US natural gas prices over time. They are both solid buys.
NOTE: Some of the above fundamental financial information is from Yahoo Finance.
Good Luck Trading.