On May 21, 2014 LINN Energy LLC (LINE) and LinnCo LLC (NASDAQ:LNCO) announced that LINE had signed an agreement to trade 25,000 net acres of its Midland Basin holdings and 1,000 net acres in Lea County, New Mexico for an approximately 500,000 net acres of Exxon Mobil's Hugoton Field holdings. The Hugoton Field holdings have proved reserves of about 700 Bcfe (78% PDP), about 400 new potential well sites (drilling inventory), future synergies with the Jayhawk gas plant, a low decline rate of about 6% per year (reserve life of 22 years), and about 85 MMcfe/d (80% natural gas and 20% NGLs) of production. XOM got only 2 Mboe/d of production in the Midland Basin in exchange for the approximately 14 Mboe/d of Hugoton production it swapped with LINE.
The above would appear to be just what the unitholders had been hoping for. LINE gave up very little production, so very little revenue. It gained roughly seven times the amount of production that it gave up in Boe terms. LINE had been planning to spend $275 million developing its Midland Basin assets in FY2014. Since it now has only 30,000 net acres of those assets left, LINE's CapEx for the Midland Basin for FY2014 should be considerably less than $275 million. On a percentage basis, it would be about $150-$175 million. This will save LINE about $100-$125 million in CapEx in FY2014. Presumably the 500,000 net acres acquired from Exxon Mobil (NYSE:XOM) will need some CapEx spending. However, they are mature; and a lot of companies are still doing very little natural gas drilling with the currently historically low natural gas prices. I would expect largely the same behavior from LINE, especially since the assets acquired from XOM are mature assets (78% PDP). When LINE says that the deal will be accretive to cash available for distribution by $30-$40 million annually, this is believable. Given that LINE was only -$3 million short of covering its distribution in Q1 2014, this extra $30-$40 million in cash available for distribution should put LINE's distribution coverage ratio strongly over 1.0. That is great news for unitholders of LINE and shareholders of LNCO.
The above trade lowers the corporate decline rate. It increases LINE's reserves by approximately 10%. It reduces LINE's debt to proved reserves by about 9%. It reduces debt to production by about 6%. Also the 1031 exchange format should allow LINE to avoid paying taxes on the exchange. LINE says it is very much interested in a similar deal for the rest of its Midland Basin assets, although it is hard to see that a further deal could beat or even equal this one.
For those interested, LINE provided the overview of the trade below:
As investors can see, LINE kept almost all of the production. Plus the acreage that it has retained is nearly 100% held by production. This means that any decisions with regard to future CapEx for this newly acquired asset will be purely voluntary.
Of course, some might argue that LINE traded away assets that were mostly oil (typically 70%-80%+ crude oil) for assets that were mostly natural gas (reserves of 70% natural gas and 30% NGLs). This is very true for the short term; but natural gas prices spiked upward in the winter just past (2013-2014) due to the unusually cold temperatures (polar vortices). They have fallen since; but they have remained higher than the average prices in the fall of 2013. Nymex natural gas futures closed May 30, 2014 at $4.542/mmbtu. This was considerably higher than the roughly $3.6/mmbtu for much of the fall. The EIA chart below shows the resultant US Storage deficit.
As readers can see, the amount of natural gas in US Storage as of May 30, 2014 is -35.2% below the year ago level; and it is -40.1% below the 5 year average level. This is apparently enough to keep prices high for the near term.
For the longer term there are many other reasons natural gas demand may remain high. These are covered to a large extent in the article, "U.S. Natural Gas Stores Are Dangerously Low, That's Good For Pipeline And Storage Companies" (click on the colored part of the title to get to the article). Some of the reasons include: a rapid ramp up of LNG exports starting at the end of 2015, an increase in pipeline exports to Mexico, an increase in power generation demand, an increase in use for ammonia fertilizer, an increase in gas to liquids demand, and an increase in CNG (compressed natural gas) demand (see the article referenced above for more specific information).
All of the above means that LINE's new natural gas assets should become more valuable with time. Historically the ratio of one barrel of oil to one mmbtu of natural gas has been 6 to 12 mmbtu per barrel. The closing Nymex price of oil on May 30, 2014 was $102.40/barrel. The current ratio is therefore approximately 22.5 mmbtu/barrel of oil. In other words the price of natural gas should over time roughly double in price relative to oil. At roughly $9/mmbtu (in today's dollars) the assets acquired from XOM will be far more valuable. All of the above make LINE and LNCO buys. LINE pays a distribution of approximately 10%, and LNCO pays a regular dividend of approximately 10.4%. Plus the company's production is well hedged, so the income stream is dependable.
The two year chart of LINE provides some technical direction for this trade.
The slow stochastic sub chart shows that LINE is neither overbought nor oversold. The main chart shows that LINE fell considerably at the beginning of July 2013; but it has since stabilized. It may even be trending upward slightly at this point. With LINE's distribution coverage ratio almost certainly over 1.0x for Q2 2014 (and for the rest of 2014), LINE is a buy.
The two year chart of LNCO provides some technical direction for this trade.
The slow stochastic sub chart shows that LNCO is neither overbought nor oversold. The main chart shows that LNCO fell considerably at the beginning of July 2013; but it has since stabilized. It may even be trending upward slightly at this point. With LINE's distribution coverage ratio almost certainly over 1.0x for Q2 2014 (and for the rest of 2014), LNCO is a buy.
LINE has an average analysts' recommendation of 2.4 (a buy). LINE has a CAPS rating of four stars (a buy). LNCO has an average analysts' rating of 2.2 (a buy). It has a CAPS rating of five stars (a strong buy). The difference is likely that the regular dividend paid by LNCO is taxed much less than the distribution paid by LINE. They are both stable stocks in Beta terms. LINE has a Beta of 0.66; and LNCO has a Beta of 0.116. Both stocks are buys, although investors may wish to average in. The stock market may be in for a downturn soon; and even low Beta stocks might follow such an overall market downturn.
NOTE: Some of the fundamental fiscal data above is from Yahoo Finance.
Good Luck Trading.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in LINE, LNCO over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.