It has been a week to try strong men, and the weeks not over yet. Like many of you, my expectations of MLP ownership have been tested, both by a market that had no use for energy producers and the companies themselves, who did not seem to have a thing to say in defense of the apparent decimation of their business models.
So it was a ray of hope on a bad day to see Vanguard Natural Resources (VNR) announce two items Wednesday that bring some coherence back to the MLP business. The first was a $10M unit buyback program. Now I know that is not much for a $2B market cap, but the fact that someone in the industry is telegraphing the message that we have gone beyond cheap in valuing upstream MLP assets is heartening. However, the second item is to me, more important: VNR published a table which gave distribution coverage based on oil and gas prices (reproduced below from their 10/15/2014 press release)
So rather than the typical guessing from third-hand sources, whether they can make their distributions, VNR is giving us the look at how well can they do on different scenarios on energy pricing. While I am sure they are assuming a fairly benign scenario for other factors, one can only hope they are not sugar coating their story.
If we look at their published hedging schedule in the same press release (below), approximately 64% of VNR production is hedged to a 1.17x (interpolated) coverage level. Even if the energy market goes to a proverbial worse case (their .80x coverage scenario) for the remaining 36%, it still leaves VNR with an overall coverage of 1.03 for 2015. If on the other hand, prices do go into a total free fall as projected by various pundits, all bets are off.
So what are my takeaways on this? First, $75 oil, which is where many analysts are putting forth as the probable low for oil, is not necessarily a disastrous scenario, unless we see a similar unwinding of natural gas prices. Given differences in their processing and use in end products, there does not appear to be a fundamental reason that oil and gas pricing need to move in tandem. Follows is 10/15/2014 (a very chaotic market day) natural gas futures quotes > $3.50 level that seem a relatively safe bet for now.
Source: CME.
Second, natural gas may become the new hope for near term solvent upstream MLP business. While oil is still driven in good part by mid-east pricing, natural gas price should be much more localized. Going from playing second fiddle to oil, it now has a stability based on its relative difficulty to transport and higher prices in Europe and Asia, so less likely to have external pricing influences
My final takeaway is that given a VNR disclosure, but how much we can infer about the rest of the upstream MLP business form the information VNR's 70% level of hedging into a new year that is essentially a quarter away does not seem excessively high compared to others. I believe Linn Energy (LINE) as example, maintains very high (90%+) levels of next year hedging. It is not clear how the coverage sensitivities differ from other MLPs (investigating this is high on my list). VNR is known for acquiring mature assets, so its capital expenditures may differ from other upstream MLPs.
Still I do applaud VNR for their openness and information to investors. Other MLPs will be well served to note that it did result in a 6% boost on a day that has other upstream MLPs still on the downtrend.
