BreitBurn Energy Partners: Only Two Months Left Until The Day Of Reckoning

| About: Breitburn Energy (BBEPQ)

Summary

BreitBurn faces many of the same problems as Linn Energy.

These include a probable upcoming borrowing base deficiency and very high leverage ratios even if oil and gas prices double.

BreitBurn may have alternative support from EIG, which has already invested $1 billion in BreitBurn's preferred units and secured debt.

A lifeline from EIG would likely result in common and preferred units being cancelled and EIG taking equity ownership of the company, similar to its Pacific E&P proposal.

BreitBurn probably needs $45 oil by April to put off a restructuring. Futures prices currently indicate that there is a less than 7% chance of oil reaching $45 by mid-April.

BreitBurn Energy Partners (BBEP) faces many of the same challenges as Linn Energy, and I believe that its upcoming borrowing base redetermination may force it to contemplate a similar move to Linn in maxing out its credit facility borrowings and preparing for a potential debt restructuring.

Similar to Linn, BreitBurn needs near $90 oil to get its leverage ratio below 5x. At $70 oil, its leverage ratio would remain around 7x to 8x, which is an extremely high level. As well, its borrowing base redetermination may result in a borrowing base as low as $1 billion or less given the current sub-$30 state of oil. This would result in a significant borrowing base deficiency.

When looking at BreitBurn, one has to consider the involvement of EIG Global Energy Partners though. EIG previously put $1 billion into BreitBurn through a combination of secured debt and preferred units, and could potentially come in again to give BreitBurn a lifeline.

EIG has the ability to sponsor a potential recapitalization scheme that would give it ownership of the company. It could also decide not to put any more money into BreitBurn, in which case BreitBurn may end up going Linn's route in maxing out its credit facility borrowings before its borrowing base is reduced. Either scenario is unlikely to leave the common unitholders (and probably the preferred unitholders) with anything though.

April Borrowing Base Redetermination

I had previously estimated that BreitBurn's borrowing base would end up around $1.1 billion to $1.15 billion after its April 2016 borrowing base redetermination. However, that was written in late December when oil was around $37 per barrel, and assumed a recovery to $46 by April when doing the borrowing base calculations to give BreitBurn the benefit of a modestly positive scenario. One and a half months later oil is at $28 and now the EIA forecasts May 2016 oil prices to be at $36. The EIA also mentions that the market-derived probability that the price of oil will be above $45 when the May 2016 futures expire was only 14% on February 4th. Based on the changes in the futures prices since then, this probability has now decreased to around 7%.

Unless oil moves up significantly in the next two months, one can be certain that the banks will be using price decks that incorporate low future oil prices (probably below $50 for 2016 and 2017) for their borrowing base redeterminations. Thus, one could say that there is a 93% chance based on futures pricing that BreitBurn's borrowing base will be less than $1.1 billion to $1.15 billion after the redetermination. Based on the current situation, BreitBurn's borrowing base could be reduced to $1 billion or less in April 2016, leaving it with a significant borrowing base deficiency.

High Leverage Even With A Price Recovery

BreitBurn's leverage ratio without hedges is very high, as its net debt to EBITDA would not fall below 5x until oil reached approximately $90. At $70 oil, BreitBurn's net debt to EBITDA is above 7x. Including preferred shares would push BreitBurn's ratio of preferred shares plus net debt to EBITDA to around 6x at $90 oil and 8x to 9x at $70 oil.

As there are not many people who think that oil will reach $90 in the next few years, it is reasonable to conclude that BreitBurn's current debt levels are unsustainable. There are many producers who are ready to increase production at $50 to $70, thus dampening prospects for a sustained rise beyond those levels for now.

BreitBurn's leverage ratios at those oil prices also indicate that any restructuring could fairly easily gain court approval to wipe out the common units and preferred units. An argument that those units should be assigned value in a restructuring since oil prices could triple at some point in the future is unlikely to gain much traction.

Potential Intervention Of EIG Global Energy Partners

There is the potential for EIG Global Energy Partners to propose a restructuring of BreitBurn in order to take control of the company and preserve part of its current investment. However, common and preferred unitholders are unlikely to see any return in that case. EIG recently proposed a restructuring of Pacific E&P that involved offering approximately $825 million for $4.1 billion in debt. As part of the restructuring, it would gain sole control of Pacific E&P.

BreitBurn's bonds are currently trading slightly higher than Pacific E&P's (around three to four cents higher) were at the time of the proposal, so a similarly structured deal would involve EIG offering approximately $275 million (including accrued interest) for BreitBurn's $1.155 billion unsecured debt. The unsecured debt and EIG's secured notes may then be converted into equity, while the preferred units and common units could be wiped out. Such a move can likely be justified by the unsecured notes trading at under 15 cents on the dollar (which implies that the preferred units and common units have zero intrinsic value). EIG made a comment about Pacific E&P's equity having no value as indicated by the low bond prices.

As well, S&P currently expects the unsecured notes to have minimal recovery, which leaves zero recovery value for the preferred units and common units. Finally, even with $70 oil, BreitBurn's debt to EBITDA ratio would be over 7x, indicating that the common and preferred units have little current value other than as an option on much higher oil prices.

If such a deal is made, EIG may need to offer BreitBurn a new secured loan to allow it to pay down its credit facility by a significant amount so that future borrowing base reductions are no longer an issue. There is the possibility that the credit facility lenders would allow BreitBurn a significant amount of time to work out the borrowing base deficiency if the other debt is converted into equity (thus resulting in the elimination of the non-credit facility interest payments).

It remains to be seen whether EIG would be willing to put more money into BreitBurn (both for the unsecured debt purchase and the secured loan) in order to give it control of the company. It could also let the credit facility lenders determine the fate of the company, but if a credit facility liquidity crunch pushed BreitBurn into restructuring, then EIG would likely only see a partial recovery on its current $650 million secured debt investment and no return on its preferred shares. Linn Energy's second-lien notes were recently trading at under 20 cents on the dollar, and BreitBurn's debt situation is not tremendously better based on leverage ratios.

Conclusion

The upcoming borrowing base redetermination is likely to result in a borrowing base deficiency for BreitBurn as its outstanding borrowings will likely be higher than its new borrowing base. A borrowing base deficiency would force BreitBurn to suspend its preferred distributions. BreitBurn may also choose to max out its credit facility borrowings ahead of the borrowing base redetermination so that it has ample cash on hand to deal with a restructuring scenario. There is also the potential for EIG to propose a restructuring deal similar to what it recently proposed for Pacific E&P. That sort of deal would involve making an offer for BreitBurn's unsecured bonds and then turning much of BreitBurn's debt into equity while canceling the current preferred and common units.

BreitBurn has around two months left before the borrowing base reductions are likely to have serious repercussions for the company. Oil probably needs to rise to at least $45 by April to avoid a restructuring scenario triggered by a significant borrowing base deficiency.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in BBEP 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.

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