BreitBurn Energy Partners - The Common Unit Distribution Isn't Going To Come Back

| About: Breitburn Energy (BBEPQ)

Summary

BreitBurn can reach near breakeven cash flow in 2017 with $40 oil and its current $86 million capital expenditure budget.

However, $86 million is well below the level of capital expenditures it needs to maintain production levels.

$86 million in capital expenditures for 2016 and 2017 may lead to production falling to 15.5 million BOE per year in 2018.

That would raise BreitBurn's breakeven point to $81 oil in 2018 before any common distributions.

In 2019, BreitBurn would need $98 oil to support a $0.50 per unit distribution. Restructuring is probably needed before a common unit distribution is feasible.

Daniel Jones recently wrote an article looking at how BreitBurn Energy Partners (NASDAQ:BBEP) would do with continued $40 oil prices. I agree with his assessment that BreitBurn can get near breakeven cash flow without common distributions at $40 oil with its current $86 million capital expenditure budget. However, what wasn't addressed was the fact that an $86 million capital expenditure budget is well below what BreitBurn needs to maintain production levels.

If 2017's capital expenditure budget is similar to 2016's, production will fall to a point where the common unit distribution is extremely unlikely to come back even with a major oil price rebound. For example, if capital expenditures are not significantly ramped up in 2017, around $98 oil would be required to generate enough distributable cash flow for a $0.50 per unit distribution in 2019, while $83 oil would be needed just to get to zero distributable cash flow. The lack of future distribution prospects will likely put a cap on what the common units can make it back to even with an oil rebound.

Effects Of An $86 Million Capital Expenditure Budget

BreitBurn previously estimated that around $200 million in capital expenditures was needed to maintain production at just over 20 million BOE per year. It budgeted $86 million for 2016 and estimated that this would result in a 9% decline in average production (guidance midpoint of 18.35 million BOE). Since production is likely to keep decreasing throughout the year, this likely translates into 2016's exit rate being around 15% below 2015's exit rate.

The decline rate may moderate a bit in 2017 due to the small number of new wells entering production (and older wells having a lower decline rate). A budget of $86 million for 2017 will likely result in another significant decrease in production though. If 2017's exit rate falls 10% from 2016's exit rate (compared to the 15% decline rate from 2015 to 2016), then BreitBurn's production will be roughly 15.5 million BOE per year entering 2018.

2018 With 15.5 Million BOE In Production

If BreitBurn wants to then maintain production levels at 15.5 million BOE, it may need to spend $150 million in capital expenditures. BreitBurn would then need WTI oil to be around $76 (for a realized price of $70 per barrel of oil) along with $3.50 Henry Hub natural gas to breakeven in 2018 without any common unit distributions or preferred unit distributions. At $76 oil and $3.50 natural gas, BreitBurn would generate around $768 million in total revenue including the effect of negative $9 million in hedge value.

 

Units

Price/Unit

$ Million

Oil Production (MBbls)

8,250

$70.00

$578

NGL Production (MBbls)

1,550

$30.40

$47

Natural Gas Production (MMCfe)

34,200

$3.60

$123

Other Revenue

   

$29

Hedge Value

   

-$9

Total Revenue

   

$768

Click to enlarge

I've calculated lease operating expense at $19 per BOE (at the midpoint of BreitBurn's current guidance) and the reduced production level of 15.5 million BOE. Cash interest is assumed to be slightly lower than current levels as BreitBurn may pay down part of its credit facility in 2016.

Expense

$ Million

Lease Operating Expense

$295

Production and Property Taxes

$64

Other Operating Expenses

$17

Cash G&A

$58

Cash Interest

$186

Maintenance Capital Expenditures

$150

Total Expenses

$770

Click to enlarge

This doesn't include any common unit distributions or preferred unit distributions. Paying preferred unit distributions in 2018 would result in BreitBurn's breakeven point increasing to around $81. BreitBurn could reach breakeven cash flow at a lower oil price if it continues to go with a lower than maintenance capital expenditure budget, but reduced production would result in an even higher oil breakeven point in future years.

2019 With 15.5 Million BOE In Production

I'm going to assume that BreitBurn is able to spend $150 million in 2018 to maintain production levels. In 2019, BreitBurn faces higher preferred unit distributions since it is able to pay its Series B distributions in kind for part of 2018, but not at all in 2019. This would result in BreitBurn's breakeven point increasing to around $83 oil and $3.50 natural gas (or $81 oil and $4.00 natural gas) if it wants to maintain production at 15.5 million BOE.

Common Unit Distributions

The declining production levels make me skeptical that BreitBurn will be able to restore its common unit distributions in the future without restructuring its debt. BreitBurn can potentially survive for a while if its credit facility lenders don't push the company into a restructuring. However, the side effect of a survival capital expenditure budget means that the common unit distribution gets pushed further out of reach. If BreitBurn has an $86 million capital expenditure budget for each of 2016 and 2017, oil would need to average above $80 for it to generate positive distributable cash flow.

For BreitBurn to generate $0.50 per unit in distributable cash flow in 2019 would require WTI oil to reach approximately $98 along with $3.50 natural gas in 2019. A higher natural gas price such as $4.50 would bring the required oil price down to around $94.

BreitBurn also has its credit facility maturing in late 2019 and other debt maturities in 2020, so even if it does manage to generate distributable cash flow, it may put that cash flow towards reducing its debt level. BreitBurn faces a leverage ratio of over 5x at $100 oil in 2019, which is still a high level of leverage that needs to be addressed.

Conclusion

BreitBurn's $86 million capital expenditure budget in 2016 makes it very likely that the common unit distribution will not come back without debt restructuring. Another year of below maintenance capital expenditures would virtually guarantee that the common unit distribution will not come back as BreitBurn would need approximately $98 oil just to support a $0.50 per unit distribution in 2019. As well, the majority of BreitBurn's debt will be maturing in 2019 and 2020, so even if it does generate some distributable cash flow, putting itself into a better position for debt refinancing would appear to be more important than restoring a distribution.

Without a distribution, there is probably a cap on the upside for BreitBurn's common units. I have a hard time envisioning a $5 unit price for BreitBurn even at $90+ oil as there would likely be looming debt maturities and no distribution.

That being said, I am not currently short BBEP since the implications of debt restructuring may push BreitBurn's management into avoiding a restructuring for as long as possible (or at least until a plan to avoid passing through cancellation of debt income to unitholders is implemented). I look for plays with a high potential of short-term moves when shorting. The tax issue leads me to believe that the highest probability long-term outcome is a drawn out decline. This isn't particularly favorable to either shorting or going long the common units, but is better for bondholders who can continue to receive coupon payments while BreitBurn continues to exist in its current form.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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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