BreitBurn Energy Partners: Signs Point To The Common Equity Being Sacrificed

| About: Breitburn Energy (BBEPQ)

Summary

BreitBurn likely needs to eliminate its bond interest to be viable in the long run.

That would reduce its breakeven point without hedges from around $75 oil to $55-$60 oil.

BreitBurn would also be able to pay down its credit facility to around $725 million by the end of 2017, leaving it less vulnerable to borrowing base reductions.

BreitBurn doesn't have much other than equity to incentivize debtholders to make a deal though.

Thus it still appears likely that the current common equity will be sacrificed in the deleveraging deals. This is also supported by the changes to the incentive compensation plan.

For BreitBurn Energy Partners (NASDAQ:BBEP) to be viable in the long term, it probably needs to eliminate its second-lien and unsecured bond interest. With that interest cost, it has a breakeven point of near $75 oil without hedges. If it eliminates that interest cost, its breakeven falls to the $55 to $60 oil range. Based on the changes to the executive incentive compensation plan, any deleveraging solution is likely to make the current common equity worthless or near worthless though.

Borrowing Base Redetermination

One item that I didn't notice before was that BreitBurn's 10-K (on page 75) indicated that its projected borrowing base (assumedly after the October redetermination) was $1.075 billion, and that it classified $154 million of its credit facility borrowings as current liabilities as a result since it would need to pay its credit facility down by that much during 2016.

Although BreitBurn also indicated in the 10-K that it expected to have a borrowing base larger than its outstanding borrowings after its April redetermination, the $1.075 billion projection for October shows that BreitBurn's liquidity was probably going to be quite tight. BreitBurn probably wouldn't be able to get its outstanding borrowings down to that level by October with a maintenance capital expenditure budget, so it went with a lower $86 million budget for 2016 that resulted in production declines.

Continued production declines would make it difficult for BreitBurn to be competitive even with sharply reduced interest costs, so that may have factored into BreitBurn's decision to take near-term action.

Incentive Compensation Plan Changes

Another indication that the common units for BreitBurn Energy Partners is likely to be of little or no value after the planned deleveraging efforts is the modified incentive compensation plan for key executives. The key executives are voluntarily forfeiting unit incentives and receiving potential cash payments for reaching various objectives instead.

BreitBurn In 2016

For BreitBurn to be a viable company in the long run, it ideally needs to eliminate its unsecured and second-lien interest costs. That would reduce its annual interest costs by around $153 million and bring its breakeven point (based on its projected 2016 production exit rate) around $55 to $60 oil and $3.25 natural gas.

At $42 oil and $2.40 natural gas in 2016 (roughly based on actual prices for the first four months followed by strip pricing for the remaining eight months), BreitBurn would end up with approximately $968 million in revenue including hedges.

Units

Price/Unit

$ Million

Oil Production (MBbls)

9,750

$37.40

$365

NGL Production (MBbls)

1,850

$16.80

$31

Natural Gas Production (MMCfe)

40,500

$2.46

$100

Other Revenue

$29

Hedge Value

$443

Total Revenue

$968

Click to enlarge

Total expenses would be $593 million, including the effect of the suspended preferred distribution, the reduced capital expenditure budget, and no bond interest payments.

Expense

$ Million

Lease Operating Expense

$349

Production and Property Taxes

$41

Other Operating Expenses

$17

Cash G&A

$58

Cash Interest

$36

Capital Expenditures

$86

Preferred Distributions

$6

Total Expenses

$593

Click to enlarge

BreitBurn would be able to pay down its credit facility debt to approximately $854 million at the end of 2016 in this scenario.

BreitBurn In 2017

BreitBurn's production is expected to be slightly lower in 2017 due to production falling throughout 2016 with its current budget. If oil averages $50 and natural gas averages $3 during 2017, then BreitBurn would generate $772 million in revenue during 2017. These oil and gas prices are modestly above strip.

Units

Price/Unit

$ Million

Oil Production (MBbls)

9,000

$44.00

$396

NGL Production (MBbls)

1,700

$20.00

$34

Natural Gas Production (MMCfe)

37,800

$3.08

$116

Other Revenue

$29

Hedge Value

$197

Total Revenue

$772

Click to enlarge

If BreitBurn wants to maintain production levels, its capital expenditures will go up to $170 million. This would result in around $643 million in cash expenses during 2017.

Expense

$ Million

Lease Operating Expense

$323

Production and Property Taxes

$45

Other Operating Expenses

$17

Cash G&A

$58

Cash Interest

$30

Maintenance Capital Expenditures

$170

Total Expenses

$643

Click to enlarge

BreitBurn would be able to pay down its credit facility further to around $725 million at the end of 2017. BreitBurn has limited hedges after 2017, but $725 million is a borrowing level that credit facility lenders would likely be content with, even without valuable hedges. This is around 57% of BreitBurn's PV-10 at the end of 2015 based on SEC pricing. If BreitBurn didn't eliminate its bond interest payments, I estimate that credit facility borrowings would be around $1.04 billion at the end of 2017, which may be a higher level than credit facility lenders would be fully comfortable with.

Restructuring Options

Frank Hacklander recently brought up the possibility of a Rex Energy like deal for BreitBurn. I think that is an interesting idea, although I don't think such a deal would do enough to solve BreitBurn's situation in the long run, and there potentially isn't enough incentive for noteholders to agree to such a deal in BreitBurn's case.

One issue is that once the interest costs come back in full, BreitBurn's breakeven point will rise to around $75 oil, which still leaves it at the high end for US producers in terms of breakeven. As well, BreitBurn would likely need to get both the second-lien and unsecured notes to agree to a deal for its situation to improve enough in the short term.

With Rex Energy, the unsecured notes represented over 95% of its interest costs, so getting the unsecured notes to swap into second-lien notes with minimal initial interest costs made a very large difference to Rex's financials. In BreitBurn's case, the unsecured notes represent approximately 48% of its interest costs. Getting the unsecureds to take a temporary minimal interest rate would certainly be beneficial to BreitBurn, but probably not enough on its own. BreitBurn would likely need EIG's second-lien notes to take a similar minimal interest rate for there to be enough impact. The second-lien plus unsecured notes account for approximately 80% of BreitBurn's interest costs.

There doesn't appear to be sufficient incentive for EIG to sacrifice its bond interest though. In Rex Energy's case, the unsecured noteholders were facing a modest recovery. Rex had $675 million in unsecured notes, a PV-10 of $301 million, $36 million in hedge value and $112 million in credit facility borrowings. If the company was hypothetically valued at PV-10 + hedge value, the unsecured notes would have a roughly 33% recovery. Rex Energy's debt exchange offer gave the unsecured noteholders the ability to wait for a potentially much higher recovery, while giving it more protection in the form of moving up to a second-lien position in case things didn't work out.

In BreitBurn's case, EIG owns $650 million in second-lien notes, the PV-10 is approximately $1.28 billion, there are $1.2 billion in credit facility borrowings outstanding, and the remaining hedges have around $500 million in value. At PV-10 + hedge value, the second-lien notes would get an 89% recovery. BreitBurn can't really offer EIG an improvement over the second-lien status.

For BreitBurn's unsecured notes, I don't think a third-lien status would be much of an improvement. The debt would still be behind $1.85 billion in first and second-lien debt. BreitBurn is also currently not allowed to issue additional second-lien debt and I doubt there would be much of a market if it wanted to raise new third-lien debt. Therefore, the difference between unsecured status and third-lien status is marginal in terms of actual impact.

As BreitBurn is unable to use the lure of moving up in the capital structure as a viable incentive for noteholders to reduce interest costs, the equity will need to be the chief carrot.

Conclusion

If BreitBurn can eliminate its bond interest, it can potentially become a viable entity in a $50 to $60 oil world. The hedges would then allow it to pay down its credit facility to a level that should be less vulnerable to borrowing base reductions. However, with BreitBurn having little capacity for additional secured debt, the main incentive it can offer to the second-lien and unsecured bondholders would be equity. As the second-lien notes would likely see at least a near-full recovery in the event of an in-court restructuring, EIG is probably going to end up with most of the equity in any deal. As indicated by the changes in the management incentive compensation plan, the current common equity is likely to have quite limited value at best post-restructuring and should be avoided.

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