As the price of crude has dropped and the unit values of the upstream MLPs have been driven down even farther, I started to wonder what effects the often reported hedging strategies of the companies like Linn Energy LLC (LINE) will actually produce when the 2014 fourth quarter and subsequent quarters are released. With Black Friday taking on a new meaning for investors in LINE and LinnCo LLC (LNCO), there has been a little voice in the back of my head going, "What about the hedges?" The question led to some digging into the supplementary financial information provided by Linn for the most recent two quarterly earnings reports.
Reported Hedging Coverage and Values
Each quarter, Linn Energy updates its hedge positions for the remainder of the year. The hedge positions remained consistent from quarter to quarter, with no changes in the values. This list of the hedge volumes and values quarter by quarter provides an analysis starting point:
Start of 2014 for remainder year:
- Natural gas: 480 MMcf/day at $5.14
- Crude oil: 69,000 BBls/day at $92.46
Sales Revenues, Selling Prices and Derivative Results
Each quarter, Linn breaks out the company's realized average prices for natural gas and crude oil, the revenue from oil, natural gas and natural gas liquids sales and the gains or losses from derivative positions. Putting the three together shows the effects of the hedge positions in relation to the realized energy prices for the quarter. Since operations at Linn have been changing significantly from quarter to quarter and even more so year-over-year, this article will review just the most recent three quarters.
- Weighted average natural gas price per Mcf: $5.23
- Weighted average crude oil price per Bbl: $92.95
- Weighted Average NGL per Bbl: $39.85
- Oil, natural gas and natural gas liquids sales: $938.88 million
- Gains (losses) on oil and natural gas derivatives: ($241.49 million) - Loss
Realized values were just slightly above the hedge prices, but Linn booked a $241 million loss on derivatives.
- Weighted average natural gas price per Mcf: $4.57
- Weighted average crude oil price per Bbl: $96.06
- Weighted Average NGL per Bbl: $38.42
- Oil, natural gas and natural gas liquids sales: $965.85 million
- Gains (losses) on oil and natural gas derivatives: ($408.79 million) - Loss
The reported derivative results from Linn can be very lumpy, but in the second quarter, realized crude prices above the hedge value appears to have produced a significant derivatives loss.
- Weighted average natural gas price per Mcf: $4.01
- Weighted average crude oil price per Bbl: $90.31
- Weighted Average NGL per Bbl: $33.01
- Oil, natural gas and natural gas liquids sales: $937.46 million
- Gains (losses) on oil and natural gas derivatives: $451.7 million
From Q2 to Q3 the lower realized energy prices resulted in a $30 million drop in revenue. Yet the derivatives gains swing was $860 million.
Effects of $70 Oil on Derivatives Value
Out of its financial black box, Linn Energy reports a "net cash provided by operating activities" which seems to wash out the large swings in the income statement derivatives gains or losses. The net cash number increased by about $40 million, quarter over quarter for the Q2 and Q3 of this year. Under the Q3 cash flow statement, Linn booked a $198.6 million gain on derivative activities. There appears to be some flexibility on how much of the derivatives gains or losses are realized in any one quarter, allowing Linn Energy to manage its cash flow to cover expenses and the distributions paid to unit holders.
From the information presented above, a rough extrapolation produces a Q4 derivatives gain of well north of $1 billion, possibly much higher than that number. Distributions to unit holders run $240 million per quarter, so it is conceivable that Linn could close out enough derivatives positions to cover the distribution through 2015 with a significant book of hedge positions remaining. This is just a random thought on my part, but the bottom line of this analysis is that when Linn Energy reports 2014 Q4 results, the net income and cash flow numbers could be a big surprise.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.