This article continues my reviews of upstream MLP hedging results through the first three quarters of 2014. The goal is to get an idea of what will happen with the MLP derivative positions, now that oil has dropped below $70 per barrel. The first two articles on Linn Energy (LINE) and Vanguard Natural Resources (NYSE:VNR) showed derivative value trends that point to very large mark-to-market derivative gains in the fourth quarter, which should provide both distribution safety and financial flexibility to these upstream MLPs. You can review the articles here:
BreitBurn Energy Partners LP (BBEP) is the final member of the three most popular - based on Seeking Alpha email subscriber numbers - of the upstream MLPs.
Income Statement Effects
On its Events page, BreitBurn provides updated summaries of the company's "Commodity Price Protection Portfolio". A year ago, in a November 2013 presentation, BreitBurn reported that for 2014, the company had forecast natural gas production 67% hedged at $4.99/MMbtu and liquids production 83% hedged at $94.78/Bbl. An early November 2014 report showed hedging coverage for the 2014 fourth quarter was little changed compared to a year earlier, with natural gas 72% hedged at $5.17/MMbtu and Q4 liquids production 86% hedged at $94.33/Bbl. These numbers provide the baseline reference when looking at the income statement derivative results for each quarter.
2014 First Quarter:
- Weighted average natural gas price per Mcf: $6.51
- Weighted average crude oil price per Bbl: $92.12
- Weighted Average NGL per Bbl: $42.89
- Oil, natural gas and natural gas liquids sales: $223.6 million - 75% from crude oil
- Adjusted EBITDA: $117.8 million
- Gains (losses) on oil and natural gas derivatives: ($40.2 million) - Loss
2014 Second Quarter:
- Weighted average natural gas price per Mcf: $4.81
- Weighted average crude oil price per Bbl: $95.74
- Weighted Average NGL per Bbl: $38.26
- Oil, natural gas and natural gas liquids sales: $219.1 million - 79% crude oil
- Adjusted EBITDA: $110.0 million
- Gains (losses) on oil and natural gas derivatives: ($127.0 million) - Loss
The WTI crude averaged $103.35 per barrel during Q2 2014, which led to the larger mark-to-market loss reported by BreitBurn.
2014 Third Quarter:
- Weighted average natural gas price per Mcf: $4.12
- Weighted average crude oil price per Bbl: $90.12
- Weighted Average NGL per Bbl: $37.87
- Oil, natural gas and natural gas liquids sales: $216.1 million - 82% crude oil
- Adjusted EBITDA: $118.7 million
- Gains (losses) on oil and natural gas derivatives: $146.2 million - Gain
Note the $273 million positive swing on the value of BreitBurn's derivatives portfolio from Q2 to Q3. In the third quarter, WTI crude averaged $97.87 per barrel, and the Henry Hub natural gas spot price was $3.96/MMcf compared to $4.61 in the second quarter. This MLP generates 75% to 80% of its revenues from crude, and a $5.50 per barrel drop in the price of crude was the primary driver of the significant - $273 million - change in the value of BreitBurn's derivative holdings.
Cash Flow Results
In the same manner used by other upstream MLPs, when it calculates EBITDA and distributable cash flow for a quarter, BreitBurn backs out the income statement derivatives loss or gains, and uses the actual cash settlements on matured derivatives contracts to determine adjusted EBITDA and DCF. For the first three quarters of 2014, the settled derivatives affect on DCF were:
- Q1: ($13.5 million) - a reduction affecting DCF
- Q2: ($17.0 million) - a reduction to DCF
- Q3: ($3.7 million) - a reduction to DCF
For the first three quarters of 2014, BreitBurn has realized cash outflow from derivatives settlements, to the tune of $34.2 million.
Out of the adjusted EBITDA for Q3, BreitBurn paid interest expense of $27.85 million and preferred unit distributions of $4.1 million. Distributions to unitholders were $61.4 million. The total cash outlay for these payments was $93.35 million. Maintenance capex of $33.4 million pushed the DCF coverage below 1.0 times to 0.78 times.
Possible Uses of Q4 Derivatives Gain
Of the three upstream MLPs on which I performed this derivatives and cash flow analysis, BreitBurn showed the greatest swing in derivatives values on the relatively small crude price decline from Q2 to Q3. In the fourth quarter, WTI will probably end up averaging in the mid $70s, resulting in a huge income statement gain on the BBEP income statement. Actual cash settlements should be nicely positive, compared to cash outflows in the previous quarters.
I have hypothesized whether it would make sense for the upstream MLPs to close out a portion of their future derivatives positions and lock in cash gains now. The cash would provide visible support for distributions going into 2015. Also, derivative contracts will never be worth more if crude oil prices start to recover after the new year. I look forward to reviewing what has happened when the Q4 results are released, but it seems obvious that the hedges held by BreitBurn will allow the partnership to maintain the current distribution level.
BreitBurn and QR Energy LP (NYSE:QRE) completed a merger in November, so the QR Energy production and hedging will be combined with BBEP results for part of Q4.
Disclosure: The author is long LNCO.
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.