Breaking Out Linn Energy's NewCo
Summary
- Linn Energy intends to separate into three standalone companies, with "NewCo" holding its remaining legacy assets.
- NewCo will produce mostly natural gas and NGLs, and only 2% of its total production will be oil at this point.
- NewCo has a relatively low 11% base decline rate, but production is currently declining in the upper single digits as Linn is not committing much capital to it currently.
- Development of the NW STACK assets may increase NewCo's oil production significantly.
- NewCo is expected to generate over $130 million EBITDAX at $2.75 natural gas.
Linn Energy (LNGG) has been selling off its assets at a rapid rate, which has made it a bit challenging to get an exact handle on what its "NewCo" would look like in the end. Linn's NewCo will be the company that holds its remaining legacy assets, while LNGG is expected to be a holding company for the 50% stake in Roan Resources and Blue Mountain Midstream also gets spun off as a separate company.
Linn has provided more information with its Q4 2017 earnings report that gives a better picture of NewCo's assets, its production mix and levels, and expected costs.
NewCo Assets
Linn's NewCo assets are listed in the slide below. The assets are located in six areas and had 305 MMcfe per day in production during Q4 2017. The reserves are mostly natural gas and NGLs, with a tiny percentage of oil, while the base decline rate is estimated at 11%.
The Hugoton has a decline rate of approximately 6%, and Michigan/Illinois has a decline rate of approximately 4%, so one can calculate that the growth asset base decline rate is approximately 18%.
Source: Linn Energy - Q4 2017 Supplemental Presentation
Linn also still owns some Permian and Drunkards Wash assets, but assumes they will be sold soon. As a result, those assets are not included in NewCo.
NewCo Guidance
Linn also provided Q1 2018 guidance along with full year FY 2018 guidance that allows us to calculate the NewCo information for Q2 2018 to Q4 2018. Linn's guidance notes assume that all its asset sales (including the remaining Permian assets and the Drunkards Wash assets it is still marketing) close in Q1 2018, so the implied guidance for the last three quarters of the year should give a good picture of the costs and production for NewCo.
Source: Linn Energy - Q4 2017 Supplemental Presentation
NewCo production is expected to average 284.3 MMcfe per day during the last three quarters of 2018. This production is expected to be 77% natural gas, 21% NGLs, and 2% oil. The operating costs per Mcfe (not including G&A) are expected to be approximately $1.78, while revenues would be approximately $2.90 per Mcfe at $59 WTI oil and $2.75 Henry Hub natural gas and a $25 per BOE realized price for NGLs. Linn expects to reduce NewCo's G&A run rate to approximately $25 million per year, which is around $0.24 per Mcfe.
Natural gas is expected to account for 62% of revenues at those commodity prices, compared to 30% for NGLs and 8% for oil.
It should be noted that the roughly $9 million per quarter NewCo oil and gas capital expenditures are not enough to maintain production, as the average production during the last three quarters of 2018 is expected to be around 7% lower than Q4 2017 production.
NewCo Expectations | Q2 to Q4 2018 |
Net Production (MMcfe/d) | 284.3 |
Natural Gas (MMcf/d) | 218.7 |
Oil (Bbls/d) | 1,134.5 |
NGL (Bbls/d) | 9,792.3 |
Costs (in thousands) | $139,000 |
Lease operating expenses | $60,500 |
Transportation expenses | $60,500 |
Taxes, other than income taxes | $18,000 |
Costs per Mcfe (Mid-Point) | $1.78 |
Lease operating expenses | $0.77 |
Transportation expenses | $0.77 |
Taxes, other than income taxes | $0.23 |
General and administrative expenses | $0.24 |
Oil and natural gas capital | $27,000 |
Weighted Average Nymex Differentials | |
Natural gas (MMBtu) | -$0.42 |
Oil [BBL] | $1.10 |
NGL price as a % of crude oil price | 42% |
Linn estimates that NewCo's 2018 EBITDAX will be approximately $133 million, which assumes the reduction in G&A to a $25 million per year run rate and the loss of $40 million EBITDAX related to Blue Mountain Midstream's separation. The numbers in the above table do not include the effect of Blue Mountain Midstream's separation. NewCo's EBITDAX will also assumedly benefit from Linn's other revenues, which net out to around $20 million per quarter.
A margin of $0.88 per Mcfe (including G&A) with 284 MMcfe per day in production gets one to around $91 million margin per year. Adding $80 million for other revenues and subtracting $40 million for Blue Mountain Midstream gets one to close to that $133 million EBITDAX number, which is how the EBITDAX outlook gets reconciled with the production and cost guidance. Q1 2018 NewCo production should be between 284 MMcfe per day (Q2 to Q4 2018 average) and 305 MMcfe per day (Q4 2017 NewCo production), which would add slightly to the $91 million per year margin number for 2018.
Source: Linn Energy - Q4 2017 Supplemental Presentation
Conclusion
Linn's NewCo company will primarily produce natural gas and NGLs for now, with oil being a very small percentage of its total production. It currently looks like it would generate a significant amount (close to $100 million per year) of positive cash flow at $2.75 Henry Hub natural gas, although it will also take a lot more than $30 million to $40 million in capital expenditures to maintain production, which may be declining in the upper single-digit percentages at that level of capital expenditures.
Much of NewCo's production mix will depend on what it does with its NW STACK acreage though. NewCo's NW STACK position has a significant amount of production growth potential, and investment there could substantially boost NewCo's oil production. SandRidge's Q4 2017 wells in the NW STACK (in SW Major County) averaged 72% oil during their peak 30 days of initial production. Results have been quite variable, with SandRidge's Q4 2017 wells recording 30 day IPs ranging from 196 BOEPD to 1,314 BOEPD (average 623 BOEPD over seven wells).
I estimated NewCo's value in a report for my premium subscription service at approximately $1.3 billion excluding cash, as well as the Drunkards Wash and remaining Permian assets. This included around $250 million in value for NewCo's NW Stack acreage, so excluding that, the valuation comes up to around 7.9x Linn's 2018 EBITDAX estimate for NewCo. This is a bit on the high side, but also reflects Linn's lack of investment in NewCo during 2018, resulting in significant positive cash flow, but also declining production.
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