LINN Energy: What’s Not to Like?

Source: Thinkstock

Source: Thinkstock

LINN Energy (NYSE:LINE) has been one of my favorite plays for growth and income since I began covering the stock around $25 last year. I mean, what is not to like? You have a 10 percent yield, you have a real chance at unit price appreciation, strong production and solid oil and gas prices. But, it has been over six months since I last highlighted the name. For those unfamiliar with the company Linn Energy is a master limited partnership and a subsidiary of Linn Co (NYSE:LNCO) that pays a hefty monthly distribution from its oil and gas operations. Linn Energy’s properties are located in the Hugoton basin, the Green River basin, the Permian basin, Michigan, Illinois, the Williston/Powder River basin, California, and East Texas in the United States. The company has been controversial, and has made some questionable moves in the past that I have covered. Now that oil and gas prices are moving higher, I thought I should check back in with the company and provide an update to its operations, which appear to be firing on all cylinders. I will discuss briefly first quarter production then give an update by region.

So let’s talk about the most recent quarterly production. First, during its most recent quarter, Linn Energy’s production averaged approximately 1,104 Millions of Cubic Feet Equivalent per Day (MMcfe/d) which exceeded the high end of the company’s guidance range. Now these better than expected results were borne from the company’s capital program and efficient management of its base assets. These efficiencies resulted in increased production across a number of operating areas, most notably in California and the Uinta Basin. However, it is important to have a grasp on the production in each of the regions to understand if the company will be able to maintain its monthly distributions to unit holders.

First, Linn Energy’s Permian Basin properties is promising. It consists of over 2,000 operated wells. Approximately 1,000 of these wells are mature, low-decline oil properties, primarily consisting of waterfloods. Since 2010, the company has been developing vertical Wolfberry wells and now operates approximately 900 vertical Wolfberry oil producing wells. Most of the acreage which has been developed in the Wolfberry formation is now prospective for horizontal Wolfcamp drilling, which could lead to increased production efficiencies. What you need to be aware of is that the company is exploring various alternatives for potential asset trades or sales for its approximately 55,000 net acres in the Midland Basin. Recently, Linn Energy completed drilling its first operated horizontal well in Midland County targeting the Wolfcamp B interval and expects to complete it in the second quarter 2014. In addition to the company’s three rigs targeting the vertical Wolfberry trend, another development program is underway in the Clearfork formation of the East Goldsmith Field, which was acquired in 2013. This three-rig program is expected to generate attractive returns from this vertical oil target.

Turning to the Hugoton Basin, Linn Energy has another wonderful property. The property consists of over 3,700 operated mature wells. Production volumes continue to gradually increase as a result of minimal capital spending on optimization projects and one operated rig, which is expected to drill approximately 80 wells this year. The company believes it has a sufficient number of locations identified to sustain this low-risk, repeatable and high-return program for the next five years at its current drilling pace. In addition to its drilling program, Linn Energy continues to aggressively pursue low-cost optimization projects in the area. Since taking over operations in July 2012, Linn Energy has implemented 535 maintenance and optimization projects, which have added over 7 MMcfe/d of production. Linn Energy has also improved the efficiency of its Jayhawk natural gas processing plant and increased throughput volumes 6 percent to 197 MMcfe/d for the first quarter 2014 from 186 MMcfe/d at the time of the acquisition in 2012.

Next there is the massive Mid-Continent regionwhere production unfortunately is actually declining. This region consists of over 3,100 operated wells located in Oklahoma, Louisiana and the Texas Panhandle. Linn Energy currently has five rigs operating in its Mid-Continent region, compared to eight operated rigs at the end of 2013. Four rigs are primarily targeting oil intervals in the Granite Wash, and the remaining rig is focused on liquids-rich opportunities in the Cleveland play located in the northern Texas Panhandle. As Linn Energy reduces its rig count in the Granite Wash, the company expects decline rates to begin to moderate in this area. Linn Energy’s remaining Mid-Continent properties consist of over 2,800 low-decline wells and include natural gas properties located in the Anadarko Basin and the Mississippi Shelf area as well as mature, oil producing waterflood properties in Oklahoma and Louisiana. So what the company plans to do is focus on optimization projects targeted at increasing volumes and lowering costs.

Moving northwest, there is The Rockies region. In this region Linn Energy has over 1,200 operated wells located in the Green River, Piceance and Uinta basins. Additionally, Linn Energy has interests in approximately 2,100 non-operated wells in the Green River Basin, Williston Basin and the Salt Creek Field in Wyoming. Active operated and non-operated drilling programs are underway in the Green River Basin targeting liquids-rich natural gas wells. In the Uinta Basin, first quarter 2014 production grew thirteen percent.Furthermore, activity levels remain high in the Williston Basin where production has increased to approximately 7,000 barrels of oil equivalents per day, up from approximately 2,500 in 2011.

Finally, Linn Energy’s California regional properties consists of over 2,100 operated oil wells and currently has three rigs drilling. Almost 75 percent of Linn Energy’s approximately 2,100 wells in the region are mature, low-declining wells located in the San Joaquin Valley and the Los Angeles Basin. These mature assets deliver stable production volumes with shallow base declines. Linn Energy has active drilling and development programs underway in both of these areas, which have delivered growth of approximately 9 percent quarter-over-quarter and 83 percent year-over-year.

All things considered, production in all areas with the exception of the Mid-Continent is increasing. When you couple the growing production with the facts that oil remains well above $100 a barrel and natural gas prices are just under five-year highs, the case for Linn Energy is strong. Further, Linn Energy’s oil, natural gas, and liquids production revenues rose 27 percent year-over-year in the company’s last reported quarter. In my opinion, the company is moving ahead nicely. With a 10 percent yield and potential for unit price growth, I continue to rate Linn Energy a buy.

Disclosure: Christopher F. Davis is long Linn Energy. He has a buy rating on the partnership and a $35.50 price target.

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