Lower-Risk Oil and Gas Inventory in Linn Energy's Future

The Company: Linn Energy, an independent oil and gas company with core operations in the Brea Olinda Field of the Los Angeles Basin and the Texas Panhandle.
The Filing: FORM 10-Q filed with the SEC on August 7, 2008.
The Finding: Moving forward with its strategy of monetizing non-core oil and gas assets, Linn Energy announced Monday that it had entered into a definitive agreement to sell its deep rights in non-producing Oklahoma acreage, which includes its Woodford Shale interval.

The Upshot: In the last two years, Linn Energy has spent more than $3.2 billion on oil and gas properties, principally in the Mid-Continent region of Oklahoma and the Texas Panhandle. The $229 million in proceeds from the announced sale will be used to strengthen a leveraged balance sheet, reflected in a working capital deficit of $330.3 million and total debt ($1.7 billion) almost 1.9 times shareholder equity at August 31, 2008.

Year-to-date, the company has completed approximately $1.0 billion in sales of oil and gas properties, including the July closing of $600 million in Appalachian Basin assets to XTO Energy. In addition to strengthening its balance sheet, management intends to re-deploy capital into lower risk, bolt-on acquisitions and/or drilling opportunities within its Mid-Continent assets, which hold approximately 87 percent of total reserves, or an estimated 1.7 trillion cubic feet of proved reserves (and a 21-year reserve life).

Going forward, the 2008 capex budget remains at $300 million, with anticipated drilling in the Texas Panhandle of 26 wells and 22 additional wells in the Granite Wash area and Brown Dolomite formation, respectively, during the remainder of the year.

Of interest, the company reported a non-cash loss on derivatives from oil and gas hedges of approximately $773.4 million for the second-quarter ended June 30, a result of the significant increase in commodity prices during the quarter. The average fixed price for existing 2008 gas and oil swap positions were $8.65 per MMbtu and $82.11 a barrel at June 30. As energy prices trend lower, these non-cash losses should reverse in coming quarters.

Lower energy prices, however, adversely affect credit metrics. For example, the total debt -to- proved reserve ratio ($/Mcfe) of $0.98 would increase as natural gas prices decline-projecting a weakened asset base profile. In other words, leverage is kinder to balance sheet health the higher energy prices climb! Ergo, there is limited economic value in maximizing acreage position as energy prices fall-which adds another dimension to asset sales!

The Question: If energy prices trend lower in coming months, will the value of shale leases decline (per acre), especially in expensive gas hotspots like Piceance Basin in Colorado and Uinta Basin in Utah?

David Phillips

David Phillips has more than 25 years' experience on Wall Street, first as a financial consultant and then as an equity analyst for several investment banking firms. He sifts through SEC filings for his blog The 10Q Detective, looking for financial statement soft spots, such as depreciation policies, warranty reserves and restructuring charges. He has been widely quoted in outlets such as BusinessWeek, The International Herald Tribune, Investor's Business Daily, Kiplinger's Personal Finance, and The Wall Street Journal.

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