Hedged Upstream Oil/Gas MLP: Safe, High Yield Plays

After reading an article on the Safe and Cheap blog regarding speculation as to what Seth Klarman's inflation hedge is, I found some interesting opportunities in the MLP space. Seth Klarman currently owns BBEP, LINE, and APL.

Seth Klarmans Inflation Hedge Article

Klarman recently talked about these MLP's in his Baupost Group Quarterly letter:

"Two publicly traded oil and gas partnerships, both heavily owned by lehman brothers, fell sharply immediately after Lehman's bankruptcy filing, to levels where we purchased large blocks at mid-teens or higher annual yields based on current distributions that are largely locked-in for five years through hedges, and at prices roughly half of the value of these companies' proven energy reserves"

I have found four upstream oil and gas MLP's that are currently fully or partially hedged out to 2012 selling for very attractive yields. These include BBEP, EVEP, LINE, and LGCY. These MLP's own very high reserve life and low decline rate oil and natural gas properties in the continental US. They usually hedge their production out 3-4 years to lock in future cash flow to support the required distribution of 90% of net income.

LINE
Linn Energy (LINE) is the safest of the three picks because it has a 21 year reserve life, is 50/50 split between oil and natural gas, and is 100% hedged out to 2011 at natural gas prices of around $8 per mcf and oil prices between $70 and $100 per barrel. They are 66% hedged in 2012. LINE currently yields 20.60% and that dividend looks safe out to 2011. They have also authorized a $100 million share repurchase which I think is a great move at these low prices.

Lehman was a heavy stock holder in LINE, with a position size over 10%. They had to liquidate that position which has added selling pressure to LINE. Also, Lehman was one of LINE's counterparties and currently owes LINE $68 million.

Recent LINE Investor Presentation

LINE CEO Interview with Jim Cramer

The CEO, Michael Linn owns 3.8 million shares of LINE, and recently sold around 500,000 shares because of a large tax liability. I am sure his interests are aligned with the shareholders. Other insiders have purchased around $2.1 million worth of LINE at prices ranging from $12-$23, which is very bullish.

The PV (10%) of the current dividend ($2.52) for 4 years is $8 per share. The dividend should be safe because of the extensive hedging done at much higher prices. So you are paying $4.52 ($520 million) per share for the terminal value, which would be 17 years of reserves (1.7 TCF) at current production. This doesnt take into effect the stock repurchase or reinvesting the dividends at rates higher than 10% by buying more LINE.

EVEP

EV Energy Partners is another upstream MLP that has 18.7 years of reserve life with a production profile of 58%/42% natural gas/oil. EVEP currently yields 24% and should be able to maintain its dividend for the next four years due to its hedge book. Insiders have recently been buying millions of dollars worth of stock on top of thier already large holdings, as they see a huge bargain.

BBEP

Breitburn Energy Partners (BBEP) has the highest yield of the group at around 36%. This is because they are currently getting sued by KWK due to some previous transactions. I believe that this lawsuit is completely frivolous and that KWK is just angry they sold BBEP some
great Antrim shale assets in Michigan with very low break-even natural gas prices. To get a better sense of this lawsuit, you can read BBEP's response here.

BBEP's hedge book is very good with prices way above today's that should ensure the dividend for at least 3 years. After these three years you essentially get whats left over for free. This is almost like a free inflation hedge as you get the oil and natural gas assets for free. BBEP's management has been around for four oil cycles and they seem very intelligent (Stanford undergrad and Harvard Business School) with a great focus on value. They own a significant amount of stock and have been buying up to the lawsuit filing by KWK. I believe they will continue to buy more at these levels once they are legally allowed to.

LGCY

Legacy Reserves current trades for a yield of 25% and 40% of the stock is owned by insiders and management. Their hedges should protect the dividend until 2011 and insiders have recently been buying hundreds of thousands of dollars worth of stock.

I think the best strategy here is to limit company specific risk by buying all four of these stocks. Because LINE is the safest and still offers a 20%+ yield, I will buy the most of LINE.

To do your own research, watch the recent company presenations that can be found at their respective websites. They offer great information about each company's hedge book and their oil and gas properties. This is an opportunity too good to pass up.

Accordingly, the TDBU portfolio will buy $100,000 worth of these upstream MLP's from the proceeds of the CHK and FFH sale, and from cash on hand. The portfolio will put $40,000 into LINE and $20,000 each into BBEP, EVEP and LGCY.

UPDATE:
1600 shares EVEP bought at $12.35
2300 shares of LGCY bought at $8.61
3200 shares of LINE bought at $12.67
3700 shares of BBEP bought at $5.53