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'Flavor of the month' MLP structure played part in LINN Energy's downfall


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'Flavor of the month' MLP structure played part in LINN Energy's downfall

LINN Energy Inc.'s failure to survive as an upstream master limited partnership reflects the challenges of applying the MLP model to the exploration and production sector, which faces more volume and price volatility than the companies that transport oil and gas.

"The closer you are to the market, the less volatility there tends to be around volumes," FBR & Co. analyst Robert Balsamo told S&P Global Market Intelligence. "If you're a producer, those volumes are going to decline as soon as you start drilling."

The volatility of commodity prices is another disadvantage for LINN and other similar MLPs. "Before hedging, they're 100% exposed to commodity prices. ... An extended period of depressed prices would be a problem because as your hedges roll off, it those commodity prices have fallen, you can't re-hedge at the original prices," Balsamo added.

Those forces — price declines leading to volume declines and the inability to favorably re-contract its hedge book and handle nearly $10 billion in liabilities — led LINN to file for Chapter 11 in May 2016. When it emerged in late February, it acknowledged the struggles created by being an MLP by ditching the model.

Other upstream MLPs faced similar hurdles in 2016 amid an extended run of low commodity prices. Breitburn Energy Partners LP also filed for Chapter 11 bankruptcy protection in May, and Atlas Resource Partners LP filed for Chapter 11 bankruptcy in July and emerged from that restructuring as Titan Energy LLC.

S&P Global Ratings analyst Michael Grande said upstream MLPs never made sense despite a the appeal of the structure to companies looking to eliminate corporate taxes. LINN, which went public in 2006, defended its structure in a January 2007 investor presentation that listed its new "tax-advantaged yield" as a structural advantage, in addition to a low cost of capital and stable cash-flow stream.

Formed to encourage growth, the MLP structure distributes earnings to the limited and general partners who pay their own taxes. Money retained at the partnership is reinvested in the business or to cover operating expenses. The model took hold in the midstream sector with pipeline companies that could offer stable and growing cash flows from long-term, fee-based natural gas and oil transportation contracts.

But as LINN would come to experience, the cash flow in the upstream space was not stable enough. After the drop in commodity prices that started in 2014, Linn slashed its 2015 CapEx budget by 65%. That year, it also suspended distribution payments and the dividend payout of LinnCo. LINN conceded in March 2016 that it likely faced a default

When it fell, Fitch Ratings recapped the company's acquisitive track record that led to an "unsustainable capital structure" given its massive pile of debt. "LINN made more than 60 acquisitions in the past 10 years, and the inability to renew hedges at profitable levels amid low market prices ultimately led to an unsustainable leverage profile," the rating agency said on May 12, 2016.

Berry Petroleum was part of that track record. When it acquired the producer for $4.3 billion in December 2013, West Texas Intermediate crude oil prices were above $90 per barrel. In January 2016 spot prices for WTI oil fell below $30 per barrel.

"I think for LINN and [refining MLP Calumet Specialty Products Partners LP], they both ran into significant problems ... because they were promising to pay a distribution consistently when their cash flows were going all over the place," Grande explained in an interview. "I think at one point it was the flavor of the month."

Investors eventually eventually realized they were going to "get burned," Grande said.

LINN Energy Inc., the reorganized successor to LINN Energy LLC and its affiliated companies, used its stint in Chapter 11 bankruptcy to re-form as a more conventional exploration and production company. President and CEO Mark Ellis said in the company's March 23 fourth-quarter 2016 earnings statement that the new focus "is on accelerating the upstream and midstream development of its core SCOOP/STACK/Merge acreage in western Oklahoma, along with additional emerging stacked pay horizontal opportunities in the Mid-Continent, Rockies, north Louisiana and east Texas." LINN said it will also look to sell "non-strategic assets," and the board has enlisted Jefferies LLC to "explore and evaluate potential strategic alternatives" to maximize value.

LINN and Berry Petroleum Co., will operate as stand-alone companies as a result of the reorganization.

LINN reported a loss of $834 million, or $2.36 per share, for the fourth quarter of 2016. It has approved a 2017 capital budget of approximately $395 million that includes about $300 million of oil and natural gas capital. The company did not respond to requests for comment.

S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc.