Could Declining Oil Prices Make Life Difficult for Linn?
Linn Energy (LINE) is a company that is well known in the US oil and natural gas segment. They offer their services throughout the country, supplying natural gas liquids, crude oil or natural gas. But seeing as how unpredictable the price of oil has been of late, there’s a good chance that speculators and investors will start to wonder what the price of oil is that would cause Linn to get in trouble when it comes to making their interest payments on the loans they hold.
It might not be a surprise to must, but Linn has chosen a hedging strategy for a large part of their gas and oil production in case the price falls quickly and dramatically. Such drops are generally hard to predict and can have a massively negative impact on the company. A quick look at historical statistics will help us arrive at the conclusion that even after enjoying significant stability over a number of years, the price of oil is still extremely volatile and can fluctuate massively within a few months. So, to protect itself against any potential damages cause by this price volatility, Linn has instituted a hedge plan where between 90 and 100 percent of their natural gas is hedged for 2016 and 2016, 60 to 70 percent of their oil is hedged for 2016 while 50 to 60 percent has been hedged for 2016, and gas weighted deals make for a natural hedge thanks to California steam operations.
These limits will act as protection for a significant part of the company’s revenues over the next two years. These significant layers of protection will make sure the company’s cash flow is secure over the next two years, no matter which direction prices start moving.
Much appears to depend on how able the company will be to cover its loan obligations. Of the $2.8 billion in revenues the company generated over the first three quarters, $442 million was allocated to interest payments. After this, the company has $1.4 billion in cash flow they could use for operational expenses. Of this amount, half was used for oil and gas well and to maintain production while the other half was given back to investors. It’s quite obvious that the company’s assets would be sufficient to cover interest cost while revenues are utilized by unit holders.
Thus, it appears that saving 10 percent over the upcoming year would have practically no effect on the company’s ability to make interest payments. It also seems that the decline of oil prices is not relevant whatsoever at this point. However, if this trend of the price dropping keeps on into 2017, it could eventually harm the company.
At the moment it’s hard to figure out what the level of price drop would be that could cause the company problems. Even so, Linn has sufficient liquidity to buy assets worth $1 billion, which would certainly provide security for their future.
Another strategy would be for the company to sell some of their assets to pay off the loan in full. It may still be a long road, though, until the company gets to the point where it is having issues making interest payments.
Thus, it appears that until 2019, the company can sit back and take a breather. However, it won’t take much for the levers to tip to one side or the other, thus it is vital that investors keep a close eye on changing trends.