BreitBurn Energy Partners (NASDAQ: BBEP) is the exemplar of everything good and bad about U.S. oil-and-gas shale.
BreitBurn is an upstream master limited partnership. Its business is developing oil and gas wells on shale formations. When times are good, cash flows freely into BreitBurn’s coffers and then out to the general partners (the unitholders).
From 2011 through mid-2014, when West Texas Intermediate crude (WTIC) was regularly priced at $100 a barrel, BreitBurn unitholders reaped the benefits. BreitBurn continually hiked the distribution per unit. By the end of 2014, BreitBurn unitholders were receiving $0.52 per unit per quarter. That produced a 10% yield on units that traded near $20 for most of 2014.
But then all hell broke loose in the fourth quarter of 2014. WTIC at $100 a barrel gave way to WTIC at $60 per barrel. The trend has been mostly down since. A month ago, WTIC was priced below $28 a barrel.
BreitBurn’s units have adhered to a similar price trajectory: A $20 unit price in 2014 has given way to a $1 unit price today. This is no surprise. With MLPs, the unit price follows the cash distribution. The $2.08 annual distribution has given way to nothing.
What’s more, the odds are that a distribution won’t be forthcoming until the distant future, if at all. BreitBurn’s existence is in doubt if low energy prices persist through 2016.
The good news for BreitBurn is that low energy prices might not hold.
WTIC is up $9 over the past month. Today, WTIC is priced around $37 a barrel. BreitBurn shares have taken flight with oil, only more so. Its units were up a stunning 72% this past Monday. Granted, the units had closed Friday at a sub-sea-level $0.68 each, but 72% is still a noteworthy move.
That said, I have no interest in BreitBurn units. They offer no income and no possibility of recourse should the company go bust. I’m interested in BreitBurn’s debt.
BreitBurn has $1.8 billion in outstanding notes. A third – $650 million – are secured notes issued to EIG Global Equity Partners. EIG is first in line in any bankruptcy proceedings. These notes are off limits to you and me.
The rest are fair game. BreitBurn also has $850 million in 7.875% senior unsecured notes due 2022 and $305 million in aggregate principal amount of 8.625% senior unsecured notes due 2020. Interest on these notes is paid semiannually, in April and October. As of Dec. 31, 2015, BreitBurn was in compliance with the covenants of these senior unsecured notes.
I’m particularly keen on the 8.625% notes due 2020 (CUSIP No. 106777AB1). These notes have a $1,000 par value and are currently trading around $80 each. Each note is contracted to pay $86.25 in annual interest. The math is straightforward enough: The annual expected interest payout is greater than the current market price. These notes have an annual yield over 100%.
The notes are priced so remuneratively for a reason: BreitBurn is priced for liquidation. This isn’t to say its demise is destiny, though. BreitBurn can easily have a future (at least an immediate future) as an ongoing business. Management guided for BreitBurn to generate EBITDA of between $490 million and $525 million this year. Management based its guidance on $30 a barrel WTIC and $2.30 per-million-cubic-feet natural gas. These are reasonable, conservative estimates.
Cash flow should outpace cash expenses this year. BreitBurn expects to spend $80 million on capital expenditures. Other operating expenses (excluding interest expense) should keep below $150 million. Interest expense shouldn’t exceed $197 million (based on management’s guidance). In other words, if BreitBurn generates $490 million in cash flow – the minimum management expects – it can easily service $197 million of interest expense.
So why the huge discount?
Investors are focused on BreitBurn’s revolving credit line. The borrowing base was $1.8 billion at the end of 2015. As of the end of February, BreitBurn had $1.2 billion in borrowings outstanding against the line. Next month lenders will redetermine the line’s borrowing base. The lenders have the discretion to lower the base below the current outstanding balance ($1.2 billion).
If the base is reduced below $1.2 billion and BreitBurn is forced to immediately repay a large outstanding balance, a liquidity crisis will occur (i.e., bankruptcy). Management is optimistic; it does not expect the base to be reduced below the outstanding balance in April (though the base will be reduced).
As of this writing, my broker quotes five BreitBurn 8.625% notes (the minimum purchase quantity) for $403.40, plus $174.90 in accrued interest. It’s a gamble, to be sure. But if you have a high risk tolerance and can stand the prospect of losing a few hundred bucks, BreitBurn notes just might be the gamble of the year.
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