With the price of natural gas sinking to less than $2 per million British thermal units in spring 2012, many producers curbed drilling in gas-producing basins and shifted their capital expenditures to liquids-rich plays that offered superior returns. Trends in the US rig count reflect this reaction: Over the course of 2012, the number of units actively drilling for natural gas plummeted from 809 rigs at the beginning of the year to only 411 by year-end.
For Linn Energy, the ultra-depressed price of natural gas represented an opportunity to purchase gas-producing acreage at fire-sale prices from producers looking to fund drilling in liquids-rich plays.
For example, the MLP purchased 136 billion cubic feet equivalent of dry-gas reserves in eastern Texas for $1.29 per million British thermal units. Not only did this extreme discount ensure that Linn Energy would earn a decent return when the price of natural gas fell below $2.00 per million British thermal unit, but this bet also appears particularly prescient when you consider that the commodity now fetches more than double the partnership’s entry cost.
Management also inked lucrative deals to acquire wet-gas acreage from BP (LSE: BP, NYSE: BP) in Wyoming and Kansas. Although the price of ethane and propane plummeted in 2012, a mixed barrel of NGLs is still worth significantly more than an energy equivalent volume of natural gas. Despite the return-enhancing liquids content in these plays, Linn Energy paid only $1.40 per million cubic feet of natural gas equivalent reserves in Wyoming and $1.64 per million cubic feet of natural gas equivalent reserves in Kansas.
To reduce exposure to fluctuations in commodity prices and lock in solid returns, Linn Energy hedged all acquired production for the next 3 to 5 years, taking advantage of the futures market’s expectation for higher natural-gas prices.
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Elliott and Roger on Jan. 29, 2019
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