Why the Linn-Berry Acquisition Could Mark the End of an Era

Postle field, Oklahoma, at sunset. Source: Wiki Commons

For upstream master limited partnerships, or MLPs, 2013 was a banner year for acquisitions. In February of last year Linn Energy (NASDAQ: LINE) announced the biggest acquisition in upstream MLP history when it acquired Berry Petroleum for what ultimately amounted to a $4.3 billion transaction. Other big names were active as well: BreitBurn Energy Partners (NASDAQ: BBEP) made a $900 million acquisition of mature, oil-producing acreage in Oklahoma last summer. This acquisition was also the biggest BreitBurn had ever done. And there were many more from others, too.

But why so many over the last few years? Many point to low interest rates, but rates have been low for the past six years. Actually, the real driver behind all this acquisition volume has been shale activity. Although upstream MLPs do not invest heavily in the shale, the companies on the selling end of these acquisition deals do. 

As exploration and production companies have acquired heavily in the shale, they used their older, mature acreage to finance this buying spree. As such, the market was flooded with mature acreage over the previous few years. 

But we can already see that this 'buyer's market' for MLPs is ending. Total upstream acquisitions in 2013 were flat, and the number for 2014 will likely be lower. Instead of acquiring new shale acreage, most firms are now focusing on optimizing what they already have. As E&P companies optimize and develop their shale acreage, that acreage will come closer to being cash flow neutral and will eventually become cash flow positive, hence eliminating the need for further financing. Finally, natural gas prices have bumped up, which compels these E&P companies to hold onto mature, gas-producing acreage instead of selling it to the MLPs. 

End of an era
All this points to the same thing; for upstream MLPs, 2014 will not likely be as active an acquisition year as 2013 was. That is not at all a bad thing, as upstream MLPs now have a lot of optimization to do themselves. As the situation for mature acreage becomes less of a buyer's market, the better upstream MLPs will be the ones that have already built up their portfolios for many years of modest but meaningful growth. 

Thankfully, many of the upstream MLPs already have done just that. Which ones do I think have the best portfolios for the future? Not to sound like a broken record, but Linn Energy is the most obvious choice. Linn's huge position in California is the envy of the upstream MLP industry, and it's not hard to see why: Long-lived production, decline rates in the low single-digits, and some of the highest EBITDA margins there are. 

Another obvious choice is BreitBurn Energy Partners. BreitBurn's western Oklahoma acreage, while not quite as profitable as Linn's in California, can produce at least another ten years of production growth. While Linn and BreitBurn are not the only two that have put the finishing touches on their portfolios, I believe that both will do well in this environment of fewer acquisitions.

Bottom line
I believe that the upstream MLP 'acquisition bonanza' of 2009-2014 is entering its last innings. The investor should not see this as a bad thing. During the acquisition spree, upstream MLPs either racked up debt or issued lots of equity to make these acquisitions. That, too, should begin to taper off. Perhaps at some point, still a few years off in the distance, some of these upstream MLPs will even begin paying off debt.