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Initiating Coverage on the E&P
MLPs at Market Weight
INITIATION
Rapid Growth, but for Whom?
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We are launching coverage on the E&P Master Limited Partnerships
with a Market Weight position. We believe that the E&P MLPs are poised
to experience rapid asset growth in the coming years through consolidation of
mature domestic properties. However, much of that growth appears to be
reflected in current valuations. We are also concerned that the many new
MLPs scheduled to come onto the market will create heightened competition
for suitable long-life mature assets, thus driving up transaction prices and
reducing the currently available accretion benefits. We are initiating coverage
on three of the six existing E&P MLP companies: EV Energy Partners L.P.
(EVEP) with an Outperform rating and $44 per unit price target; and BreitBurn
Energy Partners L.P. (BBEP) with a $36 per unit target and Linn Energy LLC
(LINE) with a $34 per unit target, both with Neutral ratings.
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E&P MLP segment set for rapid growth. The six E&P MLPs have a total
market cap of $9.2 billion and 73.4 mboe/d of production (0.5% of U.S. total).
We believe that the value of assets suitable for E&P MLPs (low decline rate,
long life) could represent some 25% of domestic production, implying a
theoretical sector market value in excess of $200 billion.
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How much will growth will the existing MLPs capture? Current
valuations of the E&P MLPs assume a large amount of acquisitions.
However, we believe that a large amount of MLP-ready assets are already
controlled by traditional E&Ps, which will have a strong incentive to form
their own MLPs. Those new MLPs will need to grow through acquisitions,
thus rapidly increasing the competition for third-party acquisitions and
lowering accretion opportunities for existing MLPs, especially those that do
not have a parent that can drop down assets.
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E&P MLPs are paying reasonable prices for assets, for now. We believe
that the prices that E&P MLPs have paid for assets to date (18 for $5.0 billion)
have been in-line with other North American E&P acquisitions. The E&P MLPs
have paid on average $11.80/boe of reserves and $76,900/flowing barrel basis
versus traditional E&Ps at $18/boe and $70,850/flowing barrel equivalent.
However, as competition heats up longer term, we believe that E&P MLPs
will tend to overpay for assets, which will eventually lead to their demise.
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E&P MLPs will force a revaluation of proved reserves. We argue that
proved reserves have been undervalued by the marketplace for all E&Ps.
Geologic risk and near-term price risk have been stripped out of the proved
stream in an E&P MLP, leaving investors with essentially a high-yield bond
that should trade at a spread to the ten-year Treasury.
Table of Contents
Investment Summary 4
Initiating Coverage of the E&P MLPs with a Market Weight Position 6
Existing MLPs Overview 6
Operating Areas 7
Small Market Footprint Currently 8
Production 8
Reserves 9
Reserves to Production 10
E&P MLPs are Gas Weighted Today 10
Maintenance Capex 11
Hedging 11
Master Limited Partnerships Overview 13
History of MLPs 13
Incentive Distribution Rights of MLPs 15
Tax Advantages of MLPs? 18
Valuation of MLPs 21
E&P MLPs Have Assumed Acquisitions Built into Valuations 23
Valuation Is Greater than PV10 23
Can the E&P MLPs Grow As Expected? 24
Benefits of E&Ps Creating Their Own MLPs May Reduce Available Acquisitions 28
Implications for Traditional E&P Valuation 29
Stripping of Lower Risk Assets Increases E&P Risk 29
Reserves to Production Ratios Should Decline 32
Is PV10 Valuation Still Right for E&Ps? 32
Cash Flows Should Increase in Variance 33
Growth Should Accelerate 33
Impact on Hedging 33
Impact on Private Equity and the Current Model 34
Disadvantages of an MLP Structure 35
MLP-able E&P Assets 36
What Makes a Good Asset for an E&P MLP? 36
Are Oil or Gas Fields Preferred? 36
Investment Cycle 38
How Big Could the Space Get? 38
When Will the Party End? 38
Could a Canadian-Like Meltdown Occur in the U.S.? 38
Risks
EVEP 40
Summary 42
Partnership Overview 42
Investment Attractions 42
Investment Concerns 42
Valuation 43
Asset Overview 45
Structure 45
Management 46
Risks 46
BBEP 52
Summary 53
Partnership Overview 53
Investment Attractions 53
Investment Concerns 54
Valuation 55
Asset Overview 57
Structure 57
Management 58
Risks
LINE 65
Summary 66
Partnership Overview 66
Investment Attractions 66
Investment Concerns 67
Valuation 67
Asset Overview 69
Structure 69
Management 70
Risks 70
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