Sometimes a company's best efforts simply are not good enough. That is certainly the case for Breitburn Energy Partners. Despite a robust hedging program, the upstream master limited partnership's stockcrashed 65% in 2014 as it was overtaken by the deep plungein the price of oil, as shown in this chart.
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The sell-off can be traced to one mistake: Breitburn, like so many other energy companies, failed to hedge all of its oil production. This left it overexposed to the commodity when it sold off in 2014.
Tripped while reaching for upside
As shown on the following slide, 75% of Breitburn Energy Partners' oil production is hedged in 2015.
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Source: Breitburn Energy Partners Investor Presentation.
Outside of a collapse in oil prices, Breitburn's hedge book is pretty strong as the company has protected the bulk of its production through 2016. However, itleft 25% of 2015 production unhedged in hopes of earninga little extra money should crude oil prices head higher than the $93.51 per barrel Breitburn locked in through its hedges. Looking back this was a poor decision, as Breitburn has now been tripped up by the falling price of crude.
Given that the company already paid out nearly all of its income each year to investors via distributions, as well as the fact that its debt levels were elevated, it should have been even more conservative on its hedge book. In obvious hindsight, only being 100% hedged for several years into the future would have enabled the company to avoid its excruciating fall in 2014.
A complete reset
Breitburn Energy Partners is now digging in for what appears to be a dismal near-term future for the oil market. This is why the company's first decision in 2015 was to reset its business by slashing both its capital spending plan and it distribution by 50%. While it didn't necessarily need to slash its payout that deeply, the company decided that it was better to make one deep cut now than many smaller reductions over the next few years if oil prices do not improve.
Meanwhile, the company can use its savingsto whittle down its debt to better position itself for any appealing acquisition opportunities. The company's current plan calls for paying out only 65% of its distributable cash flow in 2015, which leaves a sizable chunk of change that can be used to strengthen its business coming out of thedownturn.
That said, it will be interesting to see if the company revisitshow much of its production it hedges going forward. Clearly, oil companies and analysts have no clue what oil prices will do, so anything less than being completely hedged leaves a company exposed to what tends to be a very wild ride.
Upstream MLPs need to reevaluate how they manage risk. The current market has proven that being 75% hedged isn't good enough. What was once thought to be a robust hedging program has turned out to be inadequate. This burned investors twice, as not only was the unit pricedecimated, but the income streams many investors counted on have evaporated quicker than anyone ever expected.
The article This is Why Breitburn Energy Partners L.P. Crashed 65% in 2014 originally appeared on Fool.com.
Matt DiLallo has no position in any stocks mentioned. The Motley Fool recommends BreitBurn Energy Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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