Are LINN Energy LLC and BreitBurn Energy Partners L.P. Irreparably Damaged?

Upstream MLPs like LINN Energy LLC and BreitBurn Energy Partners L.P. were supposed to offer investors stable income throughout the commodity cycle. That stability was supposed to be provided through robust hedging practices that were intended to smooth out commodity price volatility to keep their cash flow pretty stable.

However, over the last commodity price cycle BreitBurn has cut its distribution twice, while LINN just made its first cut this year. This has analysts and investors wondering if the model no longer works and perhaps if these companies need to rethink their business plans.

Questioning the modelOn BreitBurn Energy Partners' last quarterly conference call, an analyst asked the company about its business model:

As the analyst points out the fixed-rate distributions haven't been quite as fixed as one would hope. Because of this, it might be better for companies like BreitBurn Energy Partners and LINN Energy to simply move to a variable rate distribution so they aren't so focused on maintaining a high payout, and risk burdening their balance sheet with additional debt when distributable cash flow slips.

BreitBurn Energy's CEO Hal Washburn responded to this question and the general line of thinking:

What Washburn is saying, basically, is that the company hedges aggressively to mitigate some of the short-term volatility of oil and gas prices. However, what it can't really hedge against is when commodity prices completely reset, as oil did over the past year. So, when prices completely reset, BreitBurn needs to reset.

Time to shift the policy?That answer prompted the analyst who asked the original question to follow up as to whether the company might be better off simply shifting to a variable-rate distribution policy instead of trying to maintain a fixed rate -- which tends to be variable when commodity prices do reset. Under such a policy, the company wouldn't pay the same amount each month, but would base its distribution on the prior quarter's cash flow.

Washburn, however, disagreed that a variable-rate distribution is the right policy for the company at the moment. He said BreitBurn believes its investors "value some sort of regular distribution." That suggests his company isn't yet willing to shift policies, as it wants to provide its investors some sort of income stability over the long term, even if it needs to be reset from time to time.

LINN Energy, likewise, doesn't yet see a reason to reverse course on the business model it has championed. Right now, the company is focused on generating enough cash flow to pay its distribution and fund its capital program with a little bit of excess cash. Further, the company spent the past year reshuffling its portfolio and is now looking for outside capital to fund its growth so more of its cash flow can go toward distributions instead of being used to drill oil and gas wells.

Investor takeawayBreitBurn's CEO does not think its business model of paying a fixed distribution is irreparably damaged. Neither does LINN Energy, for that matter. While that doesn't mean investors can bank on the distribution never being cut, it does suggest both companies will do whatever it takes to continue providing investors a steady stream of distributions in the future.

The article Are LINN Energy LLC and BreitBurn Energy Partners L.P. Irreparably Damaged? originally appeared on Fool.com.

Matt DiLallo owns shares of Linn Energy, LLC. 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.