The drop in the price of crude oil over the last quarter of 2014 was and continues to be bad news for companies that drill and own oil wells. In the jargon of the energy sector, these companies operate in the upstream portion of the spectrum from oil in the ground to gas in your car or electric power in your home.
The revenues of upstream energy companies are directly tied to the energy commodity prices. In the master limited partnership, MLP, subsector of the energy sector, the upstream MLPs are focused on owning producing oil wells and generating a steady stream of cash flow to pay high distribution yields to investors – in MLP terms called unit holders with a partnership.
The upstream MLPs use oil and gas derivative contracts to hedge or lock in the prices they will receive for a large portion of planned future oil and gas production. These hedging practices have allowed the upstream MLPs to pay steady distributions even as crude oil and natural gas prices fluctuate.
The focus MLP of this article, Breitburn Energy Partners LP (Nasdaq: BBEP), has about 75% of its forecast 2015 production hedged at over $90 per barrel for crude oil and almost $5.00 per Mcf for natural gas. Crude is trading under $50 and natural gas is at $2.94.
However, the rapid and large drop in energy commodity prices is forcing the upstream MLPs to re-calculate their 2015 budgets. Breitburn announced on January 2 that it was cutting its distribution rate by 52%, from an annual $2.08 per unit down to $1.00 per unit. Breitburn pays monthly, so investors will now earn 8.33 cents per unit every month. The market had been anticipating a distribution reduction with the fall in crude. Over the three months before the rate cut announcement, the BBEP unit price had dropped by 64%. In the two trading days since the new distribution rate announcement, BBEP has dropped just 1.4% in a market where all the major indexes were declining sharply.
With the new $1.00 per year distribution and the current $6.90 unit price, BBEP yields 14.5%. This is an attractive yield considering the steps Breitburn has taken to protect the distribution going forward.
