It finally happened. Two of the nation’s largest energy producing partnerships cut their distributions.
Linn Energy LLC and Breitburn Energy Partners LP, two of the biggest master limited partnerships (MLPs) by revenue, announced dividend decreases on Jan. 2 as months of depressed crude oil prices finally took their toll. Their high distribution yields became untenable in the face of weakened revenues. It had been what investors feared, and expected, for weeks.
Linn and Breitburn
The Houston-based Linn, an oil and gas company and the biggest MLP on the market, announced last Friday that it would cut capital expenditures and decrease its annual dividend payout by more than 50 percent from $2.90 to $1.25.
Linn’s updated strategy “contemplates a significantly lower current crude oil price than in 2014,” said CEO Mark Ellis in a statement last Friday. On the same day, Linn also disclosed a new investment from GSO Capital Partners LP, a subsidiary of private-equity firm Blackstone Group LP.
Linn’s shares have crumbled more than 60 percent over the last three months.
Breitburn cited similar environmental factors in its decision to cut 2015 dividends by 50 percent on the same day. Both companies are considered “Upstream MLPs” as they are involved in the direct exploration and production of natural resources. “Midstream” and “Downstream” MLPs, which engage in the transportation and distribution of fuels, have relatively less correlation with energy prices.
Crude oil futures posted another decline on Jan. 2, with West Texas Intermediate down 1.09 percent to $52.69 per barrel, and Brent crude down 1.59 percent to $56.42 per barrel.
Shares of Linn (Nasdaq: LINE) and Breitburn (Nasdaq: BBEP) shot up after the announcement last Friday. Linn shares jumped 12 percent while Breitburn was up 9 percent. Rival upstream MLP Vanguard Natural Resources LLC, which did not cut its distributions outlook, also saw its shares jump 11.6 percent.
The stock price movement probably had less to do with the dividends, and more to do with a positive reaction to the industry’s lowered capital expenditures for 2015 and reduced outlook on oil prices. With their prior spending assumptions and oil price outlook, the partnerships would have suffered from huge losses in the current environment.
MLPs have enjoyed a tremendous run in recent years.
MLPs are essentially partnerships that are publicly traded on stock exchanges. Its shareholders are considered members or partners and receive pass-through tax treatment befitting partnerships and LLCs. This structure allows companies to avoid corporate taxes and dole out hefty dividend distributions.
The U.S. Securities and Exchange Commission and the IRS restricts MLPs to certain industries, namely, to firms engaging in natural resource extraction, production, and transportation. MLPs must distribute most of their earnings to investors in quarterly distributions. They are similar to Real Estate Investment Trusts (REITs) in tax structure.
MLPs became immensely popular with investors over the last few years due to their ability to deliver a high yield in a low interest rate environment, with some MLPs yielding close to 20 percent annually. An added advantage is tax efficiency, as MLPs are not subject to the “double taxation” suffered by corporations that pay dividends (the earnings are taxed at the corporate level and the investor level).
Such partnerships have been a large contributor of capital in the U.S. shale boom, bankrolling drilling and oil production.
The irony lies in that the U.S. shale production boom—which was partially built on the backs of MLPs—created a supply glut which lowered global oil prices.
Those same factors today are forcing MLPs to endure painful distribution cuts.