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(B)(N) LINE Linn Energy LLC

June 20, 2013

Deal Book. Linn Energy LLC is a “master limited partnership” (MLP) which purpose is to acquire oil and gas properties and produce them so as to pay a high and steady dividend to its shareholders. And that it does, at a rate of about 7% to 8% per year since at least 2008, and the current yield is an astonishing 8.8%.


Courtesy: Linn Energy LLC

In order to do so, however, it needs to sell its production forward either through swaps of excess current production for future production, or put options which are an expense now, but which can be accounted for as a “capital expenditure” and “capitalized” and eligible for a depreciation expense just like new and then rusting plant & equipment. Moreover, the real expense of the cost of the put just vanishes.

That opens up a whole new world of opportunity in the debt market and also equities because the company has a great looking balance sheet, great revenue and earnings, and pays a high dividend. It’s a wonder and everything would be fine if the derivative contracts were profitable rather than losers, as was the case with Amaranth Advisors LLC which lost 65% of its capital in 2006 on bets that the price of natural gas would rise rather than collapse, and the firm’s failure was, at that time, one of the largest known trading losses ($5 billion) and hedge fund collapses in history. To be followed by even larger and more infamous failures and “market imperfections”.

Exhibit 1: The Price of Natural Gas 2008-2013

CME Group Natural Gas

CME Group Natural Gas

So here we are, nearly a decade later, and Linn Energy has its pros including The Street (The Street, June 19, 2013, Cramer: Over the LINE); and Leon Cooper of the Omega Advisors (The Street, June 19, 2013, Cooperman: ‘We Have Done Our Homework’ on Linn Energy) which holds 3% of the stock and is the largest institutional investor which hold, in aggregate, about 17% of the stock; and The Motley Fool, April 25, 2013, Drilling Down Into Why LINN Energy Missed Its Production Guidance, which explains that the premiums paid for put options that settled during the three months ended March 31, 2013 and March 31, 2012 and during the years ended December 31, 2012, 2011 and 2010 were approximately $43 million, $26 million, $148 million, $88 million and $94 million, respectively, and “when you subtract those premiums it suggests that LINN’s distributions were more than its distributable cash flow”. Indeed.

Exhibit 2: The Price of West Texas Intermediate (WTI) Crude Oil

CME Group WTI Crude Oil

CME Group WTI Crude Oil

And its cons (Barron’s, February 16, 2013, Drilling Into the Numbers) which concluded that “Savvy hedging has helped Linn Energy plump its payout and attract investors. But the MLP’s accounting for derivatives is starting to raise some questions.”

The average price for a barrel of West Texas Intermediate crude, the U.S. benchmark, fell by about 10% over 2012, and natural gas prices hit 12-year lows in April 2012, which led to several asset writedowns and companies with a gas-heavy profile suffered more than others.

In 2012, Linn Energy was forced to write off about $440 million worth of its reserves (assets) because of sliding gas prices, including $148 million of option expenses (as noted above) which were “capitalized” as “reserves” but might have a future value if gas prices decline enough, and to pay about $680 million in dividend expenses.

To buy or not to buy, that is the question. Linn Energy became eligible for the Perpetual Bond™ at $10 in 2009 and we’ve held it until November of 2012, obtaining capital gains at $40 plus a fantastic stream of dividends, and we were sold out on a stop/loss at $38 and we haven’t owned it since. Please see Exhibit 3 below, Red Line Stock Price (SP) above the Black Line Risk Price (SF) and for no other reason.

Should the price increase to $40 again, whatever the reason, then we might buy it. Our estimate of the downside risk due to the demonstrated volatility is minus ($3) per share so that we might reasonably expect that the company will trade between the current $33 and $30 t0 $36 without surprise. And there might be some.

It’s also noteworthy that we don’t really care about what the experts think that the stock price should be. All things considered (which they don’t), we only care about what the stock price is.

Please see our Posts, The Price of Risk, August 2012 and The Nash Equilibrium & Its Stock Price, October 2012, for more information on the theory.

Exhibit 3: (B)(N) LINE Linn Energy LLC – Risk Price Chart

(B)(N) LINE Linn Energy LLC

(B)(N) LINE Linn Energy LLC

Linn Energy LLC is an oil and natural gas company. The Company acquires, develops various oil and gas properties in the United States.

(Please Click on the Chart to make it larger if required.)

From the Company: Linn Energy LLC is an independent oil and natural gas company that engages in the acquisition and development of oil and natural gas properties. The company’s properties are located in the Mid-Continent, the Hugoton basin, the Green River basin, the Permian basin, Michigan, Illinois, the Williston/Powder River basin, California, and East Texas in the United States. As of December 31, 2012, it had proved reserves of 4,796 billion cubic feet equivalent oil, natural gas, and natural gas liquids; and operated 15,804 gross productive wells. The company was founded in 2003, has 1,100 employees, and is headquartered in Houston, Texas.

The Price of Risk

The calculated Risk Price (SF) is a provably effective estimate of the “price of risk” which is “the least stock price at which the company is likeable” (Goetze 2006) and “likeability” is determined by the demonstrated factors of “risk aversion” – we want to keep our money and obtain a hopeful return above the rate of inflation – and the properties of portfolios of such stocks. Stock prices that are less than the price of risk can be said to be “bargain prices” but with the risk attached that the company might never get a higher price other than that due to ambient volatility or “surprise”; on the other hand, investors who are willing to pay the “full price” above the price of risk, and buy and hold the stock at those prices, must also be confident, and have reason to believe, that the company will produce those values, absent new information.

Please see our Posts, The Price of Risk, August 2012 and The Nash Equilibrium & Its Stock Price, October 2012, for more information on the theory.

To see what else “risk averse” investing can do for us, please see our recent Posts, The Wall Street Put, April 2013, and earlier Posts such as The Dow Transports, March 2013, or The Risk Adjusted Dow, March 2013, or The Canada Pension Bond, February 2013, and for a more colorful description of investment risk and the application of the “price of risk” to mergers & acquisitions, please see our Post, Bystanders & Collateral Damage, April 2013.


We are The RiskWerk Company and care not a jot for mutual funds, hedge funds, “alternative investments”, the “risk/reward equation” and every other unprovable artifact of investment lore. We have just one product

The Perpetual Bond™“
Alpha-smart with 100% Capital Safety and 100% Liquidity”
With No Fees and No Loads on Capital

For more information on RiskWerk, please follow the Tags or Categories attached to this Letter or simply enter Search for additional references to any term that we have used. Related data may be obtained from us for free in a machine readable format by request to Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”. Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability. We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now. The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”, ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.

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