Upstream MLPs (master limited partnerships) have had their ups and downs—along with the rest of the market—since most went public in 2006 through 2007. However, as crude oil prices have rebounded from December 2008 lows (never mind about natural gas prices), upstream MLPs have generally seen a dramatic increase in their unit prices.

With the rebound in their equity capitalizations over the past 16 months, upstream MLPs have been active, motivated buyers of long-life, highly developed, proved-reserves properties in the Permian, Appalachian, Rocky Mountain and Michigan basins. Linn Energy LLC (LINE), EV Energy Partners LP (EVEP), Legacy Reserves LP (LGCY) and Vanguard Natural Resources LLC (VNR) have been the most active MLP buyers in the upstream category.

During this time, upstream partnerships collectively purchased some $1.6 billion (15% of total A&D transaction value) of producing oil and gas assets after buying just $380 million (3% of total A&D transaction value) in the immediately preceding 12-month period.

From December 2008 to early May 2010, unit prices of most of the active upstream MLPs increased dramatically, from 125% (Linn Energy) to more than 430% (Vanguard Natural Resources). By comparison, the stock-price increase for an arbitrary basket of public E&P companies (St. Mary Exploration & Production Co., Cimarex Energy Co., Forest Oil Corp., Chesapeake Energy Corp., Exco Resources Inc., and Petrohawk Energy Corp.) was about 100% over this same period.

The upward movement of unit prices of certain upstream MLPs since December 2008 has correlated positively to crude oil prices. This is despite many of these partnerships having substantial gas reserves in their portfolios (natural gas prices have been flat to down since December 2008) and sizable oil and gas commodity-price hedge (swap) positions on their books, limiting their ability to fully realize the beneficial effects of rising commodity prices on revenues.

Notwithstanding these factors, some upstream MLPs are actually valued higher on a per unit basis by the market now (early May 2010) than they were in the summer of 2008, when crude oil was trading at $145 per barrel and natural gas was valued at $13 per Mcf (thousand cubic feet).

Currently motivating upstream partnerships to be aggressive buyers of proved reserves is the arbitrage opportunity to purchase producing properties at “wholesale” prices on the A&D market (particularly when they buy these assets from private oil and gas companies), and then get a higher “retail” valuation for those same reserves from the public market when they book them.

On the accompanying graph, the Implied Reserves Value (IRV) as of early May 2010 for four active upstream MLP buyers is shown, versus the value on a price per flowing Mcf or barrel of oil equivalent basis of their most recent producing-property acquisitions. A company’s IRV is the total market capitalization of its debt and equity securities, less the net book value of all its non-oil and gas reserves assets as shown on its most recent balance sheet. In almost every case, these MLPs have purchased producing properties for less—in some cases substantially less—than their IRV.

The public markets exert a strong influence on the A&D market. In addition to the role public markets play in providing companies with access to capital, they also send real-time signals to companies, including upstream MLPs, of the value that investors place on oil and gas reserves.

Whether or not the reserve valuations implied by the market at any point in time for a particular company are rational and appropriate, given the risks involved, is another subject. To the extent that public markets place a high value on the reserves of public E&P companies, the A&D market will surely be an active marketplace for buyers and sellers.

A&D market participants invariably seem to have an easier time eliminating bid-ask spreads and closing A&D transactions when buyers have easier access to acquisition capital. Companies have access to acquisition capital when investors are in a positive mood about current and future market conditions and about the prospects for those companies to be able to deliver adequate-to-exceptional rates of return.

In the case of upstream MLPs, their ability to remain consistently active, viable buyers in the A&D marketplace depends greatly on their ability to satisfy investors by delivering appropriate investment returns via distributions or capital gains. As unit prices of upstream MLPs increase, however, their ability to deliver adequate returns, at the margin, may become more difficult without a rise in commodity prices.

—Charles M. Lapeyre,
Energy Spectrum Advisors Inc.,
energyspectrumadvisors.com