This is a selection from my Q2 letter to the partners of Braewick Holdings. Braewick currently has a position in BreitBurn Energy (BBEP). I posted about our first investment in BreitBurn two years ago.
BreitBurn is essentially a physical oil and gas hedge fund. They invest in properties that have proven reserves, and receive a return on that investment through extracting and selling the oil & gas at market rates. Like a hedge fund, they limit market risk by purchasing various hedges on future prices. Unlike most hedge funds, they have direct involvement in the operations of each of their holdings. Excess returns are achieved through the following methods:
- Opportunistic reserve purchases (low price-to-value, or “value investing”)
- Good hedging strategy (market timing + exploiting contango in futures prices)
- Operational efficiency (keeping costs low and extracting extra reserves)
Units of BreitBurn are currently yielding about 11%, and I believe this yield is safe for multiple years out. In other words, I believe that through a combination of the above methods, value per unit will increase at least 11% per annum.
Here’s their most recent presentation.
I’ve owned BreitBurn Energy Partners (BBEP) both personally and through Braewick Holdings LP for the past year and a half. The following is a clip from my letter to partners explaining our investment in the company:
BreitBurn is an oil and gas production company structured as an MLP (see my July 2009 letter for a similar discussion of Linn Energy, another MLP). BreitBurn’s business model is fairly simple: their only job is to extract and sell oil and gas from wells they own throughout the U.S. These are wells they have acquired—they don’t take the risk of exploring or drilling for new wells. Basically, BreitBurn is like a portfolio of interest-only bonds—assets (petroleum in the ground) that pay interest (production revenue minus extraction and administration costs) until the bond is paid off (reserves are depleted). Here’s a quick summary of BreitBurn’s goal from their 10-K:
“Our objective is to manage our oil and gas producing properties for the purpose of generating cash flow and making distributions to our unitholders.”
Because BreitBurn wants fairly steady cash flow to fund their distributions, much of their oil and gas production is hedged. That level of hedged production is immune from fluctuations in energy prices. By the summer of 2008 when prices were high, they had managed to hedge about 70-80% of production for three years out. So when energy prices (and the stock market) subsequently collapsed that fall, BreitBurn’s cash flow remained mostly unharmed. However, as with many of the MLPs, Lehman Brothers was both counterparty to their hedges and a large owner of the stock. The “perfect storm” of falling energy prices, a crashing stock market, and Lehman’s liquidation caused BreitBurn’s unit price to fall from over $20 in the summer to under $6 in December.
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