Hedging Against Falling Gasoline Prices using Gasoline Futures

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LINN Energy As A Way to Hedge The Rising Price of Gasoline

Virtually anybody who reads the financial news or drives a car knows that the price of gasoline has surged lately. This has undoubtedly had an impact on the wallets of many American consumers including, quite possibly, many of you reading this.

Fortunately, there are things that we can do to mitigate the impact that rising gasoline prices have on us as end consumers. One way to do this is to invest in stocks that are likely to rise with the price of gasoline. For example, large oil companies such as ExxonMobil , usually have stock prices that are at least somewhat correlated with oil (and gasoline) prices.

Another way to protect yourself against rising gasoline prices is to buy units of an upstream MLP. These investments have the advantage of paying relatively high distribution yields that can be used to help cover your costs of purchasing gasoline. One such MLP is LINN Energy .

About LINN Energy
LINN Energy is a member of a relatively small group of publicly traded oil and gas partnership. The company purchases known productive, and usually mature, oil and gas properties with the intention of extracting the oil and gas from the ground, selling it, and sending as much of the profit as it can to its unitholders.

It usually targets properties with a low and known depletion rate so that management has a fairly reasonable idea of how much cash flow the property containing the well will generate in advance. It has been fairly successful at this and has paid a quarterly distribution to its unitholders for 27 consecutive quarters up until the end of 2020. Beginning in 2020, LINN Energy began to use a different payout schedule and currently pays its distributions monthly .

Declining Unit Price
Linn Energy’s unit price has fallen precipitously since mid-February despite the strength in oil prices over the same period. This could present an opportunity for Foolish (not foolish with a small “f”) investors to jump in. First, let’s have a look at the magnitude of the decline. Here is the chart for LINN Energy over the past six months:

Source: Yahoo Finance

The reason for this rapid fall over the past month is that it suffered from a wave of downgrades as Jim Cramer , Howard Weil , and JP Morgan downgraded the stock. The reason for the downgrades is pretty much the same among all three parties. Basically, they are concerned that LINN Energy will not generate enough distributable cash flow to cover its per unit distribution this year .

Admittedly, these are certainly valid reasons to be concerned. After all, if LINN Energy does fail to generate enough distributable cash flow to cover its planned distributions then the company will either have to cut its distribution, take on debt, or dilute the existing unitholders by selling more partnership units in order to raise the money to make its planned distributions to the unitholders.

Reasons for Possible Difficulty
The reason for the concern surrounding LINN Energy’s ability to make its distribution payments is due to the company’s operations in the Permian Basin. These assets, which LINN Energy acquired last year , are somewhat outside of the company’s core strategy because they require horizontal drilling techniques to access the oil located in them instead of the more conventional vertical drilling techniques that LINN Energy is normally able to use on its properties.

Unfortunately, horizontal drilling is much more expensive than vertical drilling. To address this, LINN Energy is looking to sell these assets outright or trade them for more mature assets that are better aligned with the company’s core competency to operate. If it is successful in doing this, especially in obtaining the asset trade, then it should be able to reduce its capital expenditures and thus increase its distributable cash flow.

Company Can Use Hedging to Lock in Revenue
One of the advantages of LINN Energy’s core strategy of purchasing mature oil and gas producing properties with stable decline rates (Permian assets notwithstanding) is that it can fairly accurately predict its production in any given year. This allows the company to lock in a sale price in advance for the majority of its production, which greatly helps the company to predict its revenue in a given year.

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LINN Energy has done exactly this and has secured sales prices for all of its expected natural gas production from now until 2020 and all of its expected oil production this year. The company has also locked in prices for 50-60% of its expected oil production in 2020 and 2020 . This practice is known as hedging. By hedging its production and locking in oil prices, LINN Energy has effectively protected itself against a revenue decline should the price of oil and gas go down. Unfortunately, LINN Energy will also not benefit as much from the entire increase in oil and gas prices should they rise further than expected.

High Distributions
Speaking of the company’s distributions, LINN Energy pays a high one. At the time of writing, LINN Energy units trade hands for $28.34 and the company pays an annualized distribution of $2.90 per unit. This gives the units a very high distribution yield of 10.24%. Although there is some risk that the company will not generate sufficient cash flow to cover this distribution and may have to cut it as discussed above, that risk certainly appears to be baked into the price at this level.

How does LINN Energy stack up to some of its MLP peers?
Record oil and natural gas production is revolutionizing the United States’ energy position. Finding the right plays while historic amounts of capital expenditures are flooding the industry will pad your investment nest egg. For this reason, the Motley Fool is offering a look at three energy companies using a small IRS “loophole” to help line investor pockets. Learn this strategy, and the energy companies taking advantage, in our special report “The IRS Is Daring You To Make This Energy Investment.” Don’t miss out on this timely opportunity; click here to access your report — it’s absolutely free.

Daniel Gibbs has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Oil Prices Rebound On Falling Gasoline Futures

One hundred and thirty-one years after the birth of the mighty Jelly Roll Morton, the crude complex has got the blues once more. Prices moved lower initially but spiked on Russian rhetoric in the late morning, while gasoline futures fell as the Colonial pipeline panic eases, and as the ebb and flow of OPEC expectations wane once more – after wax-on action yesterday. Hark, here are six things to consider in crude oil and natural gas markets today:

1) The current situation in the U.S. gasoline market caused by the Colonial pipeline spill has been described by our fearless leader (Abudi Zein) as ‘pushing down on a balloon’: as one side is pressured lower, the other side swells up. This is exactly what is underway regarding regional gasoline supply and inventory.

East Coast gasoline stocks are being drawn down strongly amid a starvation of supply, while at the other end of the pipe, inventories on the Gulf Coast are swelling, as gasoline is stranded.

Gasoline imports into the East Coast last week were helped by a rebound in flows from both Northwest and Southern Europe, but a lack of cargoes from Canada mean there will be no blowout in terms of total imports from tomorrow’s weekly EIA inventory report.

As for the flip-side, Gulf Coast gasoline exports have been averaging around 700,000 barrels per day in the past few months, as exhibited by our ClipperData (hark, right). Nearly forty percent of these exports head to Mexico, while Latin America as a whole takes the overwhelming majority – with Venezuela, Colombia, Panama and Brazil the leading recipients.

2) If Abudi Zein is the Oracle of Oil (he is), then Eric Rosenfeldt (@energyrosen) is the Guru of Gasoline. Via the Wall Street Journal today, he expects fuel-supply problems in the Southeast to last for five or six weeks. Even once the Colonial pipeline is repaired ‘you have to replenish everything at the retail level and everything at the wholesale level, and that’s a significant amount of barrels.’

3) The latest JODI data show Saudi crude exports for July were at 7.5 million bpd. Our ClipperData show crude loadings have held at this level for August, and are currently at the same pace thus far in September.

We discussed recently how the start up of a new gas development, Wasit, in Saudi Arabia has boosted domestic natural gas production and crimped the need for the direct burn of crude by

100,000 bpd this year (hark, it is usually at

900,000 bpd at the peak of summer, summer, summertime). The latest JODI data show direct burn is down 151,000 bpd for this July compared to year-ago levels:

(Click to enlarge)

4) After starting the injection season at a whopping surplus to last year of over 1 trillion cubic feet (or 69 percent), this year’s natural gas build has been at about half the pace of that seen in recent years (see below).

This has not only been due to a lack of urgency, but also due to falling production, as well as a record power burn this summer – as cheap, cleaner-burning natural gas has continued to displace coal-fired generation.

Given this backdrop of rebalancing, prices have accordingly responded. Prices have clambered into three dollardom today. for the first time in 16 months.

(Click to enlarge)

5) The chart below shows the price per day to lease a floating rig, which cost about $500 million to purchase outright. The lease price has dropped by 60 percent in the last two years, as demand has vanished amid the lower oil price environment.

Transocean has a number of these rigs sat 12 miles offshore Trinidad and Tobago. They are cold-stacked, which means the engines have been switched off, as opposed to warm-stacking, where the motors are kept running despite them not being in use. The cost savings betwixt the two is significant: $15,000 a day, compared to $40,000.

Cold-stacking these floating rigs has helped Transocean make a surprise profit in Q2, but what is more telling is the fact they have cold-stacked them in the first place. It indicates an expectation that demand won’t be returning any time soon.

(Click to enlarge)

6) Finally, here is a link to an interview I did with Brown Brothers Harriman, with insights into the global oil market based on our data.

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