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Breitburn Energy Partners, LP (BBEP)

April 26, 2010

Just a reminder that this is the third in my series reviewing my current portfolio holdings.

Background
BBEP  “engages in the acquisition, exploitation, and development of oil and gas properties in the United States. Its assets primarily consist of producing and non-producing crude oil and natural gas reserves located primarily in the Antrim Shale in Michigan, the Los Angeles Basin in California, the Wind River and Big Horn Basins in central Wyoming, the Sunniland Trend in Florida, and the New Albany Shale in Indiana and Kentucky.”

I first came across BBEP while reviewing Baupost group’s 2q 2008 portfolio holdings. (yes, that little bit of voyeur in me likes to look at the 13Fs filed by portfolio managers that I really admire) What piqued my interest was that Klarman seemed to view BBEP as a bit of an inflation hedge, or at least that was my interpretation from the several interviews with him that referenced his position.  The company seemed to be about 80-90% hedged against fluctuations in oil and gas prices for the next three years and was paying a pretty handsome dividend.

Investment Rationale
In Oct/Nov 2008, BBEP units (this is an LP) had fallen off sharply in price and by the beginning of November were trading in the low teens, significantly below book value of around $24/share. This also meant that its dividend yield was close to 20%. I (mistakenly, as it turned out) thought that the company’s hedged position would protect its cash flow (and thus its dividend) for the next 3 years , time enough for the then-current financial crisis to pass. Not only was I buying in at a fabulous discount to book value, but I was getting close to a guaranteed 20% yield to boot! As icing on the cake, I patted myself on the back that I was buying at a price significantly below where my favorite value investor had purchased.

As to management ownership, it’s not quite where I’d like it to be; R. Breitenbach and Hal Washburn, managers of the GP, own .2% and .15% of the LP units respectively.

Subsequent Events
So what happened? Certainly not what I anticipated. The unit price continued to fall through November and I purchased more units down at around $7. Hmm… what was going on? The stock was becoming unbelievably cheap. At the time I believed that the unit price was being depressed due to the uncertainty arising from the Quicksilver lawsuit which had been filed at the beginning of November. So I viewed the lawsuit as providing a great opportunity, Mr. Market serving up a strike, as I didn’t think that the lawsuit would have any real, long-term impact on the value of BBEP. However, what I didn’t even consider (oh, hubris) was that perhaps it wasn’t the lawsuit that was depressing the price, but rather other external factors like the CREDIT FREEZE. Unlike others  who were obviously a bit more savvy, I didn’t appreciate the impact that the escalating credit freeze was having on MLP financing; MLPs, at best, need credit to grow, and at worst need access to credit on an ongoing basis just to survive. 

Subsequent to my purchases the unit price continued to meander downward for the balance of the year to as low as $5 and change, then traded up, down  and back up again as the market first advanced in January then retreated to its March lows before advancing again toward the end of the quarter. In early April BBEP units traded as high as $9/share. About that time, however,  BBEP announced that it would suspend its dividend to conserve cash, and the price promptly dropped back down into the $6 range. Now, my reading of the dividend suspension was that the motives weren’t quite so clear; after all, the company’s line of credit had been cut in late 2008, four month’s earlier. Perhaps the dividend elimination was to conserve capital, but perhaps it had more to do with the Quicksilver lawsuit; was the dividend suspension being used as leverage to pressure Quicksilver (denying them the cash flow from the properties sold to BBEP) into a quick settlement? It’s not worth going into exactly what the suit was about, suffice it to say CONTROL was the issue; after all, Quicksilver was the largest unitholder of BBEP, having swapped assets for BBEP units.

With the suit hanging like the sword of Damocles over the company and no dividend, the unit price of BBEP underperformed the market during the subsequent market runup. Then, this past February, BBEP announced a settlement of the suit with Quicksilver and reinstatement of the divided, albeit at a level below 4Q 2008, and the units promptly traded up to the $14-15 range.

Valuation
I am using book value (now about $23 per unit) as proxy for full value on this investment. My lack of a deep knowledge (or any knowledge at all, for that matter) of oil and gas property valuation, an inclination not to disturb this state of affairs, and a need to keep things absolutely simple, all lead me to this shortcut. I make no apologies.

 The catalysts for achieving full value is, I think, in the process of playing out. The lawsuit is settled, the dividend has been reinstated, with the first payment projected to be made next month, and the credit markets continue to gradually stabilization. We also continue to be helped along by relatively strong stable oil prices. I think investors will need a period of adjustment to accept BBEP again after the dividend suspension. They will also need this to be reinforced with regular dividend increases going forward. With things going well for the moment, I will check back in another 6 to 12 months to see if I need to re-evaluate my sell target price

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