The Gospel According to BP

Although BP’s (NYSE: BP) reputation as a company has suffered immensely over the past decade, it continues to compile the best energy data in the business. BP’s comprehensive reporting of energy statistics — free to the general public — is one of my major “go to” sources.

This past week marked the annual release of those global energy statistics: The BP Statistical Review of World Energy 2013. Below are 10 key takeaways from this year’s report, followed by a deeper dive into the petroleum statistics. In next week’s issue of The Energy Letter, I will take a look at natural gas, coal, nuclear, and renewable energy.

  • 1. Consumption of all forms of fossil energy grew by 1.8 percent in 2012, below the 10-year average of 2.6 percent
  • 2. Consumption and production set new records in every category except nuclear power and biofuels
  • 3. Global biofuels production recorded the first decline since 2000, but renewable energy used in power generation grew by 15.2%
  • 4. The US recorded the largest oil and natural gas production increases in the world, and the largest oil production gain in US history
  • 5. Saudi Arabia, the UAE and Qatar all reached record oil production levels
  • 6. Global oil prices reached another record high based on annual average
  • 7. Coal remained the fastest-growing fossil fuel, with China consuming half of the world’s output for the first time
  • 8. China and India accounted for nearly 90 percent of the net increase in global energy consumption
  • 9. Natural gas was the only fossil fuel to see consumption growth accelerate in 2012
  • 10. Global nuclear power output had the largest decline ever.


The biggest story in the global petroleum picture has to be the continuing shale oil revolution centered in the US. So far this phenomenon shows no signs of slowing down. The US led all countries in increasing oil production year over year, with an increase of just over 1 million barrels per day (bpd), or 13.9 percent, over 2011 production levels. The US accounted for just over half of the world’s total increase in oil production from 2011 to 2012.

US oil production chart

To put those numbers in perspective, Libya’s 700,000 bpd production increase was good for second place, but it was a result of bouncing back from the sharply reduced output caused by the Libyan revolution. Saudi Arabia’s 390,000 bpd increase was good for third place on the list.

Global proved oil reserves increased for the 14th year in a row. Year ending reserves were 1.67 trillion barrels, equivalent to 53 years of consumption at the current global pace.

Global proved oil reserves chart

I have seen various claims that global demand for oil is weakening, based on the data from the Statistical Review. That’s quite inaccurate. In 2011 global oil consumption was 88.9 million barrels per day (bpd). If global oil consumption slowed in 2012 — as several sources have indicated — then I would expect 2012 consumption to be less than 88.9 million bpd. But according to the BP report, in 2012 oil consumption was 900,000 bpd higher than in 2011 — a new all-time record.

Global oil consumption chart

What is correct is that growth in oil consumption slowed in 2012. From 2009 to 2010 global oil consumption increased by 2.8 million bpd. From 2010 to 2011, consumption increased by another 1 million bpd. But in failing to note that it is the growth in oil consumption that fell, and not actual oil consumption — many are left with a false impression that perhaps the world is beginning to wean itself off of oil. To the contrary, this is an accurate headline: “Global Oil Consumption in 2012 at New All-Time High.”

Consumption growth continued to be driven by growth in the Asia Pacific region. China and India alone were responsible for 90 percent of the world’s consumption growth, but every developing region of the world increased oil consumption, just as it has in recent years. And while Asia Pacific had the highest per barrel increase in consumption, Africa led in percentage terms with a 5.1 percent increase.

Continuing the trend from recent years, oil consumption in the US and the European Union fell. US consumption decreased 2.3 percent from 2011, and EU consumption dropped 4.6 percent. Over the past five years, US consumption has declined 10 percent, and EU consumption fell 13 percent.

Average annual Brent and Dubai crude oil prices set a new all-time high in 2012. The yearly average price for Brent crude was $111.67 per barrel, $0.41 higher than 2011’s price. Dubai crude averaged $109.08/bbl, $2.90 higher than in 2011. West Texas Intermediate (WTI) traded down $0.91/bbl from 2011 at $94.13/bbl.

The two dominant themes in the oil markets over the next few years will likely continue to be increased shale oil production — which will ultimately begin to take hold in earnest outside the US — and the continued growth of demand from developing countries.

Portfolio Update
Sticking with Linn; Bears Protest Too Much
The short-sellers have an unpersuasive case and are likely to end up disappointed

Linn Energy (Nasdaq: LINE) is an excellent short-term Buy for the risk-tolerant speculator. For a risk-averse income investor, it’s more of a hold at the moment, the double-digit dividend yield offset by the recent volatility of the unit price and the potential for further controversy.

Since Linn Energy has clearly become a battleground stock, let’s review the current order of battle. Linn is a master limited partnership that specializes in acquiring mature, long-lived oil and gas wells and using hedging to minimize the commodity price risk. It’s delivered a 240% total return since the 2006 IPO but has fallen on hard times of late amid questions about the sustainability of the business strategy. The unit price is down 21 percent since May 3, and 29 percent from last November’s record high.

Linn’s assets include wells expected by the company to produce enough cash flow this year to finance its distribution, with a prospective annual yield of 10.1 percent at the recently reduced unit price, as well as the maintenance costs required to keep production level. That’s probably the best-case scenario, but enough distributable cash flow for a yield of 8 percent is likely your downside.

More importantly for the units’ near-term prospects, Linn also is the sponsor of the LinnCo (Nasdaq: LNCO) taxable tracking stock, which raised $1.1 billion in an IPO last October with the stated goal of diversifying Linn’s ownership beyond investors in MLPs, and an unstated one of facilitating acquisitions of corporations.

LinnCo shares represent ownership of Linn units, but the pass-through dividends are taxed at the reduced dividend tax rate. Furthermore, Linn’s extensive past spending provides a valuable tax shield to LinnCo’s shareholders, though opinions vary as to its extent.

In any case, LinnCo’s tax shield certainly proved attractive enough to the directors of Berry Petroleum (NYSE: BRY) who agreed this spring to accept them in a merger at a relatively subdued 20-percent all-equity premium. A lot of that premium has since evaporated as LINE, and to a lesser extent LNCO, lost altitude. The merger was expected to close in the second quarter but appears to have been delayed by SEC fact-finding, so that shareholder approval votes haven’t yet been scheduled, even as the upside for Berry’s shareholders has diminished.

In addition, Linn has approximately $2.9 billion in available credit, against $6.2 billion of debt that’s grown rather quickly alongside management’s ambitions. The credit can be deployed in future acquisitions.

Linn’s management enjoys generally strong support from analysts at major Wall Street firms, including naturally those that do business with Linn. More than two-thirds of the analysts rate shares a Buy or Strong Buy, and the consensus price target is just below $43.

Omega Advisors, the investment vehicle of hedge fund billionaire Leon Cooperman, was the largest institutional holder as of March 31, with a $272 million stake representing just more than 3 percent of the outstanding units.

Corporate insiders have bought LINE units recently in an apparent attempt to bolster sentiment, with the CEO and the COO buying units worth a combined $459,000 Thursday and a director investing $686,000 last month.

On the other side of the free-fire zone are the short sellers, very likely including other hedge funds, which have been emboldened by their recent success in driving down the unit price.

The short-sellers have aired their concerns in no fewer than three rather one-sided articles in Barron’s, the latest of which was published Saturday.

Its (almost certainly tipped) revelation was that Linn has disclosed spending $43 million on the puts closed out in the latest quarter, and that if this were to be subtracted from distributable cash flow, the already underwhelming distribution coverage would drop to just 63 percent.

Which sounds terrible, were it not for the fact that this same $43 million was already subtracted from distributable cash flow in the quarter those puts were purchased. Linn treats its hedges as a capitalized, gradually amortizing asset and points out that they require cash outlays at the time of purchase, outlays that have a financing cost affecting distributable cash flow in the future.

The accounting issue is a red herring. But short-sellers would be on firmer ground arguing that Linn’s debt has quadrupled since 2008, and that the heavy borrowing for acquisitions could certainly be also spent on the hedges that would tent to boost cash flow in the future. Linn is right that it needs to hedge its commodity price risk, but its puts have produced returns above and beyond that goal, returns it won’t necessarily be able to duplicate on the future.

Linn’s hedging isn’t going to bring the company low, nor has it done much to obscure recent operating disappointments. But while the shorts have vastly overstated their case, remember that they’ve chosen Linn as a target for a reason, and are committed enough to pay the hefty yield on the units they’ve shorted along with the rest of the borrowing costs.

Even the strong supporters of Linn on the analytical side at Wells Fargo, for example, describe Linn’s accounting as “on the aggressive side” and suggest it could be underestimating maintenance capital requirements (thereby boosting the reported distributable cash flow.)

For Linn, the unit price is not just a barometer but a potential driver of future returns via LinnCo acquisitions, and the normal temptation to make the business fundamentals look as strong as possible is therefore all the greater.

So why are we sticking with the Buy recommendation on Linn in the relevant portfolios? Because the Berry merger will probably go through and prove highly accretive as the company claims, with other acquisitions of taxable corporations likely to follow.

On a cash flow basis, Linn is roughly twice as expensive as Berry, so its incentive for the deal has only gotten stronger. And as for Berry shareholders, despite a direct appeal from Barron’s to nix the sale, they may not find a better offer.

In fact, Berry was on the block before Linn stepped up, and drew insufficient interest. Because while it’s undervalued relative to Linn, it’s hardly some fantastic bargain relative to other taxable oil and gas producers. For example, Berry is currently priced at 6.4 times its trailing EV/Ebitda ratio, which sounds cheap indeed. But Whiting Petroleum (NYSE: WLL) is at just 5 times trailing EV/Ebitda, and Sandridge Energy (NYSE: SD) at 2.6.

Eighty-four percent of Berry’s shareholder base is institutions, led by Fidelity, which has a stake of nearly 15 percent, and these institutional investors will have likely run similar numbers. Since Linn announced the Berry acquisition, Sandridge as well as Chesapeake (NYSE: CHK) have garnered disappointingly low prices on divestitures, suggesting energy assets remain in a buyer’s market.

The odds of the Berry merger going through still look good. And the progression of that merger, starting with the scheduling of shareholder votes, is likely to provide a big positive catalyst for Linn’s units.

Bears are doing everything they can to make Linn’s offer for Berry less appealing. But time is not on their side, while every monthly distribution is money out of their pocket and into those of unit holders.

— Igor Greenwald

Stock Talk

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