How Safe Is BreitBurn Energy Partners L.P. (BBEP)’s Distribution?

Oil and gas partnership BreitBurn Energy Partners L.P. (NASDAQ:BBEP) reported its first-quarter earnings last week. One metric, the distribution coverage ratio, came in a lot lower than investors were expecting, so low in fact that it could be cause for concern. Let’s drill down into BreitBurn Energy Partners L.P. (NASDAQ:BBEP)’s distribution coverage ratio to make sure it’s still safe.

Behind the numbers
Fresh on the heels of announcing a 4% distribution increase, BreitBurn Energy Partners L.P. (NASDAQ:BBEP) CEO Hal Washburn noted on the company’s earnings call that its distribution coverage ratio had slipped to just 0.67 times. A coverage ratio of 1.0 means the company is paying out 100% of its income to investors so anything below that means the company is paying out more than its making. Further, the current ratio is well short of the 1.1-1.2 times the company is targeting.

As an asset class, upstream oil and gas MLPs are faced with more difficulty in maintaining steady cash flow from quarter to quarter. Midstream MLPs like Enterprise Products Partners L.P. (NYSE:EPD) have a much easier task – the majority of its cash flow is locked into fee-based contracts. In fact, 81% of Enterprise Products Partners L.P. (NYSE:EPD)’s gross operating margin is secured by long-term, fee-based contracts. Upstream MLPs try to replicate this income safety by hedging production for several years, but they are not always successful in locking in enough cash flow to cover the distribution from quarter to quarter.

In BreitBurn Energy Partners L.P. (NASDAQ:BBEP)’s current quarter the coverage ratio was mostly affected by lower realized commodity prices. Part of this is due to the fact that BreitBurn Energy Partners L.P. (NASDAQ:BBEP) does not hedge 100% of its production like peer Linn Energy LLC (NASDAQ:LINE). Instead, the company hedges 80% of its current-year production and then it steps it down over time so that it’s only 50% hedged in the fifth year, whereas Linn Energy LLC (NASDAQ:LINE) is typically 100% hedged that far out. That unhedged volume can be affected by lower commodity prices, which can be both positive and negative.

One other factor playing a role in the current quarter’s ratio is that the company issued units earlier this year and paid down its credit facility. It now has just $100 million outstanding on the facility, which gives it excellent liquidity. However, that came at a cost – without the equity offering, the distribution coverage ratio would have come in at 0.83 times this quarter. While that’s still under its target, it did make a noticeable impact.