With the EU sovereign-debt crisis roiling the stock market and another growth scare weighing on oil prices, investors should expect the unit price of Mid-Con Energy Partners (NSDQ: MCEP) to fluctuate in coming months. That being said, results from Mid-Con Energy Partners’ first full quarter as a publicly traded firm reaffirmed my confidence in the upstream MLP’s growth story and suggest that the stock will reward investors who stick it out for the long term.
Mid-Con Energy Partners LP owns about 10 million barrels of oil-equivalent reserves in the Midcontinent region, 69% of which are proved and developed. Crude oil accounts for about 96% of the firm’s reserves, a favorable mix in the current price environment. Like many upstream master limited partnerships, the firm operates in established plays that feature limited drilling risk and predictable decline rates.
In fact, management estimates that about 90% of the outfit’s wells have been in production since 1982 or earlier. Mid-Con Energy Partners specializes in water-flooding, an enhanced recovery technique that involves injecting large volumes of water into a mature field to restore well pressure and bolster output. So-called primary production recovers only 10% to 25% of the hydrocarbons in a field, while water-flooding and other secondary techniques can extract another 10% to 20% of resources in place.
More than 90% of Mid-Con Energy Partners’ producing wells employ water flooding to improve production rates. Six to 18 months of water injections are required to increase production, but the technique works. The MLP’s acreage in southern Oklahoma (about 55% of total reserves), which is still in the early stages of water-flooding, flowed about 220 barrels of oil equivalent per day in September 2006 and in December 2011 yielded 2,492 barrels of oil equivalent per day.
During the first quarter, Mid-Con Energy Partners extracted 1,703 barrels of oil equivalent per day – 150,000 barrels of oil and 31 million cubic feet of natural gas – up 15% sequentially. Excluding derivatives related to hedging, the MLP’s hydrocarbon sales totaled $15.5 million, while the firm’s adjusted earnings before interest, taxes, depreciation and amortization came in at $11.8 million. More important, Mid-Con Energy Partners generated distributable cash flow of $0.556 per unit, enough to cover the quarterly payout by 1.17 times. Over the long term, the MLP targets a payout ratio of between 1.15 and 1.20 times.
With management expecting daily production to average 1,850 barrels of oil equivalent per in 2012 and 75% of this output hedged at favorable prices, I expect the recent weakness in oil prices to have only a modest effect on the MLP’s near-term fortunes.
Moreover, Mid-Con Energy Partners’ growth story remains intact. In April, the company increased its borrowing base to $100 million, an amount that management told analysts would “cover any potential acquisitions for the year, but not [include] any unused availability that [the firm] wouldn’t need.”
CEO Jeffrey Olmstead also indicated that the pipeline of potential acquisitions and joint ventures appears strong, with many exploration and production companies seeking to divest mature assets to fund drilling in shale basins and other emerging plays:
“As far as opportunities arise, our deal flow really in the last six months has been as good as it has ever been. We’ve looked at more water-flood opportunities – …from grass roots [opportunities] that our people have put together themselves and gone out and found, to companies that maybe have come across some water-floods and some acquisitions they had that [weren’t] their core competency…[Some companies] have talked about divesting [these properties] and that other people talk to us about joint venturing with them. So, we’re very positive on the outlook in the deal flow that we’ve seen and hope to continue to grow with it.”
Even if Mid-Con Energy Partners doesn’t close an acquisition in 2012, management reaffirmed that 2013 will likely bring a drop-down transaction from the firm’s general partner, private-equity outfit Yorkville Partners.
Mid-Con Energy Partners’ parent, which has about $3 billion in assets under management, has invested in a number of oil- and gas-producing properties that might be a good fit for Mid-Con Energy Partners. Private affiliate Mid-Con Energy III focuses on water-flood opportunities that fit the MLP’s business model, while Mid-Con Energy IV targets primary production opportunities over a broader geographic range. Management indicated that any drop-down transactions in the near-term would likely come from Mid-Con Energy III.
By dropping down a new water-flooding project to Mid-Con Energy Partners, Yorktown Partners would monetize this asset and shield ongoing revenue from the field from corporate taxation. Meanwhile, rising production and cash flow from the dropped-down asset would enable Mid-Con Energy Partners to grow its distribution. With an almost 50% stake in Mid-Con Energy Partners’ outstanding units, Yorktown Partners has ample incentive to pursue strategies that will foster the MLP’s growth.
Prospective investors should also note that management reviews Mid-Con Energy Partners’ distribution policy every third quarter, so the payout will likely increase once annually rather than in incrementally in each quarter.