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Author: JustMee01 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 20360  
Subject: Re: Speaking of Linn Energy again Date: 7/11/2013 4:25 PM
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KitKat,

I just spoke with a Linn Energy senior analyst. The put accounting cycle works the way I guessed that it does. (Shocking, LOL).

"I have emailed them asking if they are speaking figuratively or literally. No answer."

They are speaking figuratively. The cost of the puts is NOT amortized and is NOT a component of DD&A. The puts are EFFECTIVELY amortized as a consequence of their being marked to market.

Your statement that the puts could actually rise in value when marked to market is true, of course. However, the time value within their market value is still technically reduced, even when they go deeper in the money. And eventually, it's going to zero.

I think their "amortization" statement was merely an attempt to clarify that the cost of the puts DOES show up in their GAAP income statement, and also to describe its treatment, without getting into the nitty-gritty of how that's accomplished for fair-value hedges under GAAP. (It may have backfired, and created even more questions?)

He also said that the issue was initially visited by Linn in February in response to the original short pieces. At that time, Linn reviewed their accounting with KPMG. The KPMG review concluded that all accounting was in line with standards.

Also for the record, they USED the put strategy for a very straightforward reason. Under their credit facility covenants, only 70% of their production is allowed to be hedged via SWAPS. They cannot be 100% hedged in swaps. The reason is production risk. If they have a down quarter, they'll have to still deliver that product, meaning that they'll be buying oil/gas to deliver to counterparties. The banks won't allow that to happen. To get to the 100% of volume that they want hedged, they NEED to use PUTs, because of those covenants.

That said, Linn WILL NO LONGER use that strategy. They're tired of explaining this problem to people and most of their face time (even with institutional types) is being used up explaining it. To avoid that in the future, Linn is going forward 70% hedged via swaps. They are in the process of trying to rework the covenants to expand that allowance out higher than 70%, but as of right now, Linn's corporate "strategy" (he recoiled from my use of the word "policy") is to hedge to 70% using only swaps.

As to the cost of swaps and puts? Swaps are virtually free. The banks that set up the financing take some fees, but the cost you see in the cash slow statement is 100% the cost of puts.

That cost is deducted from cash flow at the time the hedge is set up, and all premiums are paid in advance. It is carried on the balance sheet initially at cost and then marked to market quarterly. Any unrealized gain(loss) is charged to the income statement quarterly, as are realized gains, of course. On the cash flow statement, unrealized gains are taken back out, since they are non-cash. The put itself is NOT a component of DD&A.

The other question I was always interested in was how much latitude an MLP has in distributing its cash flow. You often see the statement that they're hamstrung by statute, when it comes to retention of capital. I have read in a very few places that this is false. Actually, it IS false. The statute is wishy-washy. There is a requirement that 90% of excess flow be paid out to investors, but there is a clause that allows management to retain capital to maintain its current operations. So, if Linn was really up against it, they could proactively retain capital.

Along those lines, he also seemed to intimate that Linn's preferred coverage ratio may creep up toward the 1.2 times that some of the less aggressive MLPs tend to run at. So, you may see DCF accelerate faster than distributions as this situation unravels.

As far as what is under review by the SEC, the company is really not yet aware of the scope. All they know is that something is ongoing and that is NOT a formal inquiry.

Surprisingly, he said that they've been busy dealing with this, but have had relatively few inquiries from investors. If you have any other questions, we may have talked about it. Ask and I'll try to answer. I've spoken with some IR folks in the past that were "too busy" and quick to get rid of you. This guy was polite and returned calls promptly. That's all too rare in corporate America. I give Linn points for treating its unitholders like human beings that have money on the 'line'. (sorry about the terrible pun...)

Peter
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