Vanguard Natural Resources Makes a Big Bet on Natural Gas

Vanguard Natural Resources Makes a Big Bet on Natural Gas

Vanguard Natural Resources announced today that it's making a massive $581 million bet on natural gas. The energy company is picking up heavily natural-gas-weighted properties in Wyoming's Pinedale and Jonah Fields from an unnamed seller. Let's take a closer look at the deal and why it's really a transformational acquisition for Vanguard Natural Resources.

The anatomy of a deal
Vanguard Natural Resources' $581 million natural gas acquisition adds 14,000 net acres in Wyoming. These properties currently produce 113.4 million cubic feet equivalent of natural gas per day with 80% of the production being natural gas, followed by 16% natural-gas liquids and just 4% oil. It's a truly massive deal for Vanguard in that it will grow the company's reserves by 80% and its daily production by 55%.

The prolific Pinedale and Jonah Fields of Wyoming are a solid addition to Vanguard's portfolio. These are fields favored by growth-focused drillers like Ultra Petroleum Corp. . The long-life, low-cost tight gas from both plays has enabled Ultra Petroleum to grow to become one of the lowest-cost producers of natural gas. Meanwhile, MLP-income-focused peer LINN Energy has a large position in the Jonah Field that helps fuel its large distribution. LINN Energy likes the long life and low cost of the field as it can still profitably grow its natural-gas production, even with prices still low.

Fueling future growth
What's unique about the assets that Vanguard Natural Resources is picking up is the fact that this is really a growth asset for the company. Vanguard sees more than 970 proved undeveloped future-drilling locations, with the potential for 5,200 additional future locations.

That marks quite a change for the company that had focused its attention just maintaining its production, with growth coming solely from acquisitions. Going forward the company will actually join LINN Energy in organically growing both production and cash flow. CFO Richard Robert noted this change in the company's press release when he said:

This acquisition will mark an important change in the Vanguard strategy. For the first time in its history, Vanguard will be allocating capital to drilling wells on these acquired properties which is expected to not only maintain cash flow but grow cash flow. Based on the numerous proved undeveloped drilling locations and the current number of drilling rigs in use by the operators, this combined maintenance and growth capital program will be sustainable for over ten years. Furthermore, this strategy change will allow Vanguard to more effectively compete for new acquisitions that contain both mature stable production and a significant inventory of proven undeveloped drilling locations.

In making the change Vanguard Natural Resources will go from being one of the most conservative upstream MLPs to joining LINN Energy and BreitBurn Energy Partners in acquiring assets with embedded growth. This past year both LINN Energy and BreitBurn Energy Partners were actually able to organically grow income to more than cover weak distribution coverage ratios. While Vanguard has long maintained one of the safest coverage ratios in the group, it didn't have the growth potential of LINN Energy or BreitBurn Energy Partners until today.

One other unique aspect of this deal is that the assets Vanguard Natural Resources is acquiring is part of a 100% nonoperated position with a 10% average working interest. Basically, it's just helping to fund a portion of the drilling of its two major partners, one of which just happens to be Ultra Petroleum. This helps mitigate a good portion of Vanguard's risk as its partners will be putting up a vast majority of the cash to develop these resources.

Investor takeaway
This looks like a very good deal for Vanguard Natural Resources. While the deal does mark a more aggressive approach, the fact that this is a small nonoperated position helps mitigate that risk. Further, with a top operator like Ultra Petroleum doing most of the heavy lifting, Vanguard Natural Resources is really just along for a natural-gas-fueled ride. It's a ride that should fuel increased distributions for years to come.

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Fool contributor Matt DiLallo owns shares of Linn Energy, LLC. The Motley Fool recommends BreitBurn Energy Partners L.P. and Ultra Petroleum. The Motley Fool owns shares of Ultra Petroleum and has the following options: long January 2014 $30 calls on Ultra Petroleum, long January 2014 $40 calls on Ultra Petroleum, and long January 2014 $50 calls on Ultra Petroleum. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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