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The engineering of such a price advantage has its complexities. Linn uses a combination of financial instruments like puts and swaps to lock in future prices. These instruments can either lock in an exact price, or commit the trader to set a range of prices (a floor and ceiling).
Linn’s structure as an MLP, or master limited partnership, has allowed it to take a more aggressive and constant approach to its hedging book, Ellis says. MLPs pay investors through mandatory pre-set distributions each quarter, which means its investors are expecting a more-or-less constant payout from owning stock — regardless of where fuel prices may go.
For Linn, and others that are strongly hedged – including names like Range Resources , Pioneer NaturalResources , and Venoco , it’s a strategy that is not without its costs, or risks.
Ellis says the company is willing to expose up to 10 percent of its profits on certain deals just to pay the banking fees for the hedges. And then there’s the risk that prices go higher leaving Linn potentially locked in to below-market prices on some of its hedge book.
And while on the face of it, it may seem like a strategy that is pegged to a specific price prognostication, Ellis maintains that the company is not in the business of guessing where exactly future prices will go.
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