Oil Woes May Clog Pipeline Companies' Revenues

By Conway MacKenzie Capital Advisors February 12th, 2016 News

    Scott Cockerham was quoted in the The Houston Chronicle. The article was written by Robert Grattan.

    A new wave of oil company bankruptcies is likely to hit the nation's pipeline companies, which draw revenues from producers who pay them to move and process their crude.

    The fallout is likely to be most pressing at smaller pipeline companies, which can have fewer, riskier customers.

    Investors in pipeline companies are increasingly focusing on which producers are at risk of coming up short on payments, said Scott Roberts, who manages $3 billion in energy debt for financial firm Invesco.

    "The exposure question is front and center now," he said. "It's what everyone is talking about."

    Just last week, shares of pipeline giants Williams Cos. and Energy Transfer Equity were hammered after reports that Chesapeake Energy, a significant Williams customer, was considering bankruptcy. Chesapeake denied the report, and the stock in the two companies, which are in the process of merging, staged a mild recovery.

    Already, 60 oil companies have filed for bankruptcy around the world since the downturn started, and 150 more could face bankruptcy by mid-2016 if the downturn doesn't relent, according to research firm IHS.

    "There is definitely fear out there," said Curtis Holden, senior investment officer at Houston's Tanglewood Wealth Management, which manages $830 million in assets. "If somebody who's a big customer of the midstream companies has to restructure, how will that affect their contracts?"

    Tulsa-based Williams, which has a presence in Houston, estimated early last year that revenue from Chesapeake accounted for 22 percent of its cash flow. If the shale producer were to fold or cut back, the bounty could diminish. But a spokesman for Williams stressed in an emailed statement that its infrastructure is key to many of its customers' operations, and that the company is willing to work with customers to help both parties grow.

    Williams' large exposure to a single struggling producer is unique among large pipeline companies, said Kathleen Connelly, a director at Fitch Ratings' midstream group who examines the credit risk of companies. At the nation's largest energy logistics companies, single producers typically represent a much smaller fraction of revenue. Even at Williams, Chesapeake represents a much larger share of business than other companies.

    Houston's Plains All American Pipeline said this month it expects a shipper on the BridgeTex Pipeline to default on its contract to fill 10 percent of the line's capacity. BridgeTex brings Permian Basin crude oil to Houston. Plains owns half of the pipeline alongside operator Magellan Midstream Partners. Neither company named the producer they expected to default.

    Plains has removed the revenue from that contract from its 2016 projections. The funds were a small part of $1.59 billion of cash it expects to generate in 2016. In all, the company estimates its worst-case scenario exposure to ailing producers is about 2 percent of its earnings before taxes and other items.

    Ratings agency Moody's Investor Service rates the Plains' debt investment grade, meaning it's confident the company can stay ahead of its debt obligations.

    But not all companies have Plains' scale.

    Between 2008 and 2010, one relatively smaller midstream company - Houston's Crestwood Midstream - signed contracts to gather Barnett Shale molecules from the wells of Dallas driller Quicksilver Resources near Forth Worth.

    By the time all the deals were signed, Quicksilver had contracted with Crestwood to gather production across 144,000 acres. The contracts underpinned a revenue stream worth as much as $6 million each month to Crestwood.

    In 2013, filings show that more than 10 percent of Crestwood's total revenue came from Quicksilver, though company officials say the share had fallen below 10 percent by 2015.

    In March 2015, Quicksilver filed for Chapter 11 bankruptcy protection, throwing the value of that revenue stream into doubt.

    Crestwood's contracts have loomed over Quicksilver's bankruptcy. Private equity group BlueStone Natural Resources agreed to buy the busted driller for $245 million in cash. But the deal is contingent on the bankruptcy court invalidating the promises Crestwood made - otherwise BlueStone reserves the right to walk away.

    On Feb. 5, the debtors in the Quicksilver proceedings filed a motion asking the judge to reject the contracts. The hearing is set for Feb. 26.

    BlueStone CEO John Redmond cited ongoing activity related to the acquisition and declined to comment through a spokesperson. Quicksilver Energy didn't respond to an email requesting comment.

    Crestwood's chief operating officer. Heath Deneke, said his company planned to object to the motion but would be willing to negotiate with a buyer.

    A similar motion is playing out in a New York bankruptcy court, where producer Sabine Oil & Gas Corp. has asked a judge to free it from its midstream contracts.

    In both cases, whether the producers are able to get out of the deals will come down to the specifics of the contracts and the bankruptcy laws in various states, said Tye Hancock, a partner who specializes in bankruptcies at Thompson & Knight.

    Judges will need to determine whether the midstream contracts are agreements between businesses, such as an office space lease, or a covenant placed on land that remains no matter who owns it, similar to a deed restriction, Hancock said. Contracts between businesses are easily voided in bankruptcy, but land covenants are much harder to skirt.

    "In this down cycle, these concepts are going to be tested again and again," Hancock said.

    Analysts are quick to point out that a court decision will likely be a bargaining chip that helps either a producer or a pipeline company in an inevitable renegotiation.

    Neither the midstream company nor the producer benefits if the oil and gas stop flowing, said Scott Cockerham, a managing director at Conway MacKenzie Capital Advisors.

    Producers won't make any money if they don't ship oil and gas, and many drillers have few options when it comes to pipes that connect to right to their wells. Midstream companies won't have any revenue if they allow their customers to go broke holding out for higher fees.

    "It's like any other negotiation," he said.