The $500 billion U.S. energy infrastructure sector looked like it had the perfect business model.
But these companies were merely “toll road” operators. They collected fees as they transported oil and gas through their pipelines for producers.
The fees were agreed to in (supposedly) ironclad contracts. And it was thought that those contracts would protect pipeline companies from falling energy prices.
It was the “no lose” way to invest in the United States’ booming energy sector. But in reality, it turned out to be quite different…
Bankruptcy Boom
The plunge in oil prices is bringing some U.S. shale companies to their knees. So much so that some have initiated bankruptcy proceedings, while others are nearing bankruptcy.
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According to the consulting firm Deloitte, about 175 of the roughly 500 publicly traded oil and natural gas exploration and production (E&P) companies are at risk of sliding into bankruptcy this year. Their combined debt load is $150 billion and rising.
The risk is that this bankruptcy “disease” will spread to the midstream sector. And here’s where it gets interesting…
Contracts Broken
One company in bankruptcy since July is Sabine Oil & Gas Corp. (SOGCQ). It petitioned a New York bankruptcy court to let it out of agreements with the gas gathering units of Cheniere Energy Inc. (LNG) and High Point Infrastructure Partners LLC.
Companies like Sabine are no longer pumping out lots of oil and gas. So, in effect, they’re paying pipeline companies for nothing. And, in many circumstances, pipeline firms have stubbornly refused to give these companies a price break.
The scream you may have heard was the pipeline executives when the bankruptcy judge agreed to let Sabine out of the deals. But the judge added that the ruling wasn’t binding because of procedural issues. However, the ruling meant the contracts and fees owed could now be converted from secured debts to unsecured debts.
This ruling was just the tip of the iceberg…
Infrastructure Model Leaking
Every shale firm going bankrupt will be looking to break their existing take-or-pay contracts with pipeline companies. It’s the reason the stock of Williams Companies Inc. (WMB) plunged when it was thought that Chesapeake Energy Corp. (CHK) would file for bankruptcy protection. Williams gets about 20% of its earnings from Chesapeake.
The key going forward will be whether those existing contracts apply to any owner of the land from which the oil flows – or whether the contract only applies to the owner that made the contract with the pipeline company.
The risk is high that the courts will rule in favor of the E&P firms. Michael Grande, Director for U.S. Midstream Energy and Infrastructure at Standard & Poor’s, spoke to Reuters about the contracts requiring payment even if the pipeline space isn’t used. He said, “They will probably be among the first things thrown out.”
If courts rule against the pipeline companies, the contract terms will have to be renegotiated. The new terms will no doubt be much less favorable terms for the midstream firms. This could expand the growing bankruptcy problem in the shale sector to the midstream sector.
The end result?
As Hugh Ray, a bankruptcy lawyer with McKool Smith in Houston, told Reuters, “It’s a hellacious problem. It will end with even more bankruptcies.”
So much for the Wall Street sales pitch about midstream energy companies providing steady income flow for investors for years on end…
Good investing,
Tim Maverick
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