As US Shale Sinks, Pipeline Fight Sends Woes Downstream

Reuters

WILMINGTON, Del., Feb 22 (Reuters) – Within weeks, two low-profile legal disputes may determine whether an unprecedented wave of bankruptcies expected to hit U.S. oil and gas producers this year will imperil the $500 billion pipeline sector as well.

In the two court fights, U.S. energy producers are trying to use Chapter 11 bankruptcy protection to shed long-term contracts with the pipeline operators that gather and process shale gas before it is delivered to consumer markets.

The attempts to shed the contracts by Sabine Oil & Gas and Quicksilver Resources are viewed by executives and lawyers as a litmus test for deals worth billions of dollars annually for the so-called midstream sector.

Pipeline operators have argued the contracts are secure, but restructuring experts say that if the two producers manage to tear up or renegotiate their deals, others will follow. That could add a new element of risk for already hard-hit investors in midstream companies, which have plowed up to $30 billion a year into infrastructure to serve the U.S. fracking boom.

"It's a hellacious problem," said Hugh Ray, a bankruptcy lawyer with McKool Smith in Houston. "It will end with even more bankruptcies."

A judge on New York's influential bankruptcy court said on Feb. 2 she was inclined to allow Houston-based Sabine to end its pipeline contract, which guaranteed it would ship a minimum volume of gas through a system built by a Cheniere Energy subsidiary until 2024. Sabine's lawyers argued they could save $35 million by ending the Cheniere contract, and then save millions more by building an entirely new system.

Fort Worth, Texas-based Quicksilver's request to shed a contract with another midstream operator, Crestwood Equity Partners, is set for Feb. 26.

The concerns have grown more evident in recent days, raised in law firms' client memos and investment bank research notes.

Last week, executives from Williams Companies Inc and Enbridge Inc, two of the world's largest pipeline operators, sought to allay growing investor fears, saying they were reviewing contracts or securing additional credit guarantees to minimize the impact of the biggest oil bust in a generation.

More Vulnerable Than Thought

So far, relatively few oil and gas producers have entered bankruptcy, and most were smaller firms. But with oil prices down 70 percent since mid-2014 and natural gas prices in a prolonged slump, up to a third of them are at risk of bankruptcy this year, consultancy Deloitte said in a Feb. 16 report.

Midstream operators have been considered relatively secure as investors and analysts focus on risks to the hundreds of billions of dollars in equity and debt of firms most directly exposed to commodity prices.

That's because firms such as Enterprise Products, Kinder Morgan and Plains All American relied upon multi-year contracts – the kind targeted in the two bankruptcies – that guarantee pipeline operators fixed fees to transport minimum volumes of oil or gas.

Now, with U.S. oil output shrinking and gas production stalling, many of the cash-strapped producers entering bankruptcy will be seeking to rid themselves of pricey agreements, particularly those with so-called minimum volume commitments that require paying for space even if it is not used.

"They will be probably among the first things thrown out," said Michael Grande, director for U.S. midstream energy and infrastructure at Moody's.

Run With The Land

In bankruptcy court, Sabine's lawyers argued for undoing a pipeline and gathering contract with Cheniere unit Nordheim Eagle Ford Gathering that is worth tens of millions of dollars in coming years.

Instead, a different midstream operator would be hired to build a new system that Sabine's lawyer told the bankruptcy court would literally "wrap around" Nordheim's existing infrastructure.

If Sabine gets the ruling it wants, it would immediately save the $35 million owed to Cheniere as a "deficiency fee" for failing to meet minimal volume commitments since the gathering system went into effect in September 2014.

Ryan Bennett, a Kirkland & Ellis attorney representing Sabine, told Bankruptcy Judge Shelley Chapman at a Feb. 2 hearing that Sabine had plenty of options once it shed the Cheniere contract.

"Maybe we do renegotiate with Nordheim. Maybe we buy their gathering system after this is all over," he told Chapman.


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