Lower oil prices have recently placed increasing pressure on producers, with a significant number of companies filing for bankruptcy protection in 2015, including Magnum Hunter, Quicksilver, Sabine, and Samson. If oil and gas prices remain depressed, it is likely that more producers, such as Chesapeake and California Resources, will need to restructure their debt in 2016. Producers usually tend to hold out as long as possible during downturns, hoping others will cut production first and try to position themselves to outperform once the cycle turns. In the current “lower for longer” commodity cycle, many producers have already taken advantage of easy liquidity fixes (extending durations, second lien1 issuances, up-tiering2, etc.). With hedges rolling off, bankruptcy risk becomes a serious threat for weaker capital structures with unsustainable leverage.
Investors have started raising questions on midstream contract structures and the treatment of these contracts in Exploration & Production (“E&P”) bankruptcy proceedings given considerable stress emerging across the energy value chain. Furthermore, some midstream providers have received (and will receive in the future if the current commodity environment persists) requests for contract renegotiations and rejections as producers go through the restructuring process. Although midstream players are better positioned than E&Ps and oilfield service players given lower commodity exposure and longer contract duration, counterparty risk is emerging as an ongoing concern in the following areas: (i) underutilized energy infrastructure assets, (ii) contracted capacity on new pipelines, and (iii) future commitments on new projects.
While contract portfolios and negotiations can range widely, companies with diversified footprints, strong counterparties, and fee-based MVC contracts should be best positioned throughout the cycle. “Fee-based” is no longer the sole requirement for strong contract protections. Volume protections provide an additional layer of stability.
The AMP Capital Global Listed Infrastructure team has invested a considerable amount of time investigating the issues described in this paper (counterparty risk, stability of cash flows, balance sheet strength, funding requirements, etc.) and continues to focus on companies with the qualities to weather the downturn and thrive when the upcycle unfolds.
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Author: Antonio Barbera, Portfolio Manager / Analyst, AMP Capital
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