After enduring nearly two years of falling crude oil prices, the beleaguered energy industry suffered another blow in March when a bankruptcy judge allowed an energy company to end certain pipeline contracts.
The decision in a New York bankruptcy court in favor of Sabine Oil & Gas Corp. rejects two contracts from HPIP Gonzales Holdings and Nordheim Eagle Ford Gathering, an affiliate of Cheniere Energy (LNG), focused on the gathering and processing of crude oil. Sabine says the contracts between the two companies in the midstream sector of the energy business are unnecessarily burdensome.
The midstream companies argued unsuccessfully that the contracts should go forward because these deals gave them property rights to the land where the oil or gas was produced. The decision is not binding on other courts, but energy market-watchers say it could mean other energy producers nearing bankruptcy may try to go this route, too.
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The news weighed on the shares of master limited partnerships, which are limited partnerships that trade on an exchange. Most MLPs are energy infrastructure companies, which include pipelines, storage, terminals and processing plants.
Prices of the largest MLP exchange-traded funds are down for the year, including the Alerian MLP ETF (AMLP), the JPMorgan Alerian MLP Index ETN (AMJ) and the E-TRACS Alerian MLP Infrastructure Index ETF (MLPI).
Because of the losses in the MLP space, some investors see value in these entities, but they should consider that the MLP space may still have some tough times ahead — particularly as there are a few other companies dealing with contractual issues.
All bets are off. Matt Sallee, portfolio manager at Tortoise Capital Advisors in Leawood, Kansas, says there’s no real parallel investors can apply to all contracts regarding the ruling’s impact on the broader MLP industry, “other than the fact that in a bankruptcy proceeding, all bets are off.”
He says Tortoise now views their investments with an assumption that any contract can be rejected, even though in practice that’s not likely to happen.
“The Sabine case, where it was a surprise for the market, was that it was written to be a transference of property rights and the judge allowed it. (It) should not (have been) rejected in a bankruptcy proceeding, and the judge allowed it,” Sallee says.
Sabine, which traded in April 2011 at more than $36 per share, is a fraction of its former self with shares at just more than a penny per share and a market capitalization of less than $3 million.
Darin Turner, managing director and portfolio manager for Invesco Real Estate in Dallas, says in light of the Sabine case, future rulings will be very contract-specific for the MLP space. Turner says contract language can be very different when it comes to specifying whether the pipelines “run with the land” and are specifically defined as real property versus being more opaque.
“We think those companies (with more opaque contracts) could be at risk on the issue because at that point they’re considered personal property, which much like the ruling, gives the judge a lot more leniency on what they think is more appropriate (to keep) those contacts in place or not,” Turner says.
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Not every contract dispute takes the Sabine route. Jay Hatfield, New York-based co-founder and president of InfraCap and portfolio manager of the InfraCap MLP exchange-traded fund (AMZA), says the dispute between midstream operator Crestwood Equity Partners (CEQP) and bankrupt energy firm Quicksilver Resources ended in early April, when Crestwood agreed to a 10-year deal with private equity firm BlueStone Natural Resources II to transport Quicksilver’s gas. BlueStone says the contracts between Crestwood and Quicksilver were above market value and the private equity firm would only commit to a new deal if the terms were changed.
“This is a good example of instead of the contract being the critical element, the commercial agreement/negotiation can take place in the context of ambiguous bankruptcy law relative to state law, and it will result in an agreement that is commercial reasonable,” Hatfield says.
Turner says the big potential conflict on the horizon for the MLP industry is contract negotiations between midstream operator Williams Partners (WPZ) and natural-gas supplier Chesapeake Energy (CHK). While the Sabine and Quicksilver cases were about smaller companies, Williams Partners and Chesapeake are big names in the industry.
Chesapeake isn’t in bankruptcy, so the contracts haven’t become an issue yet. Turner says the property language between the two parties, in general, is more clearly defined. If Chesapeake files for bankruptcy, a ruling on their contracts would set a greater precedent than Sabine, he says, because the language is less ambiguous.
“You should keep your radar focused on it in the coming months,” he says.
Williams Partners’ stock price took hits on their contract with Chesapeake, Hatfield says, because Williams has so much business with the energy provider, and at what are likely above-market contracts.
“There’s an easy argument to be made that they made these sweetheart contracts to get more proceeds out of the deal. And there’s easy argument to be made that there’s an above-market contract situation there,” he says, although adding that Williams has renegotiated some of its deals with Chesapeake.
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More headwinds ahead. There will likely be more headwinds for midstream MLPs in the coming months. For investors who want to buy MLPs and have a longer-term view, portfolio managers say it’s better to stick with large-cap companies versus small-cap stocks. Large-cap firms have likely been around the industry longer and have less counterparty risk.
“I recommend they buy companies that have been around 20-30 years, like an Oneok Partners (OKS),” Hatfield says.
He also recommends sticking with a closed-end fund or a diversified ETF rather than buying a single company to reduce risk.
Hatfield says the MLP space has been overly punished on the bankruptcy news, and that’s reflected in the high yields. The AMLP ETF has a yield of about 11 percent.
Turner says investors should also look closely at a MLP’s structure, such as the strength of the organization’s capital structure and how much leverage it is using. Also look at where the assets are located, as the breakeven in places like Texas’s Permian basin are much lower than North Dakota’s Bakken, for instance.
Turner says these contract issues would become less of an issue if oil prices can rebound.
“A lot of those fears on contract renegotiations would go away if oil was higher than $37,” he says. “I say that if the sentiment around oil turns positive and commodities continue on this upward trend, people will step in and buy those assets on the (exploration and production) side.”
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The Sabine Bankruptcy Ruling May Change Everything for MLP Investing originally appeared on usnews.com
