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Editorial comment

Is the reign of ‘take or pay’ over? Early March saw the news that Sabine Oil & Gas Corp. would be allowed to withdraw from its contract obligations with pipeline companies to ship oil and gas through their pipelines. A US federal bankruptcy judge agreed that Sabine was not liable for fines that would have resulted from failure to use pipeline capacity under previously agreed terms. Sabine and another company, Quicksilver, had argued that they needed to be set free from contracts with gathering company Cheniere Energy because to fulfil the terms of existing shipping contracts would mean certain bankruptcy. Sabine argued that other routes to market could be used, or built, to better effect.

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The contracts entered into between operators and shippers are typically long-term agreements: secure commitments that both parties are happy to stand by (one party receives a route to market, the other receives guaranteed transit within pipeline assets). The general rule for these agreements is ‘take or pay’: take the capacity, or pay a fine if you fall short. But in current market conditions, upstream companies are finding it harder to commit to ship set volumes at set fees, without feeling the pinch financially. Producers are increasingly at risk of letting down the pipeline operators who have shipped their goods for so long.

More litigation is expected in the Sabine case, but the bankruptcy ruling is interesting in that it opens up the field for other struggling producers to step forward with their own bankruptcy woes.

As Forbes comments: “The [Sabine bankruptcy case] could determine the viability of billions of dollars in similar contracts that pipeline and midstream companies – many of them structured as master limited partnerships – have with troubled oil and gas producers.”1

Investors are growing increasingly wary of the previously-lauded master-limited partnership (MLP) model, where dividend-style distributions churned out reliable sums year-on-year, that is, they did before oil prices dropped.

During the US shale boom, investors flocked to MLPs, which were growing as much as 8% a year.

This brings us to the tale of the shale giant Chesapeake Energy, which has suffered major setbacks recently. Last December, after Moody’s downgraded the company’s corporate debt rating, some associated parties (including pipeline companies) asked for collateral. In a filing with the SEC, the Oklahoma City-based company acknowledged: “some of our counterparties have requested or required us to post collateral as financial assurance of our performance under certain contractual arrangements, such as transportation, gathering, processing and hedging agreements.” Chesapeake had in fact been asked to hand out hundreds of millions of dollars in collateral.

Stocks in the corporation fell in February this year, following reports that the company was being restructured (it says it had simply consulted with a restructuring counsel). And this was followed by the death of the company’s CEO, Aubrey McClendon, just a day after he was indicted by a federal grand jury on charges of conspiring to rig the price of oil and gas leases.

Since March, Chesapeake’s share prices have recovered a little and the company insists it is not going to file for bankruptcy. However, pipeline companies such as Williams, Kinder Morgan, Spectra Energy Partners, Columbia Pipeline Partners and Marathon Petroleum Corp, all of whom have contracts with the wobbling company, may be scanning the horizon for major trouble: Chesapeake reports it has commitments to pay about US$2 billion/yr for space on pipelines run by MLPs.

For more on how the midstream sector is weathering the storm in North America, read our special report, starting on p.12.


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