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Oil price shock could drive more midstream distribution cuts, experts warn

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Oil price shock could drive more midstream distribution cuts, experts warn

Saudi Arabia's oil price war with Russia could force some U.S. pipeline companies to slash distributions as debt reduction becomes even more urgent, industry experts said.

While guaranteed revenues from long-term contracts help to insulate the midstream sector from direct commodity price exposure, anticipated production spending cuts could jeopardize gathering and processing operations closer to the wellhead that already faced a "no-to-low growth environment," according to analysts at energy investment bank Tudor Pickering Holt & Co.

"While our existing concern was that select [gathering and processing companies, or] G&Ps would be unable to manage leverage profiles ... that risk is now increasingly widespread as production trajectory shifts to one of absolute declines," the company wrote in a March 9 note to clients. "With upstream budget cuts imminent and every basin out of the money, midstream operators have effectively 1-2 quarters before activity rolldown filters through the system."

In order to account for reduced earnings later in 2020 while still prioritizing debt reduction, both Tudor Pickering Holt and UBS Investment Bank said they expect that the pressure on higher-yield midstream companies to cut investor payouts will intensify. Tudor Pickering Holt flagged Enable Midstream Partners, EnLink Midstream LLC, Targa Resources Corp. and Western Midstream Partners LP as candidates for "expeditious revisions" amid "deafening" calls for balance sheet conservation.

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Western Midstream CFO Michael Pearl said in February that the master limited partnership does not intend to trim investor payouts despite poor stock price performance, while EnLink's January distribution cut failed to translate into stock price momentum.

CBRE Clarion Securities portfolio manager Hinds Howard noted that, in general, midstream companies have not curtailed leverage, distributions or spending enough to be prepared for plunging crude prices and equity values even after the enormous wave of distribution cuts set in motion by collapsing commodity prices in 2014.

"Midstream companies and long-only midstream investors will put on a brave face and argue that oil and gas will still flow through pipelines. ... But the truth is nobody knows how this 35% drop in oil prices in less than a week will impact the oil and gas business in the U.S.," he said in an email. "It is not good for midstream, and ... midstream as a group of companies has not done enough to position for another downturn."

Howard also said that plunging oil prices could set the stage for further midstream M&A "as owners of some of the quality assets get fed up with the negative impact their peers are having on their valuation." Analysts at UBS, too, said in a March 9 note to clients that recent events may serve as a "catalyst for consolidation discussions."

On the operational side, any upstream activity slowdown will only intensify competition for barrels on crude pipelines out of West Texas' Permian Basin, according to analysts at SunTrust Robinson Humphrey.

The prospect of falling demand amid the COVID-19 outbreak already had already introduced the potential for a "bloodbath" as more capacity continues to come online, said Morningstar Inc. Director of Energy Commodities Research Sandy Fielden in an interview.

Still, analysts at East Daley Capital Advisors Inc. wrote in a March 9 note to clients that "several midstream companies have relatively little exposure to the decline in oil prices and could be safe havens to ride out the oil price downturn," particularly those with storage and refined products assets.