While midstream energy companies' second-quarter earnings may yield better results than initially feared thanks to an earlier recovery in drilling, the numbers will not necessarily take heightened regulatory and bankruptcy-related risks into account.
Pipeline stocks moderately recovered during the period as the price of West Texas Intermediate crude oil rebounded 92% to settle at $39.27 on June 30 and midstream firms' spending and distribution cuts took effect, but concerns about the viability of midstream infrastructure will overshadow expectations for a new baseline.
"While [second-quarter] earnings season had been keenly awaited by investors as the first full quarter to delineate COVID/OPEC+ risks — and perhaps offer clarity on the pace of recovery — legal and regulatory concerns add another dimension of headline risk," analysts at Morgan Stanley told clients July 15.
According to analyst consensus, the 11 major North American pipeline companies analyzed by S&P Global Market Intelligence should mostly record year-over-year losses in both adjusted EBITDA and revenues. Only MPLX LP and Cheniere Energy Inc. are expected to see both metrics increase, while Plains All American Pipeline LP is projected to grow revenues.
Kinder Morgan Inc. missed the analyst consensus when it kicked off the reporting period on July 22. The pipeline giant also recorded a $1 billion noncash goodwill impairment related to the pipeline giant's "natural gas non-[Federal Energy Regulatory Commission] regulated midstream business driven by the recent sharp decline in natural gas production affecting a number of our assets."
Still, analysts at Mizuho Securities USA said these results do not change the fact that Kinder Morgan has "more dependable cash flows than peers in the current backdrop with a balance sheet that should allow enhanced capital return in a more 'normalized' world as growth CapEx moderates."
Other midstream firms still need to rein in operational costs and capital spending, according to Raymond James' Justin Jenkins, though the vast majority are likely done cutting investor payouts to alleviate cash flow concerns.
"We thought DCP Midstream LP was going to be one [that cut its distribution], but they maintained it flat," he said in an interview. "Same thing with Crestwood Equity Partners LP. There might still be one or two left on the margin, but we've probably seen the bulk of what's going to happen."
Across the sector, companies will also face questions about whether oil and gas producer bankruptcies jeopardize any customer contracts, given a recent wave of Chapter 11 filings that is expected to continue through the end of 2020. Drillers have already contested gathering, processing and transportation agreements involving Crestwood, Energy Transfer LP, Kinder Morgan and Tallgrass Energy LP, but midstream firms with challenged contracts may see less combative counterparties.
"We think it likely this go-round [that] midstream broadly stands better positioned should any notable Chapter 11's pop up, perhaps owing to the fact the last down cycle was in reality not long ago where extensive contract reform took place," SunTrust Robinson Humphrey wrote in a July 16 note to clients. "We also think the space generally is more willing to work with operators in a pro-active manner to produce a 'win-win' scenario, where otherwise litigation could prove more harmful."
Regulatory issues will be top of mind given the legal battle surrounding Energy Transfer's Dakota Access LLC crude pipeline and a decision by Dominion Energy Inc. and Duke Energy Corp. to abandon the Atlantic Coast gas pipeline project. TC Energy Corp.'s Keystone XL oil pipeline project remains in limbo after the U.S. Supreme Court excluded it while reinstating the U.S. Army Corps of Engineers' Nationwide Permit 12 process for most pipelines.
"The retroactive permit revocation for Dakota Access presents a new and major investment risk for pipelines," industry consultant Ethan Bellamy said in an email. "Moving the goal line after the game is over would be a terrible precedent if upheld on appeal."
Raymond James' Jenkins added that regulatory risk will become a bigger issue ahead of U.S. federal elections in November, with the prospect of a Democratic administration that may seek to reinstate industry regulations that the Trump administration rolled back, such as rules governing environmental reviews and water quality permits.
A full shutdown of Dakota Access pending a full environmental review would also exacerbate struggling rig counts and other unfavorable conditions for Bakken shale drillers. This could bleed into some midstream companies' balance sheets through the beginning of next year, UBS analysts told clients July 13.
"Absent an increase in rig and completion activity it's possible that Q1'21 may prove to be the bottom for some especially in the Bakken if DAPL is in fact shut down as E&P CapEx looks unlikely to recover," the analysts said.