Several Appalachian gas pipeline operators have substantial exposure to a group of drillers with declining credit quality and low-growth plans for the future, an S&P Global Market Intelligence analysis found. And analysts are warning that the pipelines' earnings forecasts do not yet account for a coming wave of negotiations for lower transportation rates.
In the past month, Appalachia's largest NGL producer, Antero Resources Corp., Utica Shale driller Gulfport Energy Corp. and Marcellus Shale pioneer Range Resources Corp. were all downgraded by S&P Global Ratings, while the bond markets have begun to price in more default risk for the less-than-investment-grade gas drillers.
Significantly, Ratings also changed its outlook to negative on investment-grade EQT Corp., the United States' largest gas producer by volume. Cutting EQT to junk could rock a group of exploration and production, or E&P, companies, already under pressure in the stock market.
Ratings downgraded producers after trimming its natural gas and NGL price outlook. Moody's lowered its outlook for natural gas prices as well, saying the associated gas production from the Permian Basin will keep overwhelming the market. Producers have started to respond to the lower-for-longer price outlook.
"Q2 saw numerous nat gas levered E&Ps level-set production growth outlooks with a trend toward maintenance levels and even absolute declines in secondary basins," analysts at energy investment bank Tudor Pickering Holt & Co. told clients Aug. 14. "The combination of downward revisions to 2020-plus earnings expectations and increased counterparty risk drove steep selling pressure in natural gas levered midstream operators with [Antero Midstream Corp.] falling ~37% QTD while larger-cap operators [Williams Cos. Inc.] and [MPLX LP] declined ~15%."
The solution adopted by gas drillers is to cut costs. Once wells are drilled, the largest expense for E&P companies is paid to midstream operators for gathering, processing and transportation. EQT warned as early as the first quarter that it would be looking to renegotiate its contracts with its biggest midstream vendor, Equitrans Midstream Corp.
While few pipeline operators have acknowledged Appalachian gas's distress, Equitrans cannot hide from the issue. It shares a downtown Pittsburgh office building with EQT and was created out of EQT's midstream properties. "We're operating in an environment of lower-for-longer natural gas prices resulting in low or even no production growth," Equitrans Chairman and CEO Thomas Karam told analysts on Equitrans' second quarter earnings call July 30. "To succeed in this environment, we must continue our focus of being the low-cost midstream service provider in the basin … It also means being more willing to explore creative ways to work alongside our producer customers."
CreditSights Inc. oil and gas analyst Charles Johnston expects Equitrans' experience with EQT to be modeled by some inside the basin. "I do expect we will see some tariff relief from midstream companies in certain situations with EQT/EQM being a great example." EQM Midstream Partners LP is an Equitrans unit.
But Johnston cautioned that the impact on larger midstream operators such as Williams will be muted. "At the end of the day, it makes sense for midstream providers to support their large customers, but I don't believe we are going [to see] widespread tariff reductions that materially impact large diversified midstream names."
What will be affected by low growth and upstream pressure for cost cuts at the midstream level will be the new pipelines in Appalachia, Sanford C. Bernstein midstream analyst Jean Ann Salisbury told clients earlier this summer. "We think the new build pipelines are most at risk because they have the highest tariffs (75 cents-plus). These include [Rover Pipeline LLC], [NEXUS Gas Transmission LLC], and if built, [Mountain Valley Pipeline LLC] and [Atlantic Coast Pipeline LLC]. All the pipes before this are less risky in our view," Salisbury wrote in an August note.
Salisbury cut her rating on Williams, which has substantial processing and gathering operations in Appalachia in addition to its long-haul Transcontinental Gas Pipe Line Co. LLC. "[Williams] has the highest share of EBITDA from this in our coverage," Salisbury told clients. "Most of their counterparties are relatively solid, but the lower expectation of growth, and risk from [Chesapeake Energy Corp.]/[Southwestern Energy Co.]/EQT is enough for us to downgrade to market perform. [Energy Transfer LP] has ~7% of EBITDA from the Appalachia, but worse counterparties (mostly [Antero] and [Ascent Resources])."
This S&P Global Market Intelligence news article may contain information about credit ratings issued by S&P Global Ratings. Descriptions in this news article were not prepared by S&P Global Ratings.