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S&P raises 2017 midstream outlook on higher prices, better balance sheets

S&P Global Ratings raised its outlook on North American midstream companies from negative to stable on Feb. 1, saying the pipeline and processing sector survived the 2016 trough of low prices with imaginative moves to strengthen its balance sheets until higher commodity prices kicked back in.

"S&P Global Ratings' outlook for the North American midstream industry in 2017 is one of cautious optimism, and we are revising our industry outlook to stable from negative," primary credit analyst Michael Grande said.

The mild recovery in oil and gas prices has been a big boost to credit confidence, S&P said. The credit rating agency raised its benchmark price assumptions on Dec. 14 to $50/bbl for crude oil and $3/Mcf for natural gas.

"Higher prices will support credit quality for midstream companies and their upstream customers," S&P said. High prices for producer customers significantly reduces counterparty risk to their midstream servicers, according to the outlook. Counterparty risk should not be a factor in 2017, in contrast to 2016 when the rating agency worried about a growing number of producer bankruptcies.

Nonetheless, S&P said, credit quality in the upstream sector isn't strong with WTI crude trading 50% below its peak in 2014 and customer quality needs continuous monitoring by midstream firms.

The trend towards reworking corporate structures to eliminate incentive distribution rights payments by MLPs is the wave of the future, S&P said, on the same day another big MLP was swallowed by its corporate sponsor (ONEOK Inc. and ONEOK Partners LP).

"In our view, structural simplification for MLPs is the more transformative fix to their high cost of capital, rather than simply a distribution cut or an IDR subsidy by its general partner, and the next step in the evolution of the sector," S&P said.

In addition, the incoming Trump administration's promises of fewer regulations and speedier permitting have added to the sense of optimism to the midstream sector, S&P said, but developers should be wary: the environmental community has not gone to sleep.

"Regulatory risk should improve, but environmental hurdles will remain a key risk to development," S&P said. "We believe it is crucial that midstream companies keep their long-lead-time projects to the scheduled time and within budget, because significant delays or cost increases will postpone EBITDA and harm credit measures."

Another trend strengthening credit quality have been the announced cuts in distributions, S&P said. Previously a last-ditch move the save credit quality, the dividend cut has become a tool for balance sheet repair, S&P said. After Kinder Morgan Inc. cut its dividend 75% in December 2015 and used the savings to shore up its balance sheet, companies like Williams Cos. Inc. and Crestwood Equity Partners LP used the same tactic without being banished from the capital markets, S&P said.

"The consequences of a cut weren't viewed to be as punitive to a company's equity price as were the distribution cuts in 2008-2009," S&P said.

Capital spending by midstream firms is projected to increase in 2017, S&P said, and most plans appear to show some discipline: reducing costs and improving efficiency. S&P expects 2017 spending to be 31% off a 2015 peak, $16 billion versus $23.2 billion, with most of that cash going to projects in the Permian, Anadarko, and Appalachian shale basins. S&P expects new projects to be backed by minimum volume commitments or take-or-pay agreements to protect cash flow and volatility.

"We believe companies will remember the lessons of a tumultuous 2016 and stick to a more measured path, which should lead to improved credit profiles during the next 12 to 24 months," S&P concluded.

"Our optimism for the North American midstream sector stems from a somewhat better outlook for commodity prices, which will also provide a boost to E&P companies; better capital market access; more efficient operations as a result of cost reduction plans and lower cost of capital; and a more conservative approach by management teams toward funding future growth," S&P said in a note.

S&P Global Ratings and S&P Market Intelligence are owned by S&P Global, Inc.