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Midstream equity fallout from Chesapeake Energy Chapter 11 filing largely muted


Concern over whether midstream contacts could be rejected in bankruptcy

Precedent for both approving, denying contract rejection requests

New York — A favorable Federal Energy Regulatory Commission ruling and management team reassurances have largely spared North American midstream stocks from a beating in the wake of shale gas driller Chesapeake Energy's Chapter 11 filing.

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Chesapeake, which filed for Chapter 11 bankruptcy protection June 28, is a prolific shipper on interstate natural gas pipelines operated by heavyweights like Kinder Morgan and Energy Transfer, as well as a big gathering and processing services customer for companies like Williams and Crestwood Equity Partners.

Since Chesapeake in November 2019 warned it was in danger of violating its credit agreements, investors in midstream firms that have contracts with the producer have been concerned about the potential for Chesapeake to reject those agreements in a bankruptcy court.

That fear was realized when, as part of the first-day proceedings, Chesapeake asked the US Bankruptcy Court for the Southern District of Texas, Houston Division, to "reject certain executory contracts ... effective as of July 1, 2020 or, in the alternative, abandon their contractual rights."

There is legal precedent for both approving and denying contract rejection requests for gathering and processing services, which are often written as real property interests, as opposed to executory contracts. A real property interest, which is tied to the property, cannot be rejected in bankruptcy if written correctly, unlike an executory contract, which obligates the debtor and/or another party to fulfill its terms at a later date. Firm transportation agreements for long-haul gas pipelines, on the other hand, are more similar to executory contracts and can also get support from FERC.

Assets indispensable

In a June 29 statement, Williams said its assets remain "indispensable" to Chesapeake, and also emphasized that the company has reduced its exposure to the driller "from 18% of consolidated revenue in 2015 to 6% in 2019 [which correlates to less than 9% of EBITDA]." Crestwood the same day said it "has been preparing for this event over the past few months and is well-positioned to maintain full operations to Chesapeake throughout bankruptcy proceedings."

Williams shares were down about 1% during early afternoon trading, while Crestwood units slipped as much as 8.7%. The midstream firm got pummeled on the stock market following Chesapeake's going concern announcement in November.

Both Energy Transfer and Kinder Morgan, meanwhile, were up slightly. Neither company had responded to a request for comment at the time of publication.

In response to a petition from Energy Transfer's ETC Tiger Pipeline, FERC on June 22 issued a declaratory order stating that while Chesapeake can move to reject a contract in bankruptcy court without commission approval, this rejection of contracts in bankruptcy does not alter regulatory obligations under FERC jurisdiction per the Natural Gas Act. About 23% of ETC Tiger's contracted capacity is reserved for Chesapeake.

"To be clear, we don't see the ruling completely eliminating risks ahead, but it does provide midstream companies additional protection by effectively placing the FERC at parity with bankruptcy courts," analysts at BMO Capital Markets wrote in a June 28 note to clients.

Crestwood's Stagecoach Pipeline & Storage Company had also requested "expedited action so that the commission's authority is clarified prior to, or as soon as possible after the filing of, any bankruptcy proceeding" to protect 15% of its contracted capacity.