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Supply And Demand Shocks Are Throwing The U.S. Midstream Industry Off Balance

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Supply And Demand Shocks Are Throwing The U.S. Midstream Industry Off Balance

Global events of the last few weeks have created a perfect storm for the oil and gas industry, and the falling dominoes will likely significantly affect the North American midstream industry's credit quality. The supply shock of a possibly prolonged oil price war between Saudi Arabia and Russia, coupled with a significant demand shock from the global spread of COVID-19, has management teams on the defensive. Indeed, a few companies have announced capital spending and distribution cuts, and we expect more in the coming weeks.

We believe the risk factors we've outlined are going to have significant, but somewhat uneven, reverberations across the midstream industry. Over the next several weeks we will continue to conduct reviews of the midstream companies in our portfolio, both speculative-grade and investment-grade. What follows are our thoughts concerning credit drivers for the industry, with additional details on some of the larger, diversified investment-grade companies.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak between June and August, and we are using this assumption in assessing the economic and credit implications. We believe measures to contain COVID-19 have pushed the global economy into recession and could cause a surge of defaults among nonfinancial corporate borrowers (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Counterparty credit risk will continue to weigh on the midstream sector.  We've already taken rating actions (see Related Research) on a number of gathering and processing companies that are tied to one particular producer, either through a parent-subsidiary relationship or because they derive all or a significant portion of their revenue from that producer (Antero Midstream Partners LP, CNX Midstream Partners LP, or EQM Midstream Partners LP). These rating actions were linked to rating changes at the producer. However, widespread credit deterioration among exploration and production companies could have broader implications for producer-push pipelines and companies with significant volume and commodity price exposure, such as gatherers and processors that are closer to the wellhead.

Companies with investment-grade ratings are generally better positioned to navigate market and macroeconomic uncertainties than their speculative-grade peers.  We believe investment-grade midstream companies are better positioned to deal with the severe supply and demand shocks rippling through the energy sector. Many companies are self-funding and either refinanced early in the year or do not have debt maturities in 2020 or 2021. In addition, most credit facilities have been extended, and liquidity on revolvers is sufficient.

That said, we still believe many of these companies' financial policies could change if the cycle is in a prolonged trough. We believe it will start with significant cuts to capital-spending budgets on projects that are not in flight, and we think that distribution cuts are on the table given anemic equity prices. Ratings could come under pressure the longer the commodity trough lasts, particularly given the now-certain U.S. recession. In our view, 2020 volumes and cash flows might not be affected much, but operations for most companies could be harmed in 2021. We will be adjusting forecasts and discussing with management teams what strategies they intend to implement.

Some of the tools that worked during the last low point in the cycle will not work this time.  During the 2015-2017 downturn, the midstream industry was able to conserve excess cash through distribution cuts, raising preferred equity, or selling assets. We believe this time, the effectiveness of these tools is somewhat limited. Distribution cuts are on the table for all companies, in our opinion, but during this downturn they might only be effective for investment-grade companies. In general, we believe that speculative-grade companies already cut distributions significantly in 2016-2017, and even a suspension of the distribution this time around might not be enough to preserve liquidity and financial flexibility or repay maturing debt.

That said, two speculative-grade companies--Targa Resources Corp. and DCP Midstream LP--announced significant cuts to their distributions and capital spending to strengthen balance sheets and preserve liquidity. Targa announced a 90% cut to its quarterly distribution starting with the first quarter ending March 31, which will save about $755 million of cash flow to reduce debt. It also announced a 32% decrease in its 2020 growth capital plans to $800 million-$900 million. DCP announced a 50% distribution reduction, which will save $325 million, in conjunction with a 75% cut to growth capital spending to $150 million. Both companies' EBITDA is exposed to volumes and commodity prices, and we believe their actions are evidence of the potential threats to credit quality that most of the industry will face.

Midstream companies had a moderate amount of success with asset sales a few years ago, which we believe will be difficult to repeat. We think in-flight deals such as Blackstone's acquisition of Tallgrass Energy Partners LP and the merger between Equitrans Midstream Corp. and EQM Midstream Partners LP will move forward, but we will not factor into our forecast any aspirational deals companies were hoping to complete. Most of the deals in the market are gathering and processing assets close to the wellhead, which are the least attractive, and the bid-ask spread between buyer and seller will continue to widen with commodity prices so low.

We also don't believe it likely that private equity, infrastructure funds, or other third-party funding will provide any relief. While some sponsors have provided additional equity investments for midstream assets they already own, this was mostly to finish some in-flight growth projects or help meet certain obligations. We believe most private capital will take their idle cash balances and look elsewhere.

We are watching the capital market windows and monitoring liquidity and uses of excess cash.  We believe these three factors will become more critical to midstream ratings over the next 12-18 months. While most midstream debt maturities are manageable over this time period, there are some speculative-grade companies--such as Martin Midstream Partners LP and Ferrellgas Partners LP--facing liquidity issues due to near-term maturities and an inability to refinance in the public debt markets. Investment-grade companies have significantly more financial flexibility, with ample capacity on large revolving credit facilities. Most investment-grade companies can stay out of the public debt markets through 2021 and possibly tap their revolvers for debt maturities if they want to roll them. The other option is using excess cash flow to actually repay some debt, which we believe could happen if this downturn continues into 2021.

We've been asking management teams if they are considering fully drawing-down on their revolving credit facilities as a defensive measure. We'd expect the companies to hold the entire amount on their balance sheets and not deploy it for uses we'd deem harmful to creditworthiness, such as share repurchases of funding distributions. However, a full draw would still be slightly leveraging because we do not fully net cash against total debt. Credit ratios will also likely be pressured given our view of the high probability of lower EBITDA in the next 12–18 months.

We also believe companies could consider repurchasing debt in the open market because the whole sector's unsecured notes have traded lower. We are not sure how this will play out in the nascent downturn, but we believe companies will choose to hold onto liquidity for now. That said, if companies do market repurchases of debt, we could view this as a distressed exchange, particularly for speculative-grade companies rated 'B' and lower, even if doing so improves the balance sheet. This is because deep speculative-grade companies would likely be viewed as distressed at this time, and their investors would be receiving less than they were originally promised. If the same practice was executed by an investment-grade company, we'd instead view it as opportunistic.

Select North American Midstream Investment-Grade Companies
Issuer Rating as of March 24, 2020 Comments

Rockies Express Pipeline LLC (REX)

BBB-/Watch Neg/-- REX has meaningful exposure to lower-rated counterparties. Many of REX's anchor shippers are gas-focused companies concentrated in the Appalachian region that we've downgraded recently, and many still have negative outlooks. Although we expect the level of associated gas to decline, we believe REX faces headwinds that could complicate recontracting efforts in Zones 1 and 2 (DJ basin). Benefiting REX is its low leverage, which gives it a cushion to withstand some financial stress, but deteriorating counterparty credit could drive future rating actions.

Western Midstream Operating LP (WES)

BBB-/Negative/-- Our rating in WES is capped by our rating on Occidental Petroleum Corp. as its majority owner and main customer. We currently view WES's credit metrics as stressed, and WES will be assessing initiatives that will help the partnership to deleverage its balance sheet. The current market and economic headwinds will likely complicate the deleveraging plans, and we have revised our expectations for EBITDA growth and potential asset sales.

Enable Midstream Partners LP

BBB-/Stable/-- We believe 2020 volumes will mostly be in line with previous expectations, though there will likely be a decrease in 2021 as drilling activity slows in the basins the company serves. We expect Enable to cut costs and defer growth capital spending to shore up its balance sheet.

Energy Transfer LP

BBB-/Stable/A-3 Energy Transfer has strong liquidity and significant financial flexibility. The partnership has about $4 billion available under its revolving credit facility and can manage debt maturities through 2021 without the need to tap the capital markets. We believe debt to EBITDA will remain below 5x in the current cycle, and we view the significant excess cash flow (about 1.8x distributions) as a powerful tool that can be used to deleverage the balance sheet.

Gibson Energy Inc.

BBB-/Stable/-- Gibson's business remains positioned to weather the recent commodity headwinds, largely due to its strong contractual structure, which provides at least 60% of cash flows from take-or-pay contracts. Counterparty quality is reasonable, with a large proportion of revenue coming from investment-grade or government-owned entities. However, the company's refined products sub-segment--which produces products such as road asphalt, roofing flux, wellsite fluids, and distillates--is exposed to recession risk, as the demand for these products is affected by the level of economic and exploration and production activity.

Plains All American Pipeline LP

BBB-/Stable/A-3 Plains likely will see some pressure on crude volumes over the next 24 months, but it has some downside volume protection from take-or-pay contracts and minimum volume commitments in the transportation segment. The company could also benefit in the short term from its storage segment due to contango (when future crude prices are higher than current prices). The company currently has somewhat of a buffer in its leverage metrics relative to our downgrade trigger, allowing it to weather the weak crude environment. We believe significant cuts in growth capital spending are likely. The company has sufficient liquidity.

Kinder Morgan Inc.

BBB/Stable/A-2 Kinder Morgan is well diversified, with sufficient liquidity over the medium term. The sale of approximately 25 million shares of Pembina Pipeline Corp. (after-tax proceeds of $764 million) positions the company to weather the next 12-24 months. Approximately 10% of cash flows are either hedged or exposed to commodity prices, split about evenly between the two. We view the CO2 business as the segment with the most risk, but it makes up less than 10% of the company's total EBITDA. We believe the recent improvements to adjusted leverage position Kinder well during this period of low commodity prices.

MPLX LP

BBB/Stable/-- We are currently reviewing both MPLX and its parent company, Marathon Petroleum Corp. Given current market conditions, we expect that asset sales in this market will be limited. That said, perhaps the most notable credit factor for MPLX is related to its direct and indirect commodity price exposure. Approximately 35% of MPLX's 2019 EBITDA was tied to its gathering and processing business segment, which also has direct commodity price exposure. As of year-end, the company had over $4.4 billion of liquidity, which positions it well for the medium term. Following the conclusion of our review, we will provide a more detailed update on forecasted 2020 credit ratios.

ONEOK Inc.

BBB/Stable/A-2 Despite the recent drop in crude prices and NGLs, we believe there is good visibility into ONEOK's 2020 EBITDA growth, mostly from additional volumes out of the Bakken onto its assets recently placed into service. We are forecasting debt to EBITDA in the 4.3x area for 2020.

The Williams Cos. Inc.

BBB/Stable/A-2 We believe Williams' balance sheet could see some pressure, particularly in its northeast and western gathering and processing segments. We'd expect the company to cut back on capital spending and use excess cash flow to reduce debt to offset any EBITDA declines. We believe the sale of its western gathering and processing business is unlikely at this time. The company has sufficient liquidity.

Pembina Pipeline Corp.

BBB/Stable/-- About 90% of Pembina's EBITDA is fee-based, with approximately two-thirds under a take-or-pay or cost-of-service contract regime. Moreover, approximately 60% of its customers have investment-grade ratings, with a sizable proportion of those in the 'A' rating category. At this time, Pembina has sufficient liquidity to manage its 2020 and 2021 maturities.

Inter Pipeline Ltd. (IPL)

BBB+/Negative/-- IPL derives its core credit strength from the stability in its oil sands transportation business (about 50% of EBITDA), which is highly contracted, operating on a cost-of-service model with no volume risk or commodity price risk. Counterparties currently are mostly investment-grade, and the remaining contract term is 20 years. IPL's conventional oil pipelines, bulk liquid storage, and NGL processing businesses are exposed to varying degrees of commodity price risk, both direct and indirect. IPL is also in the process of expanding its NGL business segment through the construction of the Heartland Petrochemical Complex (HPC), which has put considerable pressure on its credit metrics. Also, IPL is exploring the sale of its bulk storage terminal business to finance the equity portion of the HPC. While details around valuation are unknown at this point, we believe that the current environment is not very conducive to a potential sale. If commodity prices remain lower for a prolonged period, we believe IPL will have to seek alternative funding solutions, as its incremental debt capacity appears maxed out for the rating.

Enbridge Inc.

BBB+/Stable/A-2 Enbridge is well diversified with highly predictable cash flows. Following asset divestitures of approximately $8 billion over the last 12-18 months, about 98% of its cash flows come from low-risk take-or-pay, fixed fee, or cost-of-service type contracts. While we expect Enbridge's counterparty credit quality to deteriorate given the revision to our price-deck, the majority (93%) of its customers have investment-grade ratings.

Enterprise Products Partners LP

BBB+/Stable/A-2 We expect the downturn in commodity prices to have a relatively minor impact on EPD. We believe that EPD also is largely insulated from counterparty credit risk with its diversified and high-quality customer base. We expect the partnership to maintain debt to EBITDA in the mid 3x area and distribution coverage of about 1.5x over the next two years. We also expect the company to continue to repurchase units on an opportunistic basis.

Magellan Midstream Partners LP

BBB+/Stable/A-2 We expect the current downturn to have a small impact on Magellan's cash flows. The volumes in the company's refined products segment could be modestly hurt due to lower demand for refined products. However, we expect the company to maintain leverage in the low to mid 3x area in 2020 and 2021. The company also has a high-quality customer base. We do believe the company could opportunistically look to repurchase units in a prudent manner to maintain appropriate credit metrics.

TC Energy Corp.

BBB+/Stable/A-2 TC Energy's EBITDA is very stable, with a strong contractual foundation of take-or-pay or cost-of-service contracts. Although credit measures are at the lower end of the range for the current rating, we do not expect them to fall below our thresholds in the next few years. If KXL moves forward, we'd expect it to be financed in a manner that would not change this view.

What's Next?

We'll be continuing our portfolio review for the next several weeks, starting with the companies we consider most vulnerable and then moving to the more resilient ones. We'll continue to provide periodic updates on the sector during this turbulent time.

Related Research

  • S&P Global Ratings Cuts WTI And Brent Crude Oil Price Assumptions Amid Continued Near-Term Pressure, March 19, 2020
  • EQM Midstream Downgraded To 'BB' On Consolidation With Equitrans; Issue-Level Ratings Lowered; Outlook Stable, Feb. 27, 2020
  • CNX Midstream Partners L.P. Rating Lowered To 'B+' From 'BB-' On Downgrade Of Parent; Outlook Negative, Feb. 5, 2020
  • Antero Midstream Partners L.P. Rating Lowered To 'B+'; Outlook Negative, Feb. 4, 2020

This report does not constitute a rating action.

Primary Credit Analyst:Michael V Grande, New York (1) 212-438-2242;
michael.grande@spglobal.com
Secondary Contacts:Luqman Ali, CFA, Toronto (1) 416-507-2589;
luqman.ali@spglobal.com
Jacqueline R Banks, New York + (212) 438-3409;
Jacqueline.Banks@spglobal.com
Stephen R Goltz, Toronto + 1 (416) 507 2592;
stephen.goltz@spglobal.com
Mike Llanos, New York (1) 212-438-4849;
mike.llanos@spglobal.com
Michael Pastrich, New York + 1 (212) 438 0604;
michael.pastrich@spglobal.com
Stephen Scovotti, New York (1) 212-438-5882;
stephen.scovotti@spglobal.com

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