Diversified midstream energy partnership Energy Transfer L.P. (ET) continues to prioritize balance sheet improvement and free cash flow generation. As a result, in December we revised the outlook to positive from stable and affirmed our 'BBB-' issuer credit rating on the company. In this report, the fifth in a series on ET's financial developments, we answer frequently asked investor questions we received since the outlook revision. For a list of other reports in the series, see Related Research below.

Frequently Asked Questions

How does S&P Global Ratings view the redemption of hybrid securities?

Energy Transfer has two preferred securities ($440 million Series C; and $434 million Series D) with upcoming rate-reset periods later this year. These securities are callable on their rate-reset date. All else unchanged, when an issuer doesn't replace a hybrid security with another hybrid or issue new common equity, we may still regard the remaining outstanding hybrids as having intermediate equity content under certain circumstances. Energy Transfer has over $6.05 billion of preferred units and $600 million in junior subordinated debt, all of which receives 50% equity treatment in our calculation of S&P Global Ratings-adjusted financial ratios. A redemption would not cause us to revisit our intermediate treatment on the remaining hybrids in the capital structure if:

• It occurred due to an external event (such as a change in tax law); or
• A redemption without replacement did not cause us to lower the long-term credit rating or revise the outlook to stable from positive; and
• It did not lead us to question Energy Transfer's intent regarding the remaining hybrids, including its commitment to keep hybrids in the capital structure to absorb losses or conserve cash during periods of stress.

Is the Lake Charles LNG project the deciding factor for attaining a 'BBB' rating?

No. The proposed project will convert Energy Transfer's existing Lake Charles liquified natural gas (LNG) import and regasification terminal to an LNG export facility. The partnership has announced six sales and purchase agreements over the past six months, bringing the total amount of LNG contracted from its Lake Charles LNG export facility to nearly 8 metric tons per annum (mtpa). Although we expect the project to further strengthen Energy Transfer's overall business mix by increasing downstream connectivity, we view the partnership's existing business mix as supportive of a 'BBB' rating. However, the determining factor for an upgrade is the partnership's financial policy--which historically has been aggressive and a headwind against its credit quality--and its expected leverage profile. Although the partnership has not yet announced final investment decision (FID) on Lake Charles LNG, we would expect the project to come at a material cost, albeit at a cost advantage over other proposed LNG projects on the Gulf Coast. If the project reaches FID, we expect the partnership to finance it in a manner that would not harm its credit measures.

When would you consider upgrading Energy Transfer to 'BBB'?

We could consider raising the rating within the next 14 months if the partnership continues to exhibit prudent financial policy while generating excess free cash flow and maintaining S&P Global Ratings-adjusted debt leverage in the low-4x area. At year-end 2022, the partnership achieved S&P Global Ratings-adjusted leverage of approximately 4.25x and we forecast it will improve to approximately 4.0x this year. We could consider raising the rating earlier in the year if the partnership performs better than expected, maintains financial prudence by generating excess cash over the coming quarters, or keeps leverage at current levels.

How do you view the proposed Lotus Midstream Operations LLC acquisition?

We view the $1.45 billion acquisition to be supportive of credit quality as our pro forma financial measures are largely unchanged. The partial equity component is supportive of ET's positive rating outlook and consistent with its stated policy of financial discipline toward potential growth and acquisition opportunities. Its previous transactions (Enable Midstream and Woodford Express) were either leverage neutral or leverage accretive and not at the expense of its balance sheet. While we forecast the partnership to generate excess cash flow over the next 24 months, we would reasonably conclude it could target additional acquisition opportunities. That said, we believe the partnership has permanently shifted its strategy and no longer expect it to pursue leveraging transactions that would increase its S&P Global Ratings-adjusted leverage profile by over 0.5x from forecasted measures.

What credit ratios do we forecast over the next two years?

The partnership reduced its long-term debt by approximately $800 million in 2022 and we expect it to continue generating surplus free operating cash flow (FOCF) in 2023 and beyond. Now that the distribution is back to its pre-pandemic levels, we expect the partnership to generate sufficient discretionary cash flow to pursue additional bolt-on transactions, debt repayments, or shareholder friendly activities including unit repurchases or distribution increases. As a result, we project the partnership to achieve S&P Global Ratings-adjusted leverage of approximately 4.0x this year and in the 3.75x-4.00x range next year. Our financial measures do not consolidate either USA Compression Partners L.P. or Sunoco L.P.'s EBITDA or debt nor does it incorporate an FID for Lake Charles LNG. Instead, we calculate EBITDA on a cash basis, including the distributions received from these subsidiaries and other unconsolidated affiliates. In addition, we proportionally consolidate the EBITDA and debt of Dakota Access Pipeline (DAPL) based on ET's 36.4% ownership interest. Although different than how we treat its other joint ventures, we proportionally consolidate ET's interest in DAPL as we consider the pipeline to be a strategic asset and expect the partnership to support DAPL if it experiences financial stress.

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Related Research

• Credit FAQ: How We Assess Hybrid Replacement Decisions When Credit Quality Improves: A Focus On Midstream Energy, March 06, 2023
• Research Update: Energy Transfer L.P. Outlook Revised To Positive From Stable On Improving Leverage; 'BBB-' Ratings Affirmed, Dec. 15, 2022
• Credit FAQ: Our Latest Views On Energy Transfer L.P., June 06, 2022
• Credit FAQ: Calm After The Storm: Our Latest Thoughts On Energy Transfer L.P., May 26, 2021
• Credit FAQ: Financial Ratio Refresh For Energy Transfer L.P. And DAPL In 2021, Feb. 08, 2021
• Credit FAQ: A Look At Calculating Financial Ratios For Energy Transfer L.P. And The Impact Of The DAPL Shutdown On Leverage, July 29, 2020