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Investment-Grade Midstream Issuers Weathered Pandemic-Related Volatility By Focusing On Leverage Reduction

Three years ago, COVID-19 shutdowns across the globe caused crude oil demand to dwindle and commodity prices to drop. While production growth slowed, especially in the U.S. Permian Basin, the majority of U.S. midstream issuers weathered the volatility. Since then, credit quality has improved for many of these issuers. Many reduced their cash outlays in 2020 by cutting dividends and reducing capital spending. For issuers with scale and strong contract profiles, this allowed them to withstand the volatility and quickly deleverage when drilling activity returned. EBITDA for our rated universe grew 17% in 2022 from 2020 while total debt increased only 1%. Capital spending decreased 32% to $44 billion in 2020 from $65 billion in 2019 and has remained below $40 billion through 2022.

As a result, we have seen a number of positive rating actions, especially for high 'BB' and investment-grade issuers. The commodity price environment and energy transition may challenge these issuers over the coming years, but we anticipate the highly rated issuers' new financial conservatism will enable them to maintain credit quality despite the headwinds.

Chart 1


Issuers Will Likely Reduce Leverage Further In 2023

We expect leverage to continue declining for both speculative-grade and investment-grade issuers in 2023, even if issuers start increasing dividends and capital spending. We expect EBITDA across our midstream rated universe to grow 6% in 2023 supported by a 14% increase in capital spending year over year. We expect debt to be repaid across the industry, mostly in the investment-grade space, resulting in a 3% debt reduction in 2023 versus 2022. As a result, debt to EBITDA will improve 25 basis points (bps) to 50 bps on average across all midstream issuers.

2023 trends for speculative-grade and investment-grade issuers
(Mil. $) EBITDA Debt Capital expenditure Dividends and buybacks Average debt to EBITDA (x)
Investment-grade 102,109 367,382 33,351 43,948 3.60
Change over 2022 (%) 5 (4) 12 (10) (0.35)
Speculative-grade 22,631 113,455 8,829 5,989 5.01
Change over 2022 (%) 8 (1) 25 (24) (0.42)

Chart 2


Credit Metrics For Investment-Grade Issuers Improved

Chart 3


We've taken several positive rating actions on investment-grade and high 'BB' issuers over the past 18 months. Investment-grade issuers reduced capital spending 28% in 2020 versus 2019 and 20% in 2020 versus 2021. Many investment-grade issuers also reduced distributions and halted buy backs. Cash preservation and resilient cash flows allowed highly rated issuers to reduce leverage. EBITDA of investment-grade issuers grew 1% from 2019 to 2020 and 11% from 2020 to 2021. Meanwhile, debt only increased 3% and 1% over the same periods. This continued into 2022 and improved average debt to EBITDA 66 bps from the high in 2020 to 2022.

Chart 4


We upgraded Enterprise Products Partners L.P. (EPD) to 'A-' in March of 2023, making it the highest-rated strategic midstream issuer of those we rate. The upgrade reflects our view of EPD's new financial policy, which targets a lower, long-term leverage sustained at 2.75x–3.25x. While EPD did not cut its dividend in 2020, it did reduce its capital spending significantly to $3.2 billion in 2020 and $2.1 billion in 2021 compared with $4.3 billion in 2019. Its cash flows remained relatively steady, with EBITDA declining less than 1% in 2020 from 2019 levels. EPD used excess cash to repay debt and fund a portion of the $3.25 billion acquisition of Navitas in 2022. The acquisition closed in 2022, and EPD ended the year with leverage below 3.0x.

Chart 5


In December 2022, we revised the outlook for our ratings on Energy Transfer L.P. (ET) to positive. This reflects our expectation for S&P Global Ratings-adjusted leverage in the low-4x area. ET repaid over $7.1 billion of debt, including debt of acquired companies in 2021 and 2022, which reduced its debt to EBITDA more than than 85 bps over the past three years. ET decreased capital spending in May 2020 by $400 million and cut its dividend by 50% in October of the same year. In February 2021, ET's EBITDA improved more than $2.5 billion due to the winter storm in Texas. ET announced the acquisition of Lotus Midstream earlier this year. We expect the partnership to fund the $1.45 billion acquisition with equity and cash.

Chart 6


We revised our ratings outlook on Plains All American Pipeline L.P. to positive in February 2023 due to its improving leverage metrics. In April 2020, Plains reduced its distribution 50% and decreased its capital spending. The company's base business (excluding the former supply and logistics business) performed only 3% lower than its pre-COVID-19 2020 budget. The limited impact from the pandemic-related commodity environment and its cash savings allowed Plains to repay more than $1 billion of debt in 2021 and more than $750 million in 2022. As of year-end 2022, its leverage was 3.4x, down more than a turn from 4.6x in 2020.

Chart 7


In March 2020, Targa Resources Corp. cut its common dividend almost 90%, reduced capital spending forecasts for both 2020 and 2021, and revised its EBITDA forecast for 2020. However, it ended the year with EBITDA mostly in line with its pre-COVID-19 expectations. Targa has almost doubled in size since 2019. Its growth, along with the cash savings it pursued in 2020, enabled it to repay debt, repurchase its preferred units, and simplify its capital structure. In 2022, Targa funded the $3.55 billion acquisition of Lucid Energy with debt, which elevated its leverage at year end; however, we expect Targa to reduce leverage below 3.5x in 2023.

Speculative-Grade Companies Reduced Leverage At A Slower Rate

Chart 8


We've seen slower deleveraging for speculative-grade issuers since 2020 compared with their investment-grade peers. Speculative-grade issuers were able to reduce their leverage 53 bps from 2020 to 2022 due to lower capital spending levels and EBITDA growth. Speculative-grade issuers reduced capital spending 42% in 2020 compared with 2019, and EBITDA grew 18% over the same period. However, some speculative-grade issuers had fewer avenues to pursue cost savings. For example, unlike investment-grade issuers that could cut distributions to reduce spending in March 2020, that was not an option for speculative-grade issuers that were not paying a distribution. Due to their small size, weaker contract profiles, and less diverse asset base, speculative-grade issuers had less cushion for commodity-related volatility. Permian-focused issuers' leverage was higher for longer given their dependence on volume and EBITDA growth to reduce leverage. Some speculative-grade issuers also experienced liquidity issues because debt capital markets were challenged in 2020. We moved four issuers into the 'CCC' category in the period between February 2020 to March 2021, reflecting our view of their leverage as unsustainable, their liquidity issues, and the potential for default.

This report does not constitute a rating action.

Primary Credit Analyst:Jacqueline R Banks, New York + (212) 438-3409;
Secondary Contacts:Michael V Grande, New York + 1 (212) 438 2242;
Mike Llanos, New York + 1 (212) 438 4849;
Stephen Scovotti, New York + 1 (212) 438 5882;
Research Assistant:Joshua Carter, New York

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