Court Decision Threatens Midstream Sector

March 2016, Vol. 243, No. 3

A federal bankruptcy judge ruled that Sabine Oil & Gas could withdraw from its contract obligations with pipeline companies to ship a certain volume of oil and gas through their pipelines.

The court decision may seem arcane, but it could have major ramifications for both producers and midstream companies. Under the contracts, a company like Sabine Oil & Gas promises to ship a certain volume of hydrocarbons through the pipeline at a set fee. If they fail to do so, they still have to pay the pipeline company for the use of the pipeline capacity.

Sabine Oil & Gas, a struggling producer, says that it can no longer ship enough volume to meet the contractual agreement and it wanted to be let out of the contract. The company went to a bankruptcy judge in Manhattan, who ruled in Sabine’s favor.

The pipeline contracts are very attractive to investors in midstream companies, who love the secure and stable revenue streams that such arrangements offer. The ruling could lead to a lot of uncertainty for the midstream sector. The Alerian MLP Index, an index fund that tracks pipeline companies, fell by more than 6 percent on March 8.

Still, the judge ruled that Texas law was not clear enough to make the ruling binding. That likely means more litigation will be forthcoming. “One could see this ruling as something favorable for producers, but it’s something that’s going to play out further in the courts,” Ed Longanecker, president of the Texas Independent Producers and Royalty Owners Association, told The Wall Street Journal.

More and more oil and gas producers are falling into bankruptcy, and even for those that avoid such a fate, meeting obligations with pipeline companies is becoming more difficult. The cloudy legality around how to get out of these contracts is creating uncertainty not just for drillers, but also for pipeline companies. The latest decision on Sabine Oil & Gas will do little to remove that uncertainty.

By Charles Kennedy of Oilprice.com

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