A recent spike in contract rejection efforts in the perennially restructuring E&P space threatens to amplify competitive and balance sheet pressures across the midstream arena. To safeguard their counterparty-reliant business models, gathering and transportation operators may need to explore more resourceful avenues for waging pushback in the coming months, said two restructuring lawyers and three advisors active in the industry.
While financial implications of Chapter 11 case progressions vary amongst current oil and gas debtors — Extraction Oil & Gas, Southland Royalty and Chesapeake Energy, to name a few — the crux of most contract-rejection arguments rests on the idea that their midstream contracts do not contain covenants that run with the land.
To be sure, these disputes are not a new phenomenon, and several troubled E&P companies since the last downturn tried to replicate Sabine Oil & Gas’s precedent-setting rejection of certain gathering contracts. What distinguishes the current situation from past cycles is the deeper extent to which pandemic and sector conditions have forced E&P companies to scale back drilling activity as part of their restructurings, the sources said. By extension, ability to fulfil pre-existing midstream obligations is lessened, and the incentive to play the contract rejection card is enhanced.
Year-to-date there have been five E&P filings involving covenant-running-with-the-land issues, according to Debtwire’s restructuring database. That’s up from three in 2019, one in 2018 and 2017, respectively, and seven in 2016.
This reemergence of contract rejection as a central sticking point for E&P workouts is taking place in a climate where the courts have been unpredictable. Bankruptcy judges over the past year prevented the likes of Badlands Energy and Alta Mesa Resources from rejecting contracts. And on the flip side, courts have come out against maintaining midstream status quo in recent debtor-friendly rulings for Extraction and Chesapeake.
"Now you’re seeing bankruptcy risks upfront and personal – [and midstream companies] are going to fight on the litigation front on a contract-by-contract basis,” one of the lawyers said.
With broad bullseyes on the backs of midstream contracts, gathering, transport and storage operators are poised to exert more pressure on regulators to circumvent debtor-friendly Chapter 11 rulings, the sources said. Additional proactive measures could take hold in state courts, which may have authority to blunt competitor attempts at undercutting midstream deals that are at-risk.
One player that’s expected to take on a greater role in the contract scrutiny game is the Federal Energy Regulatory Commission (FERC), the sources noted. Case in point: Rockies Express, which has pipelines transporting gas from the Marcellus and Utica shale, recently took the proactive move of turning to FERC in anticipation of a potential bankruptcy of Gulfport Energy.
Rockies said it could suffer roughly USD 800m in revenue loss due to the abrogation of its transport service agreement (TSAs) with Gulfport, an anchor client, and that any changes or repeal of the TSAs would harm the public interest. Meanwhile, Gulfport asserted it is one of many active shippers with Rockies, and that any changes or repeal of the agreements would not impose a major burden on Rockies’ other clients stemming from unused capacity.
FERC sided with Rockies in an order dated 28 October, concluding that Gulfport failed to meet its burden of showing that abrogation or modification is in the public interest. This was true to form with more aggressive signalling from the commission of late. Before Chesapeake Energy filed for bankruptcy in August, FERC took up ETC Tiger Pipeline’s request to declare concurrent jurisdiction with the bankruptcy court over the disposition of gas transportation agreements at issue. Chesapeake sought to invalidate the commission's order, though Judge David Jones of the US Bankruptcy Court for the Southern District of Texas denied the request.
FERC has made claims of concurrent jurisdiction in the past, including in Calpine and PG&E, though court rulings have been a mixed bag. The Ultra Petroleum case even featured a bifurcated approach where the bankruptcy court maintained jurisdiction over contract rejections, and FERC held jurisdiction over rate modifications.
“It’s a bit garbled,” the first lawyer said. “The bankruptcy court [in Ultra] didn’t say FERC has jurisdiction and laid out the scope or extent, but they said they’d like FERC to participate and value their input.”
It remains to be seen how a Chapter 11 court might view FERC with regard to Gulfport, which has yet to restructure its oversized debt load. The company is operating under a grace period after skipping bond interest payments earlier this month.
“Now that FERC has spoken, it sets up an interesting dynamic where you [may get] a bankruptcy court weighing in on public interest, which is a FERC issue,” the first lawyer said. “This puts the court in tighter position - they need to thread a couple of needles simultaneously if they were to ignore FERC’s [Rockies/Gulfport] order.”
Extracting conflict, attracting competitors
A barometer for how the convergence of FERC authority and the bankruptcy courts may play out in the coming years across the industry is the ongoing restructuring of Extraction Oil & Gas.
FERC has filed an appeal of Delaware Bankruptcy Court Judge Christopher Sontchi’s recent decision to allow debtor Extraction to reject three of its TSAs. The debtor asserted that the TSAs are an “unnecessary drain” on resources, and the bankruptcy estate will benefit from rejections because the contracts have significantly above-market rates. Echoing the sentiment of Judge Marvin Isgur in Ultra’s case, Sontchi said FERC has jurisdiction over the modification of rates, while bankruptcy courts have jurisdiction over contractual rejection.
“Sontchi gave a pretty wide berth for the company’s business judgment, saying ‘I don’t have the public interest standard that FERC has, but I do have the power to reject contracts so I’m giving the permission,’” one of the advisors said.
Prior to Sontchi’s contract rejection approval, FERC and Extraction counterparty Grand Mesa Pipelines appealed the judge’s finding that a TSA with Grand Mesa does not run with the land.
Amid the dragged-out bankruptcy case, various midstream and trucking companies in the region have offered competitive rates to transport Extraction’s oil, both industry advisors and a buysider said. However, there are logistical hurdles that may end up precluding certain parties from serving certain delivery points, the sources said.
Platte River Midstream, a UCC member that’s facing a contract rejection, and ARB Midstream have started litigation in Colorado’s Arapahoe County District Court asking the court to bar other companies from transporting Extraction’s oil. This resulted in a settlement between the current providers and the would-be encroachers that the latter will not transport any Extraction oil until there's a "final, appealable order" in the rejection of ARB and Platte's contracts – a matter currently ongoing in Extraction’s bankruptcy.
“It does raise issues with regards to violation of the automatic stay or other competitive laws,” the first lawyer said. “It goes to the free rider issue raised in Ultra - due to the way pipeline regulations work, any party can ship on the pipeline based on capacity as long as they’re willing to pay the tariffs. In a lot of cases the tariffs are lower than the contract rates that debtors are rejecting. So the Ultra case created a means for Extraction to get onto the pipelines.”
Sure enough, Extraction has countered by asking its bankruptcy judge to enforce the automatic stay against a purported "blatant violation” of its two midstream partners. One avenue the debtor has laid out to override concerns around third-party releases, estimation battles for the rejection claims of midstream partners, and claims of unfair discrimination between treatments of unsecured creditors, is floating a separate USD 50m rights offering, on top of a pro-rata share of claims equity to the general unsecured creditors.
“The challenge is they’re asking the midstream parties that would have access to the subscription rights to not have them be portable, so there’s no way they can monetize it,” one of the advisors said. “In order to get their rights, they’d have to drop their litigation against the plan – and these midstream guys aren’t going drop it when their contracts are getting rejected.”
While Extraction’s fights with midstream providers dovetail with its struggle to emerge as a standalone enterprise, the midstream squabbles around bankrupt Southland Royalty will shape its ability to attract a buyer. The Fort Worth-based oil and gas company filed for bankruptcy in part due to “escalating and unsustainable obligations” to Williams subsidiary Wamsutter under two gas gathering agreements.
Renegotiating or rejecting one of the midstream contracts is crucial to Southland’s ability to complete a sale process, according to the debtor, who asked Judge Karen Owens of the Delaware Bankruptcy Court to consider recent rulings that were favorable to E&P companies, such as Extraction’s contract, governed by Texas law; and Chesapeake’s contract, governed by Colorado law.
The argument from the debtor is “not just getting rid of a burdensome contract, but a ‘paralyzing contract’—you can’t sell the asset with that,” the second lawyer said.
Based on its current production projections, Southland estimates that roughly USD 863m of minimum volume commitment (MVC) deficiency payments will come due over the remaining term of its agreement with Wamsutter, according to a complaint filed in March.
The company is attempting to force Wamsutter to gather and process all volumes of gas under one agreement, which has more favorable terms to the debtors, while rejecting the other agreement. Still, a successful rejection may not be the end of Southland’s problems.
“There’re no readily accessible alternative for the assets to be transported, so there’s still a commercial showdown that’s mutually destructive if you don’t renegotiate the contract,” the second lawyer said.
In contrast, one example of a successful contract renegotiation is a recent agreement between Greylock Midstream and TC Energy (f/k/a TransCanada), two of the advisors said. The deal was mutually beneficial in that it helped avert the risk of a costly restructuring process, and facilitated a better commercial environment for both parties, the first source said.
It also helped matters that Greylock sponsor ArcLight Capital Partners was able to inject more money into the business, the advisor sources continued.
“More midstream contractors realize it’s better to keep the pipeline fuller than to have a customer pay a certain amount to run through a bankruptcy when it’s only due to their dispute with the [E&P] company,” the first advisor said.
In the Appalachia, where Greylock operates, it is common for gathering contracts to have MVCs, the source continued. That can be burdensome for E&Ps, which are subject to a deficiency payment if they do not meet the MVC for a specific period.
Greylock corporate affairs manager Jennifer Vieweg confirmed the company renegotiated a deal with TC, adding that the company is “proud and gratified that we were able to identify a beneficial solution for all parties involved, which will create a stronger and more sustainable position for Greylock, despite the current, challenging price environment.”
TC Energy and ArcLight did not return requests for comment.
by Rachel Butt