In what lawyers have described as a “white-hot” dispute and a “hellacious problem”, a New York State bankruptcy court sent a shockwave through the $500-billion U.S. pipeline industry with a ruling last week that allows a bankrupt oil and gas producer to break its contracts with two of its “midstream” partners.
“It’s huge,” said New York bankruptcy lawyer Heidi Sorvino. “This is going to have a domino effect on other industries.”
The ruling allows Houston-based Sabine Oil and Gas Corporation “to shed certain pipeline contracts, potentially exposing companies that transport and process gas to the crisis in the energy industry,” Reuters reports. “The ruling by New York’s influential bankruptcy court is the first major test of whether Chapter 11 can be used to end a contract with companies in what is known as the midstream sector of the energy industry.”
The decision by Judge Shelley Chapman “can be appealed and is not binding,” write correspondents Tom Hals and Tracy Rucinski. “But it may encourage other struggling producers to follow suit at a time when scores of oil and gas companies are teetering on the brink of bankruptcy.”
Standard industry contracts often require oil and gas producers to pay pipeline companies for capacity, whether or not they use it. That was one reason for investors to believe that midstream operators were insulated from the last couple of years of oil price shocks.
“The contracts provided a way for pipeline operators to ensure they could recoup the $30 billion spent annually building infrastructure for the boom in shale energy,” Reuters explains. “That stability has allowed the midstream operators to raise billions of dollars by organizing as high-yielding master limited partnerships, or MLPs.”
Now, “this case will provide case law that can be used in other cases and will push MLPs to re-strike contracts,” a development that sets up “a very negative precedent, to state the obvious,” Brean Capital, LLC wrote in a client note.
A decision in a second case, pitting Forth Worth, TX-based Quicksilver Resources Inc. against Crestwood Equity Partners, is expected to be decided later this month. “We’re here today on a white-hot issue,” Quicksilver attorney Sarah Schultz told a court in Wilmington, Delaware earlier this month.
“The Quicksilver case is one in a set of emerging legal battles that have pipeline operators fearful that their long-term contracts with oil and gas producers could be cancelled or revised as energy prices have hit record lows,” Hals wrote at the time.