Fitch: Sabine ruling could have broad US midstream implications

A bankruptcy court decision this week could have broad negative implications for US midstream services providers with exposure to distressed exploration and production companies, according to Fitch Ratings.

Judge Shelly Chapman of the US Bankruptcy Court, Southern District of New York, ruled Tuesday that Sabine Oil & Gas would be able to reject certain contracts with midstream services providers Nordheim Eagle Ford Gathering and HPIP Gonzales Holdings. The court decided that the contracts could be rejected as a "reasonable exercise of business judgement" and due to the lack of challenge to Sabine's decision making process.

The court did not make "any final determination as to whether the covenants at issue run with the land or as to any substantive legal issue other than granting authority to reject the contracts..." This was the larger issue for midstream services providers. The court offered its nonbinding analysis that the contract covenants do not run with land, but did not limit Nordheim's or HPIP ability to file further claims against Sabine's estate consistent with what they believe are their rights.

The decision could have broader implications for midstream service providers despite it being specific to Sabine's bankruptcy proceedings and contracts with Nordheim and HPIP. Most broadly, it provides leverage for distressed producers with underutilized, expensive commitments to renegotiate midstream contracts or threaten bankruptcy. While it has in the past been assumed that minimum volume contractual commitments and/or acreage dedications could not necessarily be rejected through bankruptcy proceedings, this is clearly not the view of Judge Chapman with regard to the Sabine case.

Specific impacts of this ruling will be limited to the names involved. Overall, midstream contracts tend to vary in term and structure across issuers; property law tends to differ state by state; there are practical limitations in using competing gathering and processing services when existing providers are directly connected to the wellhead; and any bankruptcy contract rejection would be expected to be heavily litigated. As such, the decision's immediate credit impacts for the midstream space are limited.

Counterparty risks continue to be a concern for the midstream services space given expectations for continued exploration and production (E&P) bankruptcy activity. With the notable exception of Williams Partners, which has outsized exposure to Chesapeake Energy, most investment-grade gathering and processing issuers rated by Fitch have diverse counterparty portfolios with relatively limited exposure to distressed producers, so contract rejection is not an immediate concern.

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