Bankruptcy Ruling May Affect Legal Scuffles Between Producers and Pipelines

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SUGAR LAND--April 14, 2016--Written by John Egan for Industrial Info Resources (Sugar Land, Texas)--Persistently low crude-oil prices may soon swamp Oil & Gas Pipelines as they have for Producers and Oilfield service companies. Bankrupt producers have asked courts to void contracts signed with pipelines, and the courts are agreeing, though their rulings have been narrow.

Last month, in a closely watched case, a bankruptcy court in New York allowed producer Sabine Oil & Gas Corporation (OTCMKTS:SOGCQ) (Houston, Texas) to break its transportation contracts with a pipeline unit of Cheniere Energy Incorporated (NYSE:LNG) (Houston), though the judge encouraged the parties to settle. In her bench ruling and non-binding analysis, Judge Shelley Chapman rejected the pipeline company's claim that its contracts with a producer could not be broken. Judge Chapman reportedly said the specific issue before her, whether contracts "run with the land," was "an unspeakable quagmire."

In an article in The National Law Review, authors Craig A. Barbarosh and Karen B. Dine wrote Judge Chapman's non-binding analysis "is likely to be influential. The Sabine decision may influence two Delaware cases currently considering similar issues: Quicksilver Resources and Magnum Hunter." Barbarosh and Dine predicted the Sabine ruling "may significantly change industry typical practices and potentially prompt more bankruptcy filings."

An online legal source, Law360.com, quoted Steve Pezanosky, a bankruptcy partner with the law firm of Haynes and Boone LLP (Dallas, Texas), as saying, "Although the Sabine decision is very instructive, it's not necessarily the binding decision on this issue in every case. Frankly, the determination is very dependent on each midstream agreement and relevant state law in each case."

Less than a week after Judge Chapman's ruling, in a Delaware bankruptcy court, Magnum Hunter Resources Corporation (OTCMKTS: MHRCQ) (Irving, Texas) cited Judge Chapman's ruling in an effort to break its natural gas contracts with Oneok Rockies Midstream L.L.C. (Denver, Colorado), a subsidiary of ONEOK Incorporated (NYSE:OKE) (Tulsa, Oklahoma).

In another case, bankrupt producer Quicksilver Resources Incorporated (OTCMKTS:KWKAQ) (Fort Worth, Texas) sold gas-producing assets in the Barnett Shale to BlueStone Natural Resources II L.L.C. (Tulsa, Oklahoma). Quicksilver had been trying to break its contracts with Crestwood Equity Partners L.P. (NYSE:CEQP) (Houston, Texas), a pipeline company. BlueStone said it would buy the assets with one condition: that Quicksilver's contracts with Crestwood would be broken. The Delaware bankruptcy court approved the transaction in January, and the sale closed in April. Earlier this month, Crestwood and BlueStone entered into a new, 10-year transportation contract.

So goes the wild, wooly and occasionally bewildering world of bankruptcy law involving Oil & Gas pipelines. Nearly 60 financially distressed producers have filed for bankruptcy protection since the start of 2015, according to Haynes & Boone. The firm expects many more such filings by producers this year, as low prices, expiring hedge contracts and bank loan redeterminations prolong difficult market conditions.

Domestic crude oil production from shale formations has fallen by about 500,000 barrels per day (BBL/d) over the last year, according to data from the U.S. Energy Information Administration (EIA) (Washington, D.C.), and most observers expect to see continued declines in production unless prices experience a prolonged surge. Natural gas prices also remain low, but production is relatively flat on a year-over-year basis.

The last time there was such dramatic shakeout in the Oil & Gas Industry, in the 1980s, pipelines tended to be integrated with producers, so there were no lawsuits despite the plunge of crude oil and natural gas prices. Since then, may pipelines have been spun off as independent companies or master limited partnerships whose attractiveness to investors reflected the companies' low risk profile and steady stream of payouts. As transporters of commodities were owned by one party and purchased by another, the pipelines were seen as low-risk investments. Until now.

A producer's ability to break its contracts with a pipeline, if upheld and broadly applied, could upend the pipeline industry. There has been speculation that financially ailing Chesapeake Energy Corporation (NYSE:CHK) (Oklahoma City, Oklahoma) may seek to break its contracts with a pipeline unit of Williams Companies Incorporated (NYSE:WMB) (Tulsa, Oklahoma).

"It used to be that you needed a geology degree to get ahead in the Oil & Gas industry," noted Jesus Davis, Industrial Info's vice president of Industrial Info's vice president of research for the Oil & Gas Production, Pipelines and Terminals industries. "Then, an MBA became a prerequisite for rapid advancement. Now, it looks like a degree in energy law may also be required."

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