The rumors of Chesapeake Energy's (CHKA.Q) demise have turned out to be true. The deeply indebted oil and gas producer has officially filed for bankruptcy protection. These proceedings will have a significant fallout for the company's existing investors and other stakeholders, since it plans to restructure its debt and legacy contractual obligation. This latter factor could have far-reaching impacts, including affecting the sporting world.
One of Chesapeake's biggest contractual obligations is with midstream companies, which gather, process, and transport oil, gas, and natural gas liquids (NGL) for the company. It spends more than $1 billion per year on these services. While that's a burdensome cost to Chesapeake, these companies provide a vital market link for its oil and gas output. A big battle appears to be brewing between the company and these service providers, with their dividend payments potentially hanging in the balance.
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Outsize exposure
Several pipeline operators have contracts with Chesapeake, including Kinder Morgan (KMI 3.35%), Williams Companies (WMB 2.53%), Energy Transfer (ET 1.42%), Crestwood Equity Partners (CEQP), and Consolidated Edison (ED 1.44%). With Chesapeake aiming to restructure some of its legacy contractual obligations, each one faces the risk that the bankruptcy court could reduce their rates or reject their contracts. So they all have a lot on the line as Chesapeake Energy works its way through bankruptcy.
For example, Williams gets about 6% of its revenue from Chesapeake. That's due in part to its acquisition of that company's gathering and processing business in 2014. Williams has been working hard to reduce its outsize exposure to Chesapeake -- which was as high as 18% -- by selling assets tied to the company and expanding assets supporting other customers.
One of the buyers of Williams' Chesapeake-focused assets was Crestwood Equity Partners, which acquired full control over its gathering and processing operations in Wyoming's Powder River Basin, where Chesapeake is the primary customer. In addition to that, Chesapeake ships some of its natural gas production out of the northeastern Marcellus shale via the Stagecoach system, which is a joint venture between Crestwood and utility Consolidated Edison.
Large-scale pipeline companies like Energy Transfer and Kinder Morgan also have some exposure to Chesapeake on their systems. In Kinder Morgan's case, it generates about $140 million in revenue from its contracts with Chesapeake. While that's a sizable amount, the company produces about $7.5 billion of annual EBITDA, meaning a rate reduction wouldn't be a crushing blow. Meanwhile, Energy Transfer counts Chesapeake as a major customer on its ETC Tiger Pipeline.
Planning to fight and protect their cash flows
Most of Chesapeake's midstream service providers have been preparing for the likelihood that the company would declare bankruptcy, so they have a good handle on their associated risk, which many deem low. For example, Crestwood put out a press release in response to Chesapeake's filing. It pointed out that its "gathering and processing systems are integral to Chesapeake's operations in the Powder River Basin, as a substantial amount of its revenues are derived from the sale of natural gas and natural gas liquids (NGLs) produced from acreage dedicated to Crestwood, which is the most economic path to market." On top of that, the company noted that it already restructured its contracts with Chesapeake in early 2017 to "competitive market terms in line with other midstream operators in the basin." Thus, it has plenty of ammunition in any fight with the company if it seeks to adjust the terms again.
Meanwhile, a vice president at Williams Companies told Reuters that the company is "confident in our ability to defend the integrity of our contracts" with Chesapeake because they're vital to maximizing the value of its production. Likewise, the pipelines of Consolidated Edison, Kinder Morgan, Energy Transfer, and others are crucial bridges between Chesapeake's wells and market centers. Furthermore, most of these contracts are at or below market rates because Chesapeake had previously renegotiated many of its midstream agreements following the oil market downturn of 2014. Thus, the bankruptcy court is less likely to rule in the company's favor if it tries to get these contracts altered or rejected.
An interesting battle to watch
Chesapeake Energy wants to emerge from bankruptcy with more sustainable capital and cost structures. While most of its creditors have already agreed to eliminate more than $7 billion in debt, service providers aren't likely to be as forgiving. The court could force these companies to take a pay cut or even reject their contracts. If that happens, some of these pipeline companies might need to reduce their dividends, which makes this courtroom battle something that income investors should watch closely.
