Two defunct energy companies -- Sabine Oil & Gas and Quicksilver Resources -- have recently filed court cases to terminate their pipeline contracts, in order to cut costs.
In this clip, Sean O'Reilly, Taylor Muckerman, and Tyler Crowe talk about just how bad this could be for pipeline companies, which depend on contracts like these for a huge part of their revenue; why the proposed cost-savings arguments the energy companies are presenting are absurd; and what investors should do if worst comes to worst and bigger players follow suit.
A transcript follows the video.
This podcast was recorded on Feb. 25, 2016.
Sean O'Reilly: Two court cases that could kill pipeline companies' cash machine. Our listeners are probably aware, if they've been paying attention to a lot of our picks, but all three of us have been saying that a lot of these pipeline players like Spectra Energy and Enterprise Products Partners and all those guys, they're kind of the babies that got thrown out with the bathwater in this huge market energy sell-off.
Currently, and this is an article that was put out by The New York Times, two defunct companies, Sabine Oil & Gas and Quicksilver Resources, are, among other things, seeking to get rid of long-term contracts the two have with several mainstream pipeline operators who count on the rates on these long-term distribution contracts to... pay the dividends!
Worse yet, in the article that was put out by The New York Times detailing the situation, an unnamed judge is inclined to allow Sabine to end its contract with the Cheniere Energy (NYSEMKT:LNG) subsidiary that operates the pipelines. Are you guys scared about this, and should we be selling all of our pipeline stocks now?
Tyler Crowe: This... I'm not completely certain how to fully digest this one yet. It's one of those things, when you read it, it does certainly throw up the red flag. One of the biggest things that they're talking about in this is, throwing out minimum volume commitments, which is something that has kind of made hay for a lot of pipeline companies.
Taylor Muckerman: It's absolutely guaranteed money.
O'Reilly: So the contractors, for our listeners, between Sabine and the Cheniere Energy subsidiary, it was guaranteed volumes through 2023. So, this is not small potatoes.
Crowe: Exactly. And so, for some of these things, you're talking about small, piddling companies. Sabine Oil & Gas and Quicksilver Resources weren't exactly the largest names when it came to selling oil and gas and using pipeline space. The bigger fear is, say you've got a large company --
Muckerman: Ultra Petroleum, for instance.
Crowe: Ultra Petroleum, or a Chesapeake Energy (NYSE:CHK)...
O'Reilly: Every lawyer's favorite word is "precedent." [laughs]
Crowe: Exactly. Somebody like a Chesapeake Energy or something like that. Then, what if one of those companies goes to a larger pipeline company and says, "We can't meet these volume commitments anymore, we're going to take you to court on it." We've seen the effects of that over the past year. One company in particular, Williams Partners, I believe it's more than 20%, it might be as high as 30% of the revenue stream comes specifically from Chesapeake Energy.
Crowe: And with Chesapeake Energy in the financial straits that it is right now, if --
O'Reilly: Although, they did just have an asset sale. Yay! $700 million! [laughs]
Crowe: But if this minimum volume commitment contract...
O'Reilly: Goes out, yeah.
Crowe: ...can get torn up, then you're looking at a pipeline company who's kind of left hat in hand, "How am I going to fill these pipes?"
O'Reilly: Taylor, I don't know how to word this, so I'm probably going to butcher it, but I was curious to get your thoughts. Isn't there an argument, if you're the Cheniere Energy subsidiary or one of the pipeline companies, isn't there an argument to be made between, "OK, listen, we've got these contracts with these guys, they're continuing to operate, our contract isn't structurally the problem, they just got overleveraged and they just need to talk with the bondholders." Isn't...
Muckerman: Yeah, that's absolutely the case. It's like, what the hell? You signed this contract.
O'Reilly: You're still using it, probably.
Muckerman: There's always going to be a point where, you're in a contract for 15 years, that there's going to be a better opportunity out there. You can't just jump ship. The comments they made, arguing that they could save $35 million by ending the contract, and then save millions more by building an entirely new system?
Muckerman: Yeah, exactly. I could sell my gas-guzzling car that's underleased, and just cancel the lease, and go get an EV and save tons of money on gas! But I'd have to pay a fee to get out of my lease --
Crowe: And when you're bankrupt, it's kind of hard to do that.
Muckerman: Yeah, exactly. So that's the thing.
O'Reilly: Yeah, and where's the money coming from to build this magical pipeline from the sky? [laughs]
Muckerman: This Cheniere company's obviously operating properly, because they're not going bankrupt. Why are you going to save a company that operated itself out of funds if they're just probably going to do it again if they get bailed out? I mean... I don't understand it. You're going to let this contagion spread to a sector that has largely been absolved from it, and... I mean... it's just totally bonkers.
Crowe: It seems to me... let's put in the hypothetical situation as an investor. If this is something that is legitimately an issue... one of the ways that I think you can maybe skirt or help yourself as an investor avoid much of this issue is to look further down the stream of the pipe. So when you have, a lot of the things they're talking about here, it's mostly, like, gathering assets. So that's like taking an individual well and taking it to a bigger pipe. Those are going to be the ones that are at the most risk here, because Quicksilver Resources isn't going to keep drilling at that specific well to keep that pipe filled. However, if you're to go from maybe a refiner to a distributor sort of pipeline network, or larger pipelines that have consolidated all that gathering, then you're looking at somebody who's probably going to be a little bit more stable, because despite, you could see 60%, 70% reduction on a gathering pipe, we're not going to see 10%, 20%, 30% production declines across the United States on large pipeline transportation networks.
Sean O'Reilly has no position in any stocks mentioned. Taylor Muckerman owns shares of Spectra Energy. Tyler Crowe owns shares of Enterprise Products Partners. The Motley Fool owns shares of and recommends Spectra Energy. The Motley Fool recommends Enterprise Products Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.