Chesapeake Energy Stock Tumbles - - Assessing Bankruptcy Risk for Pipelines
Over the past year, the stock price for Chesapeake Energy has fallen precipitously and is currently trading for less than one dollar. There is a distinct possibility Chesapeake could be the next exploration and production company to file for bankruptcy. That would be bad for its stockholders but it could also result in an economic hit to the pipelines on which it holds capacity. Today, we examine this scenario by looking at the pipelines most exposed to Chesapeake’s marketing subsidiary.
Source: Chesapeake Energy http://investors.chk.com/ (accessed on 11/19/2019)
As we discuss below, the pipeline most exposed based on the simplistic measure of the dollar value of its Chesapeake contracts is Texas Eastern Transmission. But the real impact of a shipper’s bankruptcy should also consider the total revenue of the pipeline, the credit protections contained in a pipeline’s contract and the continuing need for the capacity by the production company or any buyer of its assets. Once those factors are considered, it appears that ETC Tiger Pipeline has the greatest risk from a Chesapeake bankruptcy.
But I Have a Contract
With a couple of clicks in our platform, it is possible to identify all of the pipelines that have contracts with Chesapeake’s marketing affiliate, Chesapeake Energy Marketing.
There is a risk associated with these contracts that originates from a feature of the bankruptcy code that allows the debtor in a bankruptcy proceeding to “reject” certain types of contracts. By rejecting these “executory contracts,” the bankrupt company is able to convert a counterparty’s claim for breach into a pre-bankruptcy claim even though it occurs during the bankruptcy. Generally speaking, “executory contracts” are any contracts for which both parties to the contract still need to provide some type of performance.
In this case, the pipelines still need to provide transportation services, and the shipper still needs to pay for those services. Because of the incomplete nature of these contracts, the bankruptcy code allows the debtor to shed itself of uneconomic contracts and relegate the other party’s claim to one treated as if it arose before the bankruptcy. Claims like this are typically paid out at only pennies on the dollar despite the breach having occurred after the bankruptcy.
The risk associated with these contracts can be measured in a couple of different ways. One method uses the annual revenue associated with the contract and the other method uses the total remaining charges due for the remaining term of the contract. Set forth below we identify these amounts for the three pipelines with the largest revenue streams contracted from Chesapeake.
The ability to reject a contract creates a risk of renegotiation of the rate even if the debtor’s business is going to need the contracted capacity, because the shipper can threaten to return the capacity to the pipeline which would then need to re-sell that capacity. The market rate for the capacity will be lower than the current contract rate, or the debtor would keep the capacity and release it to a buyer. So the pipeline may agree to a rate reduction to avoid getting the capacity back.
A pipeline’s risk can be less than the remaining payments due, if the pipeline holds security to protect it from a breach by the shipper. Such security is often in the form of a letter of credit (LOC) which can be accessed even in the event of bankruptcy. FERC typically limits the amount of security a pipeline can demand to approximately three months of reservation charges under the contract. However, if the contract was an anchor contract for an expansion of the pipeline’s system, FERC allows the shipper and the pipeline to increase the security, even to an amount equal to multiple years of the reservation charges due under the contract.
EdgeMarc as a Recent Example
On May 15, 2019, EdgeMarc Energy Holdings and its affiliates filed for bankruptcy. At that time, they held capacity on Rockies Express Pipeline (REX), Texas Gas Transmission (TGT), Rover Pipeline (Rover) and Dominion Energy Transmission, Inc. (DETI). Under the TGT and Rover agreements, EdgeMarc was required to have an unrelated marketing company, BP Energy Company, provide a LOC to the two pipelines for approximately $23.3 million and $25 million, respectively. When it filed for bankruptcy, EdgeMarc was not using any of its capacity on REX, Rover or TGT and therefore moved to reject the contracts with those three pipelines.
The EdgeMarc case demonstrates nicely the various risks for pipelines from the bankruptcy filing by a shipper as discussed for each of the four pipelines.
DETI
EdgeMarc indicated that it had a continued need for the DETI contract; therefore, it notified DETI of its intent to assume the DETI contract. In advance of that decision, EdgeMarc also entered into a stipulation that allowed DETI to use a $450,000 security deposit it held to cover $175,644 EdgeMarc owed for a period prior to its bankruptcy and also to apply the remainder to amounts owed for the first two and one half months following the filing. If EdgeMarc does in fact assume the contract, then DETI will not suffer any loss from the bankruptcy.
REX
REX entered into a stipulation agreeing to the rejection of its contract as of the date of the stipulation, June 13, 2019. It does not appear REX held any security, so it will need to re-sell the capacity worth $8 million annually and a total remaining balance of over $100 million. The damage to REX will likely be the difference between the resale price and the contract rate with EdgeMarc.
Rover
Rover did not contest EdgeMarc’s motion to reject its contract, so the court approved that motion. Rover will presumably draw on the $25 million LOC it holds to compensate it for it any possible losses. However, the LOC amount is less than the $40 million in annual revenue it is due under the contract, and far less than the almost $750 million due for the remainder of the 20-year contract term.
TGT
TGT filed a limited objection to EdgeMarc’s motion to reject its contract, and the court sustained that objection. This means the rejection was effective as of the date of the court’s order, June 17, and not the date of the petition, May 15. Otherwise, the debtor was allowed to reject the contract. The LOC EdgeMarc noted it had posted for this agreement equal to $23.3 million is approximately four years of the annual $6.3 million in reservation charges due under the contract, but far less than the $83 million due for the remainder of the term. It appears that TGT had the best protection in place against a bankruptcy by EdgeMarc.
Chesapeake Bankruptcy Risk Greater for Tiger than for TETCO and TGP
While there are a number of pipelines with exposure to Chesapeake, the three biggest in terms of annual exposure and total exposure for the remaining term are Texas Eastern Transmission (TETCO), Tennessee Gas Pipeline (TGP) and ETC Tiger Pipeline (Tiger). To assess the true exposure, three other factors must be considered: first, the continuing value of the contract capacity; second, the collateral held by the pipeline to protect it from a loss; and, third, the value of the contract as a percentage of the pipeline’s total revenue.
Continuing Value of the Contract
Chesapeake describes the focus of its gas production as the Marcellus Shale in the northern Appalachian Basin in Pennsylvania and the Haynesville/Bossier Shales in northwestern Louisiana. The pipeline capacity it holds on both TETCO and TGP are designed to transport the Pennsylvania gas to markets in the Northeast. Given the capacity constraints caused by environmental opposition to new projects headed in that direction, it seems unlikely these contracts are at a high risk of being rejected, even in an effort to reduce the contract rate. Conversely, Tiger lists on its bulletin board substantial unsubscribed capacity at all of the points of receipt and delivery under the Chesapeake contract. Therefore, Chesapeake may view that contract as ripe for renegotiation, even if it will still need the capacity.
Collateral Held by the Pipeline
Our review of the contracts also shows possible key differences in the amount and type of collateral that each pipeline holds. TETCO’s and TGP’s agreements, as filed with FERC, refer to the credit terms in the underlying Precedent Agreements (PA), which neither pipeline has filed publicly. TETCO’s agreement simply states that the “credit requirements applicable to this Agreement are set forth in that certain [PA] dated December 22, 2009, as restated and amended from time to time” between Texas Eastern and Chesapeake. TGP’s contract says it supersedes the PA but then states that a number of PA provisions survive, including the one concerning credit support. Given both of these agreements were foundational contracts for expansion projects, it is very likely that they had greater credit protection for the pipeline than that offered by the pipeline’s tariff. However, both contracts have been in effect for over five years, so those additional protections may be greatly reduced by this point in the contract.
The Tiger agreement provides simply that Chesapeake Marketing must maintain the Guaranty dated January 26, 2009, as amended from time to time, provided by Chesapeake Energy Corporation in favor of Tiger, and/or such other mutually agreed credit support. If Tiger has only a guarantee from Chesapeake, it will be worth nothing in a Chesapeake bankruptcy.
Revenue Loss Impact is Also Greater for Tiger
The annual revenue from the three contracts is greater for TGP and TETCO than it is for Tiger. But those companies also have a much bigger revenue base. Based on the pipelines’ revenue reported for 2018, the annual revenue from the Chesapeake contracts is less than 5% of TETCO’s and TGP’s annual revenue, but it is more than 25% of Tiger’s annual revenue.
Based on our review, it appears the pipeline likely to be impacted most by a Chesapeake bankruptcy would be Tiger. If you would like us to analyze the risk for another shipper, please let us know.
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