Bankruptcy & Restructuring partner Stephen Rutenberg and associate Michael Greenblatt spoke with Reuters on how master limited partnerships (MLPs) that oversee pipelines and other infrastructure for the energy industry have fallen out of favor and how investors are anxious about falling oil and gas prices.
REUTERS: To what extent are energy-sector bankruptcies increasing risk for MLPs?
RUTENBERG: First, they are creating an environment in which it is increasingly difficult for MLPs to raise capital. This is problematic given MLPs often rely on debt funding to cover operating costs because they typically are required to distribute almost all of their cash to investors. Second, it is looking increasingly likely that some energy production companies may successfully invoke the bankruptcy process to reject pipeline contracts with MLPs. Until recently, pipeline contracts generally were thought to be bankruptcy proof.
REUTERS: How are low oil prices affecting sources of capital for MLPs?
GREENBLATT: MLPs utilize asset sales as one method to raise internal capital. Even if MLPs could find buyers, current market pricing for such assets likely will be unattractive and possibly below book value. Unlike most corporate structures primarily funded by income, MLPs need to raise external capital since they typically are obligated to distribute 90 percent to 95 percent of all cash generated to investors on a quarterly basis. External sources of debt and equity capital are becoming increasingly difficult for MLPs to obtain due to the current market turmoil.
REUTERS: How are MLPs responding?
RUTENBERG: Most notably, Kinder Morgan reduced its dividend by 75 percent and Linn Energy suspended its dividend entirely. Another way we are seeing MLPs respond, as evidenced by recent actions taken by Williams, Kinder Morgan and Crestwood, is by merging the MLP back into the sponsor or into another MLP. It can take some pressure off the MLP by removing requirements to pay dividends. It may also be beneficial since a larger MLP may have a bigger source of cash flows, which, when combined with cutting dividends, may help a company withstand this cycle.
REUTERS: Are MLPs at risk of bankruptcy?
RUTENBERG: It appears most MLPs are sitting tight, considering their options and trying to wait out the market turmoil before taking rash steps. For many, there remains a significant disconnect between the dividend they are paying and their stock prices, which could either be a great buying opportunity or the sign of imminent correction.
REUTERS: What themes in energy company bankruptcies could affect MLPs?
GREENBLATT: Midstream MLPs face the risk that energy production companies will attempt to use the protection of the bankruptcy court to terminate pipeline and delivery contracts. Until recently, it was assumed pipeline contracts, unlike most other contracts, were outside of the scope of a bankruptcy. The legal theory is these contracts are covenants running with the land and therefore cannot be terminated through bankruptcy. However, two cases are challenging that assumption. In the Sabine bankruptcy, Judge Chapman in New York recently ruled to allow the debtor to terminate certain pipeline contracts. In the Quicksilver bankruptcy, the debtor is requesting to terminate a pipeline agreement. These cases are already putting pressure on midstream MLPs to renegotiate supply contacts.
REUTERS: How would MLPs fare in a rising rate environment paired with sustained low and natural gas prices?
RUTENBERG: The accepted business model of most MLPs would be put into serious question. One of the key advantages of MLPs is that they are structured and operated to offer high yield returns at relatively low risk - something that more traditional asset classes have not historically been able to provide. Once interest rates start to rise, MLPs become less attractive unless the dividend yield on MLPs rises as well. Conversely, the market turmoil related to the sustained low oil prices has revealed that MLPs are perhaps much more volatile than previously thought.
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