This Court Decision Could Spur Even More US Oil And Gas Bankruptcies

Oil and gas data experts Evaluate Energy showed yesterday that U.S. E&Ps took a huge hit in 2015. With the value of total proved reserves in the sector declining by an astounding $515 billion dollars. 

The chart below shows just how great the damage is, compared to reserves valuations the last few years.

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Factors like that have caused an increasing number of high-profile E&Ps to file for bankruptcy in America. And a critical court decision this week could mean even more coming.

That ruling came Tuesday in the bankruptcy proceedings of Sabine Oil & Gas, detailed by Energy Law360. Where a New York judge ruled that bankruptcy allows Sabine to cancel contracts it holds with midstream firms on the company’s petroleum licenses in Texas.

Here’s why this is a sea change for oil and gas law.

Sabine held three separate contracts with pipeline firms in Texas, for the transport and sale of oil and gas that the company produced. These contracts came with clauses like “deliver or pay” features — where Sabine was obligated to send minimum volumes of production through the pipeline, or pay financial penalties to the pipeline operators.

Such contracts could have been a stumbling block in bankruptcy — requiring the company to deliver production or cash at a time when its operations have slowed or stopped. And so Sabine had challenged in bankruptcy court to have the agreements nixed.

And the judge in the case agreed. Ruling that the midstream contracts are not “running with the land” — in essence, saying that the contracts are not inextricably tied to the land assets that underlie Sabine.

The decision opens the door for Sabine to sever the contracts as it restructures in bankruptcy. A strategy that other E&Ps immediately jumped on — with bankrupt producer Magnum Hunter Resources yesterday striking a deal to cancel four midstream contracts as it restructures. 

With the case giving producers a greater financial incentive to declare bankruptcy, we could see such filings increase. Obviously posing a risk for equity holders — and also for midstream companies, which could see a rising amount of contract business disappear in the bankruptcy courts.

Watch for more cases of canceled contracts emerging. And possible writedowns and loss of income at midstream firms as a result. 

Here’s to running with it,

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Dave Forest

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