The midstream energy sector is a different and potentially darker place than it was in 2007 and early 2008, according to Standard & Poor's Ratings Services (S&P). Although the credit market turmoil that began with the demise of Lehman Brothers in September 2008 has moderated, S&P said it believes the effects of the credit crisis will continue to define the risks and opportunities for the midstream sector next year.
In a report issued last Tuesday titled "The Changing Landscape Of U.S. Midstream Energy Credit," S&P said credit quality could be volatile over the next 12-18 months, depending on the speed of economic recovery and the supply and demand balance for natural gas, crude oil and natural gas liquids (NGL).
"Two key factors for the midstream sector -- commodity pricing and capital market conditions -- may present perils and opportunities for investors," the ratings agency said. Despite market uncertainty, the storm clouds that might lie ahead could have a few silver linings.
"Midstream energy companies generally appear well positioned to manage lower commodity prices, lower profitability and lower growth in 2010, but roughly one in five are at risk for a downgrade," said S&P credit analyst Michael Messer.
Although capital markets and liquidity are becoming secondary issues for the sector's investment-grade companies, speculative-grade gathering and processing companies will likely continue to wrestle with uncertain access to debt and equity markets and low commodity prices that will leave very little margin for error, S&P said. Capital spending and execution risk will remain key ratings factors for all issuers. And while 2010 is shaping up to be a year that might hold a few surprises for bondholders, major changes in credit quality are unlikely, the report said.
In another report issued last Tuesday titled "2010: U.S. Midstream Energy's Prospects for a Brighter Future," S&P noted that "While gathering and processing companies are benefiting from commodity hedges that reflect the much higher prices that prevailed during the commodity boom in 2008, over the next year or so, we expect the lower commodity prices will result in lower hedge prices and margins in 2010. In addition to weaker commodity prices, profitability may decline due to lower production volumes as gas and oil production companies lower production schedules to react to weak commodity prices."
"Weak industry fundamentals and low gas prices are key concerns for many investors, but our internal scenario forecasting suggests 2010 is unlikely to be as difficult as the past 18 months have been," said S&P credit analyst William Ferara.
Summarizing the midstream outlook for 2010, the "Brighter Future" report said, "2010 is likely to be a year of unimpressive, but not overly negative, financial performance for most of the midstream sector. Most segments of the industry will remain challenged by anemic commodity prices and slowly recovering demand, but the average company in the gathering and processing, propane and diversified segments has sufficient financial cushion at current rating levels to withstand a lackluster economic environment for the next 12 months."
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