In the higher commodity price environment of 2010 to 2014, upstream companies either sold gathering systems to raise capital and/ or incentivized midstream companies to construct assets on their behalf. This typically resulted in long-term agreements that included such terms as minimum volume commitments (MVCs), dedicated acreage and, in some cases, guaranteed cash flow. At the time, both the E&P and midstream companies benefited from the contractual relationships.

E&P companies entered into such agreements in the higher commodity price environment when projected production resulting from active drilling programs substantially exceeded the MVC or other guarantees. Therefore, E&P companies were not concerned with meeting their contractual obligations at the time.

During the depressed commodity price environment over the past two years, E&P companies have slashed capital spending and revised their drilling pro¬grams. Consequently, in certain instances, production is expected to be less than originally projected, and as such, E&P companies now have a lower probability of meeting their volume commitments.

In an acquisition context, the obligation arising from the MVC likely will not make its way into the reserve report. As such, E&P companies looking to acquire producing properties should consider volume commitments and/or other contractual obligations when preparing their bids.

For financial reporting purposes these obligations can potentially be a liability.

Midstream benefits

Owning and operating gathering sys¬tems can be lucrative to midstream companies as they can market their infrastructure to multiple producers in the area and thereby expand the poten¬tial revenue streams from the systems. Further, the steady revenue stream derived from predominately fixed-fee contracts is attractive to investors in midstream companies.

While the steady revenue stream offered by gathering systems is attractive, midstream companies should consider counter-party and commodity price risks when acquiring or constructing gathering assets. The need to consider these risks has been brought to the forefront in the recent low commodity price environment. In considering a potential acquisition, midstream companies should evaluate the ability of the E&P companies to meet their volume commitments as well as meet other financial obligations.

While the agreements are legally binding contracts, MVCs have been challenged in recent bankruptcy proceedings. Sabine Oil & Gas Co., for example, argued its contracts should be rejected in bankruptcy since it could not provide the required volumes or pay the deficiency. The gathering pipeline companies that were counterparties to Sabine argued that, under Texas law, the contracts were covenants that run with the land. The bankruptcy court ruled against the notion that the covenants run with the land and rejected the contracts. (See following story.)

The potential impact of the ruling in Sabine has raised concerns for midstream companies’ ability to enforce the terms of gathering agreements in distressed situations. In some cases, it has been advantageous to both parties to renegotiate contracts. Click below to read the full article…