Chesapeake Tames Energy Transfer's Tiger (Pipeline)

| About: Energy Transfer (ETP)
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The renegotiation of the Chesapeake contract on Tiger Pipeline will result in a $440 million decline in total remaining contract value (undiscounted).

In exchange for the contract reduction, ETP has indicated that there is upside in contract extensions and future deals with Chesapeake but did not go into specifics.

Analyzing only the renegotiation on Tiger, the deal is surprisingly disadvantageous for Tiger and potentially for ETP.

The latest round of 4Q 2015 earnings calls yielded several interesting comments from management teams, one of which came from Domenic J. Dell'Osso, Chesapeake's (NYSE:CHK) CFO, who stated "we're proud to announce that we recently completed an agreement to reduce our Haynesville transportation volume commitment and fees, primarily on Energy Transfer's (NYSE:ETP) Tiger Pipeline, to better align with our volume profile, resulting in a $0.06 per Mcf reduction in our total company gas gathering transportation costs in 2016." This commentary prompted some discussion in the question and answer session of the Energy Transfer earnings call where Marshall McCrea, ETP's COO/CCO, addressed the situation by saying "We've built our relationship with creating or working with producers on their needs. And clearly there is a lot of pain on the E&P side, on all the sides. And we have, in that situation, been able to help out Chesapeake in the short-term by shifting demand charges where some of their business is more commodity now with us in the short term. And by extending contracts that were ending over the next three years to five years, for many years out, and then also adding significant business in the future."

It would seem that the deal is a complex equation that involves some contract extensions and rate negotiations in and between ETP's Interstate Segment and their Midstream Segment. ETP was hesitant to get into too many details on the call but based on filings released late last week with FERC (Docket RP16-788), we now know one side of the equation. The new agreement between Chesapeake and ETP on Tiger pipeline will result in a net decline of $26 million in revenue on Tiger for the remaining fiscal year 2016 (Q2-Q4) due to a 300 MMcf/d decline in contracted capacity to 700 MMcf/d. The contract further steps down in 2017 and 2018 leading to a $57.5 million net decline for each year from 2018-2025. The contract will be extended by 5 years to 2030 but at a much reduced rate. Over the remaining life of the contract the total value, which was $1.12 billion prior to the renegotiation, is now worth only $681 million (undiscounted).

Agreement Detail

The Tiger Pipeline was originally proposed in early 2009 as production in the Haynesville was ramping up. At the time, producers were aggressively contracting for capacity to relieve constraints out of the region. The original agreement with Chesapeake began 1/1/2011 after construction on Tiger Pipeline was completed. At that time Chesapeake signed up for a 15-year agreement to transport 1.0 Bcf/d over the life of the contract at a reservation charge of $0.315 MMcf/d.

Under the new agreement, the reservation charge on the system will remain $0.315 MMcf/d through the original term of the contract (12/31/2025). However, the contracted volume in 2016 will step down to 700 MMcf/d. Volume will then step down to 600 MMcf/d in 2017 and to 500 MMcf/d in 2018-2030. Additionally, through the extended period of the contract from 2026-2030, the reservation rate will be reduced to $0.10 MMcf/d.

Figure 1 below shows the net difference between the original contract with Chesapeake and the renegotiated contract with Chesapeake. In 2016, the impact is a $26 million reduction in revenue as a result of the reduced capacity for the remaining three quarters of the year. In 2017 the difference is $46.0 million, which then increases to $57.5 million per year through the remaining life of the original contract. The five-year extension in the renegotiated contract has a total value of $91.3 million. In total the remaining life of the original contract was $1,121 million while the value of the remaining life on the renegotiated contract is $681 million, a $440 million reduction.

Closing Thoughts

The size of reduction in total remaining contract value comes as somewhat of a surprise relative to Chesapeake's renegotiation of its Haynesville gathering contracts on Williams (NYSE:WPZ). However, that deal was supported by additional details around future well completions in the Haynesville. While we do not know what Energy Transfer and Chesapeake may have agreed to on the midstream side of the business, we now know the hurdle rate that Energy Transfer will need to make up. Chesapeake is currently active in the Marcellus and Eagle Ford, two areas of potential overlap between the two companies.

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