Pipeline expansions are generally supported by long-term contracts that ensure that the pipeline can recover the expansion costs during the initial term of those agreements.
Why does it matter?
These long-term contracts provide a solid base of revenue for pipelines and reduce their exposure to market forces with respect to the value of the pipeline’s capacity.
What’s our view?
Looking back over the last decade, it is clear that such contracts have definitely peaked and are on a substantial decline. But this decline generally follows the decline in major projects that has occurred over the last few years. Therefore, as the contracts from the past decade reach their termination dates, a pipeline may be subject to a much greater risk of revenue volatility based on the market’s valuation of the pipeline’s capacity.
Pipeline expansions are generally supported by long-term contracts that ensure that the pipeline can recover the expansion costs during the initial term of those agreements. These long-term contracts provide a solid base of revenue for pipelines and reduce their exposure to market forces with respect to the value of the pipeline’s capacity.
Today we look at the data over the last decade for contracts longer than ten years in length. It is clear that the use of such contracts has definitely peaked and is on a substantial decline. But this decline generally follows the decline in major projects that has occurred over the last few years. Absent a resurgence in expansion projects, therefore, as the contracts from the past decade reach their termination dates, a pipeline may be subject to a much greater risk of revenue volatility based on the market’s valuation of the pipeline’s capacity.
Extent of Long-Term Contracts
Looking back over the last decade, we can see that the total capacity covered by transport contracts with a length of at least ten years is quite variable from year to year.
As seen above, the absolute peak for such long-term contracts was in 2018, but there were earlier peaks in 2011 and 2014. Over the twelve-year period shown above, the total capacity of such long-term contracts was almost 200 Bcf/day. While 2021 is not yet complete, the data reflects those contracts reported as being effective for the fourth quarter of this year, so we would not expect there to be many more added during the remaining two months. Thus, 2021 is looking to be the lowest point for such contracts over this period.
The impetus to sign a long-term contract is usually the creation of expansion capacity by the pipeline for which it seeks anchor shippers willing to commit for a long period of time. Therefore, we also looked back at the amount of new pipeline capacity that was approved by FERC over essentially this same period of time.
Because it takes some time following FERC’s approval of a project before the project can be placed into service, we would expect that the FERC approval of expansion projects is a leading indicator for the initiation of these long-term contracts. The dips in FERC approvals in 2011 and 2012 correspond fairly well to the dip in long-term contracts initiated in each of the following years, 2012 and 2013, and the peak of FERC-approved expansion projects in 2017 corresponds to the peak in long-term contracts occurring in the next year, 2018. Based on this history, it looks like the days of such long-term contracts may be coming to a close as FERC’s approval of projects this year is at its lowest point during the period covered.
While 2021 is not yet over, we do not expect there to be any further approvals this year given the current split of the Commission at 2-2 and the fact that the Democrats seem unwilling to approve any expansion projects at all. Thus, we will likely see that 2022 has even lower new capacity subject to long-term contracts than 2021 has had. So while we can’t say for certain that the era of long-term contracts is over, it certainly seems to be headed toward its low point in 2022.
So with this huge crush of long-term contracts occurring over the last decade, the pipeline industry will face increased risk as these contracts end.
As seen above, there are two sets of two-year periods in this coming decade when at least 30 Bcf/day of contracts are set to expire. First, in 2024-2025 there is a total of just over 30 Bcf/day of contracts expiring during those two years, and then in 2029-2030, nearly another 32 Bcf/day are set to expire. Between now and the end of 2030, over 100 Bcf/day of contracts will expire industry-wide.
As these contracts expire, the pipelines will be exposed to renewal risk, but also price risk, as the capacity may not be as valuable in the marketplace as it was at the time the long-term contract was first signed. This risk may impact the rates that pipelines seek to charge their remaining shippers, but also could impact a pipeline’s continuing level of revenue. A leading indicator of reduced value to the original shipper would be if that shipper is regularly releasing its capacity. If you would like to monitor the release market, please let us know and we can send you our daily ETA alert, which provides a summary of all of the releases across the largest families of pipelines.
If you would like us to provide a similar assessment for a particular pipeline or group of pipelines, pleasecontact us.