Earlier this week, I explained why pipeline stocks are setting up for a major investment opportunity.
But a brand-new risk to these companies just emerged this week.
On Tuesday, microcap oil producer Sabine Oil & Gas was in bankruptcy court in New York. During the boom in oil, the small oil and gas firm agreed to long-term contracts with two pipeline companies.
And the judge’s ruling could have a major effect on those companies…[ad#Google Adsense 336×280-IA]You see, the two pipeline companies had agreed to build dedicated pipelines to Sabine’s wells.
Historically, because those pipelines are fixed in the ground and can’t be moved, the agreement is attached to the land.
In other words, if Sabine goes bankrupt and someone else comes in to operate the wells, then the pipeline agreement goes with it.
However, the judge overseeing the bankruptcy proceedings said Sabine could throw out the pipeline contracts, saying, “The debtors have satisfied the standard for the rejection of the contracts.”
The judge’s decision in the Sabine case puts many pipeline contracts in jeopardy.
That’s bad news for the pipeline companies, who are not thrilled to see that these contracts can be challenged and aren’t necessarily binding.
It sets an ugly precedent in the oil industry. And as I told you in February, we could see more oil companies go bankrupt this year. One in particular scares pipeline companies to death – Chesapeake Energy (CHK).
Chesapeake is on the brink of restructuring its debt. It lost $19.1 billion in earnings before interest, taxes, depreciation, and amortization (EBITDA) last year. The company owes more than $10 billion in debt and has less than $1 billion in cash. Chesapeake pays about $2 billion per year to pipeline companies to move its oil and gas.
Two pipeline companies in particular – Williams Companies (WMB) and Kinder Morgan (KMI) – would suffer the most if Chesapeake goes bankrupt. Both have long-term contracts in place to move Chesapeake’s oil and gas. Since whispers resurfaced last March that Chesapeake could be facing bankruptcy, shares of both Williams and Kinder Morgan have fallen more than 50%.
Major pipeline stocks should be diversified enough to withstand the bankruptcy of small oil companies. But when a giant oil company like Chesapeake goes belly-up, it creates more risk for the sector.
Here’s a quick checklist for investors interested in buying pipeline stocks…
1. Figure out who the pipeline is partnered with, and see how those companies are faring in today’s environment of low oil prices.
2. Make sure the company is big and diversified enough to withstand minor bankruptcies in oil stocks.
3. Wait for the company to cut its distributions.
People who stick to those criteria should be rewarded with triple-digit gains in the near future.
Source: Growth Stock Wire