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One of the outcomes of the energy market downturn is that it forced Williams Companies (NYSE: WMB) and Williams Partners (NYSE: WPZ) to take a closer look at their combined risk profile. As a result, both companies have undertaken strategic transactions to mitigate risk by reducing their exposure to riskier customers and assets. That trend continued this week when Williams Partners announced another deal with leading natural gas producer Chesapeake Energy (NYSE: CHK) to reduce its risks associated with that key customer going forward.
Details on the latest deal
In this latest transaction, Williams Partners and its joint venture partner Crestwood Equity (NYSE: CEQP) agreed to restructure Chesapeake Energy's gas gathering and processing servicing contracts in Wyoming's Powder River Basin. This particular contract restructuring relates to the Bucking Horse natural gas processing plant and the Jackalope Gas Gathering System, which are 50% owned by Williams Partners and Crestwood Equity. The restructured contract will replace their current cost-of-service agreements with a new long-term, fixed-fee contract, which will have minimum annual revenue guarantees.
Restructuring the contract will strengthen Chesapeake Energy's economics in the region, which will allow it to accelerate its development plans. In a sense, Williams and Crestwood are trading higher income today for a greater reward in the future as Chesapeake Energy ramps production in the region. Further, it allows for the potential expansion of their joint venture should Chesapeake Energy need new gathering or processing capacity.
Reducing risk one contract at a time
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This latest restructuring agreement is Williams' fifth with Chesapeake over the past year. Last September, for example, Williams and Chesapeake Energy agreed to expand their contract in the Utica shale while also consolidating contracts in the Haynesville shale. They did so by converting the cost-of-service contract in the Utica to a new fixed-fee contract with minimum volume commitments while combining two Haynesville contracts to one fixed-fee structure. In exchange, Williams benefits by enhancing Chesapeake's ability to grow production in both regions, which improves the volumes flowing through its assets.
Meanwhile, earlier this summer, Williams and Chesapeake restructured their agreements in the Barnett shale and the Mid-Continent Region. The Barnett restructuring allowed Chesapeake to sell those assets to a third party. One of the significant benefits of that particular transaction is that it diversifies Williams' customer base away from Chesapeake, reducing it from 20% to 15% of Williams' revenue. That's worth noting because Chesapeake's financial situation remains stressed because of its elevated debt levels. In fact, one of Williams' credit rating agencies cited its outsized exposure to Chesapeake Energy as one of the concerns leading to it to downgrade the MLP's credit rating to the bottom rung of investment grade last year.
It is exposure the company assumed when it acquired Chesapeake Energy's former pipeline subsidiary, Access Midstream. Because of that exposure, there were concerns that if Chesapeake filed for bankruptcy, Williams could be forced to accept as much as a 50% reduction in the fees it collects on gathering and processing contracts with the driller. If that were the case, the company could have lost $300 million in annual cash flow, which is a big chunk of its $4 billion in annual cash flow. That's why Williams has been diligently working with Chesapeake to restructure these contracts to support the financial health of its major customer. As a result of these efforts, as well as Chesapeake's ability to cut costs and reduce debt, the gas driller is in the position to deliver sustainable production growth of 5% to 15% annually while living within cash flow starting in 2018.
Williams' outsized exposure to Chesapeake Energy was a cause for concern. However, those concerns are easing with each step the company has taken to reduce its risk by strengthening their relationship. As a result, Williams is on much firmer footing going forward.
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