Fitch Assigns First-time 'BBB-' Rating to Rockies Express Pipeline, LLC; Outlook Stable.
REX's ratings are reflective of the expected stability in revenue and cash flow for the pipeline supported by long-term, take-or-pay contractual support for a significant amount of pipeline capacity; reasonably strong expected credit metrics over the near to intermediate term; a pipeline route that accesses the leading U.S. natural gas production basin (the Appalachian Basin) and supplements that position with access to another growing production basin on the west end of its system and provides shippers significant market flexibility; and an operating profile that possesses minimal liquidity requirements.
The ratings consider that the pipeline remains exposed to near-term recontracting risks for its legacy west-to-east capacity, though recognizes Fitch's belief that REX should be able to recontract this expiring capacity and continue to retain reasonably strong credit metrics throughout our base case forecast. The ratings are based on REX's standalone credit profile, but also recognize that its owners, Tallgrass Energy, LP (75%) and Phillips 66 (25%), have historically been supportive owners, contributing capital as needed to help fund capacity enhancements along the pipeline, and most recently to repay maturing 2018 notes.
KEY RATING DRIVERS
Cash Flow and Earnings Stability: REX's ratings reflect the cash flow stability and relatively low business risk associated with an interstate natural gas pipeline. REX has roughly 90% of its capacity currently subscribed under capacity reservation contracts providing a high amount of near term revenue and cash flow certainty. Roughly 75% of the 2.0 Bcf/d of capacity on REX's west-to-east route is contracted with a weighted average contract life of just over two years. Roughly 100% of REX's 2.6 Bcf/d of capacity on its east-to-west route is contracted with a weighted average contract life of over 14 years. Assuming only contracted cash flows, REX is expected to generate leverage metrics (Debt/EBITDA) of approximately 3.0x in 2019, with that rising to approximately 4.0x in 2020 absent any recontracting of expiring cash flows. A more reasonable base case recontracting scenario where open capacity on west-to-east is recontracted at lower rates, Fitch anticipates leverage at REX in 2020 and beyond between 3.5x and 3.75x. Fitch typically looks for leverage metrics at or below 4.5x for 'BBB-' rated regulated pipeline entities and expects REX to remain well below that level over the next several years.
Shipper Optionality: REX currently provides east flowing capacity for natural gas produced in the Rocky Mountain region as well as west flowing takeaway capacity for gas produced from the Utica and Marcellus shales at its east end. Along the way, REX provides interconnection with 31 long haul interstate pipeline systems that provide access to several demand markets in the U.S. As such, REX provides a high level of supply diversity and significant delivery connectivity to shippers, largely producers, to move their gas to demand markets. This should help mitigate recontracting risks and shifting supply demand dynamics.
Recontracting Risk: REX has roughly 43% of its contracted revenue expiring towards the end of 2019. These contracts were the initial west-to-east capacity contracts on the pipeline. These lucrative contracts are currently at significantly higher rates, compared to spot market basis differentials. The spot market suggests that replacement contracts will be recontracted at lower rates than the rates in the legacy contracts. Fitch expects this expiring capacity to be recontracted, albeit at lower rates, but there remains uncertainty around REX's ability to recontract expiring contracts at rates and tenor and with decent credit quality counterparties that are favorable to the credit profile. Fitch notes favorably that REX has already been able to recontract, or amend and extend, some of its expiring capacity and has east-to-west capacity reservation revenues which will help cash flow stability. Additionally, Fitch notes that supply/demand fundamentals in the regions that REX serves and its ability to offer significant shipper optionality should all help REX recontract open capacity at rates that are not deleterious to credit. Fitch expects REX to be able to recontract open capacity at rates that help support revenue and cash flow stability and helps REX maintain leverage between 3.5x - 3.7x for 2020 and beyond.
Limited Size, Scale, Geographic Diversity: REX is a single asset pipeline system with limited geographic and business line diversity. Fitch's rating reflect a favorable view of production growth and takeaway capacity need in the regions that REX currently serves but notes that natural gas supply/demand can shift and the lack of geographic and business line diversity can have outsized effect on single asset systems. Fitch's size and scale concerns with regard to midstream energy issuers tends to be focused on facilitating access to capital to meet funding needs, with larger entities being more easily able to access capital markets. Fitch notes that REX has demonstrated access to debt markets and supportive owners in Tallgrass Energy and Phillips 66 that have in the recent past injected capital into REX to repay its 2018 maturity. Fitch also notes it expects REX's EBITDA to remain well above $500 million which Fitch typically likes to see as a scale indicator for investment grade midstream entities.
REX's ratings reflect expected near term cash flow and earnings stability supported by capacity reservation contracts. West-to-east contracts (representing 75% of REX's west-to-east capacity) have a weighted average contract life of two years. Virtually all of its east-to-west capacity has a weighted average contract life of roughly 14 years. The ratings reflect expected near term recontracting risk as legacy 2009 contracts roll off next year. Since 2009, the Rockies region has seen other producing regions overtake it in terms of competitiveness. Notwithstanding this fact, Fitch believes that REX should be able to recontract expiring west-to-east capacity, albeit at lower rates, and continue to retain reasonably strong credit metrics throughout our base case forecast (2018 - 2021). The recommendation is reflective of REX's standalone credit profile, but also recognizes that its owners Tallgrass Energy, LP (75%) and Phillips 66 (25%) have historically been supportive owners, contributing capital as needed to help fund capacity enhancements along the pipeline, and to repay maturing notes.
REX's leverage is low. In 2020, the first full year post a significant contractual expiry, leverage is forecasted by Fitch to be in the mid-3x area, which compares favorably to its single-asset joint venture pipeline peers, whose ratings are not constrained by a parent company affiliation. Fitch typically looks for leverage metrics at or below 4.5x for 'BBB-' rated midstream entities and expects REX to remain well below that level over the next several years, which Fitch views as appropriate given the lack of geographic and business line diversity for the single asset pipeline. REX's leverage compares favorably to that of Sabal Trail's (BBB+/Stable Outlook), which Fitch expects in the mid-4x's, though Fitch recognizes that Sabal Trail has significantly lower business and recontracting risk given Sabal's position as a "demand pull" pipeline tied into utility counterparties with much longer-term contracts. REX is a "supply push" pipeline, supported by contracts with producer and marketing counterparties, which Fitch views as possessing higher business risk.
Examples of investment grade rated, supply push, single asset pipeline companies are the joint ventures Midcontinent Express Pipeline LLC (MEP; BBB-/Stable) and Ruby Pipeline, LLC (Ruby BBB-/Stable). REX is significantly larger than both MEP and Ruby, with Fitch expecting REX to generate over $700 million in 2019 EBITDA and MEP and Ruby expected to generate significantly less than that . Leverage metrics for MEP, Ruby and REX are all roughly the same for 2019 with Fitch expecting leverage between 2.9x and 3.5x for all three pipelines. MEP and Ruby both have similar recontracting risks associated with expiring long-term capacity reservation contract cliffs, but Fitch believes REX is well positioned relative to these peers given its bi-directional capabilities and its significantly higher amount of interconnects.
Fitch's Key Assumptions Within Our Rating Case for the Issuer
- Contracted revenues used where appropriate for forecast; recontracting of expiring contracts done at lower volumes and lower rates for the forecast period;
- Growth spending consistent with management guidance/maintenance spending consistent with historical run-rates;
- All cash available for distributions distributed to owners;
- All maturing debt 2019/2020 refinanced at the REX level.
Developments That May, Individually or Collectively, Lead to Positive Rating Action
- Recontracting of expiring capacity with long term contracts (5 years or greater) with counterparties of decent credit quality
(BB or better) at rates such that leverage is expected at or below 3.5x on a sustained basis.
Developments That May, Individually or Collectively, Lead to Negative Rating Action
- Leverage at or above 4.5x on a sustained basis;
- Significant credit event with a shipper that significantly impairs REX cash flow;
- Inability to recontract expiring capacity at or near rates, which are supportive of debt servicing needs;
- A significant and unfavorable change in the natural gas supply/demand dynamics within REX's service territories such that production or capacity utilitzation slows or shows declines for an expected sustained period.
LIQUIDITY AND DEBT STRUCTURE
Liquidity Adequate: REX has a $150 million revolving credit facility. The revolving credit facility includes a $75 million sublimit for letters of credit and a $20 million sublimit for swing line loans and may be used for working capital and general company purposes. The revolving credit facility also contains an accordion feature whereby REX can increase the size of the credit facility to an aggregate of $200 million, subject to receiving increased or new commitments from lenders and the satisfaction of certain other conditions precedent. As of June 30, 2018, there were no outstanding borrowings or letters of credit issued under the revolving credit facility. As of June 30, 2018, REX was in compliance with the covenants required under the revolving credit facility. The revolving credit facility generally requires REX to comply with various affirmative and negative covenants, including a limit on the leverage ratio (as defined in the credit agreement) of REX at 5.0x. Fitch expects REX to remain compliance with its covenants throughout our base case forecast period (2018 - 2021).