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Oil and gas chapter 11 cases are proliferating due to the current commodity pricing environment. Since Hon. Shelley C. Chapman's rulings earlier this year in In re Sabine Oil & Gas Corp.,1 litigation over midstream contracts has been the centerpiece of these cases. Mark Pfeiffer (Buchanan Ingersoll & Rooney PC; Philadelphia) outlined the background of, and issues presented in, these litigations in the July 2016 issue of the ABI Journal,2 which serves as the jumping-off point for this article.
Since the litigation between debtor producers and midstream providers requires a determination of the validity or extent of the midstream providers' property interests, it likely requires an adversary proceeding.3 Adversary proceedings typically take time - time during which the debtor producer has a business to run. Unless it has an alternative midstream provider that it can turn to (both practically and legally4), the debtor will need to use the services under the contract that it is trying to reject. Where that contract includes minimum volume commitments, the debtor risks administrative expense exposure unless it produces at the required levels postpetition - even if doing so would be uneconomic in the current commodity pricing environment.
Minimum Volume Commitments
Minimum volume commitments (MVCs) by the producer are a common feature of midstream contracts, particularly where the midstream provider builds a new infrastructure to support any future development of oil and gas reserves. Under the MVC structure, the producer commits to delivering certain volumes of oil, gas or wastewater to the midstream provider at the applicable contract rate per unit, failing which the producer must make a shortfall payment based on committed - but undelivered - volumes. For the midstream provider, the MVC structure provides (1) downside protection by setting a floor for the cash flow that it can expect for the MVC's duration, and (2) an upside benefit by incentivizing the producer to drill new wells and increase production, thereby increasing revenue on delivered volumes.
For the producer, the MVC structure can allow it to lock in more favorable per-unit rates for midstream services. MVCs can also serve as the quid pro quo for "firm transportation" service from the midstream provider, which guarantees the availability of pipeline capacity for the producer (as opposed to "interruptible" service, which...