Many of the midstream energy industry's opportunities and challenges that were the subject of S&P Global Ratings' Industry Credit Outlook 2024 remain top of mind as we approach the end of the first quarter. The focus of this commentary is to highlight the credit drivers that we believe are the most important to issuers' credit health for the rest of the year.

(For a broad discussion of our credit views, listen to the replay of our recent webinar, "2024 Midstream and Refining Outlook: Credit Drivers in a Time of Change - Virtual Seminar," available on on24.com until March 2025.)

Infrastructure development to press on despite a pause on LNG export licenses.

We believe midstream pipeline development in the Gulf Coast will continue unabated for the next few years despite a pause on export licenses of liquid natural gas (LNG) to non-free trade agreement countries. We still expect U.S. export capacity to grow to about 26 billion cubic feet (bcf) per day or 189 metric tons per annum (MTPA) from the current 14.3 bcf/day (106 MTPA) that is currently operating. This increase will likely happen regardless of a future decision on export licenses, because the additional 11.64 bcf/day (83 MTPA) is currently under construction and should begin exporting LNG by 2027. We expect about 21 bcf/day of LNG-related pipeline projects, mainly in the Gulf Coast region to be completed to support this growth.

The availability of natural gas storage capacity is critical to managing gas flows in the next several years.

Despite natural gas storage capacity in the U.S. marginally increasing over the past decade, it could be in short supply as we enter the winter injection season, largely because of the relatively mild winters, growing supply, and weaker-than-expected demand. As of March 8, 2024, the EIA estimates that working gas in storage in the lower 48 states was 2,325 bcf, which is approximately 25% above the five-year average of 1,876. However, while natural gas storage capacity has only marginally increased over the past decade to about 4,342 bcf, demand for natural gas has increased substantially. If storage levels approach maximum capacity this fall, natural gas prices could decline below already historically low levels and reduce throughput for some of the midstream companies we rate.

Over the next decade we expect demand for natural gas to continue to increase, driven by increased domestic demand and LNG exports. More natural gas storage will be required to support variations in domestic demand, as well as growing LNG capacity to manage variations in throughput related to operating these facilities. Specifically, the biggest need is for more natural gas storage near the Gulf Coast, close to many LNG export facility expansions. As transportation infrastructure is built out to supply feed gas, storage will be important to managing gas flows. Furthermore, the increased use of renewables will also require additional natural gas storage as a backup source of power due to the operational intermittency of wind and solar assets and their ability to meet sudden increases in demand.

Therefore, we expect midstream companies that focus on natural gas to allocate an increasing portion of their capital spending budget to build new natural gas storage facilities over the next several years, and that natural gas storage rates will continue to improve. We also believe many midstream companies will look to acquire natural gas storage capacity. For example, in January 2024 The Williams Cos. closed on a $1.95 billion acquisition of Hartree Natural Gas Storage, which added 115 bcf of working gas storage in the Gulf Coast. We believe competition for natural gas storage could also bid up purchase price multiples for these assets, which is an important factor when evaluating the impact of an acquisition on credit quality. Williams estimated its acquisition of Hartree was at a 2024 EBITDA multiple of approximately 10x.

Canadian midstream credit quality is a mixed bag, and 2024 will be a critical year.

Generally speaking, 2023 represented a stronger year for Canadian midstream companies. Both Keyera Corp. and Pembina Pipeline Corp. reported stronger EBITDA growth, resulting in improved credit metrics. This fits within the broader narrative of deleveraging in the North American midstream industry. Keyera ended the year with S&P Global Ratings-adjusted debt to EBITDA of 3.2x with all segments reporting strong cash flow generation. Moreover, with the completion of the KAPS project the company will add long-term contracted cash flow, further strengthening cash stability. Overall, this outcome is consistent with our forecast and 'BBB' corporate credit rating and stable outlook.

Pembina ended 2023 with adjusted debt to EBITDA of 3.3x, which is strong for the 'BBB' rating. However, consistent with Pembina's historic operating pattern, we expect the company is maintaining strong credit metrics in order to take advantage of growth opportunities as they arise. A good example of this is the company's acquisition of  Enbridge Inc.’s interests in the Alliance Pipeline and Aux Sable and NRGreen joint ventures. The company was able to make this $3.1 billion acquisition without any impact on its rating. In addition, we expect the cushion in the company's metrics will support its ongoing development efforts at Cedar LNG as well as other potential transactions or asset acquisitions.

For Canada's two largest midstream energy companies, 2023 closes out what was certainly one of the most active years. Cost increases at TC Energy Corp.'s Coastal Gas Link pipeline brought the cost to complete construction to approximately C$14.5 billion (from an original estimate of C$6.2 billion). As a consequence, the company has undertaken a number of asset divestitures as part of its efforts to reduce leverage. These include the recent sale of the Portland Natural Gas Transmission System to BlackRock for US$1.14 billion, as well as a 40% interest in the Columbia Gas pipeline system to Global Infrastructure Partners for C$5.3 billion. While TC did show some improvement in its credit metrics in 2023, with S&P Global Ratings-adjusted debt to EBITDA at 5.2x, this was in line with our expectations.

The company also announced in 2023 that it would be spinning out its liquids business, thus exiting the crude transportation business. We anticipate this transaction will occur in mid-2024 although we model it as a leverage-neutral transaction. While the company has indicated it will be below 5x for 2024, this includes partial-year EBITDA from its liquids business. It should be noted that typically we do not include EBITDA from discontinued businesses. However, regardless of the treatment of the partial-year EBITDA from the liquids business, a critical consideration will be whether the company was able to further deleverage in 2024.

The pace of midstream acquisitions will accelerate.

We've stated that we expect midstream companies to continue with small tuck-in acquisitions as organic growth opportunities shrink, competition heats up, and their producer customer base continues to consolidate. Midstream consolidation has generally been positive for credit, with acquirers mostly funding the transaction with equity or using their significant balance sheet strength to use some debt. We believe strategic buyers will dominate most of the future transaction activity, as we've seen Sunoco LP agree to buy NuStar Energy L.P. to diversify and build scale. Financial participants such as infrastructure funds have a lot of cash too, but will likely focus on hard-to-replicate assets such as TC Energy's sale of Portland Natural Gas Transmission to managed funds owned by BlackRock and Morgan Stanley Infrastructure Partners.

We view EQT Corp.'s March 11 acquisition of Equitrans Midstream (ETRN) in an all-stock transaction valued at $13 billion as more of a one-off based on the two companies' shared history and integration rather than a trend of upstream folding in midstream assets. In our view, EQT's business profile will benefit from the larger scale and the diversified and more stable cash flow from the midstream assets, as well as expected lower gathering costs for its upstream production. However, we revised our outlook on the EQT rating to negative due to the increased debt burden from Equitrans of about $7.3 billion, which the company plans to reduce via free cash flows and asset sale proceeds 12-18 months post close.

We placed our ratings on ETRN on CreditWatch Developing to reflect the uncertainty around the completion of Mountain Valley Pipeline (MVP) on time and on budget, as well as the potential impact to the rating if the transaction with EQT closes. The completion of MVP is a necessary condition for the transaction. Upon close, we would view it as supportive of ETRN's credit quality and believe ETRN will be considered a core subsidiary of EQT. If this occurs, we expect to align our ratings on ETRN with those on EQT.

MVP remains under construction with a target in-service date of June 1, 2024. In our research update published Feb. 21, 2024, we outlined that if MVP is further delayed we would downgrade ETRN. We do not believe the potential transaction by EQT positively influences the likelihood of MVP being completed, and we reiterate that the pipeline must be finished for the acquisition to occur. As a result, we still anticipate downgrading ETRN to the extent that MVP is further delayed, reflecting that it would lead to S&P Global Ratings-adjusted debt to EBITDA remaining above 5.5x through fiscal 2024 and could impact the likelihood and timing of the acquisition.