After weak commodity prices debilitated the North American midstream energy sector in the first half of 2016, the second half of 2016 saw commodity prices improve, capital markets open, and counter-party credit risk remain low, S&P Global said.

As of Jan. 25, 2017, the spot price for WTI crude was about $53/bbl and the spot price for Henry Hub natural gas was about $3.25/Mcfe, an increase of 104% and 103%, respectively, since February 2016 averages ($26/bbl and $1.60/Mcfe).

In December 2016, S&P Global increased its oil price assumptions to $50/bbl from $45/bbl for 2017 and raised its Henry Hub natural gas assumptions for 2017 to $3.00 per million British thermal units (MMBtu) from $2.75 per MMBtu. All of its other price assumptions are unchanged. Higher prices will support credit quality for midstream companies and their upstream customers, S&P Global said.

“Many companies — most notably ONEOK Partners L.P. — were successful in changing contracts with commodity exposure for fee-based ones, or reducing price exposure through increased hedging programs, which will somewhat offset the volatility in commodity prices going forward,” S&P Global said.

S&P Global said that there is optimism that a Trump administration will reduce regulation and create a more accommodating operating environment for the midstream energy industry in 2017. In addition to more-efficient operations as a result of cost reduction plans and lower cost of capital in the midstream energy sector, S&P Global believes that a more fiscally conservative approach by management teams will lead to improved credit profiles during the next 12 to 24 months.

“While we don’t view counter-party risk as a significant factor driving midstream credit quality in 2017, it has meaningfully weakened credit quality in the upstream industry and will require continued monitoring by midstream companies,” S&P Global said.

“U.S. oil and gas companies’ average credit quality continues to be weak. About 40% (50 companies) of rated oil and gas companies are rated ‘B-‘ or lower. In fact, 2016 saw many oil and gas companies file for bankruptcy, miss interest payments, or restructure their debt,” it added.

For the most part, exploration and production (E&P) companies have honored their contractual arrangements, even in bankruptcy. For midstream gathering and processing companies, being connected at the wellhead certainly has its advantages, since it would be extremely difficult for a producer or competitor to replicate the gathering system at the same costs in order to move the hydrocarbon to an end market, S&P Global said.

Since producers need to keep production flowing in order to meet contractual obligations, the midstream companies do have leverage. However, this isn’t to say that midstream EBITDA hasn’t been negatively affected by lower volumes, mainly due to a decline in production from producer customers, according to S&P Global.

The Canadian oil and gas sector proved to be more resilient than its U.S. counterpart, which mitigated any credit deterioration for Canadian midstream companies, S&P Global said.

“We’ve seen fewer contract renegotiations between Canadian producers and their midstream counterparts, but companies have intensified their counter-party surveillance and implemented ways to reduce their exposure through such means as increased collateral support from letters of credit, for example,” the rating company said.

“We also believe that the minimal counter-party credit issues observed thus far are a reflection of the better credit quality of the larger Canadian producers, most of which are rated investment grade. Because production in the Western Canadian Sedimentary Basin is skewed to the larger producers, counter-party exposure for the midstream credits is also generally more heavily weighted to those companies, which are a lower credit risk than the typically smaller U.S. shale producer,” it added.

S&P Global said that capital spending in the midstream sector has slowed, but MLPs still have significant plans.

S&P Global expects the amount of capital spending in 2017 to be 25% to 30% less than during the 2013-2015 period but remain significant, particularly for most diversified investment grade companies. For the investment grade peer group, spending peaked at $23.2 billion in 2015 and came down to $17.3 billion in 2016. The rating agency expects spending in 2017 to be about 30% lower than the peak at roughly $16 billion.

Certain basins will see more spending than others as E&P companies focus on basins that have better economics, it said.

“We believe the Permian and Anadarko (SCOOP and STACK) Basins and the Northeast region will see the greatest amount of capital allocation in 2017. We expect gathering and processing companies to cautiously spend 5%-10% more capital in 2017 than in 2016,” S&P Global said.

However, if commodity prices trend to levels experienced during the first half of 2016, the pace at which these companies undertake such projects would likely decline, it added.

Production growth for Canadian oil and gas producers has also slowed, S&P Global said. The Canadian Association of Petroleum Producers’ June 2016 crude oil forecasts estimate that production from 2017-2019 will be about 200,000 barrels per day lower compared with the 2015 forecast. As a result, planned midstream capital expenditures to support gathering and transmission pipelines have likely peaked, and companies are now working through their approved capital projects.

Despite the cautious optimism, S&P said that challenges from the past will linger: stretched balance sheets, weak coverage ratios, high cost of equity capital, and significant financing requirements for a backlog of projects somewhat temper the stable view. In addition, some developing midstream projects have seen delays due to environmental activism.