Unless otherwise indicated, references in this Annual Report on Form 10-K to “we,” “our,” or “us” or like terms, when referring to periods prior to September 30, 2014, refer to CNX Gathering LLC (“CNX Gathering”) our predecessor for accounting purposes. References to “CNXM,” the “Partnership,” “we,” “our,” “us” or similar expressions, when referring to periods since September 30, 2014, refer to CNX Midstream Partners LP, including its consolidated subsidiaries.
Overview
CNX Midstream Partners LP (NYSE: CNXM) is a growth-oriented master limited partnership focused on the ownership, operation, development and acquisition of midstream energy infrastructure in the Appalachian Basin. We currently provide midstream services to our customers’ production in the Marcellus Shale and Utica Shale in Pennsylvania and West Virginia under long-term, fixed-fee contracts. Our assets include natural gas gathering pipelines and compression and dehydration facilities, as well as condensate gathering, collection, separation and stabilization facilities. We are managed by our general partner, CNX Midstream GP LLC (our “general partner”), a wholly-owned subsidiary of CNX Gathering. CNX Gathering is a wholly owned subsidiary of CNX Resources Corporation (NYSE: CNX) (“CNX Resources”).
We were formed in May 2014 as a joint venture between CNX Resources and Noble Energy, Inc. (NYSE: NBL) (“Noble Energy”). On January 3, 2018, CNX Gas Company LLC (“CNX Gas”), an indirect wholly-owned subsidiary of CNX Resources, acquired from NBL Midstream, LLC (“NBL Midstream”), a wholly owned subsidiary of Noble Energy, NBL Midstream’s 50% interest in CNX Gathering. CNX Resources became our sole sponsor as a result of this transaction, and we refer to CNX Resources as our “Sponsor” throughout this Annual Report on Form 10-K. See “Developments and Highlights—CNX Resources Acquisition of General Partner” for more information related to CNX Gas’ acquisition of NBL Midstream’s indirect interest in our general partner.
We generate substantially all of our revenues under long-term, fixed-fee gathering agreements with each of CNX Resources and HG Energy II Appalachia, LLC (“HG Energy”) that are intended to mitigate our direct commodity price exposure and enhance the stability of our cash flows. The gathering agreements currently include acreage dedications of approximately 363,000 aggregate net acres, comprised of approximately 262,000 Marcellus acres and approximately 101,000 Utica acres, subject to the release provisions set forth in our gas gathering agreements. Although CNX Resources and HG Energy currently account for substantially all of our revenues, we intend to supplement our profitability and future growth by pursuing opportunities to perform gathering services for other unrelated third parties in the future. In addition, we also consider accretive acquisitions, which may include drop downs of additional interests in our existing consolidated assets.
Since our IPO in September 2014, a substantial number of wells have been turned in line in our dedication area, which contributed to our largest gross average combined throughput level of approximately 1,821 BBtu/d for the year ended December 31, 2019 (1,606 BBtu/d excluding third-party volumes under short-haul agreements). See “Our Acreage Dedication and Right of First Offer” for a more detailed explanation.
The following charts illustrate our throughput trends and well turn-in-line activity on our dedicated acreage for the periods indicated:
(1) Represents average daily combined throughput for the periods presented, excluding third-party volumes under high-pressure short-haul agreements.
(2) Represents total gross wells turned in line on our dedicated acreage in the periods presented.
Developments and Highlights
Incentive Distribution Rights Elimination Transaction
On January 29, 2020, CNX and CNXM entered into and closed definitive agreements to eliminate CNXM’s incentive distribution rights (“IDRs”) held by its general partner and to convert the 2.0% general partner interest in CNXM into a non-economic general partnership interest (collectively, the "IDR Elimination Transaction").
Pursuant to the IDR Elimination Transaction agreements, CNX will receive the following consideration in exchange for the IDRs and the 2% general partner interest:
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26 million CNXM common units;
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3 million new CNXM Class B units. The newly issued Class B units will not receive or accrue distributions until January 1, 2022, at which time they will automatically convert into CNXM common units on a one-for-one basis; and
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$135.0 million, to be paid in three installments of $50.0 million due December 31, 2020, $50.0 million due December 31, 2021 and $35.0 million due December 31, 2022.
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As a result of the IDR Elimination Transaction, CNX now owns 47.7 million common units, or approximately 53.1%, of the outstanding limited partner interests in CNXM, excluding the Class B units. Upon conversion of the Class B units to CNXM common units on January 1, 2022, CNX's ownership will increase to 50.7 million units on a proforma basis.
CNX Resources Acquisition of General Partner
On January 3, 2018, CNX Gas acquired NBL Midstream’s 50% membership interest in CNX Gathering for cash consideration of $305.0 million and the mutual release of all outstanding claims between the parties (the “Transaction”). In connection with the Transaction, CNX Gas entered into new 20-year fixed-fee gathering agreement with the Partnership. See “Our Gathering Agreements with CNX Gas and HG Energy” for more information related to our new gathering agreement with CNX Gas.
Transactions with our Sponsor and HG Energy
On May 3, 2018, we announced a strategic transaction with our Sponsor, pursuant to which we amended our gas gathering agreement (“GGA”) with CNX Gas to provide for the following (collectively, the “CNX Transactions”):
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Dedication to the Partnership of approximately 16,100 additional Utica acres in our Anchor Systems (as defined below);
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Commitment to develop 40 additional wells in the Anchor Systems by 2023, subject to the terms of the GGA;
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Contribution to the Anchor Systems of a 20” high pressure pipeline in addition to a one-time payment to us of approximately $2.0 million in cash; and
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Distribution of our 5% interest in the Growth Systems (as defined below) and related assets, as well as our 5% interest in the Moundsville midstream assets that were a part of the Additional Systems (as defined below), to CNX Gathering, which subsequently transferred the assets to HG Energy.
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On May 3, 2018, we also announced a strategic transaction with HG Energy, pursuant to which we amended our GGA with HG Energy to provide for the following (collectively, the “HG Energy Transaction”):
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Release from dedication of approximately 18,000 acres, net to the Partnership, which was comprised of approximately 275,000 acres (or approximately 14,000 acres, net to the Partnership) within the Growth and Additional Systems and approximately 4,200 scattered acres located in the Anchor Systems;
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Removal of our obligation to provide gathering services or make capital investments in the Growth Systems or in the Moundsville area of the Additional Systems; and
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Commitment by HG Energy to develop 12 additional wells in the Anchor Systems by 2021, subject to the terms of the HG Energy GGA.
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Following the CNX and HG Energy Transactions, the aggregate number of well commitments in the Anchor Systems to the Partnership increased from 140 to 192 wells over the course of the next five years. As of May 3, 2018, the Partnership has no remaining interests in the Growth Systems or the Moundsville area assets that were historically included within the Additional Systems.
Acquisition of Shirley-Penns System
Prior to March 16, 2018, CNX Gathering owned a 95% noncontrolling interest, while the Partnership owned the remaining 5% controlling interest, in the Additional Systems, which owned the gathering system and related assets commonly referred to as the Shirley-Penns System (the “Shirley-Penns System”). On March 16, 2018, the Partnership acquired the
remaining 95% interest in the Shirley-Penns System, pursuant to which the Additional Systems transferred its interest in the Shirley-Penns System on a pro rata basis to CNX Gathering and the Partnership in accordance with each transferee’s respective ownership interest in the Additional Systems. Following such transfer, CNX Gathering sold its aggregate interest in the Shirley-Penns System, which now resides in the Anchor Systems, in exchange for cash consideration in the amount of $265.0 million (the “Shirley-Penns Acquisition”). The Partnership funded the Shirley-Penns Acquisition with a portion of the proceeds from the issuance of 6.5% senior notes due 2026 (the “Senior Notes”).
Organizational Structure as of January 29, 2020
Our Midstream Assets
Our midstream assets consist of two operating segments that we refer to as our “Anchor Systems” and “Additional Systems” based on their relative current cash flows, growth profiles, capital expenditure requirements and the timing of their development.
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Our Anchor Systems, in which the Partnership owns a 100% controlling interest, include our most developed midstream systems that generate the largest portion of our current cash flows, including our five primary midstream systems (the McQuay, Majorsville, Dry Ridge, Mamont and Shirley-Penns Systems), a 20” high-pressure pipeline contributed to us in the CNX Transaction and related assets.
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Our Additional Systems, in which the Partnership owns a 5% controlling interest, include several gathering systems throughout our dedicated acreage. Revenues from our Additional Systems are currently derived primarily from the Pittsburgh Airport area, which is within the wet gas region of our dedicated acreage. Currently, the substantial majority of capital investment in these systems would be funded directly by CNX Gathering in proportion to CNX Gathering’s 95% retained ownership interest.
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As a result of the CNX Transaction and HG Energy Transaction described in Business—Developments and Highlights above, the Partnership distributed its ownership interests in (i) our “Growth Systems,” which were primarily located in the dry gas regions of our dedicated acreage in central West Virginia, and (ii) the Moundsville area assets formerly within the Additional Systems, to CNX Gathering. CNX Gathering subsequently transferred these assets to HG Energy II Appalachia, LLC (“HG Energy”).
In order to maintain operational flexibility, our operations are conducted through, and our operating assets are owned by, our operating subsidiaries. However, neither we nor our operating subsidiaries have any employees. Our general partner has the sole responsibility for providing the personnel necessary to conduct our operations, whether through directly hiring employees or by obtaining the services of others, which include personnel of CNX Resources as provided through contractual relationships with the Partnership. All of the personnel who conduct our business are employed or contracted by our general partner and its affiliates, including our Sponsor, but we sometimes refer to these individuals as our employees because they provide services directly to us.
The following map details our existing assets:
Gathering Assets and Compression and Dehydration Facilities
As of December 31, 2019, we operated 18 facilities to provide our compression and/or dehydration services. The following table provides information regarding our gathering assets and compression and dehydration facilities as of December 31, 2019:
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System
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Pipelines (in miles)
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Average Daily Throughput (BBtu/d)
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Maximum Interconnect Capacity(1) (BBtu/d)
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Compression (horsepower)
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Compression Capacity (BBtu/d)
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Anchor Systems
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253
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1,739
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2,467
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120,600
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2,565
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Additional Systems
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26
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82
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416
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—
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Total
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279
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1,821
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2,883
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120,600
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2,565
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(1) Maximum interconnect capacity is the maximum throughput that can be delivered from the system through physical interconnections to third-party facilities or pipelines. Our midstream systems currently have interconnects with the following interstate pipelines: Columbia Gas Transmission, Texas Eastern Transmission, National Fuel Gas Supply Corporation and Dominion Transmission, Inc.
Condensate Handling Facilities
Our assets include condensate handling facilities in the Majorsville and Shirley facilities located in West Virginia. Each facility provides condensate gathering, collection, separation and stabilization services and has a nominal handling capacity of approximately 2,500 Bbl/d.
Our Relationship with CNX Resources and CNX Gathering
CNX Resources, which owns a 100% interest in CNX Gathering, is a premiere independent natural gas exploration and production company, focusing on the major shale formations of the Appalachian Basin, including the Marcellus Shale and Utica Shale. CNX Resources deploys an organic growth strategy focused on developing its resource base.
CNX Gathering owns a non-economic general partnership interest (See Note 25 - Subsequent Event in the Notes to the Audited Consolidated Financial Statements in Item 8 of this Form 10-K for more information) as well as a 95% noncontrolling limited partner interest in our Additional Systems, which, combined with our right of first offer on those interests, may provide opportunities for us to grow our Distributable Cash Flow through a series of acquisitions of these retained interests over time. However, CNX Gathering is under no obligation to offer to sell us any assets, including our right of first offer (“ROFO”) assets, unless and until it otherwise intends to dispose of such assets, and we are under no obligation to buy any assets from CNX Gathering. In addition, we do not know when or if CNX Gathering will make any offers to sell assets to us.
The Partnership owns a 100% controlling interest in the Anchor Systems and a 5% controlling interest in the Additional Systems. Through our ownership of all of the outstanding general partner interests in our operating subsidiaries, the Partnership has voting control over, and the exclusive right to manage, the day-to-day operations, business and affairs of our midstream systems.
Our Acreage Dedication and Right of First Offer
As of December 31, 2019, our existing dedicated acreage covered approximately 363,000 aggregate net acres, comprised of approximately 262,000 Marcellus acres and approximately 101,000 Utica acres, subject to the release provisions set forth in our gas gathering agreements. Our gathering agreement with CNX Gas provides that, in addition to our existing dedicated acreage, any future acreage covering the Marcellus Shale formation that is acquired by CNX Gas in an area that covers over 4,100 square miles in West Virginia and Pennsylvania, which we refer to as the “dedication area,” and that is not subject to a pre-existing third-party commitment, will automatically be dedicated to us for natural gas midstream services, subject to the release provisions set forth in each agreement.
Our gathering agreement with CNX Gas also grants us ROFO rights to provide midstream services on certain of CNX Gas’ acreage, which we call the ROFO acreage. The ROFO acreage includes approximately 194,000 aggregate net acres that are not currently dedicated to us. Our ROFO acreage also includes any future acreage covering the Marcellus Shale formation that is acquired by CNX Gas in an area that covers over 11,800 square miles in Pennsylvania, that is not subject to a pre-existing third-party commitment, which we refer to as the “ROFO area”. There are no restrictions under our gathering agreements (discussed below) on the ability of CNX Gas to transfer acreage in the ROFO area, and any such transfer of acreage in the ROFO area will not be subject to our ROFO.
CNX Gathering has granted us a ROFO under the omnibus agreement between us, our general partner and CNX Resources to acquire (i) CNX Gathering’s retained interests in our Additional Systems, (ii) CNX Gathering’s other ancillary midstream assets and (iii) any additional midstream assets that CNX Gathering develops during the ten-year period ending 2024 (the “right of first offer period”). CNX Gathering is under no obligation to offer to sell us any assets (including our right of first offer assets, unless and until it otherwise intends to dispose of such assets), and we are under no obligation to buy any assets from CNX Gathering.
In addition, we do not know when or if CNX Gathering will make any offers to sell assets to us. While we believe our ROFO are significant positive attributes, they may also be sources of conflicts of interest. CNX Gathering owns our general partner, and there is substantial overlap between the officers and directors of our general partner and the officers and directors of CNX Resources. Please read “Part I. Item 1A. Risk Factors—Risks Related to our Business—CNXM does not have any officers or employees and rely on officers of our general partner and employees of our Sponsor.”
Our Gathering Agreements with CNX Gas and HG Energy
Fees, Well Commitments and Minimum Volume Commitments
We entered into a Second Amended and Restated GGA with CNX Gas in January 2018, which is a 20-year, fixed-fee gathering agreement. Although the fees for services we provide in the Marcellus Shale for existing wells remain unchanged in the new agreement, and are identical to the fees we charge to HG Energy (discussed below), the Second Amended and Restated GGA also dedicated additional acreage in the Utica Shale in and around the McQuay area and Wadestown area and introduced the following gas gathering and compression rates (rates shown effective January 1, 2020):
•Gas Gathering:
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McQuay area Utica - a fee of $0.2368 per MMBtu; and
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Wadestown Marcellus and Utica - a fee of $0.3678 per MMBtu.
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For areas not benefitting from system expansion pursuant to the Second Amended and Restated GGA, compression services are included in the base fees; and
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In the McQuay and Wadestown areas, we will receive additional fees of $0.0683 per MMBtu for Tier 1 pressure services (maximum receipt point of pressure of 600 psi) and $0.1366 per MMBtu for Tier 2 pressure services (maximum receipt point of pressure of 300 psi).
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The Second Amended and Restated GGA also commits CNX Gas to drill and complete the following number of wells in the McQuay area within the Anchor Systems for the periods indicated, provided that if a certain minimum number of wells have been drilled and completed in the Marcellus Shale, then the remainder of such planned wells must be drilled in the Utica Shale. To the extent the requisite number of wells are not drilled by CNX Gas in a given period, we will be entitled to a deficiency payment per shortfall well as set out in the parenthetical below:
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January 1, 2018 to December 31, 2018 - 30 wells (CNX exceeded this requirement by eight wells)
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January 1, 2019 to April 30, 2020 - 40 wells (deficiency payment of $3.5 million per well)
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May 1, 2020 to April 30, 2021 - 40 wells (deficiency payment of $2.0 million per well)
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May 1, 2021 to April 30, 2022 - 30 wells (deficiency payment of $2.0 million per well)
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In the event that CNX Gas drills and completes a number of wells in excess of the number required to be drilled and completed in such period, (i) the number of excess wells drilled and completed during such period will be applied to the minimum well requirement in the succeeding period or (ii) to the extent CNX Gas was required to make deficiency payments for shortfalls in the preceding period, CNX Gas may elect to cause the Partnership to pay a refund in an amount equal to (x) the number of excess wells drilled and completed during the period, multiplied by (y) the deficiency payment paid per well during the period in which the shortfall occurred. CNX Gas satisfied its minimum well obligation for the year ended December 31, 2018.
In connection with the Shirley-Penns Acquisition, the Second Amended and Restated GGA was amended to add a minimum volume commitment (“MVC”) on volumes associated with the Shirley-Penns System through December 31, 2031. The MVC commits CNX Gas to pay the Partnership the wet gas fee under the GGA for all natural gas we gather up to a specified amount per day through December 31, 2031. We will recognize minimum revenue on volumes throughout the term of the GGA, as set forth below:
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(in millions)
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Minimum Revenue
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Year ending December 31, 2020
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$
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17.5
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Year ending December 31, 2021
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40.7
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Year ending December 31, 2022
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47.7
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Year ending December 31, 2023
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42.8
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Year ending December 31, 2024
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39.6
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Remainder of term
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174.0
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Total revenue to be recognized under Shirley-Penns contract through December 31, 2031
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$
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362.3
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See “Part II. Item 8. Financial Statements and Supplementary Data—Note 4—Related Party Transactions” for additional information.
We entered into a Second Amendment to the Second Amended and Restated GGA in May 2018, which committed CNX Gas to drill and complete an additional 40 wells in the Majorsville/Mamont area within the Anchor Systems by the end of 2023. To the extent the requisite number of wells are not drilled and completed by CNX Gas in a given period, we will be entitled to a deficiency payment per shortfall well as set forth below:
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July 1, 2018 to December 31, 2020 - an additional 15 wells (As of December 31, 2019, CNX Gas has exceeded this minimum well commitment by six wells)
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January 1, 2021 - December 31, 2023 - an additional 25 wells (deficiency payment of $2.8 million per well)
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On December 1, 2016, we entered into fixed-fee gathering agreements with CNX Gas and Noble Energy that replaced the gathering agreements that had been in place since our initial public offering (“IPO”). Our gathering agreement with Noble Energy was assigned to HG Energy effective June 28, 2017 and was further amended in connection with the HG Energy Transaction. The fixed fee terms for our gathering of HG Energy’s dry gas, wet gas, and condensate remain unchanged following the June 2017 assignment and May 2018 amendment; however, other terms have changed related to our obligations to build infrastructure, the amount of acreage that is dedicated to us and can be released, service and system requirements, and minimum well development provisions. Please read “Part I. Item 1A. Risk Factors—Risks Related to Our Business—Our gathering agreements with our customers provide for the release of dedicated acreage or fee credits in certain situations.” for additional details.
We entered into a Second Amendment to the Second Amended and Restated GGA in May 2018, which committed HG Energy to drill and complete an additional 12 wells in the Majorsville area within the Anchor Systems by the end of 2021. To the extent the requisite number of wells are not drilled and completed by HG Energy in a given period, we will be entitled to a deficiency payment per shortfall well as set forth below:
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May 2, 2018 to December 31, 2018 - an additional 3 wells (HG Energy has met this requirement)
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January 1, 2019 to December 31, 2021 - an additional 9 wells (deficiency payment of $2.8 million per well)
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Under the gathering agreements with CNX Gas and HG Energy, effective January 1, 2019, we will receive a fee based on the type and scope of the midstream services we provide, summarized as follows (rates shown effective January 1, 2020):
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With respect to natural gas from the Marcellus Shale formation that does not require downstream processing, or dry gas, we receive a fee of $0.4531 per MMBtu.
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With respect to natural gas that requires downstream processing, or wet gas, we receive a fee of $0.3116 per MMBtu in the Pittsburgh International Airport area and a fee of $0.6222 per MMBtu for all other areas in the dedication area.
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Our fees for condensate services are $5.6580 per Bbl in the Majorsville area and the Shirley-Penns area.
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Each of the foregoing fees paid by CNX Gas or HG Energy, as applicable, escalates by 2.5% annually, through and including the final calendar year of the initial term. With respect to our GGA with CNX Gas, commencing on January 1, 2035, and on each January 1 thereafter, each of the applicable fees will be adjusted pursuant to the percentage change in CPI-U, but such fees will never escalate or decrease by more than 3%.
There are no restrictions under our gathering agreements with CNX Gas on the ability of CNX Gas to transfer acreage in the right of first offer (“ROFO”) area, and any such transfer of acreage in the ROFO area will not be subject to our right of first offer.
Upon completion of their initial 20-year terms, each of our gathering agreements with CNX Gas and HG Energy will continue in effect from year to year until such time as the agreement is terminated by either us or the other party to such agreement on or before 180 days prior written notice.
Other Gathering Agreement Matters
We gather, compress, dehydrate and deliver dedicated natural gas for CNX Gas and HG Energy on a first-priority basis in the Marcellus Shale, gather, inject, stabilize and/or store all of CNX Gas’ and HG Energy’s dedicated condensate on a first-priority basis in the Majorsville area and gather, inject, stabilize and/or store all of CNX Gas’ dedicated condensate on a first-priority basis in the Shirley-Penns and Pittsburgh International Airport areas, subject to certain exceptions described in our respective gathering agreements.
Pursuant to the terms of our GGA’s, we are entitled to receive ongoing updates from our two largest customers regarding their drilling and development operations, which include detailed descriptions of drilling plans, production details and well locations for periods that range from 24 to 48 months, as well as more general development plans that may extend as far as ten years. In addition, we regularly meet with our customers to discuss our current plans to construct the facilities necessary to provide midstream services to each of them on our dedicated acreage. In the event that we do not perform our obligations under a gathering agreement, CNX Gas or HG Energy, as applicable, will be entitled to certain rights and procedural remedies thereunder, including rate credits, the temporary and/or permanent release from dedication discussed below and indemnification from us. See “Part I. Item 1A. Risk
Factors—Risks Related to Our Business—Our gathering agreements with our customers provide for the release of dedicated acreage or fee credits in certain situations.” for additional details.
Third-Party Services and Commitments
Our GGAs, in certain instances, limit the scope of services we provide, which impacts the fees we charge. Under such agreements, we may provide only gathering services, while other parties may provide other services such as compression and/or dehydration.
The most significant of these agreements is with CNX Gas and relates to the Pittsburgh International Airport area, where we only provide gathering services. With respect to this area, CNX Gas has contracted with a third party for the provision of services, such as compression and dehydration, which we are not providing. Accordingly, we charge CNX Gas a reduced fee for the services we provide with respect to all natural gas and condensate produced from the Pittsburgh International Airport area. While such arrangements have historically been the exception, we do have similar arrangements with other shippers.
Title to Our Properties
Our real property interests are acquired pursuant to easements, rights-of-way, permits, surface use agreements, deeds or licenses from landowners, lessors, easement holders, governmental authorities, or other parties controlling surface estate (collectively, “surface agreements”). These surface agreements allow us to use such land for our operations. Thus, the real estate interests on which our pipelines and facilities are located are held by us as grantee, and the party who owns or controls the surface lands, as grantor. We have acquired these surface agreements without any material challenge known to us relating to the title to the land upon which the assets are located, and we believe that we have satisfactory rights and interests to conduct our operations on such lands. We have no knowledge of any challenge to the underlying title of any material surface agreements held by us or to our title to any material surface agreements, and we believe that we have satisfactory title to all of our material surface agreements.
Some of the surface agreements that were transferred to us from CNX Gathering required the consent of the grantor or other holder of such rights. CNX Gathering obtained sufficient third-party consents and authorizations and provided notices required for the transfer of the assets necessary to enable us to operate our business in all material respects. With respect to any remaining consents, authorizations or notices that have not been obtained or provided, we have determined these will not have a material adverse effect on the operation of our business should the Partnership or CNX Gathering fail to obtain or provide such consents, authorizations or notices in a reasonable time frame.
Seasonality
Demand for natural gas generally decreases during the spring and fall months and increases during the summer and winter months. However, seasonal anomalies such as mild winters or mild summers sometimes lessen this fluctuation. In addition, certain natural gas users utilize natural gas storage facilities and purchase some of their anticipated winter requirements during the summer, which can also lessen seasonal demand fluctuations. These seasonal anomalies can increase demand for natural gas during the summer and winter months and decrease demand for natural gas during the spring and fall months. With respect to our completed midstream systems, we do not expect seasonal conditions to have a material impact on our throughput volumes. Severe or prolonged winters may, however, impact our ability to complete additional well connections or complete construction projects, which may impact the rate of our growth. In addition, severe winter weather may also impact or delay the execution of our customers’ drilling and development plans.
Competition
As a result of our acreage dedications from CNX Gas and HG Energy, we do not compete for the portion of the existing operations of CNX Gas’ and HG Energy’s upstream operations for which we currently provide midstream services, and other than with respect to acreage that may be released, subject to the terms of our GGAs, we will not compete for future portions of their upstream operations that are dedicated to us pursuant to our gathering agreements. Please read “Business—Our Acreage Dedication and Right of First Offer” above. Nonetheless, CNX Gas and HG Energy have entered into agreements with third parties for the provision of certain midstream services. Please read “Business—Third-Party Services and Commitments” above. In addition, we face competition in attracting third-party volumes to our midstream systems, and these third parties may develop their own midstream systems in lieu of employing our assets.
Regulation of Operations
Our gathering and midstream operations are subject to various federal, state and local (including county and municipal level) laws and regulations. These laws and regulations cover virtually every aspect of our operations including, among other things: use of public roads; pipeline construction and the compression and transmission of natural gas and liquids; reclamation and restoration of properties after operations are completed; handling, storage, transportation and disposal of materials used or generated by our operations; and gathering of natural gas production. Numerous governmental permits, authorizations and approvals under these laws and regulations are required for midstream operations. These laws and regulations, and the permits, authorizations and
approvals issued pursuant thereto, are intended to protect, among other things: air quality; ground water and surface water resources, including drinking water supplies; wetlands; waterways; endangered plants and wildlife; state natural resources and the health and safety of our employees and the communities in which we operate.
We endeavor to conduct our operations in compliance with all applicable federal, state and local laws and regulations. However, because of extensive and comprehensive regulatory requirements against a backdrop of variable geologic and seasonal conditions, permit exceedances and violations during operations can and do occur. Such exceedances and violations generally result in fines or penalties but could make it more difficult for us to obtain necessary permits in the future. The possibility exists that new legislation or regulations may be adopted which would have a significant impact on our operations and may require us to change our operations significantly or incur substantial costs. See “Part I. Item 1A. Risk Factors—Risks Related to our Business—Existing and future governmental laws, regulations and judicial decisions that govern our business may increase our costs of doing business, restrict our operations or impede our ability to satisfy our obligations under our gas gathering agreements.” for additional discussion regarding additional laws and regulations affecting our business, operations and industry.
Regulation of the Gathering and Transportation of Natural Gas
Regulations and orders issued by the Federal Energy Regulatory Commission (FERC) impact our business to a certain degree. Although the FERC does not directly regulate our gathering and midstream activities, the FERC has stated that it intends for certain of its orders to foster increased competition within all phases of the natural gas industry. Additionally, the FERC has jurisdiction over the transportation of natural gas in interstate commerce, and regulates the terms, conditions of service, and rates for the interstate transportation of natural gas. The FERC possesses regulatory oversight over natural gas markets, including anti-market manipulation regulation. The FERC has the ability to assess civil penalties, order disgorgement of profits and recommend criminal penalties for violations of the Natural Gas Act of 1938 (the “Natural Gas Act”) or the FERC’s regulations and policies thereunder.
Section 1(b) of the Natural Gas Act exempts natural gas gathering facilities from regulation by the FERC. However, the distinction between federally unregulated gathering facilities and FERC-regulated transmission facilities is a fact-based determination, and the classification of such facilities may be the subject of dispute and, potentially, litigation. We own certain natural gas pipeline facilities that we believe meet the traditional tests which the FERC has used to establish a pipeline's status as a gatherer not subject to the FERC jurisdiction. However, FERC determines whether facilities are gas gathering facilities on a case-by-case basis, so the classification and regulation of some our gas gathering facilities may be subject to change based on future determinations by FERC, the courts, or Congress. If FERC were to determine that our facilities or services provided by us are not exempt from FERC regulation under the NGA, the rates for, and terms and conditions of, services provided by such facility would be subject to regulation by FERC under the NGA and/or the Natural Gas Policy Act (“NGPA”), which could decrease revenue, increase operating costs, and, depending upon the facility in question, adversely affect our results of operations and cash flows.
State regulation of natural gas gathering facilities and intrastate transportation pipelines generally includes various safety, environmental and, in some circumstances, nondiscriminatory take requirements and complaint-based rate regulation. States in which we operate may adopt ratable take and common purchaser statutes, which would require our gathering pipelines to take natural gas without undue discrimination in favor of one producer over another producer or one source of supply over another similarly situated source of supply. The regulations under these statutes may have the effect of imposing some restrictions on our ability as an owner of gathering facilities to decide with whom we contract to gather natural gas. States in which we operate may also adopt a complaint-based regulation of natural gas gathering activities, which allows natural gas producers and shippers to file complaints with state regulators in an effort to resolve grievances relating to gathering access and rate discrimination. We cannot predict whether such regulation will be adopted and whether such a complaint will be filed against us in the future. Failure to comply with state regulations can result in the imposition of administrative, civil and criminal remedies. To date, our midstream systems have not been adversely affected by recent state regulations.
Our gathering operations could be adversely affected should they be subject in the future to more stringent application of state regulation of rates and services. Our gathering operations also may be or become subject to additional safety and operational regulations relating to the design, installation, testing, construction, operation, replacement and management of gathering facilities. Additional rules and legislation pertaining to these matters are considered or adopted from time to time. We cannot predict what effect, if any, such changes might have on our operations, but the industry could be required to incur additional capital expenditures and increased costs depending on future legislative and regulatory changes.
Environmental Laws
Our midstream operations are subject to numerous federal, state and local level environmental laws and regulations. In addition to routine reviews and inspections by regulators to confirm compliance with applicable regulatory requirements, we have established protocols for ongoing assessments to identify potential environmental exposures. These assessments take into account industry and internal best management practices, evaluate compliance with laws and regulations and include reviews of our third-party service providers, including, for instance, waste management facilities.
The trend in environmental regulation is to place more restrictions and limitations on activities that may affect the environment and thus, there can be no assurance as to the amount or timing of future expenditures for environmental compliance or remediation and actual future expenditures may be different from the amounts we currently anticipate. As with the midstream industry in general, complying with current and anticipated environmental laws and regulations can increase our capital costs to construct, maintain and operate equipment and facilities. While these laws and regulations affect our maintenance capital expenditures and net income, we do not believe they will have a material adverse effect on our business, financial position or results of operations or cash flows. In addition, we believe that the various activities in which we are presently engaged that are subject to environmental laws and regulations are not expected to materially interrupt or diminish our operational ability to gather natural gas. We cannot assure, however, that future events, such as changes in existing laws or enforcement policies, the promulgation of new laws or regulations, or the development or discovery of new facts or conditions will not cause us to incur significant costs. Below is a discussion of the material environmental laws and regulations that relate to our business.
Hydraulic Fracturing Activities. Although we do not conduct hydraulic fracturing operations, substantially all of our customers’ natural gas production on our dedicated acreage is developed from unconventional sources, such as shales, that require hydraulic fracturing as part of the well completion process. Hydraulic fracturing is typically regulated by state oil and natural gas commissions and similar agencies, but the U.S. Environmental Protection Agency (“EPA”) has asserted certain regulatory authority over hydraulic fracturing and has moved forward with various regulatory actions, including the issuance of new regulations requiring green completions for hydraulically fractured wells, and has disclosed its intent to develop regulations to require companies to disclose information regarding the chemicals used in hydraulic fracturing. Some states, including states in which we operate, have adopted regulations that could impose more stringent disclosure and/or well construction requirements on hydraulic fracturing operations, or otherwise seek to ban some or all of these activities. Additionally, these federal requirements and proposals may be subject to further review and revision by the EPA.
Scrutiny of hydraulic fracturing activities also continues in other ways at the federal and local levels. For example, in June 2015, the EPA issued its draft report on the potential impacts of hydraulic fracturing on drinking water and groundwater. The draft report found no systemic negative impacts from hydraulic fracturing. In December 2016, the EPA released its final report on the impacts of hydraulic fracturing on drinking water. While the language was changed and included the possibility of negative impacts from hydraulic fracturing, it also included the guidance to industry and regulators on how the process can be performed safely. We cannot predict whether any other legislation or regulations will be enacted and if so, what its provisions will be.
Clean Air Act. The federal Clean Air Act and corresponding state laws and regulations regulate air emissions primarily through permitting and/or emissions control requirements. Various activities in our operations are subject to air quality regulation, including pre-construction and operational permit requirements, noise and emission limits, operational limits, and monitoring, reporting and record-keeping requirements on air emission sources, including our pipeline compression stations, as well as fugitive emissions from operations. We obtain permits, typically from state or local authorities, to conduct these activities. Additionally, we are required to obtain pre-approval for construction or modification of certain facilities, to meet stringent air permit requirements, or to use specific equipment, technologies or best management practices to control emissions. Further, some states and the federal government have proposed that emissions from certain proximate and related sources should be aggregated to provide for regulation and permitting of a single, major source. Federal and state governmental agencies continue to investigate the potential for emissions from oil and natural gas activities, and further regulation could increase our cost or temporarily restrict our ability to produce. For example, the EPA sets National Ambient Air Quality Standards for certain pollutants and changes to such standards could cause us to make additional capital expenditures or alter our business operations in some manner. See “Risk Factors—Climate change laws and regulations restricting emissions of greenhouse gases at the federal or state level could result in increased operating costs and reduced demand for the natural gas that we gather while potential physical effects of climate change could disrupt our production and cause us to incur significant costs in preparing for or responding to those effects.” for additional discussion regarding certain laws and regulations related to air emissions and related matters.
Clean Water Act. The federal Clean Water Act (“CWA”) and corresponding federal and state laws affect our midstream operations by regulating storm water or other regulated substance discharges, including pollutants, sediment, and spills and releases of oil, brine and other substances, into surface waters, and in certain instances imposing requirements to dispose of produced
wastes and other oil and gas wastes at approved disposal facilities. The discharge of pollutants into jurisdictional waters is prohibited, except in accordance with the terms of a permit issued by the EPA, the U.S. Army Corps of Engineers, or a delegated state agency. These permits require regular monitoring and compliance with effluent limitations and reporting requirements, and govern the discharge of pollutants into regulated waters. Federal and state regulatory agencies can impose administrative, civil and/or criminal penalties for non-compliance with discharge permits or other requirements of the CWA and analogous state laws and regulations. See “Risk Factors—Environmental regulations can increase costs and introduce uncertainty that could adversely impact our or our customers’ operations.” for additional discussion regarding certain laws and regulations related to clean water, the disposal or use of water and related matters.
Endangered Species Act. The Endangered Species Act and related state regulation protect plant and animal species that are threatened or endangered. Some of our operations are located in areas that are or may be designated as protected habitats for endangered or threatened species, including the Northern Long-Eared and Indiana bats, which has a seasonal impact on our construction activities and operations. New or additional species that may be identified as requiring protection or consideration may lead to delays in permits and/or other restrictions.
Safety of Gas Transmission and Gathering Pipelines. Some of our natural gas pipelines are subject to regulation by the U.S. Department of Transportation’s Pipeline and Hazardous Materials Safety Administration (“PHMSA”) pursuant to the Natural Gas Pipeline Safety Act of 1968, (“NGPSA”), as amended by the Pipeline Safety Act of 1992 (“PSA”), the Accountable Pipeline Safety and Partnership Act of 1996 (“APSA”), the Pipeline Safety Improvement Act of 2002 (“PSIA”), the Pipeline Inspection, Protection, Enforcement and Safety Act of 2006 (“PIPES Act”), and the Pipeline Safety, Regulatory Certainty, and Job Creation Act of 2011 (the “2011 Pipeline Safety Act”). The NGPSA regulates safety requirements in the design, construction, operation and maintenance of natural gas pipeline facilities, while the PSIA establishes mandatory inspections for all U.S. oil and natural gas transmission pipelines in high-consequence areas (“HCAs”).
States are largely preempted by federal law from regulating pipeline safety for interstate lines but most are certified by the Department of Transportation (“DOT”), to assume responsibility for enforcing federal intrastate pipeline regulations and inspection of intrastate pipelines. States may adopt stricter standards for intrastate pipelines than those imposed by the federal government for interstate lines; however, states vary considerably in their authority and capacity to address pipeline safety. State standards may include more stringent requirements for facility design and management in addition to requirements for pipelines. We do not anticipate any significant difficulty in complying with applicable state laws and regulations. Our natural gas pipelines have continuous inspection and compliance programs designed to keep the facilities in compliance with pipeline safety and pollution control requirements.
PHMSA has developed regulations that require pipeline operators to implement integrity management programs, including more frequent inspections and other measures to ensure pipeline safety in HCAs. Additionally, certain states, such as West Virginia, also maintain jurisdiction over intrastate natural gas lines. Should our operations fail to comply with PHMSA or comparable state regulations, we could be subject to substantial penalties and fines. PHMSA released a pre-publication copy of its final hazardous liquid pipeline safety regulations that would significantly extend the integrity management requirements to previously exempt pipelines and would impose additional obligations on hazardous liquid pipeline operators that are already subject to the integrity management requirements, but due to the change in Presidential administrations, PHMSA’s final hazardous liquid pipeline safety rule has not yet taken effect, though PHMSA is expected to finalize its hazardous liquid pipeline safety rule soon. PHMSA’s proposed rule would also require annual reporting of safety-related conditions and incident reports for all hazardous liquid gathering lines and gravity lines, including pipelines exempt from PHMSA regulations. See “Part I. Item1A. Risk Factors—Risks Related to Our Business—We may incur significant costs and liabilities as a result of pipeline operations and related increases in the regulation of gas gathering pipelines.” for additional discussion regarding gas transmission and gathering pipelines.
Resource Conservation and Recovery Act. The federal Resource Conservation and Recovery Act (RCRA) and corresponding state laws and regulations affect natural gas operations by imposing requirements for the management, treatment, storage and disposal of hazardous and non-hazardous wastes, including wastes generated by our gathering and midstream operations. Facilities at which hazardous wastes have been treated, stored or disposed of are subject to corrective action orders issued by the EPA that could adversely affect our financial results, financial condition and cash flows. Our operations generate solid wastes, including some hazardous wastes, that are subject to the RCRA, and comparable state laws, which impose requirements for the handling, storage, treatment and disposal of non-hazardous and hazardous waste. RCRA currently exempts certain wastes associated with the exploration, development or production of natural gas, which we handle in the course of our operation, including produced water. However, these exploration and production wastes may still be regulated by the EPA or state agencies under RCRA’s less stringent non-hazardous solid waste provisions, state laws or other federal laws, and it is possible that certain exploration and production wastes now classified as non-hazardous could be classified as hazardous in the future. On December 28, 2016 the EPA entered into a consent order to resolve outstanding litigation brought by environmental and citizen groups regarding the applicability
of RCRA to wastes from oil and gas development activities. In April 2019, the EPA issued a report concluding that revisions to the federal regulations for the management of exploration and production wastes under RCRA were not necessary at the time the report was issued. We cannot predict whether the EPA may change its conclusion at some point, or whether any other legislation or regulations will be enacted and if so, what their provisions will be.
Health and Safety Laws
Occupational Safety and Health Act. Our natural gas gathering and compression activities are subject to stringent and complex federal, state and local laws and regulations relating to the protection of the environment and worker health and safety. As an owner or operator of these facilities, we must comply with these laws and regulations at the federal, state and local levels. Our midstream operations are subject to regulation under the federal Occupational Safety and Health Act (OSHA) and comparable state laws in some states, all of which regulate health and safety of employees at our natural gas operations. Additionally, OSHA's hazardous communication standard, the EPA community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act and comparable state laws require that information be maintained about hazardous materials used or produced by our operations and that this information be provided to employees, state and local governments and the public.
Climate Change Laws and Regulations
Climate change continues to be a legislative and regulatory focus. There are a number of proposed and final laws and regulations that limit greenhouse gas emissions, and regulations that restrict emissions could increase our costs should the requirements necessitate the installation of new equipment or the purchase of emission allowances. These laws and regulations could also impact our customers, including the electric generation industry, making alternative sources of energy more competitive. Additional regulation could also lead to permitting delays and additional monitoring and administrative requirements, as well as to impacts on electricity generating operations. See “Part I. Item1A. Risk Factors—Risks Related to Our Business—Climate change laws and regulations restricting emissions of greenhouse gases at the federal or state level could result in increased operating costs and reduced demand for the natural gas that CNXM gathers while potential physical effects of climate change could disrupt our production and cause us to incur significant costs in preparing for or responding to those effects.” for additional discussion regarding certain laws and regulations related to climate change, greenhouse gas and related matters.
Employees
We have no employees. The officers of our general partner manage our operations and activities. All of the employees required to conduct and support our operations, including our Chief Executive Officer, Chief Financial Officer and President, are employed by CNX Resources and are subject to the operational services agreement and omnibus agreement between us, our general partner and CNX Resources. These agreements are subject to adjustment on an annual basis.
Offices
Our principal offices are located at CNX Center, 1000 CONSOL Energy Drive, Canonsburg, Pennsylvania 15317.
Insurance
We maintain insurance policies with insurers in amounts and with coverage and deductibles that we believe are reasonable and prudent. We cannot, however, assure that this insurance will be adequate to protect us from all material expenses related to potential future claims for personal and property damage or that these levels of insurance will be available in the future at economical prices.
Financial Information about Segments
Please read Part II. Item 8. Note 9—Segment Information, for financial information by business segment including, but not limited to, gathering revenue, net income (loss), and total assets, which information is incorporated herein by reference.
Legal Proceedings
Our operations are subject to a variety of risks and disputes normally incident to our business. As a result, we may, at any given time, be a defendant in various legal proceedings and litigation arising in the ordinary course of business. However, we are not currently a party to any material litigation.
Available Information
Our website is www.cnxmidstream.com. We make our periodic reports and other information filed with or furnished to the SEC, available, free of charge, on our website under “Investors/SEC Filings,” as soon as reasonably practicable after those reports and other information are electronically filed with or furnished to the SEC. Alternatively, you may access these reports at the SEC’s website at www.sec.gov. Information on our website or any other website is not incorporated by reference into, and does not constitute a part of, this Annual Report on Form 10-K.
Also posted on our website under “About/Our Governance”, and available in print upon request made by any unitholder to the Investor Relations department, are our audit committee charter and copies of our Code of Ethics (the “Code”), Corporate Governance Guidelines and Whistleblower policy. Within the time period required by the SEC and the NYSE, as applicable, we will post on our website any modifications to the Code and any waivers applicable to senior officers as defined in the Code, as required by the Sarbanes-Oxley Act of 2002.
ITEM 1A.RISK FACTORS
Limited partner interests are inherently different from the capital stock of a corporation, although many of the business risks to which CNXM is subject are similar to those that would be faced by a corporation engaged in a similar business. Unitholders should carefully consider the following risk factors together with all of the other information set forth in this Annual Report on Form 10-K, including the matters addressed under “Forward-Looking Statements,” in evaluating an investment in our common units.
If any of the following risks were to occur, our business, financial condition, results of operations, cash flows and ability to make cash distributions could be materially adversely affected. In that case, CNXM may not be able to pay the minimum quarterly distribution on our common units, the trading price of our common units could decline and unitholders could lose all or part of your investment. In addition, the current economic and political environment intensifies many of these risks.
Risks Related to Our Business
If any of our primary customers, who account for substantially all of our revenues, change their business strategies, or take actions that otherwise significantly reduce the volumes of natural gas and condensate transported through our gathering systems, our revenue would decline and our business, financial condition, results of operations, cash flows and ability to make distributions to our unitholders would be materially and adversely affected.
As CNXM currently derives substantially all of our revenue from our gathering agreements with our three main customers, including our Sponsor, any event that materially and adversely affects these customers’ business strategies with respect to drilling on and development of our dedicated acreage or their financial condition, results of operations or cash flows may adversely affect our ability to sustain or increase cash distributions to our unitholders. Accordingly, CNXM is indirectly subject to the operational and business risks of our customers, the most significant of which include the following:
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a reduction in or slowing of our customers’ drilling and development plans on our dedicated acreage;
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a reduction in, or curtailment of, production from existing wells on our dedicated acreage;
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the extreme volatility of natural gas, NGL and crude oil prices, which could have a negative effect on our customers’ drilling and development plans or their ability to finance its operations and drilling and exploration costs on our dedicated acreage;
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the availability of capital on an economic basis to fund exploration and development activities of our customers;
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drilling and operating risks associated with our customers’ operations on our dedicated acreage;
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downstream processing and transportation capacity constraints and interruptions, including the failure of our customers to have sufficient contracted processing or transportation capacity; and
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adverse effects of increased or changed governmental and environmental regulation, including environmental and climate-change related regulations and delays.
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In addition, CNXM is indirectly subject to the general business risks of our customers and other factors, including their financial condition, credit ratings, leverage, market reputation, liquidity and cash flows; their ability to maintain or replace reserves; adverse effects of regulation on their upstream operations; and losses from pending or future litigation.
Further, CNXM has no control over the business decisions and operations of our customers, and they are under no obligation to adopt business strategies that are favorable to us. CNXM is subject to the risk of non-payment or non-performance by our customers, including with respect to our gathering agreements that do not contain minimum volume commitments. In addition, our gas gathering agreements permit our customers to release portions of acreage from dedication under the respective agreements, subject to the terms of the respective gathering agreements.
Global energy commodity prices may fluctuate widely in response to market uncertainty and relatively minor changes in the supply of and demand for oil, natural gas and NGLs. Historically, oil, natural gas and NGL prices have been volatile. Lower commodity prices reduce the cash flows of our customers and may affect their borrowing ability. Our customers may be unable to obtain needed capital or financing on satisfactory terms, which could lead to lower development levels and/or a decline in their reserves as existing reserves are depleted. Lower commodity prices may also reduce the amount of natural gas, NGLs and oil that our customers can produce economically. If commodity prices further decrease, a significant portion of their exploitation, development and exploration projects on our dedicated acreage could become uneconomic. Further commodity price decreases could result in our customers having to make significant downward adjustments to their estimated proved reserves on our dedicated acreage. As a result, a substantial or extended decline in commodity prices may materially and adversely affect our customers’ future business, financial condition, results of operations, liquidity or ability to finance planned capital expenditures.
Any material non-payment or non-performance by our counterparties under our gathering agreements would have a significant adverse impact on our business, financial condition, results of operations and cash flows and could therefore have a material adverse effect on our ability to make cash distributions to our unitholders at the expected rate or at all. There is no guarantee that we will be able to renew or replace those gathering agreements on equal or better terms upon their expiration. Our ability to renew
or replace our gathering agreements with our customers following their expiration at rates sufficient to maintain our current revenues and cash flows could be adversely affected by activities beyond our control, including the activities of our customers and our competitors.
Under our gathering agreements, our customers may transfer their leasehold, working and mineral fee interests in their dedicated acreage.
Our customers may transfer their leasehold, working and mineral fee interests in, or grant an overriding royalty interest, production payment, net profits interest or other similar interest in their dedicated acreage. Each of our customers continually evaluates how to enhance its upstream portfolio, including its holdings in the Marcellus Shale and could sell, exchange, farm-out or otherwise dispose of all of, or an undivided interest in, its Marcellus Shale holdings as part of these enhancement efforts. If either of our customers transfers all or an undivided portion of its interests in the future, its economic interest in developing the dedicated acreage could decrease, which could have a material adverse effect on our business, financial condition, results of operations, cash flows and ability to make cash distributions.
CNXM may not generate sufficient Distributable Cash Flow to make the payment of the minimum quarterly distribution to our unitholders.
In order to make the payment of the minimum quarterly distribution of $0.2125 per unit per quarter, or $0.85 per unit on an annualized basis, CNXM must generate Distributable Cash Flow of approximately $13.8 million per quarter, or approximately $55.3 million per year, based on the number of common units and the general partner interest outstanding as of December 31, 2019. CNXM may not generate sufficient Distributable Cash Flow to make the payment of the minimum quarterly distribution to our unitholders.
The amount of cash CNXM can distribute on our units principally depends upon the amount of cash CNXM generates from our operations, which will fluctuate from quarter to quarter based on, among other things:
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the volume of natural gas we gather, compress and dehydrate, the volume of condensate gathered and treated and the fees paid for performing such services;
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the effects of changes in market prices of natural gas, NGLs and crude oil on our customers’ drilling and development plans on our dedicated acreage and the volumes of natural gas and condensate that are produced on our dedicated acreage;
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our customers’ ability to fund their drilling and development plans on our dedicated acreage;
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capital expenditures necessary for us to maintain and build out our midstream systems to gather natural gas and condensate from our customers’ new well completions on our dedicated acreage;
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the levels of our operating expenses, maintenance expenses and general and administrative expenses;
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regulatory action affecting: (i) the supply of, or demand for, natural gas, NGLs and condensate, (ii) the rates CNXM can charge for our midstream services, (iii) the terms upon which we are able to contract to provide our midstream services, (iv) our existing gathering and other commercial agreements or (v) our operating costs or our operating flexibility;
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our ability to generate adequate returns on capital;
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the rates CNXM charges third parties, if any, for our midstream services;
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prevailing economic conditions; and
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favorable or adverse weather conditions.
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In addition, the actual amount of Distributable Cash Flow that CNXM generates will also depend on various internal factors impacting our cash position, including the level and timing of our capital expenditures, limitations set forth in our debt agreements, our debt service requirements and other liabilities, the fees and expenses of our general partner and its affiliates (including our Sponsor) that CNXM is required to reimburse and other business risks affecting our cash levels.
Because of the natural decline in production from existing wells, our success, in part, depends on our ability to maintain or increase natural gas and condensate throughput volumes on our midstream systems, which is dependent on the level of development and completion activity on acreage dedicated to us.
The level of natural gas and condensate volumes handled by our midstream systems depends on the level of production from natural gas wells dedicated to our midstream systems, which may be less than expected and which will naturally decline over time. In order to maintain or increase throughput levels on our midstream systems, CNXM must obtain production from new wells completed by CNX Resources and any third-party customers on acreage dedicated to our midstream systems or execute agreements with other third parties in our areas of operation. We have no control over CNX Resources’ or other producers’ exploration and development determinations, levels of development and completion activity in our areas of operation, the amount of reserves associated with wells connected to our systems or the rate at which production from a well declines.
Due to a variety of factors, including projected pricing, demand, geologic considerations and other cost considerations, conservation measures that reduce demand, even if reserves are known to exist in areas served by our midstream systems, CNX Resources or other producers may choose not to develop those reserves. If CNX Resources or other producers choose not to develop their reserves or to slow their development rate, in our areas of operation, they will have no need to dedicate such additional
acreage and associated reserves to our midstream systems and the pace of such additional dedications will be below anticipated levels. In addition, our gas gathering agreements permit our customers to release portions of their acreage from dedication, subject to the terms of the agreements. Our inability to obtain additional dedications of acreage resulting from reductions in development activity, coupled with the natural decline in production from, or releases of, our current dedicated acreage, would result in our inability to maintain the then current levels of throughput on our midstream systems, which could materially adversely affect our business, financial condition, results of operations, cash flows and ability to make cash distributions.
CNXM gathers the majority of our volumes under gas gathering agreements that do not include minimum volume commitments.
Although CNXM has obtained certain acreage dedications and minimum well commitments, we gather the majority of our volumes outside the scope of minimum volume commitments, which generally would protect us against volumetric risks associated with lower-than-forecasted volumes flowing through our gathering system. Apart from minimum well commitments, our customers are not contractually obligated to us to develop their properties in the areas covered by our acreage dedications, and they may determine that it is more attractive to direct their capital spending and resources to other areas. A decrease in capital spending and development of reserves by our customers in the areas covered by our acreage dedications could result in reduced volumes serviced by us and a material decline in our revenues and cash flows. In addition, even where CNXM benefits from a commitment, our counterparty’s obligation to satisfy that commitment may be suspended due to the occurrence of a force majeure event, such as acts of God; acts of federal, state or local governments or agencies; strikes, lockouts or other industrial disturbances; acts of the public enemy, wars, blockades, insurrections, riots and epidemics; explosions, leakage, breakage, or accident to equipment or pipes; natural disasters and adverse weather events; and other similar events that are outside of our counterparty’s reasonable control.
Any decrease in the current levels of throughput on our gathering systems could materially adversely affect our business, financial condition, results of operations, cash flows and ability to make cash distributions.
Certain of our dedicated acreage is either not held by production by our customers or has not yet been earned by them under farmout agreements to which they are parties.
As of December 31, 2019, less than one-fifth of our dedicated acreage was not held by production or was yet to be earned by our customers; if the applicable shipper does not timely meet the obligations specified in the underlying leases, then the leases will terminate and will no longer be subject to our dedication. If any scenarios were to occur that result in the affected acreage no longer being dedicated to us, it could materially adversely affect our business, financial condition, results of operations, cash flows and ability to make cash distributions.
With respect to the dedicated acreage that is yet to be earned under certain farmout agreements, if the applicable customer does not meet its drilling obligations to earn the acreage subject to the farmout agreement prior to the termination of the farmout agreement, then it will have no further rights to earn any acreage that it has not previously earned under the farmout agreement. Also, if the counterparty to a farmout agreement becomes insolvent or bankrupt, then the farmout agreement may be deemed an executory contract that may be discharged in a bankruptcy proceeding. If our customers do not timely meet the obligations specified in the leases not held by production or do not earn all of the acreage subject to the farmout agreements prior to the termination of the farmout agreements or if such customer’s farmout agreements are discharged, the affected acreage will no longer be dedicated to us, which could materially adversely affect our business, financial condition, results of operations, cash flows and ability to make cash distributions.
CNXM may not own in fee the land on which our pipelines and facilities are located, which could result in disruptions to our operations.
Most of the land on which our midstream systems have been constructed is not owned in fee by us; rather, the properties are held by surface use agreements, rights-of-way or other easement rights. We are, therefore, subject to the possibility of more onerous terms or increased costs to retain necessary land use if CNXM does not have valid rights-of-way or if such rights-of-way lapse or terminate. CNXM may obtain the rights to construct and operate our pipelines on land owned by third parties and governmental agencies for a specific period of time. Our loss of these rights, through our inability to renew the right-of-way or for other reasons, could materially adversely affect our business, financial condition, results of operations, cash flows and ability to make cash distributions.
The highly competitive nature of our industry may adversely impact our ability to attract dedications of third-party volumes, which could limit our ability to grow and continue our dependence on our existing customers. Further, increased competition from other companies that provide midstream services could have a negative impact on the demand for our services, which could affect our financial results.
Over the near term, substantially all of our revenues will be earned from two customers relating to production they own or control on our dedicated acreage. Part of our long-term growth strategy includes diversifying our customer base on identifying opportunities to offer services to third parties in our areas of operation. Our ability to increase throughput on our midstream systems and any related revenue from third parties is subject to competitive pressures and is impacted by capacity limitations. Any lack of
available capacity on our systems will detrimentally affect our ability to compete effectively with other third-party systems. Some of our competitors for third-party volumes have greater financial resources and access to larger supplies of natural gas than those available to us, which could allow those competitors to price their services more aggressively. The industry has generally been experiencing increased competitive pressures as a result of both consolidation within the exploration and production industry, along with the emergence of stand-alone midstream companies. Further, hydrocarbon fuels compete with other forms of energy available to end users, including electricity and coal. Increased demand for such other forms of energy at the expense of hydrocarbons could lead to a reduction in demand for our services. In addition, the increased prevalence of non-hydrocarbon alternative fuel sources provide another source of competition for our customers, and as such, for us indirectly.
Our efforts to attract new third-party customers may be adversely affected by our relationship with our existing customers and the priority they receive under our gathering agreements with them and our desire to provide services pursuant to fee-based agreements. As a result, CNXM may not have the capacity to provide services to third parties and/or potential third-party customers may prefer to obtain services pursuant to other forms of contractual arrangements under which CNXM would be required to assume direct commodity exposure. In addition, potential third-party customers who are significant producers of natural gas and condensate may develop their own midstream systems in lieu of using our systems. All of these competitive pressures could make it more difficult for us to retain our existing customers or attract new customers as we seek to expand our business, which could have a material adverse effect on our business, financial condition, results of operations and ability to make quarterly cash distributions to our unitholders. In addition, competition could intensify the negative impact of factors discussed elsewhere throughout these risk factors that decrease demand for natural gas in the markets served by our systems, such as adverse economic conditions, weather, higher fuel costs and taxes or other governmental or regulatory actions that directly or indirectly increase the cost or limit the use of natural gas.
CNXM may not be able to make attractive offers to our Sponsor on our ROFO acreage.
Our Sponsor is required to allow us to make a first offer to provide midstream services on existing upstream acreage that is not currently dedicated to us or a third party, which, as of December 31, 2019, covered approximately 194,000 net acres, as well as future acreage acquired by our Sponsor in the ROFO area, which includes acreage outside our acreage dedication that may be serviced by our midstream systems. Our Sponsor is under no obligation to accept an offer CNXM makes on this acreage, even if CNXM submits the most attractive bid. Another midstream service provider may make a more attractive offer, whether because they have existing infrastructure on or around this acreage or otherwise. Any rejection by our Sponsor of any offer on this acreage could adversely affect our organic growth strategy or our ability to maintain or increase our cash distribution level.
Our interests in our operating subsidiaries represent our only cash-generating assets, our cash flow will depend entirely on the performance of our operating subsidiaries and their ability to distribute cash to us.
CNXM has a holding company structure, meaning the sole source of our earnings and cash flow consists exclusively of the earnings of and cash distributions from our operating subsidiaries. Therefore, our ability to make quarterly distributions to our unitholders is completely dependent upon the performance of our operating subsidiaries and their ability to distribute funds to us. CNXM is the sole member of the general partner of each of our operating subsidiaries, and CNXM controls and manages our operating subsidiaries through our ownership of our operating subsidiaries’ respective general partners.
The limited partnership agreement governing each operating company requires that the general partner of such operating company cause such operating company to distribute all of its available cash each quarter, less the amounts of cash reserves that such general partner determines are necessary or appropriate in its reasonable discretion to provide for the proper conduct of such operating company’s business. The amount of cash each operating company generates from its operations will fluctuate from quarter to quarter and the actual amount of cash each operating company will have available for distribution to its partners, including us, will depend on certain factors. For a description of the events, circumstances and factors that may affect the cash distributions from our operating subsidiaries please read the “Risk Factor—CNXM may not generate sufficient Distributable Cash Flow to make the payment of the minimum quarterly distribution to our unitholders.”
Our gathering agreements with our customers provide for the release of dedicated acreage or fee credits in certain situations.
Our gathering agreements with some of our customers, including HG Energy, provide that if CNXM fails to timely complete the construction of the facilities necessary to provide midstream services to their dedicated acreage or have an uncured default of any of our material obligations that has caused an interruption in our services to either party for more than 90 days, the affected acreage will be permanently released from our dedication. Our gathering agreement with CNX Gas provides that certain of our dedicated acreage that is generally outside of the proximity of the then-current gathering systems may be permanently released in the event that CNX Gas obtains a bona fide offer from a third party for gathering services for such dedicated acreage and CNXM elects not to provide gathering services on the terms of such bona fide offer. Any permanent releases of our customers’ acreage from our dedication could materially adversely affect our business, financial condition, results of operations, cash flows and ability to make cash distributions.
Our gathering agreement with CNX Gas provides that if we fail to timely complete the construction of the facilities necessary to provide midstream services to their dedicated acreage, we can be obligated to provide credits to amounts otherwise owed by our Sponsor under the gathering agreement for every day the services are delayed. Currently, the credits are $1,000 per day for failure to connect a fuel gas point on or before the applicable deadline for such fuel gas point, subject to a maximum credit of $365,000 per fuel gas point, and $1,000 per day for failure to connect a well on or before the applicable deadline for such well, subject to a maximum credit of $2,800,000 per well.
Our gathering agreement with HG Energy provides that in certain situations, such as an uncured default of any of our material obligations that has caused an interruption in our services for more than 45 days but less than 90 days, our dedicated acreage can be temporarily released from our dedication.
Our gathering agreement with CNX Gas also provides that if we fail for any reason, including an event of force majeure affecting us, to take all dedicated production tendered by our Sponsor at receipt points subject to the gathering agreement, the portion of dedicated production not taken by us is subject to a temporary release of dedication for as long as we fail to take such dedicated production, and if we fail to take such dedicated production for a period of more than five consecutive days or more than seven days in any 14 consecutive day period, our Sponsor has the right to have to a temporary release from dedication until the first day of the first calendar month that is 30 days following receipt by our Sponsor of a notice from us that we are ready to recommence receipt of the dedicated production. Any temporary releases of acreage from our dedication could materially adversely affect our business, financial condition, results of operations, cash flows and ability to make cash distributions.
Our midstream systems are exclusively located in the Appalachian Basin, making us vulnerable to risks associated with operating in a single geographic area.
CNXM currently relies exclusively on revenues generated from our midstream systems that are located in the Appalachian Basin. As a result of this concentration, CNXM will be disproportionately exposed to the impact of regional supply and demand factors, delays or interruptions of production from wells in this area caused by governmental regulation, market limitations, water shortages or other drought related conditions or interruption of the processing or transportation of natural gas, NGLs or condensate. If any of these factors were to impact the Appalachian Basin more than other producing regions, our business, financial condition, results of operations and ability to make cash distributions will be adversely affected relative to other midstream companies that have a more geographically diversified asset portfolio.
CNXM may be unable to grow by acquiring the noncontrolling interests in, or assets of, our operating subsidiaries owned by CNX Gathering or CNX Resources, which could limit our ability to increase our Distributable Cash Flow. Additionally, CNXM may be unable to acquire additional properties from third parties in the future and any acquired properties may not provide the anticipated benefits.
Part of our strategy for growing our business and increasing distributions to our unitholders depends on our ability to make acquisitions that increase our Distributable Cash Flow. Our growth strategy is premised in part on our expectation of future acquisitions from CNX Gathering of portions of its remaining noncontrolling interest in our non-wholly owned operating subsidiary, divestitures by CNX Gathering to our wholly-owned operating subsidiaries of assets owned by our non-wholly owned operating subsidiary or from future acquisitions from CNX Resources of other assets that it owns. Under our omnibus agreement CNXM has only a right of first offer to purchase the noncontrolling interests in our operating subsidiaries retained by CNX Gathering.
Such acquisitions will be premised on the parties deciding to sell these noncontrolling interests or assets, finding mutually agreeable terms acceptable to both parties, obtaining any necessary financing and having the ability to complete such acquisitions under existing debt agreements (including our credit facility) or other contracts. If CNX Gathering reduces its ownership interest in us, it may be less willing to sell to us such remaining noncontrolling interests or assets. If we do not acquire all or a significant portion of the noncontrolling interests in our operating subsidiaries held by CNX Gathering or if CNXM fails to acquire assets of our non-wholly owned subsidiaries that are offered to us on favorable terms, our ability to grow our business and increase our cash distributions to our unitholders may be significantly limited.
In addition to future dropdowns from CNX Gathering, our future growth may be dependent on the acquisition of assets or businesses that complement or expand our current business. No assurance can be given that CNXM will be able to identify suitable acquisition opportunities, negotiate acceptable terms, obtain financing for acquisitions on acceptable terms or successfully acquire the identified targets. The success of any completed acquisition will depend on our ability to effectively integrate the acquired business into our existing operations and to identify and appropriately manage any liabilities assumed as part of the acquisition. The process of integrating acquired businesses or assets may involve unforeseen difficulties and may require a disproportionate amount of our managerial and financial resources. Our failure to make acquisitions in the future and successfully integrate the acquired businesses or assets into our existing operations could have a material adverse effect on our financial condition and results of operations.
If third-party pipelines, whether upstream or downstream, or other midstream facilities interconnected to our gathering systems become partially or fully unavailable, our operating margin, cash flow and ability to make cash distributions to our unitholders could be adversely affected.
Our assets connect to other pipelines or facilities that are owned and operated by unaffiliated third parties not within our control. These third-party pipelines, processing and fractionation plants, compressor stations and other midstream facilities may become unavailable because of testing, turnarounds, line repair, maintenance, changes to operating conditions, delivery or receipt parameters, unavailability of firm transportation, lack of operating capacity, force majeure events, regulatory requirements and curtailments of receipt or deliveries due to insufficient capacity or because of damage from severe weather conditions or other operational issues. Additionally, our access to these pipelines and other midstream facilities may be impacted by issues related to other facilities that are not interconnected with our infrastructure. These issues may result in increased costs or the inability to receive or transport natural gas, potentially causing our operating margin, cash flow and ability to make cash distributions to our unitholders to be adversely affected.
To maintain and grow our business, CNXM will be required to make substantial capital expenditures. If CNXM is unable to obtain needed capital or financing on satisfactory terms, our ability to make cash distributions may be diminished or our financial leverage could increase.
In order to maintain and grow our business, CNXM will need to fund substantial growth capital expenditures associated with our existing systems or to purchase or construct new midstream systems. If we do not make sufficient or effective capital expenditures, CNXM will be unable to maintain and grow our business and, as a result, CNXM may be unable to maintain or raise the level of our future cash distributions over the long term. In addition, CNXM may be required to expand our midstream systems or construct additional midstream assets to services the production delivered by our customers under our existing gas gathering agreements. If we are unable to expand these systems or develop these assets, CNXM may be in breach of our gas gathering agreements, which would negatively impact our business and financial condition. To fund our capital expenditures, we will be required to use cash from our operations, incur debt or sell additional common units or other equity securities. Using cash from our operations will reduce cash available for distribution to our unitholders. Our ability to obtain bank financing or access the capital markets for future equity or debt offerings may be limited by our financial condition or that of CNX Resources, the covenants in our existing debt agreements, as well as by general economic conditions, contingencies and uncertainties that are beyond our control. Our ability to access the capital markets, or the pricing or other terms of any capital markets transactions, may also be adversely impacted by any impairment to the financial condition of CNX Resources or adverse changes in CNX Resources’ credit ratings. Similarly, material adverse changes affecting CNX Resources could negatively impact our unit price, thus limiting our ability to raise capital or negatively affect our ability to engage in, expand or pursue our business activities or certain transactions that might otherwise be considered beneficial to us.
Even if CNXM is successful in obtaining the necessary funds to support our growth plan, the terms of such financings could limit our ability to pay distributions to our unitholders. In addition, incurring additional debt may significantly increase our interest costs and financial leverage, and issuing additional limited partner interests may result in significant unitholder dilution and would increase the aggregate amount of cash required to maintain the then current distribution rate, which could materially decrease our ability to pay distributions at the then prevailing distribution rate. While CNXM has historically received funding from CNX Resources, none of CNX Resources, CNX Gathering, our general partner or any of their respective affiliates is committed to providing any direct or indirect financial support to fund our future growth.
The amount of cash CNXM has available for distribution to our unitholders depends primarily on our Distributable Cash Flow and not solely on our profitability, which may prevent us from making distributions, even during periods in which CNXM records net income.
The amount of cash CNXM has available for distribution depends primarily upon our Distributable Cash Flow and not solely on our profitability, which will be affected by non-cash items. As a result, CNXM may make cash distributions during periods when CNXM records a net loss for financial accounting purposes, and conversely, CNXM might fail to make cash distributions during periods when CNXM records net income for financial accounting purposes.
Our construction of new gathering, compression, dehydration, treating or other midstream assets may not result in revenue increases and may be subject to regulatory, environmental, political, legal and economic risks, which could adversely affect our cash flows, results of operations and financial condition and, as a result, our ability to distribute cash to our unitholders.
The construction of additions or modifications to our existing systems involves numerous regulatory, environmental, political and legal uncertainties beyond our control, including complications relating to obtaining necessary land rights and permits to construct and operate, and may require the expenditure of significant amounts of capital. If CNXM undertakes these projects, CNXM may not be able to complete them on schedule, at the budgeted cost or at all. Further, our revenues may not increase immediately (or at all) in connection with a particular project. For instance, if CNXM builds a new compression facility, the construction may occur over an extended period of time, and CNXM may not receive any material increases in revenues until the project is completed. Additionally, CNXM may construct facilities to capture anticipated future production growth in an area in
which such growth does not materialize and CNXM may not be able to attract enough throughput to achieve our expected investment return, which could materially adversely affect our business, financial condition, results of operations, cash flows and ability to make cash distributions.
The provisions and restrictions in our revolving credit facility and other debt agreements, and the risks associated therewith, could materially adversely affect our business, financial condition, results of operations and ability to make quarterly cash distributions to our unitholders.
Our $600.0 million revolving credit facility and the indenture governing our $400.0 million aggregate principal amount 6.5% senior notes due 2026 limit the incurrence of additional indebtedness unless specified tests or exceptions are met, and otherwise subject us to financial and/or other restrictive covenants, such as restrictions on granting liens on our assets, making investments, paying dividends, stock repurchases, selling assets and engaging in acquisitions. Under our senior secured credit agreement, CNXM must comply with certain financial covenants on a quarterly basis including a minimum interest coverage ratio, a maximum secured leverage ratio and a maximum total leverage ratio, each as defined therein. Failure by us to comply with these covenants could result in an event of default that, if not cured or waived, could have a material adverse effect on us (See Note 6 - Revolving Credit Facility in the Notes to the Audited Consolidated Financial Statements in Item 8 of this Form 10-K for more information).
The degree to which we are leveraged could have important consequences, including, but not limited to increasing our vulnerability to general adverse economic and industry conditions, requiring us to dedicate a substantial portion of our cash flow from operations to the payment of interest and principal due under our outstanding debt, which could limit our ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions or other general corporate requirements and limiting our flexibility in planning for, or reacting to, changes in our business and in the natural gas industry. In addition, a failure to comply with the provisions of our revolving credit facility could result in a default or an event of default that could enable our lenders to declare the outstanding principal of that debt, together with accrued and unpaid interest, to be immediately due and payable. If the payment of our debt is accelerated, our assets may be insufficient to repay such debt in full, and our unitholders could experience a partial or total loss of their investment.
The one-month LIBOR rate may be used under our secured credit facility. The transition from LIBOR to a replacement interest rate “benchmark” is ongoing, and the effects of this transition remains unclear. The discontinuation of LIBOR is not expected to occur until the end of 2021, beyond which the United Kingdom’s Financial Conduct Authority will no longer mandate publication of LIBOR, but banks and other financial institutions are being encouraged to make the transition to a replacement rate sooner rather than later. In the U.S., the Alternative Reference Rates Committee (ARRC) was convened to identify a suitable alternative to LIBOR. The ARRC has chosen the Secured Overnight Financing Rate (SOFR) as its preferred alternative, which is based on rates for overnight loans, collateralized by U.S. treasury securities, and is based on directly observable Treasury-backed repurchase transactions, which is a liquid market with daily volumes regularly in excess of $800 billion. While many financial industry experts consider SOFR to be a reliable alternative to LIBOR, CNXM cannot predict the effects of this transition, and our ability to borrow on favorable terms may be adversely affected.
Environmental regulations can increase costs and introduce uncertainty that could adversely impact our operations or our customers’ operations.
As an owner and operator of gathering and compressing systems, we are subject to various stringent federal, state and local laws and regulations relating to the discharge of materials into, and protection of, the environment, as are our customers. These laws and regulations may impose numerous obligations that are applicable to us and our respective customers’ operations. Failure to comply with these laws, regulations and related permit requirements may result in joint and several or strict liability or the assessment of administrative, civil and criminal penalties, the imposition of remedial obligations, and/or the issuance of injunctions limiting or preventing some or all of our operations. Private parties, including the owners of the properties through which our gathering systems pass, and some local municipalities may also have the right to pursue legal actions to enforce compliance, challenge governmental action, as well as to seek damages for non-compliance, with environmental laws and regulations or for personal injury or property damage. CNXM may not be able to recover all or any of these costs from insurance. There is no assurance that changes in or additions to public policy regarding the protection of the environment and worker health and safety will not have a significant impact on our operations and profitability.
Our operations, and those of our customers, also pose risks of environmental liability due to leakage, migration, releases or spills from our operations to surface or subsurface soils, and surface water or groundwater. Certain environmental laws impose strict as well as joint and several liability for costs required to investigate, remediate, and restore sites where regulated substances, have been stored or released, as well as fines and penalties for such releases. CNXM may be required to remediate contaminated properties currently or formerly operated by us regardless of the cause of contamination or whether such contamination resulted from the conduct of others. In addition, claims for damages to persons or property, including natural resources, may result from the environmental, health and safety impacts of our operations.
Additionally, the Federal Endangered Species Act (“ESA”) and similar state laws protect species threatened with extinction, and may cause us to modify gas well pad siting or pipeline right of ways or routes, or to develop and implement species-specific protection and enhancement plans and schedules to avoid or minimize impacts to endangered species or their habitats during construction or operations.
Additionally, stream encroachment and crossing permits from the Army Corps of Engineers (“ACOE”) are often required for the location of or certain impacts our pipelines cause to streams and wetlands. The EPA and the ACOE have been developing a proposed rule that would revise the definition of “waters of the United States” under the Clean Water Act. The EPA moved forward with the first step on December 11, 2018, when it issued a proposed, revised rule which would replace a prior 2015 rule with pre-2015 regulations, and which narrowed language defining “waters of the United States” under the Clean Water Act that existed prior to that time. In September 2019, the EPA and the ACOE announced that the agencies were repealing the 2015 rule. The conclusion of this rulemaking could lead to additional mitigation costs and severely limit our operations and the operations of our customers.
The foregoing and other regulations applicable to the midstream and natural gas industry are under constant review for amendment or expansion at both the federal and state levels. Any future changes may increase the costs to us or our customers, which could adversely impact our cash flows and results of operations. For example, hydraulic fracturing is an important and common practice used by our customers that is used to stimulate production of hydrocarbons from tight unconventional shale formations. The process involves the injection of water, sand and chemicals under pressure into formations to fracture the surrounding rock and stimulate production. The process is typically regulated by state oil and gas agencies. The disposal of produced water and other wastes in underground injection disposal wells is regulated by the EPA under the federal Safe Drinking Water Act or by various states in which CNXM or our customers conduct operations under counterpart state laws and regulations. Some states, including those in which CNXM operates, have adopted regulations that could impose more stringent disclosure and/or well construction requirements on hydraulic operations, or otherwise seek to ban some or all of these activities. The imposition of new environmental initiatives and regulations could include restrictions on our customers’ ability to conduct hydraulic fracturing operations or to dispose of waste resulting from such operations, thereby reducing throughput on our gathering systems and other midstream systems, which could adversely impact our revenues. CNXM cannot predict whether any such legislation will be enacted and if so, what its provisions would be. Additional levels of regulation and permits required through the adoption of new laws and regulations at the federal, state or local level could lead to delays, increased operating costs and process prohibitions that could reduce the volumes of natural gas and liquids that move through our gathering systems, which in turn could materially adversely affect our operations.
Public interest in the protection of the environment, including as it relates to issues of climate change, has increased dramatically in recent years. The trend of more expansive and stringent environmental legislation and regulations applied to the crude oil and natural gas industry could continue, potentially resulting in increased costs of doing business and consequently affecting profitability. Please read “Business—Regulation of Operations and Environmental Laws” under Item 1 of Part I of this Annual Report on Form 10-K.
Existing and future governmental laws, regulations and judicial decisions that govern our business may increase our costs of doing business, restrict our operations or impede our ability to satisfy our obligations under our gas gathering agreements.
There are numerous governmental regulations applicable to our and our customers’ industries that are not directly related to environmental regulation, many of which are under constant review for amendment or expansion at the federal and state level. Any future changes in such regulations, or changes promulgated by the courts, may affect, among other things, the pricing or marketing of our services or the natural gas production of our customers.
Our gathering and transportation operations are exempt from regulation by FERC Section 1(b) of the NGA. Although we believe that the natural gas pipelines in our gathering systems meet the traditional tests FERC has used to establish that a natural gas pipeline is a gathering pipeline not subject to FERC jurisdiction. FERC determines whether facilities are gas gathering facilities on a case-by-case basis, so the classification and regulation of some of our gathering facilities may be subject to change based on future determinations by FERC, the courts, or Congress. If FERC were to determine that any of our facilities or services provided by us are not exempt from FERC regulation under the NGA, the rates for, and terms and conditions of, services provided by such facility would be subject to regulation by FERC under the NGA and/or the NGPA, which could decrease revenue, increase operating costs, and, depending upon the facility in question, adversely affect our results of operations and cash flows.
Other FERC regulations such as policies on open access transportation, market manipulation, ratemaking, gas quality, capacity release and market center promotion, may indirectly impact our business and the markets for products derived from these businesses. Failure to comply with any applicable FERC administered statutes, rules, regulations and orders could subject to substantial penalties and fines, up to $1,213,503 per day for each violation, which could have a material adverse effect on our results of operations and cash flows. Violations of the NGA or the NGPA could also result in administrative and criminal remedies and the disgorgement of any profits associated with the violation.
Additionally, some states have begun to adopt more stringent regulation and oversight of natural gas gathering lines than is currently required by federal standards. Pennsylvania, under Act 127, authorized the Public Utility Commission (“PUC”) oversight of Class I gathering lines, as well as requiring standards and fees associated with Class II and Class III pipelines. The State of Ohio also moved to regulate natural gas gathering lines in a similar manner pursuant to Ohio Senate Bill 315 (“SB315”). SB315 expanded the Ohio PUC's authority over rural natural gas gathering lines. These changes in interpretation and regulation could require changes in reporting as well as cause an increase in costs. Various judicial decisions that may directly or indirectly impact natural gas drilling could also serve to indirectly increase our cost of doing business or restrict our operations. Pennsylvania courts are considering cases involving concepts of landowner rights, trespass claims and the historic common law concept of “rule of capture” as well as the role that Pennsylvania’s Environmental Rights Amendment may play in natural gas drilling activities. While these cases are still pending, the ultimate judicial outcomes could negatively impact future shale drilling and hydraulic fracturing within the Commonwealth of Pennsylvania if the court finds that fracing could violate the constitutional or property rights of Pennsylvania citizens and residents.
State regulation of natural gas gathering facilities pipelines generally includes various safety, environmental and, in some circumstances, nondiscriminatory take and common purchaser requirements, as well as complaint-based rate regulation. Other state regulations may not directly apply to our business, but may nonetheless affect the availability of natural gas for purchase, compression and sale.
For more information regarding federal and state regulation of our operations, please read “Business—Regulation of Operations” under Item 1 of Part I of this Annual Report on Form 10-K.
CNXM may incur significant costs and liabilities as a result of pipeline operations and related increases in the regulation of gas gathering pipelines.
PHMSA has adopted safety, transportation and operational regulations applicable to pipeline operators. Should our operations fail to comply with PHMSA or comparable state regulations, CNXM could be subject to substantial penalties and fines. In October 2019, PHMSA issued a final rule, effective in July 2020, regarding hazardous pipeline safety regulations that significantly extends the integrity management requirements to previously exempt pipelines and would impose additional obligations on hazardous liquid pipeline operators that are already subject to the integrity management requirements. PHMSA also issued a separate regulatory proposal in July 2015 that would impose pipeline incident prevention and response measures on natural gas and hazardous liquid pipeline operators. In October 2019, PHMSA published a final rule that significantly modified existing regulations related to reporting, impact, design, construction, maintenance, operations and integrity management of gas transmission and gathering pipelines. The adoption of these regulations, which apply more comprehensive or stringent safety standards than we are currently subject to, could require us to install new or modified safety controls, pursue new capital projects, or conduct maintenance programs on an accelerated basis, all of which could require us to incur increased operational costs that could be significant, which could have a material adverse effect on the Partnership’s operations. While CNXM cannot predict the outcome of legislative or regulatory initiatives, such legislative and regulatory changes could have a material effect on our cash flow. Please read “Business — Regulation of Operations” under Item 1 of Part I of this Annual Report on Form 10-K.
Climate change laws and regulations restricting emissions of greenhouse gases at the federal or state level could result in increased operating costs and reduced demand for the natural gas that CNXM gathers while potential physical effects of climate change could disrupt our production and cause us to incur significant costs in preparing for or responding to those effects.
The issue of global climate change continues to attract considerable public and scientific attention with underlying concern about the impacts of human activity, especially the emissions of greenhouse gases (“GHGs”) such as carbon dioxide (“CO2”) and methane, on the environment.
The EPA, under the Climate Action Plan, elected to regulate GHGs under the Clean Air Act (“CAA”) to limit emissions of CO2 from natural gas-fired power plants. In April 2017, the EPA announced that it was initiating a review of the Clean Power Plan consistent with President Trump’s Executive Order 13783, and in October 2017 published a proposed rule to formally repeal the Clean Power Plan. On August 20, 2018, the EPA issued the proposed “Affordable Clean Energy Rule.” On June 19, 2019, the EPA issued the final Affordable Clean Energy Rule replacing the Clean Power Plan.
The EPA has adopted regulations under existing provisions of the Clean Air Act that, among other things, establish Prevention of Significant Deterioration (“PSD”), construction and Title V operating permit reviews for certain large stationary sources that emit GHGs. Facilities required to obtain PSD permits for their GHG emissions also will be required to meet “best available control technology” standards that will be established by the states or, in some cases, by the EPA on a case-by-case basis. These EPA rulemakings could materially adversely affect our operations and restrict or delay our ability to obtain air permits for new or modified sources. In addition, the EPA has adopted rules requiring the monitoring and annual reporting of GHG emissions from specified U.S. production sources including certain gathering and boosting activities and transmission pipelines. CNXM monitors and file annual required reports for the GHG emissions from our operations in accordance with the GHG emissions reporting rule.
The EPA has also adopted, changed and amended rules to control volatile organic compound emissions from certain oil and gas equipment and operations as part of its initiative to reduce methane emissions. In response to subsequent judicial involvement, the EPA issued a proposed rule in July 2017 that would stay the methane rule for two years, which was vacated by the United States Court of Appeals for the D.C. Circuit. Thereafter in September 2018, the EPA proposed revisions to the 2016 New Source Performance Standards for the oil and gas industry. Additional revisions were proposed in August 2019. As these rules are adopted, changed or modified, these rules may result in increased costs for permitting, equipping, and monitoring methane emissions.
Additionally, some states have issued mandates, to reduce emissions of GHGs, primarily through the planned development of GHG emission inventories and potential cap-and-trade programs. For example, Pennsylvania has recently taken initial steps to bring Pennsylvania into a nine-state consortium of Northeastern and Mid-Atlantic States - the Regional Greenhouse Gas Initiative -- that set price and declining limits on CO2 emissions from power plants, and Virginia has also undertaken recent efforts. Most of these types of programs require major sources of emissions or major producers of fuels to acquire and surrender emission allowances, with the number of allowances available being reduced each year until a target goal is achieved. The cost of these allowances could increase over time.
While new laws and regulations are prompting power producers to shift from coal to natural gas, which is increasing demand for natural gas, to the extent there are new regulations imposed on producers with respect to GHG limits, such regulations could increase the costs for permitting, equipping, monitoring and reporting GHGs associated with natural gas production and use.
CNXM is responsible for mine subsidence costs in the future.
Portions of our gathering systems pass over coal mines. Activities related to the use and expansion of our gathering systems have historically been, and may continue to be, affected by mine subsidence. CNXM is currently liable for any costs or losses arising out of or attributable to mine subsidence. For the year ended December 31, 2019, CNXM incurred mine subsidence costs of approximately $0.4 million.
CNXM cannot predict the future amount of any costs or losses associated with mine subsidence that may impact our assets or our ability to meet the terms or obligations of our gas gathering agreements. Mine subsidence costs and losses that CNXM incur in the future could materially adversely affect our business, financial condition, results of operations, cash flows and ability to make cash distributions.
Our business involves many hazards and operational risks, some of which may not be fully covered by insurance. The occurrence of a significant accident or other event that is not fully insured could curtail our operations and have a material adverse effect on our ability to distribute cash and, accordingly, the market price for our common units.
Our operations are subject to all of the hazards inherent in the gathering and compression of natural gas, including damage to equipment and surrounding properties caused by design, installation, construction materials or operational flaws, natural disasters, acts of terrorism and acts of third parties; leaks or loss of natural gas or condensate as a result of the malfunction of, or other disruptions associated with, equipment or facilities; fires, ruptures, landslides, mine subsidence and explosions; and other hazards that could also result in personal injury and loss of life, pollution and suspension of operations.
Any of these risks could adversely affect our ability to conduct operations or result in substantial loss to us as a result of claims for injury or loss of life; damage to and destruction of property, natural resources and equipment; pollution and other environmental damage; regulatory investigations and penalties; suspension of our operations; and repair and remediation costs.
Although CNXM maintains insurance for a number of risks and hazards, we may not be insured or fully insured against the losses or liabilities that could arise from a significant accident in our operations, as CNXM may elect not to obtain insurance for any or all of these risks if CNXM believes that the cost of available insurance is excessive relative to the risks presented. In addition, pollution and environmental risks generally are not fully insurable. The occurrence of an event that is not fully covered by insurance could materially adversely affect our business, financial condition, results of operations, cash flows and ability to make cash distributions.
Cyber-incidents could have a material adverse effect on our business, financial condition or results of operations.
Cyber-incidents, including cyber-attacks, may significantly affect us or the operations of our customers, as well as impact general economic conditions, consumer confidence and spending and market liquidity. Strategic targets, including energy-related assets, may be at greater risk of future incidents than other targets in the United States. A cyber incident could result in information theft, data corruption, operational disruption including environmental and safety issues resulting from a loss of control of field equipment and assets, and/or financial loss. Consequently, it is possible that any of these occurrences, or a combination of them, could have a material adverse effect on our business, financial condition and results of operations. Our insurance may not protect us against such occurrences.
The oil and gas industry has become increasingly dependent on digital technologies, including information systems, infrastructure and cloud applications and services, to operate our businesses, process and record financial and operating data,
communicate with our employees and business partners, and to conduct day-to-day operations including certain midstream activities. For example, software programs are used to manage gathering and transportation systems and for compliance reporting. The use of mobile communication devices has increased rapidly. Industrial control systems such as SCADA (supervisory control and data acquisition) now control large scale processes that can include multiple sites and long distances, such as oil and gas pipelines. Our business partners, including vendors, service providers, and financial institutions, are also dependent on digital technology.
As dependence on digital technologies has increased, the threat of cyber incidents, including deliberate attacks or unintentional events, also has increased. A cyber-incident could include gaining unauthorized access to digital systems for purposes of misappropriating assets or sensitive information, corrupting data, or causing operational disruption, or result in denial-of-service on websites. SCADA-based systems are potentially vulnerable to targeted cyber-attacks due to their critical role in operations.
Our technologies, systems, networks, data centers and those of our business partners may become the target of cyber-incidents or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of proprietary and other information, or other disruption of our business operations. In addition, certain cyber-incidents, such as surveillance, may remain undetected for an extended period.
Deliberate attacks on our assets, or security breaches in our systems or infrastructure, the systems or infrastructure of third-parties, or the cloud could lead to corruption or loss of our proprietary data and potentially sensitive data, difficulty in completing and settling transactions, challenges in maintaining our books and records, environmental damage, communication interruptions, damage to our reputation, other operational disruptions and third-party liability, including the following:
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a cyber-incident impacting one of our vendors or service providers could result in supply chain disruptions, loss or corruption of our information or other negative consequences, any of which could delay or halt development of additional infrastructure, effectively delaying the start of cash flows from the project;
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a cyber-incident related to our facilities may result in equipment damage or failure;
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a cyber-incident impacting downstream pipelines could prevent us from delivering product at the tailgate of our facilities, resulting in a loss of revenues;
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a cyber-incident impacting a communications network or power grid could cause operational disruption resulting in loss of revenues;
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a deliberate corruption of our financial or operational data could result in events of non-compliance which could lead to regulatory fines or penalties; and
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business interruptions could result in expensive remediation efforts, distraction of management, damage to our reputation, or a negative impact on the price of our units.
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Our implementation of various internal and externally-facing controls and processes, including appropriate internal risk assessment and internal policy implementation, globally incorporating a risk-based cyber security framework, to monitor and mitigate security threats and other strategies to increase security for our information, facilities and infrastructure is costly and labor intensive. Moreover, there can be no assurance that such measures will be sufficient to prevent security breaches or other cyber-incidents from occurring. As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities.
A shortage of equipment and skilled labor in the Appalachian Basin could reduce equipment availability and labor productivity and increase labor and equipment costs, which could materially adversely affect our business and results of operations.
Our gathering and other midstream services require special equipment and laborers who are skilled in multiple disciplines, such as equipment operators, mechanics and engineers, among others. If CNXM experiences shortages of necessary equipment or skilled labor in the future, our labor and equipment costs and overall productivity could be materially and adversely affected. If our equipment or labor prices increase or if CNXM experiences materially increased health and benefit costs for employees, our business and results of operations could be materially and adversely affected. The demand for these services, equipment and personnel can fluctuate significantly, often in correlation with natural gas and oil prices, causing periodic shortages. Weather may also play a role with respect to the relative availability of certain materials. The costs and delivery times of equipment and supplies are substantially greater in periods of peak demand. Accordingly, CNXM cannot be assured that CNXM will be able to obtain necessary services, equipment and supplies in a timely manner or on satisfactory terms, and CNXM may experience shortages of, or increases in the costs of, equipment, personnel and associated supplies, equipment and services in the future.
CNXM does not have any officers or employees and rely on officers of our general partner and employees of our Sponsor.
CNXM is managed and operated by the board of directors and executive officers of our general partner. Our general partner has no employees and relies on the employees of our Sponsor to conduct our business and activities.
Our Sponsor conducts businesses and activities of its own in which we have no economic interest. As a result, there could be material competition for the time and effort of the officers and employees who provide services to both our general partner and our Sponsor. If our general partner and the officers and employees of our Sponsor do not devote sufficient attention to the
management and operation of our business and activities, our business, financial condition, results of operations, cash flows and ability to make cash distributions could be materially adversely affected.
Our success depends on key members of our general partner’s senior management team and our ability to attract and retain experienced technical and other professional personnel.
Our future success depends to a large extent on the services of our general partner’s key employees. The loss of one or more of these individuals could materially adversely affect our business. Furthermore, competition for experienced technical and other professional personnel remains strong. If CNXM cannot retain our current personnel or attract additional experienced personnel, our ability to compete could be adversely affected. Also, the loss of experienced personnel could lead to a loss of technical expertise.
Increases in borrowing interest rates or changes in interest rate benchmarking practices, as a result of recent regulatory developments or otherwise, could adversely impact our business, common unit price, our ability to issue equity or incur debt for acquisitions, capital expenditures or other purposes and our ability to make cash distributions at our intended levels.
Interest rates may increase in the future. As a result, interest rates on future credit facilities and debt offerings could be higher than current levels, causing our financing costs to increase accordingly. Rising interest rates could reduce the amount of cash we generate and materially adversely affect our liquidity and our ability to pay cash distributions. Moreover, the trading price of our units is sensitive to changes in interest rates and could be materially adversely affected by any increase in interest rates. As with other yield-oriented securities, our common unit price will be impacted by the level of our cash distributions and implied distribution yield. The distribution yield is often used by investors to compare and rank yield-oriented securities for investment decision-making purposes. Therefore, changes in interest rates, either positive or negative, may affect the yield requirements of investors who invest in our common units, and a rising interest rate environment could have an adverse impact on our common unit price and our ability to issue equity or incur debt for acquisitions or other purposes and to make cash distributions at our intended levels.
Assuming an outstanding balance on the revolving credit facility of $311.8 million, an increase of one percentage point in the interest rates would have resulted in an increase in interest expense during 2019 of $3.1 million. Accordingly, our results of operations, cash flows and financial condition, all of which affect our ability to make cash distributions to our unitholders, could be materially adversely affected by significant increases in interest rates.
Terrorist activities could materially and adversely affect our business and results of operations.
Terrorist attacks, including eco-terrorism, and the threat of terrorist attacks, whether domestic or foreign, as well as military or other actions taken in response to these acts, could affect the energy industry, the environment and industry-related economic conditions, including our operations and the operations of our customers, as well as general economic conditions, consumer confidence and spending and market liquidity. Strategic targets, including energy-related assets, may be at greater risk of future attacks than other targets in the United States. The occurrence or threat of terrorist attacks in the United States or other countries could adversely affect the global economy in unpredictable ways, including the disruption of energy supplies and markets, increased volatility in commodity prices or the possibility that the infrastructure on which we rely could be a direct target or an indirect casualty of an act of terrorism, and, in turn, could materially adversely affect our business and results of operations. Our insurance may not protect us against such occurrences.
CNXM may become subject to various legal proceedings and investigations, which may have an adverse effect on our business.
We may from time to time become a party to legal proceedings and investigations, in the normal course of business activities. Responding to investigations or defending these actions, especially purported class actions, can be costly and can distract management. There is also the possibility that we, or CNX or other customers on whom we rely, may become involved in future investigations or suits, including, for example, those being brought by communities against fossil fuel producers relating to climate change, which are beginning to gain prevalence in the courts. There is the potential that the costs of defending litigation, or the impact on us as a result of our Sponsor or other customers losing such suits, could have an adverse effect on our cash flows, results of operations or financial position.
Negative public perception regarding our industry could have an adverse effect on our operations.
Negative public perception regarding our industry resulting from, among other things, operational incidents or concerns raised by advocacy groups, related to environmental, health or community impacts, could result in increased regulatory scrutiny, which could then result in additional laws, regulations, guidelines and enforcement interpretations, at the federal or state level. These actions may cause operational delays or restrictions, increased operating costs, additional regulatory burdens and increased risk of litigation. Moreover, governmental authorities exercise considerable discretion in the timing and scope of permit issuance and the public may engage in the permitting process, including through intervention in the courts. Negative public perception could cause the permits CNXM needs to conduct our operations to be withheld, delayed, or burdened by requirements that restrict our ability to profitably conduct our business or could materially adversely impact our customers, which would also have a negative effect on our ability to conduct business.
Risks Inherent in an Investment in Us
Our general partner and its affiliates, including CNX Resources, have conflicts of interest with us and limited fiduciary duties to us and our unitholders, and they may favor their own interests to our detriment and that of our unitholders. Additionally, CNXM has no control over the business decisions and operations of CNX Resources, which is under no obligation to adopt a business strategy that favors us.
As of December 31, 2019, CNX Resources owns an aggregate 33.4% limited partner interest in us (See Note 11 - Subsequent Event in the Notes to the Audited Consolidated Financial Statements in Item 8 of this Form 10-K for more information regarding changes to the CNX Resources’ ownership interest). CNX Resources, through its ownership of CNX Gathering, also owns a 2.0% general partner interest and owns and controls our general partner. In addition, CNX Gathering owns a 95% noncontrolling equity interest in our Additional Systems. Although our general partner has a duty to manage us in a manner that is in the best interests of our partnership and our unitholders, the directors and officers of our general partner also have a duty to manage our general partner in a manner that is in the best interests of its owner, CNX Gathering. Conflicts of interest may arise between CNX Resources and its affiliates, including our general partner, on the one hand, and us and our unitholders, on the other hand. In resolving these conflicts, the general partner may favor its own interests and the interests of its affiliates, including CNX Resources, over the interests of our common unitholders. These conflicts include, among others, the following situations:
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neither our partnership agreement nor any other agreement requires CNX Resources to pursue business strategies that favor us or utilize our assets, which could involve decisions by CNX Resources to increase or decrease natural gas production on our dedicated acreage, release portions of their dedicated acreage, as permitted by the terms the gas gathering agreements, pursue and grow particular markets or undertake acquisition opportunities for itself. CNX Resources’ directors and officers have a fiduciary duty to make these decisions in the best interests of the stockholders of CNX Resources;
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CNX Resources may be constrained by the terms of its debt instruments from taking actions, or refraining from taking actions, that may be in our best interests;
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our partnership agreement replaces the fiduciary duties that would otherwise be owed by our general partner with contractual standards governing its duties and limits our general partner’s liabilities and the remedies available to our unitholders for actions that, without the limitations, might constitute breaches of fiduciary duty under applicable Delaware law;
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except in limited circumstances, our general partner has the power and authority to conduct our business without unitholder approval;
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our general partner determines the amount and timing of, among other things, cash expenditures, borrowings and repayments of indebtedness, the issuance of additional partnership interests, the creation, increase or reduction in cash reserves in any quarter and asset purchases and sales, each of which can affect the amount of cash that is available for distribution to unitholders;
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our general partner determines the amount and timing of any capital expenditures and whether a capital expenditure is classified as a maintenance capital expenditure, which reduces operating surplus, or an expansion capital expenditure, which does not reduce operating surplus. This determination can affect the amount of cash that is distributed to our unitholders and to our general partner;
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our general partner determines which costs incurred by it are reimbursable by us;
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our general partner may cause us to borrow funds in order to permit the payment of cash distributions;
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our general partner may elect to use cash to repurchase our common units, subject to compliance with our partnership agreement and debt arrangements;
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our partnership agreement permits us to classify up to $50.0 million as operating surplus, even if it is generated from asset sales, non-working capital borrowings or other sources that would otherwise constitute capital surplus. This cash may be used to fund distributions to our general partner in respect of the general partner interest;
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our partnership agreement does not restrict our general partner from causing us to pay it or its affiliates for any services rendered to us or entering into additional contractual arrangements with any of these entities on our behalf;
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our general partner intends to limit its liability regarding our contractual and other obligations;
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our general partner may exercise its right to call and purchase all of the common units not owned by it and its affiliates if it and its affiliates own more than 80% of the common units;
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our general partner controls the enforcement of obligations owed to us by our general partner and its affiliates, including our gathering agreements with CNX Resources; and
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our general partner decides whether to retain separate counsel, accountants or others to perform services for us.
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Neither our partnership agreement nor our omnibus agreement prohibits CNX Resources or any other affiliates of our general partner from owning assets or engaging in businesses that compete directly or indirectly with us. Under the terms of our partnership agreement, the doctrine of corporate opportunity, or any analogous doctrine, does not apply to our general partner or any of its affiliates, including CNX Resources and executive officers and directors of our general partner. Any such person or entity that becomes aware of a potential transaction, agreement, arrangement or other matter that may be an opportunity for us does not have
any duty to communicate or offer such opportunity to us. Any such person or entity will not be liable to us or to any limited partner for breach of any fiduciary duty or other duty by reason of the fact that such person or entity pursues or acquires such opportunity for itself, directs such opportunity to another person or entity or does not communicate such opportunity or information to us. Consequently, CNX Resources and other affiliates of our general partner, including CNX Gathering, may acquire, construct or dispose of additional midstream assets in the future without any obligation to offer us the opportunity to purchase any of those assets. As a result, competition from CNX Resources and other affiliates of our general partner could materially and adversely impact our results of operations and Distributable Cash Flow. This may create actual and potential conflicts of interest between us and affiliates of our general partner and result in less than favorable treatment of us and our unitholders.
Our partnership agreement requires that CNXM distribute all of our available cash, which could limit our ability to grow and make acquisitions.
Our partnership agreement requires that CNXM distribute all of our available cash to our unitholders. As a result, CNXM expects to rely primarily upon external financing sources, including commercial bank borrowings and the issuance of debt and equity securities, to fund our acquisitions and expansion capital expenditures. Therefore, if CNXM is unable to finance our growth externally, our cash distribution policy will significantly impair our ability to grow. In addition, because CNXM will distribute all of our available cash, our growth may not be as fast as that of businesses that reinvest their available cash to expand ongoing operations. To the extent CNXM issues additional partnership interests in connection with any acquisitions or expansion capital expenditures, the payment of distributions on those additional partnership interests may increase the risk that we will be unable to maintain or increase our per unit distribution level. There are no limitations in our partnership agreement on our ability to issue additional partnership interests, including partnership interests ranking senior to our common units as to distributions or in liquidation or that have special voting rights and other rights, and our common unitholders have no preemptive or other rights (solely as a result of their status as common unitholders) to purchase any such additional partnership interests. The incurrence of additional commercial bank borrowings or other debt to finance our growth strategy would result in increased interest expense, which, in turn, may reduce the amount of cash that CNXM has available to distribute to our unitholders.
Our partnership agreement replaces our general partner’s fiduciary duties to holders of our common units with contractual standards governing its duties.
Delaware law provides that a Delaware limited partnership may, in its partnership agreement, expand, restrict or eliminate the fiduciary duties otherwise owed by the general partner to limited partners and the partnership, provided that the partnership agreement may not eliminate the implied contractual covenant of good faith and fair dealing. This implied covenant is a judicial doctrine utilized by Delaware courts in connection with interpreting ambiguities in partnership agreements and other contracts and does not form the basis of any separate or independent fiduciary duty in addition to the express contractual duties set forth in our partnership agreement. Under the implied contractual covenant of good faith and fair dealing, a court will enforce the reasonable expectations of the partners where the language in the partnership agreement does not provide for a clear course of action.
As permitted by Delaware law, our partnership agreement contains provisions that eliminate the fiduciary standards to which our general partner would otherwise be held by state fiduciary duty law and replaces those duties with several different contractual standards. For example, our partnership agreement permits our general partner to make a number of decisions in its individual capacity, as opposed to in its capacity as our general partner, free of any duties to us and our unitholders. This provision entitles our general partner to consider only the interests and factors that it desires and relieves it of any duty or obligation to give any consideration to any interest of, or factors affecting, us, our affiliates or our limited partners. By purchasing a common unit, a unitholder is treated as having consented to the provisions in our partnership agreement, including the provisions discussed above. Examples of decisions that our general partner may make in its individual capacity include, among others:
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how to allocate corporate opportunities among us and other affiliates;
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whether to exercise its limited call right;
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whether to seek approval of the resolution of a conflict of interest by the conflicts committee of the board of directors of our general partner;
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how to exercise its voting rights with respect to the units it owns;
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whether to elect to reset target distribution levels; and
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whether or not to consent to any merger, consolidation or conversion of the partnership or amendment to our partnership agreement.
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Our partnership agreement restricts the remedies available to holders of our common units for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty.
Our partnership agreement contains provisions that restrict the remedies available to unitholders for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty under state fiduciary duty law. For example, our partnership agreement:
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provides that whenever our general partner makes a determination or takes, or declines to take, any other action in its capacity as our general partner, our general partner is required to make determinations, or take or decline to take action, in good faith, meaning that it subjectively believed that the determination or the decision to take or decline to take such action was in the best interests of our partnership, and will not be subject to any other or different standard imposed by our partnership agreement, Delaware law, or any other law, rule or regulation, or at equity;
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provides that our general partner will not have any liability to us or our unitholders for decisions made in its capacity as a general partner so long as it acted in good faith;
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provides that our general partner and its officers and directors will not be liable for monetary damages to us or our limited partners resulting from any act or omission unless there has been a final and non-appealable judgment entered by a court of competent jurisdiction determining that our general partner or its officers and directors, as the case may be, acted in bad faith or engaged in fraud or willful misconduct or, in the case of a criminal matter, acted with knowledge that the conduct was criminal; and
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provides that our general partner will not be in breach of its obligations under our partnership agreement or its fiduciary duties to us or our limited partners if a transaction with an affiliate or the resolution of a conflict of interest is approved in accordance with, or otherwise meets the standards set forth in, our partnership agreement.
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In connection with a situation involving a transaction with an affiliate or a conflict of interest, our partnership agreement provides that any determination by our general partner must be made in good faith, and that our conflicts committee and the board of directors of our general partner are entitled to a presumption that they acted in good faith. In any proceeding brought by or on behalf of any limited partner or the partnership, the person bringing or prosecuting such proceeding will have the burden of overcoming such presumption.
Cost reimbursements, determined in our general partner’s sole discretion, and fees due our general partner and its affiliates for services provided will be substantial and will reduce the amount of cash CNXM has available for distribution to unitholders.
Under our partnership agreement, CNXM is required to reimburse our general partner and its affiliates for all costs and expenses that they incur on our behalf for managing and controlling our business and operations. Except to the extent specified under our omnibus agreement and operational services agreement, our general partner determines the amount of these expenses. Under the terms of the omnibus agreement CNXM is required to reimburse CNX Resources for the provision of certain administrative support services to us. Under our operational services agreement, CNXM is required to reimburse CNX Resources for the provision of certain maintenance, operating, administrative and construction services in support of our operations. Our general partner and its affiliates also may provide us other services for which CNXM will be charged fees as determined by our general partner. The costs and expenses for which CNXM will reimburse our general partner and its affiliates may include salary, bonus, incentive compensation and other amounts paid to persons who perform services for us or on our behalf and expenses allocated to our general partner by its affiliates. The costs and expenses for which CNXM is required to reimburse our general partner and its affiliates are not subject to any caps or other limits. Payments to our general partner and its affiliates will be substantial and will reduce the amount of cash CNXM has available to distribute to unitholders.
Unitholders have very limited voting rights and, even if they are dissatisfied, they will have limited ability to remove our general partner.
Unlike the holders of common stock in a corporation, unitholders have only limited voting rights on matters affecting our business and, therefore, limited ability to influence management’s decisions regarding our business. For example, unlike holders of stock in a public corporation, unitholders have no “say-on-pay” advisory voting rights, and no right to elect our general partner or the board of directors of our general partner. The board of directors of our general partner is chosen by its sole member, CNX Gathering, which is owned by CNX Resources. Furthermore, if the unitholders are dissatisfied with the performance of our general partner, they have little ability to remove our general partner. As a result of these limitations, the price at which our common units trade could be diminished because of the absence or reduction of a takeover premium in the trading price.
Our general partner may not be removed unless such removal is both (i) for cause, which is narrowly defined under our partnership agreement and (ii) approved by a vote of the holders of at least 66 2/3% of the outstanding units, including any units owned by our general partner and its affiliates, voting together as a single class. “Cause” is narrowly defined under our partnership agreement to mean that a court of competent jurisdiction has entered a final, non-appealable judgment finding our general partner liable to us or any limited partner for actual fraud or willful misconduct in its capacity as our general partner. Cause does not include most cases of charges of poor management of the business. As of December 31, 2019, CNX Resources owned approximately 34.0% of our total outstanding common units. As a result, our public unitholders have limited ability to remove our general partner.
Furthermore, unitholders’ voting rights are further restricted by the partnership agreement provision providing that any units held by a person that owns 20% or more of any class of units then outstanding, other than our general partner, its affiliates, their transferees, and persons who acquired such units with the prior approval of the board of directors of our general partner, cannot vote on any matter.
Our partnership agreement also contains provisions limiting the ability of unitholders to call meetings or to acquire information about our operations, as well as other provisions limiting the unitholders’ ability to influence the manner or direction of management.
Our general partner interest and control of our general partner may be transferred to a third party without unitholder consent.
Our general partner may transfer its general partner interest in us to a third party in a merger or in a sale of all or substantially all of its assets without the consent of the unitholders. Furthermore, there is no restriction in our partnership agreement on the ability of CNX Gathering to transfer its membership interest in our general partner to a third party. The new owner of our general partner would then be in a position to replace the board of directors and officers of our general partner with its own choices.
CNXM may issue an unlimited number of additional partnership interests without unitholder approval, which would dilute unitholder interests.
At any time, CNXM may issue an unlimited number of general partner interests or limited partner interests of any type without the approval of our unitholders, and our unitholders have no preemptive or other rights (solely as a result of their status as unitholders) to purchase any such general partner interests or limited partner interests. Further, there are no limitations in our partnership agreement on our ability to issue equity securities that rank equal or senior to our common units as to distributions or in liquidation or that have special voting rights and other rights. The issuance by us of additional common units or other equity securities of equal or senior rank will have the following effects:
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our unitholders’ proportionate ownership interest in us will decrease;
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the amount of cash CNXM has available to distribute on each unit may decrease;
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the ratio of taxable income to distributions may increase;
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the relative voting strength of each previously outstanding unit may be diminished; and
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the market price of our common units may decline.
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The issuance by us of additional general partner interests may have the following effects, among others, if such general partner interests are issued to a person who is not an affiliate of CNX Resources:
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management of our business may no longer reside solely with our current general partner; and
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affiliates of the newly admitted general partner may compete with us, and neither that general partner nor such affiliates will have any obligation to present business opportunities to us except with respect to rights of first offer contained in our omnibus agreement.
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CNX Resources may sell common units in the public or private markets, and such sales could have an adverse impact on the trading price of the common units.
As of December 31, 2019, CNX Resources held 21,692,198 common units (See Note 11 - Subsequent Event in the Notes to the Audited Consolidated Financial Statements in Item 8 of this Form 10-K for more information regarding changes to CNX Resources’ ownership interest). Our partnership agreement provides CNX Resources with certain registration rights under applicable securities laws. The sale of the common units held by CNX Resources in the public or private markets could have an adverse impact on the market for and price of our common units.
Our general partner’s discretion in establishing cash reserves may reduce the amount of cash CNXM has available to distribute to unitholders.
Our partnership agreement requires our general partner to deduct from operating surplus the cash reserves that it determines are necessary to fund our future operating expenditures. In addition, the partnership agreement permits the general partner to reduce available cash by establishing cash reserves for the proper conduct of our business, to comply with applicable law or agreements to which CNXM is a party, or to provide funds for future distributions to partners. These cash reserves will affect the amount of cash CNXM has available to distribute to unitholders.
Affiliates of our general partner, including CNX Resources and CNX Gathering, may compete with us, and neither our general partner nor its affiliates have any obligation to present business opportunities to us except with respect to rights of first offer contained in our omnibus agreement.
Our agreements do not prohibit CNX Resources or any other affiliates of our general partner, including CNX Gathering, from owning assets or engaging in businesses that compete directly or indirectly with us. Under the terms of our partnership agreement, the doctrine of corporate opportunity, or any analogous doctrine, does not apply to our general partner or any of its affiliates, including CNX Resources and executive officers and directors of our general partner. Any such person or entity that becomes aware of a potential transaction, agreement, arrangement or other matter that may be an opportunity for us will not have
any duty to communicate or offer such opportunity to us. Any such person or entity will not be liable to us or to any limited partner for breach of any fiduciary duty or other duty by reason of the fact that such person or entity pursues or acquires such opportunity for itself, directs such opportunity to another person or entity or does not communicate such opportunity or information to us. Consequently, CNX Resources and other affiliates of our general partner, including CNX Gathering, may acquire, construct or dispose of additional midstream assets in the future without any obligation to offer us the opportunity to purchase any of those assets. As a result, competition from CNX Resources and other affiliates of our general partner could materially and adversely impact our results of operations and Distributable Cash Flow.
Our general partner has a limited call right that may require our unitholders to sell their common units at an undesirable time or price.
If at any time our general partner and its affiliates own more than 80% of our then-outstanding common units, our general partner will have the right, but not the obligation, which it may assign to any of its affiliates or to us, to acquire all, but not less than all, of the common units held by unaffiliated persons at a price not less than their then current market price. As a result, our unitholders may be required to sell their common units at an undesirable time or price and may not receive any return on your investment. Our unitholders may also incur a tax liability upon a sale of their units. As of December 31, 2019, CNX Resources owns approximately 34.0% of our outstanding common units (See Note 11 - Subsequent Event in the Notes to the Audited Consolidated Financial Statements in Item 8 of this Form 10-K for more information regarding changes to CNX Resources’ ownership interest).
Our general partner intends to limit its liability regarding our contractual and other obligations.
Our general partner intends to limit its liability under contractual arrangements and other obligations between us and third parties so that the counterparties to such arrangements have recourse only against our assets and not against our general partner or its assets (or against any affiliate of our general partner or its assets). Our general partner may therefore cause us to incur indebtedness or other obligations that are nonrecourse to our general partner. Our partnership agreement provides that any action taken by our general partner to limit its liability is not a breach of our general partner’s duties, even if CNXM could have obtained more favorable terms without the limitation on liability. In addition, CNXM is obligated to reimburse or indemnify our general partner to the extent that it incurs obligations on our behalf. Any such reimbursement or indemnification payments would reduce the amount of cash otherwise available for distribution to our unitholders.
Unitholders may have to repay distributions that were wrongfully distributed to them.
Under certain circumstances, unitholders may have to repay amounts wrongfully distributed to them. Under Section 17-607 of the Delaware Revised Uniform Limited Partnership Act (the “Delaware Act”), CNXM may not make a distribution to our unitholders if the distribution would cause our liabilities to exceed the fair value of our assets. Delaware law provides that for a period of three years from the date of the impermissible distribution, limited partners who received the distribution and who knew at the time of the distribution that it violated Delaware law will be liable to the limited partnership for the distribution amount. Transferees of common units are liable for the obligations of the transferor to make contributions to the partnership that are known to the transferee at the time of the transfer and for unknown obligations if the liabilities could be determined from our partnership agreement. Liabilities to partners on account of their partnership interest and liabilities that are non-recourse to the partnership are not counted for purposes of determining whether a distribution is permitted.
Units held by persons who our general partner determines are not “eligible holders” at the time of any requested certification in the future may be subject to redemption.
As a result of certain laws and regulations to which CNXM is or may in the future become subject, CNXM may require owners of our common units to certify that they are both U.S. citizens and subject to U.S. federal income taxation on our income. Units held by persons who our general partner determines are not “eligible holders” at the time of any requested certification in the future may be subject to redemption. “Eligible holders” are limited partners whose (or whose owners’) (i) U.S. federal income tax status or lack of proof of U.S. federal income tax status does not have and is not reasonably likely to have, as determined by our general partner, a material adverse effect on the rates that can be charged to customers by us or our subsidiaries with respect to assets that are subject to regulation by the FERC or similar regulatory body and (ii) nationality, citizenship or other related status does not create and is not reasonably likely to create, as determined by our general partner, a substantial risk of cancellation or forfeiture of any property in which CNXM has an interest. The aggregate redemption price for redeemable interests will be an amount equal to the current market price (the date of determination of which will be the date fixed for redemption) of limited partner interests of the class to be so redeemed multiplied by the number of limited partner interests of each such class included among the redeemable interests. The units held by any person the general partner determines is not an eligible holder will not be entitled to voting rights.
Our partnership agreement designates the Court of Chancery of the State of Delaware as the exclusive forum for certain types of actions and proceedings that may be initiated by our unitholders, which limits our unitholders’ ability to choose the judicial forum for disputes with us or our general partner’s directors, officers or other employees. Our partnership agreement also provides that any unitholder bringing an unsuccessful action will be obligated to reimburse us for any costs CNXM has incurred in connection with such unsuccessful action.
Our partnership agreement provides that, with certain limited exceptions, the Court of Chancery of the State of Delaware (or, if such court does not have subject matter jurisdiction thereof, any other court located in the State of Delaware with subject matter jurisdiction) shall be the exclusive forum for any claims, suits, actions or proceedings (i) arising out of or relating in any way to our partnership agreement, (ii) brought in a derivative manner on our behalf, (iii) asserting a claim of breach of a duty owed by any of our, or our general partner’s, directors, officers, or other employees, or owed by our general partner, to us or our partners, (iv) asserting a claim against us arising pursuant to any provision of the Delaware Act or (v) asserting a claim against us governed by the internal affairs doctrine.
If any person brings any of the aforementioned claims, suits, actions or proceedings and such person does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought, then such person shall be obligated to reimburse us and our affiliates for all fees, costs and expenses of every kind and description, including but not limited to all reasonable attorneys’ fees and other litigation expenses, that the parties may incur in connection with such claim, suit, action or proceeding. In addition, our partnership agreement provides that each limited partner irrevocably waives the right to trial by jury in any such claim, suit, action or proceeding. By purchasing a common unit, a limited partner is irrevocably consenting to these limitations and provisions regarding claims, suits, actions or proceedings and submitting to the exclusive jurisdiction of the Court of Chancery of the State of Delaware (or such other court) in connection with any such claims, suits, actions or proceedings. These provisions may have the effect of discouraging lawsuits against us and our general partner’s directors and officers.
The NYSE does not require a publicly traded limited partnership like us to comply with certain of its corporate governance requirements.
Because CNXM is a publicly traded limited partnership, the NYSE does not require us to have a majority of independent directors on our general partner’s board of directors or to establish a compensation committee or a nominating and corporate governance committee. Additionally, any future issuance of additional common units or other securities, including to affiliates, will not be subject to the NYSE’s shareholder approval rules that apply to a corporation. Accordingly, unitholders do not have the same protections afforded to certain corporations that are subject to all of the NYSE corporate governance requirements.
Our common units have a limited trading volume compared to other publicly traded securities.
Our common units are listed on the NYSE under the symbol “CNXM.” However, daily trading volumes for our common units are, and may continue to be, relatively small compared to many other securities quoted on the NYSE. The price of our common units may, therefore, be volatile.
CNXM is a publicly traded partnership which as an asset class and investment vehicle carries different risks than certain other securities that trade on public exchanges. As such, CNXM has a limited investor base which can invest in us which may affect our common unit trading volumes. CNXM is also subject to the general risks around market sentiment and demand of the publicly traded partnership asset class.
Our unitholders’ liability may not be limited if a court finds that unitholder action constitutes control of our business.
Our partnership is organized under Delaware law. Assuming that a limited partner does not participate in the control of our business within the meaning of the Delaware Act and that it otherwise acts in conformity with the provisions of our partnership agreement, its liability under the Delaware Act will be limited, subject to possible exceptions, to the amount of capital it is obligated to contribute to us for its common units plus its share of any undistributed profits and assets. If it were determined, however, that the right, or exercise of the right of, by the limited partners as a group to remove or replace our general partner for cause; approve some amendments to our partnership agreement; or take other action under our partnership agreement; constituted “participation in the control” of our business for the purposes of the Delaware Act, then the limited partners could be held personally liable for our obligations under the laws of Delaware, to the same extent as our general partner. This liability would extend to persons who transact business with us who reasonably believe that a limited partner is a general partner. Neither our partnership agreement nor the Delaware Act specifically provides for legal recourse against our general partner if a limited partner were to lose limited liability through any fault of our general partner. While this does not mean that a limited partner could not seek legal recourse, CNXM knows of no precedent for this type of a claim in Delaware case law.
Our operating subsidiaries conduct business in Pennsylvania and West Virginia. CNXM may have subsidiaries that conduct business in other states in the future. Maintenance of our limited liability as a partner or member of our subsidiaries may require compliance with legal requirements in the jurisdictions in which such subsidiaries conduct business, including qualifying such entities to do business there. Limitations on the liability of members or limited partners for the obligations of a limited liability company or limited partnership, respectively, have not been clearly established in many jurisdictions. If, by virtue of our ownership
interests in our operating subsidiaries or otherwise, it were determined that we were conducting business in any state without compliance with the applicable limited partnership or limited liability company statute, or that the right or exercise of the right by the limited partners as a group to remove or replace our general partner for cause, to approve some amendments to our partnership agreement, or to take other action under our partnership agreement constituted “participation in the control” of our business for purposes of the statutes of any relevant jurisdiction, then the limited partners could be held personally liable for our obligations under the law of that jurisdiction to the same extent as our general partner under the circumstances.
If CNXM is deemed an “investment company” under the Investment Company Act of 1940, it would adversely affect the price of our common units and could have a material adverse effect on our business.
Our initial assets consist of direct and indirect ownership interests in our operating subsidiaries. If a sufficient amount of our assets, such as our ownership interests in these subsidiaries or other assets acquired in the future, are deemed to be “investment securities” within the meaning of the Investment Company Act of 1940 (the “Investment Company Act”), CNXM would either have to register as an investment company under the Investment Company Act, obtain exemptive relief from the SEC or modify our organizational structure or our contract rights to fall outside the definition of an investment company. In that event, it is possible that our ownership of these interests, combined with our assets acquired in the future, could result in our being required to register under the Investment Company Act if CNXM were not successful in obtaining exemptive relief or otherwise modifying our organizational structure or applicable contract rights. Treatment of us as an investment company would prevent our qualification as a partnership for federal income tax purposes, in which case CNXM would be treated as a corporation for federal income tax purposes. As a result, CNXM would pay federal income tax on our taxable income at the corporate tax rate, distributions to our unitholders would generally be taxed again as corporate distributions and none of our income, gains, losses or deductions would flow through to our unitholders. Because a tax would be imposed upon us as a corporation, our cash available for distribution to our unitholders would be substantially reduced. Therefore, treatment of us as an investment company would result in a material reduction in the anticipated cash flow and after-tax return to the unitholders, likely causing a substantial reduction in the value of our common units.
Moreover, registering as an investment company could, among other things, materially limit our ability to engage in transactions with affiliates, including the purchase of additional interests in our midstream systems from CNX Resources, restrict our ability to borrow funds or engage in other transactions involving leverage and require us to add additional directors who are independent of us or our affiliates. The occurrence of some or all of these events would adversely affect the price of our common units and could have a material adverse effect on our business.
Tax Risks
Our tax treatment depends on our status as a partnership for federal income tax purposes. If the Internal Revenue Service (“IRS”) were to treat us as a corporation for federal income tax purposes, which would subject us to entity-level taxation, or if CNXM were otherwise subjected to a material amount of additional entity-level taxation, then our Distributable Cash Flow to unitholders would be substantially reduced.
The anticipated after-tax economic benefit of an investment in the common units depends largely on being treated as a partnership for federal income tax purposes. CNXM has not requested a ruling from the IRS on this or any other tax matter affecting us.
Even though CNXM is a limited partnership under Delaware law, it is possible in certain circumstances for a partnership such as ours to be treated as a corporation for federal income tax purposes. A change in business or a change in current law could cause us to be treated as a corporation for U.S. federal income tax purposes or otherwise subject us to taxation as an entity.
If CNXM were treated as a corporation for federal income tax purposes, CNXM would pay federal income tax on our taxable income at the corporate tax rate, which is currently a maximum of 21%, and would likely pay state and local income tax at varying rates. Distributions would generally be taxed again as corporate dividends (to the extent of current and accumulated earnings and profits), and no income, gains, losses, deductions, or credits would flow through to unitholders. In addition, changes in current state law may subject us to additional entity-level taxation by individual states. Several states are evaluating ways to subject partnerships to entity-level taxation through the imposition of state income, franchise and other forms of taxation. Imposition of any such taxes may substantially reduce the cash available for distribution to unitholders. Therefore, if CNXM were treated as a corporation for U.S. federal income tax purposes or otherwise subjected to a material amount of entity-level taxation, there would be a material reduction in the anticipated cash flow and after-tax return to unitholders, likely causing a substantial reduction in the value of our common units.
Our partnership agreement provides that, if a law is enacted or existing law is modified or interpreted in a manner that subjects us to taxation as a corporation or otherwise subjects us to entity-level taxation for federal, state or local income tax purposes, the minimum quarterly distribution amount and the target distribution levels may be adjusted to reflect the impact of that law on us.
The tax treatment of publicly traded partnerships or an investment in common units could be subject to potential legislative, judicial or administrative changes and differing interpretations, possibly on a retroactive basis.
The present U.S. federal income tax treatment of publicly traded partnerships, including us, or an investment in common units may be modified by administrative, legislative or judicial interpretation at any time. For example, members of Congress and the President have periodically considered substantive changes to the existing U.S. federal income tax laws that would affect the tax treatment of certain publicly traded partnerships, including the elimination of partnership tax treatment for certain publicly traded partnerships. Further, final Treasury regulations under Section 7704(d)(1)(E) of the Code published in the Federal Register interpret the scope of qualifying income requirements for publicly traded partnerships by providing industry-specific guidance. CNXM does not believe these final regulations affect our ability to be treated as a partnership for U.S. federal income tax purposes.
Any modification to the U.S. federal income tax laws and interpretations thereof may or may not be retroactively applied and could make it more difficult or impossible to satisfy the requirements of the exception pursuant to which CNXM is treated as a partnership for U.S. federal income tax purposes. CNXM is unable to predict whether any such changes will ultimately be enacted. However, it is possible that a change in law could affect us, and any such changes could negatively impact the value of an investment in our common units.
Unitholders’ share of income will be taxable for federal income tax purposes even if they do not receive any cash distributions.
Because a unitholder will be treated as a partner to whom CNXM will allocate taxable income that could be different in amount than the cash CNXM distributes, a unitholder’s allocable share of taxable income will be taxable to it, which may require the payment of federal income taxes and, in some cases, state and local income taxes, on its share of taxable income even if it receives no cash distributions. Unitholders may not receive cash distributions equal to their share of taxable income or even equal to the actual tax liability that results from that income.
If the IRS contests the federal income tax positions CNXM takes, the market for common units may be adversely impacted and the cost of any IRS contest will reduce cash available for distribution to unitholders.
CNXM has not requested a ruling from the IRS with respect to our treatment as a partnership for federal income tax purposes or any other matter affecting us. The IRS may adopt positions that differ from the positions CNXM takes, and the IRS’s positions may ultimately be sustained. It may be necessary to resort to administrative or court proceedings to sustain some or all the positions CNXM takes and such positions may not ultimately be sustained. A court may not agree with some or all the positions CNXM takes. Any contest with the IRS, and the outcome of any IRS contest, may have a materially adverse impact on the market for common units and the price at which they trade. In addition, our costs of any contest with the IRS will be borne indirectly by unitholders and general partner because the costs will reduce Distributable Cash Flow.
For partnership tax years beginning after 2017, the rules for auditing large partnerships and for assessing and collecting taxes due (including penalties and interest) as a result of a partnership-level federal income tax audit were altered. Under these rules, unless CNXM is eligible to, and do, issue revised Schedules K-1 to our partners with respect to an audited and adjusted partnership tax return, the IRS may assess and collect taxes (including any applicable penalties and interest) directly from us in the year in which the audit is completed. If CNXM is required to pay taxes, penalties and interest as a result of audit adjustments, cash available for distribution to unitholders may be substantially reduced. In addition, because payment would be due for the taxable year in which the audit is completed, unitholders during that taxable year would bear the expense of the adjustment even if they were not unitholders during the audited tax year.
Tax gain or loss on the disposition of common units could be more or less than expected.
If unitholders sell common units, they will recognize a gain or loss for federal income tax purposes equal to the difference between the amount realized and their tax basis in those common units. Because distributions in excess of their allocable share of net taxable income decrease their tax basis in their common units, the amount, if any, of such prior excess distributions with respect to the common units a unitholder sells will, in effect, become taxable income to the unitholder if it sells such common units at a price greater than its tax basis in those common units, even if the price received is less than its original cost. Furthermore, a substantial portion of the amount realized on any sale of common units, whether or not representing gain, may be taxed as ordinary income due to potential recapture items, including depreciation recapture. In addition, because the amount realized includes a unitholder’s share of nonrecourse liabilities, a unitholder that sells common units may incur a tax liability in excess of the amount of cash received from the sale.
Our unitholder's share of our taxable income, and its relationship to any distributions we make, may be affected by a variety of factors, including our economic performance, transactions in which we engage or changes in law.
A unitholder's share of our taxable income, and its relationship to any distributions we make, may be affected by a variety of factors, including our economic performance, which may be affected by numerous business, economic, regulatory, legislative, competitive and political uncertainties beyond our control, and certain transactions in which we might engage. For example, we may engage in transactions that produce additional taxable income allocations to some or all of our unitholders without a
corresponding increase in cash distributions to our unitholders, such as the recently announced IDR Transaction (See Note 25 - Subsequent Event in the Notes to the Audited Consolidated Financial Statements in Item 8 of this Form 10-K for more information) or a sale or exchange of assets, the proceeds of which are reinvested in our business or used to reduce our debt. A unitholder's ratio of its share of taxable income to the cash received by it may also be affected by changes in law. For instance, under the recently enacted law known as the Tax Cuts and Jobs Act of 2017 (the Tax Reform Legislation), the net interest expense deductions of certain business entities, including us, are limited to 30% of such entity's "adjusted taxable income," which is generally taxable income with certain modifications. If the limit applies, a unitholder's taxable income allocations will be more (or its net loss allocations will be less) than would have been the case absent the limitation.
Tax-exempt entities and non-U.S. persons face unique tax issues from owning common units that may result in adverse tax consequences to them.
Investment in common units by tax-exempt entities, such as employee benefit plans and individual retirement accounts (known as IRAs), and non-U.S. persons raises issues unique to unitholders. For example, virtually all income allocated to organizations that are exempt from federal income tax, including IRAs and other retirement plans, will be unrelated business taxable income and will be taxable to them. Distributions to non-U.S. persons will be reduced by withholding taxes at the highest applicable effective tax rate, and non-U.S. persons will be required to file federal income tax returns and pay tax on their share of taxable income.
Under the Tax Reform Legislation, if a unitholder sells or otherwise disposes of a common unit, the transferee is required to withhold 10.0% of the amount realized by the transferor unless the transferor certifies that it is not a foreign person, and CNXM is required to deduct and withhold from the transferee amounts that should have been withheld by the transferee but were not withheld. However, the Department of the Treasury and the IRS have determined that this withholding requirement should not apply to any disposition of a publicly traded interests in a publicly traded partnership (such as us) until regulations or other guidance have been issued clarifying the application of this withholding requirement to dispositions of interests in publicly traded partnerships. Accordingly, while this new withholding requirement does not currently apply to interests in us, there can be no assurance that such requirement will not apply in the future. Tax-exempt entities and non-U.S. persons should consult a tax advisor before investing in common units.
CNXM treats each purchaser of common units as having the same tax benefits without regard to the actual common units purchased. The IRS may challenge this treatment, which could adversely affect the value of common units.
Because CNXM cannot match transferors and transferees of common units and because of other reasons, CNXM adopts depreciation and amortization positions that may not conform to all aspects of existing Treasury regulations. A successful IRS challenge to those positions could adversely affect the amount of tax benefits available to unitholders. It also could affect the timing of these tax benefits or the amount of gain from the sale of common units and could have a negative impact on the value of common units or result in audit adjustments to unitholder tax returns.
CNXM prorates items of income, gain, loss and deduction between transferors and transferees of our units each month based upon the ownership of units on the first business day of each month, instead of on the basis of the date a particular unit is transferred. The IRS may challenge aspects of our proration method, and, if successful, CNXM would be required to change the allocation of items of income, gain, loss and deduction among unitholders.
CNXM prorates items of income, gain, loss and deduction between transferors and transferees of units each month based upon the ownership of units on the first business day of each month, instead of on the basis of the date a particular unit is transferred. The U.S. Department of Treasury and the IRS issued Treasury Regulations that permit publicly traded partnerships to use a monthly simplifying convention that is similar to ours, but they do not specifically authorize all aspects of the proration method CNXM has adopted. If the IRS were to successfully challenge this method, CNXM could be required to change the allocation of items of income, gain, loss and deduction among unitholders.
A unitholder whose common units are loaned to a “short seller” to effect a short sale of common units may be considered as having disposed of those common units. If so, a unitholder would no longer be treated for federal income tax purposes as a partner with respect to those common units during the period of the loan and may recognize a gain or loss from the disposition.
Because a unitholder whose common units are loaned to a “short seller” to effect a short sale of common units may be considered as having disposed of the loaned common units, a unitholder may no longer be treated for federal income tax purposes as a partner with respect to those common units during the period of the loan to the short seller and the unitholder may recognize gain or loss from such disposition. Moreover, during the period of the loan to the short seller, any income, gain, loss or deduction with respect to those common units may not be reportable by the unitholder and any cash distributions received by the unitholder as to those common units could be fully taxable as ordinary income.
CNXM has adopted certain valuation methodologies in determining a unitholder’s allocations of income, gain, loss and deduction. The IRS may challenge these methodologies or the resulting allocations, and such a challenge could adversely affect the value of the common units.
In determining the items of income, gain, loss and deduction allocable to unitholders, in certain circumstances, including when CNXM issues additional units, CNXM must determine the fair market value of our assets. Although CNXM may from time to time consult with professional appraisers regarding valuation matters, CNXM makes many fair market value estimates using a methodology based on the market value of common units as a means to measure the fair market value of our assets. The IRS may challenge these valuation methods and the resulting allocations of income, gain, loss and deduction.
A successful IRS challenge to these methods or allocations could adversely affect the amount, character and timing of taxable income or loss allocated to unitholders. It also could affect the amount of gain from unitholders’ sale of common units and could have a negative impact on the value of common units or result in audit adjustments to unitholders’ tax returns without the benefit of additional deductions.
As a result of investing in common units, a unitholder may become subject to state and local taxes and return filing requirements in jurisdictions where CNXM operates or own or acquire properties.
In addition to federal income taxes, unitholders are likely subject to other taxes, including state and local taxes, unincorporated business taxes and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which CNXM conducts business or control property now or in the future, even if they do not live in any of those jurisdictions. Unitholders are likely required to file state and local income tax returns and pay state and local income taxes in some or all of these various jurisdictions. Further, unitholders may be subject to penalties for failure to comply with those requirements. CNXM currently conducts business in Pennsylvania and West Virginia. Both Pennsylvania and West Virginia currently impose a personal income tax on individuals. As CNXM makes acquisitions or expand our business, CNXM may control assets or conduct business in additional states that impose a personal income tax. It is a unitholder’s responsibility to file all federal, state and local tax returns.
Compliance with and changes in tax laws could adversely affect our performance.
CNXM is subject to extensive tax laws and regulations, including federal, state and foreign income taxes and transactional taxes such as excise, sales/use, payroll, franchise and ad valorem taxes. New tax laws and regulations and changes in existing tax laws and regulations are continuously being enacted that could result in increased tax expenditures in the future. Many of these tax liabilities are subject to audits by the respective taxing authority. These audits may result in additional taxes as well as interest and penalties.