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Stress Testing Energy Companies in the Current Environment

Stress Testing Energy Companies in the Current Environment

This paper highlights several ways to stress testing companies within the energy industry, particularly with regards to impact of COVID-19 and the current oil price shock. We have conducted a statistical analysis in order to assess the impact of persistent low oil price on Q2 2020 Probability of Default (PD) in the energy industry. In addition to this paper, S&P Global Market Intelligence is also working on the creation of an oil price scenario tool factoring in various aspects from a supply and demand perspective.

Assessing the Impact of COVID-19

The impact of COVID-19 on the energy industry is unprecedented. According to the International Energy Association (IEA), in the first quarter of this year, global demand had decreased by 2.5 million barrels per day.[1] Aside from the price war impacting supply, demand has also suffered. An example of this is the drop in fuel demand from airlines globally due to government-imposed travel restrictions designed to curb the spread of COVID-19.

Governments have also tried to relieve the impact of mandatory business closures by using monetary and fiscal stimulus. However, a negative impact will likely be felt. As of March 31, 2020, S&P Global Ratings downgraded approximately 340 corporate entities globally and put another 370 on Negative Outlook or CreditWatch with negative implications. Almost 80% of these ratings actions apply to entities in the speculative-grade category.[2]

One of the industry approaches used to measure the potential impact of market events like the oil price shock, and COVID-19 on a company’s creditworthiness is the adjustment of annual revenue figures by simply dismissing an entire revenue tranche. In other words, completely erasing the revenue from a given quarter while keeping all other financials the same (e.g. same figures from the previous year quarter). One of the major assumptions here is that the fixed costs remain the same while the variable costs are reduced with the revenue decline.

2014-2016 Oil Price Crash

The recent oil price shock was triggered by Russia and Saudi Arabia’s oil price war. The two countries failed to agree on coordinated production cuts following diminishing demand from the biggest oil importer, China, due to COVID-19 pandemic. Oil prices fell dramatically, leading the oil industry into uncharted territory, and a number of energy companies are likely to be negatively impacted. Although we are in an unprecedented situation with regard to the energy industry, the previous oil price crash can provide a proxy to stress the financials.

In 2016, oil prices declined by 70% from their peak in 2014. There were a number of factors that contributed to the decline in oil prices during 2014-2016 period, including: China’s slowing growth rate impacting demand, and efficiency gains in United States (US) shale oil impacting supply. In the current 2020 downturn, oil company costs are comparatively lower and annual cash flow after dividends may remain positive for many large companies, but debt is still relatively high compared to the 2014-2016 downturn.

Figure 1: Average Annual Crude Spot Prices

easset upload file64833 1462409 e

Source: United States Energy Information Administration, as of April 6 2020, retrieved from: https://www.eia.gov/dnav/pet/pet_pri_spt_s1_a.htm

S&P Global Ratings base case assumptions for Brent oil prices are: $30 per barrel for the remainder of 2020, $50 per barrel in 2021, and $55 per barrel in 2022. Working on the base case assumption of $30 per barrel for 2020, this represents a drop of 53% from the 2019 average Brent spot price of $64 barrel.[3]

The observed change in the financials due to the oil price drop between 2014 and 2016 is also utilized as a stress testing approach. For example, between 2014 and 2015, the average crude spot price change for Brent was 48%. When looking at a company’s key financial metrics change over the same period, one could determine the deterioration change percentage. This change can be used to stress the input factors required for the Credit Analytics scoring models. This approach could also be combined with the revenue-erasing approach to better reflect the current business environment.

Impact on the Probability of Default

Assessing the full extent of any relationship between oil price movements and the subsequent stress on financials requires substantial time and resources. With the purpose of providing a high level and timely view, we conducted this quantitative analysis to test for a statistically significant relationship between the oil price change and the change of the PD in the energy industry.

The study was performed on quarter-over-quarter (QoQ) changes of the last twelve months (e.g. for Q1 2019: January 1, 2019 to March 31, 2019) PDs between Q1 2011 and Q4 2019. The QoQ change of the PD has been analyzed with respect to QoQ changes in oil price (oil price quarter value is calculated as the average daily value of the three consecutive months within the quarter). This study focuses on the results over a short time horizon, in particular the oil price change effect on the PD within the same quarter.

The sample data selected for the analysis consists of public companies in the energy industry with the PD pre-scored by PD Model Fundamentals (PDFN) between 2011 and 2020. We used logistic regression to regress PD on QoQ changes of oil price and the model parameters were trained via maximization likelihood estimation. The sole explanatory variable is the QoQ change of the oil price and the dependent variable is the PD in the same quarter. The PD in the previous quarter is also added to the model as a fixed feature. The QoQ oil price change is defined as the percentage change of the average oil price from one quarter to the next one. The PD is calculated by using Last Twelve Months (LTM) financials and PDFN.

Figure 2 shows the analytical process and the results structure. Two different test cases were created to maximize the statistical significance: 1) all companies (i.e. defaulted and non-defaulted companies); 2) non-defaulted companies only. We find that the majority of defaulted companies have a PD at the speculative grade level prior to default.

Figure 2: Analytical process of the study

easset upload file72110 1462409 e

Source: PD Model Fundamentals,S&P Global Market Intelligence, data as of April 1, 2020. For illustrative purposes only.

With the model trained on the historical data, one can apply the oil price forecast to predict the PD in Q2. In Figure 3, there are three suggested scenario cases where, after Q1 of 2020, the oil price falls either at $20/$30/$40 per barrel for Brent or $15/$25/$35 per barrel for West Texas Intermediate (WTI) in Q2, where the average Q1 oil price is $50 and $45 for Brent and WTI, respectively, as of April 1 2020. The results are shown for different groups, under Brent and WTI oil price, including and excluding defaults. These two cases represent different levels of vulnerability for investment grade and speculative grade companies. The impact of the oil price changes is more material for more vulnerable companies. Note that the change in PD is not linear and constant as logistic regression was utilized. The values in Figure 3 represent the approximate percentage change in PD with respect to the PD level in 2019.

Figure 3: Proxy impact of oil price levels on the PD under different scenarios

easset upload file6339 1462409 e

Note: further information is available upon request.
Source: PD Model Fundamentals, S&P Global Market Intelligence, data as of April 1, 2020. For illustrative purposes only.

In summary, various unique approaches are being conducted towards stress testing, given the exceptional nature of the circumstances. To comprehensively understand the impact on PD, a combination of these approaches may be required to factor in the various dynamics at play.

At the time of authoring this paper Saudi Arabia and Russia among other oil producing nations reached an agreement on production cuts. However, there are many concerns about the drop in oil demand, and it is hard to gauge the extent of this drop in demand as different countries experience different periods of ‘shutdown’ during the COVID-19 pandemic. Frequent stress tests, like the ones we’ve suggested in this paper, can be helpful to keep pace with the changes.

Our Credit Analytics products provides analytical tools and solutions for scenario and stress testing when running risk analysis on rated, unrated, public, and private companies.

[1] Iea. (2020, March 1). Global oil demand to decline in 2020 as coronavirus weighs heavily on markets – News. Retrieved from https://www.iea.org/news/global-oil-demand-to-decline-in-2020-as-coronavirus-weighs-heavily-on-markets

[2] “COVID-19 Weekly Digest”, S&P Global Ratings, April 1, 2020.

[3] “Harsh Downturn Prompts Rating Actions On Multiple European Oil And Gas Companies”, S&P Global Ratings, Redmond et al., March 25, 2020, retrieved from RatingsDirect® on the S&P Capital IQ platform, https://www.capitaliq.com/CIQDotNet/CreditResearch/SPResearch.aspx?DocumentId=44345397&From=SNP_CRS

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PIPE EXCHANGE PRIVACY POLICY

Last Updated: August 2019

 

Pipe Exchange LLC (“Pipe Exchange,” “we,” “us,” and “our”) respects your privacy. This privacy policy (this “Privacy Policy”) explains the accepted privacy practices for our online service and product listings (collectively, the “Services”) found via our website at https://pipexch.com/ (the “Website”). It describes the ways in which your personal information is collected and used, and the rights and options available to you with respect to such information.

 

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The Website may contain links to other sites that are not owned or controlled by Pipe Exchange. Please be aware that we are not responsible for the privacy practices of such other sites. We encourage you to be aware when you leave our site and to read the privacy statements of each and every web site that collects personally identifiable information. This Privacy Policy applies only to information collected by the Website. 

 

How We Store Your Information

Data Security

Pipe Exchange implements data security systems and procedures to secure the information stored on Pipe Exchange computer servers. Such systems and procedures reduce the risk of security breaches, but they do not provide absolute security. Therefore, Pipe Exchange cannot guarantee that the Website and Services are immune to unauthorized access to the information stored therein and to other information security risks.

 

Our Commitment to Data Security. To prevent unauthorized access, maintain data accuracy and ensure the correct use of information, we have applied reasonable and appropriate physical, electronic and managerial procedures to safeguard and secure the information we collect online. We also limit access to personal data and confidential information on our systems to only those employees with a specific need to access this information. However, due to technological limitations and the risk of unlawful interceptions and accessing of transmissions and/or data, we cannot completely assure you, and you should not expect, that your personal information, and any other electronically communicated information, will be absolutely confidential.

The security of your personal information is important to us. When you enter sensitive financial information via our Website, the transmission of that information is encrypted using secure socket layer technology (SSL).

Please remember that you play a valuable part in security as well. To the extent you have created an account on our Website, your password to access our site, which you select at registration, should never be shared with anyone and should be changed frequently.  After you have finished using our site, you should log off and exit your browser so no unauthorized persons can use our site with your name and account information.

Information Retention and Access to Personal Information. We’ll retain information for as long as your account is active or as needed to provide you the Services, to comply with applicable law, resolve disputes, and to enforce our agreements.   If your personally identifiable information changes, or if you no longer desire to use and access our Services, you may correct, update, delete/deactivate your information by emailing Pipe Exchange via the contact information listed below. Before Pipe Exchange is able to provide you with any information or correct any inaccuracies, however, we may ask you to verify your identity and to provide other details to help us to respond to your request. But please note: (1) there might be some latency in deleting this information from our servers and back-up storage; (2) we will not delete anonymized data and may continue to use it as describe in this Privacy Policy; and (3) we may retain information if necessary to comply with our legal, tax or accounting obligations, resolve disputes, manage security risks, or enforce our agreements. Even if you cease your use of the Services, we may retain certain information in order to meet our obligations.

Under California Civil Code Sections 1798.83-1798.84, California residents are entitled to ask us for a notice identifying the categories of personal information which we share with our affiliates and/or third parties for marketing purposes, and providing contact information for such affiliates and/or third parties.  If you are a California resident and would like a copy of this notice, please submit a written request to: privacy@pipexch.com

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We are a global company, with customers around the world and it is important to note that the Services, and the Website, may be operated via servers situated in the United States and elsewhere. If you are located outside of the United States, please be aware that any information which you supply to Pipe Exchange (including, without limitation, personal information (e.g., your name, phone number, email address, etc.) may be transferred to, processed, and used in the United States and elsewhere. To provide you with the Services, you irrevocably and unconditionally consent that we may store, use, process, transfer and transmit such information in accordance with this Privacy Policy in the United States and locations around the world – including those outside your country which may provide different rules, regulations, and protections regarding privacy. Information may also be stored locally on the devices used to access the Services, which may be mobile.

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Changes to this Privacy Policy

From time to time, Pipe Exchange may change the terms of this Privacy Policy. Changes will take effect once they are posted online and by accessing and/or using the Website or Services after we make any such changes to this Privacy Policy, you are deemed to have accepted such changes.  If you do not agree with any of the amended terms, you must avoid any further use of the Website and/or Services offered by Pipe Exchange.

 

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PIPE EXCHANGE TERMS OF USE

Last updated: August 2019

Welcome to https://pipexch.com/Pipe Exchange (the “Website”). The Website is owned and operated by Pipe Exchange LLCPipe ExchangePipe Exchange including its related companies, affiliates and subsidiaries (collectively “Pipe Exchange,” “we,” “us,” “our”). We make the Website available to you, subject to the following Terms of Use (these “Terms of Use”). PLEASE READ THE FOLLOWING TERMS OF USE CAREFULLY BEFORE USING THE WEBSITE. By using the Website, you agree to these Terms of Use and agree they create a legally binding agreement between you and Pipe Exchange. If you do not agree to these Terms of Use, you may not use the Website. These Terms of Use are effective unless and until terminated by Pipe Exchange.

Minors are not authorized to access or use the Website for any purpose.

CHANGES TO TERMS OF USE

Pipe Exchange reserves the right, at any time, to modify, amend, alter or update these Terms of Use. These changes will be effective as of the date we post the revised version. By continuing to use the Website following such modifications, amendments, alterations or updates, you agree to be bound by such modifications, amendments, alterations or updates. Therefore, you should periodically visit this page to review our most current Terms of Use.

You may access the current version of these Terms of Use at any time by clicking on the link marked “Terms of Use” at the bottom of each page of the Website.

PRIVACY POLICY

In the course of your use of the Website, you may be asked to provide certain personalized information to us (such information referred to hereinafter as “User Information”).  Our information collection and use policies with respect to the privacy of such User Information are set forth in the Website’s Privacy Policy which is incorporated herein by reference for all purposes.  You acknowledge and agree that you are solely responsible for the accuracy and content of User Information, and you agree to keep it up to date. 

INTELLECTUAL PROPERTY RIGHTS

Pipe Exchange respects the intellectual property rights of others. As between you and Pipe Exchange, and except any User Information which you provide, all rights, title and interests in the Website, including all the content (including, for example, audio, photographs, illustrations, graphics, other visuals, video, copy, software, etc.), code, data and materials thereon, the look and feel, design and organization of the Website, and the compilation of the content, code, data and materials on the Website, including but not limited to any copyrights, trademark rights, patent rights, database rights, moral rights, sui generis rights and other intellectual property and proprietary rights therein (collectively the “Content”) are owned by Pipe Exchange or by third parties who have licensed or provided their Content to us. The Website is protected under Trademarks (as defined below), copyright, patent, trade secret and other intellectual property rights laws, and your use of the Website does not grant to you ownership of any Content you may access on the Website. You are prohibited from using the Website to infringe or violate any intellectual property rights. Pipe Exchange may terminate your right to access the Website if it believes you are using the Website in a manner that infringes the copyright, trademark, patent or other intellectual property rights of another.

We may investigate occurrences that may involve violations of the security of the Services or of the law and we may involve, and cooperate with, law enforcement authorities in prosecuting users who are involved in such violations.

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PERSONAL USE ONLY

The Website and the Content are intended for your personal use.  You may access and view the content on the Website via your computer or other internet compatible device, and make single copies or prints of the content on the Website for your personal, internal use only.   The Website and the services offered on or through the Website, including Pipe Exchange’s e-publication and any other content and materials thereon, are only for your personal, non-commercial use. Except as otherwise provided on the Website, you may not modify, copy, distribute, transmit, display, perform, reproduce, publish, license, sell, create derivative works from, transfer, or sell any information, software, products or services obtained from the Website. Use of the Website to sell a product or service, or to increase traffic to your website for commercial reasons, such as advertising sales is expressly forbidden.

PROHIBITED USE

Any commercial distribution, publishing or exploitation of the Website, or any content, code, data or materials on the Website, is strictly prohibited unless you have received the express prior permission of Pipe Exchange or the applicable rights holder.  You may not otherwise download, display, copy, reproduce, distribute, modify, perform, transfer, create derivative works from, sell or otherwise exploit any content, code, data or materials on the Website.  If you make other use of the Website, or the content, code, data or materials thereon, except as otherwise provided above, you may violate copyright and other laws of the United States, other countries, as well as applicable state laws and may be subject to liability for such unauthorized use.  Pipe Exchange will aggressively enforce its intellectual property rights to the fullest extent of the law, including the seeking of criminal prosecution.

SECURITY

You are prohibited from violating, or attempting to violate the security of the Website. Any such violations may result in criminal and civil liabilities to you.  You warrant and agree that, while using the Website and the various services and features offered on or through the Website, you shall not: (a) impersonate any person or entity or misrepresent your affiliation with any other person or entity; (b) insert your own or a third party’s advertising, branding or other promotional content into any of the Website’s content, materials or services, or use, redistribute, republish or exploit such content or service for any further commercial or promotional purposes or take any action that would constitute or could be interpreted as an endorsement or sponsorship by Pipe Exchange of any third party site, content, information or other materials, or in any manner that would violate the terms and conditions of any such third party sites; (c) attempt to probe, scan, or test the vulnerability of any system or network; or (d) attempt to gain unauthorized access to data not intended for you and/or other computer systems through the Website.  You shall not: (i) engage in spidering, “screen scraping,” “database scraping,” harvesting of e-mail addresses, wireless addresses or other contact or personal information, or any other automatic means of accessing, logging-in or registering on the Website or for any services or features offered on or through the Website, or obtaining lists of users or obtaining or accessing other information or features on, from or through the Website or the services offered on or through the Website, including, without limitation, any information residing on any server or database connected to the Website or any services offered on or through the Website; (ii) obtain or attempt to obtain unauthorized access to computer systems, materials, information or any services made available on or through the Website through any means; (iii) use the Website or the services made available on or through the Website in any manner with the intent to interrupt, damage, disable, overburden, or impair the Website or such services, including, without limitation, sending mass unsolicited messages or “flooding,” “spamming,” or “crashing” any systems; (iv) use the Website or the Website’s services or features in violation of Pipe Exchange’s or any third party’s intellectual property or other proprietary or legal rights; or (v) use the Website or the Website’s services in violation of any applicable law.  You further agree that you may not attempt (or encourage or support anyone else’s attempt) to circumvent, reverse engineer, decrypt, or otherwise alter or interfere with the Website or the Website’s services, or any content thereof, or make unauthorized use thereof.  You agree that you will not use the Website in any manner that could damage, disable, overburden, or impair the Website or interfere with any other party’s use and enjoyment of the Website. You may not obtain or attempt to obtain any materials or information through any means not intentionally made publicly available or provided for through the Website. Pipe Exchange will investigate any alleged violations and will cooperate with law enforcement agencies in their investigations.

THIRD-PARTY CONTENT

Some of the information and material available through the Website are provided to Pipe Exchange by third parties (“Third-Party Material”). In some instances, the source of the Third-Party Material is identified. Third-Party Material is provided for your convenience only and Pipe Exchange does not endorse these materials or the parties who supply them to us. Pipe Exchange does not warrant or represent that these Third-Party Materials are current, accurate or reliable.

COPYRIGHT AGENT

We respect the intellectual property rights of others, and require that the people who use the Website do the same.  If you believe that your work has been copied in a way that constitutes copyright infringement, please forward the following information to Pipe Exchange’s Copyright Agent, designated as such pursuant to the Digital Millennium Copyright Act, 17 U.S.C. § 512(c)(2), named below:

  • Your address, telephone number, and email address;
  • A description of the copyrighted work that you claim has been infringed;
  • A description of where the alleged infringing material is located;
  • A statement by you that you have a good faith belief that the disputed use is not authorized by the copyright owner, its agent, or the law;
  • An electronic or physical signature of the person authorized to act on behalf of the owner of the copyright interest; and
  • A statement by you, made under penalty of perjury, that the above information in your Notice is accurate and that you are the copyright owner or authorized to act on the copyright owner’s behalf.
  • For all email submissions please include the subject line: DMCA Takedown Request.

 

Pipe Exchange has adopted a policy of terminating, in appropriate circumstances, accounts of users of the services or the Website who are deemed to have repeatedly uploaded content that infringes the intellectual property rights of others.

 

Copyright Agent:

Pipe Exchange Legal

c/o Pipe Exchange LLC

14025 West Road.
Suite #100
Houston, TX 77041

Phone: + (713) 934-9480

Email: dmca@pipexch.com

DISCLAIMER OF WARRANTIES

THE WEBSITE AND ITS CONTENT ARE PROVIDED ON AN “AS IS” AND “AS AVAILABLE” BASIS, WITHOUT REPRESENTATIONS OR WARRANTIES OF ANY KIND WHATSOEVER. PIPE EXCHANGE, TO THE FULLEST EXTENT PERMITTED BY LAW, DISCLAIMS ALL WARRANTIES, INCLUDING THE WARRANTY OF MERCHANTABILITY, NON-INFRINGEMENT OF THIRD PARTIES RIGHTS, AND THE WARRANTY OF FITNESS FOR PARTICULAR PURPOSE. PIPE EXCHANGE MAKES NO WARRANTIES ABOUT THE ACCURACY, RELIABILITY, COMPLETENESS, OR TIMELINESS OF THE MATERIAL, SERVICES, SOFTWARE, TEXT, GRAPHICS, AND LINKS FOUND OR CONTAINED ON THE WEBSITE. PIPE EXCHANGE DOES NOT WARRANT THAT THE WEBSITE, THE CONTENT, OR ITS SERVERS ARE FREE OF VIRUSES OR OTHER HARMFUL COMPONENTS. YOU UNDERSTAND AND AGREE THAT YOU OBTAIN MATERIAL THROUGH THE USE OF THE WEBSITE AT YOUR OWN DISCRETION AND RISK AND THAT YOU WILL BE SOLELY RESPONSIBLE FOR ANY DAMAGES TO YOUR COMPUTER SYSTEM OR LOSS OF DATA THAT RESULTS.

ALL MATERIAL CONTAINED IN THE WEBSITE IS FOR GENERAL INFORMATION ONLY, HAS NOT BEEN INDEPENDENTLY VERIFIED, HAS NOT BEEN RECOMMENDED BY ANY FEDERAL OR STATE REGULATORY AUTHORITY AND MAY CONTAIN ERRORS OR OMISSIONS OF MATERIAL INFORMATION. THE MATERIAL AND INFORMATION CONTAINED ON THE WEBSITE SHOULD NOT, THEREFORE, BE USED OR RELIED UPON FOR ANY SPECIFIC REASON OR APPLICATION WITHOUT INDEPENDENT COMPETENT PROFESSIONAL EXAMINATION AND VERIFICATION OF ITS ACCURACY, COMPLETENESS, SUITABILITY AND APPLICABILITY. ANYONE MAKING USE OF THE MATERIAL DOES SO AT HIS/HER/ITS OWN SOLE AND EXCLUSIVE RISK AND ASSUMES ANY AND ALL ACTUAL OR POTENTIAL DAMAGE OR LIABILITY RESULTING FROM SUCH USE.

LIMITATION OF LIABILITY

IN NO EVENT SHALL PIPE EXCHANGE BE LIABLE FOR ANY DAMAGES WHATSOEVER (INCLUDING, WITHOUT LIMITATION, INCIDENTAL, CONSEQUENTIAL OR PUNITIVE DAMAGES, LOST PROFITS, OR DAMAGES RESULTING FROM LOST DATA OR BUSINESS INTERRUPTION) RESULTING FROM THE USE OR INABILITY TO USE MATERIAL ON THE WEBSITE OR SITES LINKED TO THE WEBSITE, WHETHER BASED ON WARRANTY, CONTRACT, TORT, OR ANY OTHER LEGAL THEORY, AND WHETHER OR NOT PIPE EXCHANGE IS ADVISED OF THE POSSIBILITY OF SUCH DAMAGES.

TERMINATION

Pipe Exchange may terminate, change, suspend or discontinue any aspect of the Website or the Website’s services at any time.  Pipe Exchange may restrict, suspend or terminate your access to the Website and/or its services if we believe you are in breach of our terms and conditions or applicable law, or for any other reason without notice or liability.  Pipe Exchange maintains a policy that provides for the termination in appropriate circumstances of the Website use privileges of users who are repeat infringers of intellectual property rights.

USER’S REMEDY

If you are dissatisfied with any portion of the Website or with any of these Terms of Use, your sole and exclusive remedy is to discontinue using the Website.

GOVERNING LAW AND VENUE

These Terms of Use and the relationship between you and Pipe Exchange shall be governed by the laws of the United States and the State of Florida without regard to its conflict of law provisions. You hereby irrevocably submit and consent to the personal and exclusive jurisdiction of the courts located within Miami-Dade County, Florida and agree that any cause of action that may arise under these Terms of Use and all disputes arising out of or relating to the use of the Website shall be commenced and be heard in the appropriate court in Miami-Dade County, Florida. The failure of Pipe Exchange to exercise or enforce any right or provision of these Terms of Use shall not constitute a waiver of such right or provision. If any provision of these Terms of Use is found by a court of competent jurisdiction to be invalid, the parties nevertheless agree that the court should endeavor to give effect to the parties’ intentions as reflected in the provision, and the other provisions of these Terms of Use remain in full force and effect. 

QUESTIONS ABOUT TERMS OF USE

If you have any questions regarding these Terms of Use, please either:

Send an email to sales@pipexch.com

Write to Pipe Exchange at the following address:

14025 West Road

Suite 100

Houston, TX 77041