Kinder Morgan Set To Benefit From Increased Production And Consumption Of Natural Gas

Kinder Morgan Energy Partners (NYSE:KMP), a subsidiary of Kinder Morgan Inc., is provider of storage and transportation services for petroleum products, ethanol, natural gas and carbon dioxide. The company also produces carbon dioxide for use in enhanced oil recovery operations. KMP’s most valuable business division is its Natural Gas Pipelines business. This business segment is primarily involved in the transportation of natural gas via pipelines, but also carries out natural gas gathering and processing operations. The key factors which determine the revenues for this division are the levels of consumption and production of natural gas, the going market price for natural gas and the costs involved in the shipment of natural gas.

In Q1 2014, the natural gas pipelines division saw its earnings before depreciation, depletion, amortization and one time items increase by around 46% year-over-year, to about $723 million. ^[1] While the earnings growth was primarily driven by the effects of the Copano Energy acquisition, the company’s overall natural gas transportation volumes also saw significant growth. Overall natural gas transport volumes through Q1 rose by around 5% year-over-year to around 17,938 Billion British Thermal Units(Bbtu) per day (including Copano volumes for both periods) . This growth mirrored the higher natural gas demand in the United States through Q1, when colder weather and heavy snowfall boosted consumption for heating purposes. ^[2]

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Trefis has an $82 price estimate for KMP, which is slightly above the current market price.

Bright Outlook For Natural Gas

The recently published annual energy outlook report for 2014 by the U.S. Energy Information Administration(EIA) shows a significant increase in the consumption and production of natural gas in the U.S. The three key findings of the report are as follows:

• The increasing development of shale gas means that shale will provide the largest source of growth in natural gas supply in the U.S. The report projects the production of shale to more than double to 19.8 Trillion Cubic Feet(TCF) by 2040 from 9.7 TCF in 2012. ^[3]
• The production of natural gas will outpace its consumption in this period. The report says that production will grow by an average rate of 1.6% per year from 2012 to 2040, two times the 0.8% annual growth rate of total U.S. consumption over the same period. ^[3]
• The consumption of U.S. natural gas will be driven by the industrial and electrical power sectors. Low prices and environmentally friendly nature will enhance natural gas’ attractiveness as a fuel for power generation for all sectors except for residential, where population shifts to warmer regions and the increasing efficiency of heating appliances will restrict the growth of natural gas usage. ^[3]

The report also says that by 2040 the U.S. will have transitioned from being a net importer of natural gas to a net exporter. Most of the demand for exports will come from Asia, but Mexico is also likely to be a key contributor. ^[3] This is good news for natural gas companies, whose profits have been affected because of the low price of natural gas in the face of an oversupplied market. The rise in demand for natural gas should mean that the price of natural gas will correct itself and thus ensure that revenues for both shipping of natural gas and processing of natural gas reach the company’s desired levels.

Increasing Presence In Shale Plays

The EIA report projects the contribution of shale gas to U.S. dry gas production to increase from 40% currently to 53% by the end of the period. KMP has been steadily increasing its presence in shale plays. The acquisition of Copano Energy LLC for $5 billion in May 2013 gave the company access to Copano’s gas gathering, processing and transmission infrastructure at key shale gas basins in Texas, Oklahoma and Wyoming. ^[4] Through the acquisition, KMP expanded its presence in the Eagle Ford shale in Texas, considered to be one of the most promising areas in North America due to its rising high quality output and proximity to key markets. KMP was already in a joint venture with Copano for gas gathering in the Eagle Ford shale and will now become the sole owner of this operation. The firm also gained access to operations in Barnett Shale in North Texas, one of the largest shale basins in North America (in terms of production).

How Increased Consumption And Production Of Natural Gas Benefits KMP

Because of overproduction by natural gas suppliers, the prices of natural gas have been at decade low levels. Regardless, Kinder Morgan has performed strongly despite significant natural gas exposure. Even in an environment of falling natural gas prices, there is still a need to store the existing supply, and here Kinder Morgan’s storage depots come in handy. However, in the present supply glut is gas, higher storage revenues from natural gas have been offset by the reduction in gas volume transportation revenues. Given the projected rise in demand for natural gas from the industrial and electrical power sectors, the trend in falling transportation revenues should be expected to reverse. The declining prices of natural gas have impacted the margins of natural gas producers. Companies have suspended exploration and drilling activities to maintain the margins on the sale of natural gas. Further contraction in the margins can affect the willingness of these companies to pay for the high shipping costs of natural gas. If domestic demand for natural gas picks up, the companies can resume drilling and exploration activities. Furthermore, they will also be able to pay for shipping, while maintaining the same margins on sales. This will improve KMP’s ability to ask for higher realizations.

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1. Kinder Morgan SEC Filings, kindermorgan.com [↩]
2. Kinder Morgan Energy Partners CEO Discusses Q1 2014 Results – Earnings Call Transcript, Seeking Alpha, April 2014 [↩]
3. 2014 Annual Energy Outlook, EIA, May 2014 [↩] [↩] [↩] [↩]
4. KMP to Acquire Copano for Approximately $5 Billion in Unit for Unit Transaction, Businesswire, January 2013 [↩]