Earlier this week, Kinder Morgan Energy Partners (NYSE:KMP) announced that its subsidiary El Paso Natural Gas (EPNG) had signed a 25-year contract to transport natural gas from the United States to Mexico. As per the agreement, El Paso will initially transport 200 million cubic feet (mcf) of gas per day via a new 60 mile pipeline.  This new pipeline will extend between Kinder Morgan’s existing pipeline system in Tucson, AZ, and interconnect via an international border crossing to a pipeline being built by another company in Mexico. The firm expects the construction of the pipeline to begin in the first quarter of 2014, subject to regulatory approvals. If the approvals and construction go through as planned, the firm expects service to begin by September 2014.
Although the financial terms of the transaction were not disclosed, we believe that it will be attractive for KMP from a strategic and financial standpoint given the opportunities for the firm to geographically diversify its operations and play a role in feeding Mexico’s booming demand for natural gas.
While Mexican Gas Demand Booms, Supply Is Weak
Natural gas prices in Mexico are linked to the rates in the US market. The sharp decline in US natural gas prices over the last few years led to a consequent drop in prices in Mexico and a surge in demand from the country’s power plants and the industrial sector. However, supply has been slow to catch up since Pemex, a state controlled firm, has monopoly over gas production in the country and hasn’t widely adopted technologies like hydraulic fracturing to exploit reserves like shale gas.
The US exports of natural gas to Mexico have been steadily increasing on improving pipeline infrastructure and the abundance of gas in the US market. Last year the US exported about 500,000 mcf of natural gas to Mexico, up from about 290,000 mcf in 2007. (US Natural Gas Exports To Mexico) Growth during this year has been even more impressive with monthly US pipeline gas exports to Mexico having risen by about 45% since January 2012.
Volumes Will Increase But Pricing May Not Benefit Significantly
KMP’s natural gas pipeline division has been largely centralized in the US market, although it has had some exposure to the US-Mexico pipeline space via the Mier-Monterrey pipeline which has a capacity of 375 mcf/day. Its presence in this space was strengthened by its recent acquisition of a 50% stake in EPNG, which has a significant transmission capacity to northern Mexico. Expanding in Mexico allows the firm to diversify its revenue stream as well as take advantage of the growing Mexican demand for natural gas which will drive volumes of its natural gas shipments.
Shipping rates have an indirect bearing on the price of the commodity as a higher natural gas price gives midstream companies like KMP better bargaining power with oil and gas companies. However, for its Mexican pipelines, KMP may not be able to extract significantly better pricing that what it currently charges in the US given that Mexican gas prices track those in the US market.Notes: