A Closer Look At Kinder Morgan Partners’ Tennessee Gas Pipeline

Kinder Morgan Energy Partners (NYSE:KMP) acquired the Tennessee gas pipeline system (TGP), one of the largest natural gas pipelines in the United States, from its parent company Kinder Morgan Inc. (NYSE:KMI) in August 2012. These assets have had a positive impact on both the revenues and profitability of KMP’s natural gas pipelines division. We believe that they are also strategically important to KMP given their access to some of the largest shale gas plays in the U.S. Here is a brief overview of the pipeline system’s geographic reach, its operations, potential opportunities and risks.

The TGP system operates multiple-line natural gas pipelines, which begin in the natural gas producing regions of Louisiana, the Gulf of Mexico and South Texas and extend into the Northeast connecting large metropolitan areas such as Boston and New York City. The pipeline has a total system length of around 13,900 miles.

Strong Operational Performance

The TGP system has a capacity of around 8 billion cubic feet per day (bcf/d) for natural gas, and over the last year, the average throughout was 7.2 (bcf/d), which translates into a utilization rate of around 90%.  The strong utilization also reflected on its profitability. The TGP system, which was included in KMP’s results for the last five months of 2012, emerged as one of the the strongest performers within the firm’s natural gas pipelines division contributing around $421 million in revenues while EBDA (earnings before non cash items) was around $308 million. Going forward, we estimate that TGP will contribute around 25% of  the natural gas pipeline division’s revenues. The natural gas pipelines division had revenues of around $3.9 billion in 2012 while the EBDA from continuing operations was around $1.35 billion.

A Wide Footprint; Expanding In The North East

Connectivity to largest shale gas basins: The pipeline system connects to four major shale formations in the U.S – The Haynesville shale formation in northern Louisiana and Texas, the Marcellus shale formation in Pennsylvania, the Utica shale formation and the Eagle Ford formation in South Texas. ^[1] Serving shale basins is becoming increasingly important for natural gas pipeline companies from a growth perspective. The U.S. EIA estimates that almost all the growth in U.S. natural gas output over the next two decades will come from an increase in shale gas production.

Access to Canada and Mexico: The TGP system has interconnects at the U.S.-Mexico border and the U.S.-Canada border, which connect to other pipeline systems. This could provide opportunities for KMP, given that the low prices and excess supply of natural gas in the United States are encouraging producers to sell more of their produce abroad. Total pipeline based natural gas exports to Canada have grown by over 70% over the last five years while exports to Mexico have also grown by around 70% in the same period. ^[2]

Expanding capacity in the north east: The Marcellus shale formation, located in the Northeast, is now the single largest source of natural gas in the United States and its output continues to grow at a rapid pace. Capacity utilization for pipelines in this region are also typically the highest.  To tap into the booming market, KMP has undertaken a $450 million project to expand TGP’s pipeline facilities in Pennsylvania and New Jersey, to service the growing production from the Marcellus shale. The additional shipment capacity has already been subscribed entirely. The firm has received approval from the Federal Energy Regulatory Commission (FERC), and the capacity is expected to come online by the end of this year.

Risk That Inter-regional Shipments Could Decline

A large portion of the natural gas production has traditionally occurred in the southern United States and was shipped for consumption in the Northeast, contributing to relatively high utilization rates across the TGP pipeline. However, with output from the Marcellus shale growing rapidly, shipping volumes in the upstream portion of the pipeline (which is in the south) have actually been declining, while shipments within the Northeast have been growing. Utilization rates (or load factors) in the southern part of the pipeline have actually declined from around 70% to under 40% over the last four years. ^[3] Since inter-regional shipments are likely to have higher rates, considering the longer distances, a continuing decline in these shipments could impact revenues and margins adversely.

We have a price estimate of $91 for Kinder Morgan, which is about 5% ahead of the current market price.

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1. KMP 10-K [↩]
2. U.S. EIA [↩]
3. Seeking Alpha [↩]