What’s Driving Growth In KMP’s Natural Gas Pipelines Division?

Kinder Morgan Energy Partners (NYSE:KMP) operates North America’s largest natural gas pipeline network. The business remains the company’s bread and butter, accounting for more than 50% of its total annual revenues. The division has seen its shipment volumes grow from around 2,000 billion cubic feet (bcf) in 2008 to over 5,000 bcf in 2012 thanks to acquisitions as well as strong growth in natural gas consumption in the United States over that period.

Although natural gas consumption in the U.S. has grown at a compounded rate of nearly 3% per year over the last 5 years due to a glut in shale gas, consumption growth is expected to moderate to below 1% per year through 2040, according to the U.S. Energy Information Agency (EIA). ^[1] Given the relatively sluggish growth projections, we believe that some of  KMP’s natural gas pipelines division’s future growth will come from new acquisitions, further expansion into shale gas plays and more shipments to the Mexican market.

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Growth In Shale Gas Production

According to the U.S. EIA, almost all of the growth in domestic natural gas production through 2040 is expected to come from the increase in shale gas production, and KMP has been aggressively expanding its footprint in these plays. Despite the growth in U.S. shale production, many shale fields still lack the adequate pipeline infrastructure to transport gas. In May, KMP closed its $5 billion acquisition of Copano Energy. The deal helped to extend KMP’s presence in important shale gas basins such as the Mississippi Lime and Woodford shale formations in Oklahoma and the Barnett Shale in Texas and also helped the company expand its operations in the Eagle Ford shale in Texas. Additionally, in 2012, KMP took over the Tennessee gas pipeline (TGP) from its parent company Kinder Morgan Inc. (NYSE:KMI). The Tennessee gas pipeline has access to shale basins such as the Marcellus and Utica shales and also connects major cities on the East Coast such as New York and Boston. (Related read: A Closer Look At Kinder Morgan Partners’ Tennessee Gas Pipeline)

We believe that acquisitions could continue to be a key theme in the natural gas division’s growth since the construction of new interstate pipelines typically takes three years or more and involves significant regulatory approvals while also being subject to the risks of public opposition and environmental obstacles. Considering these factors, many companies prefer to acquire well-established, existing pipelines rather than building out new pipeline systems from scratch.

Exports To Mexico Provide An Opportunity Over The Medium Term

Mexico is viewed as an attractive market for U.S. natural gas. The country’s natural gas imports from the U.S. have grown by around 92% since 2008 and pipelines between the two countries are currently running at nearly full capacity. ^[2] Since natural gas prices in Mexico are tied to their U.S. prices (which are relatively low), this is stifling investment in gas drilling in the country and domestic production has actually been declining while demand has been growing. The state-run firm, Pemex, currently has a monopoly over natural gas production and has seen its production fall by around 15% since 2008. While the country has plans to reform its oil industry, potentially allowing big international oil companies to enter the Mexican market, we believe that it could take several years before they are able to tap into the country’s shale gas reserves and ramp up production to a commercial scale. Until such time, we believe that pipeline-based imports from the U.S. will be one of the more cost effective and stable means of ensuring natural gas supply.

During the Q2 2013 earnings conference call, KMP’s management had indicated that it was seeing higher demand for shipments into Mexico. KMP’s exposure to the Mexican market primarily comes from its its Mier-Monterrey pipeline and the EPNG system, which has significant transmission capacity to northern Mexico. The company currently transports around 1.8 billion cubic feet of gas to Mexico everyday. ^[3] During the second quarter, KMP signed agreements with three new customers for over 200 million cubic feet (Mcf) per day of capacity. Given the strong demand and prospects, the company has a number of expansion projects underway as well. Some of the new projects include the Sierrita pipeline project which will extend a part of the EPNG pipeline system from Arizona to the Mexican border, and another project to increase pipeline pressure on a part of the EPNG system that has access to the U.S -Mexico border.

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1. U.S. Energy Information Agency [↩]
2. Christian Science Monitor [↩]
3. Seeking Alpha [↩]