Kinder Morgan Earnings Will Be A Mixed Bag Amid Coal And Oil Volatility

Kinder Morgan Energy Partners (NYSE:KMP) will release its Q2 earnings on July 18th and we expect the results will be impacted by increased domestic use of natural gas, and decreased domestic use of coal and refined petroleum products. We expect revenues for natural gas pipelines and CO2 as well as the oil production divisions to increase significantly as the natural gas usage surged and oil recovery activities increased during the quarter. This increase in revenues may offset the revenue loss of terminals division, which is marred by low coal volumes. The product pipelines division is another division that is likely to underperform as consumption of refined petroleum products decreased during the quarter. During the course of the article, lets look at the impact of the important trends during the quarter on individual divisions in more detail.

Our price estimate of $87 for KMP, implying an 5% premium to the current market price.

See our complete analysis for Kinder Morgan Partners here

How trends in Q2 could impact individual KMP divisions

Natural Gas pipelines: Undoubtly, this division is going to perform well because of the shale gas boom, which continued into 2012. Many power generators switched from coal to gas as a primary fuel, leading to higher gas transport volumes. Gas price fell significantly compared to Q2, 2011, but that will not impact KMP’s revenues because its realizations are solely dependent on the volumes rather than on gas prices.

CO2 & Oil Production: The crude oil prices rose earlier at the turn of the year and continued to stay high till May-June, after which a decline was noticed. The exploration companies sensing an opportunity to sell the crude at high prices, enhanced oil recovery operations for most part of the year. However, the recent decline in crude prices is likely to have slowed down the oil recovery.

CO2 is a primary input used for oil recovery. We believe that CO2 consumption might have increased in Q2. Additionally, the company has ownership interests in several oil producing fields and owns a crude oil pipeline in the Permian Basin in West Texas. The crude oil production from the Permian basin has risen over the last few months. ^[1] Hence, we believe, this division could outperform other divisions.

Terminals: The terminals business could underperform because of the significant fall in coal volumes due to gas replacing coal in power generation. However, ethanol volume increased because of increased ethanol blending requirements of gasoline in the U.S. imposed in October, 2010 by the Environmental Protection Agency (EPA). Also, port activity increased due to higher exports of coal, but volumes will be materially insignificant to offset domestic coal demand volumes.

Products Pipeline: During Q2, a significant decline was observed in consumption of refined petroleum products, primarily distillate fuel oil and residual fuel oil. However, increased shale gas production has boosted the natural gas liquids volumes. The increased ethanol volumes is another emerging trend, but, it is still low on scale to have a material impact. On a consolidated basis, the reduced petroleum product volumes could more than offset natural gas liquids volume, leading to a decline in overall transport volumes for the division.

Kinder Morgan Canada: Kinder Morgan Canada’s results could be impacted by consumption patterns in the U.S. as majority of the crude is transported to the U.S. by KMP’s Canadian pipelines. The results are likely be moderate from this division.

Conclusion: We expect KMP to register moderate results in this quarter as we believe that the natural gas and ethanol volumes will more than offset coal and refined product volume loses. However, the company has solid outlook for future as supported by its tremendous expansion plans. Secondly, its commision based model, in which its realizations are only dependent on the volumes, helps it to maintain its margins. Better capacity utilization levels going forward, could improve margins marginally.

The trend of falling coal demand in the U.S. may also benefit KMP in future as it streamlines its assets along the Gulf of Mexico and East Coast to facilitate exports. Kinder Morgan has been expanding its business across all divisions and during Q2 many projects were completed, which will start to fetch revenues for it going forward. Some ongoing or completed capital spends are Transmountain expansion, Ethanol Pipeline Between Carteret and Linden, new CO2 sales contracts, cochin reversal project in Canada, and Crude/Condensate pipeline. (For more details on these projects read our article : Kinder Morgan: Key Capital Spends During Q2)

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1. Rising production in the Permian basin, eia.gov, July 10, 2012 [↩]