Kinder Morgan Energy Partners (NYSE:KMP), one of North America’s largest midstream energy companies, reported its Q2 2014 results on July 16. The company’s earnings were driven by strong shipment volumes in its natural gas pipelines segment driven by increased volumes coming from the Marcellus/Utica shale, higher refined products volumes, as well as by higher oil production in its CO2 business. While quarterly revenues grew by around 16% year-over-year to around $3.937 billion, operating income rose by around 31% to $1,013 million.  The net income attributable to KMP is down $339 million over the past three months, largely the effect of exceptional items, the most significant of which is the $558 million gain the company recorded from the revaluation of its Eagle Ford investment in the second quarter of 2013. Despite this, the distributed cash flow before certain items, a key metric for master limited partnerships, increased by 1% year-over-year to around $1.23 from $1.22 in 2013. In this note, we take a look at some of the key factors that drove the performance of the natural gas pipeline business, which accounts for over half of the company’s revenues.
Trefis has a $82 price estimate for KMP, which is slightly above the current market price. We are in the process of revising our model to reflect the latest earnings report.
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Natural Gas Pipelines Transportation Volumes Growth: KMP’s natural gas pipelines division saw its earnings before depreciation, depletion, amortization and certain items rise by around 14% year-over-year, to about $642 million.  The earnings growth was primarily driven by the increased demand for natural gas transportation. Overall natural gas transport volumes through Q2 rose by around 9% year-over-year to around 16,948 Bbtu per day.  This growth mirrors the disconnect between higher natural gas demand in the Gulf Coast and where most of the supply is being developed(Marcellus, Utica). The U.S. Energy Information Administration(EIA) pointed out earlier this week that production in the Marcellus shale would surpass the production of the Cutter shale, the world’s third-largest producer of natural gas play, by September. This shows that there are tremendous growth opportunities for KMP going forward.
Tennessee Gas Pipeline System: KMP’s Tennessee Gas Pipeline system operates multiple-line natural gas pipelines, which extend from the natural gas producing regions of Louisiana, the Gulf of Mexico, South Texas to the North Eastern United States. The pipeline also has access to the Marcellus and Utica shale plays. During Q2, the system saw its volumes rise on the back of higher volumes from the Marcellus and Utica Shale plays as well as the effect of several expansion projects that began service late last year. While the pipeline has largely been northbound, Kinder Morgan has been undertaking some reversal projects for the pipeline, to add more south bound capacity to move gas from the Marcellus and Utica shales to the Southeast and the Gulf Coast.  The company also indicated that it had added new long-term contracts, with an average life of about 15 years to transport about 1.4 Bcf a day on the Tennessee system.
EPNG and Mexico Opportunities: The El Paso Natural Gas (EPNG) system in which KMP owns a 50% stake, saw volumes rise through Q2 aided by higher gas export volumes to Mexico, growing shale production and higher LNG exports. In Q1, the company had said that it has been loading a southbound line, which was previously underutilized, with gas to export to Mexico. The rise in U.S. natural gas exports to Mexico could provide a significant growth opportunity for KMP. Over the last five years, pipeline based natural gas exports from the United States to Mexico have risen by around 80%.  This has been largely due to strong demand (brought about by the fact that Mexican gas prices are pegged to U.S. Henry hub prices plus transportation costs), weak domestic production and high costs of LNG imports to the country.
Increasing Growth Project Backlogs: According to consulting firm Wood Mackenzie, natural gas demand in the United States will rise from around 71.5 billion cubic feet (bcf) per day in 2014 to around 94.5 bcf a day by 2024. KMP could see its transportation volumes rise in tandem or possibly even faster than the national average, since it has exposure to key shale basins as well as the Mexican market. Over the quarter, the company added growth projects worth about $500 million worth to its backlog for the natural gas pipelines division, which is an increase of about $1.8 billion since its Q4 earnings release.  The total backlog of expansion related projects has now increased to $17 billion, implying an increase of $1.3 billion for the quarter. Notes: