Friday, November 04, 2011

What To Think About Kinder Morgan's $38B El Paso Deal

Friday, November 04, 2011

Kinder Morgan‘s $38 billion takeover of El Paso Corp. will create the world’s biggest pipeline company, with 80,000 miles of conduits for natural gas, petroleum and refined products. The deal will link pipeline networks from Florida to California to Illinois, New York and Montana. It is also likely to set off a round of consolidation among the nation’s other pipeline operators.

What’s the significance for the average American? Hard to tell. If Kinder Morgan can squeeze efficiencies out of the combined network and pass along lower costs to its customers, primarily natural gas drillers, then the result might be lower energy prices. If, however, Kinder decides to use its market dominance and greater heft to increase the prices it charges to move gas from fields to market, it could mean higher gas prices.

Whichever way this dynamic goes, it appears that the primary beneficiaries of this deal will be the natural gas traders of Kinder Morgan, Goldman Sachs (which owns 19% of Kinder) and Barclays (which is providing $11.5 billion in loans for the deal) who will be in a position to enjoy better knowledge of the pricing differentials of gas produced in America’s various basins.

Variable prices can yield profitable trades. Natgas may go for $3.60 per mmBTU at the NYMEX, but it’s worth less in places like North Dakota, where producers in the Bakken shale (predominantly an oil play) still flare some 20% of produced gas because there’s not enough pipelines to take it. Traders can profit by buying Bakken gas cheap, then selling it at a premium into Florida or New York.

Hopefully Kinder Morgan, with its added heft, will be willing to build pipelines to the Bakken. Getting more gas into pipelines would be good for the average consumer, bringing more supply and lower prices.

Another wrinkle in the deal is taxes. Kinder Morgan Inc. (NYSE:KMI) is buying El Paso. But Kinder Morgan Inc. owns the general partner and 11% of limited partner interests in Kinder Morgan Energy Partners, L.P. (NYSE:KMP). The latter is set up as a master limited partnership, which means all profits from the company flow through, untaxed, to unit holders (who then pay taxes on the income at individual rates). Many of El Paso’s assets, in contrast, are held, and taxed, on the regular corporate level. Profits from those assets are still subject to both corporate taxes then individual taxes when passed on to shareholders. Kinder can unlock a lot of value for existing unitholders just by moving El Paso’s assets from “Inc.” over into the MLP.

The deal is a vote of confidence by Chief Executive Rich Kinder and his team that America’s natural gas renassiance is real, that the shale plays across the country really do contain the trillions of cubic feet necessary to fill old pipelines and to justify building out new ones.

“We believe that natural gas is going to play an increasingly integral role in North America,” said, Richard Kinder, in a statement. “We are delighted to be able to significantly expand our natural gas transportation footprint at a time when it seems likely that domestic natural gas supply and demand will grow at attractive rates for years to come.”

The merger, assuming it’s approved by the Federal Trade Commission, will likely set off a slew of other deals among pipeline operators. Enterprise Products Partners (NYSE:EPD), cobbled together over decades by the late billionaire Dan Duncan, would now be looking for deals. As would Williams Cos., which this summer lost out in the bidding for Southern Union. Energy Transfer Equity, controlled by billionaire Kelcy Warren, appears to have won Southern Union, itself controlled by billionaire George Lindemann, in a $5.7 billion deal.

Other tycoons whose pipeline assets suddenly look more valuable include Trevor Rees-Jones, whose Chief Oil & Gas has a sizable network in the Marcellus shale, and Rod Lewis of Lewis Energy, who five years ago sold half of his pipelines in south Texas (Eagle Ford shale territory) to Enterprise for some $400 million. MarkWest Energy Partners L.P. (NYSE:MWE) would also be in play.

The terms of Kinder Morgan’s bid for El Paso is kind of unusual. It amounts to $26.87 a share, a 37% premium to Friday’s close. For each share Kinder is offering $14.65 in cash plus a 42% of a Kinder share plus 64% of a Kinder warrant that allows the holder to buy a Kinder share for $40 within five years. KMI is currently at $26.90 a share.

For more details on the deal, you can look here or here or here or here. My pet peeve: contrary to what many headlines say, this is not a “$21 billion” deal. It is a $38 billion deal. Kinder is buying $21 billion in equity and taking on $17 billion in debt.

View the original article here

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