Kinder Morgan Inc.'s (KMI) acquisition of El Paso Corp. is taking place in a world of growing gas supply from nonhistoric basins, which is driving the need for new and different infrastructure: gas and liquids pipelines, processing, fractionation, etc. It's too soon to say how a combined KMI-El Paso will play the infrastructure game, but consolidation among others shouldn't be a surprise, energy analysts told NGI.
"I suspect that we will see more [consolidation]..." longtime industry analyst and investor John Olson said. "The midstream and gas pipeline business has been a happy hunting ground for quite a while, and I don't see any change there simply because there are so many people, 75 different master limited partnerships [MLP], for instance, trying to grow their businesses beyond the very mature asset bases they have.
"I think the attitude is going to be 'eat lunch or be lunch.'"
On Oct. 16 KMI and El Paso said they had agreed to a friendly, $38 billion buyout of the latter to create North America's largest pipeline company worth about $94 billion. KMI CEO Rich Kinder said the deal was driven largely by the shale gas bonanza sweeping North America. The purchase price is $21.1 billion, in cash and stock, before the assumption of debt. The combined company would have 80,000 miles of pipelines and its feet firmly planted in both oil and natural gas (see Shale Daily, Oct. 18).
As far as natural gas is concerned, the deal merges El Paso's industry-leading 40,740 miles and Kinder Morgan's 9,111 miles of FERC regulated interstate natural gas pipelines. Combined, the company will operate nearly 25% of the nation's interstate natural gas pipelines, according to NGI's Shale Daily estimates.
Ben Schlesinger of Benjamin Schlesinger and Associates said, "I bet you we'll see more" deals like KMI-El Paso. But Olson said he doesn't see infrastructure development taking place any differently because of the KMI-El Paso pairing.
"I don't see that much in the way of...a snowball effect of creating incremental opportunities beyond the mainlines that they already have..." Olson said. "The infrastructure growth is going to be known and measurable in the various shale plays, in the Rockies, the Eagle Ford, the Marcellus in particular...This [combination] is just an exercise in size..."
In his opinion, El Paso "caught a very attractive bid" after years in the desert that followed an asset buying binge, which ran right into an industry meltdown precipitated by the implosion of Enron Corp.
"This is a happy ending for both sides of the table," he said. "El Paso's board of directors and employees watched their stock price go from $74 10 years ago down to $4, in round numbers, and have seen an epic struggle to get it back to more normal levels by deleveraging the company and by stabilizing the company as well."
On the KMI side of the deal, acquiring El Paso allows the company to pick up a platter of assets without having to elbow its way to the table among the several dozen MLPs out there, Olson said. "It gets to be like dogs fighting over the same bone."
But ultimately the deal comes down to financial engineering, an arbitrage across markets, Olson said.
"There is a market for master limited partnership assets; there is a market for corporate assets. And in this case they are buying a company for around 18-20 times earnings and they're going to transplant those assets into master limited partnerships, which are valued closer to 30-times earnings...That's all Kinder Morgan is doing is financial engineering this thing."
Ultimately what will result from the deal will be holding company KMI with two MLPs, Olson said.
Given the tightening economics of the pipeline industry -- i.e., flattening basis spreads -- consolidation is a natural, Schlesinger said. "In this case two players, both of them with impressive assets in the pipeline industry, should make an even stronger player," he said.
"I would hasten to add that there's still a tremendous need for pipeline infrastructure to bring gas from shale fields, tight sands...to hubs and then to markets..."
Given the significant assets involved in the combination -- "and they're all very good pipelines that are involved," Olson said -- it will take a couple of years to digest. "Suddenly what you have is a company that's going to have...massive...assets," he said. "It's going to become the Exxon or Chevron equivalent in the natural gas industry. That is good to a limit, but it's not so good in terms of trying to grow the business from this level."
Olson predicted a fair amount of "asset stripping," with the first to go most likely being the El Paso exploration and production assets. Whether that goes in one piece or piecemeal remains to be seen; the former would be preferred, Olson said, and might be accomplished through a transaction with a Chinese or Australian party, he speculated.
There could be antitrust concerns that would dictate asset dispositions, but it's too soon to say, Olson said. KMI management has said it will work with regulators to get the deal approved.
The combined company will bring together midstream processing and liquids-handling and long-haul pipelines. "I don't think that's going to be a major stop, look and listen situation for the various regulators," Olson said, noting that "Kinder Morgan is not that big a player in that arena. Yes, they have some assets here and there...That business is very Balkanized."
Schlesinger said he sees gas processing and pipelines as separate business segments. "To the degree that someone's wise enough to put them together and develop some synergies, that's great," he said.
During a conference call with financial analysts Wednesday to discuss third quarter performance, Kinder said the company enjoyed higher natural gas liquids volumes during the third quarter versus the year ago period; volumes were up 14%.
"Turning to our natural gas segment, growth in the third quarter was driven primarily by contributions from the KinderHawk acquisition [see Shale Daily, May 6], the Fayetteville Express Pipeline coming on full service on Jan. 1 of this year [see Daily GPI, Dec. 6, 2010], by good results on the Texas intrastate system, which largely reflected better processing margins, and very good results from our Eagle Ford [Shale] joint venture..." Kinder said.