New KN Energy chief Richard Kinder must have put the fear of God in the NGPL pipeline team. After years of pipeline underutilization and decontracting, NGPL locked in contracts last week for nearly all of its firm transportation capacity, just as shareholders of Kinder Morgan and KN were approving the $900 million stock-for-stock merger of the two companies. KN Energy’s transformation and recovery could be one of the fastest seen in the energy industry in a long time.

The two major gas transportation agreements include a new two-year deal for 500,000 MMBtu/d (485 MMcf/d) of firm capacity with marketer Aquila Energy, and a three-year contract renewal covering 1 million MMBtu/d (970 MMcf/d) with its largest shipper, Nicor Gas.

The Aquila deal means that for the first time in more than a year the pipeline is more than 99% subscribed, while the Nicor renewal, which covers the Chicago LDC’s entire gas transportation and storage portfolio, means that next April when Nicor’s existing contract runs out, NGPL won’t be scrambling to find someone else to fill one-third of its 3.3 Bcf/d pipeline.

“The new contract is the result of a strong customer-supplier relationship that Nicor Gas and NGPL have had for many years,” said Stewart Bliss, KN’s interim CEO. “We are pleased to enter into this mutually beneficial long-term agreement at a time when many shippers in the industry are looking for short-term contracts and/or turning capacity back to the interstate pipelines.”

An argument could be made that the underutilization problem on NGPL was one of the main stumbling blocks leading to the failure of KN’s $6 billion merger with Sempra Energy in June and the dramatic transformation that has left Richard Kinder and William Morgan of Kinder Morgan on top at the new KN Energy, soon to be renamed Kinder Morgan. Prior to the cancellation of the Sempra merger, KN officials referred to the underutilization, which stood at 14% of NGPL’s capacity in the first quarter and 12% in the second quarter. KN officials said it was costing them $20 million during the second quarter and warned that more trouble was on the way primarily because of Alliance Pipeline, which will feed up to 1.3 Bcf/d of Canadian gas into the Chicago area starting next fall.

But the pipeline apparently isn’t helping its customers pack their bags any longer. In a move that has similarities to the El Paso Natural Gas-Dynegy contract, KN awarded a two-year contract for a large package of firm space for a floor price of $31.16 million with a revenue sharing mechanism above that level. The deal is a major victory for the troubled pipeline, covering 150,000 MMBtu/d of firm capacity on NGPL’s Amarillo leg and 350,00 MMBtu/d on NGPL’s Gulf leg for two years.

“We sign a lot of deals but not many are like this,” said Mark Kissel, director of account services. “What makes this unique is that it has a lot of rates and pricing in it that are market sensitive. There are several different pricing strategies that could be used. There’s a financial baseload price and a physical baseload price, and there’s a day-to-day swing price. So this capacity could be put in any of those three categories. It’s how [Aquila wants] to use it. All those strategies will generate different revenue, and any revenue above the guaranteed revenue gets shared. As more revenue gets pulled out of the deal, a higher percentage goes to Aquila to try to motivate them to keep the market moving in the right direction and generate more revenue.

“I think for the marketers – that customer class – this is the type of deal they feel very comfortable with because it is using pricing strategies they are familiar with and use every day.”

The capacity involved in the prearranged deal with Aquila went through an eight-day auction and was awarded to two different shippers out of the 10 participating in the bidding. Aquila, the party in the prearranged deal, elected to “trump” the winning shippers and received all the capacity as a result. The capacity involved in the transaction represents 15% of NGPL’s 3.3 Bcf/d of capacity to the Chicago market from West Texas, the Midcontinent and the Gulf Coast region. NGPL now is more than 99% subscribed. Kissel said NGPL’s average contract term is two years. “It puts us back in a sold out position.”

Observers might wonder why Aquila would want to lock itself into a major capacity contract to a market that is almost certain to be oversupplied within the next year because of Alliance coming on line. “If you try to look at this deal as a stand-alone transaction you might have that impression,” said Bob Poehling, senior vice president of the asset services group of Aquila Energy. “But we’ve got other strategies. This is going to be extremely complementary [to our other assets in the Midcontinent].”

Aquila spokesman Al Butkus explained that the NGPL contract, which is Aquila’s largest pipeline capacity deal to date, fits into its bundled energy services program in the Midcontinent/Midwest region, which includes Aquila Gas Pipeline and storage assets in Texas and sales contracts and markets in Chicago.

Now that NGPL apparently is back on track for the time being, KN is expected to turn to its reorganization plans, which include selling off $1 billion or so in assets over the next few months (see NGI, Sept. 20). The revenue from the asset sales is expected to be used to pay down KN’s massive $4 billion debt.

“Debt reduction, sale of unprofitable, commodity-price sensitive assets, sharper focus on stable regulated operations, and expected internal additions to its equity base, should all contribute to rapidly restoring KN’s ability to service its fixed obligations,” Moody’s Investors Service said last week, ending its review of KN credit ratings for possible downgrade. “However, KN’s ratings are restrained by the likelihood of acquisitions and asset sales beyond those identified already. Such transactions may be very large and result in substantial changes to KN and its MLP affiliate over the next year or so.”

The stock-for-stock merger transaction approved by shareholders last week gives Kinder Morgan Inc. (KMI) a 38% stake in KN, which is now led by KMI’s senior executives, two of whom – Richard Kinder and William Morgan — are also its principal shareholders. KMI’s sole asset is its 2% interest as general partner and 1.8% interest as limited partner in Kinder Morgan Energy Partners, L.P., the largest pipeline master limited partnership in the US and the second-largest products pipeline system in North America.

Rocco Canonica

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