Image source: Kinder Morgan.
All things considered, Kinder Morgan (KMI 0.40%) is having a pretty good year. That is evident in the following chart, which shows that its stock price is trouncing the broader market:
Driving that outperformance are several smart moves as well as solid execution from its largest business segment. That said, the company has been far from perfect this year, with its decision to cancel the Northeast Energy Direct project marking its biggest failure.
Proposing a solution to a crisis
Lack of natural gas pipeline capacity in New England has become a major problem in recent years. Surging demand for gas due in part to natural gas power plants coming online caused a significant spike in gas prices during the winter months when demand for home heating increases. Further, with additional gas power plants going online in the future, it had the potential to exacerbate the problem.
To combat this growing problem, Kinder Morgan proposed to build the Northeast Energy Direct pipeline to link surging gas supplies in the Marcellus and Utica shale plays to demand centers in New England. As the slide below details, the project would have consisted of a supply path and a market path:
Source: Kinder Morgan Investor Presentation.
Those projects represented a potential investment of up to $6.5 billion if it completed both paths at maximum capacity. That would have been a major investment for the company given that its current project backlog is $13.5 billion.
The solution no one wanted
By July of 2014, the company announced that it signed up several anchor shippers on the market path of the project. A year later the company's board approved plans to move forward on the construction of the supply path, moving it into the project backlog. Though given that initial demand for capacity was tepid, the company opted for a smaller sized pipeline, which put that project's cost at $3.1 billion. That said, the company was leaving the option open to expand the pipeline to a larger size if more capacity commitments came in before construction started with Kinder Morgan planning to have it in service by November of 2018.
Unfortunately, Kinder Morgan never did get any more capacity commitments beyond its original anchor shippers. That left the company with two options, move forward with the project and hope to sign up more shippers in the future or cancel the project. It chose the latter option, citing insufficient contractual commitments.
CEO Steve Kean discussed why the company opted to pull the plug on the project by saying that,
With respect to NED... We worked very hard to get customer commitments on the project. And while many of our LDC customers did sign up, we did not receive enough contractual commitments from electric customers to make the project viable... so we're removing it from the backlog... To be specific, the return on the NED project at the level of commitments that we have would be less than 6% unlevered after tax. That's clearly not viable and we are far better off having that cash available for other uses, whether that's continued and even accelerated delevering, other investment opportunities or returning value to shareholders.
In other words, because the company failed to get customers to commit to more capacity the project's economics just were not compelling enough to move forward. That came as a big surprise to the market, with an analyst from Fort Pitt Capital Group summing up the market's sentiments by saying,
That New England project going offline is concerning... All they've talked about is the huge arbitrage between Marcellus Shale gas as some of the cheapest in the world and Northeast electricity being some of the most expensive. Unless I'm missing something, this should've worked.
The fact that it did not work is a huge failure because Kinder Morgan's customers in the region apparently didn't see it as the answer. Further, as one of the largest projects in the company's backlog, it lost a key growth driver not only for late 2018 when it was to go into service but in the future due to the potential expansion projects that could have developed.
Investor takeaway
Kinder Morgan initially thought that the NED project would provide a solution to a major problem. However, after two years of hard work it turned out that it was wrong. That marks a pretty big failure for the company because NED would have been a major growth driver. Instead, the company has to go back to the drawing board in search for another needle-moving project.
