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It Isn’t Kinder Morgan That’s a House of Cards

On Wednesday, Sept. 4, an email sent out by research firm Hedgeye, along with the author's comments on Twitter , caused shares of Kinder Morgan (NYSE: KMI  ) to fall 6% . Hedgeye claimed that the Kinder Morgan pipeline companies were "a house of cards" and that a report detailing this would be released on Tuesday, Sept. 10 .

Beyond the obvious questions of why announce it this way and why the delay, the share price movement shows how silly some investors are, selling on the merest whiff of supposition without taking time to see if analyst Kevin Kaiser of Hedgeye was right or blowing smoke.

Instead of knee-jerk selling, I held the shares of KMI my wife and I own, read the report when it finally came out, and was not impressed.

The thesis 
The major point presented by Kaiser is that Kinder Morgan has very low maintenance capital expenditure (capex), presumably cuts maintenance capex upon acquiring other pipeline operators which leads to an increased incidence in pipeline accidents, and then uses replacement of the pipes (an expansion capex) instead to "catch up" on neglected maintenance. 

The reason for this is to enrich KMI (the general partner of the limited partnerships KMP and El Paso Energy Partners (UNKNOWN: EPB.DL  ) ), as well as Richard Kinder, at the expense of the unit holders of the limited partnerships . This enrichment happens in part because maintenance capex is deducted from distributable cash flow (DCF) payable to all the partners, while expansion capex is not. By shifting maintenance capex to expansion capex, more DCF is available.

Kaiser also argued that KMI receives too much in incentive distribution rights , but I'm not going to address that here.

Maintenance capex and DCF
So is Kinder Morgan's definition of DCF unique? I looked at how El Paso defined DCF and where maintenance capex fit in. Prior to being acquired by Kinder Morgan, it too removed maintenance capex when calculating DCF . Magellan Midstream Partners (NYSE: MMP  ) and Boardwalk Pipeline Partners (NYSE: BWP  ) , two other pipeline operators, both define DCF the same way. Seems to be industry standard, so nothing apparently nefarious there.

Kaiser argues, however, that Kinder Morgan uses the "apophatic definition" that any capex that is not expansion capex is maintenance capex , and can assign dollars spent to either category. But Kinder Morgan is hardly unique here, either.

Looking again at El Paso, they define it the same way. Not in those specific words, but in context : "Our total cash capital expenditures for the year ended December 31, 2011 were $264 million, including $101 million for maintenance and $163 million for expansion." Other pipeline operators I looked at also split total capex into the same two categories.

It's industry standard, so why should Kinder Morgan be called out? However, Kaiser has more points to argue.

Maintenance capex vs. depreciation
Kaiser argues that maintenance capex should be larger than depreciation . Why? Besides an inflation argument that I found quite confusing , he points out that Chevron (NYSE: CVX  ) and ExxonMobil (NYSE: XOM  ) spend huge amounts in capex in order to keep production constant, much more than depreciation. The thought appears to be that these guys are in the oil and gas business, just like Kinder Morgan, so Kinder Morgan should also have maintenance capex at least equal to depreciation.

Pipelines are pretty static things, once they're installed. The only moving parts that would require regular replacement are the valves, the pipeline inspection "pigs," and the compressors in the compression stations . Only if a leak is found or corrosion is discovered does there need to be expensive replacement of part of the pipeline.

Chevron and ExxonMobil, on the other hand, own refineries, trucks, storage tanks, and retail outlets, and capitalize much of their well costs,  among other things. It seems reasonable that the capex and D&A issues are entirely different for these companies compared to pipeline operators. In other words, it's a huge case of apples to oranges comparison.

Kinder Morgan cuts maintenance spending
Kaiser goes to some lengths arguing that Kinder Morgan cut maintenance capex on assets obtained from Santa Fe Pipeline. (He actually addresses maintenance expenses, a different line item . It's clear, though, that he equates this with maintenance capex.) He then presents a series of pipeline accidents and implies that it was this and similar cuts to maintenance spending that led to the accidents. However, he doesn't present accident data from the time before Kinder Morgan obtained those assets, nor does he present data from other operators (who presumably keep maintenance spending at proper levels) showing a lack of accidents. In other words, he fails to connect the dots between an argued decrease in maintenance spending and an increase in pipeline accidents.

Further, the numbers do not bear Kaiser out. I looked at six pipeline operators, including Kinder Morgan and El Paso before Kinder Morgan acquired it. I was looking to see how much they all spend on maintenance capex on their pipelines. Here's what I found for 2012:


Miles of Pipeline

Maintenance Capex, 2012 (in millions)

Maintenance Capex, 2012, Per Mile

Boardwalk Pipeline Partners 




El Paso Pipeline Partners 




Enbridge Energy Partners (NYSE: EEP  )




Enterprise Products Partners (NYSE: EPD  )




Magellan Midstream Partners 





Kinder Morgan Energy Partners (UNKNOWN: KMP.DL  )




*Company projection for 2012; El Paso was acquired in May 2012 . Source: Company 10-K filings for 2012 (for 2011 in the case of El Paso).

As you can see, Kinder Morgan lies right within the range of what five other companies spend per mile on maintaining their pipelines. If Kinder Morgan is purposefully keeping maintenance capex low to boost DCF, it should be reflected in much lower amounts per mile spent compared to the others. It's not.

Given that, how strong is the argument that Kinder Morgan is boosting distributable cash flow by cutting maintenance capex and hiding what should have been spent there in expansion capex?

Not very.

Summing up
• A spate of pipeline accidents after change of ownership could be due to other events or just plain chance. Kaiser does not link cause and effect between presumed cuts to maintenance capex and any increase in accidents.

• Maintenance capex does not have to exceed DD&A expense.

• Kinder Morgan is not spending less than other pipeline operators on maintenance capex on a per mile of pipeline basis.

• Kinder Morgan does not appear, therefore, to be inflating distributable cash flow.

As a result, it is my opinion that Kaiser's and Hedgeye's argument is significantly flawed and I would not let it dictate any investing decision.

Read/Post Comments (37) | Recommend This Article (133)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 16, 2013, at 10:22 AM, CaptGene wrote:

    Your analysis is on point and easy to grasp. Thanks for that!

    PS.. If you have done the same work on HedgeEye and LINE I would like your opinion.

  • Report this Comment On September 16, 2013, at 1:57 PM, qblueleader wrote:

    Thank you for gathering the data on the other pipelines to show that our "short raider" has dramatically misrepresented the amount of money that KMI is spending on its projects and that they,in fact, are spending an industry standard level on maintenance . Unfortunately, my KMI position is full, or I would back up the track here and add more.

  • Report this Comment On September 17, 2013, at 2:09 PM, kbyrne6 wrote:

    Not sure I would classify KMI as "right within the range " of that table. More like lower than all except the outlier.But anyway do you know what ElPaso's maintenance capex was post the KMI takeover? I think Kaiser said it was decreased after the takeover and this supports his point?

    Thanks for the analysis.

  • Report this Comment On September 17, 2013, at 2:58 PM, mj2boogie wrote:

    Thanks for the detailed analysis and your opinions (which I have come to value greatly).

    I agree with your view regarding the capex and depreciation for ExxonMobil and Chevron vs Kinder Morgan. Two very different businesses, even though they are both "Oil & Gas"!

    I bought more on the drop, and though the stock price is a bit lower today, I am confident that long term this will be a good purchase.

  • Report this Comment On September 17, 2013, at 3:07 PM, cmfhousel wrote:

    Great stuff, Jim.

  • Report this Comment On September 17, 2013, at 4:12 PM, sagitarius84 wrote:

    Great article. I especially like the fact that Richard Kinder has most of his net worth in shares of Kinder Morgan Inc, and the partnership:

    I think Richard Kinder is the Buffett of energy investing...

  • Report this Comment On September 17, 2013, at 4:18 PM, wolfhounds wrote:

    I've owned KMP over 20 years and reinvested the distributions on the original 1000 shares since. If Kaiser's analysis had an ounce of substance (I do read annual reports), the house would have folded long ago. Instead, I'm living quite comfortably (partially) from my KMP investment.

    Thanks for the analysis.

  • Report this Comment On September 17, 2013, at 5:49 PM, john603 wrote:

    Great job. Wow, the guy was sort of a dork to do such a weak analysis.

  • Report this Comment On September 17, 2013, at 8:30 PM, PuddinHead42 wrote:

    I want to really thank Kevin Kaiser for letting me fill out my position at a 4.2% yield. He is my hero :-).

  • Report this Comment On September 17, 2013, at 8:37 PM, awallejr wrote:

    "As a result, it is my opinion that Kaiser's and Hedgeye's argument is significantly flawed and I would not let it dictate any investing decision."

    I wouldn't follow any advice from Hedgeye just on principle.

  • Report this Comment On September 17, 2013, at 10:07 PM, MadStockMan wrote:

    Believe it or not the dude Kaiser was only 3 days into his first job out of ivy league and was able to move the market cap of KMI down by $4 billion with the stupid article. But more importantly Rich Kinder, chairman of Kinder Morgan, bought opportunistically on the dip, about $18 million of stock.

  • Report this Comment On September 17, 2013, at 10:09 PM, sgander wrote:

    That report helped me, I bought stock :)

  • Report this Comment On September 17, 2013, at 11:20 PM, rook09 wrote:

    Pipeline companies are now using the large amounts of data about the flow within there pipeline. This data is gathered in house with an IT team and scanned using Rackspace. They then take this and can better pen point where the leaks or accidents are happening within the pipelines. This would cut down on maintenance because they are now maybe paying a few workers to physically scan the pipelines as apposed to armies of them.

  • Report this Comment On September 17, 2013, at 11:36 PM, HonkieHK wrote:

    Thanks Jim for the straight forward analysis. I get the impression the Hedgeye model is to focus on stocks with heavy retail ownership and then produce something that scares the wits out of this less sophisticated investor base. I wasn't able to find any information on Hedgeye actually positioning pre/post report release day. I'm pretty sure that would be an illegal activity.

  • Report this Comment On September 18, 2013, at 8:51 AM, Truth2Power wrote:

    Very well-written and reasoned article, Jim (although I do agree with kbyrne6 that KMI is on the low end of the expenses table). I, too, took the opportunity to increase my long position in KMI.

  • Report this Comment On September 19, 2013, at 7:32 PM, mfmmcf wrote:

    Question: I have a good % of KMP; ALSO a little of EPB. KMP stock price has been going down for quite a while. Does your suggestion that Kinder Morgan stock is fine also apply to KMP???

  • Report this Comment On September 20, 2013, at 3:38 PM, 88melter wrote:

    ... and we thought that sketch from Monty Python's "The Meaning of Life", about how the cost of the machine that goes BING! had been shifted from the capital account to operating expenses by leasing it back from the company they sold it to was just a JOKE. HAH!

    This is yet another example of how whenever there is a system in place to protect the small and medium outside investor, that is, a payout structure for dividends, insiders and Big Playas find a way to game the system to their advantage.

    Most people do this, and so it is certainly a human nature question, and not just one limited to economics or business. Yet, its pernicious influence described here affects more people in larger dollar amounts than someone who buys hamburger on food stamps to feed their dog, because pet food is not purchase-able on food stamps.


  • Report this Comment On September 20, 2013, at 4:11 PM, ejrad wrote:

    Question : How does TransCanada pipelines TRP fit into the comparison as they would be maintaining the Keystone if its approved and may have to operate under different US law??

  • Report this Comment On September 20, 2013, at 4:26 PM, jrhooker wrote:

    "Pipelines are pretty static things, once they're installed. The only moving parts that would require regular replacement are the valves, the pipeline inspection "pigs," and the compressors in the compression stations"

    Aaaand that that point, I can no longer take anything you say seriously; your near-complete ignorance about how pipelines are built and why they fail is fully evident in those two lines.

    It does, however, qualify you to be the CEO of either a pipeline or railroad company. The higher you go up the management chain of capital-intensive companies like these, the less understanding you find of how their industries are actually built. They inherit so much of the business in the form of installed infrastructure that it's possible to cut maintenance to the bone, show good profits, then be out the door before the chickens come home to roost.

    Kinder Morgan's expenses are low because they're constantly patching rather than fixing and pushing off the real expenses into the future, and they're run by people who mistake the numbers in the spreadsheets for the business itself. Or at least they pretend to do so while collecting their outsize paycheques.

  • Report this Comment On September 20, 2013, at 4:32 PM, rpfromrc wrote:

    In other words, the Hedgeye report says KMI cheats on its books and on its maintenance. MF says that is OK because it is standard for the industry.

    For the public, that means more and more pipeline failures that will not be adequately cleaned up.

  • Report this Comment On September 20, 2013, at 4:41 PM, jwfarr wrote:

    Appreciate your review & analysis...I bought more KMP on the dip.

  • Report this Comment On September 20, 2013, at 4:57 PM, jm7700229 wrote:

    I wonder if it isn't very questionable behavior from a legal standpoint, to short a stock, then announce that you will announce bad news in a few days, and then issue a negative report that is nothing but guesswork and speculation. I think there is price manipulation here and it should be investigated.

    That said, I want to thank Kaiser for his premature announcement. I added to my KMI on his dip and I have added him to my little list of people to bet against.

  • Report this Comment On September 20, 2013, at 6:45 PM, TheToxicAvenger wrote:

    Kaiser analysis is very poor. The only rationale for such rubbish and announcing it is to manipulate te price.....down then up when they realise the utter drivel...... Oil majors capex is predominantly in building new production capability to try and replace declining production. Their maintenance cost are not capitalised they will show in opex.

  • Report this Comment On September 20, 2013, at 9:02 PM, njtjt wrote:

    just curious, how much exposure does KMI/KMP have in the flood damage in Colorado?

  • Report this Comment On September 21, 2013, at 12:49 AM, Jdrew555 wrote:

    just so we're all clear, Kinder Morgan is involved in a non-sustainable exploitation of natural resources to which they have no natural entitlement. They are a vampire company among many such, and their machinations are no different from the other thieves of the natural resources that need to be considered the property of ourselves and many generations hence.

    Better to put your money where it can do some good than be greedy vampires yourselves.

    Just saying

  • Report this Comment On September 21, 2013, at 1:49 AM, ObsidianMTness wrote:

    Hedgeye has come out with similar types of analysis on LINE as well thus decreasing the stock's price and increasing shorting of the stock. In recent times, I've observed a number of "firms" and "financial analysts" who would write negative articles with weak to scant support but sensationalized information to drive down a company's stock price. The results could manipulate the market enough to cause a company's plans to go awry and possibly take it down. Stocks that have been relatively stable became wildly volatile. It seems to be the reverse of hyping the stock or company to drive up the share price. However, now investors and firms would rather make money by using their option to short the stock instead. Either way it is a manipulation of the market.

  • Report this Comment On September 21, 2013, at 10:11 AM, thesalesman87 wrote:

    I would like to know what does Hedgeye call new car sales the truth when they count lease cars as sales.You can't sale a leased car you don't own it and when the lease runs out the vehicle goes back to the dealer to be sold as used or to the auction. So with what we are told by news source's looks like you check information real good and I include the global warming crowd too.

  • Report this Comment On September 21, 2013, at 11:44 AM, catcherupper100 wrote:

    Mr. Mueller's argument appears quite cogent. The only fly in the ointment would be if Kinder's pipelines are measurably older and therefore would require substantially more money to maintain on a cost per mile comparison basis. I wonder if this factor was considered.

  • Report this Comment On September 21, 2013, at 10:26 PM, ZLine wrote:

    Regardless of the analysis done, KMP has crossed into BEAR market territory, so this is your chance to unload on any rebound back toward $84

  • Report this Comment On September 21, 2013, at 10:34 PM, ZLine wrote:

    So that you can compare this analysis with other instruments, you can view some similar analysis for the Dow, Gold and Miners at

  • Report this Comment On September 21, 2013, at 11:01 PM, mj2boogie wrote:


    I'm not sure if I understand you comments. What type of 'natural entitlement' would one have or have to transport oil or gas in a pipeline? And where would one get this 'natural entitlement'? Also, I'm not sure that transporting a product through a pipeline would really be considered 'non-sustainable exploitation'.

    What exactly is it that makes Kinder Morgan a 'vampire company' any more than any other company in existence? If they are 'thieves of the natural resources', who is it they are stealing these natural resource from? The Public? I believe the public gets money from those who conduct businesses of extraction and transport of natural resources.

    Do you have some recommendations as to where one could put money where it can do some good?



  • Report this Comment On September 21, 2013, at 11:45 PM, prowalt1 wrote:

    Am I the only one seeing this?

    Let's compare KMP to EPD since these 2 are closest in miles of pipeline.

    EPD capex is 365.8 million on 50k of pipeline

    KMP capex is 285 million on 46k of pipeline.

    (8% less pipeline but 22.1% less on capex)

    Similarly EPD is at $7316 per mile, but KMP is only $6196 per mile. 15.3% less.

    These are huge differences. If I were a KMP shareholder, I would start worrying about extreme liabilities.

  • Report this Comment On September 22, 2013, at 8:14 PM, mj2boogie wrote:


    Not knowing the types, ages, locations, and previous maintenance histories of pipelines owned by two separate companies makes looking at the differences you describe in capex vs miles of pipeline not necessarily meaningful. Without knowing much more detail about the specific pipelines, I wouldn't necessarily start worrying about extreme liabilities. There could be lots of other explanations for the differences you are seeing.


  • Report this Comment On September 22, 2013, at 10:18 PM, Montereyjackson wrote:

    Thanks, Jim Mueller-- well focused research and article.

    Thanks, JDrew, for bringing a moral perspective.

    Cheap solar is not yet a mainline energy source an burning nat gas releases a lot less C02 than burning coal does.

    So nat gas production and transmission is arguably a moral and pragmatic choice if... IF it is produced and transported without harmful methane leaks or other kinds of harm. That's why cap ex per mile, and more importantly, accidents per mile of pipeline, are important.

    I own medium/small amounts of Broadway and Kinder and will be checking their records as soon as time allows, using an approach based on Jim Mueller's. Numbers, not company advertising or speechifying, is the way I want to go.

    If we owned big positions in companies like these, wouldn't we want to make our money with the most responsible operators?

  • Report this Comment On September 29, 2013, at 1:58 PM, compufixer wrote:

    Correct me if I'm mistaken: Is not a large part of Rich Kinder's personal fortune in KMP shares? So is it therefore implausible that he would act in a way that would imperil the profitability of KMP? Is it not generally understood that Kimder is as savvy a pipeline operator as any? I was busy & didn't go long KMP nor KMI nor KMR. To paraphrase the iconic Texas bumper sticker "Lord, could I please have another Short. I promise not to wast3 it this time."

  • Report this Comment On September 29, 2013, at 1:59 PM, compufixer wrote:


  • Report this Comment On October 01, 2013, at 3:53 PM, Seanickson wrote:

    Fantastic article. While its true that most companies with primarily long lived fixed assets have maintenance capex costs far above depreciation (railroads, oil, etc), you do a great job spelling out how thats not the case in the pupeline industry.

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