Kinder Morgan Inc (NYSE: KMI) has managed to come through the oil crash relatively unscathed, especially compared to the rest of the energy sector. Is now still a good time to buy shares of this pipeline blue chip?
Source: Kinder Morgan investor presentation.
While I remain a fan of Kinder's long-term prospects, I'm reminded of the advice of Charlie Munger -- Warren Buffett's right hand man at Berkshire Hathaway -- to "invert, always invert." By this, Mr. Munger means that investors should not just attempt to determine what factors will benefit a stock, but also what risks could disprove their theses. In other words, instead of pricing stocks based on what might go right, focus on what might go wrong and cause shares to sink.
In that spirit, let's examine two short-medium-term risks -- falling oil prices, and the risks of a shrinking backlog due to cancelled oil projects -- that might send Kinder's share price crashing during the next few quarters. My goal here isn't to make doomsday predictions that these things will happen, or scare you away from buying Kinder Morgan at today's prices; my goal is give you insight into what might go wrong so you can avoid the mistake that cost so many investors so dearly -- panic selling into what actually may be an amazing long-term buying opportunity.
Oil prices may crash further
Given that each $1 per barrel decline in oil costs Kinder $10 million in distributable cash flow, or DCF -- which sustains the dividend -- oil prices are something Kinder Morgan investors need to be aware of.
Now I'll admit that I have no idea what oil prices will do in the short-medium term and for 150 years "experts" have largely been proving that they don't either. However, given our goal of anticipating what might go wrong for Kinder over the next few quarters let's look at two reasons that oil prices may stay low or even drop further.
First, Iran's recent discussions with the "P5+1" powers about its nuclear program could potentially flood the world market with up to 1 million barrels per day of Iranian oil exports. This would result in a potential 56% increase in the world's oil supply glut, and could send crude prices crashing to new lows.
According to Olivier Jakob of the Swiss energy consultancy PetroMatrix, "Saudi Arabia is going for it," meaning that they are actually increasing production, to a record high of 10.3 million barrels per day in March. In fact, the threat of Iran -- Saudi Arabia's historic rival in the Middle East -- gaining market share at its expense, along with Libya and Iraq both reporting stronger-than-expected oil production recently, has caused OPEC's oil production to increase by 1.2 million and 2 million barrels per day compared to February and March 2014, respectively.
With OPEC members apparently playing a game of chicken with themselves, as well as U.S. shale producers, crude prices may still have substantially further to fall. This could mean substantially less DCF for Kinder Morgan to sustain and grow its dividend in the short-medium term. Why is Kinder so vulnerable to falling oil prices? The answer is largely two fold and perhaps a bit surprising..
Cancelled oil projects putting backlog growth at risk
During its fourth quarter conference call Kinder revealed that it had to remove $785 million in oil projects from its backlog. These projects -- mostly associated with its CO2 enhanced oil recovery operations -- were delayed due to low commodity prices.
With its fourth quarter CO2 segment earnings declining by 6% compared to the same quarter in 2013 due to low oil prices, I'm concerned that, should oil prices fail to recover over the next few quarters, Kinder may be forced to delay additional CO2 projects which still make up $1.8 billion, or 10.2%, of the company's $17.6 billion growth backlog.
Kinder is actually a highly diversified oil producer
Many investors think of Kinder as mainly an operator of natural gas pipelines. While this is indeed where the company gets the majority of its cash flow from, Kinder has also, in recent years, diversified into other energy sectors including owning a working interest in 2,169 oil wells on 87,288 net acres of oil producing acreage.
As part of its 2015 budget -- which calls for a $2 per share dividend -- Kinder is anticipating an average oil price of $70 per barrel. Should crude prices fail to recover this year or the next, the company's ability to meet its previous dividend growth guidance of 10% per year through 2020 might prove untenable, and its share price may suffer as a result.
Bottom Line: low or falling oil prices could take the wind out of Kinder's sails in the short-medium-term
Don't get me wrong, I'm not predicting that oil prices will necessarily stay low or fall further and cause Kinder shares to crash during the next few months; but I would be remiss if I didn't warn current and potential investors of the possibility. My goal is to teach you to think about both the bear and bull case of dividend stocks like Kinder, so that should the share price decline you can make a decision about whether or not to sell or buy more based on an intelligent understanding of the facts and risks associated with such an investment.
