Pipeline projects are becoming increasingly difficult to build in North America -- that is, particularly after the planned TransCanada's (TRP 0.03%) Keystone XL pipeline was blocked. Fueled by that win, environmental preservation initiatives are in the works to block other projects. Unfortunately for their shareholders, these initiatives have Energy Transfer Partners' (ETP) Bakken Pipeline and TransCanada's Energy East -- among others -- in their sights. In light of the controversies surrounding the construction of new pipelines, and in order to offer up an opposing argument, Kinder Morgan (KMI 1.21%) founder Richard Kinder offered his perspective on the segment's future, providing three takeaways for investors.
1. Constrained capacity will cause the value of existing networks to grow
Kinder started off by reminding investors:
First, to the extent it becomes difficult to build new infrastructure that tends to make existing pipeline networks more valuable, and we obviously have a tremendous existing network.
Demand for oil and gas continues to rise. According to energy analysts at Wood Makenzie, natural gas demand in the U.S. alone is expected to grow by 35% over the next decade. Given that outlook, the increasing likelihood of constrained pipeline capacity resulting from growing opposition to new construction suggests that companies such as Kinder Morgan should be able to increase pipeline tariffs in the future. The increasing cash flow from those rising rates will make its vast network even more valuable, providing investors with upside that might not have been there otherwise.
2. It is still possible to construct new pipelines
Next, Kinder pointed out:
Second, while the protestors tend to get the headlines, it is still possible to build out new infrastructure. This quarter, for example, we completed an expansion on our Texas Gas pipeline network.
While increasing opposition to pipeline projects is making it harder to expand, it has not caused growth to grind to a halt. Aside from the Texas Gas pipeline, rival Energy Transfer Partners completed the first phase of its Bayou Bridge pipeline in Texas during the second quarter, which boosted the volumes and earnings of its liquids transportation and services segment.
Most pipeline companies have a tremendous backlog of future projects either under construction or close to development. Kinder Morgan, for example, has $13 billion worth of investments in its five-year project backlog, while Energy Transfer Partners has $10 billion in projects scheduled to come online by the end of next year. Meanwhile, TransCanada has $7.3 billion in projects across its U.S. natural gas pipeline system alone over the next five years, which is part of its CAD$25 billion of visible near-term capital investments. In short, the sector is not lacking in growth.
3. The company needs to adjust to roadblocks
Third, and maybe most importantly I think is to distinguish the permitting environment, both geographically and jurisdictionally. There is a big difference for example between state permitted projects where eminent domain is a function of state law and the federally certificated natural gas project. Ultimately we realize that the environment is changing and we are adapting by building those changing circumstances into how we budget and plan our projects.
Kinder notes that because things are changing, it must adapt. That said, it will fight against what it views as inconsistent changes. For example, CEO Steve Kean noted on the same conference call that the company is fighting an eminent-domain issue on its Utopia project:
We had a Wood County judge who, interpreting the eminent domain statute, interpreted that our pipeline didn't qualify for eminent domain. We're feeling that ... it's been consistent with other decisions, including appellate decisions that have been made in the state, so we think we're ultimately going to prevail on appeal there.
Still, this increasing difficulty in securing pipeline permits is forcing the company to strategize how it will acquire the remaining right-of-way for that project. Overall, eminent-domain issues are a growing problem for the pipeline giant. The company cited that issue as the driving force behind its decision to cancel the Palmetto project in the Southeast after the state of Georgia put a one-year moratorium on eminent domain.
Of course, increasing trouble to secure pipeline routes could hamper the company's ability to grow. That's why Kinder Morgan and its peers need to take a very measured approach to expansion projects in the future to avoid problematic pathways that could end up being major roadblocks. Further, they will need to continue focusing on strengthening stakeholder relations to ensure that they have the support necessary to move forward with major pipeline projects.
Kinder Morgan's founder wants investors to know that the sector's recent controversies are both an opportunity and an obstacle. The hindrances to growth will force the company to work harder to secure the right projects that benefit all stakeholders. On the other hand, because of increasing regulatory difficulties, the sector's upside remains compelling, which should continue to open up doors to create value for investors.