Oil prices have recently plunged at their fastest rate since the financial crisis and are now trading at five-year lows. Understandably income investors who have been turning to high-yielding energy companies such as Kinder Morgan Inc (NYSE:KMI) in recent years may be nervous about the safety and growth prospects of those payouts. Let's see just how bad things could get for Kinder and whether or not it's still a good idea for income investors, especially retirees, to rely on this pipeline giant.
How exposed is Kinder Morgan to oil?
As this image shows, Kinder Morgan generates 82% of its EBITDA, or earnings before interest, taxes, depreciation, and amortization, from long-term fixed-fee contracts, which have annual price increases baked in. The company's only direct exposure to oil prices is the 14% of EBITDA it earns from CO2 enhanced oil recovery from its collection of oil wells in the Permian basin, which produced 57,000 barrels per day in the last quarter. Kinder also faces 6% indirect exposure from storage and transportation of CO2.
Kinder Morgan is aggressive in hedging its oil production. For example, the company has hedged 22.3 million barrels worth of production as of last quarter, which represents 1.07 years worth of production.
In addition, the prices at which Kinder is hedged are very favorable, with 2014 oil hedged at $95/barrel (for 82% of this year's production) and 64% of 2015 production hedged at $91/barrel.
However, as comforting as these facts may be, what Kinder Morgan investors want to know most is whether management's previous guidance of 16% dividend growth in 2015 and 10% growth through 2020 is likely to be affected by the oil price crash.
How will oil's plunge hurt the dividend?
According to Kinder's management, for each dollar per barrel that oil declines below $96.15, it decreases the company's distributable cash flow, or DCF, by $7 million per year. This means at today's oil price of $61, Kinder's DCF could facing a decline of $246.1 million from management's previous projections.
However, while that may sound alarming, you need to realize that this shortfall only represents approximately 3.2% of Kinder Morgan's projected 2015 DCF of about $7.7 billion.
In addition, according to Kinder Morgan's Chief Financial Officer Kimberly Dang, the company currently has about $400 million in excess coverage to protect the dividend from short-term oil price shocks.
So, the bottom line is that as long as West Texas Intermediate (the kind of oil Kinder produces) stays above an average price of $55 for 2015, Kinder's dividend is safe, at least this year. Oil prices at current levels may slow the growth rate of the dividend but are unlikely to threaten the current payout.
Bottom line: Dividend is safe, but growth may be affected
Thankfully for income investors, Kinder Morgan's exposure to commodity prices is relatively small. While plunging oil prices, if they were to fall further or remain low for a long time, could slow the dividend's growth, the chances of a dividend cut are small unless crude prices decline below $55 and remain there for a prolonged period. Thus I would recommend income investors view current share price declines as a long-term buying opportunity into one of America's best energy companies -- one that has a proven track record of rewarding investors with growing income payments and capital gains.
Adam Galas has no position in any stocks mentioned. The Motley Fool recommends Kinder Morgan. The Motley Fool owns shares of EOG Resources and Kinder Morgan. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.