Long-time readers know that Kinder Morgan's (NYSE: KMI) project backlog is one of the most important things to watch in terms of the health of the company's future dividend growth prospects. Yet over the past two quarters, Kinder's backlog has shrunk by $500 million. Find out why, and whether you should be worried about management's dividend growth guidance.
Why the backlog is shrinking
Investors might be forgiven for being a bit confused about the state of Kinder's backlog, because in its most recent earnings announcement Kinder announced a record backlog of $18.3 billion.
The apparent $700 million increase in Kinder's backlog compared with last quarter was due to an accounting change in how Kinder calculates is capital overhead costs.
On a comparable basis, Kinder's actual backlog shrank in the first quarter by $200 million, mainly because of the removal of $900 million in oil-related projects, specifically the potentially long-term delay of the St. John's CO2 field and Lobos CO2 pipeline projects resulting from the crash in oil prices.In the past two quarters, low oil prices have caused Kinder to remove $1.685 billion in oil-related CO2 projects from its backlog. How bad could this trend of a shrinking backlog get? And could it threaten the company's 10% dividend growth plan through 2020?
Kinder's backlog still at risk ...in the short-term
At the end of 2014, Kinder had $1.8 billion in CO2 projects in its backlog, so after Q1's $900 million removal, that leaves $900 million in CO2 projects that might still have to be removed from the backlog should oil prices stay low for several quarters.
However, Kinder has an ace up its sleeve that means this recent backlog shrinkage shouldn't worry investors about its ability to either sustain or grow its dividend.
... but enormous shadow backlog means long-term backlog is safe
Investors need to realize that Kinder Morgan has two backlogs: the official backlog -- based on projects that are officially going forward within a specific time frame -- and a shadow backlog that consists of projects the company is planning and in the early stages of negotiation with potential customers to ensure that there's sufficient demand to make a project a worthwhile investment.
According to Tom Martin, Kinder's president of Natural Gas Pipelines, Kinder's gas portion of its shadow backlog currently stands at around $17.5 billion, meaning Kinder Morgan has at least $35.8 billion in total backlog projects that it's either actively working on or planning to invest in. It's also important to note that Kinder hasn't cancelled its $1.685 billion in CO2 projects but merely delayed them because of low oil prices; they've most likely been moved back to the company's shadow backlog.
What kind of gas projects does Kinder have to take up the slack in oil-based CO2 projects? As it turns out, the company is most excited about one major project in particular.
North East Direct: backbone of Kinder's shadow backlog
The North East Direct Project -- which represents about 33% of Kinder's shadow backlog -- would transport up to 3.4 billion cubic feet of natural gas per day from the Utica and Marcellus shale to major markets in the Northeast, such as New York and Boston.
Source: Kinder Morgan investor presentation.
Kinder estimates that the $4.5 billion-to-$6.5 billion project could save the Northeast around $3 billion per year in energy costs, because currently the region is paying far higher natural gas prices than is necessary, especially in winter.
Source: EIA.
As this chart shows, starting in the winter of 2012-2013, New York and Boston have ended up paying between 50% and 300% more for natural gas than the market Henry Hub rate. The North East Direct project thus represents a logical way for the Northeast to save a lot of money by tapping into the very cheap gas that's being produced in nearby Pennsylvania and Ohio. In fact, according to Kinder Morgan, in the past two winters the energy savings from electricity production alone would have saved the region $5 billion, enough to potentially cover the entire cost of the project.
Kinder is confident that it will be able to secure sufficient contracts for the NED, as it recently announced it had secured 550 million cubic feet per day of contracted demand to anchor the Market Path component of the project. Once Kinder has secured a bit more contracted demand, it should move the project -- which is scheduled to go online November 2018 -- from its shadow backlog to its current backlog, which should grow enormously as a result.
Bottom line: Kinder's backlog is shrinking because of oil project delays, but the dividend growth plan isn't threatened
Kinder's shrinking backlog is probably a short-term occurrence that shouldn't threaten Kinder's long-term dividend growth plans. Once oil recovers, the delayed CO2 projects should be returned to the backlog, and Kinder's shadow backlog and projects such as the NED stand ready to ensure many years of cash flow and dividend growth.
