AUthor: Ron Hiram
Published: September 19, 2013
I recently received the following question from a reader: “Since you have raised similar concerns more than once, I would very much appreciate your thoughts on the recent allegations by Kevin Kaiser that Kinder Morgan is skimping on maintenance at EPB and their other holdings in order to facilitate distributions.”
As early as May 11, 2012, I noted in an article on El Paso Pipeline Partners, L.P. (EPB): “Investors should note the decrease in maintenance capital expenditures”. I based this on a comparison of maintenance capital expenditures prior to and after the acquisition of EPB’s general partner by Kinder Morgan, Inc. (KMI), the general partner of Kinder Morgan Energy Partners LP (KMP). EPB’s general partner was previously owned by EL Paso Corporation.
I mentioned this again in an article on EPB dated August 5, 2012: “… sustainable DCF for the current period has not improved by much over the prior year, and would have shown deterioration but for maintenance capital expenditures being much lower. Management expects maintenance capital expenditures to total $55-60 million in 2012 vs. ~$100 million actually spent in 2011 and ~$94 million actually spent in 2010. Whether this lower level is sufficient is an open question”
However, these concerns were not, in my mind, based on a factual basis sufficient to conclude that management was “skimping” on maintenance capital expenditures. I so noted in various articles, including on March 2 and on May 7, 2013, saying: “My concerns about these cuts are based on gut feel. But I recognize that it is quite possible that management prudently generated cost savings (including in maintenance expenditures)” and “Maintenance capital expenditures continue to be much lower than they were when EPB was part of El Paso Corp. Hopefully the lower levels reflect careful pruning of maintenance expenditures and corners are not being cut. “
I think investors still do not have the factual basis to conclude that the Kinder Morgan entities “starve the assets of routine maintenance expenses and capex in order to maximize DCF (distributable cash flow)”. EPB is the only Kinder Morgan entity for which maintenance capital expenditure numbers under different management teams (i.e., different general partners) were available and therefore could be compared. Now that the same team that manages KMP manages EPB, it is reasonable to assume that both master limited partnerships (“MLPs”) approach maintenance capital expenditure decisions similarly. But the fact that the El Paso management team spent twice as much does not make it self–evident that the current team is underfunding. For me, it is a risk item that has to be evaluated together with many others before a Buy, Sell or Hold conclusion is reached. I don’t know of any metric available to the public that would reliably indicate the sufficiency or insufficiency of these maintenance capital expenditures.
I was long EPB before the El Paso transaction and, following its consummation, have yet to substantially reduce my position. This despite concerns regarding maintenance capital expenditures and despite EPB having adopted the Kinder Morgan definition and method of deriving DCF (what KMP refers to as “DCF before certain items”), which are more complex and differs considerably from other MLPs I cover.
I am less comfortable with KMP than I am with EPB because I believe there is an additional layer of concern. My concerns were expressed in prior articles. For example, on June 2, 2013 I noted: “I am uncomfortable with KMP’s distribution coverage. If distributions to KMR had been funded by cash instead of issuing additional capital, I estimate coverage for the TTM ended 3/31/13 would have been…considerably lower…”
I believe MLP management teams (of which Kinder Morgan’s is held in quite high regard) are fully cognizant of the risk posed by inadequate maintenance. If major environmental damage results from such “skimping”, the result could be financially catastrophic for MLP investors and management teams. It could also result in galvanizing public opposition to the unconventional gas revolution; in that context, and to understand how the damage could spill over to the entire MLP industry, see a documentary titled “Gaslands” by Josh Fox. When weighed against such an eventuality, I see no sensible rationale for taking any risks by not properly maintaining the infrastructure. A decision to do so seems to me risky to the point of being cost ineffective. Beyond that, the risk of falling afoul of the regulators is also substantial. For example, Energy Transfer Partners L.P. (ETP) unit prices fell >12% when FERC announced that it is seeking civil penalties and the disgorgement of a relatively small profit ($167 million) in connection with its trading in wholesale natural gas markets.
If I am more sanguine about the maintenance capital expenditure issue than others, it is due to the considerations cited above.