Kinder Morgan Energy Partners' Investors Webcast (Transcript)

Sep.19.13 | About: Kinder Morgan (KMP)

Kinder Morgan Energy Partners LP (NYSE:KMP)

Investors Webcast

September 18, 2013 08:30 AM ET


Rich Kinder - Chairman and CEO

Steve Kean - President and COO

Kim Dang - CFO


Stephen Maresca - Morgan Stanley

Shneur Gershuni - UBS

Mark Reichman - Simmons

Bradley Olsen - Tudor Pickering

Craig Shere - Tuohy Brothers

Becca Followill - U.S. Captial Advisors.


Good morning and welcome to the Kinder Morgan Conference Call. At this time, all participant lines are in a listen-only mode. (Operator Instructions) Today's conference is being recorded. If you have any objections, you may disconnect at this time. And now it’s my pleasure to turn the meeting over to Mr. Rich Kinder, Chairman and CEO of Kinder Morgan. Sir, you may begin.

Rich Kinder

Thank you, Marla, and thanks to everybody for calling in at a pretty early hour. I have with me on the phone, Steve Kean, our Chief Operating Officer, and Kim Dang, our CFO and David Michaels, our VP of Investor Relations. I'd also start by saying that as usual, we'll be making comments that may fall within the parameters of the Securities Act of 1933 and the Securities and Exchange Act of 1934.

Some questions have been raised recently about Kinder Morgan’s sustaining CapEx policy and we thought we would take this opportunity to address that issue. I will start with our philosophy regarding this area, and then reconcile in some detail the differences between sustaining CapEx spend by El Paso in 2011 prior to its acquisition by Kinder Morgan, compared to our expenditures on the same assets in 2013. I believe when you hear the details, you will conclude as we do, that the reductions we made in sustaining CapEx did not impact the integrity of those pipeline assets that we are managing and that we are managing all those assets appropriately.

After my comments, we will open the call to questions but we do plan to conclude this call prior to the opening of the market.

Let me start with our philosophy which can be expressed I think very generally as seeking to maintain our assets in the best possible condition and do so on a cost effective basis. We have a bottoms-up approach which is driven by our operating management and our engineering teams.

There are several key points I think to keep in mind about this whole matter. The first is that most cost of real pipeline integrity are not in sustaining CapEx at all, they in the expense category. And these for example they include all of the running of ILI tools like Smart Pigs, and most of the repairs on anomalies that are made as a result of running those tools. Those are all expense items or almost all of them are expense items. And so sustaining CapEx is in some respect a misleading indicator of how well you are maintaining your system and I will get into that when we talk more about integrity.

We think the key indicator is how the assets perform in various environmental health and safety metrics. For example, spills per mile or a number of pipeline incidents in a given period. Now we have, we are not naïve, we have 82,000 miles of pipeline and 180 terminals and there will be incidents no matter how hard we try. But we measure ourselves, our performance on EH&S categories against 31 categories across all of our five business segments and in all of those we are better than industry average.

And we believe we are applying a more conservative repair and ruination criteria to the El Paso assets than were done before the merger. And we are already seeing some positive indications in the number of incidents and the severity of the incidents since the merger was completed. We also believe we have a more rigorous damage prevention program that encompasses all the people out in the field who make certain that third-parties do not strike the lines, who manage construction out in the field, we think we are more rigorous on that than was done pre to merger.

I would also add that we have developed and continue to develop new tools and techniques to detect what were previously undetectable flaws. We've actually have a couple of patents on one of these, called KMAP, but we have KMAP and EMAP and actually we are showing some of those services to third-parties in the pipeline industry today. So, we believe we are an industry leader and not a follower in this regard.

Now let me make it very clear that we don’t gold plate our sustaining CapEx or anything else that we do at Kinder Morgan, for those of you who followed me for 16.5 years, you know that’s just not our style. So we do not believe in spending sustaining CapEx just to spend money and put it in a rate base and then earn on it. We don’t believe that was appropriate and I am going to say maybe when I started out 33 years ago in this business, but that’s not appropriate today because everything that you do, it naturally gets into the rates you charge for your transportation services and today unlike 33 years ago, this is a very competitive world and if we don’t do our best to minimize cost in a consistent way we are short changing ourselves and customers.

As an example of how we approach this, when we looked at our compressors, we analyzed whether to replace a compressor based on diagnostic tests not just on hours of run. That saves money over the long run and we think it’s a more effective way but it reduces sustaining CapEx.

I would also say that experience counts. As I said, I have 33 years in the pipeline industry, the rest of the team making the real decisions on maintaining our pipelines have as a combined total 100s of years of experience in this business. And I would suggest that investors should prefer to rely on that expertise, rather than the opinion of one analyst looking at a number of financial reports and I can’t let it pass without mentioning the sum of the numbers in that report, were just flat out wrong. For example, he made a point that the maintenance on SFPP that’s our products pipeline on the West Coast, in 2002 was reduced to $400,000, a 99% reduction. When we went back and pulled out the Form 2 and we submitted on the Form 2 that year, our sustaining CapEx was $38 million, not $400,000.

Now let me say that it’s hard to make industry comparisons about sustaining CapEx versus EBITDA or other categories. But last week on September 9th some of you may have read Goldman Sachs came out with a piece in which they attempted to compare sustaining CapEx as a percentage of EBITDA spent by all the various large MLPs.

Kinder Morgan in 2012 under this categorization has spent 11.1% of EBITDA on sustaining CapEx, the industry average was 9.8%; for 2013 based on estimates 9.8% for Kinder Morgan versus 8.9% for the industry average. And let me caveat very quickly that we don’t believe that these comparisons are overly meaningful because pipelines defer dramatically in the size of their pipe and the age of their pipe and where those pipes run. There are too many variables to reduce to a metric in our opinion. But I think and we have not independently verified what Goldman or the other analysts put out, but I think it does show that we are not an industry outlier in this way.

Now let me try to reconcile the sustaining CapEx expenditures of El Paso in 2011 with what we are spending on sustaining CapEx in 2013. Let me start by saying this is a difficult task, because there are many categories within sustaining CapEx many buckets if you will and we operate under a different ID system than El Paso did back in 2011. In addition, we have different personnel today compared to 2011. With that said and with those caveats here is what our analysis which took hours and hours of work reveal.

Let me reconcile these numbers. The analyst started with $499 million for sustaining CapEx on these El Paso assets in 2011. He included in that $499 million, the full sustaining CapEx on the Citrus pipeline which is the owner of Florida Gas Transmission. Now we only own 50% of it. We don’t operate it. We don’t make the decisions on that. We removed that $160 million because we wanted to get to those assets and those expenditures that the Kinder Morgan management team controls. So that takes you to 339 then we added back $15 million, which were spent on sustaining CapEx in 2011 on other pipes that were not covered in the analyst presentation. So 499, less 160, plus 15 gets you to 354 capital spend on sustaining CapEx for those same assets in 2013 is $132 million.

For purposes of this analysis reviews the budget and I can say that actually we’re going to come in right at that or actually probably a few million above that 132. But 354 minus 132 leaves a variance of $222 million. I am going to give you about five or six categories that reconcile 201 million of that 222 million and you will see that that $201 million does not negatively impact the integrity of the pipeline whatsoever.

Let me start with the first item which is launchers and receivers. In 2011, El Paso was in the process of a long-term plan to put launchers and receivers on all their pipelines. Now for those of you not in the pipeline industry this is simply the mechanical facts that you use to insert the pigs or other ILI devices into the pipeline and then we treat them at the end of the run. Because El Paso was completing this project and it was finished in 2012, in 2011 they spent $41 million on launchers and receivers because that project was completed and we’re only spending $6 million on launchers and receivers in 2013 that is a difference of $35 million if you’re keeping score put down 35.

Second item is maybe the most interesting and this is the heart of integrity management and its all anomaly repairs. What happens when you run your smart tools or do a hydro test if you uncover any anomalies, in other words the test reveals that there may be a weakness in the pipe, the thickness of the pipe maybe thinner than you would desire you go dig that up. Sometimes you find that there is nothing wrong with that pipe and you cover it back up, sometimes you find there is a dent, sometimes you find a section of that pipe needs to be replaced.

El Paso in 2011 spent $40 million on anomaly repairs in sustaining CapEx. We will spend this year $5.3 million on anomaly repair, so you say oh my goodness that’s a huge difference they must not be repairing their pipeline. But let’s look at the whole story in 2011 as I said most of this is expensed but not sustaining CapEx. When you do these digs and do these repairs unless they are truly major repairs FERC accounting requires you to put them over in the expense category.

Bear in mind in 2011 El Paso spent $40 million on anomaly repairs and sustaining CapEx and $33.9 million on anomaly repairs in these pigs, so the total that they spent on anomaly repairs was $73.9 million. 2013 in Kinder Morgan as I said, we're spending $5.3 million in anomaly repairs in sustaining CapEx and we’re spending $96.8 million in O&M expense for anomaly repairs. So the total in 2013 on these assets being spent on anomaly repairs and that's where the rubber meets the road, is $102.1 million this year, versus $73.9 million in 2011. We’re spending $28 million more but the net reduction in sustaining CapEx is $35 million. So you got another 35 to put down.

The next item is much easier to explain and it's IT. We saved $36 million in IT cost between 2011 and 2013, and that IT came in two buckets, the first is that of course in IT as you buy new programs and bring them online that's all sustaining CapEx. We're spending $12 million less on that than El Paso did, we just run a much smaller, leaner IT shop not criticizing anybody, we just have a different philosophy on IT.

In addition, so that's $12 million, an additional $24 million resulted from the fact that El Paso spent $24 million in 2011 on the project called Foresight and that was a project that they were ramping up to spend over a period of years to put one pipeline system in affect that would control and monitor all the other pipelines, because El Paso was built on a series of mergers they had different IT systems for their various pipelines and they were trying to put it together.

When we took over, we eliminated that and moved all the El Paso systems over to our DART system which we had in affect for all the Kinder Morgan pipelines. So the total savings comparing 2011 to 2013 on IT was $36 million.

The next category is mechanical and equipment. And the number there, savings is $30 million and let me explain what that is, it has nothing to do with pipeline integrity. It embraces matters like compressor overhauls, automation projects, vehicles across all of our 1000s of employees and equipment used by field employees. Again it has nothing to do with pipeline safety or integrity. The difference and one difference I referred to earlier is we use diagnostic testing to determine the need for replacement of compressors, not just an hour’s run mechanism. And we only replace those that show up on the diagnostic testing as being replacement. In addition we only replace the equipment that is based on that data. We don't replace ancillary equipment that doesn't pre-indicate a problem under diagnostic testing.

So we don't go in the compressor station and say, well we have a problem with one compressor let's replace all the compressors, we just replaced the one we have problem with. May seem minor but we run all our vehicles to 160,000 miles and that's just longer and that saved us a few million dollars as part of this category.

So that's $30 million to add to the list, so we have got 35, 35, 36 and now 30. The next category is company policy and regulatory. And that was a savings of $29 million. Now this includes cost, some of them we include in OpEx, like pipe replacement and recoating, but we budget and spend for compliance on a cost effective manner, this is what I said earlier, we don't budget to put items in because we want to build our rate base. Our company policy is to maintain compliance and focus our researches on the areas that are most essential for pipeline safety like repair criteria.

Now we track all this at our compliance systems and we show a 99.5% on-time compliance when we have exceptions we identify them and track them down, that's $29 million.

The final item is retirements and reimbursables. Let me give you an example of what this is. If you have to relocate a pipeline, let's say you need to relocate a pipeline because State is putting a new four lane highway across an area where your pipeline runs and let us say it costs you $6 million to relocate that pipeline. Most states reimburse those but if you spend the $6 million if you put it in your reimbursables category as a gross cost, you actually in the end don't spend all of that because and my example, let's say $5.5 million was reimbursed by the State of Texas or the State of Oklahoma or whatever.

So in 2011 the total on retirement of assets and reimbursables that El Paso spent was $37 million, this year we totaled up all our retirements and reimbursables and we have a net zero for 2013. Now that may vary year-to-year but this year it’s zero, so that's $37 million. So if you add up the numbers I have just gave you in those five or six categories that equals to $201 million of the $222 million variance, and again I will submit that that kind of detail demonstrates very substantially that what we did in reducing cost is not related to spending on the integrity of our pipelines. And in fact I would argue that by spending $28 million more on repairing anomalies, we are actually putting more money on the integrity of the pipelines that was put on those same assets back in 2011.

Now let me end by talking about expansion capital versus sustaining CapEx, and there was an allegation that somehow we are skipping on sustaining CapEx and then we make this up like a Houdini with expansion CapEx and solve all of our problems.

What we do is consistent with our partnership agreement which was entered into 1992, long before Bill Morgan and I took over this company and consistent with what we believe are good economics. We treat as expansion CapEx those expenditures which increase the capacity of the pipeline. We treat as sustaining CapEx those expenditures that just maintain the present system.

Now this cuts both ways, for example in Canada on our Trans Mountain system, we spent millions of dollar a year, we counted as sustaining CapEx, it’s a reduction to DCF but actually under the agreement we have with our shippers those costs are passed through and we actually earn on those. So you could argue while you’re spending money, you’re making money on it, that should be expansion CapEx. But because of the definition I’ve just given you, that’s sustaining CapEx.

So this link cuts both ways. Now the Hedgeye analyst also went ahead to say that there were some expansions in Arizona on our Santa Fe Pacific system, again that’s our refined products system on the West Coast where we were just replacing outdated pipe with new pipe. Even though they were bigger and even though they can handle more volumes we were just doing it to replace what should have been sustaining CapEx.

Let me review that in detail. And the numbers we are talking about is around $450 million on some separate projects. We made those investment decisions back in the middle of the last decade in anticipation of incremental demand in the State of Arizona. And sometimes I'm kind of a believer in anecdotal vignettes or whatever, I remember specifically I went out to Arizona and to Phoenix and met with the Governor of Arizona, who went on to other things like Homeland Security, and when I told her that we were going to expand our system east and west, so we could serve Phoenix in particular and to a lesser extent Tucson, with better volume opportunity. She said that’s the best news I have had all week or something to that affect, and went on to talk about how fast Arizona was growing.

Now I would admit that demand in Arizona has not grown as fast as we would have expected at that time, due to the factors that are beyond our control, like a major recession, and like 10% ethanol mandate. Ethanol, of course, cannot move through those pipelines. But we certainly were correct in making an investment decision at that time with the factors that we saw at that time. Again the amount involved in this is about $450 million in total and that’s out of about $40 billion that we spent at Kinder Morgan on acquisitions and expansions over the last 16 years.

So let me say again our philosophy is not to stamp on maintenance CapEx and replace it with expansion CapEx. And the real test is, if we were doing that our return on invested capital would go down. But it hasn’t. If you look at the numbers that we present every January, at our analyst conference, you see that our return on invested capital for the past several years has been between 13% and 14%. If we were loading up the denominator in that equation with lots of unwarranted expansion CapEx, you would see that go down and yet it has not.

Also if we were doing this nefarious action, you would see our debt-to-EBITDA change precipitously. And it has not. It has remained relatively constant over the years.

To sum up we believe our policy and actions on maintaining our pipelines are correct and appropriate. We have always been a very transparent company. As you know we put our budget out on the website at the beginning of January, and the issues that are raised, and that I am talking about today, have for the most part been consistently disclosed to our investors over the years. We intend to maintain our focus at this Company on running America’s largest pipeline system in a manner that benefits our customers, our shareholders, and the public.

And with that in mind, I will take any questions that you may have.

Question-and-Answer Session


Thank you, sir. (Operator Instructions) And our first question comes from Stephen Maresca, Morgan Stanley.

Stephen Maresca - Morgan Stanley

Thank you very much for the call, really appreciate the detail. A question on pipes and a question on CO2, you went in great detail on the difference, on integrity going into OpEx versus maintenance. I guess, two things on that; what determines whether it goes into O&M or whether it ultimately goes into that sustaining CapEx line? And then, how much of what you spend is on a percent basis, regulated, you're forced to spend by DOT or FMSA? And how much is all the leeway that you have?

Rich Kinder

Steve, do you want to tackle that one.

Steve Kean

Yes, on the distinction between O&M and sustaining CapEx, let me give you some specific examples and it relates back to pipeline replacement. Specifically for the most part as Rich pointed out when we run tools and we go out and identify pieces of the pipe that needed to be replaced, we are treating that as OpEx and since about 2007, that's been the FERC accounting treatment for it and that's what GAAP incorporates. Now there are some difference in approach to get specific, if we -- we won’t classify pipe replacement as CapEx unless we’re replacing a 100 contiguous feet of pipe.

And that’s typically not what’s happening that’s why over 90% of what we’re doing on anomaly repair is OpEx, because we’re replacing a joint, we’re putting a sleeve on a piece of the pipe, cutting out of a weld and putting a small pup or piece of pipe in between the two joints.

El Paso and perhaps other companies took the view that if you were replacing 40 feet, which should be a single joint that you would capitalize it. So there are some differences in terms of how different companies look at it, they are both legitimate approaches but that’s the general way that you make the distinction between sustaining and capital, it’s about how much pipe is being replaced. And again, I’m sorry between expense and sustaining capital and it’s based on how much pipe you’re replacing. So that’s kind of the key point there and I’m sorry the second part of your question?

Stephen Maresca - Morgan Stanley

How much of what you spend is regulated? How much of what you spend is forced to be spent by the regulators?

Steve Kean

Yes I know and it’s a good question and a very good point. So, we have -- this is not a discretionary, I mean some of the things that we do are above and beyond what is required from a regulatory standpoint. The development of the new technologies and other things that we’re doing the right-of-way protection and things like that, but there is a very detailed set of regulatory requirements that govern all interstate natural gas pipelines and liquids pipelines. And then we have to put together and have put together an integrity management program that incorporates into our O&M procedures all of the details that implement those very detailed regulations.

And then that plan is subject to audit which it has been, I think for everyone of our assets subject to audit by the DOT, so these are not, for us or anybody else maintaining safe pipelines and having a good integrity management program it is not a matter of discretion. Now where discretion comes in is, in some of the things that we think we do, maybe a little bit more or a little bit better like the repair criteria that Rich alluded to, but don’t think that there are aside from us even that there are interstate pipelines out there that somehow elect whether or not to have integrity management programs and elect what to do. Detailed regulations implemented by detailed O&M and subject to follow-up audit by the regulator.

Stephen Maresca - Morgan Stanley

Thanks for that. And then if I can ask a question, Rich on away from pipes on CO2, which is another issue that was kind of brought up and banded about over the past two weeks or so. Just your philosophy again on the CO2 sustaining versus growth, and why you feel what you're doing is very appropriate there, too?

Rich Kinder

We certainly so, Steve you want to go into more detail on that?

Steve Kean

Yes, sure. First let’s kind of put things in context, we’re not an E&P MLP. Our business mix has changed overtime and particularly with the El Paso acquisition and it continues to change. If you look a KMI level and a KMP level respectively, the EOR portion of our overall segment earnings before DD&A is 14% and 18% respectively, so let’s make sure we understand that context. Also looking forward of our $14 billion project backlog, 10% of that is in the CO2, EOR part of the business. So, it’s important to have that context.

Now let’s talk about what we’re doing in expansion CapEx within CO2 specifically. So, we are expanding our CO2 source and transportation business, now it’s about half of our backlog, project backlog and CO2. We are also expanding in EOR and if you look forward we’re expanding production here at Katz, the recently acquired Goldsmith unit, the residual oil zone recovery effort which we have just started to invest in. Those are all expanding production in those fields on a year-over-year basis. So the focus of the attention on expansion CapEx that’s not increasing production has really been a focus on Yates and SACROC and so let’s put that in context. For this year, we’re going to put about $300 million, $305 million into Yates and SACROC combined in expansion capital. We’ll get about $990 million worth of distributable cash flow out of those two fields, so again just to help calibrate this for you a little bit.

Now, specifically let’s talk about Yates and SACROC. When we invest expansion dollars in those fields, we’re investing in new flow lines, new injection in producing wells, tanks, manifolds, measurement equipment all of those things. Tangible assets that we’re putting capital into put on the ground or in the ground. For that investment, we’re getting back oil that we can identify that we can measure, that we can sell for cash and that cash provides a return of and a return on that capital. That’s expansion capital, that’s expansion capital in our book, it’s expansion capital in the partnership agreement and I think it’s an investment under anybody’s use of the term.

That’s how we’ve been doing this for years, it’s well know, it’s discussed, it’s the right way to do it. I think the focus on whether or not the base business is growing or not is an inapt focus. This is expansion capital, it’s on this part of that part of our business that we’re spending that money and spending it that way.

Stephen Maresca - Morgan Stanley

I am sure a lot of effort went into this, so thanks again. That is all for me.


Our next question is from Shneur Gershuni from UBS.

Shneur Gershuni - UBS

Just kind of as a follow-up to your prepared remarks and Steve’s questions, I was wondering if you can sort of spend a minute talking about maintenance capital across all the various segments. I know you spent a lot kid of specifically on the El Paso side. Are there some segments that in your view consume more or less sustaining CapEx as a percentage of EBITDA? And also I was wondering if you could give a little bit of detail, if there are other segments where you feel that there is some questionable, whether it is sustaining CapEx or O&M and where you record it as O&M versus sustaining CapEx that we should be thinking about as well, too?

Rich Kinder

Well, I'll take a crack at that, I think in general again our whole approach across all of our other segments just like our natural gas asset is to do bottoms-up budgeting every year. In fact we just started with the ’14 budget now. Steve then receives all that sustaining CapEx, it comes up from the various regions reviewed by the segment VP of Operations and then they sit down with Steve and go through it. So it’s a very bottoms-up approach and I don’t think there -- I don’t have much more say about that, I don’t have at my fingertips what percentage of EBITDA that sustaining CapEx bodes down to. Of course all our segments are pipelines with the exception of the CO2, EOR business and with the exception of our Terminals business.

Our sustaining CapEx in Terminals business is pretty large, because we have 180 Terminals and every year there are tank inspections that have to be done, bottom heel replacements on the tanks and again there is a lot of DOT mandates on that. The great bulk of our liquids Terminals are subject to DOT regulation, so we have to go through and inspect all those tanks on a regular basis under an integrity plan that’s not all different from the integrity plan that we have on our pipeline. So I just don’t know what the percentage is, but I think it’s the way we run it in the same manner that we run on the El Paso assets or any of our natural gas assets.

As sustaining CapEx versus O&M, the only issue I’m aware of is the one that was raised on these Arizona operations on our Santa Fe Pacific pipeline and that’s a refined products line. There was reference made to spending money on the Las Vegas expansion that we did, we spent about $20 million on that in preparation to expand. At the time we spent that money, we were running -- we had capacity around 150,000 barrels a day. We were running in the 140s. Again, we met with the Mayor of Las Vegas and the airport authority there, they wanted us to expand and we started the processing on it, it’s still not quite complete.

In the meantime of course Las Vega has probably hit as bad as any place by the recession. And then the competing pipeline came in for Salt Lake City. So we’re not spending additional sums on that at this time and the total expenditure is $20 million. And that’s all on permitting and getting the appropriate clearances from the core of engineers and various parties it has nothing to do with replacing pipe, that was all new line that we were going to put in. But those are the only example that I know of.

Steven Kean

Yes just one more point on where we have more sustaining CapEx and you really need to think about sustaining our maintenance CapEx in terms of replacing stuff that wares out. And so that’s -- we have a lot more moving parts in the Terminal asset for example and so Terminals we will probably spend a little over $100 million this year on sustaining CapEx, so that’s a bigger share of EBITDA than probably on our other assets and that underscores another point. There is a big difference between DD&A, on a pipeline asset in particular and sustaining our maintenance CapEx. Maintenance CapEx as I said gets attracted to things like compressor stations maybe meter stations, delivery points, receive points things like that there are kind of the moving parts.

There is very little that’s attracted to the pipe because the pipe if it’s properly protected and coated and periodically inspected and repaired, really can last indefinitely and it doesn’t require its DD&A on a percentage basis to be made up in maintenance CapEx, so that’s a very important distinction in a pipeline context DD&A tells you next to nothing about what you need to do to actually maintain your assets.

And then just one other point on the projects out on the Pacific Pipeline System, in our gas business for example and most of our other businesses the way we would have approached that growing market is we would have gone out and gotten contracts for it. We would have secured it, we would have gotten demand charges, we would have gotten incremental revenue and earnings and return on that investment. The Pacific System is a common carrier pipe. And so it’s not a contract carriage system, so that creates a little bit of a different dynamic out there. But we wouldn’t even be having this conversation for example if this would have been an investment on the natural gas system.

Schneur Gershuni – UBS

Great, thank you very much for all the details, guys. Thank you.


Our next question is from Mark Reichman from Simmons.

Mark Reichman - Simmons

It seems to me that the recent criticism has really been directed at the integrity of the partnership's financial reporting. So I wanted to ask about management's philosophy regarding non-GAAP financial disclosures. And as is the case with C Corps, mini MLPs will adjust earnings to reflect what they consider to be pull ongoing earnings. I mean some use language such as net income before certain items, while some exclude items affecting comparability.

And I was wondering if you could address how you think about what you include and/or exclude, and to what degree your public accounting firm and legal counsel opines on the financial reporting, including the non-GAAP disclosures? And then the second part of my question extends to the computation of distributable cash flow, and to what degree you think that the distributable cash flow measure shown in the earnings release should reflect the economic reality or actual cash flow available for distribution to unitholders?

Rich Kinder

Kim, Chief Financial Officer, you want to take a crack at that?

Kim Dang

Sure, Mark look, all of our GAAP -- what PWC signs off on is our GAAP financial statements and that's what they deliver an opinion on. We show investors DCF, we adjust that DCF for certain items to reflect as you said what we believe is our business' ongoing ability to generate cash. We provide detailed information on the certain items. We break them out on a one-by-one basis for any ones that are significant, so that investors can form their own opinion.

In addition DCF is reconciled to our GAAP numbers, so you can see any items that are different between our net income and the DCF that we are reporting. If you look at our certain items, we have had both positive and negative certain items in the past. On the positive side, we've had things like the gain on the sale of assets. We had express sale in the first quarter of 2013, there we're actually receiving cash on that sale and cash in excess of what the gain is, but we don't think that the sale of assets is indicative of our ongoing ability to generate cash and so we treat that as a certain item.

Another certain item that we had in the second quarter was the re-measurement of assets to fair value, that is a non-cash gain and that was over $550 million. We don’t believe that non-cash gains or re-measurements are indicative of our ongoing ability to generate cash and so we treat that as a certain item.

On the negative side, we've had things like a loss on sale when we had to sell the FTC assets as part of the El Paso merger pursuant to the FTC order. We don't think that is indicative, we actually got cash on that sale, but again we don't think that's indicative of the entity's ability to generate cash.

Something that's been mentioned out there is environmental and legal reserves, if you look at our environmental and legal reserves; on the legal reserves what we treat as a certain item is a legal reserve that relates to prior years and if you go back and when you listen to the second quarter call, what I've said was any amount of that legal reserve that relates to the current year operations, read the DOT, in determining our DCF. So what we're saying is, take out the prior years, because that does not relate to the entity's ability to generate cash on an ongoing basis. What does relate to the entity's ability to generate cash on an ongoing basis is the reserve associated with current operations. And so we deduct that in determining our DCF.

On the environmental side, environmental reserves often involve; one or typically non-cash in the current year; and two often involve future years. What GAAP requires is, is it requires companies to book a lifetime reserve when we determine that a site has future expenditures that are probable and assignable, so what you're seeing there is most times as you're seeing reserves that relate to future years, again that is going to future years, not to the current year and the ability to generate ongoing cash and so we pull that out.

But the bottom-line on all this, is we are very transparent on the certain items, we give the investors sufficient information to form their own opinion and make adjustments as they see fit and we provide a reconciliation of all of our non-GAAP measures back to our GAAP financials.

Rich Kinder

And I'd add one more example that's even much simpler and easier to understand probably and that's hurricane damage, when hurricane Sandy we hit we had damage to our terminals in the Northeast and we treated that as a certain item which was a negative. As a point of fact of course the great bulk of that has been and is being reimbursed by our insurance carriers under our insurance policies. And as that cash comes in and only when the cash comes in, we treat that as a certain item also, so you start out with a x million dollar negative, ends up being a whole series of positives and in the end you come pretty close to zero, the difference being the deductible. But that's another example of a certain item. Marla, do we have any other questions?


Yes, thank you. Our next question is Bradley Olsen from Tudor Pickering.

Bradley Olsen - Tudor, Pickering

Thanks for the detail on the acquired pipeline operations. It is really above and beyond to provide that level of disclosure. I would like to dig a little deeper on CO2 CapEx, because I think it’s where there is probably the most difference of opinion around what might be the appropriate way to do it versus kind of how it is done currently. And I think that the way the partnership agreement stipulates growth capital, and it has been discussed in various Analyst Days, is that any capital that increases DCF is growth capital. But it seems that over the last few years as a result of higher realized hedge prices, DCF has grown in large part because of commodity price impact, which is something that is outside the partnership's control.

Now, you rightly noted earlier that the CO2 business and the EOR portion of the CO2 business, is a shrinking portion of your overall portfolio, pro forma for the El Paso acquisition. Now, given the fact that it is a smaller piece today than it ever has been before, are you considering changing the definition of what is growth CapEx away from what grows overall cash flows to potentially what grows production volumes in the EOR business, just in light of the fact that that seems to be one of the concerns that has come up in the past?

Rich Kinder


Steve Kean

Yes, first of all, with the partnership agreement does not define things in terms of increasing DCF or increasing EBITDA, it’s not really a revenue based determination. It’s really focused on adding capacity or adding throughput and that’s important as Rich alluded to. You get some anomalous results on the other side when you look at it that way too. So you think a lot of discussion and focus on CO2 and that CapEx.

We also have sustaining CapEx that does add to EBITDA and I will give you a couple of examples, Rich mentioned one of them. When we put sustaining CapEx into our regulated assets, Canada is one where it’s actually tracked and updated every year. In other regulated assets, it’s really a between rate case issue. When you go in for a rate case or brought in for a rate case or do a rate settlement, that sustaining CapEx has been added to your rate base and in your rate base you are entitled to a return of, and a return on that capital, that’s still sustaining capital in our mind whether that does attract additional revenue or not. So it is a capacity based definition.

Another example might be, you do a sustaining capital project that reduces expense, okay, if it’s not increasing the capacity or the throughput of the asset, it’s still sustaining even though it’s improving EBITDA. So, there are some things on kind of both sides to that line, but really the focus is on capacity and throughput. And as I said before when we are making capital investments in our CO2 business, we are investing in real assets, real steel drilling rigs to put holes in the ground, to inject CO2 and to produce it, submersible pumps, all those things and when we do a development at SACROC, for example, we can show geographically this is where this thing is happening, this is the area and we are producing identifiable oil there that again we sell and we get cash and we get returns on. That ramps up and then it ramps back off when it starts to decline.

But that is an investment in producing new oil and that’s the way it’s always been defined I think that’s the proper way to look at it under the partnership agreement. And we don’t really have any plans to change it. I think, but instead will continue to do is just be very transparent about it. And so I think what people are -- and again this is an approach that’s been in place for a decade or more and it has been talked about for a decade or more. And I think when people look at our CO2 business they take that into account and I think when they look across our whole business they are taking not only that into account but also all of our other growth CapEx, all of the other performance up and down in our base business, generally up. And using that to determine whether or not the distribution is going to be grow and at what rate.

And so I think the way we will continue to approach that is just to be very transparent about what we are doing and how we are doing it.

Bradley Olsen - Tudor Pickering

I guess the only other -- just to make sure I am understanding your methodology correctly, just given the fact that each new well is considered kind of a separate investment in new barrels of oil as you mentioned, and new production growth. I think that probably necessarily means that going forward the EOR portion of your overall CapEx budget will be an overwhelmingly growth-oriented CapEx and relatively small maintenance CapEx. Is that kind of the right way to understand it?

Steve Kean

Yes, I think that’s right and I would also point you to and again we are in early stages here, but we did acquire a new field. We are doing some analysis right now on some residual oil zone recoveries and of course there is the Katz project. We do have even in our EOR sector, there is expansion CapEx that’s developing new production in fields that are growing year-over-year. SACROC and Yates are still the biggest piece of that business and probably will be for some time but that’s just another thing to keep in mind.

Bradley Olsen - Tudor Pickering

And I guess my final comment would just be that, I understand the perspective and your methodology does -- it does make sense, it’s just that something that obviously is causing some concern in various reports. And so to the extent that holding production volumes flat were kind of the metric that were used, I think that would take the legs out of a lot of these criticisms.


Our next questioner is Craig Shere with Tuohy Brothers.

Craig Shere - Tuohy Brothers

Two quick questions, with respect to CO2, EOR operations would you at some point be in a position to start providing multiyear production outlook separate from a third-party engineering estimates that have proved conservative overtime?

Kim Dang

We do provide a long-term outlook and have since 2004 probably and you can find that in our Analyst Conference presentation. It’s typically one of the last pages of the CO2 presentation, in the 2013 it is Page 27, and that provides the long-term outlook. In this case through 2022 in terms of the DCF and also provides the capital to be spent and then the following page shows our long-term outlook over the years and how it has actually continued to grow versus our prior projections.

Craig Shere - Tuohy Brothers

I'm familiar with the DCF guidance and I'm focusing specifically on production.

Kim Dang

We give you the estimates with respect to price and so you can back into the production or get close to it that underlies the DCF.

Craig Shere - Tuohy Brothers

And the last question, I understand that you all do bottoms-up. So you are not really forecasting or pegging artificial CapEx spend figures, which makes average numbers against the benchmark difficult to say over long-term. Is there any way to characterize 2013 maintenance CapEx levels. Because when you have new projects come online, ongoing maintenance against those assets tends to be lower as has already been mentioned on the call. Certain assets may have more maintenance CapEx than others due to their fundamental nature.

And often you have maintenance like [indiscernible] themselves that could be a partial year or 18 months or longer where you just know you have more spend at a certain point in time and you can target that on the calendars? In 2013…

Rich Kinder

Yes, I would say that’s a very good question and in your question you identified a lot of those moving parts. I would say generally and Steve could jump in here, but I would say generally that maintenance CapEx, sustaining CapEx and the O&M part of our operations tend to increase year-over-year, it’s just lot government regulation. For instance on our pipelines we have more as pick any city where we operate in Huston, Los Angeles wherever, as these cities grow out more of the areas where we have pipe become HCA high-consequence areas which moves you into a different level of testing and cost.

So in general I think the trend line is probably up over the years, but you’re absolutely right it does vary and you make absolutely a bright point on the fact that as we put new pipelines into effect, you’re not going or new assets you’re not going to have the same level of sustaining CapEx.

There for example we’re building the splitter for BP as an Houston ship channel that’s the process, the condensate that’s coming across our Kinder Morgan Crude condensate line, it’s a $360 million project. There will be and my guess is virtually no sustaining CapEx in the early years on that $360 million investment. We’re putting in a group of tanks that in total will cost in excess of $100 million to service the output from that splitter and those tanks while we have to do API inspections, those API inspections that don’t really hit until about the fifth year [indiscernible] with the guys with the tank but about the fifth year after you go into operation so the first year you spent $75 million on a bunch of tanks and you have no maintenance CapEx or no O&M in terms of maintaining those tanks.

But after a set of period of time mandated by the DOT, you have to go in and do an API inspection and you have to drain the tanks and to the extent you find the problem with the interior of the tank you have to fix it before you complete it back in. And so it is really multi-faceted and the bottoms-up approach based on my life in this business is the only way I know to do it. You just have to do it kind of like zero some budgeting from the beginning of the year and that’s what we do. We don’t say well gee products pipelines you spent ex billions of dollars last year, you have got that and what else have you got for us. They come in and say look we need to do this activity in 2013 or ’14 whatever year is and I need $7 million to do it that’s how specific it is.

Craig Shere - Tuohy Brothers

I don't know if it is just me, but you cut out there a little bit on the phone line connection. Hopefully, the transcript can pick up your actual words.

Rich Kinder

Okay I’m sorry. Marla, do we have any other questions?


Yes, sir. Our next question is Becca Followill with U.S. Captial Advisors.

Becca Followill - U.S. Capital Advisors

Just to clarify, I know we've gone through this before, but your partnership agreement says growth capital is anything that increases the capacity of the asset of a system. What do you define as the asset or the system, is it the well, is it the field, is it the entire E&P business, what is it?

Rich Kinder


Steve Kean

Yes, what we’re doing is we’re looking at that specific project and it’s just typically not that hard, if you look at the vast majority of our expansion capital projects we’re putting new pump stations, new compression, new pipeline looping, new tanks, new wells you name it. I mean we’re putting in identifiable new facilities and equipment and for that investment we’re doing an economic analysis and it’s usually not that hard to do that, it’s backed up typically by long-term contracts again it can be a little bit different in a common carrier context but even that has moved a little bit overtime to more of a contracted basis.

And so we have that identifiable capital that we’re putting in the ground or on the ground to increase our ability to move a particular commodity or store a particular commodity and we’ve got typically again the vast majority of cases we’re looking at contracts that underwrite that that provide revenue that we’re then using to determine whether we’re getting an adequate return before we go ahead with that project. So, it’s just not that difficult to make that call.

On the other side sustaining CapEx, Rich gave several examples of that, we go in and we’re inspecting a tank and we got to replace the floor, we’ve got to do some work on the associated piping or maybe some wells on some of the panels or something like that. Again, it’s pretty clear so there is not a lot of close calls there I would say.

Becca Followill - U.S. Capital Advisors

Okay. And I would also just make this request in the interest of transparency. You guys, historically, in your earnings calls as you report at 3.00, you talk at 3.30 and it's gotten basically impossible to get through all the press releases that you guys put out. So if there is any way you could change it, such as the call the next day, it would be really helpful.

Rich Kinder

Okay. Thank you, Becca. And I’m showing about two minutes till the market opens, so we’ll cut it off there. Again, we’re happy to answer additional questions, just feel free to call any of us but particularly David Michael and his IR team is kind of the point on this and we’ll be happy to answer any other questions you might have. Again, we appreciate very much you’re spending this last hour with us and look forward to continue to working with you. Thank you.


Thank you all for participating in today’s conference. You may disconnect your lines at this time.

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