Kinder Morgan Suffers Mounting Oil Losses

Losses from shorting crude oil may exceed a cumulative $2 billion by the end of 2008, taking into account the latest quarterly results reported on April 16 by sell-recommended Kinder Morgan Energy Partners (KMP) and Kinder Morgan Management LLC (KMR). Directed by the heavily-conflicted general partner [GP], the partnership apparently sold short through 2012 an amount of crude oil approximating the expected volume from its Sacroc and Yates properties in West Texas.

When benchmark crude oil was $98 a barrel in the latest quarter, the partnership gave up precious production for $50 a barrel. Ironically, one of the parties that profits from taking partnership oil at half price and selling it at full price is an owner of the GP, Wall Street house Goldman Sachs (GS), as we judge from the partnership’s limited disclosures. Aside from highlighting an obvious conflict of interest, past and future oil losses heighten the risks for the partnership in what has become a precarious economic environment for highly-leveraged, opaque entities. The partnership needs to borrow money and sell new units to pay its distribution, not to mention fund a multibillion dollar capital program.

Should more realistic recognition of risk cause that financing to dry up as it did for venerable Bear Stearns, unit price would likely react so fast that few investors would be able to sell near the current price. Valuation also remains high as the partnership has the highest unlevered cash flow multiple (EV/Ebitda) of any stock in our oil and gas research coverage. Finally, it is hard to justify the extreme level of compensation to the general partner which equals or exceeds the distributions to limited partners who have furnished essentially all the capital.

On the positive side, the outlook appears favorable for the energy infrastructure industry in which the partnership operates. Despite our concerns, stock market performance for the partnership has been about average on the face of it. Taking account of financial leverage, performance has been below average. Compared to buy recommendations, the underperformance gap widens further.

Originally published on April 16, 2008.

Comments

[hammer2003:]

So this guy is comparing KMP, an entity with very stable cash flows that is levered 1.7x to equity, to Bear Stearns which was levered 30x+ and had lots of highly speculative investments? I think this author may be slightly biased. And by 'slightly', I mean ridiculously obviously.

2008 May 20 12:04 PM

[hammer2003:]

Author should also realize that selling oil production forward is not the same as shorting. That is very basic finance.

2008 May 20 12:07 PM

[Chancer:]

Kurt Wulff never misses an opportunity to write something negative about Kinder Morgan. Unfortunately, he has done it so often, it is a bit like the "boy who cried: Wulff! Wulff!"

If this were written by anyone else, it might have some credibility worth considering.

2008 May 20 12:16 PM

[hammer2003:]

Totally. He may very well have a valid point that the GP is pillaging the LP but with the ridiculous Bear comparison (and Enron and Carlyle Capital (HA!) comparisons in earlier articles) and the misunderstanding of basic finance it's impossible to take him seriously. I would be interested in seeing an analysis of this GP/LP relationship from someone who actually knows what he's talking about.

2008 May 20 12:39 PM

[Jake2:]

Too much emotion all the way around here. When will clearer heads prevail, including Mr. Wulff's head?

2008 May 20 01:07 PM

[muguwmper12:]

I wish Wulff could write more clearly. He really does a horrible job of explaining his ideas. I'm not a total blockhead and I really can't understand the point(s) he's trying to make.

2008 May 20 07:27 PM

[CrossProfit_:]

From the Q1 earnings call...

"Let me just start out by talking about the quarter itself. We had an exceptionally strong first quarter. In fact, I guess in terms of financial performance, it's the best quarter we've ever had. We announced today an increase in our quarterly distribution per unit to $0.96, that's up from our $3.84 annualized, which is up for $0.92 in the prior quarter compared to the first quarter of 2007, that's a 16% increase.

Distributable cash flow before certain items was a little over $280 million, that's up 49% from last year. Probably the most meaningful number is that the distributable cash flow per unit was a $1.12, that's 37% above the $0.82 per unit for the comparable period last year. So, we earned a $1.12 per unit, or distributing $0.96 per unit for the first quarter."

BSC didn't have what to distribute. Besides, we haven't heard the limited partners complaining...

CrossProfit

As an aside, lower profits based on would have or could have done something else does NOT translate into losses. All it means is that there is potential for higher profits in the future.

2008 May 20 08:50 PM

[buffeteer:]

The $50 price mentioned in the article was a price set by hedges established several years ago. The new hedges established this year are fixed at a much higher price and the new prices will flow to the bottom line. The idea is to hedge oil prices so that the core business, i.e., the pipeline business, is not jerked around by volatile changes in the price of oil but instead mainly acts as a toll-road for the movement of oil and gas around the country.

2008 May 22 06:19 PM

[User 201888:]

S&P AND ARGUS HAVE STRONG BUYS. WHAT ARE THEY MISSING?

2008 May 29 02:49 PM

[searcher:]

I'd hate to attribute mendacity or studity, or both, to Mr. Wulff, but his non-sequitors in just this short propangana piece would stand out in a monograph several times more extensive.

2008 Jun 25 10:33 AM

[Mmarrkk:]

Someone else mentioned it in a much more eloquent way than I but here's the rub: Selling crude oil/natural gas forward does not result in a LOSS! Except in the fairy tale world of the SEC and Financial Accounting. In the REAL WORLD of cash flow, all it does is reduces the amount that we COULD HAVE MADE. Like if I bought Microsoft when it was $2/share and sold it when it went to $10/share. Did I lose anything? Even though I could have waited and sold it at $100? No! I made $8/share, I did not lose $90/share.

Wulf: get your act together.

2008 Jun 25 10:40 AM