Pipeline & Gas Journal
March issue 2000:

Above: Richard Kinder (left) and William Morgan have built Kinder Morgan Inc. into one of the nations leading natural gas and liquids Pipelines Co.

by Jeff Share/Editor

Who and what is Kinder Morgan?
The “who” are Richard D. Kinder, the former No. 2 executive at Enron Corp., and William V. Morgan, a former president of Florida Gas Transmission, Transwest-ern Pipeline and Northern Natural Gas - all Enron pipelines. They are old friends who met in the early 1960s while attending the University of Missouri where both earned law degrees. As irony would have it, that’s also where Morgan was introduced to a frat brother named Ken Lay, founder and chairman of Enron Corp.

The “what” is more complicated to explain. In essence, there are two Kinder Morgans. Kinder Morgan Energy Partners L.P., is the nation’s largest pipeline master limited partnership (MLP). It owns and operates one of the nation’s largest products and NGL pipelines, with 5,000 miles of pipelines and more than 20 related terminals serving customers in 16 states. The MLP owns 51 percent of Plantation Pipe Line Company and 20 percent of the Shell CO-2 Company Ltd., which produces, transports and markets CO-2 for enhanced oil recovery. The company also has a small coal marketing joint venture with Southern Company.

The general partner of the MLP is owned by Kinder Morgan, Inc., (KMI) one of the biggest midstream companies in the nation with more than 30,000 miles of natural gas and product pipelines in 26 states. It also has retail businesses tied to the pipelines.
KMI was formerly known as KN Energy, a multibillion-dollar integrated gas company based in Lakewood, CO that had fallen on hard times in recent years.

Last spring, a proposed merger with Sempra Energy fell through after Sempra declined to assume KN’s heavy debt load; Kinder, who had been on KN’s board for just a year, resigned, then promptly suggested a deal in which KN Energy would buy Kinder Morgan, but retain the Kinder Morgan name and allow the Kinder Morgan team to run the company.

It was an unusual deal, but Kinder Morgan is a most unusual company because it is purely a domestic, onshore pipeline company. In this era of deregulation and increased competition that sees many energy companies venturing into areas in which they have less expertise, Kinder Morgan has adopted a reverse strategy, preferring to contract rather than expand. It’s a pretty simple theory, the way Kinder and Morgan explained it to P&GJ during a lengthy interview in their downtown Houston office.

“Frankly, we can operate pipelines as well as anybody in the world and better than most. This is an area where we, and our staff, have a tremendous amount of experience,” said Kinder, the company’s chairman and CEO. Morgan is vice chairman and president.

Morgan left Enron in 1987 and involved himself in the handling of private investment transactions in energy assets. By 1996, Enron decided to sell Enron Liquids Pipeline, L.P., and began talks with Morgan’s group. Morgan subsequently contacted Kinder, who had built a high profile at Enron as well as a reputation as a savvy strategist. He was ready to leave Enron in search of other challenges. When he joined Morgan, they restructured the transaction, closed the deal with Enron in February 1997 and formed Kinder Morgan Energy Partners, with assets of about $300 million. Today, it has an enterprise value of $3.7 billion; including KMI’s assets, it’s a $10 billion company.
The size of Kinder Morgan is reflected in P&GJ’s Annual 500 Report that ranks the nation’s leading gas transmission, distribution and liquids pipelines:

• Natural Gas Pipeline Co. of America (NGPL) has 11,902 miles of transmission & gathering lines, placing it #5 on the Gas Pipeline list. It serves as the anchor of KMI’s interstate pipeline transportation and storage business. Its acquisition in 1997 by KN quadrupled the size of KN.
• KN Interstate Gas Transmission Co. has 6,694 miles of transmission lines, placing it #16 in gas transmission.
• It’s a majority partner of Trailblazer Pipeline Co., with 436 miles of transmission lines, ranking it #72, and a 50-50 partner in TransColorado Gas Transmission Co., ranking it #82.
• KN Energy, another division of KMI, ranks #68 on the list of Gas Distribution Utilities with 224,677 customers and 7,380 miles of mains.
• Kinder Morgan Pacific (formerly Santa Fe Pipe Line) ranks #9 on the Liquids Pipeline list with 1998 throughput of 382 million barrels. Its North Line, also known at Kinder Morgan Operating L.P., ranked #65 with 37.5 million barrels.
• Plantation Pipe Line Co., in which Kinder Morgan owns a majority interest, ranked #19 with 222 million barrels.

The combined company is the nation’s third-largest in terms of miles of total pipe; sixth-largest in terms of natural gas throughput; largest independent owner/operator of refined products pipelines, and second overall only to Colonial Pipeline.

Kinder Morgan’s major assets at the start were a pair of interstate common carrier NGL pipeline systems: the 1,616-mile North System which is a major transporter of products between the NGL hub in central Kansas and Chicago-area industrial customers, and Cypress Pipeline, a 100-mile NGL line from East Texas to Lake Charles, LA, with capacity to move 55,000 barrels a day; and a central basin CO2 pipeline, which operates in the Permian Basin and was later combined into Shell C02 Company, Ltd. in exchange for equity.

In October 1997, they bought Santa Fe Pacific Pipeline Partners, L.P. from Burlington Northern Santa Fe Railroad for about $1 billion in units (rather than shares) and cash; they also assumed about $350 million worth of debts. Renamed Kinder Morgan Pacific, the deal added 3,300 miles of common carrier pipeline and 14 truck-loading terminals in Arizona, California, Texas, New Mexico, Nevada and Oregon. It created the largest pipeline MLP in the nation and more importantly, gave Kinder Morgan a crucial foothold on the West Coast. The acquisition has been extremely successful for the partnership in terms of revenue growth and cost cutting.

Quickly, they were able to take $20 million a year in costs out of the system, which was 16 percent of the general administration and O&M side. The system moves all of the gasoline, jet fuel and diesel into Arizona, mostly from Los Angeles with some emanating in El Paso. Santa Fe also moved them into Nevada, where they’re the only supplier to a products pipeline into Las Vegas, and Reno. Morgan said the company touches about 60 percent of all the products piped into California, covering nearly all of Southern and Northern California in addition to a small line that stretches into Oregon.

Then in June 1998, the MLP paid $110 million for Equilon’s 24 percent interest in Plantation Pipe Line. A year later they took over majority ownership by spending $124 million for Chevron’s 27 percent ownership in Plantation. Plantation owns and operates a 3,144-mile common carrier refined products system throughout the Southeast, including Atlanta, Charlotte and culminating in the Washington, D.C., area. Equilon was required to divest its Plantation holdings as the result of the joint venture between Texaco and Shell Oil.

An MLP has certain tax advantages over being a publicly held “C” corporation, which KN Energy was, and is what KMI still is. Both the MLP and KMI are publicly traded with corporate structures. MLPs were popular entities in the early ‘90s as a means of eliminating corporate tax burdens. They were considered good moneymakers because a requirement in these partnership agreements is that all available cash flow is paid out instead of having a chance to grow. Kinder and Morgan decided to create a growth MLP. By looking at assets and returns on a pretax basis, they have a definite advantage over publicly traded companies in terms of bidding for particular acquisitions, Morgan said.

“We thought if we could grow the business and get the price of the units up, we could use that as our currency to acquire additional pipelines and assets, and that’s the way it worked,” Kinder said. Since they took over, they’ve returned 266 percent to their unitholders from Jan. 1, 1997 to Jan. 1, 2000, a statistic that has made them highly regarded by Wall Street.

Certain book-keeping rules make it difficult to acquire “C” corporations, so Kinder and Morgan and First Union, their other major investment partner, decided to take the general partner, which manages the MLP in return for a percentage of the cash flow, public. The IPO would allow them to have a “C” corporation currency. Then in July, KN’s deal with Sempra suddenly collapsed. Kinder Morgan pulled their IPO off the road and assembled a deal in which KN would buy Kinder Morgan’s general partner. KN also had to hand over management control, even though Kinder Morgan and First Union would only own about 38 percent of the company.

“We certainly were not going to put up a substantial part of our personal fortunes and not have control of the enterprise,” Kinder said. The deal was closed on Oct. 7 and Kinder Morgan Inc. was formed. They quickly formulated a three-part plan to improve unit holder value.
“We recognized that there was risk in the KN group of assets, but we thought fundamentally they were very strong assets,” Kinder said. “We needed to get the company back to basics.” First, the new managers redefined the company’s core businesses: interstate natural gas pipelines and associated assets, interstate refined products pipelines, retail natural gas distribution, and power development.

They said they would sell off $750 million to $1 billion worth of KN assets and use that money to pay down debt. Because they prefer to focus on businesses that are fee-based, high on their list of divestitures are the processing plants which normally face steep volatility based on cyclical commodity prices. They are divesting KN’s international assets which consisted of operations in Mexico; marketing and trading oprations along with the West Texas pipelines; Wattenberg Gathering and Processing; KN Field Services and Compressor Pump & Engine and Orcom. (Editor’s Note: On Feb. 8, ONEOK agreed to buy all of KMI’s gas gathering and processing businesses in Oklahoma, Kansas and West Texas, in addition to KMI’s marketing and trading business, and certain storage and transmission pipelines in the mid-continent region. KMI gets $114 million in cash plus other considerations that could make the whole deal worth $400 million).
Kinder Morgan also dumped en.able, KN’s highly touted but unsuccessful energy services subsidiary. They still plan to do some product marketing through their retail sales operation, but it will be strictly gas related, such as selling gas-fired fireplace logs and warranties on gas appliances.

Cable TV is history.
“They were trying to do telephone, cellular service and a lot of other things,” Kinder said, noting that energy companies need to be careful where they venture.

“It turned out to be more trouble than the money they were making off of it,” he said. “Cross marketing is very difficult because you train your people to understand natural gas and how to dispatch crews to fix a broken line in Colorado. You don’t train them about TV dishes and home security. It got to the point where they really were not doing a good job at servicing those customers and it was flopping over. When people are dissatisfied with the way you treat them on one thing, they naturally infer you must not be very good on the natural gas side either.”
Kinder Morgan chopped KN corporate overhead costs by about $70 million. One-third came from payroll reductions including lopping off 500 positions through attrition and layoffs. Almost all of the cuts were at the corporate level rather than field operations.

“You don’t take a meat clever in the field because they require a lot of autonomy. That’s your lifeline out there,” Kinder said.

Second, Kinder Morgan moved more than $700 million of remaining assets, including KN Interstate Gas Transmission Co., into the MLP so that KMI can participate in its future growth through its general partner interest.

“Rather than sell an asset to another company for $100 million and use that to pay down debt, if we sell to the MLP, we not only pay down debt but as the general partner we still get about 40 percent of the cash flow and earnings from that asset. It’s like getting a third more and that’s a powerful financial tool that you can use to put these things together.”

Aggressive Management
Kinder and Morgan work for $1 a year each, that dollar allowing them to be eligible for health insurance. Kinder owns about 25 million shares and Morgan about 8 million shares.
“I don’t think there’s any other energy company that has management with this much of an equity position in it,” Kinder said. “This is not a deal where we get a bunch of additional options or pay ourselves bonuses. Where you have a management so directly aligned in interest with the shareholders is very positive.”

With their personal fortunes directly tied to the company’s bottom line, they wince every time they have to write a check. So there are no private planes or fancy offices housing Kinder Morgan. They also got rid of $1 million in sports tickets in Chicago, Denver and Houston which they inherited from KN’s previous management. They even combined their insurance programs to save a few bucks.

Third, Kinder Morgan has very aggressive managers, said Kinder, who, during a spate of recent promotions, announced that they are targeting $1 billion in new acquisitions.

“The end result is we’re going to have two very large companies operated by the same management team. We think we can make this a very successful multibillion-dollar company and continue to grow,” Morgan said. Plenty of know-how in operating pipelines is another of their fortes. Kinder and Morgan have 50 years between them; William Allison, who is responsible for the natural gas pipelines, came from Enron with many years of experience; so did Deborah McDonald, who is in charge of NGPL, their largest single asset; and Thomas Bannigan, who was named president of products pipelines last year. He previously worked for Exxon and Plantation Pipe Line.
To their way of thinking, liquids pipelines, especially in California, represents tremendous market potential. A city’s population might grow, but that does not guarantee natural gas use will grow proportionately, Kinder and Morgan said. But products pipelines that move gasoline for cars and jet fuel for planes are directly related to demographics. Kinder Morgan Pacific’s products lines serve four of the 10 fastest growing metropolitan areas in the country. They expect volume on their California mainlines to grow by “an incredible” 3.4 percent for 1999. That will amount to about $11 million that will almost all fall to the bottom line.

Growth on their other main products line, Plantation, which runs from the Southeast into Washington, D.C., will show a 1.5-2 percent growth, a “good” growth rate, Kinder said. The company now moves about 370 million barrels a year; that should grow by about 12.5-13 million barrels.

After acquiring Santa Fe, Kinder Morgan aggressively went about developing the system. They expanded the mainline coming out of six refineries in the Long Beach port area. They spent $30 million adding 16 miles which gave them more 53 percent more capacity (from 340,000 bpd to 520,000 bpd) down to San Diego, out to Las Vegas and even more importantly, to Phoenix. They’re now de-bottlenecking a part of the San Diego line which is running full. They’ll also be doing more debottlenecking near Phoenix. One project they’re not quite ready to undertake is connecting the two California systems. Neither the Northern California refiners nor the Southern California customers have been willing to pay through long-term throughput agreements to connect the two, and Kinder Morgan won’t build pipelines unless the customers are willing to support them.

“The truth is a lot of these products that have come down end up in our line anyway, coming to the port and connecting with our Long Beach station,” Morgan said.
Kinder Morgan breaks down its capital expenditures into two parts: in 1999 the MLP had a “sustaining” capital budget of $25 million to cover normal O&M costs. Between $45-$50 million was spent last year on new projects, mostly in Southern California. They spent another $5-$6 million on projects in the Midcontinent area. For 2000, they’ll spend $22-$23 million on the capital budget and about $30 million for expansions, primarily in San Diego. This excludes Plantation, which has its own maintenance budget since it’s a joint venture. KMI, the old KN, will have a capital budget of $100-$120 million.

One opportunity Kinder and Morgan are watching closely involves the Plantation Pipeline, of which they own 51 percent. ExxonMobil has been ordered to sell either Exxon’s 49 percent interest in Plantation or Mobil’s interest in Colonial Pipeline by August. Kinder Morgan has right of first refusal on Plantation and if it’s put up for sale, Morgan said he is “almost certain we will get it.” They are also looking at certain assets that BP Amoco is selling.

“The whole idea of these merging majors is a help for us on the products pipeline side because this is not something they need to stay in and we can run it very cheaply for them,” Kinder said. “You don’t gain an advantage by owning, if you’re a shipper across that line, which we are not. It’s not like Exxon can own a pipeline and charge itself a 20-cent tariff and charge everybody else 40 cents. We’re a good outsourcing tool as these majors merge and rationalize their assets.”
They are also studying prospects to expand in the Southeast off of Plantation to areas such as such as Charleston and Nashville.

Kinder and Morgan also expect opportunities to evolve on the natural gas side of their business. “Obviously what we would be interested in are pipelines that connect with us that could take throughput off of our system to other areas of the country,” Kinder said. They would like to expand the natural gas retail system because their call center can accommodate about 1 million meters, four times than what is now connected, at minimum extra expense, he said. That means they might be in the market for some local distribution companies, especially in the Rocky Mountain states where KMI is centered.

“There are a lot of LDCs in this country, many with 10,000 customers. They are generally not as efficient because it’s just too expensive to spread your cost over 10,000 meters vs. spreading them over a million meters. There is some room to grow there and it’s a profitable business if you run it right, especially if you can roll several of them together. That would be our strategy,” Kinder said.
The restructuring of the gas industry on the local level is appealing to Kinder Morgan because, as transporters, LDCs will operate as fee-based assets, much as the long-line pipelines already are. Kinder Morgan has zero interest in marketing, and is selling off its marketing company.

Future Expansion
Plans to increase throughput by one-third over the next 15 years will require considerable expansion, especially for electric generation facilities. KMI is in a unique position because its mainline, NGPL, serves the Chicago area, where the need for power generation is probably unmatched in North America. The company is working with third parties to assemble plants along its line and will participate as an owner in several of them, Kinder predicted. They already have a small power subsidiary near Denver, but it is seen merely as an added moneymaker, he said. They don’t really care who builds or owns them, as long as they see increased throughput. KMI has renewed long-term agreements with its two largest customers, Nicor Gas and Peoples Energy, and entered into new long-term agreements with Aquila Energy and Ameren Corp.
Regarding competing fuel sources, Kinder said there will always be a need for significant coal generating capacity in the U.S., but doubts there will be any new coal plants built. He expects nuclear power will have a declining role, with not only no new plants to be constructed, but many shutting down before their licenses expire. The use of hydropower is relatively modest and seems to have few prospects for growth, he said. All of this portends to a rosy future for natural gas.
“The only source for that new generating capacity, at least for the next 20 years or so, is natural gas,” Kinder said. Users will range from centrally located merchant or independent power plants to small distributive power generators that will grow as the cost comes down over the next 10 to 15 years.

Kinder Morgan recently increased its ownership of the Trailblazer Pipeline System from one-third to two-thirds share. It inherited a partnership with Questar on the TransColorado Pipeline that so far has been underutilized. That may change if and when Rocky Mountain gas ever moves down and over to California, Kinder said.

Some industry experts contend that the industry can actually use more peak-shaving facilities instead of more pipeline construction. Kinder takes issue.
“Peakers still need pipelines to get the gas there. In fact, you could argue that peakers require more capacity because they are peakers - they don’t use it all the time but when they need it, they really need it. You may see a real anomaly a few years from now because you may have summer markets in part of the North that you think are not big in the summer but will be very big for natural gas just because of the electric demand,” he said.

O&M
The company will never scrimp on maintaining its extensive system, Kinder said, vowing that he and his fellow executives will “ride the back of the bus” if they have to in order to keep their pipelines in shape. They are in the midst of smart pigging their entire Pacific system, which should take another 18 months. Operators found one weakness last summer in the desert and immediately replaced 180 feet of pipe. The plan is to smart pig the whole system on a four-year rotational basis, starting with Kinder Morgan Pacific and Plantation, then moving on to NGPL, which Kinder said is physically in very good shape.

The company maintains several control rooms and has no plans to consolidate them, Kinder said.
“It may be impressive to control all of this from one floor in the building, but in point of fact you have to have separate people on each of these machines anyway. You can’t have one person who’s watching more than one pipeline at a time,” he said.

Although the technology is somewhat different, the similarities outweigh the differences when comparing liquids and natural gas pipelines, Kinder said. “There are different nuances, but it’s not a stretch at all to run both types of pipelines.”

How do you benchmark this type of company? Only the bottom line can tell you how to do that, said Kinder, who once oversaw a big benchmarking project while serving as chairman of the Interstate Natural Gas Association of America, (INGAA).

“It’s hard to compare pipelines because how many people does it take to run a particular district? It really depends on what your compression format is, what your volumes are—whether they’re seasonal or year-round—are you going through climates where you have freezes, are you going through swamps.

“Benchmarking against other companies is always interesting and we do some of that, but the most important thing when you’ve been in business as long as we have is that you get a feel for what’s efficient and what’s not. You’ve got to benchmark yourselves more than anything else,” he said.

Added Morgan, “Today we’re really running the company for the shareholders and the real benchmark is what kind of value we produce for them.”

Morgan and Kinder are lawyers. Ken Lay, who talked Morgan into joining Florida Gas Transmission (and Morgan shortly afterwards talked Kinder into joining Florida Gas as well), is an economist with a Ph.D. It’s indicative of the new wave of executive being chosen to lead the gas industry, and subsequently the energy industry today.

“It’s been this way since deregulation started,” Kinder said. “The mindset that you need to run a successful midstream energy business really calls for having some understanding of the law, economics and ratemaking has become virtually required. Not that you don’t need people who are good engineers and can operate the pipelines and understand depletion. But these other skill sets are very important today.” P&GJ