What Happened With Kinder’s Write-Down: The Difference a Decade Makes

What to know about KMI’s $350 million write-down of MEP:

1. Potential for ETP, the other 50% partner, to also take a write-down
2. We’ve seen MLP write-downs before (without disastrous results)
3. Ten years is a long time and steel in the ground holds its value

What Happened With MEP
The MidContinent Express Pipeline (MEP) is a 50/50 JV between Kinder Morgan (KMI) and Energy Transfer Partners (ETP). A 42 inch natural gas pipeline, it began service in 2009, running from Bennington, OK (northeast of Dallas) to Butler, AL (near the Mississippi border) where it connects with Transco’s pipeline. During the initial contracting period (open season), the pipeline was so obviously popular that a capacity expansion (from 1.5 Bcf/d to 1.8 Bcf/d) was planned and that additional space sold.

While the details of the contracts are private due to competitive reasons, typically, they are structured so that the MLP pipeline operator will make the necessary IRR during the initial term, which in this case, was 10 years.

Analysts may have been generally pleased with KMI’s earnings release last week, but it did include a $350 million write-down for MEP, driven by “expectations for lower future transportation contract rates.”

(This is one time the debt ratings agencies were ahead of the equity investors. Moody’s downgraded the pipeline back in March, astutely citing counterparty risk with Chesapeake Energy (CHK).)

Just to be clear: a write-down is a paper loss, meaning the asset is worth less on the financial statements. It’s still negative, but it’s not “the customers are not paying” or “this asset got damaged and is unusable”.

A Hiccup, Not the Beginning of the End
The immediate implication is that ETP may also take a similar write-down when it reports earnings. Even if it doesn’t, KMI’s write-down puts a pin in the value of the asset, and one hopes that both companies have already earned the necessary cash to make building the pipeline worthwhile.

As much as everyone loves pointing fingers, no obvious misstep was made. Ten years is simply a very long time and a lot changes in a decade. When MEP was first conceived of in 2006, it was only the beginning of the energy renaissance and “shale gas” was just entering our vocabulary; neither the financial crisis, nor the commodity bust were to be imagined. Not to mention, the exponential growth of Marcellus gas production, which has now displaced gas that MEP moves, hadn’t even begun in 2006. CHK was a major anchor shipper, but by no means the only one. The challenges CHK is facing may have been the impetus for the write-down, but CHK is not alone in struggling right now.

We’ve Seen This Before
This isn’t the first time a major pipeline has seen the world change from under it during the initial 10-year contract period. Famously, the Rockies Express (REX) originally brought natural gas from the Rockies to New England. REX was originally conceived of and built by KMI and Sempra Energy (SRE). First announced in 2005, the first stage was complete and gas began flowing in 2008. However, REX delivered gas to the heart of the Marcellus shale under ten year contracts that were only a few years old when fracking and horizontal drilling opened up the natural gas reserves in the area.

SRE took write-downs on REX in 2012, and Tallgrass Energy Partners (TEP) bought Kinder’s stake the same year (and eventually purchased SRE’s share this year). However, these midstream operators and stakeholders did not simply write the asset off because someone else had to write it down. The idea to reverse the flow of the pipeline was first floated in 2013, and the first gas began flowing westward in 2014. Steel in the ground continues to prove useful, even if that use would surprise its creators.

Again, Don’t Panic
Unlike REX, the customers of MEP are still likely very interested in using their allocated capacity (in the original direction!) but may need to renegotiate for lower rates. It’s not ideal, and the write-down is not good news, and ETP may also see a hit. However, given that steel in the ground holds its value, this news only reinforces Alerian’s commitment to MLPs as a long-term investment, not a short-term trade.