Paying attention to Kinder Morgan’s (Parent: NYSE: KMI, daughter: TSX: KML) announcement that they’re stopping non-essential expenditures in relation to the Trans-Mountain pipeline (that goes roughly between Edmonton, Alberta to Burnaby, BC) expansion.
There’s a lot of political rumblings and a ton of public ignorance displayed, which usually is a good recipe for market reactions that lead to opportunity.
KMI owns 70% of KML. KML owns the assets relating to the Trans-Mountain pipeline. The assets currently pump about 300,000 barrels per day and very roughly, in 2017 produced $250 million in operating cash flow (allow me to ignore the very relevant capital expenditures in this post – they spent $618 million, the majority of which was on the Trans-Mountain expansion project – $445 million on pipelines and $173 million on terminals).
There are about 350 million shares outstanding in KML, so the most elementary analysis possible is that if KML decided to pack up shop and just keep the existing (and aging) infrastructure in place, they will generate about 65 cents of cash for shareholders – this is subtracting the amount given to preferred shareholders. Other than the preferred shares and pension liabilities, there are no other material amounts of debt or obligations on the balance sheet that is noteworthy for this analysis.
Obviously this amount would not be enough to sustain the existing stock price – currently CAD$18.44/share – the earnings yield would be around 3.5%, although this would be a very stable yield given that this is the only oil pipeline connecting the west coast of Canada to oil-rich Alberta. The expansion project is expected to bring in $900 million in EBITDA in the first 12 months of operations, plus spot volumes up to another $200 million. Since the project is expected to cost around $7 billion, a financing at 5% would still result in substantial after-tax cash flows.
A tripling of the pipeline capacity will, suffice to say, be extremely profitable for Kinder Morgan. Strategically speaking, the asset is the only oil-carrying pipeline from Alberta to Vancouver (good pipeline map resource here). Vancouver’s sole oil refinery is the Chevron facility, west of SFU. The nearest competitor is refined fuel product from Cherry Point, WA, which makes Vancouver extremely vulnerable to any slowdown/shutdowns in both oil capacity and refining capacity.
Politically speaking, there are a set of huge competing interests at play:
– The federal Liberal government attempted to play a “middle ground” by supporting the pipeline, but they are dragging their feet on doing anything to getting it approved, and one can infer from Bill C-69 that the government intends to create so much regulatory uncertainty in the approval of any major national projects that they simply are not going to be built. Bill C-69 makes it impossible to know what conditions (and thus costs) it will take to approve projects requiring federal environmental assessment (soon to named “impact assessment”) approval. The Liberal government probably realizes at this point there is zero vote-getting ability for them to support the Trans-Mountain expansion, so they will only give lip service toward its approval – and lip service so they can avoid being seen as flip-flopping.
– The Alberta Government, led by NDP Premier Rachel Notley, has a huge economic interest in the pipeline. While inherently most of the people in her party are against pipelines in general, a lot of Alberta’s economy depends on the fortunes of the oil industry and if the NDP are going to have any chance of being re-elected, they need to galvanize the feelings of voters that they (and not UCP leader Jason Kenney) are best to fight Ottawa and British Columbia.
– The BC Government, led by NDP Premier John Horgan, is fighting on a side which inherently favours them. They attempted to enact some provincial regulatory reforms to make it more difficult for the pipeline to proceed, and they can do this because they have the support of their party and also the 3 Green Party MLAs that are strongly against the pipeline (the government is a narrow minority government that requires the support of the 3 Green Party MLAs in order to maintain supply). They have everything to gain by combating Alberta and Ottawa and only a modest amount to lose as not too many NDP supports would support the economic-creation aspects of pipeline construction. In addition, the majority of gains to be made if the pipeline expansion is completed is Albertan oil companies, so this does not favour BC. The BC Government will likely do anything it can to stall the project and will only yield way if required to do so by court judgement – that will be their “out” to explain to the public that they tried.
It appears pretty obvious to me that the current Nash Equilibrium is the pipeline expansion will be indefinitely stalled. It will probably take a Supreme Court ruling to unlock the situation and one is not forthcoming due to the Federal government intentionally deciding to not participating in a planned BC-Alberta reference case – lest the reference (info) definitively decide the matter (which works against the three governments’ existing interests).
The whole point of carbon pricing is that you can cut out all this regulatory middleman stuff. Set the rules, step back, see what happens. Yet governments at every level seem to think carbon pricing is something completely separate from everything else in their regulatory toolbox.
Pipelines are the most egregious example, but in general it feels like we’re collectively losing the ability to build things as a society. We all want to enjoy things that are built, nobody wants to be seen actually building them.
@Andrew: Don’t get me started on carbon taxation! What I find particularly funny is that so many people bought into the line of “revenue neutrality” when one can use the same claim for any form of taxation imposed on people that gets dumped into general revenues (the accounting for revenue neutrality was an arbitrarily selected fiction with arbitrary benchmarks). At least the current BC NDP government is honest enough to get rid of that claim of revenue neutrality which is a stance I can actually respect.
“but in general it feels like we’re collectively losing the ability to build things as a society.” – I’d prefer to refine this claim as “we’re collectively losing the will to build things as a society”. I don’t think there is any debate that we can build the pipeline if we wanted to, but the constraint here is political and not engineering/technical.
That said, if technical skills stagnate long enough, then subsequent constructions will become much more expensive to implement. A good example of this is nuclear power engineering…
carbon pricing is just another money grab in disguise – just like the paperless statement from my broker / a nickel for shopping bags, another excuse to hike fees while cutting service and them pocketing the profit in either fees or savings
the environmentalists on the left along with the social conservatives on the right are two major progress hindering forces in North America right now.
KML is down 11% to $16.50/share. It opened as low as $15 in the very beginning of trading (a lot of participants obviously decided to hit the sell button).
Given that the approvals are good until 2021, there seems to be the capacity to stall out the clock, so the stock is going to increasingly price a lower probability of the Trans-Mountain expansion being built.
The question then becomes – how much is a KML worth with a deal Trans-Mountain expansion killed? Roughly 75 cents per share cash flows, minus some maintenance CapEx, preferred share dividends, taxation? A most rough estimate (this is just really picking arbitrary numbers) would be 7%, which would render roughly an $11 share price.
Headline: “Alberta prepared to buy Trans Mountain pipeline outright, Notley says” – this is never going to happen unless the province is stupid enough to offer billions for it (roughly $7-8 billion and I think Kinder Morgan would take it). Not going to happen.
Doesn’t KML looks quite undervalued now post this transaction? They get to keep the terminal segment and that generates 48% of the EBDA.
Depends what management does with their $12/share (i.e. doesn’t give out executive bonuses like Halloween candy!). If KMI doesn’t absorb KML they should probably just special dividend the cash off and be a standalone entity or sell the rest of it out to PKI or something. But yes, post-transaction they do seem somewhat cheap.