- Created on Tuesday, 18 October 2011 07:00
- Published on Tuesday, 18 October 2011 07:00
- Written by Justice Litle, Editor, Inside Investing Daily
- Hits: 8505
The biggest ever pipeline deal highlights a clear truth: America's energy future is bound up in natural gas.
Standard Oil made John D. Rockefeller the richest man in history (adjusted for inflation).
Now a new deal maker, Richard Kinder, is cementing a reputation as the Rockefeller of natural gas pipelines.
Old John D. established Standard Oil in 1870. By 1911, some 41 years later, Standard Oil had grown too big and powerful. In response to public outcry, the U.S. Supreme Court forced a break-up of Standard Oil under the Sherman Antitrust Act. A few of the companies to emerge from that breakup were Exxon, Mobil (later to combine as Exxon Mobil), Amoco and Chevron.
Richard Kinder's company, Kinder Morgan (KMI:NYSE), is going the other way -- rolling up new assets to get bigger, not smaller. And natural gas pipelines are the crown jewel. "If you believe in natural gas, you believe in putting together the biggest possible network," Kinder says.
With the just announced deal for Kinder Morgan to buy El Paso Energy Corp. (EP:NYSE), Kinder Morgan will own 67,000 miles worth of oil and gas pipelines, transporting more than 1 million barrels of fuel per day... making it the largest natural gas pipeline operator and the fourth largest energy company (by enterprise value) in America.
The El Paso deal is Kinder Morgan's largest ever, at $38 billion ($21 billion in shares and cash plus $17 billion in debt). The merged company will have a combined enterprise value of $94 billion. It counts as a "once in a lifetime transaction that is a win-win for both companies," Kinder said.
The combined companies could see $350 million per year in cost savings, worth 5% of earnings. Kinder Morgan's stock rose on the news -- a sign that shareholders approve of the move. (Oftentimes an acquirer will face punishment, in the form of a falling share price, if the Street does not like the price paid in a deal.)
The merger is essentially a big bet on North American shale. The oil and gas extracted will need pipelines to transport it, and Kinder Morgan will make a mint supplying them.
And when it comes to shale, America is rich indeed: The Utica shale, for example, contains an estimated 25 billion barrels of oil and gas (according to Chesapeake Energy CEO Aubrey McClendon).
The race to tap these shale deposits has been a godsend to the Rust Belt -- the forsaken flatlands of middle America -- as leasing rates for drilling rights jump a hundredfold or more.
"In eastern Ohio," the Financial Times reports, "brand-new tractors have been zooming off the dealers' lots, snapped up by local farmers." Those newly flush farmers are seeing rates of $1,500-$4,000 per acre for drilling on their land, where they would have seen just $15 per acre not long before.
Natural gas could change everything. For the Rust Belt states, phrases are being thrown around like "economic revolution" and "industrial renaissance."
Says Aaron Liveris, CEO of Dow Chemical: "It's a phenomenal opportunity... This is a gift that American entrepreneurs, the wildcatters, the oil and gas drillers, have given the country: 100 years of natural gas supply. There's no country on the planet that wouldn't love to get that, and then use it."
Right now, though, more pipelines are needed to capture and move that gas. As The New York Times reports,
Many of the country's shale fields, including the Bakken in North Dakota, the Eagle Ford in south Texas and the Marcellus in Pennsylvania, lack the pipeline capacity to carry all the oil and gas being produced there. The surge in output has produced such a glut that the price of natural gas has plummeted, and excess gas is being burned off instead of being captured.
Kinder Morgan's story is fascinating in its own right. Richard Kinder had a 16-year stint with Enron, the disgraced energy company that stumbled 10 years ago this week.
As president and CEO of Enron, Kinder dodged a bullet when he decided to leave the company in 1996. His later replacement, CEO Jeff Skilling, wound up serving 24 years in prison.
Kinder, meanwhile, formed Kinder Morgan with the help of a partner, William Morgan, and sought to invest in $40 million worth of unsexy pipeline assets that Enron no longer wanted. From its very modest start, Kinder Morgan then grew through a rush of shrewd deal-making over the years -- most of them less than $500 million.
Where is there opportunity here?
One place to look is the Revere Natural Gas ETF (FCG:NYSE), which represents a basket of high-quality natural gas companies.
As America moves closer to its natural gas renaissance, more pipelines and transport infrastructure will be put in place. Excess shale gas will be tapped and shipped to users (instead of getting burned off for lack of means to transport it). This will boost the profits of the natural gas sector, as more sales fatten the bottom line.
The increased availability of cheap gas will then cause demand to ramp higher, as consumers grow more reliant on such a domestic and abundant energy source. At some point the government will embrace natural gas economics too... fueling a virtuous circle for natural gas companies in general.