DBRS Confirms Kinder Morgan Energy Partners, L.P. at BBB (high), R-2 (high), Stable Trends

DBRS has today confirmed the R-2 (high) rating on the Commercial Paper and the BBB (high) rating on the Medium-Term Notes & Unsecured Debentures of Kinder Morgan Energy Partners, L.P. (KMP or the Partnership), both with Stable trends. The confirmation reflects DBRS’s expectations that KMP will restore its credit metrics to 2007 and 2008 levels by 2011 to be consistent with the current ratings. The credit metrics were negatively affected by the $921 million purchase of a 50% interest in a joint venture with Petrohawk Energy Corporation (Petrohawk) in May 2010 (the Transaction) as well as rate cases settlement (total payments of $206 million) on the Products pipelines segment. On a positive note, DBRS believes that KMP has passed the point of maximum risk on project execution. Its business risk has improved by proxy of the rising long-term contractual support from its three largest natural gas pipeline projects in full service from the second half of 2009 (H2 2009). Regulated pipelines and take-or-pay contracts are estimated to account for over 50% of EBIT and distributable cash flow (DCF) in 2010 (2% to 3% above 2009 levels) and should remain at this level, near term.

The majority of the remaining businesses are low-risk and fee-based with minimum volume guarantees, including the KinderHawk joint venture (JV) recently established pursuant to the Transaction, providing a measure of earnings and cash flow stability. In addition, crude oil production, the most volatile of the operations (projected at 22% of 2010 DCF), is close to 90% hedged for 2010 and 72% in 2011 at rising prices. KMP’s balance sheet leverage is aggressive (63% at June 30, 2010) with cash flow-to-debt falling below 0.20 times for the first time in the last ten years to 0.18 times, and debt-to-EBITDA of 4.2 times for the last 12 months ended June 30, 2010 (LTM), although other cash flow coverages shown incremental improvements.

On an adjusted basis excluding the one-time rate cases settlement, cash flow-to-debt of 0.20 times is more acceptable. The cash flow coverage ratios are more meaningful measures for a Master Limited Partnership (MLP) which pays out almost all available cash flow, depressing its equity base. DBRS expects de-leveraging from 2010 to restore debt-to-capital to the low-50% levels, over time, when the final major gas pipeline project, the Fayetteville Express Pipeline (Fayetteville - 50/50 with Energy Transfer Partners) is scheduled to commence in Q4 2011 and the JV is in full operation. (KMP’s 9M 2010 operating results are within expectations.)

The Transaction entailed the purchase of a 50% interest in the JV, consisting of Petrohawk’s natural gas gathering and treating business (G&T) in the Haynesville shale formation (Louisiana) for $875 million plus $46 million of capex and other adjustments. This provides KMP with access to one of the most prolific shale gas basins in North America, which is supported by the first five years of minimum volume commitments by Petrohawk, and life of lease dedication of volumes from all its operated Haynesville and Bossier shale gas fields in Louisiana. Total volume of 600 mmcf/d is expected to rise to 800 mmcf/d by year end (ultimately to 2bcf/d), enhancing KMP’s transportation and treating capacity on a fee-for-service basis, with no direct exposure to commodity prices. The rate cases settlement mentioned above related to the long-standing disputes with all but one of the shippers in the Pacific region of the Products pipelines segment. To mitigate the impact of the $206 million settlement on DCF, KMP’s 13% parent (including a 2% General Partner (GP) interest), Kinder Morgan Inc. (KMI), has agreed to effectively reduce its incentive distributions by about $168 million in December 2010. This should help KMP to achieve its stated target of $4.40 per unit distributions for 2010 (4.8% growth over 2009).

KMI (rated BBB (low), Stable trend, by DBRS) typically receives about half of KMP’s cash distributions mostly through its ownership in the GP. However, KMP is a stand-alone operation that is legally separate from KMI. It also put in place “ring-fencing” mechanisms in 2007 and a board structure with majority independent board members when Knight (then renamed from KMI and reverted to KMI in 2009) was taken private. Distribution parameters are also relatively well-defined.

KMP maintains sufficient liquidity through its new three-year $2 billion credit facility ($1.2 billion undrawn at June 30, 2010) negotiated in June to replace its $1.79 billion line, expiring in August. It has also succeeded in raising close to $1 billion of equity and $1 billion of senior notes to date, which should mostly suffice to meet capex and modest debt maturities ($250 million) for the remainder of 2010. Both Rockies Express (REX) and Midcontinent Express (MEP) pipelines are considered self-financing and previous owner guaranteed project debt has largely been refinanced on a non-recourse basis upon project completion. DBRS expects Fayetteville’s guaranteed debt will be similarly refinanced, going forward.

KMP’s significant organic growth phase from 2007-2011 has mostly been completed, principally with the three major gas pipeline projects, REX, MEP and Louisiana in full service, and Fayetteville scheduled for start-up in December 2010. Future growth is expected to be more spread out through acquisitions and more modest-sized organic expansions. This should leverage on the partnership’s pipeline access to all major shale gas basins in North America and the expanding terminal network in handling renewable fuels. The projected annual growth of 5% to 7% (8% previously) should be achievable at the lower end, mostly based on contracted and fee-based businesses.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating North American Energy Utilities (Electric, Natural Gas, and Pipelines), which can be found on our website under Methodologies.