DBRS Confirms Kinder Morgan Energy Partners, L.P. at BBB (high) and Kinder Morgan Kansas, Inc. at BBB (low), Both with Stable Trends

DBRS has today confirmed the BBB (high) rating on the Medium-Term Notes & Unsecured Debentures of Kinder Morgan Energy Partners, L.P. (KMP or the Partnership) with a Stable trend. DBRS has also confirmed the BBB (low) rating on the Senior Medium-Term Notes and Debentures of Kinder Morgan Kansas, Inc. (KMK; formerly, Kinder Morgan, Inc.) with a Stable trend. Concurrently, DBRS has discontinued the R-2 (high) rating on the Commercial Paper of KMP. DBRS notes that the discontinuation is unrelated to KMP’s credit profile.

The confirmation of the Partnership reflects its stable regulated pipeline businesses and solid coverage ratios at the end of the first half of 2011 (H1 2011). In July 2011, KMP acquired the remaining 50% interest in KinderHawk Field Services LLC (KinderHawk), a natural gas gathering and treatment business, for $911 million in cash and assumed $77 million in debt. This acquisition, combined with the acquisition of the initial 50% interest in KinderHawk in 2010 for $917.4 million and other minor acquisitions made earlier in the year, has modestly increased KMP’s business risk, reflecting the unregulated nature of the businesses acquired. In the near to medium term, KMP’s risk will be mitigated by the long-term contracts with Petrohawk Energy Corporation (Petrohawk) and other shippers. On a pro forma basis, the debt-to-capital ratio increased to 64%, 4% higher than the level at the end of H1 2011. Although this leverage level is considered relatively aggressive given the higher business risk, cash flow-to debt (20%) and EBITDA-interest coverage (5.00 times (x)), all on a pro forma basis, remain within KMP’s current rating category.

In addition, cash flow contributions from regulated businesses still account for 50% of total consolidated, supporting cash flow stability. Furthermore, DBRS believes that KMP’s non-regulated business risk is mitigated by medium- to long-term contracts that have minimum-capacity payment requirements.

KMP benefited from increased earnings in 2010 and H1 2011 from its regulated businesses as a result of substantial capital investments made in 2008 and 2009. In addition, higher-risk non-regulated businesses, especially the carbon dioxide (CO2), have also made strong earnings contributions, reflecting higher crude oil prices and volumes.

The current rating is supported by: (1) Regulated pipelines remain the key cash flow contributors to the Partnership, benefiting from stable regulations in the United States and Canada. In addition, KMP also benefits from the rising long-term contractual support from its three largest natural gas pipeline projects in full service, with very limited short-term price and volume risk. The average contract life of all regulated pipelines is approximately nine years, providing predictable cash flow.; and (2) Non-regulated businesses (CO2 and Terminals) currently benefit from still-strong crude oil prices. Although these two segments are exposed to long-term economic conditions and commodity price volatility, the exposure is mitigated by contracts that feature minimum-payment requirements. The average life of all contracts is approximately three to four years for terminals and 4.7 years for CO2.

KMP maintains sufficient liquidity through its new five-year $2.2 billion credit facility ($2.0 billion available at July 1, 2011). Although the available amount should be further reduced following the KinderHawk acquisition, DBRS believes that KMP’s liquidity currently remains sufficient to finance its ongoing working capital and capex needs. KMP’s financing strategy is to finance its capex and acquisition with credit facilities and to refinance with a mix of long-term debt and equity in the long term. Although KMP’s stated financing strategy is to maintain its expansion budget and acquisitions with 50% debt and 50% equity, debt levels in the capital structure have been at or above 60%, reflecting the impact of distributions well in excess of net income, which is in the nature of the MLP vehicle.

Despite these strengths, KMP faces a few challenges, including regulatory risk in the regulated segments and long-term exposure to commodity and market risk in the unregulated operations. In H1 2011, the Partnership recorded a non-cash charge of $165 million related to various claims from regulatory proceedings from the West Coast products pipeline transportation rate. In addition, contracts in CO2 and Terminals can only mitigate the price and volume risk in the near to medium term. Since the Partnership’s business risk has increased, DBRS expects KMP to remain disciplined in its financing strategy to maintain an appropriate leverage level. DBRS expects the current leverage to return to the pre-KinderHawk acquisition level over the medium term and all other key metrics to remain within the current rating parameters.

RATIONALE FOR CONFIRMATION OF KMK:
In February 2011, Kinder Morgan, Inc. (KMI) changed its name to Kinder Morgan Kansas, Inc. (KMK) and the parent of KMI, Kinder Morgan Holdco LLC, changed its name to Kinder Morgan, Inc. (New KMI) for initial public offering (IPO) purposes. Following the name change, DBRS’s rating of KMI applicable to KMK since all the debt remained at the KMK level. New KMI, through KMK, owns a 13% effective interest and a 50% economic interest in KMP.

The confirmation of KMK reflects strong cash distributions from KMP, which account for approximately 96% to 97% of all cash distributions received by the parent (KMK). On a deconsolidated basis, cash flow-to-interest coverage has been strong over the past years and remained very strong at the end of H1 2011, with a pre-tax cash flow-to-interest coverage of more than 8.0x (greater than 5.5x since 2008). Going forward, even if zero cash distributions from its 20% interest in Natural Gas Pipeline Company of America (NGPL) is assumed, the level of cash distributions from the Partnership is still more than sufficient to service its financial obligations at the parent level. The two-notch difference between KMK and KMP reflects the following: (1) KMK’s debt is structurally subordinated to the debt at KMP; (2) high debt levels remain at KMK, while KMK relies mostly on a single source of cash flow to finance its debt; and (3) there is the potential of regulatory restrictions on cash distributions from the regulated pipeline entities.

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

The applicable methodology is Rating North American Pipeline and Diversified Energy Companies, which can be found on our website under Methodologies.