Kinder Morgan’s New Fundraising Effort Still A Massive Risk for Investors

“[T]he main story here continues to be the expansion of Trans Mountain from 300,000 barrels a day to 890,000 barrels a day, expansions under long-term contracts, approved by NEB. We've got our Facilities Application on file. We expect to complete construction still at the end of 2017.”

That was current KML CEO Steven J. Kean in KMI’s 2013 quarterly earnings call, shortly after the company filed its application with the National Energy Board for the Trans Mountain expansion project (the “Project”). Since then, the story has been delay after delay after delay -- the most recent, a 9 month construction delay, with estimated completion now at September 2020.

After a recent regulatory victory, KML is now trying to raise another $250M to help pay for the Project. But they won’t say what the recent delays have done to the Project costs. So how did we get here? And what might happen next?

Keen Kean observers already know to take Kinder Morgan executive’s statements with a large grain of salt. Some investors have even coined the term getting “Kindered”.

Kinder Morgan last updated its cost estimate in March 2017 when it was increased to $7.4B. The original estimate was $5.4B.

Since that March cost update, A LOT has happened, including:

• A new government was formed in British Columbia between two parties who were elected on platforms that both opposed the project.
• KML was launched in an IPO in which KMI packaged all of its Canadian assets, plus the Trans Mountain expansion project into a new company, KML. KMI sold 30% of the company to raise $1.75B. In doing so, it had to lower its price (from $22 to $17) and sell 5% more of the company than it originally wanted – a loss of about $1.2B in valuation of the new company.
• 17 legal challenges were heard in the Federal Court of Appeal and BC Supreme Court, with decisions expected sometime in 2018. Success or partial success in any of those cases could overturn approvals or cause further delay.
• Kinder Morgan lost a Federal Court of Appeal case on the original pipeline.
• Kinder Morgan was caught illegally installing anti-salmon spawning mats
• Protest camps have set up on Burnaby Mountain and near Kamloops
• Route hearings continue, and are expected to continue well into 2018
• Kinder Morgan won a motion with the NEB that allowed it to bypass 3 of the City of Burnaby Bylaws. A further motion on a process for other municipal and provincial bylaws and permits has not been decided upon yet.

With all of that change, why wouldn’t Kinder Morgan update the construction costs? Kinder Morgan stated in a press release:

Construction delays entail increased costs due to a variety of factors including extended personnel, equipment and facilities charges, storage charges for unused material and equipment, extended debt service, and inflation, among others. Because those costs are highly uncertain at this stage of the project and the extent of a delay, if any, is currently unknown, Trans Mountain is not updating its cost estimate at this time.

Highly uncertain costs. Doesn’t sound like a great time to raise equity.

Kinder Morgan told the NEB that they would fund the Project entirely, but they have been struggling. When they couldn’t find a Joint Venture Partner, they resorted to an IPO that was supported by the big five Canadian banks, in part, because they were overleveraged in KMI and could offset any losses with fees and the loans they were able to give KML.

Remember, the IPO was meant never to finance the Project, rather it paid down some of KMI’s massive debt, and allowed for the new company to access credit unencumbered by KMI’s heavy debt load. With $5.5B in credit facilities, KML still has to raise at least $2.1B to pay for construction.

KML raised about $300M in August 2017, and now are looking to raise another $250M, fresh off their recent NEB win.

What is the Cost of Delay?

In an affidavit sworn on October 26, 2017 for the NEB Bylaw hearing, KMC VP of Operations Michael Davies, stated delays would cost the company $30 to $35 million in costs, including salaries, contracts, fees, travel, office, overhead and other expenses. "Additionally, based on current estimates, projected loss of revenue to TM (Trans Mountain) due to the delay in the Project start-up is likely to exceed $90 (million) per month of delay.”

Kinder Morgan further stated in its 2018 Financial Expectations that “Each month of change in our in-service date is expected to result in a change of approximately $75 million of Adjusted EBITDA.”

According to Math

The most recent 9 month delay will cost KML $270M in costs, and $810M in loss of revenue; and $675M of Adjusted EBITDA.

If we take Kinder Morgan’s numbers and compare the original completion date (December 2017) with the current date (September 2020), a 33 month delay, then the cost of delay jumps to $990M in costs and $2.97B in revenue.

Why the delays?

Kinder Morgan has blamed the City of Burnaby for deliberately delaying the issuing of permits, while Burnaby argued that it was Kinder Morgan’s incompetence in filing permit applications that caused the delay. Whichever is true, it is clear that there are still thousands of permits required to begin construction, which is why Kinder Morgan has asked the NEB for an expedited process to bypass other municipal and Provincial laws.

What is certain, is that Kinder Morgan has never undertaken a project like TMEP before. Most of KMI’s assets were purchased, and not built by the company. Kinder they have not built a project this size in a foreign jurisdiction.

Indeed, some of the delays can be attributed to Kinder Morgan’s inexperience in building pipelines. For example, the construction schedule, filed in May 2017 did not allow for any variance or accomodation in the NEB’s route hearings which are now underway, and required before construction starts. These were mandatory hearings that Kinder Morgan should have known were going to be contested, with some formerly supportive municipalities and landowners now opposing the pipeline route.

So, now Kinder Morgan is trying to raise more money to pay for its inexperience, while refusing to update its cost estimates, due to high uncertainty.

These cost overruns should be understood as a project under duress. Further delay is almost certain - with the coming court decisions appealable to the Supreme Court of Canada and BC Court of Appeal; tens of thousands of residents who have pledged to block the project; and further regulatory process ahead.

So it’s no wonder why Kinder Morgan is now trying to raise more money while keeping investors in the dark. As they stated in their

Anyone paying half attention should take Grand Chief Stewart Phillip’s words to heart when he said recently “Anyone investing in Kinder Morgan should prepare for a long, drawn-out and very expensive battle." and Kinder Morgan’s words that “if TMEP continues to be "faced with unreasonable regulatory risks due to a lack of clear processes to secure necessary permits . . . it may become untenable for Trans Mountain's shareholders . . . to proceed."”