Kinder Morgan, Inc. (KMI) Earnings Call Transcript & Summary

Yes. It's something that we've been looking at and a lot of people -- and our customers have been looking and a lot of people in our industry have been looking at. Right now, the hydrogen that's produced in the U.S. runs around 3.5 Bcf or so, with some expectation that, that's going to expand by a multiple, let's say, 8x or so. But it's still a decade or more away, I think, at this point, to see really a meaningful activity there. However, I do think it's something that we will see come to pass. It is part of the overall low carbon solution. And right now a lot of it is being produced in refineries and produced in refineries for their own use in the refining process. But I think as people look at how it might be produced using entirely renewable electric resources, wind and solar and the like, then it will become more attractive as a part of the longer-term low-carbon solution. Midstream infrastructure is well suited to it even largely the way it is today, and we could accommodate between 5% and 10% hydrogen content. And as we're looking at some of the downstream uses, typically, the downstream uses can accommodate about 5% to 10%. Getting beyond that would require new technologies and retrofitting, and that's what brings up the analogy to natural gas eventually taking over coal. If you've got to have a lot of new capital, a lot of new investment that lengthens out the time for which the transition can occur. But we can get to 5% to 10%. Beyond that, the issue for midstream infrastructure is that hydrogen acts on certain kinds of corrosion in pipelines. And so if you have pipe that's susceptible to stress corrosion cracking, for example, hydrogen is not a good thing to have in the pipeline. And so your ability to push beyond those 10% or less levels, call it, is more limited. But there is a fair amount of infrastructure that can accommodate hydrogen as it is today or largely as it is today, as that infrastructure is today. And so it is an opportunity, and it does create another act for -- or another opportunity for midstream natural gas infrastructure. And so that does affect how you would look at terminal value in our business. I want to make one broader point, though, about that terminal value. You look at the third-party analyses. I know that you look at them. Others in our business and investors look at them. And those -- there's a fair amount of consensus that the lifetime for natural gas, utility of natural gas in the overall energy mix is longer than it is for other commodities, certainly coal but also oil and petroleum. It is a longer lifetime. And I think for a company like ours, we can look at decades, decades-long runway for our business, which is unique in the hydrocarbon business, but especially unique, I think, in just about any business. I mean, I don't know how many businesses can assess their lifetime and say that really, without dramatic change in the asset footprint and how it's operated, et cetera, we've got a decades-long runway in our business. And that's true of a company like ours that's heavily weighted toward natural gas. So hydrogen is an opportunity, but even without it, I think natural gas has a much longer life and a much longer runway than even other hydrocarbons.

That was really helpful. That was the most I've ever learned about hydrogen in a single sitting. On that note, I noticed you put out your first stand-alone ESG presentation today. Kinder Morgan has been one of the notable leaders with respect to ESG disclosures within midstream. So can you talk about what's in the presentation that's new or different? And any sort of targets the company has set for itself, and under what time frame?

Okay. Yes. Let me start with one bit of important news. So the ratings that we follow are the Sustainalytics ratings. And in our sector, Sustainalytics has ranked us #1 in ESG. And that's not just ESG reporting, how good is your reporting, that's how you manage ESG risk. And so look, that ranking is going to move around. We were ranked 2 at one point. We were ranked 4 at one point. We'd like to stay in the top 10. We're #1 currently for how we manage ESG risk. And the reason I say the rating is going to move around some is because everybody is now starting to compete on this. And so people are putting more effort into it. We're certainly putting additional effort into it. We're going to be adding a 4-degree centigrade scenario to complement our 2-degree centigrade analysis that's in our report this year. We are still working on gathering all the information to report fully our Scope 1 and 2 emissions. That's to come. And that -- our newest ESG report will be out soon. But as you pointed out, our ESG presentation, which is more of a summary level, look, has been posted today. Look, I think being good at this is about running your company well. If you look at what we need to do as a company, we transport methane. We get paid to move it. We don't get paid to lose it. And so methane emissions and keeping those down have been part of what we've done in our operations since the early '90s. It's good economic sense. It makes good economic sense as well as good environmental sense. Methane is a more powerful greenhouse gas than CO2, about 25x more powerful in terms of its impact on global warming. And so getting it out of -- making sure that it doesn't escape our pipelines is good for our business, and it's good for the environment. And -- but that gave us a bit of an early lead, if you will. I mean we've been working on it for a long time, and we've been tracking it, measuring it, reducing it, mitigating it, continuing to find new ways to do that. We've also been reporting on safety for a long time. Since probably 2005 or '06, we've been reporting our safety and environmental statistics, reporting those publicly, compensating based on how well we do on those measures versus our industry peers. Those things that are just part of running a company well fed nicely into ESG and ESG reporting. So a big part of it, and this is part of what's contributed to our early lead, is a matter of taking the things that we were already doing and reporting them well. What's next? We have started in our quarterly business review, so identifying the low-hanging fruit in terms of additional CO2 emissions reduction opportunities. And right now, the ones we're doing are the ones that make sense for the environment but also make sense for our shareholders. We've identified in vapor combustion units, for example, that we use around our refined products assets, opportunities to reduce the CO2 emissions and reduce our natural gas usage. And the payout on that is a year or less. And so we're looking at those, but then we're also starting to ask, okay, what if we had a carbon tax? What if that carbon tax was $25? What would it make sense to do for our shareholders to further reduce CO2 emissions. So those are the kinds of things that we're looking at that are still to come. But again, to repeat, I think doing this right is part of managing your business well. And certainly, that's true of the governance piece of it. Governing our business, investing wisely, running in a disciplined way to have safe and reliable, compliant and efficient operations. That's good governance. The C-Corp structure is part of a good governance picture as well. And so these are all things that we're doing that fit well within the ESG objectives as well.

Now maybe if I can move over to regulatory backdrop. Pipeline construction has only gotten more difficult, especially in areas outside Texas. Then you have the negative potential for an existing and already operating pipeline having to shut down. How do you view this challenging backdrop? On the one hand, it might increase the value for pipes already in the ground. But on the other hand, it can cap the production growth from the U.S. and also to attract investors from coming into this space if regulators can come back and shut you down after you've spent all this capital. So does this change how you or others in the industry decide how you want to allocate capital?

Yes. It has definitely -- the environment has definitely changed. And the result of that are several of the things that you mentioned. One is that it does tend to increase the value of existing pipe in the ground, and we've got over 83,000 miles of pipe and around the country in serving various commodities but primarily natural gas. And so that infrastructure, all things being equal, should tend to increase in value. Now all things are not equal. There's a lot of other factors and forces at play. But if it's more difficult for somebody -- for my competitor to build into a market that I serve that makes the existing infrastructure more valuable, all things being equal. It also means greater care in deciding where to invest. And it's very difficult to build a pipeline in New York, right? And some would say impossible. And there's recent evidence of that. However, we are looking, for example, at a project. We are doing a project -- in the process of doing a project that would serve Westchester County, New York, with facilities that are installed on land that we own in New Jersey. And so you have to be thoughtful about how you approach the market needs and the market opportunity. You have to pay close attention to the environment that you're in and whether or not you can ultimately get something permitted there or not. And increasingly, it's no longer enough to have a FERC 7(c) certificate. More and more at the state and local level, there are other obstacles that are thrown in the way. So you have to carefully examine those things. You have to invest more in public outreach. You have to schedule more, meaning allow more time, allow the money for land, allow the time and money for the additional permitting and outreach that's required. You can still do it. You just have to be very, very judicious about it. And another aspect of that is when we are building in more challenging environments, we're building in the Northeast right now, and it's not a tremendous amount of capital investment, but we are building in the Northeast right now. We have more contractual protections built in, things to guard and protect our return. Cost-sharing mechanisms, second looks, right, a new assessment, a new FID, if you will, as we progress in the projects, so those kinds of things that are -- that were changing our approach to how we're approaching permitting and public outreach and also how we're approaching contracting to make sure that we can still continue to invest. So existing infrastructure does tend to become more valuable. New builds tend to take longer and cost more and require more thought and analysis. And if you're really honest about your assessment, you're really just looking at the way things are, not the way you think they should be. There are some places where you just won't go, and I think some of the best decisions that we've made are the non-investment decisions, the decision to not go forward or to walk away from a project that we didn't -- we couldn't reliably finish, rather than continuing to throw money at it and continuing to try to persuade or cajole people into saying that we should be allowed to build it. And so I think all those things are creatures of this new environment.

Seems like now would be a good time to ask for an update on Permian Highway.

Yes. So Permian Highway is almost completely in the ground. We are on a 430-mile project. We have about 11 miles left. All of our spreads, the tie-ins have been complete, and backfill has occurred. Our compression is nearly done as we reported in the second quarter call. And so things have gone very well. The one thing that were remaining to get done, we decided rather than crossing the Blanco River at a particular part, the Blanco River kind of -- it doubles back, and we would have to cross it multiple times, and instead, we decided to go around it. And we've acquired all the land. We have every scrap of right-of-way that we need. We've acquired all the easements, and we're just asking for one modification to allow us to accommodate that reroute, which is undeniably in the public interest. It's just a question of getting it through the U.S. Fish and Wildlife and the Army Corps of Engineers, which we think will happen. And we'll be able to do it because it's in -- it is in the best interest of all concerned. But we don't absolutely have to have it. We've got alternatives that we can pursue to accommodate it, but we really would like to have it, and that's the only thing really remaining. We're currently I think, beyond the threat of any litigation shutting down our pipeline. The permitting process, Nationwide rule 12 (sic) [ Nationwide Permit 12 ] is what we're operating under. That had a bit of a brush with death with a decision that came out of the Montana court dealing with Keystone. It wasn't even our project, but there was a moratorium in place. And what that meant really was existing projects continue as like ours, for example. And then ultimately, with the Supreme Court stay of that decision, that risk has kind of been put to the side as well. So I think things are going very well. We're going to get this pipe in the ground. And then the question becomes, and it goes back probably to your very first question, which is when will the next one be needed? And we had been, before the pandemic and the OPEC shock and everything, we have been talking with customers about a third Permian pipe, third for us, fourth overall but third for us. And those discussions are just pushed off into the right now. As we look at it from our fundamental analysis and if you look at WoodMac and others, they say that, that pipe will be needed, but we're probably looking at the middle of the decade as opposed to the next 2 or 3 years. So I think we'll get Permian in, and then I think there'll be a relative pause on infrastructure development there, even natural gas infrastructure. And I guess I didn't answer part of your question on the earlier one. You asked about will the difficulty in permitting put a cap on U.S. production. I think not, at least for a while. I think what we're going to see is what the pipelines are getting completed for NGLs and for crude and the like. That's going to provide enough slack for a while to accommodate a return to growth for a while. And a lot of the infrastructure that is going to be needed over, call it, the medium term on natural gas, in particular, I think it's about 75% of the natural gas demand growth that's projected that's going to happen in Texas and Louisiana. And a lot of that is going to come from resources in Texas and Louisiana. And so I think that, that's a better permitting environment for us to be able to get things done. So I don't think infrastructure will be a holdback for the longer-term picture for U.S. energy supply. It may be continuing to be a pinch point on demand. There's incremental demand requirements in the Northeast and in New England that right now are being met with LNG imports. That's a -- it's more of a constraint, I think, on certain demand locations than it is on the supply side.

Actually, your last comments about slack capacity and things like that is a great segue into the final question before wrapping this up. Midstream has long been thought of a business where you have to spend money to make money. So in that context, how do we think about Kinder Morgan's ability to grow in the near and medium-term with spending levels being below historical levels? And which of your assets is there operating leverage where you can see cash flow growth without much spend?

Right. So there's no question, there's been a lot of investment in the midstream sector to accommodate the shale growth, and that's where growth has come from. We showed a waterfall slide on EBITDA to show the pluses and minuses on the base business and how ultimately it was the EBITDA growth that came from capital projects where we invested at very attractive multiples. We met our targets, actually, did a little bit better. That offset the downturn and then applied growth. Again, what happens to base business EBITDA is a function of the larger environment. I think for us, we think that natural gas is -- has, over the long term, tailwinds associated with it, meaning that we're going to be able to get more out of the assets that we have, even without a tremendous amount of capital investment. Now to get there for us, as you know, we update investors on this every year. To get there for us, there are some contract roll-offs associated with expansions that were done 10 years ago that we've been chewing through for the last couple of years, and we'll continue to chew through for a couple of more. But ultimately, I think we get to a point where, because the overall natural gas supply and demand story is a good one, whether it's coming from associated gas or coming from dry gas, I think we get a tailwind there. But there's no doubt that in the recent period, it's the EBITDA growth that's come from our projects that's helped to offset some base business degradation associated again with those contract roll-offs. So I think we do have opportunities for good, efficient capital investment. There is some slack even in the natural gas grid. If you look at, for example, our Haynesville assets. So we've got a 2 Bcf a day system there. If you look at the trunk line capacity, that is moving less than a Bcf a day. Now it depends on where producers drill. But as dry gas prices grow, they were up to just under $3 for the last 3 months of this year with yesterday's trading, we're starting to see more interest in the Haynesville. And that will -- that's a pretty capital-efficient expansion for us. We can take on the additional -- again, you got to connect the wells, and it depends on where on the system those wells get drilled. But generally speaking, that's a pretty capital-efficient expansion for us. Other parts of our system, really, if you look at where the constraints are, the constraints are really into the Northeast. And I don't think there's going to be a great deal of capital investment to debottleneck that. We're doing a little bitty debottlenecking projects up there. The question becomes do you need another southbound expansion. We've got one more of those probably that we can do on a relatively cost-effective basis before you look at more capital-intensive kind of looping or new build pipeline investments. And other debottlenecking investments that we're doing on our Western pipes and NGPL and places like that, those are pretty capital-efficient opportunities for us. We still haven't seen storage values get to the point where more expansions there are warranted, but that's another part of our business. We're the largest natural gas storage provider in the U.S. And so I think over the longer term, particularly as you put more renewables into the grid, that's a good opportunity for us. Natural gas storage with a combined cycle generating facility is way more efficient, cost-effective than batteries -- grid scale battery technology. And it lasts a lot longer. You don't just get a 4-hour bump from -- like you get from grid level battery storage. You get multiple days of deliverability, which is going to be important as we put more renewables into the stack. So I think good investment opportunities for us across our natural gas space.

Thank you, Steve, so much for your time and sharing your insights with us today. And I'd like to thank everybody else for tuning in.

All right. Thank you.