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

All right. Good morning, everybody. We're going to kick it off now with Kinder Morgan, and from the company is David Michels, the CFO. So David, thanks for joining us.

Thanks for having me.

We're going to start off with a few prepared remarks and then jump into some Q&A, so I'd kick it over to you.

All right. Really great to see everybody and really nice for you guys doing this in person. The virtual conferences are really killing us so...

Us too.

Yes. So very nice to see this and great to be up here in Vail. So before we get kicked off, just to level set, I mean, what's been interesting in the space here recently, and everybody in the room knows this, is we moved from the shale revolution and the build-out of replumbing everything going from the Appalachian to a region of the country that had always been a supply region to -- which is now a demand region in the Gulf Coast. We went through that growth build-out, which was significant, a revolution really in the midstream space. So now we're growing -- moving into a phase of the industry, which is much more of a stable growth, steady contribution of cash flows and so forth, which I think has been a little bit dismissed here recently. Ever since the pandemic hit, I think people saw traditional fossil fuel use plummet during the year in 2020 and thought, "Okay, great. Now we can move away from fossil fuels and go to something a little bit more sustainable going forward." I think recent events have helped demonstrate that, that really is not going to be the case, not in any time soon anyway. So this new phase we're in now, I think, is getting a new -- renewed perspective that it really is a slow growth, steady state contributor for base business. And incremental to that, it's not necessarily a risk. It's much more of an opportunity set for us to also contribute by looking at energy transition opportunities and fuels of the future. And so for us, when we've been talking about our internal plan and forecast going forward, it's a -- we get a little sense of optimism and excitement really about what the future has to hold because right now, a lot of those energy transition opportunities are relatively small, not a huge needle mover, especially for a company our size. But there are some, on the horizon, 5-plus years down the road, that could be needle movers and that's pretty exciting.

Yes. So maybe let's start there and talk a little bit more about macro, just given how much is going on. And the market was obviously tight well before the events over the last week. And so you think about what's driving that. You mentioned capital discipline on the producer side. We had Pioneer in here earlier today kind of say it's going to take a heck of a price environment to really make that move. And so we've been really impressed with some of that discipline. And so as you're thinking about what happens next, I mean, what breaks the levee? And how do you plan 5 years out? I mean, what kind of crude price environment are you thinking about when you make these decisions? It's probably not 100, but what actually happens next?

Right. Well, I think it just comes down to, I don't know is the answer, but I think it comes down to the dynamics on the demand and supply side. On the supply side, it feels like you're exactly right. I mean, it seems like the producers have been very disciplined. Clearly, in 2020, everybody was going to ramp back. Prices were awful. And then 2021, we saw that discipline really get demonstrated. And it's still there. I think we are seeing more capital being allocated. We're seeing rigs increase and activity levels ramp up but on a really much more measured way than what we've seen in the past. When you see $90, $95 per barrel oil prices, you saw ramp-ups much more significant than what we're seeing today. OPEC is being relatively measured in their approach. They're hitting their mandates. Spare capacity that I've seen there is between 2 million and 3 million barrels a day, so there is some opportunity for them to potentially bring more supply to the market, but it doesn't seem like that's been their MO here as of late. So on the supply side, it feels like -- oh, and one other thing is, in 2021, the other thing that helped producers hit some of their production targets were the DUC inventory. And now that DUC inventory is much more depleted. The quality of some of those DUCs are lower quality than some that were taken advantage of last year. So again, I think on the supply side, I think we're going to see we're going to see a more steady supply. So nothing that seems to really threaten the current levels of oil that we're seeing. On the demand side, Omicron. Omicron, I think, was a variant that was very contagious but low severity rate, which seems to be a signal that future variants may not be as severe as well, who knows. But if that's the case, then lockdowns, widespread lockdowns across the country, across the world seem to be less likely, which means the demand for the product should stay robust, which is good. That plus the underdevelopment of significant projects over the last few years, should -- all of that coming together should allow oil prices to stay pretty high for some period of time, clearly through 2022. For us, we don't really take a longer-term view of it. We kind of react to those types of activities and opportunities as they present themselves.

Got it, helpful. And so if we think about, once again, the events of the last week or so, it seems like a very fluid situation, obviously, but hearing about different types of proposals that could impact us here. I just recently saw a headline talking about LNG by rail again, which I'm not entirely sure what that's going to do. But just curious how you think about that. And then if we do actually ban Russian imports of crude oil, you obviously have a Jones Act tanker fleet that maybe benefits from that. I mean, anything you're thinking about in terms of the variables that can impact you guys?

Yes. LNG by rail just is not a good idea. The LNG market generally, though, is really benefiting from higher prices across the world, Asian prices, European prices. It was nice to see Europe commit to a couple of additional regasification facilities. I think energy independence is another factor that's really been lost in the whole conversation here as of late. Energy independence for America is extremely important. And it used to be extremely important on a federal stage. These days, it feels like it's been lost in this climate change conversation. Although I think with the recent conflict, I think it's reemerging as an important aspect to America's political strength. And so hopefully, that means we will see a little bit more flexibility at the federal level around some of the projects that will help promote energy independence, which is great because we've seen more policies go the other way, restrict our own energy development and infrastructure development that's needed to get into parts -- to get the product to market. But we'll see.

Got it. So coming back home now and thinking about some of the growth, while there is capital discipline, it's not like the Permian is not growing, right? And I think that's created a bit of an issue. It sounds like in late 2023, we're going to need another pipeline solution. You all are -- you have 2 pipelines out there now. You're looking at a third one yourselves. You've got a few brownfield projects announced by some of your peers. Curious how you think that, that bottleneck gets resolved? Is it brownfield/greenfield, combination of both?

Yes. Again, a question that I don't know the answer to, but I'll do my best to paint the -- or to set the stage because I think a solution is going to happen here. The production is going to come to market. The solution is likely to be needed at some point in 2024. So an FID and even beginning phases to secure right-of-way and so forth, if it's a greenfield project, will need to be started this year in 2022 in order to meet that demand. The new dynamics are better dynamics that are at play today versus when we built PHP are -- there is greater regulation around flaring in the Permian. And so producers are feeling a little bit more pressure on that front, bringing them to the table a little bit ahead of time relative to when we were having conversations around PHP. And you're also seeing a higher-priced byproduct versus what we've seen in the past. With natural gas, it used to be this relatively cheap, low-margin byproduct. It wasn't the primary product that they were targeting when they were drilling in the Permian. Now it's more valuable. It does create more margin for them. And so both of those aspects are bringing people to the table a little bit earlier this go-around versus last go-around. With that being said, there are numerous alternatives to how that need is going to be met. Our project is an attractive one. We have demonstrated our ability to get a project to market, so we have that kind of constructability checkbox behind our name versus maybe some others who don't. We have the downstream intrastate system, which connects to Mexico, LNG, industrial demand, petrochemical demand, et cetera. And so that's very helpful. It provides us a little bit of an advantage. But at the end of the day, the producers are looking for a cheap alternative. And there are competitors out there with really good projects that are very competitive. So it's going to be a battle, and we're going to put our best foot forward and see what we can do.

Great, yes. And so as you think about other basins that you're excited about, I think Haynesville comes to mind. I'm just curious where else you're seeing a lot of activity that maybe bottlenecks will need to be cleared at some point, too.

Yes. Haynesville is one that is easy on, easy off. Someone asked me earlier today or asked us earlier today if there was enough supply to meet all of the needs coming out of the LNG industry and all the new trains coming on, new development projects coming online. And it feels like there is and Haynesville is one of those kind of more swing-ish-type basins that can come on quickly to meet new supply needs and can be turned off if it needs to be. For us, the bigger opportunity is really about our KinderHawk system, which is our gathering and processing system in that basin that is not fully utilized today. So we have some ready opportunities for us to meet some gathering and processing needs coming out of the basin. There's also going to be some egress needed, most likely here in the near future. We may or may not have a role in that.

Okay, great. Let's switch gears a little bit. You mentioned energy transition earlier. And it sounds like we maybe went a little too hard, too fast in 1 direction and we got to check ourselves now a little bit. But I suspect that's not stopping you and the team from continuing to pursue projects on that side of the aisle. So curious, what are you focused on in the near term? What are some near-term project you guys are advancing? And then when you think longer term, what are the things you're sort of picking at now?

Yes. Well, first of all, to your point about moving too fast or maybe too recklessly into a particular path, that's something that when we developed our Energy Transition Ventures group, we said we've got to stick to our knitting. We got to make sure that the returns that we generate in this business are the same as or significantly the same as the returns that we would generate in our traditional fossil fuel business because we have to be -- we want to be good stewards to the environment. We want to change with changing circumstances and so forth, but we also need to be good stewards to our shareholders' and investors' capital. And so far, that's worked out really well for us. We've avoided certain circumstances stances where we wouldn't have generated adequate returns, consistent returns with our traditional business. And we've moved into a largely renewable natural gas, renewable diesel, sustainable aviation fuel type opportunities where we are seeing those returns available to us. And so it's focused our opportunity set on those that are actionable, achievable and generate good returns.

And so as you think long term, right, those are in front of you, I know hydrogen comes up, CCUS comes up. I think CCUS, maybe before hydrogen, is how you guys [ step back, ] is that right now? And I guess, what are the projects you could participate in there? You obviously use carbon-free EOR business, but I think you'd probably look to branch out and do something different, right?

Yes, that's right. I think the lower-hanging fruit, the more near-term opportunities are going to be the ones that feed into the enhanced oil recovery system. We have CO2 pipelines right now that run through a corridor where there are natural gas processing plants. You could capture the CO2 on those plants coming off of those plants, put them into a CO2 pipe and use them for enhanced oil recovery. The 45Q credit that you get from that is not at the higher level. It's at the $35 per ton level. So that's not a very large contributor to the economics incrementally, but it is -- it does offer an incremental opportunity for us to at least begin in this effort. And those are the things that Jesse Arenivas, our President of our CO2 Group said, in the next 12, 18 months, there is actionable opportunities there. That's what he was really talking about. Longer term, the pure sequestration type opportunities are there. I think it is going to be longer term because it takes a long time to permit a sequestration field. It takes a long time to build a CO2 pipeline, if there's not 1 that's readily available for a sequestration play. And we have a lot of experience with building new greenfield pipe. It's not easy. It's not -- doesn't look like it's going to get easier anywhere in the country. So it just takes a long time. So before an effort like that really gets underway, the value chain needs to be figured out. And the 45Q credit and whether or not it's direct pay also needs to be resolved.

Got it. You also mentioned LNG earlier and you shouted out the Haynesville [indiscernible] you guys supply 50% of that market, right?

That's about right.

[indiscernible] 50% share. And you've also got, of course, got Elba that's operating and then Gulf LNG at some point maybe comes back in. So curious as you think about that now in the context of the last week or so. I think all we've heard on -- during this conference so far is we need to get more U.S. LNG to Europe. How do you think about the impact to you, given how large a market share you have? And I think as I remember at the Analyst Day, you had sort of briefly said that you're looking at expanding Elba potentially. It didn't sound like it was near term. So wondering now if that is a near-term priority for you.

Yes. I think Shell is our counterparty in ELC, our Elba liquefaction facility and they'd be the ones who will drive a phase 2 expansion into that facility. And they're involved in divesting some Russian assets, which might prompt them to take a look at that phase 2 a little bit more closely here. As a result, we haven't had any specific conversations yet, so more remains to be seen. But with regard to overall, the LNG backdrop, I mean, we've started off the year with a very robust backdrop for U.S. LNG, with Asian prices and European prices being where they are. Now you've got renewed optimism around -- a renewed interest, I guess, in attracting U.S. shipments to Europe. I think it's just going to bolster that backdrop and help facilitate some of the FID and development for the facilities that we were already working on here. As you said, we're very well positioned for the incremental -- the next wave of facilities coming on. We've got contracts in place with many of them. We're working on additional contracts to secure supplies to those facilities. We're not working on any opportunities today to participate directly in those liquefaction facilities but to supply them with gas out of our network. And the nice thing about it is, I said this earlier in one of our group meetings that most of the projects that we have either built and developed or are going to build and develop to supply gas, natural gas to third-party-owned liquefaction facilities are under long-term take-or-pay arrangements. So whether or not those counterparties actually use the facilities that we've provided to them is relatively -- it's irrelevant to our margin. But what's nice about the current higher utilization that we've seen in the last few years and projection that it's going to continue to ramp up is the second derivative type effects filling up the networks behind the lateral or extension of our pipeline that actually supplies the liquefaction facilities directly is useful because it increases the utilization, increases the value of those things. It benefits our recontracting conversations that we're having with people because those molecules are moving the space and capacity is becoming less and less available, making those things more and more valuable.

Got it, yes. And so let's switch gears now and get into your realm as the CFO, we're going to talk about capital allocation. And so you mentioned that kind of what this industry has gone through over the last few years from spending CapEx, growing and then returning a lot of that capital at the time and obviously levering the balance sheets -- those days are long gone, right? And so as you think about the path going forward, how do you think about funding projects? How do you think about returning capital? You guys obviously have a nice healthy dividend that you continue to grow. You talked about, I think, upwards of $750 million in buybacks this year potentially. And so as you look out going forward, how do you think about prioritizing that capital allocation?

Right. Yes. I think we've -- ever since 2016, when we've been living in kind of a little bit of a newer paradigm for Kinder Morgan, we've struck a good balance with regard to paying out a healthy dividend but also covering that dividend with a healthy amount of cash flow. So we've had about half of our cash flow from operations in our dividend. And going forward, we would anticipate growing our dividend at a level relatively in line with our cash flow growth, which means that coverage level will stay approximately the same. I feel like that's a pretty good balance. We're returning a lot of value to our shareholders, $2.5 billion -- almost $2.5 billion of dividends paid out last year, but also maintaining a lot of firepower to fund growth capital projects and have some excess on top of that because our growth capital projects have become a little bit more within -- underneath our cash flow. Relative to our cash flow, it's been a little bit smaller. So this year, we're projecting, as you said, $750 million of available cash flow for unbudgeted investment opportunities, which include share repurchases. And on a go-forward basis, I think our growth capital forecast is in the kind of $1 billion to $2 billion area, which means we should have a similar amount of excess cash flow available on a go-forward basis. And so the question then is, do you take that and put it to your balance sheet or do you repurchase shares? We're not share price agnostic when we repurchase shares or when we look at share repurchases; we think that's the right way to approach it. You'd love to wait for a dislocation in the market and take advantage of that. And we've seen some of those here recently. At the same time, you hope that your good efforts and execution increases your share price. You get a capital appreciation, which would mean that you should take some advantage of whatever the share price is today. So there's a healthy tension there that we try to take into account. We do run return math on share repurchases by looking at the foregone dividend, some terminal value view of what the share price is using the current EV/EBITDA multiple and applying that to a forward EBITDA, and then we run sensitivity math around that. And so I think I've been using the word balanced a lot here. I think that's the right way to do it because ultimately, there are a lot of different views on this, including among management as well. And so I think we will have a bit of a balanced approach to how we allocate that capital. And if you put it to the balance sheet, the nice thing about that is there is a real option value to it. It's not like that's wasted money. You do reduce some of your debt cost, which is good. And then you have that balance sheet capacity available for you at the future, should there be some real attractive opportunity.

Got it, great. When we think about consolidation, we did a look at this a few weeks ago. And we looked back at 2014, there was something like 135 midstream companies; maybe there's around 70 today. So we've clearly been consolidating over time. Curious as you look forward, next 5, 10 years, what do you think this space looks like? And I guess what is Kinder's role there? You've been somewhat active, recently bought some RSG, RNG assets. You bought Stagecoach recently, some nice bolt-ons there. But curious as we go forward, what does the space look like to you?

Yes. We have seen nice consolidation. Most of that was simplification of affiliates. So it's hard to say. But you think that if we do -- if we are moving into a kind of a more permanently kind of slower growth type environment for this industry, a little bit of a more mature industry, that's when you tend to see more consolidation happen. You've seen that across other industries that have gone through these types of phases in their industries. With that being said, I think for us, we really would like to see our capital -- our share price relative valuation appreciate a lot more before we take advantage of a lot of these potential consolidation opportunities. It's really hard to call. You've got social issues you've got to manage through. You've got management and Board members and then backers who all have different views. The one thing that you can count on is you do have some private equity-backed companies out there who once you reach that higher cash flow generating capacity of a business because you have gone through some growth phase, and now you're at a little bit more of a more mature phase is that's a good opportunity for people to take that value and lock in the value that they've created. So I think there will be some of those consolidation opportunities. Harder to say if there's anything more significant across the industry, though.

And so as you think about the types of assets or maybe even the regions that are exciting to you, Stagecoach comes to mind in that, that was a big storage position. And storage clearly proved to be the crown jewel during Uri, events like that. And so I could see why you want more storage. I mean, outside of that, how do you think about where you want to be? I imagine your -- extensions of your current footprint make the most sense, but just curious how do you think about desirable assets.

Yes, I thought you might ask that question, and I was going to point back to Stagecoach. If we find another Stagecoach, that's the exact type of asset we'd like to buy. But since you took that answer from me, I'll go to something a little bit more general. We have, really by strategy, tried to avoid falling in love with specific geographies, specific products and so forth because that's when you find yourself overpaying for stuff. And so instead, our criteria for an acquisition has been very constant, it's been relatively broad and it's based more on economics than anything. You need the investment returns to meet your threshold, number one. Number two, we really like the fee-based type business. We really like contracted assets, long-term contracted assets that are core to their position in the industry, that have a long-term need, whether it's a supply need or a demand need or both. Those are the types of assets that we really like. If it integrates with some of our existing systems, that makes it that much more attractive to us. It allows us to potentially be even more competitive in a competitive process. Just like Stagecoach, it was -- I mean, we -- to have storage facilities in New York that integrate into our largest asset in Tennessee Gas Pipeline allow us to debottleneck some of our peaking services in the wintertime. That's a tremendous combination and a really nice opportunity for us, so we were very pleased to have accomplished that one.

Yes. No, agreed. So when you think about just your organic growth and you talked about a few different projects you have, what's the most exciting to you as you look forward to the projects you're working on now? And what do you feel like maybe some investors might be underappreciating?

Yes. I think underappreciating, I'm not sure people are underappreciating. I think we have our Texas Intrastate system that is benefiting this year and I think will benefit in the future years from a couple of aspects: one, obviously, the Permian build-out, a lot of that gas is going to continue to come into the Texas intrastate segment because of all of the different egress options, demand areas that it touches. It also benefits from the fact that it's got significant storage availability and the recent memory of Uri and the unreliability of the Texas grid is going to promote increased margins across that business for, I think, years to come. We buy and sell. That's one of the rare assets where we actually buy the commodity and sell the commodity on the other end. We typically do that in a way that it's back to back. So we synthetically create a take-or-pay arrangement and we generate our margin on it. We feel like that margin should expand coming -- going forward as a result of those dynamics. Storage across our businesses, we have 700 billion cubic feet of total storage capacity across our assets. And storage has been something in the natural gas space that has been underappreciated generally. But consistent with the market because the market has been low volatility for natural gas, low prices absolutely for natural gas, and as we transition to a higher-priced market, a more volatile market, storage assets should appreciate, and rates where we have market-based rates should appreciate. And we have a good opportunity for margin expansion across those types of assets. And we've talked about some of the energy transition areas. I don't think they're being underappreciated. I think the underappreciation, I think, for Kinder Morgan specifically might be the lack of headwinds in our base business, that we've had some years where we've had some rollover risk, and we tried to be real transparent about those over the last few years. Now those are largely behind us, and so that base business is going to be more of a steady contributor like we've designed. So I think that might be a little bit underappreciated because I think we continue to get that question or where is the next big rollover coming? And the answer is there isn't 1, which is nice, which allows that base business to be a low, steady grower and then incremental growth opportunities to really add incremental growth on top of that.

Got it. Last one. In our last 2 minutes here, kind of a 2-part question. Just where are you seeing competitive forces really kick in now? Like in the basins you participate in, where are you seeing a lot of competition? Where do you feel like you've got a strategic edge? And then when you look at valuations across just the different asset classes, I guess what still looks interesting? What hasn't re-rated yet in your view?

Well, we already touched on a couple of those. I think storage is a big one. It hasn't re-rated yet. [ Intra, Stage ] really hasn't re-rated to the degree that we think it will. Unfortunately, I think that answers most of the question. Competitive pressures in most of our base businesses, I mean, 65% of our customers and our businesses across our portfolio are end users who are more or less captive to our services. And so we don't have a ton of competition out there that we face on a day-to-day basis. Where we see most of the competition is on new opportunities. And so we talked about the Permian egress opportunity for us. Lots of competition there. We're seeing competition across all of these LNG facilities that we connect to. We're seeing competition on each of those. We have a very fortunate footprint, and that's ultimately what wins the day on something like signing up a new contract to secure an LNG supply contract. So the very fortunate footprint really kind of benefits us very nicely. It is a very good strategic advantage.

Great. Well, I think we'll call it there. Please join me in thanking Dave Michels from Kinder Morgan. Thanks, guys.

Thanks a lot, Spiro. Thank you.