Q3 2003 Kinder Morgan Earnings Conference Call - Final.

Original Source: FD (FAIR DISCLOSURE) WIRE

EDITOR: [Missing Text]

RICHARD D. KINDER, CHAIRMAN AND CEO, KINDER MORGAN INC.: particularly with the Yankees, Red Sox game just started you will have some of your interest diverted elsewhere. As usual we'll be talking about the Kinder Morgan Inc. family of companies. Kinder Morgan Inc. Inc., which trades in the New York Stock Exchange under KMI and that's the way I'll refer to it is one of the largest mid stream energy companies in America. Among its other assets it also owns the general partner interest in Kinder Morgan Inc. Energy Partners which I'm refer to as KMP. KMP of course is the largest master lender partnership in America. We will also be making statements throughout the call that are subject to Securities Act of 1933 and the Securities Exchange Act of 1934. I'll give an overview of the situation and the earnings, and C. Park Shaper, our Chief Financial Officer, will provide financial details in his usual format of ultimate details. And then Michael C. Morgan, our President, Park and I will be available to answer any and all questions that you may have.

Let me start out by saying that the third quarter of '03 was another positive quarter for the Kinder Morgan Inc. companies. KMI had net income of $95.6m, or $0.77 a share, versus $80.4m or $0.66 a share in the third quarter of '02, an increase of 17% in earnings per share, and an increase of 19% in total earnings. Cash flow continues very strong for the quarter, as Park will talk to you about, and year to date, we have now had free cash flow of $418m. That's well on track to make our amended goal of $530m. As you will recall, we started the year with a budget of $470m, so cash flow continues very strong, and Park will take you through that.

At KMP, we've increased the distribution per unit from $0.65 per quarter or an annualized rate of $2.60 per year to $0.66 per quarter or $2.64 a year. This contrasts with a year ago when we were paying out $0.61 a quarter or $2.44 a year. An increase of a little over 8% and that's very consistent with our objective that we've often spoken of, of increasing distributions per unit at KMP by about 8% to 10% a year from internal growth at KMP without acquisitions. I might add that this distribution increase for this quarter is the 17th increase in distributions over the six and a half years since we formed KMP.

As I said, Park will review the financial performance of each business segment at both KMI and KMP in just a few minutes but I'd like to discuss some important strategic and operational accomplishments for you and provide an outlook on our future performance. First, a comment regarding corporate governance. The boards of our two companies today approved certain steps and is detailed in the earnings release, but they include the formation of a nomination and governance committee and outside lead director for both companies. We believe we have adopted all necessary items as required by all relevant New York Stock Exchange and S.E.C. requirements, even though some of those have not yet been formally adopted by those two agencies. But at any rate we believe we are in full compliance with all of those. Now we have implemented those effective today. In a broader sense I'll remind you of course in my rather jaundiced view of corporate governance, the key thing is are you running it for the shareholders or the officers? I assure you we are running it for the shareholders. We are running a company by the shareholders for the shareholders.

Let me talk about strategic and operational issues. Let me start with the products pipeline segment of KMP. And again Park will take you through the financial numbers. But I want to talk a little bit about the volume numbers. If you look at the volume numbers, included in our earnings release today, they show a decline in overall refined product volumes of about 1.6% for the third quarter, and about 2.3% year to date. As we've previously indicated, those numbers, in order to get apples to apples comparable period of '02, need to be adjusted for the impact of the fact that MTBE in California has now been replaced by methanol on our Pacific system. MTBE is blended at the refinery and move through the pipeline. While ethanol cannot be moved through the pipeline and is blended at the terminal. So we've gone through some length to strip that out. This impact would reduce the 1.6% decline in the third quarter to about a .6% decline and for year to date, the 2.3% decline goes to decline of 1.3%. And incidentally, adjusted for that change the total volumes on the Pacific system which we kind of use as a bell cow, the total volumes on the Pacific systems of all refined products showed an increase of 1.3% for the third quarter and a little less than 1% year to date. Now, that contrasts with our long range target of about 3% and with a national average of historically in the 1% to 2% range. We feel very comfortable that we will experience about a 3% gain in volumes and about a 4% total revenue gain year to year. This ethanol adjustment is important and it reflects economic reality. As you know ordinarily throughput volumes are very important in evaluating the economic performance of our products pipelines. In this case, the loss of revenue occasioned by not moving this ethanol through our pipeline is more than offset by the fees we earn from our customers for blending ethanol into the product at our terminals, and we've said that all along. And Park will take you through the financial numbers which shows of course revenue is increasing and profits are up at the Pacific system.

And the other issue on products volumes we did have some supply issues at certain refineries that ship on the plantation system, which inevitably impacted the volumes on that system on the third quarter. Adjusted with the impact of replacing MTBE with ethanol on our Pacific system all of our pipelines except plantation showed increases product throughput on third quarter and year to date.

The other significant development in this products pipeline segment was our purchase announced in September and closed at the beginning of October of five products terminals in California, Arizona and Nevada from Shell. While this was relatively small with the purchase price of about $20m, and as we indicated we intend to spend $8m to increase the capacity of these tanks, then it's important to note that this is a strategic transaction for two reasons. First of all, it's very strategic to our Pacific products pipeline system. They're right on our pipelines and in a number of cases right next to present terminals that we have. And secondly and maybe more importantly, it demonstrates the willingness of majors to divest mid stream energy assets. We anticipate additional and larger acquisitions of similar terminals over the next six months or so. More to come about that later.

Now, turning to Natural Gas Pipeline of America, NGPL, some important trends there also. As you know the driver of financial performance at KMI, at NGPL is the ability of our team to renew and extend transportation and storage contracts. Now, historically, these contracts have an average life of about three years, and as we've explained before, as they expire, they need to be renewed. So about 30% or so of the contracts should roll over on average every year. We've had an extraordinarily good year of renewing contracts. We are now between 98% and 99% sold out on long-haul transport for the winter season. And our storage is virtually 100% sold out for the next several months.

But let's look further ahead. If you look at calendar year '04, we only have 14% of our long-haul transportation volumes rolling over next year. That contrasts to much higher volumes ordinarily as I said, ordinarily about a third, and in some cases as much as 40%. And the same is true on both market storage and field storage. We have a much lower than normal rollovers in 2004. All of this I think is a very positive sign for NGPL and something I've said before, you ought to watch us on and check us on. What it demonstrates to me as I told our board today our team at NGPL is very proficient in working with our customers to establish and maintain mutually beneficial contractual arrangements. Because frankly you don't roll these contracts over if your customers aren't satisfied with your performance and if they don't really need the capacity whether it's long haul transport or storage.

Now let me talk about CO2 operations, that is of course part of KMP and one of our really fast-growing segments. As Park will tell you they had an outstanding quarter. Earnings before DD&A was up 56%for the quarter and close to that for year to date. The average [missing audio], an increase of 54%. Year to date, we've averaged 19,200 barrels per day of production, that's up 56% from year to date numbers for 2002. In the third quarter, the increase quarter to quarter from rolling quarter from the second quarter of '03 to the third quarter of '03, was about 7%. Now, that sounds kind of nice, but really sort of hit a plateau in the third quarter. As some of -- we were putting on some new patterns during the quarter. That's simply where you have an injection well and then several withdrawal wells around it. As we were doing that. And we had some minor delay in construction due to the weather. Put another way, like I say it was kind of a plateau we hit even though we averaged close to 21,000 barrels. I'm happy to say that here in the first half of October, I think we moved significantly out of that plateau. We are now over 23,000 barrels a day, in the last couple of days we've actually been right at 24,000 barrels. For the full year 2003, we expect to average a little over 20,000 barrels per day, which is consistent with the original budget we started at the beginning of the year and we expect to be producing about 25,000 barrels per day, maybe a little over, by year end, again consistent with our original budget target. So in terms of Sack rock production, I think things are very much on track to achieve our goals for the year.

On the acquisition front in CO2, we're still continuing to discuss with Marathon Oil Company the acquisition of its interest in operator ship in the Yates field, which is of course part of the Permian Basin. Those discussions seem to be going well and we're hopeful of signing and closing this transaction during this fourth quarter of 2003. Although as I've said before, nothing is certain until the horse is in the corral and you put the saddle on. But things look good on that front.

Let me talk a little bit about TransColorado Pipeline which is part of KMI and more importantly a little bit about our general strategy on transporting natural gas out of the Rockies and again I'll bore you to tears with some of the numbers here. But as you're aware, the Rocky Mountain area particularly Wyoming and Colorado constitutes the fastest growing on shore producing area for natural gas in the lower 48 states. Clearly, there's a great need for additional pipeline infrastructure to move that gas toward key markets in the Midwest and elsewhere. We are already a large player in that area. We have our Kinder Morgan Inc. interstate gas transmission, our Trail blazer system, pony express, TransColorado and red cedar system, add that all up we are now moving over 2b cubic feet per day out of Colorado and Wyoming making us we believe the second largest transporter of gas out of those two states. We intend to expand our systems in this area whenever we can obtain long term throughput agreements from credit worthy shippers. In this regard, we announced on September 25th our 125m cubic feet per day expansion of our TransColorado system with all, all of that additional capacity fully subscribed for ten years by a third party credit worthy shipper. And this expansion will move additional gas from the rapidly developing [inaudible] western Colorado, to the Blanco New Mexico hub. We are pursuing additional potential projects out of the Rockies again Colorado and Wyoming and believe there is real potential for growth in this region. But we will not do these projects without good long term throughput agreements. But it could be very significant for us in the future.

We'd also like to talk briefly about our Power segment which is less than 2% of our earnings at KMI. As you know, about a year ago, we scaled back that power operation significantly. We now own interest in three facilities near Denver. And one near Detroit, all told under long term agreements, where other parties bring the gas and market the power and we get paid a fee for producing the electricity. In addition, as you know, we own a preferred stock in a plant near Little Rock, Arkansas, the Wrightsville plant. Mirant company owns the common stock, operates it brings the fuel to the plant and markets the power. Mirant as you probably know filed for bankruptcy in July and last week put this plant into bankruptcy. We have been working with Mirant for some period of time to restructure ourselves that facility. And as you know, at the end of last year we significantly reduced the value of our investment in that plant. We've had a number of questions since Mirant did file, push the plant into bankruptcy and the short answer is we don't know the impact of the plant's filing on these restructuring efforts that we have. We're not in a position now to predict what any specific outcome might be or that it would become necessary to reduce what's a pretty minimal carrying value of our investment any further. But we assure you we'll watch that situation clearly and decide what to do over the next few months.

I think it's important to stress three things. With regard to this plant, first of all, in the event that we decided to do anything in terms of riding down the plant, we did not have any earnings or cash flow from this plant in our '03 budget. We do not have it in any budget or projections beyond '03. And any write-down or reduction in carrying value that we take would be pretty minimal. $30m after tax or less. And of course, it would be noncash in nature. And again it would have no impact on future earnings or cash flow of KMI. So while it's not terribly strategic or significant, we've prided ourselves on being completely open with you, and responding any time there's an issue that impacts us. And certainly the fact that that plant has filed for bankruptcy is an issue for us, and we'll keep you posted on it.

Now let me talk a little bit about our outlook for the remainder of '03, and for '04. First of all, …