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The Fortnightly 40 Financial Ratings

Which is the best energy company?

Fortnightly Magazine - September 2005

oil and gas exploration.

He writes that the MLP corporate structure is designed to allow energy companies to spin off their production and transportation assets in separately managed companies. By creating an MLP, the energy company benefits by raising cash to pay down debt or invest in other businesses, he writes, and the assets packaged in an MLP generally are considered to be a slow-growth or even declining-value asset, but with a steady cash flow, such as producing properties, pipelines or gathering systems.

"Since the MLP pays out all of its earnings to MLP unit holders, the corporation therefore pays no taxes on those future earnings. Essentially, the MLP structure allows companies to sell their assets to investors at a market price in return for a promise to pay out the cash flow, after maintenance expenses, while maintaining a degree of control over the assets," writes Vasey. He also notes the advantage of an MLP is that it only pays taxes once at the unit-holder level. By contrast, most corporations are taxed twice, once at the corporate level, and once at the shareholder level.

But in the beginning, Kinder Morgan's Shaper says the very reason people thought an MLP structure wouldn't work was because, "the MLP actually pays out all of its cash flows to its partners every quarter… So, the question is where does the cash come from for new investment?"

Shaper says that essentially [Kinder Morgan] believed that it would be able to raise capital for new investment projects from the capital markets if the assets were attractive, and demonstrated that it could be done.

Moreover, in addition to having a "low-cost" corporate structure, Shaper says his company's high-quality assets are the reason for Kinder Morgan's performance.

"The growth comes largely from just normal internal growth. It comes from increased utilization of our assets, which is largely driven by incremental demand for the products we handle. Demand for refined products (gasoline, diesel fuel, and jet fuel) across the nation generally grows at about 2 percent. We tend to serve higher growth areas on the West Coast—California, Arizona and Nevada. We tend to get three-percent volume growth out of those assets," he says.

In addition, Shaper says growth at the company comes from tariff increases from the pipeline business. "We'll get four percent growth in revenue every year," he says of the pipeline business. Vasey point out in his report that an MLP usually contains assets generally that are of diminishing value, so an MLP usually maintains growth by acquiring more assets.

"We [do] also look to expand our assets. Whether that is build a new pipeline, expand a storage facility, add tanks, add a terminal facility, generally with contracts from customers that support that investment. So, that is the other component of that growth," says Shaper.

In fact, in early August, Kinder Morgan dominated the headlines after announcing plans to buy Canada's Terasen Inc. in a $5.6 billion deal that would expand the company's natural gas and petroleum-pipeline operations in North America.

The transaction is the second-biggest U.S. buy of