Use these links to rapidly review the document
TABLE OF CONTENTS
TABLE OF CONTENTS
INDEX TO KNIGHT INC. FINANCIAL STATEMENTS
As filed with the Securities and Exchange Commission on February 12, 2009
Registration No. 333-156783
Registration No. 333-156783-01
Registration No. 333-156783-02
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
PRE-EFFECTIVE
AMENDMENT
NO. 1 TO
REGISTRATION STATEMENTS
UNDER
THE SECURITIES ACT OF 1933
FORM S-3 | FORM S-1 | |
Kinder Morgan Management, LLC Kinder Morgan Energy Partners, L.P. (Exact name of registrant as specified in its charter) |
Knight Inc. (Exact name of registrant as specified in its charter) |
|
Delaware Delaware (State or other jurisdiction of incorporation or organization) |
Kansas (State or other jurisdiction of incorporation or organization) |
|
76-0669886 76-0380342 (I.R.S. Employer Identification Number) |
48-0290000 (I.R.S. Employer Identification Number) |
|
4610 4610 (Primary Standard Industrial Classification Code Number) |
4923 (Primary Standard Industrial Classification Code Number) |
500 Dallas Street, Suite 1000 Houston, Texas 77002 (713) 369-9000 (Address, including zip code, and telephone number, including area code, of each registrant's principal executive offices) |
Joseph Listengart 500 Dallas Street, Suite 1000 Houston, Texas 77002 (713) 369-9000 (Name, address, including zip code, and telephone number, including area code, of agent for service) |
Copy to:
Gary W. Orloff
Bracewell & Giuliani LLP
711 Louisiana Street, Suite 2300
Houston, TX 77002-2770
(713) 221-1306
(713) 221-2166 (Fax)
Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of these registration statements.
If the only securities being registered on this Form are being offered pursuant to dividend or interest reinvestment plans, please check the following box o
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other than securities offered only in connection with dividend or interest reinvestment plans, check the following box. o
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this Form is a registration statement pursuant to General Instruction I.D. or a post-effective amendment thereto that shall become effective upon filing with the Commission pursuant to Rule 462(e) under the Securities Act, check the following box. o
If this Form is a post-effective amendment to a registration statement filed pursuant to General Instruction I.D. filed to register additional securities or additional classes of securities pursuant to Rule 413(b) under the Securities Act, check the following box. o
Indicate whether each registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Kinder Morgan Management, LLCLarge Accelerated Filer
Kinder Morgan Energy Partners, L.P.Large Accelerated Filer
Knight Inc.Non-accelerated Filer
The Registrants hereby amend these Registration Statements on such date or dates as may be necessary to delay their effective date until the Registrants shall file a further amendment which specifically states that these Registration Statements shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statements shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.
EXPLANATORY NOTE
These registration statements contain a prospectus to be used in connection with the offer and sale of Kinder Morgan Management, LLC shares. These registration statements also register:
The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.
Subject to Completion, dated February 11, 2009.
PRELIMINARY PROSPECTUS
Shares
Representing Limited Liability Company Interests
We are offering to sell up to shares representing limited liability company interests of Kinder Morgan Management, LLC. Our shares are listed on the New York Stock Exchange under the symbol "KMR." On , 2009, the last reported sale price of our shares on the New York Stock Exchange was $ per share.
Investing in the shares involves risks. "Risk Factors" begin on page 4.
|
Per Share | Total | |||||
---|---|---|---|---|---|---|---|
Public offering price |
$ | $ | |||||
Underwriting discount |
$ | $ | |||||
Proceeds to us before expenses |
$ | $ |
We have granted the underwriters a 30-day option to purchase up to shares on the same terms and conditions as set forth above if the underwriters sell more than shares in this offering.
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
The underwriters expect to deliver the shares on or about , 2009.
The date of this prospectus is , 2009.
|
Page | |
---|---|---|
ii | ||
1 | ||
4 | ||
10 | ||
10 | ||
11 | ||
20 | ||
Modification of Fiduciary Duties Owed to our Shareholders and to the Owners of Units |
22 | |
25 | ||
30 | ||
32 | ||
35 | ||
35 | ||
35 | ||
A-1 |
You should rely only on the information contained or incorporated by reference in this prospectus. Kinder Morgan Management, LLC, Kinder Morgan Energy Partners, L.P. and Knight Inc. have not authorized anyone to provide you with different information. This prospectus may only be used where it is legal to sell the offered securities. You should not assume that the information in this prospectus is accurate as of any date other than the date on the front cover of this prospectus. You should not assume that the information incorporated by reference in this prospectus is accurate as of any date other than the date the respective information was filed with the Securities and Exchange Commission. The business, financial condition, results of operations and prospects of Kinder Morgan Management, LLC, Kinder Morgan Energy Partners, L.P. and Knight Inc., respectively, may have changed since those dates.
i
WHERE YOU CAN FIND MORE INFORMATION
Kinder Morgan Management, LLC and Kinder Morgan Energy Partners, L.P. have filed on Form S-3, and Knight Inc. has filed on Form S-1, a registration statement with the Securities and Exchange Commission, or the SEC, under the Securities Act of 1933, as amended, or the Securities Act, with respect to the securities offered in this offering. This prospectus, which is a part of the registration statement, does not contain all of the information set forth in the registration statement, or the exhibits that are part of the registration statement, parts of which are omitted as permitted by the rules and regulations of the SEC. For further information about Kinder Morgan Management, LLC, Kinder Morgan Energy Partners, L.P. and Knight Inc. and about the securities to be sold in this offering, please refer to the information below and to the registration statement, which term includes all amendments, and to the exhibits which are part of the registration statement.
Kinder Morgan Management, LLC, Kinder Morgan Energy Partners, L.P. and Knight Inc. file annual, quarterly and special reports and other information with the SEC. While Kinder Morgan Management, LLC and Kinder Morgan Energy Partners, L.P. are required to make such filings, Knight Inc. voluntarily makes annual and quarterly filings. The SEC allows Kinder Morgan Management, LLC and Kinder Morgan Energy Partners, L.P. to incorporate by reference the information they file with it, which means that Kinder Morgan Management, LLC and Kinder Morgan Energy Partners, L.P. can disclose important information to you by referring you to those documents. The information incorporated by reference is an important part of this prospectus, and information that Kinder Morgan Management, LLC and Kinder Morgan Energy Partners, L.P. file later with the SEC will automatically update and supersede this information as well as the information in this prospectus. Some documents or information, such as that called for by Items 2.02 and 7.01 of Form 8-K, are deemed furnished and not filed in accordance with SEC rules. None of those documents and none of that information is incorporated by reference into this prospectus. Kinder Morgan Management, LLC and Kinder Morgan Energy Partners, L.P. incorporate by reference the documents listed below and any future filings made with the SEC under Sections 13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of 1934 until the completion of the sale of the securities offered hereby:
Kinder Morgan Management, LLC SEC Filings (File No. 1-16459) |
Period | |
---|---|---|
Annual Report on Form 10-K |
Year ended December 31, 2007 |
|
Quarterly Reports on Form 10-Q |
Quarters ended March 31, 2008, June 30, 2008 and September 30, 2008 |
|
Current Report on Form 8-K |
Filed January 23, 2009 |
|
Registration Statement on Form 8-A/A |
Filed July 24, 2002 |
|
Kinder Morgan Energy Partners, L.P. SEC Filings (File No. 1-11234) |
Period |
|
Annual Report on Form 10-K |
Year ended December 31, 2007 |
|
Quarterly Reports on Form 10-Q |
Quarters ended March 31, 2008, June 30, 2008 and September 30, 2008 |
|
Current Reports on Form 8-K |
Filed April 21, 2008, June 23, 2008, July 25, 2008, September 19, 2008, January 12, 2009, January 16, 2009 and January 23, 2009 |
|
Registration Statement on Form 8-A/A |
Filed March 7, 2002 |
The SEC maintains an Internet web site that contains reports, proxy and information statements and other material that are filed through the SEC's Interactive Data Electronic Applications (IDEA) System. This system can be accessed at http://www.sec.gov. You can find information Kinder Morgan Management, LLC, Kinder Morgan Energy Partners, L.P. and Knight Inc. file with the SEC by
ii
reference to their respective names or to their respective SEC file numbers. You may read and copy any document they file with the SEC at the SEC's public reference room located at:
100 F
Street, N.E., Room 1580
Washington, D.C. 20549
Please call the SEC at 1-800-SEC-0330 for further information on the public reference room and its copy charges. Because Kinder Morgan Management, LLC's shares and Kinder Morgan Energy Partners, L.P.'s common units are listed on the New York Stock Exchange, their SEC filings are available to the public through the exchange at 20 Broad Street, New York, New York 10005.
Kinder Morgan Management, LLC and Kinder Morgan Energy Partners, L.P., respectively, will provide a copy of any document incorporated by reference in this prospectus and any exhibit specifically incorporated by reference in those documents at no cost by request directed to them at the following address and telephone number:
Kinder
Morgan Management, LLC
Kinder Morgan Energy Partners, L.P.
Investor Relations Department
500 Dallas Street, Suite 1000
Houston, Texas 77002
(713) 369-9000
The information concerning Kinder Morgan Energy Partners, L.P. contained or incorporated by reference in this document has been provided by Kinder Morgan Energy Partners, L.P., and the information concerning Knight Inc. contained in this document has been provided by Knight Inc.
iii
This summary highlights information contained elsewhere in this prospectus. It does not contain all of the information that you should consider before making an investment decision. We urge you to read the entire prospectus and the documents incorporated by reference in this prospectus carefully, including the financial statements and notes to those financial statements included or incorporated by reference in this prospectus. Please read "Risk Factors" and "Information Regarding Forward-Looking Statements" herein and in the Annual Reports on Form 10-K for the year ended December 31, 2007 of Kinder Morgan Management, LLC and Kinder Morgan Energy Partners, L.P. and their subsequently filed Exchange Act reports for more information about important risks that you should consider before investing in the shares. Unless the context indicates otherwise, information presented in this prospectus assumes the underwriters do not exercise their option to purchase additional common shares. As used in this prospectus, other than Annex A, "we," "us" and "our" mean Kinder Morgan Management, LLC and, unless the context otherwise indicates, include its subsidiaries; and "Kinder Morgan Energy Partners" means Kinder Energy Partners, L.P. and, unless the context otherwise indicates, includes its subsidiary operating limited partnerships and their subsidiaries.
Kinder Morgan Management, LLC
We are a limited liability company, formed in Delaware in February 2001, that has elected to be treated as a corporation for United States federal income tax purposes. Our shares trade on the NYSE under the symbol "KMR." We are a limited partner in Kinder Morgan Energy Partners and manage and control its business and affairs. The outstanding shares of the class that votes to elect our directors are owned by Kinder Morgan G.P., Inc., the general partner of Kinder Morgan Energy Partners. Kinder Morgan G.P., Inc. has delegated to us, to the fullest extent permitted under Delaware law and the Kinder Morgan Energy Partners partnership agreement, all of its rights and powers to manage and control the business and affairs of Kinder Morgan Energy Partners and its subsidiary operating limited partnerships and their subsidiaries, subject to Kinder Morgan G.P., Inc.'s right to approve specified actions.
Kinder Morgan Energy Partners, L.P.
Kinder Morgan Energy Partners is a limited partnership, formed in Delaware in August 1992, with its common units traded on the NYSE under the symbol "KMP." Kinder Morgan Energy Partners is one of the largest publicly-traded pipeline limited partnerships in the United States in terms of market capitalization. Kinder Morgan Energy Partners' operations are conducted through its subsidiary operating limited partnerships and their subsidiaries and are grouped into the following business segments: Products Pipelines, Natural Gas Pipelines, CO2, Terminals and Kinder Morgan Canada.
Knight Inc.
Knight Inc. (formerly Kinder Morgan, Inc.) is a Kansas corporation incorporated in 1927. Knight Inc. is not publicly owned. Knight Inc. is a large energy transportation and storage company, operating or owning an interest in approximately 37,000 miles of pipelines and approximately 165 terminals. Knight Inc. owns all the common equity of the general partner of, and a significant limited partner interest in, Kinder Morgan Energy Partners. Knight Inc. also owns a significant number of our shares. Under the terms of an agreement, which is part of our limited liability company agreement, upon the occurrence of specified mandatory purchase events, Knight Inc. will be required to purchase for cash all of our shares that it and its affiliates do not own. For more information regarding Knight Inc., please read Annex A.
Principal Offices
The principal executive office of each of Kinder Morgan Management, LLC, Kinder Morgan Energy Partners and Knight Inc. is located at 500 Dallas, Suite 1000, Houston, Texas 77002, and the phone number at this address is (713) 369-9000.
1
Organizational Structure
The following chart depicts the current organizational structure of Kinder Morgan Management, LLC, Kinder Morgan Energy Partners and Knight Inc.
On December 19, 2008, Kinder Morgan Energy Partners issued $500 million of its 9.00% senior notes due February 1, 2019. Kinder Morgan Energy Partners received net proceeds of approximately $498.2 million which were used to reduce borrowings under its revolving bank credit agreement and for general partnership purposes. The notes contain a provision allowing each holder to require Kinder Morgan Energy Partners to repurchase all or a portion of the notes held by such holder on February 1, 2012 at a purchase price equal to 100% of the principal amounts tendered by the holder plus accrued and unpaid interest.
On December 22, 2008, Kinder Morgan Energy Partners completed an offering of 3.9 million of its common units at a price of $46.75 per common unit. Kinder Morgan Energy Partners received net proceeds of approximately $177 million, which were used to reduce borrowings under its revolving bank credit agreement and for general partnership purposes.
In December 2008, Kinder Morgan Energy Partners received approximately $194 million in the termination of two interest rate swap agreements having a combined notional value of $700 million, of which $375 million was associated with its 5.95% senior notes due 2018 and $325 million was associated with its 6.95% senior notes due 2038. In January 2009, Kinder Morgan Energy Partners received approximately $144 million in the termination of an interest rate swap agreement having a combined notional value of $300 million associated with its 7.40% senior notes due 2031.
2
The Offering
Shares offered by Kinder Morgan Management, LLC |
shares ( shares if the underwriters' over-allotment option is exercised in full). | |
Shares to be outstanding after this offering (based on the number of shares outstanding on , 2009) |
shares ( shares if the underwriters' over-allotment option is exercised in full). | |
Public offering price |
$ per share. | |
New York Stock Exchange symbol |
KMR | |
Use of proceeds |
We estimate that our net proceeds from this offering, after deducting the underwriting discount and estimated expenses of the offering payable by us, will be approximately $ million. We will use the net proceeds of this offering to purchase from Kinder Morgan Energy Partners a number of i-units equal to the number of shares we sell in this offering. Kinder Morgan Energy Partners intends to use the proceeds it receives from our purchase of i-units to repay borrowings under its revolving bank credit facility and for general partnership purposes. The underwriters or their affiliates may receive proceeds from this offering if they are lenders under the revolving bank credit facility. Please see "UnderwritingRelationships/FINRA Rules." | |
Timing of quarterly distributions |
We make distributions on our shares on a quarterly basis. The distributions are in the form of additional shares. We generally pay distributions on our shares within 45 days following each March 31, June 30, September 30 and December 31. We will declare and pay the first distribution payable to purchasers of the shares offered by this prospectus in the quarter of 2009. Purchasers of these shares will be entitled to that distribution if they own such shares on the record date. The amount of the distribution is generally calculated by dividing the Kinder Morgan Energy Partners cash distribution on each of its common units by the average closing price of our shares on the NYSE for the 10 trading days prior to the ex-dividend date of our shares. Please read "Price Range of Shares and Distributions" and "Description of Our SharesDistributions" for further information about our distribution policy. | |
Risk factors |
See "Risk Factors" and other information included or incorporated by reference in this prospectus for a discussion of factors you should carefully consider before deciding to invest in our shares. |
3
You should carefully consider the risks described below, in addition to the other information contained or incorporated by reference in this prospectus. Specifically, please see "Information Regarding Forward-Looking Statements" and "Risk Factors" included in the Annual Reports on Form 10-K for the year ended December 31, 2007 of Kinder Morgan Management, LLC and Kinder Morgan Energy Partners and their subsequently filed Exchange Act reports for a discussion of risks and events that may affect our business. You also should carefully consider the risks related to Knight Inc. described in Annex A under the caption "Risk Factors." Realization of any of those risks or events could have a material adverse effect on our business, financial condition, cash flows and results of operations. Realization of any of those or the following risks could result in a decline in the trading price of our shares, and you might lose all or part of your investment.
Because our only significant assets are the i-units issued by Kinder Morgan Energy Partners, our success is dependent solely upon our operation and management of Kinder Morgan Energy Partners and its resulting performance.
We are a limited partner in Kinder Morgan Energy Partners. In the event that Kinder Morgan Energy Partners decreases its cash distributions to its common unitholders, distributions of i-units on the i-units that we own will decrease correspondingly, and distributions of additional shares to owners of our shares will decrease as well. The risk factors that affect Kinder Morgan Energy Partners also affect us. Please see the risk factors described in Kinder Morgan Energy Partners' Annual Report on Form 10-K for the year ended December 31, 2007 and its subsequent Exchange Act reports, which are incorporated in this prospectus by reference.
The value of the quarterly distribution of an additional fractional share may be less than the cash distribution on a common unit of Kinder Morgan Energy Partners.
The fraction of a Kinder Morgan Management, LLC share to be issued per share outstanding with each quarterly distribution is based on the average closing price of the shares for the ten consecutive trading days preceding the ex-dividend date for our shares. Because the market price of our shares may vary substantially over time, the market value of our shares on the date a shareholder receives a distribution of additional shares may vary substantially from the cash the shareholder would have received had the shareholder owned common units instead of our shares.
The tax treatment applied to Kinder Morgan Energy Partners depends on its status as a partnership for United States federal income tax purposes, as well as Kinder Morgan Energy Partners not being subject to a material amount of entity-level taxation by individual states. If the IRS treats Kinder Morgan Energy Partners as a corporation or Kinder Morgan Energy Partners becomes subject to a material amount of entity-level taxation for state tax purposes, it would substantially reduce the amount of cash available for distribution to common unitholders, the value of i-units that Kinder Morgan Energy Partners will distribute quarterly to us and the value of our shares that we will distribute quarterly to our shareholders.
The anticipated benefit of an investment in our shares depends largely on the treatment of Kinder Morgan Energy Partners as a partnership for United States federal income tax purposes. In order for Kinder Morgan Energy Partners to be treated as a partnership for United States federal income tax purposes, current law requires that 90% or more of its gross income for every taxable year consist of "qualifying income," as defined in Section 7704 of the Internal Revenue Code. Kinder Morgan Energy Partners may not meet this requirement or current law may change so as to cause, in either event, Kinder Morgan Energy Partners to be treated as a corporation for United States federal income tax purposes or otherwise subject to United States federal income tax. Kinder Morgan Energy Partners has not requested, and does not plan to request, a ruling from the IRS on this or any other matter affecting Kinder Morgan Energy Partners.
4
If Kinder Morgan Energy Partners were to be treated as a corporation for United States federal income tax purposes, it would pay United States federal income tax on its income at the corporate tax rate, which is currently a maximum of 35%, and would pay state income taxes at varying rates. Distributions to us of additional i-units would generally be taxed as a corporate distribution. Because a tax would be imposed upon Kinder Morgan Energy Partners as a corporation, the cash available for distribution to common unitholders would be substantially reduced, which would reduce the values of i-units distributed quarterly to us and our shares distributed quarterly to our shareholders. Treatment of Kinder Morgan Energy Partners as a corporation would cause a substantial reduction in the value of our shares.
Current law or Kinder Morgan Energy Partners' business may change so as to cause Kinder Morgan Energy Partners to be treated as a corporation for United States federal income tax purposes or otherwise subject Kinder Morgan Energy Partners to entity-level taxation. Members of Congress are considering substantive changes to the existing United States federal income tax laws that affect certain publicly-traded partnerships. For example, United States federal income tax legislation has been proposed that would eliminate partnership tax treatment for certain publicly-traded partnerships. Although the currently proposed legislation would not appear to affect Kinder Morgan Energy Partners' tax treatment as a partnership, we are unable to predict whether any of these changes, or other proposals, will ultimately be enacted. Any such changes could negatively impact the value of an investment in our shares.
In addition, because of widespread state budget deficits and other reasons, several states are evaluating ways to subject partnerships to entity-level taxation through the imposition of state income, franchise or other forms of taxation. For example, Kinder Morgan Energy Partners is now subject to an entity-level tax on the portion of its total revenue that is generated in Texas. Specifically, the Texas margin tax is imposed at a maximum effective rate of 0.7% of Kinder Morgan Energy Partners' total revenue that is apportioned to Texas. This tax reduces, and the imposition of such a tax on Kinder Morgan Energy Partners by any other state will reduce, Kinder Morgan Energy Partners' cash available for distribution to its partners. If any state were to impose a tax upon Kinder Morgan Energy Partners as an entity, the cash available for distribution to its common unitholders would be reduced, which would reduce the values of i-units distributed quarterly to us and our shares distributed quarterly to our shareholders.
Kinder Morgan Energy Partners' partnership agreement provides that if a law is enacted that subjects Kinder Morgan Energy Partners to taxation as a corporation or otherwise subjects Kinder Morgan Energy Partners to entity-level taxation for United States federal income tax purposes, the minimum quarterly distribution and the target distribution levels will be adjusted to reflect the impact on Kinder Morgan Energy Partners of that law.
As an owner of i-units, we may not receive value equivalent to the common unit value for our i-unit interest in Kinder Morgan Energy Partners if Kinder Morgan Energy Partners is liquidated. As a result, a shareholder may receive less per share in our liquidation than is received by an owner of a common unit in a liquidation of Kinder Morgan Energy Partners.
If Kinder Morgan Energy Partners is liquidated and Knight Inc. does not satisfy its obligation to purchase your shares, which is triggered by a liquidation, then the value of your shares will depend on the after-tax amount of the liquidating distribution received by us as the owner of i-units. The terms of the i-units provide that no allocations of income, gain, loss or deduction will be made in respect of the i-units until such time as there is a liquidation of Kinder Morgan Energy Partners. If there is a liquidation of Kinder Morgan Energy Partners, it is intended that we will receive allocations of income and gain in an amount necessary for the capital account attributable to each i-unit to be equal to that of a common unit. As a result, we will likely realize taxable income upon the liquidation of Kinder Morgan Energy Partners. However, there may not be sufficient amounts of income and gain to cause
5
the capital account attributable to each i-unit to be equal to that of a common unit. If they are not equal, we, and therefore our shareholders, will receive less value than would be received by an owner of common units.
Further, the tax indemnity provided to us by Knight Inc. only indemnifies us for our tax liabilities to the extent we have not received sufficient cash in the transaction generating the tax liability to pay the associated tax. Prior to any liquidation of Kinder Morgan Energy Partners, we do not expect to receive cash in a taxable transaction. If a liquidation of Kinder Morgan Energy Partners occurs, however, we likely would receive cash which would need to be used at least in part to pay taxes. As a result, our residual value and the value of our shares likely will be less than the value of the common units upon the liquidation of Kinder Morgan Energy Partners.
Kinder Morgan Energy Partners may issue additional common or other units and we may issue additional shares, which would dilute your ownership interest.
The issuance of additional common or other units by Kinder Morgan Energy Partners or shares by us other than in our quarterly distributions to you may have the following effects:
The market price of our shares on any given day generally is less than the market price of the common units of Kinder Morgan Energy Partners.
Since our initial public offering, our shares have generally traded on the New York Stock Exchange at prices at a discount to, but in general proximity to, the prices of common units of Kinder Morgan Energy Partners. Thus, the market price of our shares on any given day generally is less than the market price of the common units of Kinder Morgan Energy Partners. The market price of our shares will depend, as does the market price of the common units of Kinder Morgan Energy Partners, on many factors, including our operation and management of Kinder Morgan Energy Partners, the future performance of Kinder Morgan Energy Partners, conditions in the energy transportation and storage industry, general market conditions, and conditions relating to businesses that are similar to that of Kinder Morgan Energy Partners.
Your shares are subject to optional and mandatory purchase provisions which could result in your having to sell your shares at a time or price you do not like and could result in a taxable event to you.
If either of the optional purchase rights are exercised by Knight Inc., or if there is a mandatory purchase event, you will be required to sell your shares at a time or price that may be undesirable, and could receive less than you paid for your shares. Any sale of our shares for cash, to Knight Inc. or otherwise, will be a taxable transaction to the owner of the shares sold. Accordingly, a gain or loss will be recognized on the sale equal to the difference between the cash received and the owner's tax basis in the shares sold. For further information regarding the optional and mandatory purchase rights, please read "Description of Our SharesOptional Purchase" and "Description of Our SharesMandatory Purchase." Please also read "Material Tax ConsiderationsTax Consequences of Share Ownership."
6
Our board of directors has the power to change the terms of the shares in ways our board determines, in its sole discretion, are not materially adverse to the owners of our shares. You may not like the changes, and even if you believe the changes are materially adverse to the owners of shares, you may have no recourse to prevent them.
As an owner of our shares, you may not like the changes made to the terms of the shares and you may disagree with the board's decision that the changes are not materially adverse to you as a shareholder. Your recourse if you disagree will be limited because our limited liability company agreement gives broad latitude and discretion to the board of directors and eliminates or reduces the fiduciary duties that our board of directors would otherwise owe to you. For further information regarding amendments to the shares, our limited liability company agreement and other agreements, please read "Description of Our SharesLimited Voting Rights."
Knight Inc. may be unable to purchase shares upon the occurrence of the mandatory purchase events, resulting in a loss in value of your shares.
The satisfaction of the obligation of Knight Inc. to purchase shares following a purchase event is dependent on Knight Inc.'s financial ability to meet its obligations. There is no requirement for Knight Inc. to secure its obligation or comply with financial covenants to ensure its performance of these obligations. If Knight Inc. is unable to meet its obligations upon the occurrence of a mandatory purchase event, you may not receive cash for your shares.
A person or group owning 20% or more of the aggregate number of issued and outstanding Kinder Morgan Energy Partners common units and our shares, other than Knight Inc. and its affiliates, may not vote common units or shares; as a result, you are less likely to receive a premium for your shares in a hostile takeover.
Any common units and shares owned by a person or group that owns 20% or more of the aggregate number of issued and outstanding common units and shares cannot be voted. This limitation does not apply to Knight Inc. and its affiliates. This provision may:
For example, a third party will probably not attempt to remove the general partner of Kinder Morgan Energy Partners and take over our management of Kinder Morgan Energy Partners by making a tender offer for the common units at a price above their trading market price.
Owners of our shares have limited voting rights and therefore have little or no opportunity to influence or change our management.
Kinder Morgan G.P., Inc. owns all of our shares eligible to vote on the election of our directors and, therefore, is entitled to elect all of the members of our board of directors. For a description of the limited voting rights you will have as an owner of shares, see "Description of Our SharesLimited Voting Rights."
Kinder Morgan G.P., Inc. has delegated to us, to the fullest extent permitted under Delaware law and the Kinder Morgan Energy Partners partnership agreement, all of its rights and powers to manage and control the business and affairs of Kinder Morgan Energy Partners, subject to Kinder Morgan G.P., Inc.'s right to approve specified actions.
7
There is a potential for change of control if Knight Inc. defaults on debt.
Knight Inc. owns all of the outstanding capital stock of the general partner of Kinder Morgan Energy Partners. If Knight Inc. defaults on its debt, in exercising their rights as lenders, Knight Inc.'s lenders could acquire control of the general partner of Kinder Morgan Energy Partners or otherwise influence the general partner of Kinder Morgan Energy Partners through control of Knight Inc.
Our limited liability company agreement restricts or eliminates a number of the fiduciary duties that would otherwise be owed by our board of directors to our shareholders, and the partnership agreement of Kinder Morgan Energy Partners restricts or eliminates a number of the fiduciary duties that would otherwise be owed by the general partner to the unitholders.
Modifications of state law standards of fiduciary duties may significantly limit the ability of our shareholders and the unitholders to successfully challenge the actions of our board of directors and the general partner of Kinder Morgan Energy Partners, respectively, in the event of a breach of their fiduciary duties. These state law standards include the duties of care and loyalty. The duty of loyalty, in the absence of a provision in the limited liability company agreement or the limited partnership agreement to the contrary, would generally prohibit our board of directors or the general partner of Kinder Morgan Energy Partners from taking any action or engaging in any transaction as to which it has a conflict of interest. Our limited liability company agreement and the limited partnership agreement of Kinder Morgan Energy Partners contain provisions that prohibit our shareholders and the limited partners, respectively, from advancing claims that otherwise might raise issues as to compliance with fiduciary duties or applicable law. For example, the limited partnership agreement of Kinder Morgan Energy Partners provides that the general partner of Kinder Morgan Energy Partners may take into account the interests of parties other than Kinder Morgan Energy Partners in resolving conflicts of interest. Further, it provides that in the absence of bad faith by the general partner of Kinder Morgan Energy Partners, the resolution of a conflict by the general partner will not be a breach of any duty. The provisions relating to the general partner of Kinder Morgan Energy Partners apply equally to us as its delegate. Our limited liability company agreement provides that none of our directors or officers will be liable to us or any other person for any acts or omissions if they acted in good faith.
If the market price of our shares fluctuates after your purchase pursuant to this offering, you could lose a significant part of your investment.
There has been significant volatility in the market price and trading volume of equity securities, which often is unrelated to the financial performance of the companies issuing the securities. The market price of our shares is likely to be similarly volatile, and you may not be able to resell your shares at or above your purchase price due to fluctuations in the market price of our shares, including changes in price caused by factors unrelated to our or Kinder Morgan Energy Partners' operating performance or prospects.
Specific factors that may have a significant effect on the market price for our shares include:
8
In addition, many of the other risks that are described under the heading "Risk Factors" in the Annual Reports on Form 10-K for the year ended December 31, 2007, of Kinder Morgan Energy Management, LLC and Kinder Morgan Energy Partners and their subsequent Quarterly Reports on Form 10-Q filed during 2008 and any subsequently filed Annual Reports or other Exchange Act reports could also materially and adversely affect the price of our shares. Stock markets have experienced price and volume volatility that has affected the market price of many companies' equity securities. Fluctuations such as those could affect the market price of our shares.
9
We will use all the net proceeds from the sale of shares in this offering to purchase i-units from Kinder Morgan Energy Partners. Kinder Morgan Energy Partners intends to use virtually all of the proceeds from our purchase of i-units to repay borrowings under its revolving bank credit facility and for general partnership purposes. As of , 2009, the weighted average interest rate on the revolving bank credit facility borrowings to be repaid was approximately % and Kinder Morgan Energy Partners' outstanding borrowings under the credit facility were approximately $ million. The revolving bank credit facility matures on August 18, 2010. Affiliates of several of the underwriters are lenders under the revolving bank credit facility. The underwriters and their affiliated and associated persons may receive proceeds from this offering if they are lenders under the revolving bank credit facility. Please see "UnderwritingRelationships/FINRA Rules."
PRICE RANGE OF SHARES AND DISTRIBUTIONS
The following table sets forth, for the periods indicated, the high and low sale prices per share, as reported on the New York Stock Exchange, the principal market in which our shares are traded, and the amount of share distributions declared per share in respect of the periods indicated.
|
Price Range | |
||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
Share Distributions |
|||||||||
|
High | Low | ||||||||
2009 |
||||||||||
First quarter (through , 2009) |
$ | $ | ||||||||
2008 |
||||||||||
Fourth quarter |
50.80 | 34.01 | ||||||||
Third quarter |
56.62 | 46.45 | 0.021570 | |||||||
Second quarter |
57.32 | 51.02 | 0.018124 | |||||||
First quarter |
56.23 | 47.21 | 0.017716 | |||||||
2007 |
||||||||||
Fourth quarter |
53.19 | 46.21 | 0.017312 | |||||||
Third quarter |
53.24 | 44.06 | 0.017686 | |||||||
Second quarter |
54.70 | 49.50 | 0.016331 | |||||||
First quarter |
51.78 | 44.42 | 0.015378 |
The last reported sale price of the shares on the New York Stock Exchange on , 2009 was $ per share.
Except in connection with our liquidation, we do not pay distributions on our shares in cash. Instead, we make distributions on our shares in additional shares and fractions of shares. The amount of the distribution is generally calculated by dividing the Kinder Morgan Energy Partners cash distribution on each of its common units by the average closing price of our shares on the NYSE for the 10 trading days prior to the ex-dividend date of our shares. See "Description of Our SharesDistributions."
We will pay the first distribution on the shares offered by this prospectus in the quarter of 2009.
10
Number of Shares
Pursuant to our limited liability company agreement, all of our voting shares are held by Kinder Morgan G.P., Inc. The shares offered pursuant to this prospectus are the same class we have previously sold to the public, which we call our listed shares, and do not entitle owners of such shares to vote on the election of our directors. Other than our voting shares, as of January 31, 2009, we had 77,997,904 listed shares outstanding, including approximately 11,128,826 listed shares held by Knight Inc. and its controlled affiliates. Our limited liability company agreement does not limit the number of shares we may issue.
Where Shares are Traded
Except for our voting shares, all of which are held by Kinder Morgan G.P., Inc., our outstanding shares are listed on the New York Stock Exchange under the symbol "KMR." The shares we will issue in this offering will also be listed on the NYSE.
General
The following is a summary of the principal documents which relate to our shares, as well as documents which relate to the Kinder Morgan Energy Partners i-units that we own and that will be purchased by us upon completion of an offering of our shares. Copies of those documents are on file with the SEC as part of our registration statement. See "Where You Can Find More Information" for information on how to obtain copies. You should refer to the provisions of each of the following agreements because they, and not this summary, will govern your rights as a holder of our shares. These agreements include:
11
Distributions
Under the terms of our limited liability company agreement, except in connection with our liquidation, we do not pay distributions on our shares in cash. Instead, we make distributions on our shares in additional shares or fractions of shares. At the same time that Kinder Morgan Energy Partners makes any cash distribution on its common units, we distribute on each of our shares that fraction of a share determined by dividing the amount of the cash distribution to be made by Kinder Morgan Energy Partners on each common unit by the average market price of a share determined for the ten consecutive trading days immediately prior to the ex-dividend date for our shares.
Kinder Morgan Energy Partners distributes an amount equal to 100% of its available cash to its unitholders of record on the applicable record date and the general partner within approximately 45 days after the end of each quarter. Available cash is generally, for any calendar quarter, all cash received by Kinder Morgan Energy Partners from all sources less all of its cash disbursements and net additions to reserves.
The Kinder Morgan Energy Partners partnership agreement provides for distributions to the extent of available cash to common unitholders, Class B unitholders and the general partner in cash and to us in additional i-units except in the event of a liquidation or dissolution. Therefore, generally, non-liquidating distributions will be made in cash to owners of common units, Class B units and the general partner and in additional i-units to us.
We also will distribute to owners of our shares additional shares if owners of common units receive a cash distribution or other cash payment on their common units other than a regular quarterly distribution. In that event, we will distribute on each share that fraction of a share determined by dividing the cash distribution declared by Kinder Morgan Energy Partners on each common unit by the average market price of a share determined for a ten consecutive trading day period ending on the trading day immediately prior to the ex-dividend date for the shares.
Our limited liability company agreement provides that a shareholder's right to a distribution that has been declared (or for which a record date has been set) but that has not yet been made ceases on the purchase date if the funds for Knight Inc.'s optional or mandatory purchase of the shares are deposited with the transfer agent and the notice of purchase has been given.
There is no public market for trading fractional shares. We issue fractional shares in payment of the distribution to owners of our shares. No fraction of a share can be traded on any exchange on which our shares are traded until a holder acquires the remainder of the fraction and has a whole share.
The term average market price is used above in connection with the share distributions and it is used below in connection with the optional and mandatory purchase of our shares. When we refer to the average market price of a share or a common unit, we mean the average closing price of a share or common unit during the ten consecutive trading days prior to the determination date but not including that date, unless a longer or shorter number of trading days is expressly noted.
The closing price of securities on any day means:
12
A trading day for securities means a day on which:
Distributions are made in accordance with the New York Stock Exchange's distribution standards.
Limited Voting Rights
The shares offered pursuant to this prospectus are the same class we have previously sold to the public, and do not entitle owners of such shares to vote on the election of our directors. Kinder Morgan G.P., Inc. owns all shares eligible to elect our directors and elects all of our directors. Owners of our shares are entitled to vote on the specified matters described under the following caption.
Actions Requiring Vote of Owners of Our Shares. Our limited liability company agreement provides that we will not, without the approval of a majority of the shares owned by persons other than Knight Inc. and its affiliates, amend, alter or repeal any of the provisions of our limited liability company agreement, including the Knight Inc. purchase provisions, the Knight Inc. tax indemnification agreement or the delegation of control agreement, in a manner that materially adversely affects the preferences or rights of the owners of our shares as determined in the sole discretion of our board of directors, or reduces the time for any notice to which the holders of our shares may be entitled, except as provided below under "Actions Not Requiring the Vote of Holders."
Under the terms of Kinder Morgan Energy Partners' partnership agreement, the i-units it issues to us are entitled to vote on all matters on which the common units are entitled to vote. We will submit to a vote of our shareholders any matter submitted to us by Kinder Morgan Energy Partners for a vote of i-units. We will vote our i-units in the same way that our shareholders vote their shares for or against a matter, including non-votes or abstentions. In general, the i-units, common units and Class B units will vote together as a single class, with each i-unit, common unit and Class B unit having one vote. The i-units vote separately as a class on:
Our limited liability company agreement also provides that we will not, without the approval of a majority of our shares owned by persons other than Knight Inc. and its affiliates, take an action that we have covenanted not to take without shareholder approval, as summarized below, or issue any shares of classes other than the two classes of shares that are currently outstanding.
13
Limitations on Voting Rights of Knight Inc. and its Affiliates. The shares owned by Knight Inc. and its affiliates, generally, are entitled to vote on any matter submitted to us as the owner of i-units. Shares owned by Knight Inc. or its affiliates will not, however, be entitled to vote on the matters described below when submitted to a vote of shareholders to determine how the i-units should be voted as long as Knight Inc. or its affiliates owns our voting shares:
When any shares, including voting shares, owned by Knight Inc. and its affiliates are not entitled to vote as described above, they will be treated as not outstanding. Therefore, they will not be included in the numerator of the number of shares voting for approval or the denominator of the number of shares outstanding in determining whether the required percentage has been voted to approve a matter. Similarly, a number of i-units equal to the number of our shares, including voting shares, owned by Knight Inc. and its affiliates will be treated as not being outstanding and will not be included in the numerator or denominator in determining if the required percentage of i-units or total units has been voted to approve a matter.
Limitations on Voting Rights of 20% or More Holders. A person or group owning 20% or more of the aggregate number of issued and outstanding common units and shares is not entitled to vote its shares. Therefore, such shares will not be included in the numerator of the number of shares voting for approval or the denominator of the numbers of shares outstanding in determining whether the required percentage has been voted to approve a matter. This limitation does not apply to Knight Inc. and its affiliates, including Kinder Morgan G.P., Inc., although, as described above, there are a number of matters on which Knight Inc. and its affiliates may not vote.
Actions Not Requiring the Vote of Holders. The relevant agreements provide that notwithstanding the voting provisions described above, we may make changes in the terms of our shares, our limited liability company agreement (including the purchase provisions), the tax indemnification agreement and the delegation of control agreement without any approval of holders of our shares, in order to meet the requirements of applicable securities and other laws and regulations and exchange rules, to effect the intent of the provisions of the limited liability company agreement and to make other changes which our board of directors determines in its sole discretion will not have a material adverse effect on the preferences or rights associated with our shares or reduce the time for any notice to which the holders of our shares may be entitled. The agreements provide that we are also permitted, in the good faith discretion of our board of directors, to amend the terms of the shares and these agreements without the approval of holders of shares to accommodate the assumption of the obligations of Knight Inc. by a person, other than Knight Inc. and its affiliates, who becomes the beneficial owner of more than 50% of the total voting power of all shares of capital stock of the general partner of Kinder Morgan Energy Partners in a transaction that does not constitute a mandatory purchase event but that requires the vote of the holders of the outstanding common units and shares, or to accommodate changes resulting from a merger, recapitalization, reorganization or similar transaction involving Kinder Morgan Energy Partners which in each case does not constitute a mandatory purchase event but that requires the vote of the holders of the outstanding common units and shares. We believe that amendments made pursuant to these agreements, except in some cases in the context of a merger, recapitalization, reorganization or similar transaction, would not be significant enough to constitute the
14
issuance of a new security; but, if an amendment constituted the issuance of a new security, we would have to register the issuance of the securities with the SEC or rely on an exemption from registration.
Anti-Dilution Adjustments
The partnership agreement of Kinder Morgan Energy Partners provides that Kinder Morgan Energy Partners will adjust proportionately the number of i-units held by us through the payment to us of an i-unit distribution or by causing an i-unit subdivision, split or combination if various events occur, including:
Our limited liability company agreement provides that the number of all of our outstanding shares, including the voting shares, shall at all times equal the number of i-units we own. If there is a change in the number of i-units we own, we will make to all our shareholders a share distribution or effect a share split or combination to provide that at all times the number of shares outstanding equals the number of i-units we own. Through the combined effect of the provisions in the Kinder Morgan Energy Partners partnership agreement and the provisions of our limited liability company agreement, the number of outstanding shares and i-units always will be equal.
Covenants
Our limited liability company agreement provides that our activities will be limited to being a limited partner in, and controlling and managing the business and affairs of, Kinder Morgan Energy Partners and its operating partnerships and engaging in any lawful business, purpose or activity related thereto. It also includes provisions that are intended to maintain a one-to-one relationship between the number of i-units we own and our outstanding shares, including provisions:
Under the terms of the Kinder Morgan Energy Partners partnership agreement, Kinder Morgan Energy Partners agrees that it will not:
15
The Kinder Morgan Energy Partners partnership agreement provides that when any cash is to be received by a common unitholder as a result of a consolidation or merger of Kinder Morgan Energy Partners with or into another person, other than a consolidation or merger in which Kinder Morgan Energy Partners is a survivor and which does not result in any reclassification, conversion, exchange or cancellation of outstanding common units, or as a result of the sale or other disposition to another person of all or substantially all of the assets of Kinder Morgan Energy Partners, that payment will require Kinder Morgan Energy Partners to issue additional i-units or fractions of i-units to us except in liquidation. The distribution of additional i-units or fractions of i-units will be equal to the cash distribution on each common unit divided by the average market price of one of our shares determined for a consecutive ten day trading period ending immediately prior to the effective date of the transaction. This will result in us also issuing an equal number of shares to the holders of our shares.
Optional Purchase
The Knight Inc. purchase provisions, which are part of our limited liability company agreement, provide that if at any time Knight Inc. and its affiliates own 80% or more of our outstanding shares, then Knight Inc. has the right, but not the obligation, to purchase for cash all of our outstanding shares that Knight Inc. and its affiliates do not own. Knight Inc. can exercise its right to make that purchase by delivering notice to the transfer agent for the shares of its election to make the purchase not less than ten days and not more than 60 days prior to the date which it selects for the purchase. We will use reasonable efforts to cause the transfer agent to mail the notice of the purchase to the record holders of the shares.
The price at which Knight Inc. may make the optional purchase is equal to 110% of the higher of:
16
The Knight Inc. purchase provisions, which are a part of our limited liability company agreement, and Kinder Morgan Energy Partners' partnership agreement each provides that if at any time Knight Inc. and its affiliates own 80% or more of the outstanding common units and the outstanding shares on a combined basis, then Knight Inc. has the right to purchase all of our shares that Knight Inc. and its affiliates do not own, but only if the general partner of Kinder Morgan Energy Partners, elects to purchase all of the common units that Knight Inc. and its affiliates do not own. The price at which Knight Inc. and the general partner may make the optional purchase is equal to the highest of:
Knight Inc. or the general partner, as the case may be, may exercise its right to make the optional purchase by giving notice to the transfer agent for the shares and for the common units of its election to make the optional purchase not less than ten days and not more than 60 days prior to the date which it selects for the purchase. We will use reasonable efforts to cause the transfer agent to mail that notice of the purchase to the record holders of our shares.
If either elects to purchase either our shares or the combination of the common units and our shares, Knight Inc. and, if applicable, the general partner, will deposit the aggregate purchase price for the shares and the common units, as the case may be, with the respective transfer agents. On and after the date set for the purchase, the holders of the shares or the common units, as the case may be, will have no rights as holders of shares or common units, except to receive the purchase price, and their shares or common units will be deemed to be transferred to Knight Inc., or the general partner in the case of the common units, for all purposes.
Knight Inc. will comply with Rule 13e-3 under the Securities Exchange Act if it makes an optional purchase.
Mandatory Purchase
General. Under the terms of the Knight Inc. purchase provisions, upon the occurrence of any of the following mandatory purchase events, Knight Inc. will be required to purchase for cash all of our shares that it and its affiliates do not own at a purchase price equal to the higher of the average market price for the shares and the average market price for common units as determined for the ten-day trading period immediately prior to the date of the applicable event.
A mandatory purchase event means any of the following:
17
Procedure. Within three business days following any event requiring a mandatory purchase by Knight Inc., Knight Inc. will mail or deliver to the transfer agent for mailing to each holder of record of the shares on the earlier of the date of the purchase event and the most recent practicable date, a notice stating:
On or prior to the date of the purchase, Knight Inc. will irrevocably deposit with the transfer agent funds sufficient to pay the purchase price. Following the purchase date, a share owned by any person other than Knight Inc. and its affiliates will only represent the right to receive the purchase price.
18
For purposes of the optional and mandatory purchase provisions, including the definitions of the mandatory purchase events, Knight Inc. will be deemed to include Knight Inc., its successors by merger, and any entity that succeeds to Knight Inc.'s obligations under the purchase provisions and the tax indemnification agreement in connection with an acquisition of all or substantially all of the assets of Knight Inc.
Knight Inc. will comply with Rule 13e-3 under the Securities Exchange Act in connection with the occurrence of a mandatory purchase event.
Tax Indemnity of Knight Inc.
We have a tax indemnification agreement with Knight Inc. Pursuant to this agreement, Knight Inc. agreed to indemnify us for any tax liability attributable to our formation or our management and control of Kinder Morgan Energy Partners, and for any taxes arising out of a transaction involving our i-units to the extent the transaction does not generate sufficient cash to pay our taxes.
Transfer Agent and Registrar
Our transfer agent and registrar for the shares is Computershare Inc. It may be contacted at 525 Washington Blvd., Jersey City, New Jersey 07310.
The transfer agent and registrar may at any time resign, by notice to us, or be removed by us. That resignation or removal would become effective upon the appointment by us of a successor transfer agent and registrar and its acceptance of that appointment. If no successor has been appointed and accepted that appointment within 30 days after notice of that resignation or removal, we are authorized to act as the transfer agent and registrar until a successor is appointed.
Replacement of Share Certificates
We will replace any mutilated certificate at your expense upon surrender of that certificate to the transfer agent. We will replace certificates that become destroyed, lost or stolen at your expense upon delivery to us and the transfer agent of satisfactory evidence that the certificate has been destroyed, lost or stolen, together with any indemnity that may be required by us or by the transfer agent.
Fractional Shares
We will make distributions of additional shares, including fractional shares. Records of fractional interests held by the holders of shares will be maintained by the Depositary Trust Company or the broker or other nominees through whom you hold your shares. You will be able to sell such fractional shares on the New York Stock Exchange only when they equal, in the aggregate, whole shares. Certificates representing fractional shares will not be issued under any circumstances. Fractional shares will receive distributions when distributions are made on our shares. All fractional shares will be rounded down, if necessary, and stated in six decimal places.
19
The i-units are a separate class of limited partner interests in Kinder Morgan Energy Partners. All the i-units will be owned by us and will not be publicly traded. A number of the covenants in our limited liability company agreement and in Kinder Morgan Energy Partners' partnership agreement affect us as the holder of i-units. For a description of the material covenants, see "Description of Our SharesCovenants."
Voting Rights
Owners of i-units generally vote together with the common units and Class B units as a single class and sometimes vote as a class separate from the holders of common units and Class B units. The i-units have the same voting rights as the common units and Class B units voting together as a single class on the following matters:
The i-units vote separately as a class on the following:
In all cases, i-units will be voted in proportion to the affirmative and negative votes, abstentions and non-votes of owners of our shares.
For further information regarding the voting rights of i-units and shares of Kinder Morgan Management, LLC, see "Description of Our SharesLimited Voting Rights."
Distributions and Payments
The number of i-units distributed to us by Kinder Morgan Energy Partners is based upon the amount of cash to be distributed by Kinder Morgan Energy Partners to an owner of a common unit. Kinder Morgan Energy Partners distributes to us a number of i-units equal to the number of shares distributed by us.
Typically, if cash is paid to the holders of common units, we, as the owner of i-units, receive additional i-units or fractions of i-units instead of cash. The fraction of an i-unit received per i-unit owned by us is determined as if the cash payment on the common unit were a cash distribution.
If additional units are distributed to the owners of common units, as the owner of i-units, we receive an equivalent amount of units based on the number of i-units that we own.
20
Merger, Consolidation or Sale of Assets
In the case of any of the following events:
if the owners of the common units receive cash in the transaction, a distribution on each i-unit will be made in additional i-units or fractions of i-units determined by dividing the cash received on a common unit by the average market price of one of our shares determined for a ten consecutive day trading period ending immediately prior to the effective date of the transaction, except that in the case of a liquidation, as the owner of the i-units, we will receive the distribution provided pursuant to the liquidation provisions in Kinder Morgan Energy Partners' partnership agreement.
United States Federal Income Tax Characteristics and Distribution Upon Liquidation of Kinder Morgan Energy Partners
The i-units we own generally will not be allocated income, gain, loss or deduction until such time as there is a liquidation of Kinder Morgan Energy Partners. Therefore, we do not anticipate that we will have material amounts of taxable income resulting from our ownership of the i-units unless we enter into a sale or exchange of the i-units or Kinder Morgan Energy Partners is liquidated.
Upon the liquidation of Kinder Morgan Energy Partners, Knight Inc. is generally obligated to purchase all of our outstanding shares at a price equal to the higher of the average market price for the shares and the average market price of the common units. If Knight Inc. fails to do so, then, as described below, the value of your shares will depend on the amount of the liquidating distribution received by us as the owner of the i-units and the taxes we incur as a result of that liquidation.
The liquidating distribution per i-unit may be less than the liquidating distribution received per common unit. The liquidating distribution for each i-unit and common unit will depend upon the relative per unit capital accounts of the i-units and the common units at liquidation. It is anticipated that over time the capital account per common unit will exceed the capital account per i-unit because the common units will be allocated income and gain prior to liquidation, but the i-units will not. At liquidation, it is intended that each i-unit will be allocated income and gain in an amount necessary for the capital account attributable to each i-unit to be equal to that of a common unit. However, there may not be sufficient amounts of income and gain at liquidation to cause the capital account of an i-unit to be increased to that of a common unit. In that event, the liquidating distribution per common unit will exceed the liquidating distribution per i-unit.
As a result of the allocation of income and gain to the i-units upon a liquidation, we will be required to pay taxes on that income and gain. Thus, in the event income and gain is allocated to us, then, because of taxes we pay, shareholders will receive less than the holders of the common units.
Because of these factors, and if Knight Inc. fails to purchase our shares as described above, the value of our shares likely will be lower than the value of the common units upon the liquidation of Kinder Morgan Energy Partners.
21
MODIFICATION OF FIDUCIARY DUTIES OWED TO OUR SHAREHOLDERS
AND TO THE OWNERS OF UNITS
The fiduciary duties owed to you by our board of directors are prescribed by Delaware law and our limited liability company agreement. Similarly, the fiduciary duties owed to the owners of units of Kinder Morgan Energy Partners by the general partner of Kinder Morgan Energy Partners are prescribed by Delaware law and its partnership agreement. The Delaware Limited Liability Company Act and the Delaware Limited Partnership Act provide that Delaware limited liability companies and Delaware limited partnerships, respectively, may, in their limited liability company agreements and partnership agreements, as applicable, restrict the fiduciary duties owed by the board of directors to us and our shareholders and by the general partner to the limited partnership and the limited partners.
Our limited liability company agreement and the Kinder Morgan Energy Partners partnership agreement contain various provisions restricting the fiduciary duties that might otherwise be owed. The following is a summary of the material restrictions of the fiduciary duties owed by our board of directors to us and our shareholders and by Kinder Morgan G.P., Inc., the general partner of Kinder Morgan Energy Partners, to the partnership and its limited partners. Any fiduciary duties owed to you by Knight Inc. and its affiliates, as the beneficial owner of all our voting shares, are similarly restricted or eliminated.
State-law fiduciary duty standards | Fiduciary duties are generally considered to include an obligation to act with due care and loyalty. The duty of care, unless the limited liability company agreement or partnership agreement provides otherwise, would generally require a manager or general partner to act for the limited liability company or limited partnership, as applicable, in the same manner as a prudent person would act on his own behalf. The duty of loyalty, in the absence of a provision in a limited liability company agreement or partnership agreement providing otherwise, would generally prohibit a manager of a Delaware limited liability company or a general partner of a Delaware limited partnership from taking any action or engaging in any transaction where a conflict of interest is present. | |
Our limited liability company agreement modifies these standards |
Our limited liability company agreement contains provisions that prohibit the shareholders from advancing claims arising from conduct by our board of directors that might otherwise raise issues as to compliance with fiduciary duties or applicable law. For example, our limited liability company agreement permits the board of directors to make a number of decisions in its "sole discretion." This entitles the board of directors to consider only the interests and factors that it desires, and it has no duty or obligation to give any consideration to any interest of, or factors affecting, us, our affiliates or any shareholder. Knight Inc., its affiliates, and their officers and directors who are also our officers or directors are not required to offer to us any business opportunity. |
22
Except as set out in our limited liability company agreement, our directors, Knight Inc. and their affiliates have no obligations, by virtue of the relationships established pursuant to that agreement, to take or refrain from taking any action that may impact us or our shareholders. In addition to the other more specific provisions limiting the obligations of our board of directors, our limited liability company agreement further provides that our board of directors will not be liable for monetary damages to us, our shareholders or any other person for any acts or omissions if our board of directors acted in good faith. | ||
Kinder Morgan Energy Partners' limited partnership agreement modifies these standards |
The limited partnership agreement of Kinder Morgan Energy Partners contains provisions that prohibit its limited partners from advancing claims arising from conduct by Kinder Morgan Energy Partners' general partner that might otherwise raise issues as to compliance with fiduciary duties or applicable law. For example, the limited partnership agreement of Kinder Morgan Energy Partners permits the general partner of the partnership to make a number of decisions in its "sole discretion." This entitles the general partner to consider only the interests and factors that it desires, and it has no duty or obligation to give any consideration to any interest of, or factors affecting, the partnership, its affiliates or any limited partner. Knight Inc., its affiliates and their officers and directors who are also our officers or directors or officers or directors of the general partner of Kinder Morgan Energy Partners are not required to offer to the partnership any business opportunity. The general partner of Kinder Morgan Energy Partners is permitted to attempt to avoid personal liability in connection with the management of Kinder Morgan Energy Partners, pursuant to the partnership agreement. The partnership agreement provides that the general partner does not breach its fiduciary duty even if the partnership could have obtained more favorable terms without limitations on the general partner's liability. |
23
The partnership agreement of Kinder Morgan Energy Partners contains provisions that allow the general partner to take into account the interests of parties in addition to Kinder Morgan Energy Partners in resolving conflicts of interest, thereby limiting its fiduciary duty to the partnership and the limited partners. The partnership agreement also provides that in the absence of bad faith by the general partner, the resolution of a conflict by the general partner will not be a breach of any duty. Also, the partnership agreement contains provisions that may restrict the remedies available to limited partners for actions taken that might, without such limitations, constitute breaches of fiduciary duty. In addition to the other more specific provisions limiting the obligations of the general partner, the partnership agreement provides that the general partner, its affiliates and their respective officers and directors will not be liable for monetary damages to the partnership, its limited partners or any other person for acts or omissions if the general partner, affiliate or officer or director acted in good faith. We or the general partner may request that the conflicts and audit committee of the general partner's board of directors review and approve the resolution of conflicts of interest that may arise between Knight Inc. or its subsidiaries, on the one hand, and Kinder Morgan Energy Partners, on the other hand. | ||
All of these provisions in the Kinder Morgan Energy Partners partnership agreement relating to the general partner apply equally to us as the delegate of the general partner. |
By becoming one of our shareholders, a shareholder agrees to be bound by the provisions in our limited liability company agreement, including the provisions discussed above. This is in accordance with the policy of the Delaware Limited Liability Company Act favoring the principle of freedom of contract and the enforceability of limited liability company agreements. It is not necessary for a shareholder to sign our limited liability company agreement in order for the limited liability company agreement to be enforceable against that person.
24
This section is a summary of material United States federal income tax considerations that may be relevant to prospective owners of shares and, unless otherwise noted in the following discussion, expresses the opinion of our counsel, Bracewell & Giuliani LLP, insofar as it relates to legal conclusions with respect to United States federal income tax law. This section is based upon current provisions of the Internal Revenue Code, existing and proposed Treasury Regulations and current administrative rulings and court decisions, all of which are subject to change. Later changes in these authorities may cause the tax consequences to vary substantially from the consequences described below.
No attempt has been made in the following discussion to comment on all United States federal income tax matters affecting us, Kinder Morgan Energy Partners or the owners of shares. Moreover, the discussion does not address the United States federal income tax consequences that may be relevant to certain types of investors subject to specialized tax treatment, such as non-U.S. persons, financial institutions, insurance companies, real estate investment trusts, estates, trusts, dealers and persons entering into hedging transactions. Accordingly, each prospective owner of shares is urged to consult with, and is urged to depend on, his own tax advisor in analyzing the United States federal, state, local and non-United States tax consequences particular to him of the ownership or disposition of shares.
All statements as to matters of law and legal conclusions, but not as to factual matters, contained in this section, unless otherwise noted, are the opinion of Bracewell & Giuliani LLP and are based on the accuracy of the representations made by us and, where applicable, Kinder Morgan Energy Partners and the general partner of Kinder Morgan Energy Partners.
No ruling has been or will be requested from the IRS regarding any matter affecting us or prospective owners of shares. Unlike a ruling, the opinion of Bracewell & Giuliani LLP represents only that firm's best legal judgment and does not bind the IRS or the courts. Accordingly, the opinions and statements made here may not be sustained by a court if contested by the IRS. Any contest of this sort with the IRS may materially and adversely impact the market for shares and the prices at which shares trade. In addition, the cost of any contest with the IRS will be borne directly or indirectly by us and the owners of shares. Furthermore, the tax treatment of us or Kinder Morgan Energy Partners or of an investment in us or Kinder Morgan Energy Partners may be significantly modified by future legislative or administrative changes or court decisions. Any modifications may or may not be retroactively applied.
U.S. Federal Income Tax Considerations Associated with the Ownership and Disposition of Shares
Kinder Morgan Management, LLC's Status as a Corporation For United States Federal Income Tax Purposes
An election has been made with the IRS to treat us as a corporation for United States federal income tax purposes. Thus, we are subject to United States federal income tax on our taxable income at tax rates up to 35%. Additionally, in certain instances we could be subject to the alternative minimum tax of 20% on our alternative minimum taxable income to the extent that the alternative minimum tax exceeds our regular tax.
The terms of the i-units provide that the i-units owned by us are not entitled to allocations of income, gain, loss or deduction of Kinder Morgan Energy Partners until such time as it is liquidated. Thus, we do not anticipate that we will have material amounts of either taxable income or alternative minimum taxable income resulting from our ownership of the i-units unless we dispose of the i-units in a taxable transaction or Kinder Morgan Energy Partners is liquidated. Please read "U.S. Federal Income Tax Considerations Associated with the Ownership of i-units."
25
Tax Consequences of Share Ownership
No Flow-Through of Our Taxable Income. Because we are treated as a corporation for United States federal income tax purposes, an owner of shares will not report on its United States federal income tax return any of our items of income, gain, loss and deduction.
Distributions of Additional Shares. Under the terms of our limited liability company agreement, except in connection with our liquidation, we will not make distributions of cash in respect of shares but rather will make distributions of additional shares. Because these distributions of additional shares will be made proportionately to all owners of shares, the receipt of these additional shares will not be includable in the gross income of an owner of shares for United States federal income tax purposes. As each owner of shares receives additional shares, he will be required to allocate his basis in his shares in the manner described below. Please read "Basis of Shares."
Basis of Shares. An owner's initial tax basis for his shares will be the amount paid for them. As additional shares are distributed to an owner of shares, he will be required to allocate his tax basis in his shares equally between the old shares and the new shares received. If the old shares were acquired for different prices, and the owner can identify each separate lot, then the basis of each old lot of shares can be used separately in the allocation to the new shares received with respect to the identified old lot. If an owner of shares cannot identify each lot, then he must use the first-in first-out tracing approach. A shareholder cannot use the average cost for all lots for this purpose.
Disposition of Shares. Gain or loss will be recognized on a sale or other disposition of shares, whether to a third party or to Knight Inc. pursuant to the Knight Inc. purchase provisions or in connection with the liquidation of us, equal to the difference between the amount realized and the owner's tax basis for the shares sold or otherwise disposed of. An owner's amount realized will be measured by the sum of the cash and the fair market value of other property received by him.
Except as noted below, gain or loss recognized by an owner of shares, other than a "dealer" in shares, on the sale or other disposition of a share will generally be taxable as capital gain or loss. Capital gain recognized by an individual on the sale of shares held more than 12 months will generally be taxed at a maximum rate of 15%, subject to the discussion below relating to straddles. Capital gain recognized by a corporation on the sale of shares will generally be taxed at a maximum rate of 35%. Net capital loss may offset capital gains and no more than $3,000 of ordinary income, in the case of individuals, and may only be used to offset capital gains in the case of corporations.
Capital gain treatment may not result from a sale of shares to Knight Inc. pursuant to the Knight Inc. purchase provisions or otherwise if a single shareholder of us or our shareholders as a group own 50% or more of the stock of Knight Inc. In that case, if either we or Knight Inc. has earnings and profits, then the amount received by a seller of shares may be taxed as ordinary income to the extent of his portion of those earnings and profits, but only if the seller sells less than all of his shares or is a shareholder of Knight Inc. after applying the ownership attribution rules.
For purposes of determining whether capital gains or losses on the disposition of shares are long or short term, subject to the discussion below relating to straddles, an owner's holding period begins on his acquisition of shares. As additional shares are distributed to him, the holding period of each new share received will also include the period for which the owner held the old shares to which the new share relates.
Because the purchase rights in respect of the shares arise as a result of an agreement other than solely with us, these rights do not appear to constitute inherent features of the shares for tax purposes. Please read "Description of Our SharesOptional Purchase," and "Mandatory Purchase." As such, it is possible that the IRS would assert that shares and the related purchase rights constitute a straddle for United States federal income tax purposes to the extent that those rights are viewed as resulting in
26
a substantial diminution of a share purchaser's risk of loss from owning his shares. In that case, any owner of shares who incurs interest or other carrying charges that are allocable to the shares (as would be the case if the owner finances his acquisition of shares with debt) would have to capitalize those interest or carrying charges to the basis of the related shares and purchase rights rather than deducting those interest or carrying charges currently. In addition, the holding period of the shares would be suspended, resulting in short-term capital gain or loss (generally taxed at ordinary income rates) upon a taxable disposition even if the shares were held for more than 12 months. However, we believe that the purchase rights have minimal value and do not result in a substantial diminution of a share purchaser's risk of loss from owning shares. Based on that, the shares and the related purchase rights should not constitute a straddle for United States federal income tax purposes and therefore should not result in any suspension of an owner's holding period or interest and carrying charge capitalization, although there can be no assurance that the IRS or the courts would agree with this conclusion.
Investment in Shares by Tax-Exempt Investors, Regulated Investment Companies and Non-U.S. Persons. Employee benefit plans and most other organizations exempt from United States federal income tax, including individual retirement accounts, known as IRAs, and other retirement plans, are subject to United States federal income tax on unrelated business taxable income. Because we will be treated as a corporation for United States federal income tax purposes, an owner of shares will not report on its United States federal income tax return any of our items of income, gain, loss and deduction. Therefore, a tax-exempt investor will not have unrelated business taxable income attributable to its ownership or sale of shares unless its ownership of the shares is debt financed. In general, a share would be debt financed if the tax-exempt owner of shares incurs debt to acquire a share or otherwise incurs or maintains a debt that would not have been incurred or maintained if that share had not been acquired.
A regulated investment company, or "mutual fund," is required to derive at least 90% of its gross income for every taxable year from qualifying income. As stated above, an owner of shares will not report on its United States federal income tax return any of our items of income, gain, loss and deduction. Thus, ownership of shares will not result in income which is not qualifying income to a mutual fund. Furthermore, any gain from the sale or other disposition of the shares, and the associated purchase rights, will qualify for purposes of that 90% test. Finally, shares, and the associated purchase rights, will constitute qualifying assets to mutual funds which also must own at least 50% qualifying assets at the end of each quarter.
Because distributions of additional shares will be made proportionately to all owners of shares, the receipt of these additional shares will not be includable in the gross income of an owner of shares for United States federal income tax purposes. Therefore, no withholding taxes will be imposed on distributions of additional shares to non-resident alien individuals and non-United States corporations, trusts or estates. A non-United States owner of shares generally will not be subject to United States federal income tax or subject to withholding on any gain recognized on the sale or other disposition of shares unless:
27
We believe that we are a USRPHC for United States federal income tax purposes. Therefore, any gain on the sale or other disposition of shares by a non-United States owner will be subject to United States federal income tax unless the shares are regularly traded on an established securities market and the non-United States owner has not actually or constructively held more than 5% of the shares at any time during the shorter of the five-year period preceding the disposition or that owner's holding period. Our shares currently trade on an established securities market.
United States Federal Income Tax Considerations Associated with the Ownership of i-units
A partnership is not a taxable entity and incurs no United States federal income tax liability. Instead, each partner of a partnership is required to take into account its allocable share of items of income, gain, loss and deduction of the partnership in computing its United States federal income tax liability, regardless of whether cash distributions are made to it by the partnership. Distributions of cash by a partnership to a partner are generally not taxable unless the amount of cash distributed to the partner is in excess of its adjusted basis in its partnership interest.
With respect to the i-units owned by us, the Kinder Morgan Energy Partners partnership agreement provides that no allocations of income, gain, loss or deduction will be made in respect of the i-units until such time as there is a liquidation of Kinder Morgan Energy Partners. If there is a liquidation of Kinder Morgan Energy Partners, it is intended that we will receive allocations of income and gain, or deduction and loss, in an amount necessary for the capital account attributable to each i-unit to be equal to that of a common unit. The aggregate capital account of our i-units will not be increased as a result of our ownership of additional i-units.
Thus, each additional i-unit we own after a cash distribution to other unitholders generally will represent the right to receive additional allocations of such income and gain, or deduction and loss, on the liquidation of Kinder Morgan Energy Partners. As a result, we would likely realize taxable income or loss upon the liquidation of Kinder Morgan Energy Partners. However, no assurance can be given that there will be sufficient amounts of income and gain to cause the capital account attributable to each i-unit to be equal to that of a common unit. If they are not equal, we will receive less value than would be received by a holder of common units upon such a liquidation. We would also likely realize taxable income or loss upon any sale or other disposition of our i-units.
Section 7704 of the Internal Revenue Code provides that publicly-traded partnerships will, as a general rule, be taxed as corporations. However, an exception, referred to as the "Qualifying Income Exception," exists with respect to publicly traded partnerships whose gross income for every taxable year consists of at least 90% "qualifying income." Qualifying income includes income and gains derived from the exploration, development, mining or production, processing, refining, transportation or marketing of any mineral or natural resource, including crude oil, natural gas and products thereof. Other types of qualifying income include interest other than from a financial business, dividends, gains from the sale of real property and gains from the sale or other disposition of assets held for the production of income that otherwise constitutes qualifying income. Kinder Morgan Energy Partners estimates that, as of the date of this prospectus, more than 90% of its current gross income is qualifying income.
The anticipated benefit of an investment in our shares depends largely on the treatment of Kinder Morgan Energy Partners as a partnership for United States federal income tax purposes. No ruling has been or will be sought from the IRS and the IRS has made no determination as to Kinder Morgan Energy Partners' status as a partnership for United States federal income tax purposes or whether Kinder Morgan Energy Partners' operations generate "qualifying income" under Section 7704 of the Internal Revenue Code. Instead, we will rely on the opinion of Bracewell & Giuliani LLP that, based upon the Internal Revenue Code, its regulations, published revenue rulings and court decisions and the
28
representations described below, Kinder Morgan Energy Partners has been, is and will continue to be treated as a partnership for United States federal income tax purposes.
In rendering its opinion, Bracewell & Giuliani LLP has relied on the following factual representations made by us, Kinder Morgan Energy Partners and its general partner:
If Kinder Morgan Energy Partners fails to meet the Qualifying Income Exception, other than a failure which is determined by the IRS to be inadvertent and which is cured within a reasonable time after discovery, it will be treated as if it had transferred all of its assets, subject to liabilities, to a newly formed corporation, on the first day of the year in which it fails to meet the Qualifying Income Exception, in return for stock in that corporation, and then distributed that stock to its unitholders in liquidation of their interests in Kinder Morgan Energy Partners. This contribution and liquidation should be tax-free to unitholders and Kinder Morgan Energy Partners, so long as Kinder Morgan Energy Partners, at that time, does not have liabilities in excess of the tax basis of its assets. Thereafter, Kinder Morgan Energy Partners would be treated as a corporation for United States federal income tax purposes.
If Kinder Morgan Energy Partners were treated as a corporation in any taxable year, either as a result of a failure to meet the Qualifying Income Exception or otherwise, its items of income, gain, loss and deduction would be reflected only on its tax return rather than being passed through to its unitholders, and its net income would be taxed to it at corporate rates. In addition, any distribution made to a unitholder, including distributions of additional i-units to us, would be treated as either taxable dividend income, to the extent of Kinder Morgan Energy Partners' current or accumulated earnings and profits, or, in the absence of earnings and profits, a nontaxable return of capital, to the extent of the unitholder's tax basis in his units, or taxable capital gain, after the unitholder's tax basis in his units is reduced to zero. In addition, the cash available for distribution to a common unitholder would be substantially reduced which would reduce the values of i-units distributed quarterly to us and our shares distributed quarterly to you. Accordingly, Kinder Morgan Energy Partners' treatment as a corporation would result in a substantial reduction of the value of our shares.
THE PRECEDING SUMMARY OF VARIOUS UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS RELATED TO THE PURCHASE, OWNERSHIP, AND DISPOSITION OF THE SHARES IS SOLELY FOR GENERAL INFORMATION ONLY, AND IS NOT INTENDED TO BE, AND SHOULD NOT BE CONSTRUED TO BE, LEGAL OR TAX ADVICE. THIS SUMMARY DOES NOT ADDRESS ALL THE TAX CONSEQUENCES THAT MAY BE IMPORTANT TO A PARTICULAR HOLDER IN LIGHT OF THE HOLDER'S INVOLVEMENT WITH THE ISSUER OR OTHER CIRCUMSTANCES. ACCORDINGLY, PROSPECTIVE PURCHASERS SHOULD CONSULT THEIR OWN TAX ADVISORS ON THE U.S. FEDERAL, STATE AND LOCAL, AND FOREIGN TAX CONSEQUENCES OF THEIR PURCHASE, OWNERSHIP, AND DISPOSITION OF THE SHARES, AND ON THE CONSEQUENCES OF ANY CHANGES IN APPLICABLE LAW.
29
The following is a summary of material considerations arising under the Employee Retirement Income Security Act of 1974, as amended, commonly known as "ERISA," and the prohibited transaction provisions of section 4975 of the Internal Revenue Code that may be relevant to a prospective purchaser of shares. The discussion does not purport to deal with all aspects of ERISA or section 4975 of the Internal Revenue Code that may be relevant to particular shareholders in light of their particular circumstances.
The discussion is based on current provisions of ERISA and the Internal Revenue Code, existing and currently proposed regulations under ERISA and the Internal Revenue Code, the legislative history of ERISA and the Internal Revenue Code, existing administrative rulings of the Department of Labor, referred to as the "DOL," and reported judicial decisions. No assurance can be given that legislative, judicial, or administrative changes will not affect the accuracy of any statements herein with respect to transactions entered into or contemplated prior to the effective date of such changes.
A fiduciary making a decision to invest in the shares on behalf of a prospective purchaser that is an employee benefit plan, a tax-qualified retirement plan, or an individual retirement account, commonly called an "IRA," is advised to consult its own legal advisor regarding the specific considerations arising under ERISA, section 4975 of the Internal Revenue Code, and state law with respect to the purchase, ownership, sale or exchange of the shares by such plan or IRA.
Each fiduciary of a pension, profit-sharing, or other employee benefit plan subject to Title I of ERISA, known as an "ERISA Plan," should consider carefully whether an investment in the shares is consistent with his fiduciary responsibilities under ERISA. In particular, the fiduciary requirements of Part 4 of Title I of ERISA require an ERISA Plan's investments to be (1) prudent and in the best interests of the ERISA Plan, its participants, and its beneficiaries, (2) diversified in order to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so, and (3) authorized under the terms of the ERISA Plan's governing documents (provided the documents are consistent with ERISA). In determining whether an investment in the shares is prudent for purposes of ERISA, the appropriate fiduciary of an ERISA Plan should consider all of the facts and circumstances, including whether the investment is reasonably designed, as a part of the ERISA Plan's portfolio for which the fiduciary has investment responsibility, to meet the objectives of the ERISA Plan, taking into consideration the risk of loss and opportunity for gain (or other return) from the investment, the diversification, cash flow, and funding requirements of the ERISA Plan's portfolio.
The fiduciary of an IRA, or of a qualified retirement plan not subject to Title I of ERISA because it is a governmental or church plan or because it does not cover common law employees, referred to as a "Non-ERISA Plan," should consider that such an IRA or Non-ERISA Plan may only make investments that are authorized by the appropriate governing documents and under applicable state law.
Fiduciaries of ERISA Plans and persons making the investment decision for an IRA or other Non-ERISA Plan should consider the application of the prohibited transaction provisions of ERISA and the Internal Revenue Code in making their investment decision. A "party in interest" or "disqualified person" with respect to an ERISA Plan, Non-ERISA Plan or IRA subject to Internal Revenue Code section 4975 is subject to (1) an initial 15% excise tax on the amount involved in any prohibited transaction involving the assets of the plan or IRA and (2) an excise tax equal to 100% of the amount involved if any prohibited transaction is not corrected. A party in interest with respect to an ERISA Plan that is not subject to Internal Revenue Code section 4975 is subject to a penalty imposed by the DOL up to 5% of the amount involved in any prohibited transaction involving the assets of the plan, but if the prohibited transaction is not corrected, the penalty may be up to 100% of the amount involved. If the disqualified person who engages in a prohibited transaction with respect to an IRA is the individual on behalf of whom the IRA is maintained (or his beneficiary), the IRA will
30
lose its tax-exempt status and its assets will be deemed to have been distributed to such individual in a taxable distribution (and no excise tax will be imposed on account of the prohibited transaction). In addition, a fiduciary who permits an ERISA Plan to engage in a transaction that the fiduciary knows or should know is a prohibited transaction may be liable to the ERISA Plan for any loss the ERISA Plan incurs as a result of the transaction or for any profits earned by the fiduciary in the transaction.
The following section discusses certain principles that apply in determining whether the fiduciary requirements of ERISA and the prohibited transaction provisions of ERISA and the Internal Revenue Code apply to an entity because one or more investors in the equity interests in the entity is an ERISA Plan or is a Non-ERISA Plan or IRA subject to section 4975 of the Internal Revenue Code. An ERISA Plan fiduciary also should consider the relevance of those principles to ERISA's prohibition on improper delegation of control over or responsibility for "plan assets" and ERISA's imposition of co-fiduciary liability on a fiduciary who participates in, permits (by action or inaction) the occurrence of, or fails to remedy a known breach by another fiduciary.
Regulations of the DOL defining "plan assets," referred to as the "Plan Asset Regulations," generally provide that when an ERISA Plan or Non-ERISA Plan or IRA acquires a security that is an equity interest in an entity and the security is neither a "publicly-offered security" nor a security issued by an investment company registered under the Investment Company Act of 1940, unless one or more exceptions specified in the Plan Asset Regulations are satisfied, the ERISA or Non-ERISA Plan's or IRA's assets include both the equity interest and an undivided interest in each of the underlying assets of the issuer of such equity interest, and therefore any person who exercises authority or control respecting the management or disposition of such underlying assets, and any person who provides investment advice with respect to such assets for a fee (direct or indirect), is a fiduciary of the investing plan.
The Plan Asset Regulations define a publicly-offered security as a security that is "freely transferable," part of a class of securities that is "widely held" and either part of a class of securities registered under the Exchange Act, or sold pursuant to an effective registration statement under the Securities Act, provided the securities are registered under the Exchange Act within 120 days after the end of the fiscal year of the issuer during which the offering occurred. The Plan Asset Regulations provide that a class of securities is "widely held" only if it is a class of securities that is owned by 100 or more investors independent of the issuer and of one another. A class of securities will not fail to be widely held solely because the number of independent investors falls below 100 subsequent to the initial public offering as a result of events beyond the issuer's control. The Plan Asset Regulations provide that whether a security is "freely transferable" is a factual question to be determined on the basis of all relevant facts and circumstances.
We believe that the shares meet the criteria of publicly-offered securities under the Plan Asset Regulations. We believe the shares are held beneficially by more than 100 independent persons. There are no restrictions, within the meaning of the Plan Asset Regulations, imposed on the transfer of shares and the shares are registered under the Exchange Act.
31
and are acting as joint book-running managers and as representatives of the underwriters. Under the terms and subject to the conditions contained in an underwriting agreement dated the date of this prospectus, each of the underwriters named below has severally agreed to purchase from us the respective number of shares shown opposite its name below:
Underwriters
|
Number of Shares |
||||
---|---|---|---|---|---|
Total |
|||||
The underwriting agreement provides that the underwriters are obligated to purchase, subject to certain conditions, all of the shares in the offering if any are purchased, other than those covered by the over-allotment option described below. The conditions contained in the underwriting agreement include requirements generally to the effect that:
Commission and Expenses
The representatives of the underwriters have advised us that the underwriters propose to offer the shares directly to the public at the price to the public set forth on the cover page of this prospectus and to selected dealers, which may include the underwriters, at the offering price less a selling concession not in excess of $ per share. After the offering, the underwriters may change the offering price and other selling terms.
The following table shows the underwriting discount we will pay to the underwriters. These amounts are shown assuming both no exercise and full exercise of the underwriters' over-allotment option to purchase additional shares. The underwriting fee is the difference between the public offering price and the amount the underwriters pay us to purchase the shares from us.
|
No Exercise |
Full Exercise |
|||||
---|---|---|---|---|---|---|---|
Per Share |
$ | $ | |||||
Total |
$ | $ |
We estimate that the total expenses for this offering, excluding underwriting discount, will be approximately $950,000.
Option to Purchase Additional Shares
We have granted the underwriters an option exercisable for 30 days after the date of this prospectus to purchase, in whole or in part, up to an aggregate of shares at the public offering price less underwriting discount. This option may be exercised if the underwriters sell more than shares in connection with this offering. To the extent that this option is exercised, each underwriter will be obligated, subject to certain conditions, to purchase its pro rata portion of these additional shares based on the underwriter's percentage underwriting commitment in the offering as indicated in the table at the beginning of this Underwriting section.
32
Lock-Up Agreements
Kinder Morgan Management, LLC, Kinder Morgan Energy Partners, Kinder Morgan G.P., Inc. and their respective directors and executive officers, and Knight Inc. have agreed with the underwriters not to, subject to limited exceptions, directly or indirectly, sell, offer, pledge or otherwise dispose of any shares of Kinder Morgan Management, LLC or Class B units or common units representing limited partner interests of Kinder Morgan Energy Partners, referred to as "common units," or any securities substantially similar to, convertible into or exchangeable or exercisable for shares, Class B units or common units or enter into any derivative transaction with similar effect as a sale of shares, Class B units or common units for a period of days after the date of this prospectus without the prior written consent of the underwriter. The restrictions described in this paragraph do not apply to any sale by Kinder Morgan Energy Partners of i-units to us. The restrictions also do not apply to the sale of shares to the underwriters, to any existing employee benefit plans, share option plans or compensation plans or to the acquisition of assets, businesses or the capital stock or other ownership interests of businesses by any such entities in exchange for shares, Class B units or common units or securities substantially similar to convertible or exchangeable into or exercisable for shares, Class B units or common units.
The representatives, in their discretion, may release the shares, Class B units and common units subject to lock-up agreements in whole or in part at any time with or without notice. When determining whether or not to release shares, Class B units or common units from lock-up agreements, the representatives will consider, among other factors, the shareholders' reasons for requesting the release, the number of shares, Class B units or common units for which the release is being requested, and market conditions at the time.
Indemnification
We have agreed to indemnify the underwriters against certain liabilities, including liabilities under the Securities Act, or to contribute to payments that may be required to be made in respect of these liabilities.
Stabilization, Short Positions and Penalty Bids
In connection with this offering, the underwriters may engage in stabilizing transactions, over-allotment transactions, syndicate covering transactions, and penalty bids or purchases for the purpose of pegging, fixing or maintaining the price of the shares in accordance with Regulation M under the Exchange Act.
33
which they may purchase shares through the over-allotment option. If the underwriters sell more shares than could be covered by the over-allotment option, a naked short position, the position can only be closed out by buying shares in the open market. A naked short position is more likely to be created if the underwriters are concerned that there could be downward pressure on the price of the shares in the open market after pricing that could adversely affect investors who purchase in the offering.
These stabilizing transactions, syndicate covering transactions and penalty bids may have the effect of raising or maintaining the market price of our shares or preventing or retarding a decline in the market price of the shares. As a result, the price of the shares may be higher than the price that might otherwise exist in the open market. These transactions may be effected on the New York Stock Exchange or otherwise and, if commenced, may be discontinued at any time.
Neither we nor any of the underwriters make any representation or prediction as to the direction or magnitude of any effect that the transactions described above may have on the price of the shares. In addition, neither we nor any of the underwriters make any representation that the underwriters will engage in these stabilizing transactions or that any transaction, once commenced, will not be discontinued without notice.
Relationships/FINRA Rules
Certain of the underwriters and their related entities have, from time to time performed, and may in the future perform, various financial advisory, commercial banking and investment banking services for us and our affiliates for which they received or will receive customary fees and expense reimbursement. Affiliates of several of the underwriters are lenders under Kinder Morgan Energy Partners, L.P.'s revolving bank credit facility and/or the credit facilities of some of our other affiliates.
As described under "Use of Proceeds," Kinder Morgan Energy Partners, L.P. intends to use the proceeds from its sale of i-units to us with the proceeds of this offering to repay borrowings under its revolving bank credit facility. The underwriters or their affiliates may receive proceeds from this offering if they are lenders under the revolving bank credit facility. Because it is possible that the underwriters or their affiliates could receive more than 10% of the proceeds of this offering as repayment for such debt, this offering is made pursuant to the provisions of Section 5110(h) of the Financial Industry Regulatory Authority, or FINRA Rules. Pursuant to that section, the appointment of a qualified independent underwriter is not necessary in connection with this offering, as a bona fide independent market (as defined in the NASD Conduct Rules, which are part of the FINRA Rules) exists in our shares.
Because FINRA views the shares offered hereby as interests in a direct participation program, the offering is being made in compliance with Rule 2810 of the NASD's Conduct Rules. Investor suitability with respect to the shares should be judged similarly to the suitability with respect to other securities that are listed for trading on a national securities exchange.
34
The validity of the shares we are offering will be passed upon for us by Bracewell & Giuliani LLP, Houston, Texas. Certain legal matters with respect to the shares will be passed upon for the underwriters by . performs legal services for us and our affiliates from time to time on matters unrelated to the offering of the shares.
The consolidated financial statements and management's assessment of the effectiveness of internal control over financial reporting (which is included in Management's Report on Internal Control Over Financial Reporting) of Kinder Morgan Management, LLC, incorporated in this prospectus by reference to Kinder Morgan Management, LLC's Annual Report on Form 10-K for the year ended December 31, 2007 have been so incorporated in reliance on the reports of PricewaterhouseCoopers LLP, an independent registered public accounting firm, given on the authority of said firm as experts in auditing and accounting.
The consolidated financial statements and management's assessment of the effectiveness of internal control over financial reporting (which is included in Management's Report on Internal Control Over Financial Reporting) of Kinder Morgan Energy Partners, incorporated in this prospectus by reference to Kinder Morgan Energy Partners' Annual Report on Form 10-K for the year ended December 31, 2007 have been so incorporated in reliance on the report of PricewaterhouseCoopers LLP, an independent registered public accounting firm, given on the authority of said firm as experts in auditing and accounting.
The consolidated balance sheet of Kinder Morgan G.P., Inc. as of December 31, 2007 incorporated in this prospectus by reference to Kinder Morgan Energy Partners' Current Report on Form 8-K dated June 20, 2008, has been so incorporated in reliance on the report of PricewaterhouseCoopers LLP, an independent registered public accounting firm, given on the authority of said firm as experts in auditing and accounting.
The description of the review performed by Netherland, Sewell & Associates, Inc., independent petroleum consultants, included in Kinder Morgan Energy Partners' Annual Report on Form 10-K for the year ended December 31, 2007, is incorporated herein by reference.
The consolidated financial statements of Knight Inc. as of December 31, 2007 and December 31, 2006 and for each of the periods ended December 31, 2007, May 31, 2007, December 31, 2006 and December 31, 2005 included in this prospectus have been so included in reliance on the reports of PricewaterhouseCoopers LLP, an independent registered public accounting firm, given on the authority of said firm as experts in auditing and accounting.
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This prospectus and the documents incorporated in this prospectus by reference include forward-looking statements. These forward-looking statements are identified as any statement that does not relate strictly to historical or current facts. They use words such as "anticipate," "believe," "intend," "plan," "projection," "forecast," "strategy," "position," "continue," "estimate," "expect," "may," or the negative of those terms or other variations of them or comparable terminology. In particular, statements, express or implied, concerning future actions, conditions or events, future operating results or the ability to generate sales, income or cash flow or to make distributions are forward-looking statements. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Future actions, conditions or events and future results of operations may differ materially from those expressed in these forward-looking statements. Many of the factors that
35
will determine these results are beyond our ability to control or predict. Specific factors which could cause actual results to differ from those in the forward-looking statements include:
36
The foregoing list should not be construed to be exhaustive. We believe the forward-looking statements in this prospectus are reasonable. However, there is no assurance that any of the actions, events or results of the forward-looking statements will occur, or if any of them do, what impact they will have on our results of operations or financial condition. Because of these uncertainties, you should not put undue reliance on any forward-looking statements.
When considering forward-looking statements, please review the risk factors included herein or in the Annual Reports on Form 10-K for the year ended December 31, 2007 of Kinder Morgan Management, LLC and Kinder Morgan Energy Partners and the other filings with the SEC that are incorporated by reference into this prospectus. The risk factors described in those documents could cause our actual results to differ materially from those contained in any forward-looking statement. You also should consider the risks related to Knight Inc. described in Annex A under the caption "Risk Factors." We disclaim any obligation, other than as required by applicable law, to update the above list or to announce publicly the result of any revisions to any of the forward-looking statements to reflect future events or developments.
37
INFORMATION REGARDING KNIGHT INC.
Because Knight Inc. is not eligible to incorporate by reference information it has filed with the SEC, this Annex A sets forth information regarding Knight Inc. required by Form S-1. In this Annex A, unless the context requires otherwise, references to "we," "us" and "our" mean Knight Inc. and its consolidated subsidiaries, including Kinder Morgan Energy Partners, L.P., both before and after the Going Private transaction referred to below.
On May 30, 2007, we completed our Going Private transaction whereby Kinder Morgan, Inc. merged with a wholly owned subsidiary of Knight Holdco LLC, with Kinder Morgan, Inc. continuing as the surviving legal entity and subsequently renamed Knight Inc. Knight Holdco LLC is a private company owned by Richard D. Kinder, our Chairman and Chief Executive Officer; our co-founder William V. Morgan; former Kinder Morgan, Inc. board members Fayez Sarofim and Michael C. Morgan; members of our senior management, most of whom are also senior officers of Kinder Morgan G.P., Inc. and Kinder Morgan Management, LLC; and affiliates of (1) Goldman Sachs Capital Partners, (2) American International Group, Inc., (3) the Carlyle Group, and (4) Riverstone Holdings LLC. As a result of the Going Private transaction, we are now privately owned, our stock is no longer traded on the New York Stock Exchange, and we have adopted a new basis of accounting for our assets and liabilities.
A-2 | ||
A-14 | ||
A-16 | ||
Management's Discussion and Analysis of Financial Condition and Results of Operations |
A-18 | |
A-120 | ||
A-141 | ||
A-156 | ||
A-157 | ||
A-162 |
A-1
You should carefully consider the risks described below, in addition to the other information contained in this Annex A. Please also see "Information Regarding Forward-Looking Statements." Realization of any of these risks or events could have a material adverse effect on our business, financial conditions, cash flows and results of operations.
Current levels of market volatility are unprecedented.
The capital and credit markets have been experiencing extreme volatility and disruption for more than 12 months. In some cases, the markets have exerted downward pressure on stock prices and credit capacity for certain issuers. Our plans for growth require regular access to the capital and credit markets. If current levels of market disruption and volatility continue or worsen, access to capital and credit markets could be disrupted making growth through acquisitions and development projects difficult or impractical to pursue until such time as markets stabilize.
Our operating results may be adversely affected by unfavorable economic and market conditions.
Economic conditions worldwide have from time to time contributed to slowdowns in the oil and gas industry, as well as in the specific segments and markets in which we operate, resulting in reduced demand and increased price competition for our products and services. Our operating results in one or more geographic regions may also be affected by uncertain or changing economic conditions within that region, such as the challenges that are currently affecting economic conditions in the United States. Volatility in commodity prices might have an impact on many of our customers, which in turn could have a negative impact on their ability to meet their obligations to us. In addition, decreases in the prices of crude oil and natural gas liquids will have a negative impact on the results of our CO2 business segment. If global economic and market conditions (including volatility in commodity markets), or economic conditions in the United States or other key markets, remain uncertain or persist, spread or deteriorate further, we may experience material impacts on our business, financial condition and results of operations.
The recent downturn in the credit markets has increased the cost of borrowing and has made financing difficult to obtain, each of which may have a material adverse effect on our results of operations and business.
Recent events in the financial markets have had an adverse impact on the credit markets and, as a result, the availability of credit has become more expensive and difficult to obtain. Some lenders are imposing more stringent restrictions on the terms of credit and there may be a general reduction in the amount of credit available in the markets in which we conduct business. In addition, as a result of the current credit market conditions and the recent downgrade of Kinder Morgan Energy Partners' short-term credit ratings by Standard & Poor's Rating Services, it is currently unable to access commercial paper borrowings and instead is meeting its short-term financing and liquidity needs through borrowings under its bank credit facility. The negative impact on the tightening of the credit markets may have a material adverse effect on Kinder Morgan Energy Partners resulting from, but not limited to, an inability to expand facilities or finance the acquisition of assets on favorable terms, if at all, increased financing costs or financing with increasingly restrictive covenants.
The failure of any bank in which we deposit our funds could reduce the amount of cash we have available for operations to pay distributions and to make additional investments.
We have diversified our cash and cash equivalents between several banking institutions in an attempt to minimize exposure to any one of these entities. However, the Federal Deposit Insurance Corporation, or "FDIC," only insures amounts up to $250,000 per depositor per insured bank. We currently have cash and cash equivalents and restricted cash deposited in certain financial institutions in
A-2
excess of federally insured levels. If any of the banking institutions in which we have deposited funds ultimately fails, we may lose our deposits over $250,000. The loss of our deposits could reduce the amount of cash we have available to distribute or invest and could result in a decline in the value of your investment.
There can be no assurance as to the impact on the financial markets of the U.S. government's plan to purchase large amounts of illiquid, mortgage-backed and other securities from financial institutions.
In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, President Bush signed the Emergency Economic Stabilization Act of 2008 ("EESA") into law on October 3, 2008. Pursuant to the EESA, the U.S. Treasury has the authority to, among other things, purchase up to $700 billion of mortgage-backed and other securities from financial institutions for the purpose of stabilizing the financial markets. There can be no assurance what impact the EESA will have on the financial markets, including the extreme levels of volatility currently being experienced. Although we are not one of the institutions that will sell securities to the U.S. Treasury pursuant to the EESA, the ultimate effects of the EESA on the financial markets and the economy in general could materially and adversely affect our business, financial condition and results of operations, or the trading prices of Kinder Morgan Energy Partners' common units and Kinder Morgan Management's shares.
The Going Private transaction resulted in substantially more debt to us and a downgrade of the ratings of our debt securities, which has increased our cost of capital.
In conjunction with the Going Private transaction, Knight Inc. incurred approximately $4.8 billion in additional debt. Standard & Poor's Rating Services and Moody's Investor Services downgraded the ratings assigned to Knight Inc.'s senior unsecured debt to BB- and Ba2, respectively. Upon the February 2008 80% ownership interest sale of our NGPL business segment, which resulted in Knight Inc.'s repayment of a substantial amount of debt, Standard & Poor's Rating Services and Moody's Investor Services upgraded Knight Inc.'s senior unsecured debt to BB and Ba1, respectively. However, these ratings are still below investment grade. Since the Going Private transaction, Knight Inc. has not had access to the commercial paper market and is currently utilizing its $1.0 billion revolving credit facility for its short-term borrowing needs.
Our substantial debt could adversely affect our financial health and make us more vulnerable to adverse economic conditions.
As of September 30, 2008, we had outstanding $11.5 billion of consolidated debt (excluding the value of interest rate swaps). Of this amount, $8.3 billion was debt of Kinder Morgan Energy Partners and its subsidiaries, and the remaining $3.2 billion was debt of Knight Inc. and its subsidiaries, other than Kinder Morgan Energy Partners and its subsidiaries. Knight Inc.'s debt is currently secured by most of the assets of Knight Inc. and its subsidiaries, but the security interest does not apply to the assets of Kinder Morgan G.P., Inc., Kinder Morgan Energy Partners, Kinder Morgan Management and their respective subsidiaries. This level of debt could have important consequences, such as:
A-3
Each of these factors is to a large extent dependent on economic, financial, competitive and other factors beyond our control.
Our variable rate debt makes us vulnerable to increases in interest rates.
As of September 30, 2008, we had outstanding $11.5 billion of consolidated debt (excluding fair value of interest rate swaps). Of this amount, approximately 36.1% was subject to floating interest rates, either as short-term or long-term debt of floating rate credit facilities or as long-term fixed-rate debt converted to floating rates through the use of interest rate swaps. Should interest rates increase significantly, the amount of cash required to service our debt would increase.
Our debt instruments may limit our financial flexibility and increase our financing costs.
The instruments governing our debt contain restrictive covenants that may prevent us from engaging in certain transactions that we deem beneficial and that may be beneficial to us. The agreements governing our debt generally require us to comply with various affirmative and negative covenants, including the maintenance of certain financial ratios and restrictions on:
The instruments governing any future debt may contain similar or more restrictive restrictions. Our ability to respond to changes in business and economic conditions and to obtain additional financing, if needed, may be restricted.
There is the potential for a change of control of the general partner of Kinder Morgan Energy Partners if we default on debt.
We own all of the common equity of Kinder Morgan G.P., Inc., the general partner of Kinder Morgan Energy Partners. If we default on our debt, in exercising their rights as lenders, our lenders could acquire control of Kinder Morgan G.P., Inc. or otherwise influence Kinder Morgan G.P., Inc. through their control of us. While our operations provide cash independent of the dividends we receive from Kinder Morgan G.P., Inc., a change in control could materially affect our cash flow and earnings.
The tax treatment applied to Kinder Morgan Energy Partners depends on its status as a partnership for United States federal income tax purposes, as well as it not being subject to a material amount of entity-level taxation by individual states. If the IRS treats it as a corporation or if it becomes subject to a material amount of entity-level taxation for state tax purposes, it would substantially reduce the amount of cash available for distribution to its partners, including us.
The anticipated after-tax economic benefit of an investment in Kinder Morgan Energy Partners depends largely on it being treated as a partnership for United States federal income tax purposes. In order for it to be treated as a partnership for United States federal income tax purposes, current law requires that 90% or more of its gross income for every taxable year consist of "qualifying income," as defined in Section 7704 of the Internal Revenue Code. Kinder Morgan Energy Partners may not meet this requirement or current law may change so as to cause, in either event, it to be treated as a corporation for United States federal income tax purposes or otherwise subject to United States federal income tax. Kinder Morgan Energy Partners has not requested, and does not plan to request, a ruling from the IRS on this or any other matter affecting it.
A-4
If Kinder Morgan Energy Partners were to be treated as a corporation for United States federal income tax purposes, it would pay United States federal income tax on its income at the corporate tax rate, which is currently a maximum of 35%, and would pay state income taxes at varying rates. Under current law, distributions to its partners would generally be taxed again as corporate distributions, and no income, gain, losses or deductions would flow through to its partners. Because a tax would be imposed on Kinder Morgan Energy Partners as a corporation, its cash available for distribution would be substantially reduced. Therefore, treatment of Kinder Morgan Energy Partners as a corporation would result in a material reduction in the anticipated cash flow and after-tax return to its partners, likely causing a substantial reduction in the value of our interest in Kinder Morgan Energy Partners.
Current law or the business of Kinder Morgan Energy Partners may change so as to cause it to be treated as a corporation for United States federal income tax purposes or otherwise subject it to entity-level taxation. Members of Congress are considering substantive changes to the existing United States federal income tax laws that affect certain publicly-traded partnerships. For example, United States federal income tax legislation has been proposed that would eliminate partnership tax treatment for certain publicly-traded partnerships. Although the currently proposed legislation would not appear to affect Kinder Morgan Energy Partners, L.P.'s tax treatment as a partnership, we are unable to predict whether any of these changes, or other proposals, will ultimately be enacted. Any such changes could negatively impact the value of our interest in Kinder Morgan Energy Partners.
In addition, because of widespread state budget deficits and other reasons, several states are evaluating ways to subject partnerships to entity-level taxation through the imposition of state income, franchise or other forms of taxation. For example, Kinder Morgan Energy Partners is now subject to an entity-level tax on the portion of its total revenue that is generated in Texas. Specifically, the Texas margin tax is imposed at a maximum effective rate of 0.7% of its total revenue that is apportioned to Texas. This tax reduces, and the imposition of such a tax on Kinder Morgan Energy Partners by any other state will reduce, its cash available for distribution to its partners, including us.
The Kinder Morgan Energy Partners partnership agreement provides that if a law is enacted that subjects Kinder Morgan Energy Partners to taxation as a corporation or otherwise subjects it to entity-level taxation for United States federal income tax purposes, the minimum quarterly distribution and the target distribution levels will be adjusted to reflect the impact of that law on Kinder Morgan Energy Partners.
Kinder Morgan Energy Partners adopted certain valuation methodologies that may result in a shift of income, gain, loss and deduction between its general partner and its unitholders. The IRS may challenge this treatment, which could adversely affect the value of the common units.
When Kinder Morgan Energy Partners issues additional units or engages in certain other transactions, it determines the fair market value of its assets and allocates any unrealized gain or loss attributable to its assets to the capital accounts of its unitholders and its general partner. This methodology may be viewed as understating the value of Kinder Morgan Energy Partners' assets. In that case, there may be a shift of income, gain, loss and deduction between certain unitholders and its general partner, which may be unfavorable to such unitholders. Moreover, under Kinder Morgan Energy Partners' current valuation methods, subsequent purchasers of common units may have a greater portion of their Internal Revenue Code Section 743(b) adjustment allocated to its tangible assets and a lesser portion allocated to its intangible assets. The IRS may challenge these valuation methods, or Kinder Morgan Energy Partners' allocation of the Section 743(b) adjustment attributable to its tangible and intangible assets, and allocations of income, gain, loss and deduction between its general partner and certain of its unitholders.
A successful IRS challenge to these methods or allocations could adversely affect the amount of taxable income or loss being allocated to Kinder Morgan Energy Partners' partners, including us. It
A-5
also could affect the amount of gain from Kinder Morgan Energy Partners' unitholders' sale of common units and could have a negative impact on the value of the common units or result in audit adjustments to its unitholders' tax returns without the benefit of additional deductions.
Kinder Morgan Energy Partners' treatment of a purchaser of common units as having the same tax benefits as the seller could be challenged, resulting in a reduction in value of the common units.
Because Kinder Morgan Energy Partners cannot match transferors and transferees of common units, it is required to maintain the uniformity of the economic and tax characteristics of these units in the hands of the purchasers and sellers of these units. It does so by adopting certain depreciation conventions that do not conform to all aspects of the United States Treasury regulations. A successful IRS challenge to these conventions could adversely affect the tax benefits to a unitholder of ownership of the common units and could have a negative impact on their value or result in audit adjustments to unitholders' tax returns.
Pending Federal Energy Regulatory Commission and California Public Utilities Commission proceedings seek substantial refunds and reductions in tariff rates on some of Kinder Morgan Energy Partners' pipelines. If the proceedings are determined adversely to Kinder Morgan Energy Partners, they could have a material adverse impact on us.
Regulators and shippers on our pipelines have rights to challenge the rates we charge under certain circumstances prescribed by applicable regulations. Some shippers on Kinder Morgan Energy Partners' pipelines have filed complaints with the Federal Energy Regulatory Commission, or the FERC, and California Public Utilities Commission that seek substantial refunds for alleged overcharges during the years in question and prospective reductions in the tariff rates on Kinder Morgan Energy Partners' Pacific operations' pipeline system. We may face challenges, similar to those described in Note 18 to our Interim Consolidated Financial Statements included in this Annex A, to the rates we receive on our pipelines in the future. Any successful challenge could adversely and materially affect our future earnings and cash flows.
Rulemaking and oversight, as well as changes in regulations, by the FERC or other regulatory agencies having jurisdiction over our operations could adversely impact our income and operations.
The rates (which include reservation, commodity, surcharges, fuel and gas lost and unaccounted for) we charge shippers on our natural gas pipeline systems are subject to regulatory approval and oversight. Furthermore, regulators and shippers on our natural gas pipelines have rights to challenge the rates shippers are charged under certain circumstances prescribed by applicable regulations. We can provide no assurance that we will not face challenges to the rates we receive on our pipeline systems in the future. Any successful challenge could materially adversely affect our future earnings and cash flows. New laws or regulations or different interpretations of existing laws or regulations, including unexpected policy changes that sometimes occur following a change of presidential administration, applicable to our assets could have a material adverse impact on our business, financial condition and results of operations.
Our business is subject to extensive regulation that affects our operations and costs.
Our assets and operations are subject to regulation by federal, state, provincial and local authorities, including regulation by the FERC, and by various authorities under federal, state and local environmental, human health and safety and pipeline safety laws. Regulation affects almost every aspect of our business, including, among other things, our ability to determine terms and rates for our interstate pipeline services, to make acquisitions or to build extensions of existing facilities. The costs of complying with such laws and regulations are already significant, and additional or more stringent
A-6
regulation could have a material adverse impact on our business, financial condition and results of operations.
In addition, regulators have taken actions designed to enhance market forces in the gas pipeline industry, which have led to increased competition. In a number of U.S. markets, natural gas interstate pipelines face competitive pressure from a number of new industry participants, such as alternative suppliers, as well as traditional pipeline competitors. Increased competition driven by regulatory changes could have a material impact on business in our markets and therefore adversely affect our financial condition and results of operations.
Energy commodity transportation and storage activities involve numerous risks that may result in accidents or otherwise adversely affect operations.
There are a variety of hazards and operating risks inherent to natural gas transmission and storage activities, and refined petroleum products and carbon dioxide transportation activitiessuch as leaks, explosions and mechanical problems that could result in substantial financial losses. In addition, these risks could result in loss of human life, significant damage to property, environmental pollution and impairment of operations, any of which also could result in substantial losses. For pipeline and storage assets located near populated areas, including residential areas, commercial business centers, industrial sites and other public gathering areas, the level of damage resulting from these risks could be greater. If losses in excess of our insurance coverage were to occur, they could have a material adverse effect on our business, financial condition and results of operations.
Competition could ultimately lead to lower levels of profits and adversely impact our ability to recontract for expiring transportation capacity at favorable rates or maintain existing customers.
In the past, competitors to our interstate natural gas pipelines have constructed or expanded pipeline capacity into the areas served by our pipelines. To the extent that an excess of supply into these market areas is created and persists, our ability to recontract for expiring transportation capacity at favorable rates or to maintain existing customers could be impaired. In addition, our products pipelines compete against proprietary pipelines owned and operated by major oil companies, other independent products pipelines, trucking and marine transportation firms (for short-haul movements of products) and railcars. Throughput on our products pipelines may decline if the rates we charge become uncompetitive compared to alternatives.
Cost overruns and delays on our expansion and new build projects could adversely affect our business.
We currently have several major expansion and new build projects planned or underway, including Kinder Morgan Energy Partners' approximately $6.0 billion Rockies Express Pipeline, approximately $1.9 billion Midcontinent Express Pipeline and approximately $1.3 billion Fayetteville Express Pipeline joint ventures and Kinder Morgan Energy Partners' approximately $1.0 billion Kinder Morgan Louisiana Pipeline. A variety of factors outside our control, such as weather, natural disasters and difficulties in obtaining permits and rights-of-way or other regulatory approvals, as well as the performance by third-party contractors, has resulted in, and may continue to result in, increased costs or delays in construction. Cost overruns or delays in completing a project could have a material adverse effect on our results of operations and cash flows.
Our rapid growth may cause difficulties integrating and constructing new operations, and we may not be able to achieve the expected benefits from any future acquisitions.
Part of our business strategy includes acquiring additional businesses, expanding existing assets, or constructing new facilities. If we do not successfully integrate acquisitions, expansions, or newly
A-7
constructed facilities, we may not realize anticipated operating advantages and cost savings. The integration of companies that have previously operated separately involves a number of risks, including:
We may not be able to maintain the levels of operating efficiency that acquired companies have achieved or might achieve separately. Successful integration of each acquisition, expansion, or construction project will depend upon our ability to manage those operations and to eliminate redundant and excess costs. Because of difficulties in combining and expanding operations, we may not be able to achieve the cost savings and other size-related benefits that we hoped to achieve after these acquisitions, which would harm our financial condition and results of operations.
Our acquisition strategy and expansion programs require access to new capital. Tightened credit markets or more expensive capital would impair our ability to grow.
Part of our business strategy includes acquiring additional businesses. We may need new capital to finance these acquisitions. Limitations on our access to capital will impair our ability to execute this strategy. We normally fund acquisitions with short-term debt and repay such debt through the issuance of equity and long-term debt. An inability to access the capital markets may result in a substantial increase in our leverage and have a detrimental impact on our credit profile.
Environmental laws and regulations could expose us to significant costs and liabilities.
Our operations are subject to federal, state, provincial and local laws, regulations and potential liabilities arising under or relating to the protection or preservation of the environment, natural resources and human health and safety. Such laws and regulations affect many aspects of our present and future operations, and generally require us to obtain and comply with various environmental registrations, licenses, permits, inspections and other approvals. Liability under such laws and regulations may be incurred without regard to fault under the Comprehensive Environmental Response, Compensation, and Liability Act, commonly known as CERCLA or Superfund, the Resource Conservation and Recovery Act, commonly known as RCRA, or analogous state laws for the remediation of contaminated areas. Private parties, including the owners of properties through which our pipelines pass may also have the right to pursue legal actions to enforce compliance as well as to seek damages for non-compliance with such laws and regulations or for personal injury or property damage. Our insurance may not cover all environmental risks and costs or may not provide sufficient coverage in the event an environmental claim is made against us.
Failure to comply with these laws and regulations may expose us to civil, criminal and administrative fines, penalties and/or interruptions in our operations that could influence our results of operations. For example, if an accidental leak, release or spill of liquid petroleum products, chemicals or other hazardous substances occurs at or from our pipelines or our storage or other facilities, we may experience significant operational disruptions and it may have to pay a significant amount to clean up the leak, release or spill, pay for government penalties, address natural resource damage, compensate for human exposure or property damage, install costly pollution control equipment or a combination of these and other measures. The resulting costs and liabilities could materially and negatively affect our
A-8
level of earnings and cash flows. In addition, emission controls required under the Federal Clean Air Act and other similar federal, state and provincial laws could require significant capital expenditures at our facilities.
We own and/or operate numerous properties that have been used for many years in connection with our business activities. While we have utilized operating and disposal practices that were standard in the industry at the time, hydrocarbons or other hazardous substances may have been released at or from properties owned, operated or used by us or our predecessors, or at or from properties where our or our predecessors' wastes have been taken for disposal. In addition, many of these properties have been owned and/or operated by third parties whose management, handling and disposal of hydrocarbons or other hazardous substances were not under our control. These properties and the hazardous substances released and wastes disposed on them may be subject to laws in the United States such as CERCLA, which impose joint and several liability without regard to fault or the legality of the original conduct. Under the regulatory schemes of the various Canadian provinces, such as British Columbia's Environmental Management Act, Canada has similar laws with respect to properties owned, operated or used by us or our predecessors. Under such laws and implementing regulations, we could be required to remove or remediate previously disposed wastes or property contamination, including contamination caused by prior owners or operators. Imposition of such liability schemes could have a material adverse impact on our operations and financial position.
In addition, our oil and gas development and production activities are subject to numerous federal, state and local laws and regulations relating to environmental quality and pollution control. These laws and regulations increase the costs of these activities and may prevent or delay the commencement or continuance of a given operation. Specifically, these activities are subject to laws and regulations regarding the acquisition of permits before drilling, restrictions on drilling activities in restricted areas, emissions into the environment, water discharges, and storage and disposition of wastes. In addition, legislation has been enacted that requires well and facility sites to be abandoned and reclaimed to the satisfaction of state authorities.
Further, we cannot ensure that such existing laws and regulations will not be revised or that new laws or regulations will not be adopted or become applicable to us. The clear trend in environmental regulation is to place more restrictions and limitations on activities that may be perceived to affect the environment, and thus there can be no assurance as to the amount or timing of future expenditures for environmental compliance or remediation, and actual future expenditures may be different from the amounts we currently anticipate. Revised or additional regulations that result in increased compliance costs or additional operating restrictions, particularly if those costs are not fully recoverable from our customers, could have a material adverse effect on our business, financial position, results of operations and prospects.
Climate change regulation at the federal, state or regional levels and/or new regulations issued by the Department of Homeland Security could result in increased operating and capital costs for us.
Studies have suggested that emissions of certain gases, commonly referred to as "greenhouse gases," may be contributing to warming of the Earth's atmosphere. Methane, a primary component of natural gas, and carbon dioxide, a byproduct of the burning of natural gas, are examples of greenhouse gases. The U.S. Congress is actively considering legislation to reduce emissions of greenhouse gases. In addition, at least nine states in the Northeast and five states in the West have developed initiatives to regulate emissions of greenhouse gases, primarily through the planned development of greenhouse gas emission inventories and/or regional greenhouse gas cap and trade programs. The EPA is separately considering whether it will regulate greenhouse gases as "air pollutants" under the existing federal Clean Air Act. Passage of climate control legislation or other regulatory initiatives by Congress or various states of the U.S. or the adoption of regulations by the EPA or analogous state agencies that regulate or restrict emissions of greenhouse gases including methane or carbon dioxide in areas in
A-9
which we conduct business could result in changes to the consumption and demand for natural gas and could have adverse effects on our business, financial position, results of operations and prospects.
Such changes could increase the costs of our operations, including costs to operate and maintain our facilities, install new emission controls on our facilities, acquire allowances to authorize our greenhouse gas emissions, pay any taxes related to our greenhouse gas emissions and administer and manage a greenhouse gas emissions program. While we may be able to include some or all of such increased costs in the rates charged by some of our pipelines, such recovery of costs is uncertain and may depend on events beyond our control including the outcome of future rate proceedings before the FERC and the provisions of any final legislation.
The Department of Homeland Security Appropriation Act of 2007 requires the Department of Homeland Security, or DHS, to issue regulations establishing risk-based performance standards for the security of chemical and industrial facilities, including oil and gas facilities that are deemed to present "high levels of security risk." The DHS has issued rules that establish chemicals of interest and their respective threshold quantities that will trigger compliance with these standards. Covered facilities that are determined by DHS to pose a high level of security risk will be required to prepare and submit Security Vulnerability Assessments and Site Security Plans as well as comply with other regulatory requirements, including those regarding inspections, audits, recordkeeping and protection of chemical-terrorism vulnerability information. We have not yet determined the extent of the costs to bring our facilities into compliance, but it is possible that such costs could be substantial.
Current or future distressed financial conditions of customers could have an adverse impact on us in the event these customers are unable to pay us for the products or services we provide.
Some of our customers are experiencing, or may experience in the future, severe financial problems that have had or may have a significant impact on their creditworthiness. We cannot provide assurance that one or more of our financially distressed customers will not default on their obligations to us or that such a default or defaults will not have a material adverse effect on our business, financial position, future results of operations, or future cash flows. Furthermore, the bankruptcy of one or more of our customers, or some other similar proceeding or liquidity constraint, might make it unlikely that we would be able to collect all or a significant portion of amounts owed by the distressed entity or entities. In addition, such events might force such customers to reduce or curtail their future use of our products and services, which could have a material adverse effect on our results of operations and financial condition.
Increased regulatory requirements relating to the integrity of our pipelines will require us to spend additional money to comply with these requirements.
Through our regulated pipeline subsidiaries, we are subject to extensive laws and regulations related to pipeline integrity. There are, for example, federal guidelines for the U.S. Department of Transportation and pipeline companies in the areas of testing, education, training and communication. Compliance with laws and regulations requires significant expenditures. We have increased our capital expenditures to address these matters and expect to significantly increase these expenditures in the foreseeable future. Additional laws and regulations that may be enacted in the future or a new interpretation of existing laws and regulations could significantly increase the amount of these expenditures.
A-10
Kinder Morgan Energy Partners does not own approximately 97.5% of the land on which its pipelines are constructed, and it is subject to the possibility of increased costs to retain necessary land use.
Kinder Morgan Energy Partners obtains the right to construct and operate pipelines on other owners' land for a period of time. If it were to lose these rights or be required to relocate its pipelines, its business could be affected negatively.
Whether Kinder Morgan Energy Partners has the power of eminent domain for its pipelines, other than interstate natural gas pipelines, varies from state to state depending upon the type of pipelinepetroleum liquids, natural gas or carbon dioxideand the laws of the particular state. Kinder Morgan Energy Partners' interstate natural gas pipelines have federal eminent domain authority. In either case, Kinder Morgan Energy Partners must compensate landowners for the use of their property and, in eminent domain actions, such compensation may be determined by a court. The inability of Kinder Morgan Energy Partners to exercise the power of eminent domain could negatively affect its business if it were to lose the right to use or occupy the property on which its pipelines are located.
Future business development of our products pipelines is dependent on the supply of, and demand for, crude oil and other liquid hydrocarbons, particularly from the Alberta oilsands.
Our pipelines depend on production of natural gas, oil and other products in the areas serviced by our pipelines. Without reserve additions, production will decline over time as reserves are depleted and production costs may rise. Producers may shut down production at lower product prices or higher production costs, especially where the existing cost of production exceeds other extraction methodologies, such as at the Alberta oilsands. Producers in areas serviced by us may not be successful in exploring for and developing additional reserves, and the gas plants and the pipelines may not be able to maintain existing volumes of throughput. Commodity prices and tax incentives may not remain at a level which encourages producers to explore for and develop additional reserves, produce existing marginal reserves or renew transportation contracts as they expire.
Changes in the business environment, such as a decline in crude oil prices, an increase in production costs from higher feedstock prices, supply disruptions, or higher development costs, could result in a slowing of supply from the Alberta oilsands. In addition, changes in the regulatory environment or governmental policies may have an impact on the supply of crude oil. Each of these factors impact our customers shipping through our pipelines, which in turn could impact the prospects of new transportation contracts or renewals of existing contracts.
Throughput on our products pipelines may also decline as a result of changes in business conditions. Over the long term, business will depend, in part, on the level of demand for oil and natural gas in the geographic areas in which deliveries are made by pipelines and the ability and willingness of shippers having access or rights to utilize the pipelines to supply such demand. The implementation of new regulations or the modification of existing regulations affecting the oil and gas industry could reduce demand for natural gas and crude oil, increase our costs and may have a material adverse effect on our results of operations and financial condition. We cannot predict the impact of future economic conditions, fuel conservation measures, alternative fuel requirements, governmental regulation or technological advances in fuel economy and energy generation devices, all of which could reduce the demand for natural gas and oil.
We are subject to U.S. dollar/Canadian dollar exchange rate fluctuations.
As a result of the operations of our Kinder Morgan CanadaKMP segment, a portion of our assets, liabilities, revenues and expenses are denominated in Canadian dollars. We are a U.S. dollar reporting company. Fluctuations in the exchange rate between United States and Canadian dollars
A-11
could expose us to reductions in the U.S. dollar value of our earnings and cash flows and a reduction in our stockholder's equity under applicable accounting rules.
The future success of Kinder Morgan Energy Partners' oil and gas development and production operations depends in part upon its ability to develop additional oil and gas reserves that are economically recoverable.
The rate of production from oil and natural gas properties declines as reserves are depleted. Without successful development activities, the reserves and revenues of the oil producing assets within Kinder Morgan Energy Partners' CO2 business segment will decline. Kinder Morgan Energy Partners may not be able to develop or acquire additional reserves at an acceptable cost or have necessary financing for these activities in the future. Additionally, if Kinder Morgan Energy Partners does not realize production volumes greater than, or equal to, its hedged volumes, Kinder Morgan Energy Partners may be liable to perform on these hedges.
The development of oil and gas properties involves risks that may result in a total loss of investment.
The business of developing and operating oil and gas properties involves a high degree of business and financial risk that even a combination of experience, knowledge and careful evaluation may not be able to overcome. Acquisition and development decisions generally are based on subjective judgments and assumptions that, while they may be reasonable, are by their nature speculative. It is impossible to predict with certainty the production potential of a particular property or well. Furthermore, a successful completion of a well does not ensure a profitable return on the investment. A variety of geological, operational, or market-related factors, including, but not limited to, unusual or unexpected geological formations, pressures, equipment failures or accidents, fires, explosions, blowouts, cratering, pollution and other environmental risks, shortages or delays in the availability of drilling rigs and the delivery of equipment, loss of circulation of drilling fluids or other conditions may substantially delay or prevent completion of any well, or otherwise prevent a property or well from being profitable. A productive well may become uneconomic in the event water or other deleterious substances are encountered, which impair or prevent the production of oil and/or gas from the well. In addition, production from any well may be unmarketable if it is contaminated with water or other deleterious substances.
The volatility of natural gas and oil prices could have a material adverse effect on our business.
The revenues, profitability and future growth of Kinder Morgan Energy Partners' CO2 business segment and the carrying value of its oil and natural gas properties depend to a large degree on prevailing oil and gas prices. Prices for oil and natural gas are subject to large fluctuations in response to relatively minor changes in the supply and demand for oil and natural gas, uncertainties within the market and a variety of other factors beyond our control. These factors include, among other things, weather conditions and events such as hurricanes in the United States; the condition of the United States economy; the activities of the Organization of Petroleum Exporting Countries; governmental regulation; political stability in the Middle East and elsewhere; the foreign supply of oil and natural gas; the price of foreign imports; and the availability of alternative fuel sources.
A sharp decline in the price of natural gas or oil prices would result in a commensurate reduction in our revenues, income and cash flows from the production of oil and natural gas and could have a material adverse effect on the carrying value of Kinder Morgan Energy Partners' proved reserves. In the event prices fall substantially, Kinder Morgan Energy Partners may not be able to realize a profit from its production and would operate at a loss. In recent decades, there have been periods of both worldwide overproduction and underproduction of hydrocarbons and periods of both increased and relaxed energy conservation efforts. Such conditions have resulted in periods of excess supply of, and reduced demand for, crude oil on a worldwide basis and for natural gas on a domestic basis. These periods have been followed by periods of short supply of, and increased demand for, crude oil and
A-12
natural gas. The excess or short supply of crude oil or natural gas has placed pressures on prices and has resulted in dramatic price fluctuations even during relatively short periods of seasonal market demand. These fluctuations necessarily impact the accuracy of assumptions used in our budgeting process.
Our use of hedging arrangements could result in financial losses or reduce our income.
We currently engage in hedging arrangements to reduce our exposure to fluctuations in the prices of oil and natural gas. These hedging arrangements expose us to risk of financial loss in some circumstances, including when production is less than expected, when the counterparty to the hedging contract defaults on its contract obligations, or when there is a change in the expected differential between the underlying price in the hedging agreement and the actual prices received. In addition, these hedging arrangements may limit the benefit we would otherwise receive from increases in prices for oil and natural gas.
The accounting standards regarding hedge accounting are very complex, and even when we engage in hedging transactions (for example, to mitigate our exposure to fluctuations in commodity prices or currency exchange rates or to balance our exposure to fixed and floating interest rates) that are effective economically, these transactions may not be considered effective for accounting purposes. Accordingly, our financial statements may reflect some volatility due to these hedges, even when there is no underlying economic impact at that point. In addition, it is not always possible for us to engage in a hedging transaction that completely mitigates our exposure to commodity prices. Our financial statements may reflect a gain or loss arising from an exposure to commodity prices for which we are unable to enter into a completely effective hedge.
Terrorist attacks, or the threat of them, may adversely affect our business.
The U.S. government has issued public warnings that indicate that pipelines and other energy assets might be specific targets of terrorist organizations. These potential targets might include our pipeline systems or storage facilities. Our operations could become subject to increased governmental scrutiny that would require increased security measures. Recent federal legislation provides an insurance framework that should cause current insurers to continue to provide sabotage and terrorism coverage under standard property insurance policies. Nonetheless, there is no assurance that adequate sabotage and terrorism insurance will be available at rates we believe are reasonable in the near future. These developments may subject our operations to increased risks, as well as increased costs, and, depending on their ultimate magnitude, could have a material adverse effect on our business, results of operations and financial condition.
A-13
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This Annex A includes forward-looking statements. These forward-looking statements are identified as any statement that does not relate strictly to historical or current facts. They use words such as "anticipate," "believe," "intend," "plan," "projection," "forecast," "strategy," "position," "continue," "estimate," "expect," "may," or the negative of those terms or other variations of them or comparable terminology. In particular, statements, express or implied, concerning future actions, conditions or events, future operating results or the ability to generate sales, income or cash flow, to satisfy any necessary purchase obligation with respect to the Kinder Morgan Management, LLC shares or to service debt or to pay dividends or make distributions are forward-looking statements. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Future actions, conditions or events and future results of operations may differ materially from those expressed in these forward-looking statements. Many of the factors that will determine these results are beyond our ability to control or predict. Specific factors that could cause actual results to differ from those in the forward-looking statements include:
A-14
The foregoing list should not be construed to be exhaustive. We believe the forward-looking statements in this document are reasonable. However, there is no assurance that any of the actions, events or results of the forward-looking statements will occur, or if any of them do, what impact they will have on our results of operations or financial condition. Because of these uncertainties, you should not put undue reliance on any forward-looking statements.
See "Risk Factors" in this Annex A for a more detailed description of these and other factors that may affect the forward-looking statements. When considering forward-looking statements, one should keep in mind the risk factors described in this Annex A. The risk factors described could cause our actual results to differ materially from those contained in any forward-looking statement. We disclaim any obligation, other than required by applicable law, to update the above list or to announce publicly the result of any revisions to any of the forward-looking statements to reflect future events or developments.
A-15
The following selected financial data includes significant impacts from acquisitions and dispositions of assets. See Notes 4 and 5 to our Annual Consolidated Financial Statements included in this Annex A for additional information.
|
Successor Company | Predecessor Company | |||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008(1) |
Seven Months Ended December 31, 2007(1) |
Four Months Ended September 30, 2007(1) |
|
Year Ended December 31, | ||||||||||||||||||||
|
Five Months Ended May 31, 2007 |
||||||||||||||||||||||||
|
2006(2)(3) | 2005(3) | 2004 | 2003 | |||||||||||||||||||||
|
(In millions) |
(In millions) |
|||||||||||||||||||||||
Operating Revenues |
$ | 9,752.1 | $ | 6,394.7 | $ | 3,545.9 | $ | 4,165.1 | $ | 10,208.6 | $ | 1,025.6 | $ | 877.7 | $ | 848.8 | |||||||||
Gas Purchases and Other Costs of Sales |
6,433.9 | 3,656.6 | 2,040.0 | 2,490.4 | 6,339.4 | 302.6 | 194.2 | 232.1 | |||||||||||||||||
Other Operating Expenses(4)(5)(6)(7) |
6,081.8 | 1,695.3 | 903.7 | 1,469.9 | 2,124.0 | 341.7 | 342.5 | 316.5 | |||||||||||||||||
Operating Income |
(2,763.6 | ) | 1,042.8 | 602.2 | 204.8 | 1,745.2 | 381.3 | 341.0 | 300.2 | ||||||||||||||||
Other Income and (Expenses) |
(687.6 | ) | (566.9 | ) | (388.3 | ) | (302.0 | ) | (858.9 | ) | 470.0 | 365.2 | 281.5 | ||||||||||||
Income (Loss) from Continuing Operations Before Income Taxes |
(3,451.2 | ) | 475.9 | 213.9 | (97.2 | ) | 886.3 | 851.3 | 706.2 | 581.7 | |||||||||||||||
Income Taxes |
194.4 | 227.4 | 95.9 | 135.5 | 285.9 | 337.1 | 208.0 | 225.1 | |||||||||||||||||
Income (Loss) from Continuing Operations |
(3,645.6 | ) | 248.5 | 118.0 | (232.7 | ) | 600.4 | 514.2 | 498.2 | 356.6 | |||||||||||||||
Income (Loss) from Discontinued Operations, Net of Tax(8) |
(0.6 | ) | (1.5 | ) | (2.1 | ) | 298.6 | (528.5 | ) | 40.4 | 23.9 | 25.1 | |||||||||||||
Net Income |
$ | (3,646.2 | ) | $ | 247.0 | $ | 115.9 | $ | 65.9 | $ | 71.9 | $ | 554.6 | $ | 522.1 | $ | 381.7 | ||||||||
Capital Expenditures(9) |
$ |
1,922.8 |
$ |
1,287.0 |
$ |
652.8 |
$ |
652.8 |
$ |
1,375.6 |
$ |
134.1 |
$ |
103.2 |
$ |
132.0 |
|||||||||
A-16
|
As of September 30, | As of December 31, | |||||||||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Successor Company |
Successor Company |
Predecessor Company | ||||||||||||||||||||||||||||||||||
|
2008(1) | |
2007(1) | |
2006(2) | |
2005(3) | |
2004 | |
2003 | |
|||||||||||||||||||||||||
|
(In millions) |
|
(In millions) |
|
(In millions, except percentages) |
||||||||||||||||||||||||||||||||
Total Assets |
$ | 24,708.7 | $ | 36,101.0 | $ | 26,795.6 | $ | 17,451.6 | $ | 10,116.9 | $ | 10,036.7 | |||||||||||||||||||||||||
Capitalization: |
|||||||||||||||||||||||||||||||||||||
Common Equity(4) |
$ | 4,412.7 | 23 | % | $ | 8,069.2 | 30 | % | $ | 3,657.5 | 20 | % | $ | 4,051.4 | 34 | % | $ | 2,919.5 | 45 | % | $ | 2,691.8 | 39 | % | |||||||||||||
Deferrable Interest Debentures |
35.7 | | % | 283.1 | 1 | % | 283.6 | 2 | % | 283.6 | 2 | % | 283.6 | 4 | % | 283.6 | 4 | % | |||||||||||||||||||
Capital Securities |
| | | | 106.9 | 1 | % | 107.2 | 1 | % | | | | | |||||||||||||||||||||||
Minority Interests |
3,474.3 | 19 | % | 3,314.0 | 13 | % | 3,095.5 | 17 | % | 1,247.3 | 10 | % | 1,105.4 | 17 | % | 1,010.1 | 15 | % | |||||||||||||||||||
Outstanding Notes and Debentures(5) |
10,900.6 | 58 | % | 14,814.6 | 56 | % | 10,623.9 | 60 | % | 6,286.8 | 53 | % | 2,258.0 | 34 | % | 2,837.5 | 42 | % | |||||||||||||||||||
Total Capitalization |
$ | 18,823.3 | 100 | % | $ | 26,480.9 | 100 | % | $ | 17,767.4 | 100 | % | $ | 11,976.3 | 100 | % | $ | 6,566.5 | 100 | % | $ | 6,823.0 | 100 | % | |||||||||||||
A-17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The following discussion should be read in conjunction with our annual and interim consolidated financial statements and related notes included elsewhere in this Annex A.
We are an energy infrastructure provider through our direct ownership and operation of energy-related assets, and through our ownership interests in and operation of Kinder Morgan Energy Partners. Our strategy and focus are on ownership of fee-based energy-related assets which are core to the energy infrastructure of North America and serve growing markets. These assets tend to have relatively stable cash flows while presenting us with opportunities to expand our facilities to serve additional customers and nearby markets. We evaluate the performance of our investment in these assets using, among other measures, segment earnings before depreciation, depletion and amortization.
Our principal business segments are:
As an energy infrastructure owner and operator in multiple facets of the United States' and Canada's various energy businesses and markets, we examine a number of variables and factors on a routine basis to evaluate our current performance and our prospects for the future. The profitability of our products pipeline transportation business is generally driven by the utilization of our facilities in relation to their capacity, as well as the prices we receive for our services. Transportation volume levels are primarily driven by the demand for the petroleum products being shipped or stored. The prices for shipping are generally based on regulated tariffs that are adjusted annually based on changes in the Producer Price Index. Because of the overall effect of utilization on our products pipeline
A-18
transportation business, we seek to own refined products pipelines located in or that transport to stable or growing markets and population centers.
With respect to our interstate natural gas pipelines and related storage facilities, the revenues from these assets tend to be received under contracts with terms that are fixed for various periods of time. We monitor the contracts under which we provide interstate natural gas transportation services and, to the extent practicable and economically feasible in light of our strategic plans and other factors, we generally attempt to mitigate risk of reduced volumes and prices by negotiating contracts with longer terms, with higher per-unit pricing and for a greater percentage of our available capacity. However, changes, either positive or negative, in actual quantities transported on our interstate natural gas pipelines may not accurately measure or predict associated changes in profitability because many of the underlying transportation contracts, sometimes referred to as take-or-pay contracts, specify that we receive the majority of our fee for making the capacity available, whether or not the customer actually chooses to utilize the capacity.
Our CO2 sales and transportation business, like our natural gas pipelines business, generally has take-or-pay contracts, although the contracts in our CO2 business typically have minimum volume requirements. In the long term, our success in this business is driven by the demand for CO2. However, short-term changes in the demand for CO2 typically do not have a significant impact on us due to the required minimum volumes under many of our contracts. In the oil and gas producing activities within our CO2 business segment, we monitor the amount of capital we expend in relation to the amount of production that is added or the amount of declines in production that are postponed. In that regard, our production during any period and the reserves that we add during that period are important measures. In addition, the revenues we receive from our crude oil, natural gas liquids and CO2 sales are a function of, in addition to production quantity, the prices we realize from the sale of these products. Over the long term, we will tend to receive prices that are dictated by the demand and overall market price for these products. In the shorter term, however, published market prices are likely not indicative of the revenues we will receive due to our risk management, or hedging, program in which the prices to be realized for certain of our future sales quantities are fixed, capped or bracketed through the use of financial derivatives, particularly for oil.
As with our pipeline transportation businesses, the profitability of our terminals businesses is generally driven by the utilization of our terminals facilities in relation to their capacity, as well as the prices we receive for our services, which in turn are driven by the demand for the products being shipped or stored. The extent to which changes in these variables affect this business in the near term is a function of the length of the underlying service contracts, the extent to which revenues under the contracts are a function of the amount of product stored or transported and the extent to which such contracts expire during any given period of time. As with our pipeline transportation businesses, we monitor the contracts under which we provide services and, to the extent practicable and economically feasible in light of our strategic plans and other factors, we generally attempt to mitigate the risk of reduced volumes and pricing by negotiating contracts with longer terms, with higher per-unit pricing and for a greater percentage of our available capacity. In addition, weather-related factors such as hurricanes, floods and droughts may impact our facilities and access to them and, thus, the profitability of certain terminals for limited periods of time or, in relatively rare cases of severe damage to facilities, for longer periods.
In our discussions of the operating results of individual businesses that follow, we generally identify the important fluctuations between periods that are attributable to acquisitions and dispositions separately from those that are attributable to businesses owned in both periods. Principally through Kinder Morgan Energy Partners, we have a history of making accretive acquisitions and economically advantageous expansions of existing businesses. Our ability to increase earnings and Kinder Morgan Energy Partners' ability to increase distributions to us and other investors will, to some extent, be a function of Kinder Morgan Energy Partners' success in acquisitions and expansions. Kinder Morgan
A-19
Energy Partners continues to have opportunities for expansion of its facilities in many markets and expects to continue to have such opportunities in the future, although the level of such opportunities is difficult to predict. Kinder Morgan Energy Partners' ability to make accretive acquisitions is a function of the availability of suitable acquisition candidates and, to some extent, its ability to raise necessary capital to fund such acquisitions, factors over which it has limited or no control. The availability of suitable acquisition candidates has lessened in recent periods, largely due to prices that are not attractive to Kinder Morgan Energy Partners, but it has no way to determine the extent to which it will be able to identify accretive acquisition candidates, or the number or size of such candidates, in the future, or whether it will complete the acquisition of any such candidates.
In addition to any uncertainties described in this discussion and analysis, we are subject to a variety of risks that could have a material adverse effect on our business, financial condition, cash flows and results of operations. See "Risk Factors" included elsewhere in this Annex A.
During 2006 and 2007, we reached agreements to sell certain businesses and assets in which we no longer have any continuing interest, including Terasen Gas, Corridor, the North System and our Kinder Morgan Retail segment. Accordingly, the activities and assets related to these sales are presented as discontinued items in the accompanying Consolidated Financial Statements (see Note 7 to our Annual Consolidated Financial Statements). Notes 5 and 15 to our Annual Consolidated Financial Statements contain additional information on asset sales and our business segments. As discussed following, many of our operations are regulated by various federal and state regulatory bodies.
In February 2007, we entered into a definitive agreement to sell our Canada-based retail natural gas distribution operations to Fortis Inc., for approximately C$3.7 billion including cash and assumed debt, and as a result of a redetermination of fair value in light of this proposed sale, we recorded an estimated goodwill impairment charge of approximately $650.5 million in the fourth quarter of 2006. This sale was completed in May 2007 (see Note 6 to our Annual Consolidated Financial Statements). In prior filings, we referred to these operations principally as the Terasen Gas business segment. In March 2007, we entered into an agreement to sell the Corridor Pipeline System to Inter Pipeline Fund in Canada for approximately C$760 million, including debt. This sale was completed in June 2007. Inter Pipeline Fund also assumed all of the debt associated with the expansion taking place on Corridor at the time of the sale. Also in March 2007, we completed the sale of our U.S. retail natural gas distribution and related operations to GE Energy Financial Services, a subsidiary of General Electric Company, and Alinda Investments LLC for $710 million and an adjustment for working capital. In prior periods, we referred to these operations as the Kinder Morgan Retail business segment. In December 2007, we entered into a definitive agreement to sell an 80% ownership interest in our NGPL business segment at a price equivalent to a total enterprise value of approximately $5.9 billion, subject to certain adjustments (see Note 1(M)) to our Annual Consolidated Financial Statements. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the financial results of the Terasen Gas, Corridor and Kinder Morgan Retail operations have been reclassified to discontinued operations for all periods presented, and 100% of the assets and liabilities associated with the NGPL business segment were reclassified to assets and liabilities held for sale and the non-current assets and long-term debt held for sale balances were then reduced by our 20% ownership interest in the NGPL business segment, which was recorded as an investment as of December 31, 2007. Refer to the heading "Discontinued Operations" included elsewhere in Management's Discussion and Analysis for additional information regarding discontinued operations.
On April 30, 2007, Kinder Morgan, Inc. sold the Trans Mountain pipeline system to Kinder Morgan Energy Partners for approximately $550 million. The transaction was approved by the independent members of our board of directors and those of Kinder Morgan Management following the receipt, by each board, of separate fairness opinions from different investment banks. The Trans Mountain pipeline system transports crude oil and refined products from Edmonton, Alberta, Canada
A-20
to marketing terminals and refineries in British Columbia and the State of Washington. An impairment of the Trans Mountain pipeline system was recorded in the first quarter of 2007; see Note 6 to our Annual Consolidated Financial Statements.
On November 20, 2007, we entered into a definitive agreement to sell our interests in three natural gas-fired power plants in Colorado to Bear Stearns. The closing of the sale occurred on January 25, 2008, effective January 1, 2008, and we received net proceeds of $63.1 million.
On August 28, 2008, Knight Inc. sold its one-third interest in the net assets of Express and of the net assets of Jet Fuel to Kinder Morgan Energy Partners for approximately 2 million Kinder Morgan Energy Partners' common units worth approximately $116 million. Express is a crude oil pipeline system that runs from Alberta to Illinois. Jet Fuel is a fuel pipeline that serves the Vancouver, British Columbia airport. This sale transaction and the sale of Trans Mountain pipeline system to Kinder Morgan Energy Partners as discussed above resulted in a change to our reportable segments.
As discussed in Note 1(B) to our Annual Consolidated Financial Statements, due to our adoption of EITF No. 04-5, effective as of January 1, 2006, Kinder Morgan Energy Partners and its consolidated subsidiaries are included as consolidated subsidiaries of Knight Inc. in our consolidated financial statements. Accordingly, their accounts, balances and results of operations are included in our consolidated financial statements for periods beginning on and after January 1, 2006, and we no longer apply the equity method of accounting to our investment in Kinder Morgan Energy Partners. Notwithstanding the consolidation of Kinder Morgan Energy Partners and its subsidiaries into our financial statements pursuant to EITF 04-5, we are not liable for, and our assets are not available to satisfy, the obligations of Kinder Morgan Energy Partners and/or its subsidiaries and vice versa. Responsibility for payments of obligations reflected in our or Kinder Morgan Energy Partners' financial statements is a legal determination based on the entity that incurs the liability. The determination of responsibility for payment among entities in our consolidated group of subsidiaries was not impacted by the adoption of EITF 04-5.
Our adoption of a new basis of accounting for our assets and liabilities as a result of the Going Private transaction, our adoption of EITF No. 04-5, our acquisition of Terasen Inc., the reclassification of the financial results of our retail natural gas distribution and related operations and our Corridor operations, the impairment of goodwill described above and other acquisitions and divestitures (including the transfer of certain assets to Kinder Morgan Energy Partners) discussed in Notes 1(B), 4, 5, 6, 7 and 19 to our Annual Consolidated Financial Statements affect comparisons of our financial position and results of operations between periods.
To convert December 31, 2007 and 2006 balances denominated in Canadian dollars to U.S. dollars, we used the December 31, 2007 and 2006 Bank of Canada closing exchange rate of 1.012 and 0.8581 U.S. dollars per Canadian dollar, respectively.
Critical Accounting Policies, Estimates and Annual Goodwill Impairment Test
Our discussion and analysis of financial condition and results of operations are based on our consolidated financial statements, prepared in accordance with accounting principles generally accepted in the United States of America and contained within this Annex A. Certain amounts included in or affecting our consolidated financial statements and related disclosure must be estimated, requiring us to make certain assumptions with respect to values or conditions that cannot be known with certainty at the time the financial statements are prepared. The reported amounts of our assets and liabilities, revenues and expenses and associated disclosures with respect to contingent assets and obligations are necessarily affected by these estimates. We evaluate these estimates on an ongoing basis, utilizing historical experience, consultation with experts and other methods we consider reasonable in the particular circumstances. Nevertheless, actual results may differ significantly from our estimates. Any
A-21
effects on our business, financial position or results of operations resulting from revisions to these estimates are recorded in the period in which the facts that give rise to the revision become known.
In preparing our consolidated financial statements and related disclosures, we must use estimates in determining the economic useful lives of our assets, the fair values used to determine possible impairment charges, the effective income tax rate to apply to our pre-tax income, deferred income tax balances, obligations under our employee benefit plans, provisions for uncollectible accounts receivable, cost and timing of environmental remediation efforts, potential exposure to adverse outcomes from judgments or litigation settlements, exposures under contractual indemnifications and various other recorded or disclosed amounts. Certain of these accounting estimates are of more significance in our financial statement preparation process than others, which policies are discussed following. Our policies and estimation methodologies are generally the same in both the predecessor and successor company periods, except where explicitly discussed.
Environmental Matters
With respect to our environmental exposure, we utilize both internal staff and external experts to assist us in identifying environmental issues and in estimating the costs and timing of remediation efforts. We expense or capitalize, as appropriate, environmental expenditures that relate to current operations, and we record environmental liabilities when environmental assessments and/or remedial efforts are probable and we can reasonably estimate the costs. We do not discount environmental liabilities to a net present value, and we recognize receivables for anticipated associated insurance recoveries when such recoveries are deemed to be probable.
The recording of environmental accruals often coincides with the completion of a feasibility study or the commitment to a formal plan of action, but generally, we recognize and/or adjust our environmental liabilities following routine reviews of potential environmental issues and claims that could impact our assets or operations. These adjustments may result in increases in environmental expenses and primarily result from quarterly reviews of potential environmental issues and resulting changes in environmental liability estimates. In making these liability estimations, we consider the effect of environmental compliance, pending legal actions against us, and potential third-party liability claims. For more information on our environmental disclosures, see Note 17 to our Annual Consolidated Financial Statements.
Legal Matters
We are subject to litigation and regulatory proceedings as a result of our business operations and transactions. We utilize both internal and external counsel in evaluating our potential exposure to adverse outcomes from orders, judgments or settlements. To the extent that actual outcomes differ from our estimates, or additional facts and circumstances cause us to revise our estimates, our earnings will be affected. In general, we expense legal costs as incurred. When we identify specific litigation that is expected to continue for a significant period of time and require substantial expenditures, we identify a range of possible costs expected to be required to litigate the matter to a conclusion or reach an acceptable settlement. If no amount within this range is a better estimate than any other amount, we record a liability equal to the low end of the range. Any such liability recorded is revised as better information becomes available.
As of September 30, 2008 and December 31, 2007, our most significant ongoing litigation proceedings involved Kinder Morgan Energy Partners' Pacific operations. Tariffs charged by Kinder Morgan Energy Partners' Pacific operations' pipeline systems are subject to certain proceedings at the Federal Energy Regulatory Commission ("FERC") involving shippers' complaints regarding the interstate rates, as well as practices and the jurisdictional nature of certain facilities and services. Generally, the interstate rates on Kinder Morgan Energy Partners' Pacific operations' pipeline systems
A-22
are "grandfathered" under the Energy Policy Act of 1992 unless "substantially changed circumstances" are found to exist. To the extent "substantially changed circumstances" are found to exist, Kinder Morgan Energy Partners' Pacific operations may be subject to substantial exposure under these FERC complaints and could, therefore, owe reparations and/or refunds to complainants as mandated by the FERC or the United States' judicial system. For more information on Kinder Morgan Energy Partners' Pacific operations' regulatory proceedings, see Note 17 and Note 18 to our Annual Consolidated Financial Statements and our Interim Consolidated Financial Statements, respectively.
Intangible Assets
Intangible assets are those assets which provide future economic benefit but have no physical substance. We account for our intangible assets according to the provisions of Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. These accounting pronouncements introduced the concept of indefinite life intangible assets and provided that all identifiable intangible assets having indefinite useful economic lives, including goodwill, will not be subject to periodic amortization. Such assets are not to be amortized unless and until their lives are determined to be finite. Instead, the carrying amount of a recognized intangible asset with an indefinite useful life must be tested for impairment annually or on an interim basis if events or circumstances indicate that the fair value of the asset has decreased below its carrying value. For the Predecessor Company, an impairment measurement test date of January 1 of each year was selected; for the Successor Company, we expect to use an annual impairment measurement date of May 31.
As of September 30, 2008 and December 31, 2007, our goodwill was $4,775.7 million and $8,174.0 million, respectively. Included in these goodwill balances is $250.1 million related to the Trans Mountain pipeline, which we sold to Kinder Morgan Energy Partners on April 30, 2007. This sale transaction caused us to reconsider the fair value of the Trans Mountain pipeline system in relation to its carrying value, and to make a determination as to whether the associated goodwill was impaired. As a result of our analysis, we recorded a goodwill impairment charge of $377.1 million in the first quarter of 2007.
Our remaining intangible assets, excluding goodwill, include customer relationships, contracts and agreements, technology-based assets and lease value. These intangible assets have definite lives, are being amortized on a straight-line basis over their estimated useful lives, and are reported separately as "Other Intangibles, Net" in the accompanying Consolidated Balance Sheets. As of September 30, 2008 and December 31, 2007 and 2006, these intangibles totaled $256.2 million, $321.1 million and $229.5 million, respectively.
In conjunction with our annual impairment test of the carrying value of goodwill, performed as of May 31, 2008, we determined that the fair value of certain reporting units that are part of our investment in Kinder Morgan Energy Partners were less than the carrying values. The fair value of each reporting unit was determined from the present value of the expected future cash flows from the applicable reporting unit (inclusive of a terminal value calculated using a market multiple for the individual assets). The implied fair value of goodwill within each reporting unit was then compared to the carrying value of goodwill of each such unit, resulting in the following goodwill impairments by reporting unit: Products PipelinesKMP (excluding associated terminals)$1.19 billion, Products Pipelines TerminalsKMP (separate from Products PipelinesKMP for goodwill impairment purposes)$70 million, Natural Gas PipelinesKMP$2.09 billion, and TerminalsKMP$677 million, for a total impairment of $4.03 billion. We have finalized our goodwill impairment calculation initially recorded in the second quarter of 2008. This resulted in an increase to the goodwill impairment by our Products PipelinesKMP (excluding associated terminals) reporting unit of $152.6 million and a decrease to the goodwill impairment by our Natural Gas PipelinesKMP
A-23
reporting unit of $152.6 million, with no net impact to the total goodwill impairment charge. The goodwill impairment is a non-cash charge and does not have any impact on our cash flow.
While the fair value of the CO2KMP segment exceeded its carrying value as of the date of our goodwill impairment test, decreases in the market value of crude oil led us to reconsider this analysis as of September 30, 2008. This analysis again showed that the fair value of the CO2KMP segment exceeded its carrying value, however the amount by which the fair value exceeded the carrying value decreased. If the market price of crude oil continues to decline, we may need to record non-cash goodwill impairment charges on this reporting unit in future periods.
Estimated Net Recoverable Quantities of Oil and Gas
We use the successful efforts method of accounting for Kinder Morgan Energy Partners' oil and gas producing activities. The successful efforts method inherently relies on the estimation of proved reserves, both developed and undeveloped. The existence and the estimated amount of proved reserves affect, among other things, whether certain costs are capitalized or expensed, the amount and timing of costs depleted or amortized into income and the presentation of supplemental information on oil and gas producing activities. The expected future cash flows to be generated by oil and gas producing properties used in testing for impairment of such properties also rely in part on estimates of net recoverable quantities of oil and gas.
Proved reserves are the estimated quantities of oil and gas that geologic and engineering data demonstrates with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Estimates of proved reserves may change, either positively or negatively, as additional information becomes available and as contractual, economic and political conditions change.
Hedging Activities
We engage in a hedging program that utilizes derivative contracts to mitigate (offset in whole or in part) our exposure to fluctuations in energy commodity prices, fluctuations in currency exchange rates and to balance our exposure to fixed and floating interest rates, and we believe that these hedges are generally effective in realizing these objectives. However, the accounting standards regarding hedge accounting are complex, and even when we engage in hedging transactions that are effective economically, these transactions may not be considered effective for accounting purposes.
According to the provisions of current accounting standards, to be considered effective, changes in the value of a derivative contract or its resulting cash flows must substantially offset changes in the value or cash flows of the item being hedged. A perfectly effective hedge is one in which changes in the value of the derivative contract exactly offset changes in the value of the hedged item or expected cash flow of the future transactions in reporting periods covered by the derivative contract. The ineffective portion of the gain or loss and any component excluded from the computation of the effectiveness of the derivative contract must be reported in earnings immediately; accordingly, our financial statements may reflect some volatility due to these hedges.
In addition, it is not always possible for us to engage in a hedging transaction that completely mitigates our exposure to unfavorable changes in commodity prices. For example, when we purchase a commodity at one location and sell it at another, we may be unable to hedge completely our exposure to a differential in the price of the product between these two locations. Even when we cannot enter into a completely effective hedge, we often enter into hedges that are not completely effective in those instances where we believe to do so would be better than not hedging at all, but due to the fact that the part of the hedging transaction that is not effective in offsetting undesired changes in commodity prices (the ineffective portion) is required to be recognized currently in earnings, our financial
A-24
statements may reflect a gain or loss arising from an exposure to commodity prices for which we are unable to enter into a completely effective hedge.
Employee Benefit Plans
With respect to the amount of income or expense we recognize in association with our pension and retiree medical plans, we must make a number of assumptions with respect to both future financial conditions (for example, medical costs, returns on fund assets and market interest rates) as well as future actions by plan participants (for example, when they will retire and how long they will live after retirement). Most of these assumptions have relatively minor impacts on the overall accounting recognition given to these plans, but two assumptions in particular, the discount rate and the assumed long-term rate of return on fund assets, can have significant effects on the amount of expense recorded and liability recognized. We review historical trends, future expectations, current and projected market conditions, the general interest rate environment and benefit payment obligations to select these assumptions. The discount rate represents the market rate for a high quality corporate bond. The selection of these assumptions is further discussed in Note 12 to our Annual Consolidated Financial Statements. While we believe our choices for these assumptions are appropriate in the circumstances, other assumptions could also be reasonably applied and, therefore, we note that, at our current level of pension and retiree medical funding, a change of 1% in the long-term return assumption would increase (decrease) our annual retiree medical expense by approximately $725,000 ($725,000) and would increase (decrease) our annual pension expense by $2.6 million ($2.6 million) in comparison to that recorded in 2007. Similarly, a 1% change in the discount rate would increase (decrease) our accumulated postretirement benefit obligation by $6.9 million ($6.3 million) and would increase (decrease) our projected pension benefit obligation by $31.5 million ($28.0 million) compared to those balances as of December 31, 2007.
Income Taxes
We record a valuation allowance to reduce our deferred tax assets to an amount that is more likely than not to be realized. While we have considered estimated future taxable income and prudent and feasible tax planning strategies in determining the amount of our valuation allowance, any change in the amount that we expect to ultimately realize will be included in income in the period in which such a determination is reached. In addition, we do business in a number of states with differing laws concerning how income subject to each state's tax structure is measured and at what effective rate such income is taxed. Therefore, we must make estimates of how our income will be apportioned among the various states in order to arrive at an overall effective tax rate. Changes in our effective rate, including any effect on previously recorded deferred taxes, are recorded in the period in which the need for such change is identified.
New Basis of Accounting
The Going Private transaction was accounted for as a purchase business combination and, as a result of the application of the Securities and Exchange Commission's "push-down" accounting requirements, this transaction has resulted in our adoption of a new basis of accounting for our assets and liabilities. Accordingly, our assets and liabilities have been recorded at their estimated fair values as of the date of the completion of the Going Private transaction, with the excess of the purchase price over these combined fair values recorded as goodwill.
Therefore, in the accompanying financial information, transactions and balances prior to the closing of the Going Private transaction (the amounts labeled "Predecessor Company") reflect the historical basis of accounting for our assets and liabilities, while the amounts subsequent to the closing (the amounts labeled "Successor Company") reflect the push-down of the investors' new accounting basis to our financial statements. While the Going Private transaction closed on May 30, 2007, for
A-25
convenience, the Predecessor Company is assumed to end on May 31, 2007 and the Successor Company is assumed to begin on June 1, 2007. The results for the two-day period, from May 30 to May 31, 2007, are not material to any of the periods presented. Additional information concerning the impact of the Going Private transaction on the accompanying financial information is contained under "Consolidated Financial Results" following.
Our adoption of a new basis of accounting for our assets and liabilities as a result of the Going Private transaction, the sale of our retail natural gas distribution and related operations, our Corridor operations, the North System and our 80% interest in NGPL PipeCo LLC ("PipeCo"), the goodwill impairments described above, and other acquisitions and divestitures, among other factors, affect comparisons of our financial position and results of operations between certain periods.
A-26
Three Months Ended September 30, 2008 and 2007 (Successor Company), Nine Months Ended September 30, 2008 (Successor Company), Four Months Ended September 30, 2007 (Successor Company) and Five Months Ended May 31, 2007 (Predecessor Company)
Consolidated Financial Results
The following provides management's discussion and analysis of the financial results for the three months ended September 30, 2008 and 2007, both of which are Successor Company periods. The following also provides management's discussion and analysis of the nine months ended September 30, 2008 and four months ended September 30, 2007, which are periods after the Going Private transaction (Successor Company), and of the five months ended May 31, 2007, which is prior to the Going Private transaction (Predecessor Company).
|
Three Months Ended September 30, |
Increase/(Decrease) Change from 2007 |
||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | $ | % | ||||||||||
|
(In millions, except percentages) |
|||||||||||||
Segment Earnings (Loss) before Depreciation, Depletion and Amortization Expense and Amortization of Excess Cost of Equity Investments(1) |
||||||||||||||
NGPL(2) |
$ | 11.5 | $ | 158.1 | $ | (146.6 | ) | (93 | )% | |||||
Power |
1.6 | 5.0 | (3.4 | ) | (68 | )% | ||||||||
Products PipelinesKMP(3) |
(22.4 | ) | 127.0 | (149.4 | ) | (118 | )% | |||||||
Natural Gas PipelinesKMP(4) |
337.6 | 142.3 | 195.3 | 137 | % | |||||||||
CO2KMP |
237.7 | 184.2 | 53.5 | 29 | % | |||||||||
TerminalsKMP |
117.3 | 84.4 | 32.9 | 39 | % | |||||||||
Kinder Morgan CanadaKMP(5) |
44.5 | 31.0 | 13.5 | 44 | % | |||||||||
Segment Earnings before DD&A |
727.8 | 732.0 | (4.2 | ) | (1 | )% | ||||||||
Depreciation, Depletion and Amortization Expense |
(217.2 | ) | (204.1 | ) | (13.1 | ) | (6 | )% | ||||||
Amortization of Excess Cost of Equity Investments |
(1.4 | ) | (1.4 | ) | | | % | |||||||
Other Operating Income |
11.1 | 0.2 | 10.9 | 5,450 | % | |||||||||
General and Administrative Expense |
(85.9 | ) | (77.9 | ) | (8.0 | ) | (10 | )% | ||||||
Interest and Other, Net |
(246.4 | ) | (304.9 | ) | 58.5 | 19 | % | |||||||
Income from Continuing Operations before Income Taxes(1) |
188.0 | 143.9 | 44.1 | 31 | % | |||||||||
Income Taxes(1) |
(79.1 | ) | (53.8 | ) | (25.3 | ) | (47 | )% | ||||||
Income from Continuing Operations |
108.9 | 90.1 | 18.8 | 21 | % | |||||||||
Loss from Discontinued Operations, Net of Tax |
(0.2 | ) | (4.4 | ) | 4.2 | 95 | % | |||||||
Net Income |
$ | 108.7 | $ | 85.7 | $ | 23.0 | 27 | % | ||||||
A-27
|
Successor Company | Predecessor Company |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008 |
Four Months Ended September 30, 2007 |
Five Months Ended May 31, 2007 |
||||||||
|
(In millions) |
(In millions) |
|||||||||
Segment Earnings (Loss) before Depreciation, Depletion and Amortization Expense and Amortization of Excess Cost of Equity Investments(1) |
|||||||||||
NGPL(2) |
$ | 116.2 | $ | 217.5 | $ | 267.4 | |||||
Power |
4.4 | 7.4 | 8.9 | ||||||||
Products PipelinesKMP(3) |
(859.3 | ) | 174.4 | 224.4 | |||||||
Natural Gas PipelinesKMP(4) |
(1,546.9 | ) | 192.1 | 228.5 | |||||||
CO2KMP |
721.6 | 241.4 | 210.0 | ||||||||
TerminalsKMP(5) |
(293.2 | ) | 122.7 | 172.3 | |||||||
Kinder Morgan CanadaKMP(6) |
114.0 | 42.7 | (332.0 | ) | |||||||
Segment Earnings (Loss) before DD&A |
(1,743.2 | ) | 998.2 | 779.5 | |||||||
Depreciation, Depletion and Amortization Expense |
(651.0 | ) | (276.3 | ) | (261.0 | ) | |||||
Amortization of Excess Cost of Equity Investments |
(4.3 | ) | (1.9 | ) | (2.4 | ) | |||||
Other Operating Income |
27.9 | 0.6 | 2.9 | ||||||||
General and Administrative Expense |
(264.0 | ) | (107.9 | ) | (283.6 | ) | |||||
Interest and Other, Net |
(836.7 | ) | (419.6 | ) | (348.2 | ) | |||||
Income (Loss) from Continuing Operations before Income Taxes(1) |
(3,471.3 | ) | 193.1 | (112.8 | ) | ||||||
Income Taxes(1) |
(174.3 | ) | (75.1 | ) | (119.9 | ) | |||||
Income (Loss) from Continuing Operations |
(3,645.6 | ) | 118.0 | (232.7 | ) | ||||||
Income (Loss) from Discontinued Operations, Net of Tax |
(0.6 | ) | (2.1 | ) | 298.6 | ||||||
Net Income (Loss) |
$ | (3,646.2 | ) | $ | 115.9 | $ | 65.9 | ||||
A-28
Three months ended September 30, 2008 compared to three months ended September 30, 2007
The increase in net income was principally due to (i) increases in our Natural Gas PipelinesKMP segment, primarily due to contributions from Rockies Express-West, which was fully operational for the quarter ended September 30, 2008, along with earnings generated from the improved margins in the Texas Intrastate operations, (ii) higher oil production at the SACROC Unit, which increased CO2KMP sales and transport volumes, along with higher hedge prices and higher oil and CO2 prices, (iii) increased earnings in the TerminalsKMP segment due to increased contributions from the completion of expansion projects at existing facilities and acquisitions that have occurred over the last year, (iv) earning contributions to the Kinder Morgan CanadaKMP segment from the April 2008 completion of the first portion of the Anchor Loop expansion of the Trans Mountain Pipeline, which boosted capacity from 260,000 to 285,000 barrels per day and resulted in a higher tariff and (v) lower interest costs due to the use of proceeds from the sale of an 80% interest in NGPL PipeCo LLC to retire and reduce debt.
The above favorable variances were offset by (i) increased DD&A expense in 2008 due principally to increases in 2007 and 2008 capital expenditures, (ii) lower earning contributions from NGPL and Power, as portions of these segments were sold in the first quarter of 2008 and (iii) $15.4 million of incremental expenses associated with hurricanes Gustav and Ike, and fires at three separate terminal locations.
Kinder Morgan Energy Partners also estimated that it lost $21.5 million in earnings related to these hurricane casualties mentioned above due to loss of business.
Nine months ended September 30, 2008
The net loss primarily resulted from a $4.03 billion non-cash goodwill impairment charge that was recorded in the second quarter of 2008 (see Note 3 to our Interim Consolidated Financial Statements). Other items negatively affecting results for the nine months ended September 30, 2008 include (i) reduced earning contributions from NGPL and Power as portions of these segments were sold in 2008, (ii) depreciation, depletion and amortization expense and amortization of excess cost of equity investment ("DD&A") associated with expansion capital expenditures, (iii) general and administrative costs that included labor costs and associated costs for new hires during this period to support Kinder Morgan Energy Partners' growing operations and (iv) $15.4 million of incremental expenses associated with hurricanes Gustav and Ike and fires at three separate terminal locations.
Kinder Morgan Energy Partners also estimated that it lost $21.5 million in earnings related to these hurricane casualties mentioned above due to loss of business.
The net loss was partially offset by (i) contributions from Rockies Express-West, which began service in January 2008 and reached full operations in May 2008 and increasing margins in the Texas Intrastate pipelines, (ii) favorable interest expense due to the February 2008 sale of an 80% ownership interest in NGPL PipeCo LLC for approximately $5.9 billion, with the proceeds from the sale used to pay down debt, (iii) strong CO2 sales and transport volumes in the CO2KMP segment, as well as increases of the average crude oil sale prices, (iv) the completion of expansion projects at existing facilities and recent acquisitions within the TerminalsKMP segment and (v) the completion of the Pump Station and anchor loop expansion within Kinder Morgan CanadaKMP.
A-29
Four months ended September 30, 2007
Net Income for the period was driven by solid contributions from CO2KMP, NGPL, Natural Gas PipelinesKMP and Products PipelinesKMP, which accounted for 24%, 22%, 19% and 17%, respectively, or 82% collectively, of segment earnings before DD&A. CO2KMP was driven almost equally by our sales and transport and oil and gas producing activities. The Texas Intrastate Pipelines accounted for over 50% of the Natural Gas PipelinesKMP performance and the Pacific Operations accounted for approximately 50% of the Product PipelinesKMP segment.
Net income was adversely impacted by (i) expenses related to the $4.8 billion in incremental debt resulting from the Going Private transaction (see discussion below on impact of purchase method of accounting on segment earnings) and (ii) DD&A expense associated with expansion capital expenditures.
Five months ended May 31, 2007
Net income was driven by solid performance from NGPL as well as all Kinder Morgan Energy Partners segments except Kinder Morgan CanadaKMP, as discussed below. NGPL contributed $267 million while Products PipelinesKMP, Natural Gas PipelinesKMP and CO2KMP each contributed over $200 million.
Offsetting these positive factors were (i) a $377.1 million goodwill impairment charge associated with the Trans Mountain Pipeline (see Note 3 to our Interim Consolidated Financial Statements) and (ii) $141.0 million in additional general and administrative expense associated with the Going Private transaction.
Impact of the purchase method of accounting on segment earnings
Except for the second quarter 2008 goodwill impairment charge described previously, the impacts of the purchase method of accounting on segment earnings (loss) before DD&A relate primarily to the revaluation of the accumulated other comprehensive income related to derivatives accounted for as hedges in the CO2KMP and Natural Gas PipelinesKMP segments. Where there is an impact to segment earnings (loss) before DD&A from the Going Private transaction, the impact is described in the individual business segment discussions, which follow. The effects on DD&A expense result from changes in the carrying values of certain tangible and intangible assets to their estimated fair values as of May 30, 2007. This revaluation results in changes to DD&A expense in periods subsequent to May 30, 2007. The purchase accounting effect on interest expense, net result principally from the revaluation of certain debt instruments to their estimated fair values as of May 30, 2007, resulting in changes to interest expense in subsequent periods.
Results of Operations
The following comparative discussion of our results of operations is by segment for factors affecting segment earnings, and on a consolidated basis for other factors.
We manage our various businesses by, among other things, allocating capital and monitoring operating performance. This management process includes dividing the company into business segments so that performance can be effectively monitored and reported for a limited number of discrete businesses. The business segments are described in Note 14 to our Interim Consolidated Financial Statements.
The accounting policies we apply in the generation of business segment earnings are generally the same as those applied to our Consolidated Statements of Operations and described in Note 1 to our Annual Consolidated Financial Statements. Certain items included in earnings from continuing operations are either not allocated to business segments or are not considered by management in its
A-30
evaluation of business segment performance. In general, the items not included in segment results are interest expense, general and administrative expenses and DD&A. In addition, for our business segments that are not also business segments of Kinder Morgan Energy Partners (currently the NGPL and Power business segments), certain items included in "Other Income and (Expenses)" and income taxes are not included in segment results. With adjustment for these items, we currently evaluate business segment performance primarily based on segment earnings before DD&A in relation to the level of capital employed. Beginning in 2007, the segment earnings measure was changed from segment earnings to segment earnings before DD&A for segments not also segments of Kinder Morgan Energy Partners. This change was made to conform our disclosure to the internal reporting we use as a result of the Going Private transaction. Because Kinder Morgan Energy Partners' partnership agreement requires it to distribute 100% of its available cash to its partners on a quarterly basis (Kinder Morgan Energy Partners' available cash consists primarily of all of its cash receipts, less cash disbursements and changes in reserves), we consider each period's earnings before all non-cash depreciation, depletion and amortization expenses to be an important measure of business segment performance for our segments that are also segments of Kinder Morgan Energy Partners. In addition, for our business segments that are also business segments of Kinder Morgan Energy Partners, we use segment earnings before depreciation, depletion and amortization expenses ("EBDA") internally as a measure of profit and loss for evaluating business segment performance and for deciding how to allocate resources to these business segments. We account for intersegment sales at market prices, while we account for asset transfers between entities at either market value or, in some instances, book value.
Following are operating results by individual business segment (before intersegment eliminations), including explanations of significant variances between the three months ended September 30, 2008 and 2007, both of which are Successor Company periods.
The following also provides management's discussion and analysis of the nine months ended September 30, 2008 and four months ended September 30, 2007, which are periods after the Going Private transaction (Successor Company), and of the five months ended May 31, 2007, which is prior to the Going Private transaction (Predecessor Company).
Natural Gas Pipeline Company of America
|
Successor Company | ||||||
---|---|---|---|---|---|---|---|
|
Three Months Ended September 30, |
||||||
|
2008 | 2007 | |||||
|
(In millions) |
||||||
Segment Earnings Before DD&A |
$ | 11.5 | $ | 158.1 | |||
Successor Company |
Predecessor Company |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008 |
Four Months Ended September 30, 2007 |
Five Months Ended May 31, 2007 |
|||||||
|
(In millions) |
(In millions) |
||||||||
Segment Earnings Before DD&A |
$ | 116.2 | $ | 217.5 | $ | 267.4 | ||||
As discussed in Note 11 to our Interim Consolidated Financial Statements, on February 15, 2008, we sold an 80% ownership interest in NGPL PipeCo LLC (formerly MidCon Corp.), which owns Natural Gas Pipeline Company of America and certain affiliates, collectively referred to as "NGPL," to Myria Acquisition Inc. for approximately $2.9 billion. We also received $3.0 billion of cash previously held in escrow related to a notes offering by NGPL PipeCo LLC in December 2007, the net proceeds
A-31
of which were distributed to us as repayment of intercompany indebtedness and as a dividend, immediately prior to the closing of the sale to Myria. Pursuant to the purchase agreement, Myria acquired all 800 Class B shares and we retained all 200 Class A shares of NGPL PipeCo LLC. We will continue to operate NGPL's assets pursuant to a 15-year operating agreement. Myria is owned by a syndicate of investors led by Babcock & Brown, an international investment and specialized fund and asset management group. As a result of the sale, beginning February 15, 2008, we account for NGPL's earnings derived from our 20% ownership interest of NGPL PipeCo LLC under the equity method.
Three months ended September 30, 2008 compared to three months ended September 30, 2007
At the 100% asset ownership level, NGPL's earnings before depreciation, depletion and amortization expenses for the three months ended September 30, 2008 were $176.1 million. NGPL's earnings before depreciation, depletion and amortization increased by $18.0 million (11%) for the three months ended September 30, 2008 over the comparable period in 2007. This increase in earnings was due to (i) $25.3 million of gross profit primarily earned on increased transport and storage service capacity and (ii) a $5.7 million increase in other income primarily related to a gain on sale of land recognized in September 2008. These increases in earnings were offset by $13.0 million of incremental operating expenses. The difference between the $176.1 million of segment earnings at the 100% asset ownership level described previously, and the $11.5 million of segment earnings for the three months ended September 30, 2008 recorded on Knight Inc.'s books results from the reduction in our ownership to 20% and our accounting for NGPL under the equity method after February 14, 2008.
Nine months ended September 30, 2008
At the 100% ownership level, NGPL's earnings before depreciation, depletion and amortization expenses for the nine months ended September 30, 2008 were $510.0 million. Earnings for this period reflect strong transportation and storage revenues of $765.8 million, strong natural gas sales of $117.4 million, and a $5.6 million gain related to a sale of land in September 2008. These positive impacts were offset by gas purchase expenses of $236.4 million and other costs of sales as well as other operating expenses of $147.4 million. The difference between the $510.0 million segment earnings at the 100% asset ownership level described previously, and the $116.2 million of segment earnings for the nine months ended September 30, 2008 recorded on Knight Inc.'s books results from the reduction in our ownership to 20% and our accounting for NGPL under the equity method after February 14, 2008.
Four months ended September 30, 2007
NGPL's earnings before DD&A for the four months ended September 30, 2007 were $217.5 million, consisting of operating revenues of $413.2 million, gas purchases and other cost of sales of $137.5 million, other operating expenses of $58.9 million and equity in earnings of Horizon of $0.7 million. Gross margins during this period were positively impacted by strong transportation and storage system revenues associated with the re-contracting of services, partially offset by pipeline rehabilitation, electric compression, and other system operational and maintenance expenses.
Five months ended May 31, 2007
NGPL's earnings before DD&A for the five months ended May 31, 2007 were $267.4 million, consisting of operating revenues of $426.5 million, gas purchases and other cost of sales of $99.3 million, other operating expenses of $60.4 million and equity in earnings of Horizon of $0.6 million. Transportation and storage revenues reflected the positive impact of re-contracted services. Gross margins were offset slightly by pipeline rehabilitation, electric compression, and other system operational and maintenance expenses.
A-32
Power
As discussed in Note 11 to our Interim Consolidated Financial Statements, on January 25, 2008, we sold our interests in three natural gas-fired power plants in Colorado to Bear Stearns. The closing of the sale was effective January 1, 2008, and we received net proceeds of $63.1 million.
The remaining operations for the Power segment are (i) Triton Power Michigan LLC's lease and operation of the Jackson, Michigan 550-megawatt natural gas fired electric power plant and (ii) a 103-megawatt natural gas fired power plant in Snyder, Texas whose only customer is the CO2KMP segment that generates electricity for its SACROC operations.
|
Successor Company | ||||||
---|---|---|---|---|---|---|---|
|
Three Months Ended September 30, |
||||||
|
2008 | 2007 | |||||
|
(In millions) |
||||||
Operating Revenues |
$ | 17.5 | $ | 21.0 | |||
Operating Expenses and Minority Interests |
(15.9 | ) | (19.3 | ) | |||
Equity in Earnings of Thermo Cogeneration Partnership |
| 3.3 | |||||
Segment Earnings Before DD&A |
$ | 1.6 | $ | 5.0 | |||
Successor Company |
Predecessor Company |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008 |
Four Months Ended September 30, 2007 |
Five Months Ended May 31, 2007 |
|||||||
|
(In millions) |
(In millions) |
||||||||
Operating Revenues |
$ | 38.2 | $ | 29.9 | $ | 19.9 | ||||
Operating Expenses and Minority Interests |
(33.8 | ) | (27.1 | ) | (16.1 | ) | ||||
Equity in Earnings of Thermo Cogeneration Partnership |
| 4.6 | 5.1 | |||||||
Segment Earnings Before DD&A |
$ | 4.4 | $ | 7.4 | $ | 8.9 | ||||
Three months ended September 30, 2008 compared to three months ended September 30, 2007
Power's segment earnings before DD&A decreased from $5.0 million in the third quarter of 2007 to $1.6 million in the third quarter of 2008, a decrease of $3.4 million (68%). This decrease was principally the result of (i) a $4.1 million decrease in earnings before DD&A related to the power assets sold in January 2008 and (ii) a $1.6 million increase in minority interest expense. These negative impacts were partially offset by a $2.2 million decrease in operating expenses.
Nine months ended September 30, 2008
Earnings before DD&A for the first nine months of 2008 reflect (i) the loss of $11.6 million and $9.7 million of 2007 operating revenues and equity earnings, respectively, related to the power assets sold in January 2008 and (ii) $15.4 million in minority interest expense. These negative impacts were partially offset by (i) $8.9 million in 2007 operating expenses associated with those sold power assets and (ii) a $1.5 million property tax settlement received in 2008.
Four months ended September 30, 2007
Earnings before DD&A for the four months ended September 30, 2007 reflect (i) a loss in operating revenues due to 2006 equipment sales, (ii) a negative impact to operating revenues at the Thermo Greeley facility related to gas purchase and sale agreements and (iii) $3.1 million in expenses
A-33
for our Jackson, Michigan power facility plant dispatch. These adverse impacts to earnings were partially offset by (i) strong operating revenues of $4.3 million from our Jackson, Michigan facility and (ii) our earnings from our investment in Thermo Cogeneration Partnership.
Five months ended May 31, 2007
Earnings before DD&A for the five months ended May 31, 2007 reflect (i) an unfavorable impact to operating revenues associated with 2006 equipment sales and (ii) $3.2 million in expenses for our Jackson, Michigan power facility plant dispatch. These unfavorable impacts to earnings were partially offset by (i) strong operating revenues of $4.5 million from our Jackson, Michigan facility (ii) our earnings from our investment in Thermo Cogeneration Partnership, and (iii) earnings from our Thermo Greeley facility associated with gas purchase and sales agreements.
Products PipelinesKMP
|
Successor Company | ||||||
---|---|---|---|---|---|---|---|
|
Three Months Ended September 30, |
||||||
|
2008 | 2007 | |||||
|
(In millions) |
||||||
Operating Revenues(1) |
$ | 205.6 | $ | 202.7 | |||
Operating Expenses(2) |
(78.7 | ) | (80.1 | ) | |||
Other Income (Expense)(3) |
(0.3 | ) | 0.6 | ||||
Goodwill Impairment(4) |
(152.6 | ) | | ||||
Earnings from Equity Investments(5) |
3.3 | 7.3 | |||||
Interest Income and Other Income, Net(6) |
0.4 | 2.9 | |||||
Income Tax Benefit (Expense) |
(0.1 | ) | (6.4 | ) | |||
Segment Earnings (Loss) Before DD&A |
$ | (22.4 | ) | $ | 127.0 | ||
Operating Statistics (MMBbl) |
|||||||
Gasoline |
101.1 | 111.2 | |||||
Diesel Fuel |
40.0 | 42.1 | |||||
Jet Fuel |
29.6 | 31.9 | |||||
Total Refined Product Volumes |
170.7 | 185.2 | |||||
Natural Gas Liquids |
5.8 | 7.4 | |||||
Total Delivery Volumes(7) |
176.5 | 192.6 | |||||
A-34
Successor Company |
Predecessor Company |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008 |
Four Months Ended September 30, 2007 |
Five Months Ended May 31, 2007 |
|||||||
|
(In millions) |
(In millions) |
||||||||
Operating Revenues(1) |
$ | 602.5 | $ | 269.4 | $ | 331.8 | ||||
Operating Expenses(2) |
(209.6 | ) | (103.1 | ) | (116.4 | ) | ||||
Other Income (Expense)(3) |
(0.6 | ) | 1.7 | (0.6 | ) | |||||
Goodwill Impairment(4) |
(1,266.5 | ) | | | ||||||
Earnings from Equity Investments(5) |
13.6 | 10.2 | 12.4 | |||||||
Interest Income and Other Income (Expense), Net(6) |
2.2 | 3.5 | 4.7 | |||||||
Income Tax Expense |
(0.9 | ) | (7.3 | ) | (7.5 | ) | ||||
Segment Earnings (Loss) Before DD&A |
$ | (859.3 | ) | $ | 174.4 | $ | 224.4 | |||
Operating Statistics (MMBbl) |
||||||||||
Gasoline |
299.5 | 149.2 | 182.8 | |||||||
Diesel Fuel |
120.2 | 55.6 | 66.6 | |||||||
Jet Fuel |
89.2 | 42.7 | 51.3 | |||||||
Total Refined Product Volumes |
508.9 | 247.5 | 300.7 | |||||||
Natural Gas Liquids |
18.7 | 9.1 | 13.7 | |||||||
Total Delivery Volumes(7) |
527.6 | 256.6 | 314.4 | |||||||
A-35
Following is information related to the increases and decreases, in the same comparable periods of 2008 and 2007, of the segment's remaining changes in EBDA and changes in operating revenues after certain items:
Three months ended September 30, 2008 compared to three months ended September 30, 2007
|
EBDA Increase/(Decrease) |
Revenues Increase/(Decrease) |
||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
(In millions, except percentages) |
|||||||||||||
Pacific Operations |
$ | (9.2 | ) | (13 | )% | $ | (2.3 | ) | (2) | |||||
Cochin Pipeline System |
(1.0 | ) | (10 | )% | (3.5 | ) | (21 | )% | ||||||
Southeast Terminals |
3.9 | 34 | % | 8.8 | 55 | % | ||||||||
West Coast Terminals |
2.3 | 20 | % | 2.7 | 15 | % | ||||||||
Central Florida Pipeline |
1.1 | 11 | % | 1.6 | 14 | % | ||||||||
All Other (Including Eliminations) |
(0.7 | ) | (2 | )% | 0.7 | 2 | % | |||||||
Total Products Pipelines |
$ | (3.6 | ) | (3 | )% | $ | 8.0 | 4 | % | |||||
Combined, the certain items described in the footnotes to the table above, including the $152.6 million goodwill impairment charge, decreased the Products Pipelines' segment earnings before depreciation, depletion and amortization expenses by $145.8 million when compared to the three months ended September 30, 2007. Following is a discussion of the segment's earnings before DD&A, excluding the effect of certain items described in the footnotes to the table above.
The decrease in EBDA from the Pacific operations was driven by a $6.8 million (47%) increase in operating and maintenance expenses in the third quarter of 2008, relative to the third quarter last year due to (i) increased major maintenance and pipeline integrity expenses (resulting mainly from project timing), (ii) lower capitalized overhead credits, (iii) incremental expenses resulting from environmental liability adjustments and (iv) lower gross profit on reduced revenues, which decreased $2.3 million (2%) compared to the third quarter last year, mainly due to an 8% decrease in mainline delivery volumes (primarily gasoline volumes) as a result of reduced demand (primarily in the state of California and Arizona).
The decrease in EBDA from the Cochin Pipeline was due to lost gross profit on reduced revenues, linked heavily to lower pipeline delivery volumes in 2008 versus 2007. The decreases in volumes were largely due to a continued decrease in demand for propane in Eastern Canadian and Midwestern U.S. petrochemical and fuel markets since the end of the third quarter last year.
The increase in EBDA and revenues from the Southeast Terminals, Central Florida Pipeline and West Coast Terminals operations was principally from (i) higher margins on increased liquids inventory sales, (ii) sales generated from incremental terminal throughput and storage activity, (iii) increased demand for ethanol, and (iv) incremental returns from the completion of a number of capital expansion projects that modified and upgraded terminal infrastructure, enabling Kinder Morgan Energy
A-36
Partners to provide additional ethanol related services to its customers. The Central Florida Pipeline also benefited from higher product delivery revenues, driven by an increase in the average tariff per barrel moved as a result of a mid-year 2007 tariff rate increase on product deliveries.
For all segment assets combined, revenues for the third quarter of 2008 from refined petroleum products deliveries were flat, but total volumes delivered fell 7.9%, when compared to the third quarter of 2007. Compared to the third quarter last year, the segment's volumes were negatively impacted by reductions in demand, driven primarily by higher crude oil and refined product prices and weaker economic conditions, and partly by lost business associated with two hurricanes in the third quarter of 2008. The decrease in delivery volumes included a 9% drop in gasoline volumes, a 5% drop in diesel fuel volumes, and a 7% decline in total jet fuel volumes. Excluding deliveries by Plantation Pipeline, total segment refined products delivery volumes decreased 7.3% in the comparable three month period. Although Plantation sustained no hurricane damage in 2008, the pipeline system pumped reduced volumes in the third quarter of 2008 due to hurricane-induced refinery shutdowns and to extended delays in restarting certain refineries impacted by the hurricanes. Delivery volumes on Plantation returned to pre-hurricane levels in early October.
Following is segment earnings before DD&A, and operating revenues information related to the nine and four month periods ended September 30, 2008 and 2007, respectively, and the five month period ended May 31, 2007:
Earnings Before DD&A by Segment Assets:
|
Successor Company | Predecessor Company |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008 |
Four Months Ended September 30, 2007 |
Five Months Ended May 31, 2007 |
||||||||
|
(In millions) |
(In millions) |
|||||||||
Pacific Operation |
$ | 182.4 | $ | 90.2 | $ | 105.1 | |||||
Cochin Pipeline System |
24.7 | 15.4 | 15.3 | ||||||||
Southeast Terminals |
38.8 | 14.9 | 16.6 | ||||||||
West Coast Terminals |
36.9 | (0.2 | ) | 19.3 | |||||||
Central Florida Pipeline |
31.9 | 12.6 | 15.3 | ||||||||
Goodwill Impairment Charge |
(1,266.5 | ) | | | |||||||
All Other (Including Eliminations) |
92.5 | 41.5 | 52.8 | ||||||||
Total Segment Earnings Before DD&A |
$ | (859.3 | ) | $ | 174.4 | $ | 224.4 | ||||
A-37
Operating Revenues by Segment Assets:
|
Successor Company | Predecessor Company |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008 |
Four Months Ended September 30, 2007 |
Five Months Ended May 31, 2007 |
||||||||
|
(In millions) |
(In millions) |
|||||||||
Pacific Operation |
$ | 281.5 | $ | 130.2 | $ | 156.0 | |||||
Cochin Pipeline System |
38.7 | 22.4 | 32.3 | ||||||||
Southeast Terminals |
63.0 | 22.3 | 29.9 | ||||||||
West Coast Terminals |
57.0 | 24.1 | 29.1 | ||||||||
Central Florida Pipeline |
38.8 | 15.5 | 19.3 | ||||||||
All Other (Including Eliminations) |
123.5 | 55.0 | 65.1 | ||||||||
Total Segment Operating Revenues |
$ | 602.5 | $ | 269.5 | $ | 331.7 | |||||
Nine months ended September 30, 2008
Earnings before DD&A were positively affected by strong earnings for the Southeast Terminals, Central Florida Pipeline and West Coast Terminals operations that were principally from (i) favorable margins on liquids inventory sales, (ii) incremental terminal throughput and storage activity, (iii) solid demand for ethanol, and (iv) incremental returns from the completion of a number of capital expansion projects that modified and upgraded terminal infrastructure, enabling Kinder Morgan Energy Partners to provide additional ethanol related services to its customers. The Central Florida Pipeline also benefited from strong product delivery revenues, driven by an increase in the average tariff per barrel moved as a result of a mid-year 2007 tariff rate increase on product deliveries.
Earnings before DD&A were adversely affected by (i) a $1,266.5 million goodwill impairment charge (see Note 3 to our Interim Consolidated Financial Statements), (ii) Pacific operations expenses for: (a) major maintenance and pipeline integrity expenses (resulting mainly from project timing), (b) incremental expenses resulting from environmental liability adjustments, and (iii) weak demand for propane in Eastern Canadian and Midwestern U.S. petrochemical and fuel markets resulting in lower volumes on the Cochin Pipeline.
Four months ended September 30, 2007
Kinder Morgan Energy Partners' Pacific operations are the largest contributor to this segment's earnings before DD&A. Earnings before DD&A were also positively affected by (i) higher oil loss allowance tariff rates in 2007 and lower pipeline integrity expenses within the Plantation Pipeline, (ii) an increase in average tariff rates and increased mainline delivery volumes from the 2006 expansion of the East Line pipeline and demand from West Coast military bases in the Pacific operations, (iii) terminal revenues for the West Coast operations included higher throughput volumes from the combined Carson/Los Angeles Harbor terminal system, and from the Linnton and Willbridge terminals located in Portland, Oregon and (iv) the West Coast operation's $3.6 million gain on the sale of its interest in the Black Oil pipeline system in Los Angeles, California in June 2007.
A-38
Five months ended May 31, 2007
Kinder Morgan Energy Partners' Pacific operations are the largest contributor to this segment's earnings before DD&A. Earnings before DD&A were also positively affected by (i) Kinder Morgan Energy Partners' January 1, 2007 acquisition of the remaining ownership interest in Cochin (approximately 50.2%) that it did not already own, at which time Kinder Morgan Energy Partners became the pipeline operator, (ii) an increase in average tariff rates and mainline delivery from the 2006 expansion of the East Line pipeline and demand from West Coast military bases contributed to the Pacific operations revenues and earnings, (iii) higher throughput volumes from the combined Carson/Los Angeles Harbor terminal system, and from the Linnton and Willbridge terminals located in Portland, Oregon, for the West Coast operations and (iv) in May 2006 Kinder Morgan Energy Partners completed construction and placed into service the Greensboro facility used for petroleum pipeline transmix operations for a capitalized cost of approximately $11 million.
Natural Gas PipelinesKMP
|
Successor Company | ||||||
---|---|---|---|---|---|---|---|
|
Three Months Ended September 30, |
||||||
|
2008 | 2007 | |||||
|
(In millions) |
||||||
Operating Revenues |
$ | 2,359.4 | $ | 1,526.8 | |||
Operating Expenses(1) |
(2,203.3 | ) | (1,387.5 | ) | |||
Other Income |
0.1 | 0.4 | |||||
Goodwill Impairment(3) |
152.6 | | |||||
Earnings from Equity Investments |
25.5 | 4.0 | |||||
Interest Income and Other Income, Net |
3.9 | | |||||
Income Tax Benefit (Expense) |
(0.6 | ) | (1.4 | ) | |||
Segment Earnings Before DD&A |
$ | 337.6 | $ | 142.3 | |||
Operating Statistics (Trillion Btus) |
|||||||
Natural Gas Transport Volumes(5) |
559.0 | 441.7 | |||||
Natural Gas Sales Volumes(6) |
220.0 | 224.4 |
A-39
Successor Company |
Predecessor Company |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008 |
Four Months Ended September 30, 2007 |
Five Months Ended May 31, 2007 |
|||||||
|
(In millions) |
(In millions) |
||||||||
Operating Revenues |
$ | 6,916.6 | $ | 2,114.7 | $ | 2,640.6 | ||||
Operating Expenses(1) |
(6,463.5 | ) | (1,929.7 | ) | (2,418.5 | ) | ||||
Other Income (Expense)(2) |
2.8 | 1.8 | (0.1 | ) | ||||||
Goodwill Impairment(3) |
(2,090.2 | ) | | | ||||||
Earnings from Equity Investments(4) |
80.4 | 5.3 | 8.9 | |||||||
Interest Income and Other Income, Net |
8.8 | | 0.2 | |||||||
Income Tax Benefit (Expense) |
(1.8 | ) | | (2.6 | ) | |||||
Segment Earnings (Loss) Before DD&A |
$ | (1,546.9 | ) | $ | 192.1 | $ | 228.5 | |||
Operating Statistics (Trillion Btus) |
||||||||||
Natural Gas Transport Volumes(5) |
1,599.5 | 568.8 | 707.4 | |||||||
Natural Gas Sales Volumes(6) |
660.0 | 295.2 | 345.8 |
A-40
Following is information related to the increases and decreases, in the same comparable periods of 2008 and 2007, of the segment's remaining changes in EBDA and changes in operating revenues after certain items:
Three months ended September 30, 2008 compared to three months ended September 30, 2007
|
EBDA Increase/(Decrease) |
Revenues Increase/(Decrease) |
||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
(In millions, except percentages) |
|||||||||||||
Rockies Express Pipeline |
$ | 23.0 | 568 | % | $ | n/a | n/a | |||||||
Texas Intrastate Natural Gas Pipeline Group |
13.6 | 18 | % | 834.7 | 59 | % | ||||||||
TransColorado Pipeline |
3.1 | 28 | % | 2.9 | 23 | % | ||||||||
Kinder Morgan Louisiana Pipeline |
3.0 | n/a | | | ||||||||||
Casper and Douglas Gas Processing |
(3.0 | ) | (48 | )% | 3.9 | 14 | % | |||||||
Trailblazer Pipeline |
(2.7 | ) | 20 | % | (1.1 | ) | (7 | )% | ||||||
All Others |
(1.8 | ) | (5 | )% | (7.9 | ) | (13 | )% | ||||||
Intrasegment Eliminations |
| | 0.1 | 27 | % | |||||||||
Total Natural Gas Pipelines |
$ | 35.2 | 25 | % | $ | 832.6 | 55 | % | ||||||
For the three months ended September 30, 2008, the certain items related to the Natural Gas PipelinesKMP business segment, described in the footnotes to the table above, including the $152.6 million goodwill impairment adjustment, increased earnings before depreciation, depletion and amortization expenses by $160.1 million when compared to the same period last year.
One of these certain items is an increase in earnings of $12.2 million in the comparable three month periods due to an unrealized mark to market gain resulting from the removal of hedge designation, effective April 1, 2008, on certain derivative contracts used to mitigate the price risk associated with future sales of natural gas liquids from the Casper and Douglas natural gas processing operations. For more information on the gain from the discontinuance of hedge accounting, see Note 15 to our Interim Consolidated Financial Statements.
The overall increases in segment earnings before depreciation, depletion and amortization expenses in the three months ended September 30, 2008, when compared to the same period last year, were driven primarily by incremental contributions from Kinder Morgan Energy Partners' 51% equity ownership interest in the Rockies Express Pipeline, higher earnings from its Texas intrastate natural gas pipeline group, improved performance from its TransColorado Pipeline and incremental earnings from its Kinder Morgan Louisiana Pipeline.
The incremental earnings from Kinder Morgan Energy Partners' investment in Rockies Express relates to higher net income earned by Rockies Express Pipeline LLC, primarily due to the start-up of service on the Rockies Express-West pipeline segment in January and May 2008. Rockies Express-West began interim service for up to 1.4 billion cubic feet per day of natural gas on the segment's first 503 miles of pipe on January 12, 2008, and service on the remaining 210 miles (to Audrain County, Missouri) began on May 20, 2008. Now fully operational, Rockies Express-West has the capacity to transport up to 1.5 billion cubic feet per day and can make deliveries to interconnects with the KMIGT Pipeline system, Northern Natural Gas Company, Natural Gas Pipeline Company of America LLC, ANR and Panhandle Eastern Pipeline Company.
Rockies Express conducted further hydrostatic testing of portions of its system during September 2008 to satisfy U.S. Department of Transportation testing requirements to operate at its targeted higher operating pressure. This hydrostatic test resulted in a temporary outage of pipeline delivery points and reduction of firm capacity available to firm shippers. By the terms of the Rockies Express FERC Gas Tariff, firm shippers are entitled to daily reservation revenue credits for non-force majeure and planned
A-41
maintenance outages, and the estimated impact from any temporary outages were included in the third quarter results.
Kinder Morgan Energy Partners' Texas intrastate natural gas pipeline group includes the operations of (i) Kinder Morgan Tejas (including Kinder Morgan Border Pipeline), (ii) Kinder Morgan Texas Pipeline, (iii) Kinder Morgan North Texas Pipeline, and (iv) Mier-Monterrey Mexico Pipeline. The group's quarter-to-quarter increase in earnings in 2008 versus 2007 was mainly attributable to higher natural gas sales margins driven by higher average sales prices. This increase in earnings was partially offset by a decrease in the Texas intrastate group's natural gas transportation and sales volumes, which were down 9% and 2%, respectively.
Because the Texas intrastate group buys and sells significant quantities of natural gas, the variances from period to period in both segment revenues and segment operating expenses (which include natural gas costs of sales) are partly due to changes in the intrastate group's average prices and volumes for natural gas purchased and sold. To the extent possible, Kinder Morgan Energy Partners balances the pricing and timing of its natural gas purchases to its natural gas sales, and these contracts are frequently settled in terms of an index price for both purchases and sales. In order to minimize commodity price risk, most sales are balanced with purchases at the index price on the date of settlement.
The increases in the 2008 third quarter earnings from the TransColorado Pipeline reflect contract improvements and expansions completed since the end of the third quarter of 2007, caused by an increase in natural gas production in the Piceance and San Juan basins of New Mexico and Colorado. In December 2007, an approximately $50 million expansion project on the TransColorado Pipeline was completed. The Blanco-Meeker project was placed into service January 1, 2008, and boosted natural gas transportation capacity on the pipeline by approximately 250 million cubic feet per day from the Blanco Hub area in San Juan County, New Mexico through TransColorado's existing pipeline for deliveries to the Rockies Express Pipeline at an existing point of interconnection located at the Meeker Hub in Rio Blanco County, Colorado. All of the incremental capacity is subscribed under a long-term contract with ConocoPhillips.
The incremental earnings before DD&A from the Kinder Morgan Louisiana Pipeline reflects other non-operating income realized in the third quarter of 2008 pursuant to FERC regulations governing allowances for capital funds that are used for pipeline construction costs (an equity cost of capital allowance). The equity cost of capital allowance provides for a reasonable return on construction costs that are funded by equity contributions, similar to the allowance for capital costs funded by borrowings.
The decrease in quarter-to-quarter earnings before DD&A from the Casper Douglas gas processing operations was primarily attributable to higher natural gas purchase costs, due to increases in both prices and volumes, relative to last year. The higher cost of sales expense more than offset period-to-period revenue increases resulting from both higher average prices on natural gas liquids sales and higher revenues from sales of excess natural gas.
The decrease in earnings before DD&A from the Trailblazer Pipeline was mainly due to lower revenues from natural gas transportation services and unfavorable timing differences on the settlement of pipeline transportation imbalances in the three months ended September 30, 2008, relative to 2007.
A-42
Following is segment earnings before DD&A and operating revenues information related to the nine months ended September 30, 2008, four months ended September 30, 2007 and five months ended May 31, 2007:
Earnings Before DD&A by Segment Asset:
|
Successor Company | Predecessor Company |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008 |
Four Months Ended September 30, 2007 |
Five Months Ended May 31, 2007 |
||||||||
|
(In millions) |
(In millions) |
|||||||||
Rockies Express Pipeline |
$ | 58.7 | $ | (5.4 | ) | $ | (4.3 | ) | |||
Texas Intrastate Natural Gas Pipeline Group |
288.0 | 106.0 | 133.0 | ||||||||
TransColorado Pipeline |
41.6 | 14.5 | 17.9 | ||||||||
Kinder Morgan Louisiana Pipeline |
6.0 | | | ||||||||
Casper and Douglas Gas Processing |
8.9 | 10.2 | 7.3 | ||||||||
Trailblazer Pipeline |
34.5 | 18.0 | 18.1 | ||||||||
Goodwill Impairment Charge |
(2,090.2 | ) | | | |||||||
All Others |
105.6 | 48.8 | 56.5 | ||||||||
Total Segment Earnings Before DD&A |
$ | (1,546.9 | ) | $ | 192.1 | $ | 228.5 | ||||
Operating Revenues by Major Segment Asset:
|
Successor Company | Predecessor Company |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008 |
Four Months Ended September 30, 2007 |
Five Months Ended May 31, 2007 |
||||||||
|
(In millions) |
(In millions) |
|||||||||
Texas Intrastate Natural Gas Pipeline Group |
$ | 6,575.5 | $ | 1,964.2 | $ | 2,492.4 | |||||
TransColorado Pipeline |
47.5 | 17.1 | 20.7 | ||||||||
Casper and Douglas Gas Processing |
111.4 | 35.9 | 34.7 | ||||||||
Trailblazer Pipeline |
42.5 | 21.5 | 22.6 | ||||||||
All Others |
143.0 | 76.5 | 70.7 | ||||||||
Eliminations |
(3.3 | ) | (0.5 | ) | (0.5 | ) | |||||
Total Segment Operating Revenues |
$ | 6,916.6 | $ | 2,114.7 | $ | 2,640.6 | |||||
Nine months ended September 30, 2008
The Natural Gas Pipelines-KMP segment's earnings before DD&A in the nine months ended September 30, 2008 were driven by (i) a strong performance by the Texas intrastate natural gas pipeline group due to higher natural gas sales margins and volumes partially due to incremental sales on a long-term contract with one if its largest customers that became effective April 1, 2007 and greater natural gas processing volumes and margins, (ii) contributions from Kinder Morgan Energy Partners' 51% ownership interest in the Rockies Express Pipeline as described previously, (iii) a strong performance from the TransColorado Pipeline primarily due to contract improvements and expansions completed since the end of the third quarter of 2007 as described previously and (iv) earnings from the Kinder Morgan Louisiana Pipeline that benefited from FERC regulations governing allowances for capital funds that are used for pipeline construction costs (an equity cost of capital allowance).
A-43
Offsetting the above positive impacts to the segment's earnings before DD&A were the following: (i) a $2,090.2 million goodwill impairment charge (see Note 3 to our Interim Consolidated Financial Statements), (ii) the Casper and Douglas gas processing operations were adversely affected by higher natural gas purchase costs, due to increases in both prices and volumes, which more than offset revenue increases resulting from both higher average prices on natural gas liquids sales and higher revenues from sales of excess natural gas and (iii) the Trailblazer Pipeline's earnings were affected by lower revenues from natural gas transportation services and unfavorable timing differences on the settlement of pipeline transportation imbalances.
Four months ended September 30, 2007 and five months ended May 31, 2007
Earnings before DD&A in the four months ended September 30, 2007 and five months ended May 31, 2007 were positively affected by (i) strong performances by the Texas intrastate natural gas pipeline group due to higher natural gas sales margins and volumes partially due to incremental sales on a long-term contract with one if its largest customers that became effective April 1, 2007 and greater natural gas processing volumes and margins and (ii) earnings from Casper and Douglas gas processing operations that had solid natural gas liquids sales revenues driven by higher prices and volumes.
Adversely affecting the earnings before DD&A in the four months ended September 30, 2007 and five months ended May 31, 2007 was a loss from Kinder Morgan Energy Partners' investment in Rockies Express due to depreciation and interest expenses allocable to a segment of this project that generated only limited natural gas reservation revenues and volumes since it was placed in service in February 2007, as described previously.
CO2KMP
|
Successor Company | ||||||
---|---|---|---|---|---|---|---|
|
Three Months Ended September 30, |
||||||
|
2008 | 2007 | |||||
|
(In millions) |
||||||
Operating Revenues(1) |
$ | 339.6 | $ | 256.8 | |||
Operating Expenses |
(105.4 | ) | (75.8 | ) | |||
Earnings from Equity Investments |
4.2 | 4.1 | |||||
Other Income, Net |
| | |||||
Income Tax Benefit (Expense) |
(0.7 | ) | (0.9 | ) | |||
Segment Earnings Before DD&A |
$ | 237.7 | $ | 184.2 | |||
Operating Statistics |
|||||||
Carbon Dioxide Delivery Volumes(Bcf)(2) |
171.3 | 150.4 | |||||
SACROC Oil Production (Gross)(MBbl/d)(3) |
27.9 | 27.3 | |||||
SACROC Oil Production (Net)(MBbl/d)(4) |
23.3 | 22.8 | |||||
Yates Oil Production (Gross)(MBbl/d)(5) |
27.1 | 27.1 | |||||
Yates Oil Production (Net)(MBbl/d)(4) |
12.0 | 12.0 | |||||
Natural Gas Liquids Sales Volumes (Net)(MBbl/d)(4) |
7.6 | 10.0 | |||||
Realized Weighted Average Oil Price per Bbl(5)(6) |
$ | 51.45 | $ | 36.77 | |||
Realized Weighted Average Natural Gas Liquids Price per Bbl(6)(7) |
$ | 77.97 | $ | 53.68 |
A-44
Successor Company |
Predecessor Company |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008 |
Four Months Ended September 30, 2007 |
Five Months Ended May 31, 2007 |
|||||||
|
(In millions) |
(In millions) |
||||||||
Operating Revenues(1) |
$ | 1,002.1 | $ | 336.6 | $ | 324.2 | ||||
Operating Expenses |
(292.7 | ) | (101.1 | ) | (121.5 | ) | ||||
Earnings from Equity Investments |
15.3 | 5.6 | 8.7 | |||||||
Other Income (Expense), Net |
(0.2 | ) | 0.1 | (0.1 | ) | |||||
Income Tax Benefit (Expense) |
(2.9 | ) | 0.2 | (1.3 | ) | |||||
Segment Earnings Before DD&A |
$ | 721.6 | $ | 241.4 | $ | 210.0 | ||||
Operating Statistics |
||||||||||
Carbon Dioxide Delivery Volumes(Bcf)(2) |
530.1 | 200.3 | 272.3 | |||||||
SACROC Oil Production (Gross)(MBbl/d)(3) |
27.6 | 27.5 | 29.1 | |||||||
SACROC Oil Production (Net)(MBbl/d)(4) |
23.0 | 22.9 | 24.2 | |||||||
Yates Oil Production (Gross)(MBbl/d)(3) |
27.9 | 27.4 | 26.4 | |||||||
Yates Oil Production (Net)(MBbl/d)(4) |
12.4 | 12.0 | 11.7 | |||||||
Natural Gas Liquids Sales Volumes (Net)(MBbl/d)(4) |
8.7 | 10.0 | 9.7 | |||||||
Realized Weighted Average Oil Price per Bbl(5)(6) |
$ | 51.50 | $ | 36.25 | $ | 35.03 | ||||
Realized Weighted Average Natural Gas Liquids Price per Bbl(6)(7) |
$ | 73.37 | $ | 53.02 | $ | 45.04 |
The CO2KMP segment's primary businesses involve the production, marketing and transportation of both carbon dioxide (commonly called CO2) and crude oil, and the production and marketing of natural gas and natural gas liquids. For each of the segment's two primary businesses,
A-45
following is information related to the increases and decreases, in the comparable three month period of 2008 and 2007, of the segment's EBDA, and changes in operating revenues after certain items:
Three months ended September 30, 2008 compared to three months ended September 30, 2007
|
EBDA Increase/(Decrease) | Revenues Increase/(Decrease) | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
(In millions, except percentages) |
|||||||||||||
Sales and Transportation Activities |
$ | 39.6 | 94 | % | $ | 47.8 | 105 | % | ||||||
Oil and Gas Producing Activities |
25.7 | 27 | % | 56.9 | 32 | % | ||||||||
Intrasegment Eliminations |
| | (10.1 | ) | (88 | )% | ||||||||
Total |
$ | 65.3 | 47 | % | $ | 94.6 | 45 | % | ||||||
Combined, the certain items described in the footnotes to the table above decreased the CO2 segment's EBDA by $11.7 million, when compared to the same period last year. Following is a discussion of the segment's earnings before DD&A, excluding the effect of the certain items described in the footnotes to the table above.
The quarter-to-quarter increase in earnings before DD&A from the segment's sales and transportation activities was largely related to (i) a $32.3 million (214%) increase in carbon dioxide sales revenues related to (a) a 104% quarter-to-quarter increase in average sales price and (b) a 27% quarter-to-quarter increase in sales volume, and (ii) a $4.2 million (23%) increase in carbon dioxide and crude oil pipeline transportation revenues due to (a) a 14% increase in carbon dioxide delivery volumes and (b) higher volumes.
The increase in average sales prices reflects continued customer demand for carbon dioxide for use in oil recovery projects throughout the Permian Basin area. In addition, a portion of the carbon dioxide contracts is tied to crude oil prices, which, as discussed above, have increased since the third quarter of 2007. Profits are not recognized on carbon dioxide sales within Kinder Morgan Energy Partners. The increase in sales and delivery volumes was largely due to the January 17, 2008 start-up of the Doe Canyon carbon dioxide source field located in Dolores County, Colorado. The new carbon dioxide source field is named the Doe Canyon Deep unit and we hold an approximately 87% working interest in the field. Since January 2007, Kinder Morgan Energy Partners has invested approximately $90 million to develop this source field. In addition, investments were also made to drill additional carbon dioxide wells at the McElmo Dome unit, increase transportation capacity on the Cortez Pipeline, and extend the Cortez Pipeline to the Doe Canyon Deep unit.
The quarter-to-quarter increase in earnings before DD&A from the oil and gas producing activities was largely related to (i) a $50.2 million (42%) increase in sales from ownership interests in oil-producing fields, which benefited from a 40% increase in the realized weighted average price per barrel, (ii) a $5.0 million (10%) increase in sales from natural gas processing plant operations where sales volume decreases of 24%, primarily related to effects from Hurricane Ike that shut-down third-party fractionation facilities, were more than offset by increases in the realized weighted average price per barrel.
Because prices of crude oil and natural gas liquids are subject to external factors over which Kinder Morgan Energy Partners has no control, and because future price changes may be volatile, the CO2KMP segment is exposed to commodity price risk related to the price volatility of crude oil and natural gas liquids. To some extent, Kinder Morgan Energy Partners is able to mitigate this risk through a long-term hedging strategy that is intended to generate more stable realized prices by using derivative contracts as hedges to the exposure of fluctuating expected future cash flows produced by changes in commodity sales prices. Nonetheless, decrease in the prices of crude oil and natural gas liquids will have a negative impact on the results of the CO2KMP business segment. All of the hedge gains and
A-46
losses for crude oil and natural gas liquids are included in the realized average price for oil. Had Kinder Morgan Energy Partners not used energy derivative contracts to transfer commodity price risk, crude oil sales prices would have averaged $116.08 per barrel in the third quarter of 2008, and $73.12 per barrel in the third quarter of 2007. For more information on hedging activities, see Note 15 to our Interim Consolidated Financial Statements.
Average gross oil production for the third quarter of 2008 was 27.9 thousand barrels per day at the SACROC field unit, 2% higher when compared to the third quarter of 2007. At the Yates unit, average gross oil production in the third quarter of 2008 was identical to the production in the same quarter last year.
Compared to the third quarter of 2007, the segment's $29.6 million (39%) increase in combined operating expenses in the three months ended September 30, 2008 was largely due to higher severance and property tax expenses, field operating expenses, and fuel and power expenses. The increase in severance tax expenses was related to the period-to-period increase in crude oil revenues. The increase in property tax expenses was largely due to higher oil prices leading to higher tax assessment, and increased asset infrastructure resulting from the capital investments Kinder Morgan Energy Partners has made since the end of the third quarter of 2007. The increase in operating expenses was driven by both higher well workover and repair expenses in 2008 and rising price levels since the end of the third quarter of 2007, which impacted rig costs and other materials and services. The increase in workover expenses was largely related to infrastructure expansion projects at the SACROC and Yates oil field units and at the McElmo Dome carbon dioxide unit. The increase in operating expenses from price level changes was largely due to increased demand driving up the prices charged by the industry's material and service providers.
Following is segment earnings before DD&A and operating revenues information related to the nine months ended September 30, 2008, four months ended September 30, 2007 and five months ended May 31, 2007:
Earnings Before DD&A by Segment Asset:
|
Successor Company | Predecessor Company |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008 |
Four Months Ended September 30, 2007 |
Five Months Ended May 31, 2007 |
||||||||
|
(In millions) |
(In millions) |
|||||||||
Sales and Transportation Activities |
$ | 323.8 | $ | 117.1 | $ | 67.2 | |||||
Oil and Gas Producing Activities |
397.8 | 124.3 | 142.8 | ||||||||
Total Segment Earnings Before DD&A |
$ | 721.6 | $ | 241.4 | $ | 210.0 | |||||
A-47
Operating Revenues by Segment Asset:
|
Successor Company | Predecessor Company |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008 |
Four Months Ended September 30, 2007 |
Five Months Ended May 31, 2007 |
||||||||
|
(In millions) |
(In millions) |
|||||||||
Sales and Transportation Activities |
$ | 347.4 | $ | 120.0 | $ | 71.3 | |||||
Oil and Gas Producing Activities |
714.3 | 231.4 | 271.7 | ||||||||
Intersegment Eliminations |
(59.6 | ) | (14.8 | ) | (18.8 | ) | |||||
Total Segment Operating Revenues |
$ | 1,002.1 | $ | 336.6 | $ | 324.2 | |||||
Nine months ended September 30, 2008
The CO2KMP segment's earnings before DD&A in the nine months ended September 30, 2008 were positively affected by strong average crude oil prices (which also impact the price of carbon dioxide under some contracts) and natural gas plant product prices. Generally, earnings for the segment's oil and gas producing activities, which include the operations associated with its ownership interests in oil-producing fields and natural gas processing plants, are impacted by its average hedge price and market price for a large percent of its volumes. Both have increased over last year.
Earnings for the segment's sales and transportation activities were positively impacted by factors affecting carbon dioxide sales revenues (both price and volume related) and carbon dioxide and crude oil pipeline transportation revenues. Transportation revenues were impacted by increased carbon dioxide delivery volume due to rising customer demand for carbon dioxide for use in oil recovery projects throughout the Permian Basin, as described previously.
With respect to crude oil, overall sales volumes were essentially flat, but the segment benefited from an increase in its realized weighted average price per barrel. With respect to natural gas liquids, a decrease in sales volumes was more than offset by increases in its realized weighted average price per barrel. Sales volumes were affected by the effects from Hurricane Ike, which resulted in pro-rationing (production allocation), as described previously.
Four months ended September 30, 2007
The CO2KMP segment's earnings before DD&A in the four months ended September 30, 2007 were positively affected by strong average crude oil and natural gas plant product prices. Highlights for the oil and gas producing activities in the four months ended September 30, 2007 included strong oil production at the Yates field unit and improved earnings due to an increased realized weighted average price per barrel in the SACROC field unit gas processing operations.
The average carbon dioxide sales price realized in the segment's sales and transportation activities during the four months ended September 30, 2007 was negatively affected by the December 2006 expiration of significantly high-priced sales contracts. In addition, carbon dioxide delivery volumes during this period were negatively impacted by oil production at the SACROC unit.
With respect to crude oil, overall sales volumes were stable, but the segment benefited from a strong realized weighted average price per barrel. With respect to natural gas liquids, unfavorable sales volumes were more than offset by a favorable realized weighted average price per barrel.
A-48
Five months ended May 31, 2007
The segment's sales and transportation activities were adversely affected by a decrease in average carbon dioxide prices. A significant portion of the decrease in average carbon dioxide prices is timing related, as some of the segment's carbon dioxide contracts are tied to crude oil prices in prior periods, and the 2007 contracts had been tied to lower crude oil prices, relative to 2006. These decreases in carbon dioxide prices were only partially offset by slightly higher carbon dioxide sales volumes related to increased carbon dioxide production from the McElmo Dome source field.
Highlights surrounding oil and gas producing activities for the five months ended May 31, 2007 include (i) increases in oil production at the Yates field unit, (ii) higher weighted average price per barrel, (iii) solid earnings from natural gas liquids sales volumes and prices, largely due to increased recoveries at the SACROC gas processing operations.
TerminalsKMP
|
Successor Company | ||||||
---|---|---|---|---|---|---|---|
|
Three Months Ended September 30, | ||||||
|
2008 | 2007 | |||||
|
(In millions) |
||||||
Operating Revenues |
$ | 306.2 | $ | 247.2 | |||
Operating Expenses(1) |
(175.0 | ) | (158.0 | ) | |||
Other Income (Expense)(2) |
(6.9 | ) | 1.5 | ||||
Earnings from Equity Investments |
0.7 | 0.3 | |||||
Interest Income and Other Income (Expense), Net |
(1.3 | ) | 0.3 | ||||
Income Tax Expense(4) |
(6.4 | ) | (6.9 | ) | |||
Segment Earnings Before DD&A |
$ | 117.3 | $ | 84.4 | |||
Operating Statistics |
|||||||
Bulk Transload Tonnage (MMtons)(5) |
26.8 | 24.5 | |||||
Liquids Leaseable Capacity (MMBbl) |
54.2 | 46.3 | |||||
Liquids Utilization |
98.2 | % | 96.5 | % |
A-49
Successor Company |
Predecessor Company |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008 |
Four Months Ended September 30, 2007 |
Five Months Ended May 31, 2007 |
|||||||
|
(In millions) |
(In millions) |
||||||||
Operating Revenues |
$ | 887.1 | $ | 326.8 | $ | 364.5 | ||||
Operating Expenses(1) |
(483.9 | ) | (198.7 | ) | (192.2 | ) | ||||
Other Income (Expense)(2) |
(6.5 | ) | 2.9 | 3.0 | ||||||
Goodwill Impairment(3) |
(676.6 | ) | | | ||||||
Earnings from Equity Investments |
2.4 | 0.3 | | |||||||
Interest Income and Other Income (Expense), Net |
1.4 | | 0.3 | |||||||
Income Tax Expense(4) |
(17.1 | ) | (8.6 | ) | (3.3 | ) | ||||
Segment Earnings (Loss) Before DD&A |
$ | (293.2 | ) | $ | 122.7 | $ | 172.3 | |||
Operating Statistics |
||||||||||
Bulk Transload Tonnage (MMtons)(5) |
76.5 | 31.3 | 41.4 | |||||||
Liquids Leaseable Capacity (MMBbl) |
54.2 | 46.3 | 43.6 | |||||||
Liquids Utilization |
98.2% | 96.5% | 97.5% |
Three months ended September 30, 2008 compared to three months ended September 30, 2007
For the three months ended September 30, 2008, the certain items related to the TerminalsKMP business segment, described in the footnotes to the table above, increased earnings before DD&A expenses by $9.8 million when compared to the same period last year. Following is a discussion of the segment's earnings before DD&A, excluding the effect of certain items described in the footnotes to the table above.
The segment's remaining $23.1 million (27%) increase in earnings before DD&A in the third quarter of 2008 versus the third quarter of 2007, was due to a combination of internal expansions and strategic business acquisitions as follows: (i) incremental amounts of earnings before depreciation, depletion and amortization of $5.6 million, revenues of $19.1 million, and operating expenses of $13.5 million, respectively, in the third quarter of 2008 for the Vancouver Wharves bulk marine
A-50
terminal and other acquired operations, (ii) $5.9 million (22%) from Kinder Morgan Energy Partners' Gulf Coast terminals, primarily the two large liquids terminal facilities located along the Houston Ship Channel in Pasadena and Galena Park, Texas, primarily due to higher liquids throughput volumes and increased liquids storage capacity as a result of expansions completed since the third quarter of 2007, (iii) the $5.7 million (59%) from Kinder Morgan Energy Partners' Mid-Atlantic terminals, primarily from the Pier IX bulk terminal located in Newport News, Virginia, due to higher period-over-period coal transfer volumes, and the Fairless Hills, Pennsylvania bulk terminal, largely due to incremental earnings from a new import fertilizer facility that began operations in the second quarter of 2008, (iv) $5.2 million (70%) from Kinder Morgan Energy Partners' Western terminals, primarily from the North 40 terminal, which began operations in the second quarter of 2008 and (v) $3.2 million (23%) from Kinder Morgan Energy Partners' Northeast terminals, primarily from the Perth Amboy, New Jersey liquids terminal, located in the New York Harbor area, driven by higher liquids throughput volumes as a result of an expansion completed at the end of the first quarter of 2008. Offsetting the above increases to earnings before depreciation, depletion and amortization was a decrease of $2.5 million (17%) from Kinder Morgan Energy Partners' Texas Petcoke terminals, primarily due to lost petroleum coke business, a portion of which was sidelined because of refinery shut-downs following Hurricane Ike.
For the TerminalsKMP segment combined, expansion projects completed since the end of the third quarter of 2007 have increased Kinder Morgan Energy Partners' liquids terminals' leasable capacity to 54.2 million barrels, up 17% from a capacity of 46.3 million barrels in the third quarter of 2007. At the same time, Kinder Morgan Energy Partners increased its overall liquids utilization capacity rate (the ratio of actual leased capacity to estimated potential capacity) to 98.2%, up almost 2% since the third quarter last year.
Nine months ended September 30, 2008
Segment earnings before DD&A were positively affected by assets acquired or expanded in the last eighteen months including (i) $8.3 million from the Vancouver Wharves bulk marine terminal, (ii) $22.2 million from Kinder Morgan Energy Partners' Marine Terminals, Inc. and other acquired operations, (iii) $100.0 million from Kinder Morgan Energy Partners' Gulf Coast terminals, primarily from its two expanded large liquids terminal facilities located along the Houston Ship Channel in Pasadena and Galena Park, Texas, (iv) $42.6 million from the Mid-Atlantic terminals, strong coal transfer volumes primarily from its Pier IX bulk terminal (including earnings from the first quarter 2008 completion of a $70 million construction of a new ship dock and installation of added terminal equipment) located in Newport News, Virginia, and its Fairless Hills, Pennsylvania bulk terminal that began operations in the second quarter of 2008 with a new $11.2 million import fertilizer facility that included construction of two storage domes, conveying equipment, and outbound loading facilities for both rail and truck, (v) $21.3 million from the Western terminals, primarily from its North 40 terminal, (vi) $53.3 million from the Northeast terminals, primarily from its Perth Amboy, New Jersey liquids terminal, located in the New York Harbor area, driven by liquids throughput volumes as a result of an expansion completed at the end of the first quarter of 2008 and (vii) $42.9 million in Texas Petcoke terminal's earnings before DD&A, which is net of lost petroleum coke business that was sidelined because of refinery shut-downs following Hurricane Ike.
Segment earnings before DD&A for this period were adversely impacted by (i) a $676.6 million goodwill impairment charge and (ii) $10.8 million in hurricane and fire damage clean-up, repair and write-offs, net of income tax benefit.
Four months ended September 30, 2007
Since the end of the first quarter of 2006, Kinder Morgan Energy Partners has invested approximately $191.1 million in cash and $1.7 million in common units to acquire terminal assets and,
A-51
combined, these operations accounted for $10.7 million of incremental earnings before DD&A during the four months ended September 30, 2007. The significant terminal acquisitions since the end of the second quarter of 2006 and their contributions included the following (i) $0.7 million from Transload Services, LLC, which provides material handling and steel processing services at 14 steel-related terminal facilities located in the Chicago metropolitan area and various cities in the United States, acquired November 20, 2006, (ii) $1.7 million from Devco USA L.L.C., which includes a proprietary technology that transforms molten sulfur into solid pellets that are environmentally friendly and easier to transport, acquired December 1, 2006, (iii) $6.8 million from Vancouver Wharves bulk marine terminal, which includes five deep-sea vessel berths and terminal assets located on the north shore of the Port of Vancouver's main harbor, acquired May 30, 2007 and (iv) $1.5 million from Marine Terminals, Inc. acquired on September 1, 2007, which are primarily involved in the handling and storage of steel and alloys and consist of two separate facilities located in Blytheville, Arkansas, and individual terminal facilities located in Decatur, Alabama, Hertford, North Carolina, and Berkley, South Carolina.
Segment earnings before DD&A were also affected by strong earnings contributions consisting of (i) $18.3 million from Kinder Morgan Energy Partners' Texas Petcoke operations, largely due to petroleum coke throughput volumes at its Port of Houston facility; (ii) $7.5 million from the combined operations of the Kinder Morgan Energy Partners' Argo and Chicago, Illinois liquids terminals, including impacts of increased ethanol throughput and incremental liquids storage and handling business; (iii) $9.4 million from Kinder Morgan Energy Partners' Lower Mississippi (Louisiana) terminals, which include its 662/3% ownership interest in the International Marine Terminals partnership and its Port of New Orleans liquids facility located in Harvey, Louisiana and (iv) $2.9 million from Kinder Morgan Energy Partners' Pier IX terminal, located in Newport News, Virginia, largely due to coal transfer volumes.
Five months ended May 31, 2007
Acquisitions in 2006 and 2007 as described above contributed $2.8 million in earnings before DD&A during the five months ended May 31, 2007 include the following (i) $2.0 million from Transload Services, LLC and (ii) $0.8 million from Devco USA L.L.C.
A-52
Segment earnings before DD&A included strong earnings contributions consisting of (i) $5.9 million from Kinder Morgan Energy Partners' Shipyard River terminal located in Charleston, South Carolina; (ii) $17.3 million from the Lower Mississippi (Louisiana) terminals (which include its 662/3% ownership interest in the International Marine Terminals partnership and the Port of New Orleans liquids facility located in Harvey, Louisiana) and (iii) $7.8 million from the combined operations of its Argo and Chicago, Illinois liquids terminals. The increases from the Shipyard River terminal related to completed expansion projects since the middle of 2006 that increased handling capacity for imported coal volumes and the earnings increases from the Chicago liquids facilities were driven by higher revenues, due to increased ethanol throughput and incremental liquids storage and handling business.
Kinder Morgan CanadaKMP
|
Successor Company | ||||||
---|---|---|---|---|---|---|---|
|
Three Months Ended September 30, |
||||||
|
2008 | 2007 | |||||
|
(In millions) |
||||||
Operating Revenues |
$ | 57.2 | $ | 44.6 | |||
Operating Expenses |
(18.6 | ) | (19.9 | ) | |||
Earnings from Equity Investment |
3.4 | 8.6 | |||||
Interest Income and Other Income, Net |
3.5 | 2.9 | |||||
Income Tax Benefit (Expense) |
(1.0 | ) | (5.2 | ) | |||
Segment Earnings Before DD&A |
$ | 44.5 | $ | 31.0 | |||
Operating Statistics |
|||||||
Transport Volumes (MMBbl) |
22.6 | 25.3 |
Successor Company |
Predecessor Company |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008 |
Four Months Ended September 30, 2007 |
Five Months Ended May 31, 2007 |
|||||||
|
(In millions) |
(In millions) |
||||||||
Operating Revenues |
$ | 145.4 | $ | 59.1 | $ | 62.0 | ||||
Operating Expenses |
(51.3 | ) | (24.9 | ) | (23.1 | ) | ||||
Other Income (Expense)(1) |
| | (377.1 | ) | ||||||
Earnings from Equity Investments |
7.7 | 11.3 | 5.4 | |||||||
Interest Income and Other Income, Net |
9.6 | 2.3 | 1.7 | |||||||
Income Tax Benefit (Expense) |
2.6 | (5.1 | ) | (0.9 | ) | |||||
Segment Earnings (Loss) Before DD&A |
$ | 114.0 | $ | 42.7 | $ | (332.0 | ) | |||
Operating Statistics |
||||||||||
Transport Volumes (MMBbl) |
63.5 | 33.7 | 36.4 |
The Kinder Morgan CanadaKMP segment includes operations Knight Inc. sold to Kinder Morgan Energy Partners: (i) Trans Mountain pipeline system (transferred effective April 30, 2007), (ii) one-third interest in the Express pipeline system (transferred effective August 28, 2008) and (iii) Jet Fuel pipeline system (transferred effective August 28, 2008). These operations had been reported
A-53
separately in previous reports. The information in the table above reflects the results of operations for Trans Mountain, the one-third interest in Express and Jet Fuel for all periods presented. See Note 14 to our Interim Consolidated Financial Statements.
Three months ended September 30, 2008 compared to three months ended September 30, 2007
Segment earnings before DD&A increased by $13.8 million (45%) for the three months ended September 30, 2008 over the comparable period in 2007. This increase is primarily due to (i) higher earnings of $17.2 million (78%) from the Trans Mountain pipeline system and (ii) lower earnings of $3.4 million from the Express and Jet Fuel pipeline systems. The increase in earnings from Trans Mountain was driven primarily by higher operating revenues, largely due to the April 2007 completion of an expansion project that included the commissioning of ten new pump stations that boosted capacity on Trans Mountain from 225,000 to approximately 260,000 barrels per day, and to the April 28, 2008 completion of the first portion of the Anchor Loop expansion that boosted pipeline capacity from 260,000 to 285,000 barrels per day and resulted in higher period-to-period average toll rates. The higher tariffs more than offset declines in mainline throughput volumes of 11% for the comparable three month periods. The decreases in volumes were primarily due to lower demand for water-borne exports out of Vancouver, British Columbia.
Nine months ended September 30, 2008
Earnings before DD&A for the nine months ended September 30, 2008 include strong operating revenues resulting from the April 2007 completion of an expansion project that included the commissioning of ten new pump stations that boosted capacity on Trans Mountain from 225,000 to approximately 260,000 barrels per day, and to the April 28, 2008 partial completion of the first portion of the Anchor Loop expansion that boosted pipeline capacity from 260,000 to 285,000 barrels per day and resulted in higher period-to-period average toll rates. Kinder Morgan Energy Partners completed construction on a final 15,000 barrels per day expansion on October 30, 2008 and total pipeline capacity is now approximately 300,000 barrels per day.
Four months ended September 30, 2007
Earnings before DD&A for the four months ended September 30, 2007 include $5.1 million of Canadian income taxes principally due to taxes payable on dock premiums collected.
Five months ended May 31, 2007
During the five months ended May 31, 2007, earnings before DD&A were adversely affected by a $377.1 million goodwill impairment charge recorded against the Trans Mountain asset, see Note 3 to our Interim Consolidated Financial Statements. Slightly offsetting this negative impact to earnings was the completion of a Pump Station expansion on April 30, 2007 and its associated positive impact to revenue for the period.
A-54
General and Administrative Expense
|
Successor Company | ||||||
---|---|---|---|---|---|---|---|
|
Three Months Ended September 30, |
||||||
|
2008 | 2007 | |||||
|
(In millions) |
||||||
Knight Inc. General and Administrative Expense |
$ | 11.5 | $ | 16.0 | |||
Kinder Morgan Energy Partners General and Administrative Expense |
74.4 | 61.9 | |||||
Consolidated General and Administrative Expense |
$ | 85.9 | $ | 77.9 | |||
Successor Company |
Predecessor Company |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008 |
Four Months Ended September 30, 2007 |
Five Months Ended May 31, 2007 |
|||||||
|
(In millions) |
(In millions) |
||||||||
Knight Inc. General and Administrative Expense |
$ | 40.1 | $ | 21.3 | 138.6 | |||||
Kinder Morgan Energy Partners General and Administrative Expense |
223.9 | 86.6 | 136.2 | |||||||
Terasen General and Administrative Expense |
| | 8.8 | |||||||
Consolidated General and Administrative Expense |
$ | 264.0 | $ | 107.9 | 283.6 | |||||
The $8.0 million increase in general and administrative expense in the third quarter of 2008, relative to 2007, was due to (i) a $12.5 million increase in general and administrative expense of Kinder Morgan Energy Partners, primarily driven by increased costs of supporting continued customer and business growth, including higher compensation-related expensescomprising salary and benefit expenses, payroll taxes and other employee and contractor related expenses, (ii) incremental expenses associated with the assets and businesses Kinder Morgan Energy Partners acquired since the third quarter of 2007including the Express and Jet Fuel pipeline systems acquired from Knight Inc. effective August 28, 2008, and Kinder Morgan Energy Partners' recently acquired bulk terminal operations and (iii) a $6.6 million increase in Knight Inc. general and administrative expenses as a result of higher compensation expense, partially offset by a $11.1 million decrease in Knight Inc. general and administrative expenses related to NGPL, which became an equity investment on February 15, 2008 when an 80% interest in NGPL PipeCo LLC was sold.
General and administrative expense for the nine months ended September 30, 2008 includes $ 33.9 million of Knight Inc. general and administrative expense, $223.9 million of Kinder Morgan Energy Partners general and administrative expense, primarily associated with compensation expense ($158.2 million) and outside services ($43.3 million), and $6.2 million of general and administrative expense related to NGPL PipeCo LLC during the period January 1, 2008 through February 14, 2008, the period prior to the sale of an 80% interest in NGPL PipeCo LLC.
General and administrative expense for the four months ended September 30, 2007 includes $21.3 million of Knight Inc. general and administrative expense and $86.6 million of Kinder Morgan Energy Partners general and administrative expense, primarily associated with compensation expense ($64.1 million) and outside services ($14.4 million).
General and administrative expense for the five months ended May 31, 2007 includes a total of $141.0 million related to the Going Private transaction, consisting of $114.8 million expensed by Knight Inc. and $26.2 million allocated to Kinder Morgan Energy Partners. In addition, during the five
A-55
months ended May 31, 2007 we incurred $4.3 million in selling expenses associated with the sale of our (i) U.S. based retail natural gas distribution and related operations, (ii) Terasen Inc., and (iii) Terasen Pipelines (Corridor) Inc.
Kinder Morgan Energy Partners' general and administrative expenses tend to increase over time in large part because the expansion of their businesses through acquisitions and internal growth requires the hiring of additional employees, resulting in increased payroll and other employee-related expense. Knight Inc.'s general and administrative expenses have decreased over time as it has sold assets such as an 80% interest in NGPL PipeCo LLC in 2008 and Terasen Inc., Terasen Pipelines (Corridor) Inc. and the U.S.-based retail natural gas distribution and related operations in 2007.
Interest and Other, Net
|
Successor Company | ||||||
---|---|---|---|---|---|---|---|
|
Three Months Ended September 30, |
||||||
|
2008 | 2007 | |||||
|
(In millions) |
||||||
Interest Expense and Other, Net |
|||||||
Interest Expense, Net |
$ | (141.5 | ) | $ | (252.6 | ) | |
Interest ExpenseDeferrable Interest Debentures |
(0.5 | ) | (5.4 | ) | |||
Other, Net |
2.4 | 5.5 | |||||
Consolidated Interest Expense and Other, Net |
(139.6 | ) | (252.5 | ) | |||
Minority Interest |
|||||||
Kinder Morgan Management |
(19.5 | ) | (10.0 | ) | |||
Kinder Morgan Energy Partners |
(78.5 | ) | (34.5 | ) | |||
Triton |
(9.3 | ) | (7.7 | ) | |||
Other |
0.5 | (0.2 | ) | ||||
Consolidated Minority Interests Expense |
(106.8 | ) | (52.4 | ) | |||
|
$ | (246.4 | ) | $ | (304.9 | ) | |
Successor Company |
Predecessor Company |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008 |
Four Months Ended September 30, 2007 |
Five Months Ended May 31, 2007 |
|||||||
|
(In millions) |
(In millions) |
||||||||
Interest Expense |
||||||||||
Interest Expense, Net |
$ | (493.8 | ) | $ | (336.1 | ) | $ | (241.1 | ) | |
Interest ExpenseDeferrable Interest Debentures |
5.6 | (7.3 | ) | (9.1 | ) | |||||
Other, Net |
10.9 | 10.7 | (7.3 | ) | ||||||
Consolidated Interest Expense |
(477.3 | ) | (332.7 | ) | (257.5 | ) | ||||
Minority Interest |
||||||||||
Kinder Morgan Management |
(72.2 | ) | (16.3 | ) | (17.1 | ) | ||||
Kinder Morgan Energy Partners |
(271.8 | ) | (58.0 | ) | (75.1 | ) | ||||
Triton |
(15.0 | ) | (12.0 | ) | 2.3 | |||||
Other |
(0.4 | ) | (0.6 | ) | (0.8 | ) | ||||
Consolidated Minority Interests Expense |
(359.4 | ) | (86.9 | ) | (90.7 | ) | ||||
|
$ | (836.7 | ) | $ | (419.6 | ) | $ | (348.2 | ) | |
A-56
The $111.1 million decrease in interest expense, net in the third quarter of 2008, relative to 2007, was primarily due to a reduction in Knight Inc.'s debt that was paid down with proceeds from asset sales undertaken during the last year and a decrease in interest rates partially offset by a 20% increase in debt balances at Kinder Morgan Energy Partners required to support capital expansion programs, net of Kinder Morgan Energy Partners 18% decrease in the weighted average interest rate on all of its borrowings.
Interest expense, net for the nine months ended September 30, 2008 includes: $207.7 million of Knight Inc. interest expense and $286.1 million of Kinder Morgan Energy Partners interest expense. Approximately $5.9 billion of the proceeds from the sale of an 80% interest in NGPL were used to pay down Knight Inc.'s interest bearing debt in February 2008. Kinder Morgan Energy Partners' interest expense includes: $50.8 million of interest expense related to $1.6 billion of additional debt incurred in Kinder Morgan Energy Partners' senior notes public offerings as follows: (i) on February 12, 2008 Kinder Morgan Energy Partners issued (a) $600 million of 5.95% notes and (b) $300 million of 6.95% notes and (ii) on June 6, 2008 Kinder Morgan Energy Partners issued: (a) $375 million of 5.95% notes and (b) $325 million of 6.95% notes.
Interest expense, net for the four months ended September 30, 2007 includes: $200.8 million of Knight Inc. interest expense and $135.3 million of Kinder Morgan Energy Partners interest expense. The Knight Inc. interest expense included $108.0 million of interest expense related to $4.5 billion of additional debt incurred in the Going Private transaction.
Interest expense, net for the five months ended May 31, 2007 includes (i) $155.0 million of Kinder Morgan Energy Partners interest expense and (ii) $86.1 million of Knight Inc. interest expense. Kinder Morgan Energy Partners interest expense tends to increase over time as it incurs additional debt to fund its capital spending and its acquisition of new assets and businesses.
Our minority interest expense associated with our ownership interests in Kinder Morgan Management increased $9.5 million from $10.0 million for the third quarter of 2007 to $19.5 million for the third quarter of 2008. This increase was principally due to Kinder Morgan Management's share of Kinder Morgan Energy Partner's increase in earnings over this period.
The $44.0 million increase in minority interest expense associated with Kinder Morgan Energy Partners from $34.5 million for the third quarter of 2007 as compared to $78.5 million for the third quarter of 2008 was principally due to the public's share in the increased earnings of Kinder Morgan Energy Partners over this period.
During the nine months ended September 30, 2008, four months ended September 30, 2007 and five months ended May 31, 2007, our minority interest expense associated with our ownership interests in Kinder Morgan Management was $72.2 million, $16.3 million and $17.1 million, respectively. Minority interest expense reflects the earnings recorded by Kinder Morgan Management that are attributed to its shares held by the public. Kinder Morgan Management's earnings are solely dependent on its ownership of Kinder Morgan Energy Partnership i-units. Therefore, our minority interest expense associated with Kinder Morgan Management for these two periods is a function of Kinder Morgan Energy Partners' earnings offset by our ownership of Kinder Morgan Management shares, of which we owned approximately 14% as of September 30, 2008 and September 30, 2007.
During the nine months ended September 30, 2008, the four months ended September 30, 2007 and the five months ended May 31, 2007, our minority interest expense associated with our ownership interests in Kinder Morgan Energy Partners was $271.8 million, $58.0 million and $75.1 million, respectively. Minority interest expense reflects the earnings from continuing operations recorded by Kinder Morgan Energy Partners that are attributed to its units held by the public.
A-57
Income Taxes
Income taxes from continuing operations increased from $74.6 million in the third quarter of 2007 to $87.9 million in the third quarter of 2008, an increase of $13.3 million (18%) primarily due to a $32.1 million increase in income from continuing operations.
During the nine months ended September 30, 2008 income taxes included (i) a reduction of approximately $53 million in deferred income tax liabilities, and income tax expense, related to the termination of certain of our subsidiaries' presence in Canada resulting in the elimination of future taxable gains and (ii) the tax deduction permitted for dividends received from domestic corporations. These decreases to income tax expense were partially offset by (i) state income taxes and (ii) the impact of consolidating the Kinder Morgan Management income tax provision.
During the four months ended September 30, 2007 and the five months ended May 31, 2007, our income tax expense included (i) state income taxes, (ii) the impact of consolidating the Kinder Morgan Management income tax provision, (iii) foreign earnings subject to different tax rates and (iv) the impact of consolidating Kinder Morgan Energy Partners' income tax provision. The five months ended May 31, 2007 income tax expense also included non-deductible fees associated with the Going Private transaction.
Fair Value Measurements
On September 15, 2006, the Financial Accounting Standards Board ("FASB") issued SFAS No. 157, Fair Value Measurements ("SFAS No. 157"). SFAS No. 157 established a hierarchal disclosure framework associated with the level of pricing observability utilized in measuring fair value. This framework defined three levels of inputs to the fair value measurement process, and requires that each fair value measurement be assigned to a level corresponding to the lowest level input that is significant to the fair value measurement in its entirety. We utilize energy commodity derivative contracts for the purpose of mitigating our risk resulting from fluctuations in the market price of natural gas, natural gas liquids and crude oil, and utilize interest rate swaps to mitigate our risk from fluctuations in interest rates. See Note 15 to our Interim Consolidated Financial Statements for additional information regarding SFAS No. 157.
At September 30, 2008, the fair value of our derivative instruments classified as Level 3 under the fair value hierarchy consisted primarily of West Texas Sour ("WTS") oil swaps and West Texas Intermediate ("WTI") options (costless collars). Costless collars are designed to establish floor and ceiling prices on anticipated future oil production from the assets we own in the SACROC oil field. While the use of these derivative instruments limits the downside risk of adverse price movements, they may also limit future revenues from favorable price movements. In addition to these oil-commodity derivatives, Level 3 derivative instruments consist of Natural Gas Basis swaps. Basis swaps are used in connection with another derivative contract to reduce hedge ineffectiveness by reducing a basis difference between a hedged exposure and a derivative contract. The following tables summarize the
A-58
total fair value asset and liability measurements of our Level 3 energy commodity derivative contracts in accordance with SFAS No. 157.
|
Significant Unobservable Inputs (Level 3) | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Assets | Liabilities | ||||||||||||||||||
|
September 30, 2008 |
December 31, 2007 |
Change | September 30, 2008 |
December 31, 2007 |
Change | ||||||||||||||
|
(In millions) |
(In millions) |
||||||||||||||||||
Natural Gas Basis Swaps |
$ | 4.9 | $ | 2.8 | $ | 2.1 | $ | (7.0 | ) | $ | (4.7 | ) | $ | (2.3 | ) | |||||
WTS Oil Swaps |
0.0 | 0.0 | 0.0 | (90.1 | ) | (94.5 | ) | 4.4 | ||||||||||||
WTI Options |
46.7 | 0.0 | 46.7 | (28.7 | ) | 0.0 | (28.7 | ) | ||||||||||||
Other |
1.0 | 1.0 | 0.0 | (7.4 | ) | (4.9 | ) | (2.5 | ) | |||||||||||
Total |
$ | 52.6 | $ | 3.8 | $ | 48.8 | $ | (133.2 | ) | $ | (104.1 | ) | $ | (29.1 | ) | |||||
The largest change in fair value of Level 3 assets and liabilities between December 31, 2007 and September 30, 2008 is related to WTI options, which amount to an increase of $46.7 and $28.7 million in assets and liabilities, respectively. The majority of these contracts were entered into during 2008, which accounts for the change. There were no transfers into or out of Level 3 during the period.
The valuation techniques used for the above Level 3 input derivatives are as follows:
Commodity derivative contracts are recorded at their estimated fair values as of each reporting date. For commodity derivatives, the most observable inputs available are used to determine the fair value of each contract. In the absence of a quoted price for an identical contract in an active market, we use broker quotes for identical or similar contracts, or internally prepared valuation models as primary inputs to determine fair value. Valuation methods have not changed during the quarter ended September 30, 2008.
When appropriate, valuations are adjusted for various factors including credit considerations. Such adjustments are generally based on available market evidence, including but not limited to Kinder Morgan Energy Partners credit default swap quotes as of September 30, 2008. Collateral agreements with our counterparties serve to reduce our credit exposure and are considered in the adjustment. Our fair value measurements of derivative contracts are adjusted for credit risk in accordance with SFAS No. 157, and the "Accumulated Other Comprehensive Loss" balance in the accompanying interim Consolidated Balance Sheet as of September 30, 2008 includes a gain of $14.1 million related to discounting the value of our energy commodity derivative liabilities for the effect of credit risk.
With the exception of the Casper and Douglas hedges and the ineffective portion of our derivative contracts, our energy commodity derivative contracts are accounted for as cash flow hedges. In
A-59
accordance with SFAS No. 133, gains and losses associated with cash flow hedges are included in the caption "Accumulated Other Comprehensive Loss" in the accompanying interim Consolidated Balance Sheets.
Liquidity and Capital Resources
Liquidity
We believe that we and our other subsidiaries and investments, including Kinder Morgan Energy Partners, have liquidity and access to financial resources as discussed below sufficient to meet future requirements for working capital, debt repayment and capital expenditures associated with existing and future expansion projects as follows:
Our diverse set of energy infrastructure assets generated $583.8 million of cash flows from continuing operations for the nine months ended September 30, 2008. Additionally, Kinder Morgan Energy Partners expansion projects in aggregate are expected to generate positive returns on our investment, based on long-term contracted customer commitments and our current estimated expansion project costs.
As of September 30, 2008, Knight Inc. had available credit capacity of $668.0 million and Kinder Morgan Energy Partners had available credit capacity of $810.3 million under existing credit facilities, both of which are net of Lehman Brothers' commitments (see Customer and Capital Market Liquidity). Kinder Morgan Energy Partners' joint venture projects, Rockies Express Pipeline LLC and Midcontinent Express Pipeline LLC, have undrawn capacity of $1.1 billion and $741.7 million, respectively, under their separate credit facilities, net of Lehman Brothers' commitments (see Customer and Capital Market Liquidity).
Since July 1, 2007, Kinder Morgan Energy Partners and its equity investment, Rockies Express Pipeline LLC, collectively have raised $3.4 billion of long-term debt, and Kinder Morgan Energy Partners has raised $843.2 million of equity through the sale of Kinder Morgan Energy Partners units. Including the quarterly share distributions by Kinder Morgan Management, which essentially constitute an automatic distribution re-investment program, a total of approximately $1.2 billion in equity was raised during this timeframe.
Additionally, in October 2008, our board of directors indicated its willingness to purchase up to $750 million of Kinder Morgan Energy Partners equity over the next 18 months, if necessary, to support its capital raising efforts.
On October 13, 2008, S&P revised its outlook on Kinder Morgan Energy Partners' long-term credit rating to negative from stable (but affirmed Kinder Morgan Energy Partners' long-term credit rating at BBB), due to Kinder Morgan Energy Partners' previously announced expected delay and cost increases associated with the completion of the Rockies Express Pipeline project. At the same time, S&P lowered Kinder Morgan Energy Partners, Rockies Express LLC, and Cortez Capital Corporation's short-term credit rating to A-3 from A-2. As a result of this revision and current commercial paper market conditions, Kinder Morgan Energy Partners, Rockies Express Pipeline LLC and Cortez Capital Corporation are unable to access commercial paper borrowings. However, Kinder Morgan Energy Partners, Rockies Express Pipeline LLC and
A-60
Cortez Capital Corporation expect that short-term financing and liquidity needs will continue to be met through borrowings made under their respective bank credit facilities. In conjunction with the Going Private transaction, Knight Inc. incurred approximately $4.8 billion in additional debt. Standard & Poor's Rating Services and Moody's Investor Services downgraded the ratings assigned to Knight Inc.'s senior unsecured debt to BB- and Ba2, respectively. Upon the recent 80% ownership interest sale of our NGPL business segment, which resulted in Knight Inc.'s repayment of a substantial amount of debt, Standard & Poor's Rating Services and Moody's Investor Services upgraded Knight Inc.'s senior unsecured debt to BB and Ba1, respectively. However, these ratings are still below investment grade. Since the Going Private transaction, Knight Inc. has not had access to the commercial paper market and is currently utilizing its $1.0 billion revolving credit facility for its short-term borrowing needs. A securities rating is not a recommendation to buy, sell or hold a security, may be subject to revision or withdrawal at any time by the issuing ratings agency in its sole discretion and should be evaluated independently of any other rating.
Customer and Capital Market Liquidity
Some of Kinder Morgan Energy Partners' customers are experiencing, or may experience in the future, severe financial problems that have had or may have a significant impact on their creditworthiness. These financial problems may arise from the current credit markets crisis, changes in commodity prices or otherwise. Kinder Morgan Energy Partners is working to implement, to the extent allowable under applicable contracts, tariffs and regulations, prepayments and other security requirements, such as letters of credit, to enhance their credit position relating to amounts owed from these customers. Kinder Morgan Energy Partners cannot provide assurance that one or more of their financially distressed customers will not default on their obligations to them or that such a default or defaults will not have a material adverse effect on Kinder Morgan Energy Partners' business, financial position, future results of operations, or future cash flows; however, Kinder Morgan Energy Partners believes it has provided adequate allowance for such customers.
On September 15, 2008, Lehman Brothers Holdings Inc. filed for bankruptcy protection under the provisions of Chapter 11 of the U.S. Bankruptcy Code. No Lehman Brothers affiliate is an administrative agent for us or any of our subsidiaries; however, one of the Lehman entities is a lending bank providing less than 5% of the commitments in Kinder Morgan Energy Partners' $1.85 billion five-year credit facility. It also provides less than 5% of the commitments in Rockies Express Pipeline LLC's $2.0 billion credit facility (Kinder Morgan Energy Partners is a 51% owner in Rockies Express Pipeline LLC) and less than 10% of the commitments in Midcontinent Express Pipeline LLC's $1.4 billion credit facility (Kinder Morgan Energy Partners is a 50% owner in Midcontinent Express Pipeline LLC). Since Lehman Brothers declared bankruptcy, its affiliate, which is a party to the Rockies Express Pipeline LLC and Midcontinent Express Pipeline LLC credit facilities, has not met its obligations to lend under those agreements. Thus, Kinder Morgan Energy Partners' available capacity on each of the three facilities (Kinder Morgan Energy Partners, Rockies Express Pipeline LLC and Midcontinent Express Pipeline LLC) will be reduced by the Lehman commitment. The commitments of the other banks remain unchanged and the facilities are not defaulted.
Also, on October 12, 2008, the U.S. Federal Reserve approved the application of Wells Fargo & Company to acquire Wachovia Corporation and its subsidiary banks. Wells Fargo will acquire all of Wachovia Corporation and all its businesses and obligations, including its preferred equity and indebtedness, and all its banking deposits. Wachovia Bank, National Association is the administrative agent of Kinder Morgan Energy Partners' five-year unsecured credit facility. In addition, Wachovia is a 6% lending bank participant in Knight Inc.'s $1.0 billion six-year senior secured credit facility. We do not expect that this merger will adversely impact our or Kinder Morgan Energy Partners' access to capital.
A-61
Invested Capital
The following table illustrates the sources of our invested capital. Our net debt to total capital increased in the first nine months of 2008, principally the result of a $4.03 billion goodwill impairment charge associated with the Going Private transaction (see Note 3 to our Interim Consolidated Financial Statements) as well as $1.6 billion in additional borrowings by Kinder Morgan Energy Partners during the first nine months of 2008. This increase was partially offset by debt reductions made possible by $5.9 billion in total proceeds related to the sale of an 80% ownership interest in NGPL PipeCo LLC, which proceeds were used to pay off the entire outstanding balances of our senior secured credit facility's Tranche A and Tranche B term loans, to repurchase $1.6 billion of our outstanding debt securities and to reduce balances outstanding under our $1.0 billion revolving credit facility.
Our net debt to total capital decreased in 2007 principally the result of (i) a net increase of approximately $2.7 billion in common equity, excluding accumulated other comprehensive loss, resulting from the Going Private transaction, (ii) an approximate $2.8 billion reduction in net debt due to the sales of Terasen Inc. and Terasen Pipelines (Corridor) Inc. and (iii) approximately $305.0 million of payments made on senior notes of Knight Inc. These decreases were partially offset by (i) a net of $4.5 billion of additional borrowings under our new $5.755 billion credit agreement primarily used to finance the Going Private transaction and (ii) increased debt by Kinder Morgan Energy Partners. See "Significant Financing Transactions" following for additional discussion regarding these financing transactions. Our ratio of net debt to total capital increased in 2006 compared to 2005 due to our adoption of EITF No. 04-5, which resulted in the inclusion of the accounts, balances and results of operations of Kinder Morgan Energy Partners in our consolidated financial statements beginning January 1, 2006. Although the total debt on our consolidated balance sheet increased as a result of including Kinder Morgan Energy Partners' debt balances with ours, Knight Inc. has not assumed any additional obligations with respect to Kinder Morgan Energy Partners' debt. See Note 1(B) to our Interim Consolidated Financial Statements for information regarding EITF No. 04-5.
A-62
In addition to the direct sources of debt and equity financing shown in the following table, we obtain financing indirectly through our ownership interests in unconsolidated entities. See Note 13 to our Interim Consolidated Financial Statements. Changes in our long-term and short-term debt are discussed under "Net Cash Flows from Financing Activities" following and in Note 13 to our Interim Consolidated Financial Statements.
|
Successor Company | Predecessor Company | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
September 30, 2008 |
December 31, 2007 |
December 31, 2006 |
December 31, 2005 |
||||||||||
|
(Dollars in millions) |
(Dollars in millions) |
||||||||||||
Long-term Debt |
||||||||||||||
Outstanding Notes and Debentures |
$ | 10,800.6 | $ | 14,714.6 | $ | 10,623.9 | $ | 6,286.8 | ||||||
Deferrable Interest Debentures Issued to Subsidiary Trusts |
35.7 | 283.1 | 283.6 | 283.6 | ||||||||||
Preferred Interest in General Partner of KMP |
100.0 | 100.0 | | | ||||||||||
Capital Securities |
| | 106.9 | 107.2 | ||||||||||
Value of Interest Rate Swaps |
233.8 | 199.7 | 46.4 | 51.8 | ||||||||||
|
11,170.1 | 15,297.4 | 11,060.8 | 6,729.4 | ||||||||||
Minority Interests |
3,474.3 | 3,314.0 | 3,095.5 | 1,247.3 | ||||||||||
Common Equity, Excluding Accumulated Other Comprehensive Loss |
4,412.7 | 8,069.2 | 3,657.5 | 4,051.4 | ||||||||||
|
19,057.1 | 26,680.6 | 17,813.8 | 12,028.1 | ||||||||||
Value of Interest Rate Swaps |
(233.8 | ) | (199.7 | ) | (46.4 | ) | (51.8 | ) | ||||||
Capitalization |
18,823.3 | 26,480.9 | 17,767.4 | 11,976.3 | ||||||||||
Short-term Debt, Less Cash and Cash Equivalents(1) |
433.1 | 819.3 | 2,046.7 | 841.4 | ||||||||||
Invested Capital |
$ | 19,256.4 | $ | 27,300.2 | $ | 19,814.1 | $ | 12,817.7 | ||||||
Capitalization |
||||||||||||||
Outstanding Notes and Debentures |
57.4 | % | 55.5 | % | 59.8 | % | 52.5 | % | ||||||
Minority Interests |
18.5 | % | 12.5 | % | 17.4 | % | 10.4 | % | ||||||
Common Equity |
23.4 | % | 30.5 | % | 20.6 | % | 33.8 | % | ||||||
Deferrable Interest Debentures Issued to Subsidiary Trusts |
0.2 | % | 1.1 | % | 1.6 | % | 2.4 | % | ||||||
Preferred Interest in General Partner of KMP |
0.5 | % | 0.4 | % | | % | | % | ||||||
Capital Securities |
| % | | % | 0.6 | % | 0.9 | % | ||||||
Invested Capital |
||||||||||||||
Net Debt(2)(3) |
58.3 | % | 56.9 | % | 63.9 | % | 55.6 | % | ||||||
Common Equity, Excluding Accumulated Other Comprehensive Loss and Including Deferrable Interest Debentures Issued to Subsidiary Trusts, Preferred Interest in General Partner of KMP, Capital Securities and Minority Interests |
41.7 | % | 43.1 | % | 36.1 | % | 44.4 | % |
A-63
Except for Kinder Morgan Energy Partners and its subsidiaries, we employ a centralized cash management program that essentially concentrates the cash assets of our subsidiaries in joint accounts for the purpose of providing financial flexibility and lowering the cost of borrowing. Our centralized cash management program provides that funds in excess of the daily needs of our subsidiaries be concentrated, consolidated, or otherwise made available for use by other entities within our consolidated group. We place no restrictions on the ability to move cash between entities, payment of intercompany balances or the ability to upstream dividends to parent companies other than restrictions that may be contained in agreements governing the indebtedness of those entities; provided that neither we nor our subsidiaries (other than Kinder Morgan Energy Partners and its subsidiaries) have rights with respect to the cash of Kinder Morgan Energy Partners or its subsidiaries except as permitted by Kinder Morgan Energy Partners' partnership agreement.
In addition, certain of our operating subsidiaries are subject to FERC-enacted reporting requirements for oil and natural gas pipeline companies that participate in cash management programs. FERC-regulated entities subject to these rules must, among other things, place their cash management agreements in writing, maintain current copies of the documents authorizing and supporting their cash management agreements, and file documentation establishing the cash management program with the FERC.
Short-term Liquidity
Our principal sources of short-term liquidity are our revolving bank facility, Kinder Morgan Energy Partners' revolving bank facility and cash provided by operations. The following represents the revolving credit facilities that were available to Knight Inc. and its respective subsidiaries, short-term debt outstanding under the credit facilities or an associated commercial paper program, and available borrowing capacity under the facilities after deducting outstanding letters of credit.
|
At September 30, 2008 | At December 31, 2008 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Short-term Debt Outstanding |
Available Borrowing Capacity |
Short-term Debt Outstanding |
Available Borrowing Capacity |
|||||||||
|
(In millions) |
||||||||||||
Credit Facilities |
|||||||||||||
Knight Inc. |
|||||||||||||
$1.0 billion, six-year secured revolver, due May 2013 |
$ | 270.0 | $ | 668.0 | $ | 8.8 | $ | 929.2 | |||||
Kinder Morgan Energy Partners |
|||||||||||||
$1.85 billion, five-year unsecured revolver, due August 2010 |
$ | 295.0 | $ | 810.3 | $ | | $ | 1,510.7 |
These facilities can be used for the respective entity's general corporate or partnership purposes. Kinder Morgan Energy Partners' facility is also used as backup for its commercial paper program, and is shown net of Lehman Brothers' commitments.
Our current maturities of long-term debt of $289.7 million at September 30, 2008 represent (i) $5.0 million of our 6.50% Series Debentures due September 1, 2009, (ii) $18.5 million in principal amount of tax-exempt bonds due April 1, 2024 (Kinder Morgan Energy Partners' subsidiary Kinder Morgan Operating L.P. "B" is the obligor on the bonds and the bonds are due on demand pursuant to call provisions), (iii) Kinder Morgan Energy Partners' $250.0 million in principal amount of 6.30% senior notes due February 1, 2009, (iv) $9.7 million of a 5.40% long-term note of Kinder Morgan Operating L.P. "A" and Kinder Morgan Canada Company and (v) $6.5 million of Kinder Morgan Texas
A-64
Pipeline, L.P.'s 5.23% series notes. Apart from our notes payable, current maturities of long-term debt, and the fair value of derivative instruments, our current liabilities, net of our current assets, represent an additional short-term obligation of $329.5 million at September 30, 2008. Given our expected cash flows from operations, our unused debt capacity as discussed above, including our credit facilities, and based on our projected cash needs in the near term, we do not expect any liquidity issues to arise.
In October 2008, Standard & Poor's Rating Services lowered Kinder Morgan Energy Partners, Rockies Express Pipeline LLC and Cortez Capital Corporation's short-term credit rating to A-3 from A-2. As a result of this revision and current commercial paper market conditions, Kinder Morgan Energy Partners, Rockies Express Pipeline LLC and Cortez Capital Corporation are unable to access commercial paper borrowings. However, Kinder Morgan Energy Partners, Rockies Express Pipeline LLC and Cortez Capital Corporation expect that short-term financing and liquidity needs will continue to be met through borrowings made under their respective bank credit facilities.
Significant Financing Transactions
On February 12, 2008, Kinder Morgan Energy Partners completed an offering of 1,080,000 of its common units at a price of $55.65 per unit in a privately negotiated transaction. Kinder Morgan Energy Partners received net proceeds of $60.1 million for the issuance of these 1,080,000 common units, and used the proceeds to reduce the borrowings under its commercial paper program.
In March 2008, Kinder Morgan Energy Partners completed a public offering of 5,750,000 of its common units at a price of $57.70 per unit, including common units sold pursuant to the underwriters' over-allotment option, less commissions and underwriting expenses. Kinder Morgan Energy Partners received net proceeds of $324.2 million for the issuance of these common units, and used the proceeds to reduce the borrowings under its commercial paper program.
The combined effect of the public offerings of common units had the associated effects of increasing our (i) minority interests associated with Kinder Morgan Energy Partners by $368.9 million and (ii) associated accumulated deferred income taxes by $5.6 million and reducing our (i) goodwill by $25.8 million and (ii) paid-in capital by $16.0 million.
On June 6, 2008, Kinder Morgan Energy Partners completed an additional public offering of senior notes. Kinder Morgan Energy Partners issued a total of $700 million in principal amount of senior notes, consisting of $375 million of 5.95% notes due February 15, 2018, and $325 million of 6.95% notes due January 15, 2038. Kinder Morgan Energy Partners received proceeds from the issuance of the notes, after underwriting discounts and commissions, of approximately $687.7 million, and used the proceeds to reduce the borrowings under its commercial paper program.
In March 2008, we paid $1.6 billion in cash to repurchase $1.67 billion par value of debt securities. See Note 13 to our Interim Consolidated Financial Statements for additional information regarding this debt security purchase.
On February 15, 2008, the entire outstanding balances of our senior secured credit facility's Tranche A and Tranche B term loans, and amounts outstanding at that time under our $1.0 billion revolving credit facility, on a combined basis totaling approximately $4.6 billion, were paid off with proceeds from the closing of the sale of an 80% ownership interest in NGPL PipeCo LLC.
On February 12, 2008, Kinder Morgan Energy Partners completed an additional public offering of senior notes. Kinder Morgan Energy Partners issued a total of $900 million in principal amount of senior notes, consisting of $600 million of 5.95% notes due February 15, 2018 and $300 million of 6.95% notes due January 15, 2038. Kinder Morgan Energy Partners received proceeds from the issuance of the notes, after underwriting discounts and commissions, of approximately $894.1 million, and used the proceeds to reduce the borrowings under its commercial paper program.
A-65
Contingent Debt
In October 2008, pursuant to the standby purchase agreement provisions contained in the bond indenturewhich require the sellers of those guarantees to buy the debt backcertain investors elected to put (sell) back their bonds at par plus accrued interest. A total principal and interest amount of $11.8 million was tendered and drawn against Kinder Morgan Energy Partners' letter of credit and accordingly, Kinder Morgan Energy Partners paid this amount pursuant to the letter of credit reimbursement provisions. This payment reduced the face amount of Kinder Morgan Energy Partners' letter of credit from $22.5 million to $10.7 million. The remarketing agent is attempting to re-sell the bonds that were put back. If any of these bonds are re-sold, we will receive the proceeds and Kinder Morgan Energy Partners' letter of credit obligation will increase by the same amount.
Effective June 30, 2006, West2East Pipeline LLC (and its subsidiary Rockies Express Pipeline LLC was deconsolidated and subsequently is accounted for under the equity method of accounting (See Note 4 to our Annual Consolidated Financial Statements). Pursuant to certain guaranty agreements, all three member owners of West2East Pipeline LLC (which owns all of the member interests in Rockies Express Pipeline LLC) have agreed to guarantee, severally in the same proportion as their percentage ownership of the member interests in West2East Pipeline LLC, borrowings under Rockies Express Pipeline LLC's (i) $2.0 billion five-year, unsecured revolving credit facility, due April 28, 2011; (ii) $2.0 billion commercial paper program; and (iii) $600 million in principal amount of floating rate senior notes due August 20, 2009. The three member owners and their respective ownership interests consist of the following: Kinder Morgan Energy Partners' subsidiary Kinder Morgan W2E Pipeline LLC51%, a subsidiary of Sempra Energy25%, and a subsidiary of ConocoPhillips24%.
On September 20, 2007, Rockies Express Pipeline LLC closed an unregistered Rule 144A offering of $600 million in principal amount of senior unsecured floating rate notes. The notes have a maturity date of August 20, 2009, and interest on these notes is paid and computed quarterly on an interest rate of three-month LIBOR (London Interbank Offered Rate) plus a spread. Upon issuance of the notes, Rockies Express Pipeline LLC entered into two floating-to-fixed interest rate swap agreements having a combined notional principal amount of $600 million and a maturity date of August 20, 2009.
On April 28, 2006, Rockies Express Pipeline LLC entered into a $2.0 billion five-year, unsecured revolving credit facility due April 28, 2011. This credit facility supports a $2.0 billion commercial paper program that was established in May 2006, and borrowings under the commercial paper program reduce the borrowings allowed under the credit facility. This facility can be amended to allow for borrowings up to $2.5 billion. Borrowings under the Rockies Express Pipeline LLC credit facility and commercial paper program are primarily used to finance the construction of the Rockies Express interstate natural gas pipeline and to pay related expenses, and the borrowings do not reduce the borrowings allowed under our credit facilities.
In addition to the $600 million in senior notes, as of December 31, 2007, Rockies Express Pipeline LLC had $1,625.4 million of commercial paper outstanding with an average interest rate of approximately 5.50%, and there were no borrowings under its five-year credit facility. Accordingly, as of December 31, 2007, Kinder Morgan Energy Partners' contingent share of Rockies Express Pipeline LLC's debt was $1,135.0 million (51% of total borrowings).
As of September 30, 2008, Kinder Morgan Energy Partners' contingent share of Rockies Express Pipeline LLC's and Midcontinent Express Pipeline LLC's debt was $741.6 million and $262.5 million, respectively. In addition, Kinder Morgan Energy Partners' contingent share of Rockies Express Pipeline LLC's and Midcontinent Express Pipeline LLC's outstanding letters of credit as of September 30, 2008 was $16.0 million and $16.7 million, respectively. See Note 13 to our Interim Consolidated Financial Statements.
A-66
Kinder Morgan Energy Partners has posted a letter of credit as security for borrowings under Adjustable Demand Revenue Bonds issued by the Nassau County, Florida Ocean Highway and Port Authority. The bonds were issued for the purpose of constructing certain port improvements located in Fernandino Beach, Nassau County, Florida. Kinder Morgan Energy Partners' subsidiary, Nassau Terminals LLC is the operator of the marine port facilities. The bond indenture is for 30 years and allows the bonds to remain outstanding until December 1, 2020. Principal payments on the bonds are made on the first of December each year and corresponding reductions are made to the letter of credit. As of September 30, 2008, this letter of credit had a face amount of $22.5 million.
Capital Expenditures
Our sustaining capital expenditures for the nine months ended September 30, 2008 were $119.7 million, and we expect to spend another $85.3 million during the final quarter of 2008, including $11.3 million for hurricane and fire repair and replacement costs. Our sustaining capital expenditures are funded with cash flows from operations.
Our expansion capital expenditures for the nine months ended September 30, 2008 were $1,803.1 million primarily with Kinder Morgan Energy Partners. Kinder Morgan Energy Partners expects to spend another $545 million during the final quarter of 2008. In addition, Kinder Morgan Energy Partners expects to spend approximately $1.4 billion for its share of the 2008 expansion capital expenditures for both the Rockies Express and Midcontinent Express natural gas pipeline projects in the final quarter of 2008. Kinder Morgan Energy Partners' share of the capital expenditures for these projects is being funded by borrowings under Rockies Express Pipeline LLC's and Midcontinent Express Pipeline LLC's own revolving credit facilities or by those entities issuing short-term commercial paper or long-term notes and a $306 million equity infusion by Kinder Morgan Energy Partners. Kinder Morgan Energy Partners has funded its expansion capital expenditures and its $306 million equity infusion noted above through borrowings under its $1.85 billion revolving credit facility and by issuing short-term commercial paper. To the extent these sources are not sufficient, Kinder Morgan Energy Partners could fund additional amounts through the issuance of long-term notes or its common units for cash. During 2008, Kinder Morgan Energy Partners used sales of long-term notes and common units to refinance portions of its short-term borrowings.
Interest in Kinder Morgan Energy Partners
At September 30, 2008, we owned, directly, and indirectly in the form of i-units corresponding to the number of shares of Kinder Morgan Management we owned, approximately 32.6 million limited partner units of Kinder Morgan Energy Partners. These units, which consist of 16.4 million common units, 5.3 million Class B units and 10.9 million i-units, represent approximately 12.5% of the total outstanding limited partner interests of Kinder Morgan Energy Partners. In addition, we indirectly own all the common equity of the general partner of Kinder Morgan Energy Partners, which holds an effective 2% combined interest in Kinder Morgan Energy Partners and its operating partnerships. Together, our limited partner and general partner interests represented approximately 14.2% of Kinder Morgan Energy Partners' total equity interests at September 30, 2008. As of the close of the Going Private transaction, our limited partner interests and our general partner interest represented an approximately 50% economic interest in Kinder Morgan Energy Partners. This difference results from the existence of incentive distribution rights held by the general partner of Kinder Morgan Energy Partners. The approximately 50% economic interest was used in applying a new accounting basis to this less than wholly owned subsidiary. See Note 2 to our Interim Consolidated Financial Statements.
In conjunction with Kinder Morgan Energy Partners' acquisition of certain natural gas pipelines from us at December 31, 1999, December 31, 2000 and November 1, 2004, we agreed to indemnify Kinder Morgan Energy Partners with respect to approximately $733.5 million of its debt. We would be
A-67
obligated to perform under this indemnity only if Kinder Morgan Energy Partners' assets were unable to satisfy its obligations.
Additional information on Kinder Morgan Energy Partners is contained in its Annual Report on Form 10-K for the year ended December 31, 2007 and in its Form 10-Q for the quarterly period ended September 30, 2008, both of which are incorporated by reference in this prospectus.
Cash Flows
The following table summarizes our net cash flows from operating, investing and financing activities for each period presented.
|
Successor Company | Predecessor Company | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
Nine Months Ended September 30, 2008 |
Four Months Ended September 30, 2007 |
Five Months Ended May 31, 2007 |
||||||||
|
(In millions) |
(In millions) |
|||||||||
Net Cash Provided by (Used in): |
|||||||||||
Operating Activities |
$ | 583.1 | $ | 509.6 | $ | 603.0 | |||||
Investing Activities |
3,968.0 | (12,142.7 | ) | 723.7 | |||||||
Financing Activities |
(4,569.6 | ) | 9,872.5 | 440.9 | |||||||
Effect of Exchange Rate Changes on Cash |
(3.5 |
) |
(2.4 |
) |
7.6 |
||||||
Cash Balance Included in Assets Held for Sale |
|
|
(2.7 |
) |
|||||||
Net (Decrease) Increase in Cash and Cash Equivalents |
$ | (22.0 | ) | $ | (1,763.0 | ) | $ | 1,772.5 | |||
Nine months ended September 30, 2008
Net cash flows from operating activities during the period were positively affected by (i) net income of $1,311.0 million, net of non-cash items including, among other things, a $4.0 billion goodwill impairment charge in the second quarter of 2008 and (ii) distributions received from equity investments of $185.0 million, comprised mainly of (a) $54.6 million of initial distributions received from West2East Pipeline LLC, (b) $43.0 million from our investment in the Express Pipeline System and (c) $26.7 million from NGPL PipeCo LLC.
Partially offsetting these cash inflows were (i) an $851.7 million use of cash for working capital items, primarily resulting from income tax payments made during the period related to our ongoing operations and the sale of an 80% ownership interest in NGPL PipeCo LLC, (ii) $23.3 million of FERC-mandated reparation payments to certain Kinder Morgan Energy Partners' Pacific operations' pipelines, net of $12.6 million incremental legal reserves for settlements reached with certain shippers on Kinder Morgan Energy Partner's Pacific operations' East Line pipeline and (iii) a $28.0 million increase of gas in underground storage. Significant period-to period variations in cash used or generated from gas in storage transactions are generally due to changes in injection and withdrawal volumes as well as fluctuations in natural gas prices.
Net cash flows from investing activities during the period were positively affected by (i) net proceeds of $2,899.3 million from the sale of an 80% ownership interest in NGPL PipeCo LLC, (ii) $3,106.4 million of proceeds from NGPL PipeCo LLC restricted cash, (iii) return of capital from equity investments of $92.5 million consisting primarily of $89.1 million and $3.4 million from Midcontinent Express Pipeline LLC and NGPL PipeCo LLC, respectively, (iv) net proceeds received of $113.3 million for the sale of other assets and (v) a $40.3 million decrease in margin deposits.
A-68
These positive impacts were partially offset by (i) capital expenditures of $1,922.8 million, primarily from Kinder Morgan Energy Partners' natural gas pipeline projects, including the construction of Kinder Morgan Louisiana Pipeline, the expansion of the Trans Mountain crude oil and refined petroleum products pipeline system, and additional infrastructure to Kinder Morgan Energy Partners' carbon dioxide producing and delivery operations, (ii) incremental contributions to equity investments of $342.1 million, consisting primarily of (a) a $306.0 million contribution to West2East Pipeline LLC made in February 2008 and (b) contributions of $27.5 million for our share of Midcontinent Express Pipeline constructions costs and (iii) other acquisitions of $16.4 million.
Net cash flows used in financing activities during the period were affected by (i) a use of cash of $5,809.1 million for the retirement of long-term debt, primarily for (a) $1.6 billion for a cash tender offer to purchase a portion of our outstanding long-term debt, (b) a $997.5 million use of cash for the retirement of our Tranche A term loan facilities and (c) a $3,191.8 million use of cash for the retirement of our Tranche B term loan facilities, (ii) a net $323.1 million decrease in short-term borrowings relating to Kinder Morgan Energy Partners' credit facility and (iii) minority interest distributions of $463.3 million, primarily resulting from Kinder Morgan Energy Partners' distributions to common unit holders.
The impact of these factors were partially offset by (i) net proceeds of $1,585.8 million from Kinder Morgan Energy Partnership debt issuances, (ii) minority interest contributions of $385.0 million, primarily from Kinder Morgan Energy Partners' issuance of common units from its first quarter 2008 public offerings, (iii) an increase in cash book overdrafts of $43.5 million and (iv) a $2.7 million increase in short-term advances from unconsolidated affiliates.
Four months ended September 30, 2007
Net cash flows from operating activities during the period were positively impacted by (i) net income of $504.4 million, net of non-cash items, (ii) $45.1 million of distributions received from equity investments and (iii) a $34.5 million decrease of gas in underground storage.
Partially offsetting these factors were (i) a $13.6 million use of cash for working capital items, (ii) a $2.5 million use of cash attributable to discontinued operations during the period and (iii) a $2.2 million payment for the termination of interest rate swap agreements.
Net cash flows used in investing activities during the period were affected by (i) $11,534.3 million of cash used to purchase Kinder Morgan, Inc. stock in the Going Private transaction, (ii) $656.1 million in capital expenditures, (iii) $119.7 million of other acquisitions, (iv) incremental margin deposits of $22.9 million and (v) contributions of $17.5 million to equity investments.
These negative impacts were partially offset by (i) $190.9 million of cash provided by discontinued investing activities, primarily from the sale of Corridor, (ii) $10.6 million of net proceeds from the sale of other