Tight Credit Threatens Pipeline Expansion

NEW YORK (THE WALL STREET JOURNAL via Dow Jones Newswires), Dec. 29, 2008

Steady expansion for pipeline companies is grinding to a halt as tight credit makes it harder to raise construction money, potentially limiting their ability to bring new supplies of natural gas to market.

U.S. gas-pipeline construction boomed in recent years as demand for natural-gas grew and production shifted to new areas, such as north Texas and the Rocky Mountains.

Pipeline demand has remained strong despite falling energy prices, but the financial crisis has made it harder and more expensive for companies such as El Paso Corp., Kinder Morgan Energy Partners LP and others to raise cash to build new conduits.

Canceled and scaled-back pipeline projects are bad news for natural-gas consumers and producers, who now could face higher fees and limitations on how much gas they can move from new production areas.

In October, Enterprise Products Partners LP cited high capital costs in withdrawing from a project to build a 673-mile-long pipeline from Colorado to North Dakota. El Paso recently said it was cutting its 2008 capital budget to $3.5 billion from $3.8 billion and would spend just $3 billion on projects in 2009.

The retrenchment also spells trouble for pipeline companies' growth, which depend on new projects. Analysts expect many of the smaller pipeline companies to become takeover targets next year. "It truly is survival of the fittest," said Dan Rogers, an energy attorney at King & Spalding in Houston.

Some larger pipeline companies with less debt have been able to raise money in recent weeks, but at sharply higher costs than a few months ago. El Paso this month raised $500 million in 5-year notes paying 12%, interest after paying just 7.25% in May for $600 million in 10-year notes.

Dallas-based Energy Transfer Partners LP said last week it had raised $600 million through the sale of 11-year notes paying 9.7% interest. In March, it sold 10-year notes for 6.7%.

The challenges for the pipeline industry are coming even though their profits have been holding up better than other parts of the energy sector, said Mark Easterbrook, an analyst with RBC Capital Markets.

Pipeline companies make their money by charging fees to access their pipes. Those fees are generally based on the volume of gas moving through the pipeline and negotiated in advance, so pipeline revenue isn't directly tied to commodities prices.

But while existing pipelines provide a steady source of revenue, new pipelines are the source of companies' growth. Future projects are getting postponed or scaled back. Last month, Regency Energy Partners LP said it would cut capacity 30% on a planned pipeline that would bring natural gas from a new field by using smaller-sized pipe.

Pipeline companies depend on outside capital because many of them are structured as master limited partnerships rather than corporations. Such partnerships carry tax advantages that help improve returns. But the structure also requires companies to return virtually all their cash flow to investors in the form of quarterly distributions. That means long-term projects must be funded by borrowing money or issuing equity.

"The [partnership] model in terms of growth really only works when you have a healthy capital market," said Wachovia analyst Michael Blum. His firm anticipates capital spending will drop roughly 25% across the industry next year.

Stronger companies that have been able to raise new capital may turn to acquisitions for growth. "There's probably less competition, and there will be more acquisition opportunities," said Kinder Morgan President C. Park Shaper.

The pipeline construction slowdown comes despite the fact that pipeline demand remains strong. Gas producers cut back on drilling as prices tumbled, but most of the cuts have been in older fields that have plenty of pipeline capacity. Newer fields in Louisiana, Arkansas and Pennsylvania are still growing rapidly and may quickly outgrow their existing pipelines.

"The gas is now being produced in areas where no one contemplated production before. The pipeline infrastructure does not exist in many of those areas," Energy Transfer Partners LP Chief Executive Kelcy Warren said.

Copyright (c) 2008 Dow Jones & Company, Inc.

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