Means of Mining Shale Natural Gas Research Paper
The invention of cheaper means of mining shale natural gas has resulted in an increase in production of gas in the U.S. With the availability of shale gas in large quantities, consumers consider substituting their energy needs with power generated from gas. Coal is still considered the leading source of energy used by industries.
There are possibilities of natural gas acting as a substitute in many areas such as residential and transportation sectors. Kinder Morgan (KMI) indicates an investment activity cash flow of over $5 billion in 2012. There are projections that the company may grow by 153.1% in the current year.
KMI represents the highest growth among the three competitors under consideration. TransCanada invested a large amount in 2010. Earnings per share (EPS) for both companies are almost similar. Spectra Energy indicates high EPS rates than its competitors.
Spectra Energy is expected to grow at a lower rate than the other two competitors. The political environment indicates great concern over pollution. Policies put in place are likely to encourage the generation and consumption of renewable energy (EIA 2012).
The government is likely to prolong a tax credit of about 30% to corporations that generate renewable green energy. Consumers will be required to use more energy efficient devices that will result in a decrease in energy consumed. Political parties are associated with a particular trend of voting.
Republicans may prefer increased production and consumption. China and India are expected to account for 50% of the increase in energy demand in the long-run (EIA 2012). The export of gas in the U.S. is expected to increase. The rate of increase of production exceeds the rate of growth in consumption.
Imports in fossil fuel are expected to decrease until 2019 when the cost of production in U.S. increases. Canada may resume as the main exporter of fossil fuel to the U.S. after 2019.
Methodology/literature review
Porters Five Forces have been used for industry analysis in the oil & gas transportation industry. Grundy (2006) discusses that Porters five forces simplifies micro-economic theory. It has been used to predict the long-run rate of returns in the particular industry (Grundy 2006, p. 215).
Its factors are interdependent with other factors such that it fills the gap between PEST and SWOT analysis (Arons & Waalewijn n.d. p. 3). the cost of shifting between companies, the amount of capital required, and access to distribution channels (Warner 2010, p. 43).
Randall (2008) discusses that the Porters Five Forces require a modification of terms to fit the energy industry. Buyers refer to producers of oil and gas instead of consumers.
Randall (2008) discusses that companies in the energy industry gain competitive advantage through the satisfaction of different stakeholder requirements (p. 35). Most companies operate regionally almost like monopolies.
A company needs to generate more income than the cost of its capital. Koller, Goedhart & Wessels (2010) discuss that a company is valued by its ability to keep the rate of return on invested capital (ROIC) higher than its cost of capital (p. 57).
A company is likely to create more value for stakeholders if it can maintain high ROIC for a longer period. KMI shows ability to maintain high IRR for a period more than 15 years.
A comparable valuation of the three companies is used on key market indicators such EPS, dividends and expected growth. Meitner (2006) discusses that company valuation may use discounted cash flows (DCF) or comparable company valuation. Market prices of shares have no significance in valuation.
Other aspects of share value become important through comparison with main competitors in the industry. KMI is compared with growth rate estimates for Spectra Energy, and TransCanada.
Bensoussan & Fleisher (2008, p. 172) discuss that political/legal environment examines policies and laws that have an influence in decision making. It also considers ability to influence political decisions, voting trends, and public opinion (Mennen 2011).
Legislation regarding regulation and taxation is affected by a Republican majority or Democrats reformist trends. Authorities are committed to reducing greenhouse gases (GHG) emissions and efficient energy usage.
Bensoussan & Fleisher (2008) discuss that the activism of regulatory agencies may determine the allocation of resources by the government and the private sector. Government tax cuts that are related to renewable energy may be about $2.5 billion per year between 2011 and 2035 (EIA 2012, p. 23).
Technology is likely to influence the allocation of resources by consumers and producers. Technological factors include new discoveries, the speed of technological transfer and obsolescence (Bowhill 2008, p. 332).
Inkpen and Moffett (2011, p. 394) discuss that safety issues have gained more concern over the years. There have been accidents related to fuel transportation such as pipeline leakages, and truck rollovers.
the purchasing power of individuals. Bensoussan & Fleisher (2008) discuss that the economic factors to consider include the GDP growth rate, income distribution, balance of payments, rate of inflation among others (p. 172).
According to EIA (2012) report, populations grows at an average rate of 0.9% from 2010 to 2035. Increase in population will ensure that local consumption of energy increases. Some fraction reduces as a result of using efficient appliances.
About 50% of the increase in energy consumption is accounted for by expansion in China and India (EIA 2012, p. 74). The consumption of liquid fuel in the U.S. is expected to reach 19.9 million barrels per day in 2035. Carbon dioxide usage grows to 650,000 barrels per day.
Reports indicate that estimates about reserves vary from time to time (EIA 2012, p. 56). There is uncertainty about stocks in reserves.
There is a major shift from the generation of nuclear energy to safer energy sources (EIA 2012). The tsunami catastrophe in Japan that damaged nuclear reactors has led to a change in public opinion about the use of nuclear energy.
Most countries that had planned to use nuclear energy as a substitute for fossil fuels have considered other means of electricity generation. With countries planning to reduce their reliance on nuclear energy, consumption of fossil fuels is likely to increase.
Macro-environment
Political/legal environment
Renewable energy generation doubles as a result of the incentives to reach about 20% of entire electricity generation. In the No Sunset case (EIA 2012 p. 19), a majority of companies that generate renewable energy are able to receive 30% tax credit.
Consumers through the Extended Policies case will be required to use more energy efficient appliances. Gas used in the residential areas is expected to reduce (EIA 2012, p. 77). Consumers incur an additional cost in purchasing more energy-efficient appliances.
The Cross-State Air Pollution Rule was drafted to minimize the level of sulfur dioxide and nitrogen oxides emissions in power plants that generate more than 25 megawatts from fossil fuels (EIA 2012, p. 8).
When the private sector shifts to other sources of energy because of costs related to pollution, the demand for fossil fuels decreases. The average expected decline in residential gas usage between 2010 and 2035 is 13.2% (EIA 2012, p. 77). The decrease is as a result of using efficient devices.
However, there is an opportunity in the use of gas for electricity generation. Overall usage of gas grows by 0.4% annually from 2010 to 2035 (EIA 2012, p. 76). Companies that transport gas are likely to gain.
Economic environment
Economic growth is boosted by labor productivity which grows at a rate of 1.9% per year in the period under consideration (EIA 2012, p. 219). High productivity indicates higher income levels that may drive higher demand. at a rate of 1.0% annually.
The energy intensive sector grows at an average rate of 1.0% per year from 2010 to 2035. The average GDP growth rate from 2010 to 2035 is 2.5% (EIA 2012, p. 104). Energy demand increases with GDP growth.
Low production in Mexico is likely to influence an increase in production in the U.S. The U.S. is expected to have an increase in exports until local prices exceed those in Canada by 2019.
At that point, exports will stabilize at an annual rate of 1.1 trillion cubic feet (EIA 2012, p. 94). International prices have an influence on the level of production in the U.S.
Social factors
Social factors include changes in consumer trends (Henry 2008, p. 56). People are likely to shift to warmer regions instead of using heating systems. In 2010, the U.S. consumed more natural gas than it produced (EIA 2012, p. 92).
Consumption increases at a rate of 0.4% per year while production increases at a rate of 1.0% per year. The surplus will support the stability of the export market. Shipment companies are likely to gain through the increase in exports.
The expansion in energy demand in India, China, and the world as a whole creates a sustainable market for energy suppliers and distributors. The world consumption increases by 47% between 2010 and 2035.
Technology
Tax credit issued on renewable sources of energy may increase their demand because of reduced prices (EIA 2012). Consumers are expected to use more efficient appliances that reduce consumption of energy. The invention of the vehicle battery is expected to have an impact on light duty vehicles.
Heavy duty vehicles are likely to continue using fossil fuels even after 2035. Using LNG on vehicles remains a challenge because of the lack of infrastructure to support the sale of the product to motorists. Crude oil still remains the best positioned product with infrastructure (EIA 2012, p. 44).
Threat of new entrants
New entrants are determined by the cost of entry and the expected profits. Ahlstrom and Bruton (2010) discuss that if an industry is experiencing high returns, then other firms will wish to enter that industry (p. 133). Ahlstrom and Bruton (2010) discuss that cost of establishment is a great barrier when it is large.
In the fuel transportation industry, only big companies are able to invest in shipment or pipeline business. Entry is reduced when there is limitation on the access to distribution channels (Ahlstrom and Bruton 2010, p. 134).
The pipeline business may be barred by restrictions that allow only one company to operate pipelines in a region. The restrictions are used to allow efficient use of resources. Transportation by trucks may easily face new entrants.
Threat of substitute services
Transportation of oil involves transport of oil and gas fields to refineries and from refineries to the market. Oil may be transported in many ways unlike gas which is mostly transported through pipelines (Inkpen & Moffett 2011, p. 393).
Gas may also be transported as liquefied natural gas for export. Initially, oil was transported after it was packed in barrels. The crude oil supertankers are considered a low cost transport means.
A 50-millimeter-pipeline running for 50km may cost about $2.5 million (Inkpen & Moffett 2011, p. 399). Pipelines require high initial cost and a little maintenance cost.
Buyers in most cases rely on transportation companies that they have contracted before. Transportation companies prefer to use trucks to and from the drilling sites (PLS Logistics n.d.). The number of truck trips for one multi-well pad is estimated to be between 5,850 and 8,905 (PLS Logistics n.d., p. 2).
It includes delivery of the equipment and materials used in drilling. Barge is rarely chosen because most companies lack enough freight to fill its capacity. Threat of alternative services is reduced by the fact that a contractor may lack the necessary infrastructure. It may force buyers to use already existing transporters.
Fuel transportation companies sell their services to a few major distributors or outlets. Ahlstrom and Bruton (2010) discuss that if a small number of buyers purchase about half of the industrys output then buyer power is high (p. 133).
There is difficulty in shifting between different suppliers where the delivery is made through pipelines. Sea and road delivery may be shifted from one supplier to another. The services do not have an influence on the quality of product (Henry 2008, p. 73). In that case, buyers have a stronger bargaining power.
Bargaining power of suppliers
Suppliers have a higher bargaining power if their products are highly demanded (Ahlstrom and Bruton 2010). In the transportation industry, suppliers include the manufacturers of tankers, trucks, barge, trains, and pipes. Suppliers have a low bargaining power if buyers are few and large (Hill & Jones 2008, p. 51).
Fuel transporters are few and large. Suppliers bargaining power is reduced if industry entities, such as Kinder Morgan, manufacture their own pipes. They are unlikely to manufacture trucks or tankers.
Intensity of rivalry among competitors
Competition among pipeline companies is reduced because major pipelines are owned by a group of companies that are involved in drilling. For example, the Colonial Pipeline is owned partly by BP (17.96%) and CITGO Petroleum (15.79%) among other companies (Pipeline Companies 2013).
Companies are buyers of their own services. Pipelines also cover regions which eliminates the possibility of competition. For example, the Trans Alaskan pipeline System serves the Alaskan North Slope to Valdez (Pipeline Companies 2013, para. 4).
Investment thesis
Kinder Morgan Valuation and Financial Analysis
Company description
Kinder Morgan Inc. (KMI) comprises of holdings in The Kinder Morgan Energy Partners (KMP) as a general partner as well as a limited partner.
KMI owns a 20% stake in the Natural Gas Pipeline Company of America (NGPL). KMI acquired El Paso Corporation. El Paso is involved with distribution of gas to consumers (Edwards et al 2012).
The companys growth is attributed to acquisitions and Greenfield/expansion projects in fixed assets such as gas pipelines and oil production fields (Edwards et al. 2012, p. 2). KMIs shares are considered unique because of the clear growth prospects and high yields per share.
The company proposes a 12.5% annual dividend growth rate for the next few years. Its infrastructure in the energy sector is diversified. It reduces exposure to fluctuations in the market.
Credit Suisse forecasts a target yield of 3.75% for KMI. Credit Suisse forecasts a target price of $42 and total return that ranges between 125 and 34% (Edwards et al. 2012).
Valuation of Business
KMI had an estimated market capitalization value of $37.083 billion as of October 2012 (Edwards et al. 2012) and 38.86B as of 5 April, 2013 (Kinder Morgan, Inc 2013 Yahoo Finance). KMI appears to be overvalued against other general partners (GPs) and undervalued against utilities. A fair yield against GPs would be about 4.1%. KMI pays almost all of its to shareholders in the form of dividends.
KMI uses the Rockies Express Pipeline (REX) to transport fuel in the Midwest and Northeast markets. REX with a capacity of 3.8 Bcf/d is contracted 97%in the long term. The pipeline is about 1,685 miles consisting of branches with a diameter of 36 inches and 42 inches for the mainline (Martin 2012, p. 7).
The Kinder Morgan Interstate Gas Transmission (KMIGT) consisting of 5,054 miles of pipeline of varying diameter and other terminals. KMIGT has a storage capacity of 14.8 Bcf (billion cubic feet) and transport capacity of 0.98 Bcf. It has been contracted 96% in the short term.
The is 301 miles of 24 inches diameter for the mainline. More than 90% capacity is sold for a long term period (Martin 2012, p. 12). KMI owns other pipelines, processing and treating plants.
