In the midstream energy industry, Kinder Morgan has made an impressive showing among its peers. The company claims status as the largest energy infrastructure company in North America, with a corporate umbrella that includes 80,000 miles of pipelines and 180 terminals that move about one-third of the natural gas consumed in America.
With such a dominant position in the Western Hemisphere, Kinder Morgan’s latest foray into the European debt market might seem completely out of place. As the energy giant joins a growing group of U.S. companies seeking financing across the Atlantic, should Kinder Morgan investors worry about potential financial fallout from its latest move? Let’s take a closer look at Kinder Morgan’s newest innovation in raising capital and what the risks and rewards are for the company.
Kinder Morgan explores for Eurobonds
In early March, Kinder Morgan tapped the European credit markets for financing for the first time ever. The energy giant sold about 1.25 billion euros’ worth of bonds, including 750 million euros in notes that mature in 2022, and 500 million euros of bonds that come due in 2027. Kinder Morgan said it plans to use the resulting cash, which should equate to around $1.3 billion to $1.35 billion at current exchange rates, to refinance existing debt.
The obvious reason for looking overseas for financing is that interest rates in the eurozone have fallen to even lower levels than we’ve seen in the U.S. recently. Even after incorporating a typical premium over euro-denominated government debt to reflect the greater chance of default for a corporate issuer, Kinder Morgan will pay just 1.5% in interest on its seven-year debt, and 2.25% on the 12-year bonds it issued.
The savings Kinder Morgan will reap in financing costs will be huge compared to what it pays on its dollar-denominated debt. Just last year, Kinder Morgan issued more than $9 billion in corporate notes, with maturities ranging from 2017 to 2044, and interest rates of as much as 5.55%. In particular, for debt maturing in the same date range as its recent euro-denominated offerings, Kinder Morgan had to pay between 3.5% and 4.3%. Lower European rates will therefore save the company about 2 percentage points in debt-maintenance costs.
With lower rates come higher risk
These cost savings come at a price for Kinder Morgan, though. Because it operates in North America, Kinder Morgan doesn’t have any obvious source for revenue in euros, and therefore, it will have to make arrangements to convert U.S. dollars to euros every time it makes an interest or principal payment on its euro-denominated debts. That leaves Kinder Morgan with currency risk to address.
Recently, those companies that had the foresight to issue debt in euros have been richly rewarded, as the value of the euro has plunged from $1.25 just a few months ago to around $1.05 right now. That means any company that borrowed in euros in December and then exchanged the proceeds to U.S. dollars is sitting on about a 20% paper profit right now — not even considering the long-term benefits of the lower-rate debt.
Yet some fear that currency markets have moved too far too fast. Currently, the euro is at a 12-year low against the dollar, and while most currency analysts appear to think the momentum toward a stronger dollar will continue, where the euro will trade seven to 12 years from now — when Kinder Morgan’s debt comes due — is uncertain. If the euro returned to its highest levels of the past decade at around $1.60, Kinder Morgan could have to repay its debt in euros worth 50% more than the ones it just received.
Is Kinder Morgan pre-hedging an expansion?
Financial engineering would allow Kinder Morgan to protect itself from future currency swings by using derivatives. Yet the cost of that protection has risen sharply in recent months, and paying for it would wipe out much of the advantage Kinder Morgan would gain from raising Eurobond debt in the first place.
As a result, some speculate that Kinder Morgan might seek to expand internationally. As projects like liquefied natural gas exports from the U.S. and European shale-gas plays start taking shape, the need for pipeline infrastructure in Europe could well increase. If Kinder Morgan attacks that market, then it could start reaping euro revenue that it could use to repay its Eurobonds, covering risks on both sides of the equation.
Without some sort of offsetting move, though, Kinder Morgan’s Eurobond experiment could backfire in the long run. Currency-risk exposure will produce immediate benefits for the pipeline giant, but it introduces a new dynamic for investors to keep in mind for the future.
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Dan Caplinger has no position in any stocks mentioned.