Kinder Morgan - El Paso Deal Makes Sense

We recently saw the biggest proposed acquisition in the oil and gas industry since the $41 billion purchase of XTO in 2009 by ExxonMobil (NYSE: XOM).

The proposed acquisition, of course, was the $38 billion bid for El Paso (NYSE: EP) by Kinder Morgan (NYSE: KMI, KMP, KMR). It was a bold bet on the future of the natural gas industry in the United States based on the extraction of shale gas and oil with fracking technology.

The deal highlights an emerging trend in merger & acquisition activity in the sector. As jon Wolff, an analyst at ISI, says: “It's the infrastructure era.”

Bidding is shifting away from companies with upstream assets such as XTO and toward midstream pipeline and processing businesses that will benefit once the large shale gas reserves come onstream.

Just look at the prior $7.9 billion bid for Southern Union (NYSE: SUG) by Energy Transfer Partners (NYSE: ETP) or the $2.9 billion sale by Energy Partners of its propane operations to Amerigas Partners (NYSE: APU).

Why are such companies like El Paso so attractive to potential suitors?

At a time of uncertainty and high volatility, these businesses offer stability. They earn relatively stable, often regulated returns from shippers paying to use their pipelines. Yet they have growth prospects thanks to the large investment in gas processing and transportation that will be need in the years ahead.

The Interstate Natural Gas Association of America has published forecasts showing that the United States will need $205 billion of investment in new gas pipelines and processing facilities (in 2010 dollars). And a further $46 billion in new pipelines will be needed for oil and other liquids, in order to meet the expected increases in supply and demand.

This forecast means the industry will have to invest roughly an average of $10 billion a year on such infrastructure. The easy way to do this is simply to buy existing pipelines.

This is just what Kinder Morgan. It already has 23,600 miles of gas pipelines and if successful, it will add El Paso's 43,000 miles of gas pipelines.

The deal also puts Kinder Morgan in a prime position with exposure in all the key areas where gas production is expected to soar – namely, the Marcellus shale in Pennsylvania, the Utila shale in Ohio and Pennsylvania, and the Haynesville shale in Louisiana.

Look for the Kinder Morgan bid for El Paso to inspire even more potential buyers of midstream assets.