Kinder Morgan's Oil Spill Problem

"Maybe this is what has really caused the cancellation of non-essential spending!"

Firm faces steep costs and “unlimited liability” for a Trans Mountain spill.

On April 8, Kinder Morgan Canada held an unusual Sunday conference call to announce an immediate halt to all non-essential spending on the controversial Trans Mountain pipeline, threatening to pull the plug on the project completely unless the escalating political conflicts over the pipeline could be resolved by May 31.

Kinder Morgan’s announcement set off a furor of finger-pointing and political posturing. Alberta’s premier threatened trade retaliation against British Columbia for standing in the way of the pipeline, Canadian premier Justin Trudeau hinted that he could complete the project with taxpayer money, and BC’s premier dug in his heels, recommitting his government to defending the coast from the risk of an oil spill.

But a few days later—and lost in the hubbub following the announcement—Canada’s National Energy Board (NEB) quietly issued a decision that must have given Trans Mountain executives a serious case of heartburn: the parent corporation of Kinder Morgan Canada, the Houston-based Kinder Morgan, Inc., would have to set aside a half-billion dollars to cover the costs of a potential oil spill.

In early 2017, the National Energy Board required Kinder Morgan Canada to maintain a line of credit of $500 million Canadian with its corporate parent to cover short-term costs to contain and clean up oil spills. But Kinder Morgan had petitioned to replace this cash guarantee with a “credit facility”—akin to a corporate credit card—that it had arranged with a consortium of Canadian banks. If the NEB had agreed to this request, the pipeline’s corporate parent would no longer have to keep a half-billion dollars of ready cash on hand to deal with spills.

But the NEB ruled that Kinder Morgan’s effort to shift responsibility for cleanup off their books simply did not meet the Board’s legal requirements:

“The Contingent Credit Facility does not provide Trans Mountain with funds on demand and at its sole discretion … is not irrevocable … [and] not meet the requirements of automatically renewing and remaining in force.”

Because the board deemed the proposed credit facility inadequate, it ordered the company to keep its original line of credit in place—meaning that Kinder Morgan, Inc. must continue to keep at least a half a billion dollars available to be spent on a moment’s notice to deal with a Trans Mountain oil spill.

For Kinder Morgan, this move has a deep—and disturbing—financial impact in several ways:

It complicates KMI’s finances

For the moment, KMI must continue to extend a $500 million credit line to its subsidiary. This either saddles the company with extra credit costs, or ties up capital that the company otherwise would prefer to use for new capital projects, reducing debt, or paying back investors. In January 2017, the NEB acknowledged the company’s claim that securing “a parental/affiliate guarantee from Kinder Morgan could … increase Trans Mountain’s cost of borrowing.” Kinder Morgan, Inc. was hoping to sidestep those costs and free up its credit—but the NEB has squashed that option.

It undermines KMI’s “pay nothing” strategy for Trans Mountain

KMI had been working for years to build a financial firewall around its Canadian subsidiary and the risky and controversial Trans Mountain pipeline, pledging to investors that it would not use its own capital to build the pipeline. For example, the company’s 2017 annual report says:

“Subsequent to its IPO, KML has obtained a credit facility and completed two preferred share offerings. KMI expects KML to be a self-funding entity and does not anticipate making contributions to fund its growth or specifically to fund the TMEP.” [Emphasis added.]

The NEB denial now forces Kinder Morgan to remain financially responsible for its subsidiary, throwing a monkey wrench into its plan to put no capital on the line for the pipeline.

It signals massive oil spill liability for the parent company

Kinder Morgan Canada’s annual report lists the daunting financial requirements the company faces to meet oil spill cleanup standards under Canadian law, including absolute liability of up to $1 billion regardless of fault as well as $500 million of short-term cash on hand to pay for cleanup. Most important, the law holds the company accountable for unlimited—yes, unlimited—payouts for damages and cleanup costs if found at fault for a spill. Kinder Morgan itself lays out the situation:

“In June 2016, the Pipeline Safety Act, which enshrines in law the “polluter pays” principle, came into force in Canada. Under the Pipeline Safety Act, in the event that an environmental incident occurs with respect to one of our pipeline assets, we will have unlimited liability if we are determined to be at fault or negligent.” [Emphasis added.]

Under this law, a major oil spill could trigger a financial crisis for Kinder Morgan, Inc. To guard against this, the company has attempted to use subsidiaries and shell corporations to wall off the Trans Mountain project, and its Canadian subsidiary as a whole, from the rest of the company’s assets. But NEB’s requirement that the parent company keep a half-billion in cash on hand may signal the potential for Kinder Morgan, Inc. to remain on the hook for full cleanup costs—raising serious concerns for the parent firm’s finances in the event of a catastrophic spill.

Now, more than ever, Kinder Morgan has excellent reason to pull the plug on Trans Mountain. The upside of the project is limited by law; the NEB specifies a tariff rate that ensures that the company can only realize modest profits from the project. But the downside is quite literally unlimited: a single spill could potentially bankrupt the company. And for a company with a safety record as tarnished as Kinder Morgan’s, the financial downside of a spill—including a $500 million cash fund just to ante up for the Trans Mountain game—may prove to be one of the deciding factors that sours Kinder Morgan on the long-term prospects for the pipeline.