| KINDER MORGAN ENERGY PARTNERS L P Item 1A Risk Factors |
| 39 Item 1A Risk Factors |
| You should carefully consider the risks described below, in addition to the other information contained in this document |
| Realization of any of the following risks could have a material adverse effect on our business, financial condition, cash flows and results of operations |
| There are also risks associated with being an owner of common units in a partnership that are different than being an owner of common stock in a corporation |
| Investors in our common units must be aware that realizations of any of those risks could result in a decline in the trading price of our common units, and they might lose all or part of their investment |
| Further, we are well-aware of the general uncertainty associated with the current world economic and political environments in which we exist and we recognize that we are not immune to the fact that our financial performance is impacted by overall marketplace spending and demand |
| We are continuing to assess the effect that terrorism would have on our businesses and in response, we have increased security with respect to our assets |
| Recent federal legislation provides an insurance framework that should cause current insurers to continue to provide sabotage and terrorism coverage under standard property insurance policies |
| Nonetheless, there is no assurance that adequate sabotage and terrorism insurance will be available at reasonable rates throughout 2006 |
| Currently, we do not believe that the increased cost associated with these measures will have a material effect on our operating results |
| 39 Risks Related to our Business Pending Federal Energy Regulatory Commission and California Public Utilities Commission proceedings seek substantial refunds and reductions in tariff rates on some of our pipelines |
| If the proceedings are determined adversely, they could have a material adverse impact on us |
| Regulators and shippers on our pipelines have rights to challenge the rates we charge under certain circumstances prescribed by applicable regulations |
| Some shippers on our pipelines have filed complaints with the Federal Energy Regulatory Commission and California Public Utilities Commission that seek substantial refunds for alleged overcharges during the years in question and prospective reductions in the tariff rates on our Pacific operations &apos pipeline system |
| We may face challenges, similar to those described in Note 16 to our consolidated financial statements included elsewhere in this report, to the rates we receive on our pipelines in the future |
| Any successful challenge could adversely affect our future earnings and cash flows |
| Proposed rulemaking by the Federal Energy Regulatory Commission or other regulatory agencies having jurisdiction over our operations could adversely impact our income and operations |
| New laws or regulations or different interpretations of existing laws or regulations applicable to our assets could have a negative impact on our business, financial condition and results of operations |
| Increased regulatory requirements relating to the integrity of our pipelines will require us to spend additional money to comply with these requirements |
| Through our regulated pipeline subsidiaries, we are subject to extensive laws and regulations related to pipeline integrity |
| There are, for example, federal legislation guidelines for the US Department of Transportation and pipeline companies in the areas of testing, education, training and communication |
| Compliance with laws and regulations require significant expenditures |
| We have increased and may need to further increase our capital expenditures to address these matters |
| Additional laws and regulations that may be enacted in the future or a new interpretation of existing laws and regulations could significantly increase the amount of these expenditures |
| Our rapid growth may cause difficulties integrating new operations, and we may not be able to achieve the expected benefits from any future acquisitions |
| Part of our business strategy includes acquiring additional businesses that will allow us to increase distributions to our unitholders |
| If we do not successfully integrate acquisitions, we may not realize anticipated operating advantages and cost savings |
| The integration of companies that have previously operated separately involves a number of risks, including: * demands on management related to the increase in our size after an acquisition; * the diversion of our managementapstas attention from the management of daily operations; * difficulties in implementing or unanticipated costs of accounting, estimating, reporting and other systems; * difficulties in the assimilation and retention of necessary employees; and * potential adverse effects on operating results |
| We may not be able to maintain the levels of operating efficiency that acquired companies have achieved or might achieve separately |
| Successful integration of each of their operations will depend upon our ability to manage those operations and to eliminate redundant and excess costs |
| Because of difficulties in combining operations, we may not be able to achieve the cost savings and other size-related benefits that we hoped to achieve after these acquisitions, which would harm our financial condition and results of operations |
| Our acquisition strategy and expansion programs require access to new capital |
| Tightened credit markets or more expensive capital would impair our ability to grow |
| Part of our business strategy includes acquiring additional businesses that will allow us to increase distributions to our unitholders |
| During the period from December 31, 1996 to December 31, 2005, we made a significant number of acquisitions that increased our asset base over 39 times and increased our net income over 68 times |
| We regularly consider and enter into discussions regarding potential acquisitions and are currently contemplating potential acquisitions |
| These transactions can be effected quickly, may occur at any time and may be significant in size relative to our existing assets and operations |
| We may need new capital to finance these acquisitions |
| Limitations on our access to capital will impair our ability to execute this 40 strategy |
| We normally fund acquisitions with short term debt and repay such debt through the issuance of equity and long-term debt |
| An inability to access the capital markets may result in a substantial increase in our leverage and have a detrimental impact on our credit profile |
| One of the factors that increases our attractiveness to investors, and as a result may make it easier for us to access the capital markets, is the fact that distributions to our partners are not subject to the double taxation that shareholders in corporations may experience with respect to dividends that they receive |
| Tax legislation, beginning with The Jobs and Growth Tax Relief Reconciliation Act of 2003, has generally reduced the maximum tax rate on dividends paid by corporations to individuals |
| The maximum federal income tax rate on qualified dividends paid by corporations to individuals was 15prca in 2005 and, for taxpayers in the 10prca and 15prca ordinary income tax brackets, 5prca in 2005 through 2007 and zero in 2008 |
| The maximum federal income tax rate on net long term capital gains for individuals was 15prca in 2005 and, for taxpayers in the 10prca and 15prca ordinary income tax brackets, 5prca in 2005 through 2007 and zero in 2008 |
| The differences in the tax rates may cause some investments in corporations to be more attractive to individual investors than they used to be when compared to an investment in partnerships, thereby exerting downward pressure on the market price of our common units and potentially making it more difficult for us to access the capital markets |
| Environmental regulation could result in increased operating and capital costs for us |
| Our business operations are subject to federal, state and local, and some foreign laws and regulations relating to environmental protection |
| For example, if an accidental leak, release or spill of liquid petroleum products, chemicals or other products occurs from our pipelines or at our storage facilities, we may experience significant operational disruptions and we may have to pay a significant amount to clean up the leak, release or spill or pay for government penalties, address natural resource damage, compensate for human exposure or property damage, or a combination of these measures |
| The resulting costs and liabilities could negatively affect our level of cash flow |
| In addition, emission controls required under the Federal Clean Air Act and other similar federal and state laws could require significant capital expenditures at our facilities |
| The impact on us of US EPA standards or future environmental measures could increase our costs significantly if environmental laws and regulations become stricter |
| In addition, our oil and gas development and production activities are subject to certain federal, state and local laws and regulations relating to environmental quality and pollution control |
| These laws and regulations increase the costs of these activities and may prevent or delay the commencement or continuance of a given operation |
| Specifically, we are subject to laws and regulations regarding the acquisition of permits before drilling, restrictions on drilling activities in restricted areas, emissions into the environment, water discharges, and storage and disposition of hazardous wastes |
| In addition, legislation has been enacted which requires well and facility sites to be abandoned and reclaimed to the satisfaction of state authorities |
| The costs of environmental regulation are already significant, and additional or more stringent regulation could increase these costs or could otherwise negatively affect our business |
| Our future success depends in part upon our ability to develop additional oil and gas reserves that are economically recoverable |
| The rate of production from oil and natural gas properties declines as reserves are depleted |
| Without successful development activities, the reserves and revenues of our CO2 business segment will decline |
| We may not be able to develop or acquire additional reserves at an acceptable cost or have necessary financing for these activities in the future |
| The development of oil and gas properties involves risks that may result in a total loss of investment |
| The business of developing and operating oil and gas properties involves a high degree of business and financial risk that even a combination of experience, knowledge and careful evaluation may not be able to overcome |
| Acquisition and development decisions generally are based on subjective judgments and assumptions that are speculative |
| It is impossible to predict with certainty the production potential of a particular property or well |
| Furthermore, a successful completion of a well does not ensure a profitable return on the investment |
| A variety of geological, operational, or market-related factors, including, but not limited to, unusual or unexpected geological formations, pressures, equipment failures or accidents, fires, explosions, blowouts, cratering, pollution and other environmental risks, shortages or delays in the availability of drilling rigs and the delivery of equipment, loss of circulation of drilling fluids or other conditions may substantially delay or prevent completion of any well, or otherwise prevent a property or well from being profitable |
| A productive well may become uneconomic in the event water or other deleterious substances are encountered, which impair or prevent the production of oil and/or gas from the well |
| In 41 addition, production from any well may be unmarketable if it is contaminated with water or other deleterious substances |
| The volatility of natural gas and oil prices could have a material adverse effect on our business |
| The revenues, profitability and future growth of our CO2 business segment and the carrying value of our oil and natural gas properties depend to a large degree on prevailing oil and gas prices |
| Prices for oil and natural gas are subject to large fluctuations in response to relatively minor changes in the supply and demand for oil and natural gas, uncertainties within the market and a variety of other factors beyond our control |
| These factors include, weather conditions and events such as hurricanes in the United States; the condition of the United States economy; the activities of the Organization of Petroleum Exporting Countries; governmental regulation; political stability in the Middle East and elsewhere; the foreign supply of oil and natural gas; the price of foreign imports; and the availability of alternative fuel sources |
| A sharp decline in the price of natural gas or oil prices would result in a commensurate reduction in our revenues, income and cash flows from the production of oil and natural gas and could have a material adverse effect on the carrying value of our proved reserves |
| In the event prices fall substantially, we may not be able to realize a profit from our production and would operate at a loss |
| In recent decades, there have been periods of both worldwide overproduction and underproduction of hydrocarbons and periods of both increased and relaxed energy conservation efforts |
| Such conditions have resulted in periods of excess supply of, and reduced demand for, crude oil on a worldwide basis and for natural gas on a domestic basis |
| These periods have been followed by periods of short supply of, and increased demand for, crude oil and natural gas |
| The excess or short supply of crude oil or natural gas has placed pressures on prices and has resulted in dramatic price fluctuations even during relatively short periods of seasonal market demand |
| Our use of hedging arrangements could result in financial losses or reduce our income |
| We currently engage in hedging arrangements to reduce our exposure to fluctuations in the prices of oil and natural gas |
| These hedging arrangements expose us to risk of financial loss in some circumstances, including when production is less than expected, when the counter-party to the hedging contract defaults on its contract obligations, or when there is a change in the expected differential between the underlying price in the hedging agreement and the actual prices received |
| In addition, these hedging arrangements may limit the benefit we would otherwise receive from increases in prices for oil and natural gas |
| The accounting standards regarding hedge accounting are very complex, and even when we engage in hedging transactions (for example, to mitigate our exposure to fluctuations in commodity prices or to balance our exposure to fixed and floating interest rates) that are effective economically, these transactions may not be considered effective for accounting purposes |
| Accordingly, our financial statements may reflect some volatility due to these hedges, even when there is no underlying economic impact at that point |
| In addition, it is not always possible for us to engage in a hedging transaction that completely mitigates our exposure to commodity prices |
| Our financial statements may reflect a gain or loss arising from an exposure to commodity prices for which we are unable to enter into a completely effective hedge |
| Competition could ultimately lead to lower levels of profits and lower cash flow |
| We face competition from other pipelines and terminals in the same markets as our assets, as well as from other means of transporting and storing energy products |
| For a description of the competitive factors facing our business, please see Items 1 and 2 "e Business and Properties "e in this report for more information |
| We do not own approximately 97dtta5prca of the land on which our pipelines are constructed and we are subject to the possibility of increased costs to retain necessary land use |
| If we were to lose these rights or be required to relocate our pipelines, our business could be affected negatively |
| Southern Pacific Transportation Company has allowed us to construct and operate a significant portion of our Pacific operations &apos pipeline system on railroad rights-of-way |
| Southern Pacific Transportation Company and its predecessors were given the right to construct their railroad tracks under federal statutes enacted in 1871 and 1875 |
| The 1871 statute was thought to be an outright grant of ownership that would continue until the land ceased to be used for railroad purposes |
| Two United States Circuit Courts, however, ruled in 1979 and 1980 that railroad rights-of-way granted under laws similar to the 1871 statute provide only the right to use the surface of the land for railroad purposes without any right to the underground portion |
| If a court were to rule that the 1871 statute does not permit the use of the underground portion for the operation of a pipeline, we may be required to obtain permission from the landowners in order to continue to maintain the pipelines |
| Approximately 10prca of our pipeline assets are located in the ground underneath railroad rights-of-way |
| Whether we have the power of eminent domain for our pipelines varies from state to state depending upon the type of pipeline--petroleum liquids, natural gas or carbon dioxide--and the laws of the particular state |
| Our inability to exercise the power of eminent domain could negatively affect our business if we were to lose the right to 42 use or occupy the property on which our pipelines are located |
| For the year ended December 31, 2005, all of our right-of-way related expenses totaled dlra14dtta1 million |
| Our debt instruments may limit our financial flexibility and increase our financing costs |
| The instruments governing our debt contain restrictive covenants that may prevent us from engaging in certain transactions that we deem beneficial and that may be beneficial to us |
| The agreements governing our debt generally require us to comply with various affirmative and negative covenants, including the maintenance of certain financial ratios and restrictions on: * incurring additional debt; * entering into mergers, consolidations and sales of assets; * granting liens; and * entering into sale-leaseback transactions |
| The instruments governing any future debt may contain similar or more restrictive restrictions |
| Our ability to respond to changes in business and economic conditions and to obtain additional financing, if needed, may be restricted |
| If interest rates increase, our earnings could be adversely affected |
| As of December 31, 2005, we had approximately dlra2dtta8 billion of debt, excluding market value of interest rate swaps, subject to variable interest rates |
| This amount included dlra2dtta1 billion of long-term fixed rate debt converted to variable rate debt through the use of interest rate swaps |
| Should interest rates increase significantly, our earnings could be adversely affected |
| Some of our customers are experiencing severe financial problems, and other customers may experience severe financial problems in the future |
| The bankruptcy of one or more of them, or some other similar proceeding or liquidity constraint might make it unlikely that we would be able to collect all or a significant portion of amounts owed by the distressed entity or entities |
| In addition, such events might force such customers to reduce or curtail their future use of our products and services, which could have a material adverse effect on our results of operations and financial condition |
| The interests of KMI may differ from our interests and the interests of our unitholders |
| KMI indirectly owns all of the stock of our general partner and elects all of its directors |
| Our general partner owns all of KMRapstas voting shares and elects all of its directors |
| Furthermore, some of KMRapstas directors and officers are also directors and officers of KMI and our general partner and have fiduciary duties to manage the businesses of KMI in a manner that may not be in the best interests of our unitholders |
| KMI has a number of interests that differ from the interests of our unitholders |
| As a result, there is a risk that important business decisions will not be made in the best interests of our unitholders |
| Risks Related to Our Common Units Common unitholders have limited voting rights and limited control |
| Holders of common units have only limited voting rights on matters affecting us |
| Our general partner manages partnership activities |
| Under a delegation of control agreement, our general partner has delegated the management and control of our and our subsidiaries &apos business and affairs to KMR Holders of common units have no right to elect the general partner on an annual or other ongoing basis |
| If the general partner withdraws, however, its successor may be elected by the holders of a majority of the outstanding common units (excluding units owned by the departing general partner and its affiliates) |
| The limited partners may remove the general partner only if: * the holders of at least 66 2/3prca of the outstanding common units, excluding common units owned by the departing general partner and its affiliates, vote to remove the general partner; 43 * a successor general partner is approved by at least 66 2/3prca of the outstanding common units, excluding common units owned by the departing general partner and its affiliates; and * we receive an opinion of counsel opining that the removal would not result in the loss of limited liability to any limited partner, or the limited partner of an operating partnership, or cause us or the operating partnership to be taxed other than as a partnership for federal income tax purposes |
| A person or group owning 20prca or more of the common units cannot vote |
| Any common units held by a person or group that owns 20prca or more of the common units cannot be voted |
| This limitation does not apply to the general partner and its affiliates |
| This provision may: * discourage a person or group from attempting to remove the general partner or otherwise change management; and * reduce the price at which the common units will trade under certain circumstances |
| For example, a third party will probably not attempt to take over our management by making a tender offer for the common units at a price above their trading market price without removing the general partner and substituting an affiliate of its own |
| The general partnerapstas liability to us and our unitholders may be limited |
| Our partnership agreement contains language limiting the liability of the general partner to us or the holders of common units |
| For example, our partnership agreement provides that: * the general partner does not breach any duty to us or the holders of common units by borrowing funds or approving any borrowing |
| The general partner is protected even if the purpose or effect of the borrowing is to increase incentive distributions to the general partner; * the general partner does not breach any duty to us or the holders of common units by taking any actions consistent with the standards of reasonable discretion outlined in the definitions of available cash and cash from operations contained in our partnership agreement; and * the general partner does not breach any standard of care or duty by resolving conflicts of interest unless the general partner acts in bad faith |
| Unitholders may have liability to repay distributions |
| Unitholders will not be liable for assessments in addition to their initial capital investment in the common units |
| Under certain circumstances, however, holders of common units may have to repay us amounts wrongfully returned or distributed to them |
| Under Delaware law, we may not make a distribution to unitholders if the distribution causes our liabilities to exceed the fair value of our assets |
| Liabilities to partners on account of their partnership interests and non-recourse liabilities are not counted for purposes of determining whether a distribution is permitted |
| Delaware law provides that for a period of three years from the date of such a distribution, a limited partner who receives the distribution and knew at the time of the distribution that the distribution violated Delaware law will be liable to the limited partnership for the distribution amount |
| Under Delaware law, an assignee who becomes a substituted limited partner of a limited partnership is liable for the obligations of the assignor to make contributions to the partnership |
| However, such an assignee is not obligated for liabilities unknown to the assignee at the time the assignee became a limited partner if the liabilities could not be determined from the partnership agreement |
| Unitholders may be liable if we have not complied with state partnership law |
| In some of those states the limitations on the liability of limited partners for the obligations of a limited partnership have not been clearly established |
| The unitholders might be held liable for the partnershipapstas obligations as if they were a general partner if: * a court or government agency determined that we were conducting business in the state but had not complied with the stateapstas partnership statute; or 44 * unitholders &apos rights to act together to remove or replace the general partner or take other actions under our partnership agreement constitute "e control "e of our business |
| If at any time the general partner and its affiliates own 80prca or more of the issued and outstanding common units, the general partner will have the right to purchase all, and only all, of the remaining common units |
| The purchase price for such a purchase will be the greater of: * the 20-day average trading price for the common units as of the date five days prior to the date the notice of purchase is mailed; or * the highest purchase price paid by the general partner or its affiliates to acquire common units during the prior 90 days |
| The general partner can assign this right to its affiliates or to the partnership |
| We may sell additional limited partner interests, diluting existing interests of unitholders |
| Our partnership agreement allows the general partner to cause us to issue additional common units and other equity securities |
| When we issue additional equity securities, including additional i-units to KMR when it issues additional shares, unitholders &apos proportionate partnership interest in us will decrease |
| Such an issuance could negatively affect the amount of cash distributed to unitholders and the market price of common units |
| Issuance of additional common units will also diminish the relative voting strength of the previously outstanding common units |
| Our partnership agreement does not limit the total number of common units or other equity securities we may issue |
| The general partner can protect itself against dilution |
| Whenever we issue equity securities to any person other than the general partner and its affiliates, the general partner has the right to purchase additional limited partnership interests on the same terms |
| This allows the general partner to maintain its proportionate partnership interest in us |
| Therefore, only the general partner may protect itself against dilution caused by issuance of additional equity securities |
| Our partnership agreement and the KMR limited liability company agreement restrict or eliminate a number of the fiduciary duties that would otherwise be owed by our general partner and/or its delegate to our unitholders |
| Modifications of state law standards of fiduciary duties may significantly limit the ability of our unitholders to successfully challenge the actions of our general partner in the event of a breach of fiduciary duties |
| The duty of loyalty, in the absence of a provision in the limited partnership agreement to the contrary, would generally prohibit our general partner from taking any action or engaging in any transaction as to which it has a conflict of interest |
| Our limited partnership agreement contains provisions that prohibit limited partners from advancing claims that otherwise might raise issues as to compliance with fiduciary duties or applicable law |
| For example, that agreement provides that the general partner may take into account the interests of parties other than us in resolving conflicts of interest |
| It also provides that in the absence of bad faith by the general partner, the resolution of a conflict by the general partner will not be a breach of any duty |
| The provisions relating to the general partner apply equally to KMR as its delegate |
| It is not necessary for a limited partner to sign our limited partnership agreement in order for the limited partnership agreement to be enforceable against that person |
| We could be treated as a corporation for United States income tax purposes |
| Our treatment as a corporation would substantially reduce the cash distributions on the common units that we distribute quarterly |
| The anticipated benefit of an investment in our common units depends largely on our treatment as a partnership for federal income tax purposes |
| We have not requested, and do not plan to request, a ruling from the Internal Revenue Service on this or any other matter affecting us |
| Current law requires us to derive at least 90prca of our annual gross income from specific activities to continue to be treated as a partnership for federal income tax purposes |
| We may not find it possible, regardless of our efforts, to meet this income requirement or may inadvertently fail to meet this income requirement |
| Current law may change so as to cause us to be treated as a corporation for federal income tax purposes without regard to our sources of income or otherwise subject us to entity-level taxation |
| 45 If we were to be treated as a corporation for federal income tax purposes, we would pay federal income tax on our income at the corporate tax rate, which is currently a maximum of 35prca and would pay state income taxes at varying rates |
| Under current law, distributions to unitholders would generally be taxed as a corporate distribution |
| Because a tax would be imposed upon us as a corporation, the cash available for distribution to a unitholder would be substantially reduced |
| Treatment of us as a corporation would cause a substantial reduction in the value of our units |
| In addition, because of widespread state budget deficits, several states are evaluating ways to subject partnerships to entity-level taxation through the imposition of state income, franchise or other forms of taxation |
| If any state were to impose a tax upon us as an entity, the cash available for distribution to our unitholders would be reduced |
| Risks Related to Ownership of Our Common Units if We or KMI Default on Debt Unitholders may have negative tax consequences if we default on our debt or sell assets |
| If we default on any of our debt, the lenders will have the right to sue us for non-payment |
| Such an action could cause an investment loss and cause negative tax consequences for unitholders through the realization of taxable income by unitholders without a corresponding cash distribution |
| Likewise, if we were to dispose of assets and realize a taxable gain while there is substantial debt outstanding and proceeds of the sale were applied to the debt, unitholders could have increased taxable income without a corresponding cash distribution |
| There is the potential for a change of control if KMI defaults on debt |
| KMI owns all of the outstanding capital stock of the general partner |
| KMI has significant operations which provide cash independent of dividends that KMI receives from the general partner |
| Nevertheless, if KMI defaults on its debt, its lenders could acquire control of the general partner |