DealBook: A Pipeline Merger Meets a Need, and Perhaps Resistance

Kinder Morgan, via European Pressphoto AgencyA Kinder Morgan pipeline in Concord, Calif. A combination with El Paso would control 67,000 miles of pipeline across the country.

Kinder Morgan’s planned $21.1 billion takeover of the El Paso Corporation is seen as a potential catalyst for consolidation in an unheralded but increasingly important part of the energy industry: the companies whose pipes carry the oil and gas.

Kinder Morgan’s deal is based on the belief that natural gas will become an increasingly important fuel for the nation, and that its growth is hampered by a lack of adequate pipeline networks.

“It’s a bet that hydrocarbons are going to be the most significant component of our energy mix for a long, long time,” E. Russell Braziel, a managing director of the consulting firm Bentek Energy, said.

Energy companies have been racing to gain bigger positions in shale formations throughout the country. Beyond oil and natural gas, they are also hoping to tap into vast reservoirs of natural gas liquids like butane and propane, which are in high demand from chemical manufacturers.

But exploration and production players are increasingly constrained by the lack of a national pipeline system that connects those fields to refining centers and, ultimately, cities and other customers.

Made up of companies that send gas and oil through pipes that snake across the continent, the so-called midstream sector has long been known for being extremely fragmented. As recently as a decade ago, the industry was considered staid and hardly a business that could reap significant profits.

Yet today more than 50 pipeline operators are active, with a mishmash of pipes that aren’t necessarily connected to the right locations, according to Rodney L. Waller, a senior vice president for Range Resources, a natural gas exploration company.

Pipeline construction in the Marcellus shale field in Pennsylvania has not kept pace with drilling activity there, limiting the amount of gas that can be sent to the Northeast. In the Bakken field in North Dakota, producers are shipping much of their new oil production by train to Gulf Coast refineries, and excess gas production is being flared — that is, burned off — as waste.

New gas and oil shale fields, meanwhile, are being developed in Ohio, Kansas, Oklahoma, Texas and Colorado.

All of this has led to a glut of oil and natural gas that depresses prices and makes the construction of new pipe almost too expensive. Since late last year, the oil storage depot in Cushing, Okla., has been so stuffed with excess oil that the West Texas Intermediate benchmark price has plummeted $20.

“Low gas prices, the development of new shales, all the pipes being in the wrong place — all of that is kind of moving the whole business topsy-turvy,” Mr. Waller said. “Consolidation is an obvious answer to all that.”

By adding El Paso’s pipes, Kinder Morgan will connect its network to large cities in Florida, New York, West Texas and California. The combined company will own or operate some 67,000 miles of pipe, moving more than a million barrels of fuel a day.

“This deal is definitely going to change the industry,” Fadel Gheit, a senior oil analyst at Oppenheimer Company, said. “We need another Exxon Mobil in the pipeline industry to look and invest long term, and Kinder Morgan is the prime candidate to fill that role. There is a tremendous need to improve infrastructure.”

Few analysts believe that interlopers will emerge, citing the size of the deal and how well El Paso’s pipes mesh with Kinder Morgan’s.

Perhaps the biggest concern weighing over the El Paso deal is also the transaction’s biggest benefit — the sheer size of the network and potential antitrust risk. Kinder Morgan’s chairman and chief executive, Richard D. Kinder, played down such worries, saying that the only meaningful overlap is on the West Coast. He added that he was willing to sell assets to help close the deal.

“We’ll just work with the regulators on that,” he said on a conference call with analysts on Monday. “We don’t think it’s a significant problem.”

At least a few analysts were not as confident. Faisel Khan, an analyst at Citigroup, wrote in a research note on Monday that the Federal Energy Regulatory Commission may take a hard look at a deal of this size and its level of cost savings. The agency may consider imposing restrictions like rate freezes.

Indeed, while El Paso shares jumped 25 percent on Monday, to $24.45, they remained below Kinder Morgan’s $26.87 offer price, suggesting that investors may be wary of roadblocks to completing the deal.

Some oil and gas companies may be unhappy with the prospects of a growing pipeline empire. The chief executive of one gas explorer that depends on a Kinder Morgan pipe said that others in the energy sector might be unhappy should the company gain more control of the country’s pipes.

“They take advantage of everything they can,” the executive said, requesting anonymity since he depends on Kinder for his business. “They negotiate very hard on every transaction. They are arrogant and litigious. They are never fun.”

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