An estimated 300,000 people journeyed to the western United States during the California Gold Rush to strike it rich. The thought of finding gold and becoming wealthy overnight was (and is) a tremendously sexy idea, even if few people harnessed the skills required to be successful. Ironically, the skills and businesses that were most common – sewing, gambling houses, laundry, etc. – were also the most profitable. In other words, the less obvious the business the more successful it became.
I can see a similar scenario playing out before investors today. Each type of alternative fuel that society creates – a biofuel, compressed natural gas (CNG), hydrogen, or even compressed air – claims to be a petrol killer and a modern day gold mine for investors. In reality, a combination of fuels will contribute to the energy hungry societies of the future, but it is much too early for investors to pick the winners. So instead of throwing money directly at the obvious, why not seek out less obvious, future-enabling investments?
What do Super Mario and Kinder Morgan Energy Partners (NYSE: KMP ) have in common? Green pipes. Unbeknown to many, Kinder Morgan's fastest-growing segments are those concerning the transportation, storage, and blending of ethanol and biodiesel. The Renewable Fuel Standard (RFS) legally requires fuel blenders such as Exxon, Chevron, BP, and Shell to purchase 15 billion gallons of ethanol and 1.28 billion gallons of biodiesel in 2013. Without utilizing Kinder Morgan's pipelines these blenders would pay hefty fines to the EPA. It usually pays to be the middleman.
In 2011 Kinder Morgan transported 61 million barrels of ethanol or 18.3% of all ethanol produced in the United States. That is up 87% from 2009 thanks to strategic investment in the industry. Over the last two years the company has invested close to $150 million in new biofuel pipelines and terminal facilities. Two widely covered projects bringing biodiesel to new markets in Fresno and Tampa Bay garnered more than $16 million and $10 million, respectively.
Pipelines don't reach all parts of the country, which makes the company's terminal partnerships with railways an important part of the growth equation. TRANSFLO, a subsidiary of CSX (NYSE: CSX ) , and Kinder Morgan have teamed up to cost-effectively transport ethanol blends to central Florida and other parts of the Eastern Seaboard. The railway can transport bulk ethanol shipments in trains up to 96-cars long – exponentially more efficient than highway bulk. Several West Coast railroads catalyzed the company's growth in ethanol terminal revenue, which soared 75% in 2010 due in large part to California's green energy mandates.
An unlikely leader
Shoving some biofuels into a pipe and pumping them around the country may sound like a simple operation, but thanks to some tricky chemistry it is a bit more involved. Biodiesel can contaminate jet fuel, shipments of which may run in the same pipelines, and ethanol can attract water to the steel walls of your pipes, slowly eroding them away. Thus, quantities of B100 must be blended at concentrations near 5% with petrol diesel before being shipped through a pipeline. Again it may not sound like much, but when you consider that other pipelines only dare to send 2% blends it becomes a big deal.
In fact, Kinder Morgan owns one of the loudest megaphones when it comes to supporting a national 5% biodiesel blend mandate – similar to ethanol's 10% requirement. Given the fact that the biodiesel industry has an annual capacity of 2.1 billion gallons but is only required to sell 1.28 billion gallons, it is safe to say that a 5% blend mandate will likely accommodate future RFS increases. This would be great news for middlemen like Kinder Morgan and producers such as Renewable Energy Group (NASDAQ: REGI ) , which has built its own national distribution network rather than waiting for infrastructure to catch up. Similar to Kinder Morgan, REG has various offtake agreements with CSX and TRANSFLO.
The company is on track to produce 375 million gallons per year (mmgy) by 2014, which will represent up to 25% of the country's total biodiesel output. Two state-of-the-art biorefineries with 60 mmgy capacities are currently under construction in Kansas and Louisiana. That's a lot of biodiesel, but the two locations are also situated near strategic rail and pipeline terminals. And that's hardly by mistake. Access to transportation is crucial for moving inventory quickly, which is exactly what Kinder Morgan, CSX, REG, and investors want to hear.
Did ethanol save Kinder Morgan in 2011?
Compared to 2010, the company's 2011 fiscal year was detrimentally affected by lower natural gas prices. Despite shipping 13% more natural gas to customers EBDA fell 7.5%. Ironically, the year-over-year changes in EBDA for the company's natural gas segment (-$62.1 million) were exactly offset by increases in EBDA for terminal businesses ($63.2 million).
Falling natural gas prices haven't hurt everyone. Clean Energy Fuels (NASDAQ: CLNE ) , which can produce up to 90 million liquid natural gas gallons per year, states that CNG fuel can be up to $1.50 cheaper than a gallon of diesel. Similar to REG, the company has developed its own national distribution network complete with production sites, terminals, and fueling stations.
Pipeline operators, railroads, and emerging growth companies with masterful distribution networks should treat long-term investors well. Every time you read the words "glut" or "bottleneck" regarding energy you should think about the tremendous growth ahead (and desperately needed) in the transportation of transportation fuels.
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