Kinder Morgan Defies Critics With Its Latest Move

Management at Kinder Morgan Energy Partners (NYSE: KMP  ) recently announced that it would be spending an additional $671 million in capital expenditures to expand CO2 production operations in the Cow Canyon area of McElmo dome in Colorado. These funds will also help it to expand the Cortez Pipeline, which will move that CO2 to the Permian Basin where it will be used for enhanced oil recovery. 

Of that $671 million, $344 million will be spent on increasing CO2 production by 200 million cfe per day. This project will include 16 new production wells, activation of 1 production well, 3D seismic mapping, produced water handling, and a central compressor. Half of that increase, 100 million cfe, will be online by July 2015. 

The remaining $327 million will be spent expanding the Cortez Pipeline from a capacity of 1.35 billion cfe per day to 2 billion cfe per day. Kinder Morgan will add three pressure stations, modify five, and add a 60-mile loop in New Mexico.

These projects are a response to increasing CO2 demand. The additional CO2 moved into the Permian will be used to help producers there, including Kinder Morgan, increase oil production through CO2 flooding. This $671 million is in addition to the $1 billion in CO2 projects which management announced in March.

Media concerns about CO2
A few months ago, Barron's published two negative articles on Kinder Morgan. In both articles Barron's interviewed Kevin Kaiser, who voiced several concerns. One of the concerns was that, unlike all other pipeline companies, a large chunk of Kinder Morgan's distributable cash flow relied on actual oil production. Kaiser pointed out that not only was Kinder Morgan exposed to oil price fluctuations, but these mature fields would also soon peak and begin declining. Such a decline would take Kinder Morgan's cash flow with it.

Courtesy of Investor Relations

The best is yet to come
While it's true that all oilfields eventually decline, most people tend to overlook just how far CO2-aided oil recovery has progressed since it was first employed in the 1980s. The above chart from Kinder Morgan really speaks volumes. According to original 2007 estimates, distributable cash flow from CO2 oil recovery should be half of what it actually is today.

Thanks largely to technological improvements and a constant refining of best practices, cash flow projections have consistently increased over the years. This has further put off the eventual date when oil produced from this recovery method finally begins to decline. Management currently expects production to peak three years from now, but it doesn't expect meaningful declines in distributable cash flow until 2019. Management also believes that growth from other business segments in the coming five years will more than offset a decline in cash flow from CO2.

Bottom line: More CO2, more distributions
By far, CO2 represents the most profitable business segment of the Kinder Morgan family. As an example, Kinder Morgan Partners posted an average return on investment of 12.66% in 2013. Meanwhile, of all Kinder Morgan's business segments, CO2 posted the highest return at 26.6%.

There is no doubt that CO2 transportation and CO2-injection oil recovery are the most profitable parts of Kinder Morgan's business. If "peak CO2" is at least five years off, and in the meantime is easily the most profitable business segment in the company, why not continue investing in what works? Once you look at things a little deeper, it's obvious that Kinder Morgan is doing the right thing.

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