Kinder Morgan (NYSE:KMI) recently reported a solid quarter, taking another big step forward as it turns around following a very tough stretch. Leading the way was its core natural gas pipeline business, which helped more than offset the lingering effects of the oil market downturn on the company's carbon dioxide business, which not only transports the greenhouse gas but uses it to pump more oil out of depleting oil fields.
While this business is starting to show signs of life, analysts have long wondered why the company continues to hold on to it. Those questions continued this quarter as a couple of analysts asked the company on its conference call if it's still committed to this segment. Here's what CEO Steve Kean had to say about the company's plans for its oil business.
Making sense of carbon's place in the portfolio
Two analysts on the call asked for Kinder Morgan's current thoughts on its carbon dioxide business. One of them noted that as they look at Kinder Morgan, they see it as a leader in the midstream space due to its strategically positioned fee-based assets that generate predictable cash flows. However, when it comes to the carbon dioxide business "it seems like... you live with the downside, and we don't realize the upside" since the company locks in the price of a significant portion of its oil with hedging contracts. Because of that, the analyst wanted the company to "just add a little more color" to "help us understand why it makes sense to remain involved in that business?"
Kean took this one and noted that the overall carbon dioxide business contributes about 11% of its earnings. He then pointed out that of the 11%, 4% is supply and transportation,
Which looks a little bit more like a midstream business. That's where we're moving the CO2 into the market for our use but also for the use of third-party customers who are involved in enhanced oil recovery (EOR). That leaves 7% that's EOR.
It's that oil business that many don't see as a fit. However, Kean continued by saying that:
There is very economically recoverable oil out there at today's prices and even prices that are much lower than today's prices. The only way you can get that out is with CO2. We've got the CO2, and we've got the deals, and we've got the EOR expertise. So it's an opportunity we kind of integrated forward into, if you will. We started with the pipeline, and then we added an enhanced oil recovery field. We get good returns in the business. It's a business that we understand. We hedge in order to make those cash flows more predictable for our investors. So it has more of a stable and predictable cash flow. Our production is very predictable there. We come within 1%, 1.5% of what we budget every year.
In other words, Kinder Morgan sees it as a very integrated business that produces predictable results and earns high returns. As a result, it's "a good business for us," according to Kean, and one "we are happy to hold."
That doesn't mean we won't sell
However, Kean did add a caveat to his response, saying:
Notwithstanding all those good attributes, we are a shareholder-driven company. And if we found the right opportunity, somebody who's willing to pay us a sufficient amount and it was in the best interest of our shareholders, we'd obviously evaluate that.
To put it another way, unless someone offered the company a significant premium for this business, it remains happy to continue holding.
That seems to be the likely course of action since there are few logical buyers. Occidental Petroleum (NYSE:OXY) and Denbury Resources (NYSE:DNR) are the only publicly traded companies with a significant focus on EOR. Occidental even recently bulked up on its industry-leading EOR position in the Permian Basin -- which is where Kinder Morgan operates -- by acquiring assets from Hess (NYSE:HES) last June. Occidental paid $600 million for an interest in the Seminole-San Andres Unit, which produced 8,200 barrels of oil equivalent per day for Hess in 2016 as well as a stake in a gas processing plant, two CO2 source fields, and some pipelines. Meanwhile, Denbury recently sanctioned a new multiyear EOR expansion project.
However, while both companies are investing capital to expand their EOR business, neither appear likely to pay big bucks for Kinder Morgan's position. That's because Occidental seems more focused on developing its shale resources in the area while Denbury's balance sheet remains a work in progress, so it doesn't have the funding for a major transaction. Consequently, holding appears to be Kinder Morgan's only option for the business.
Know when to hold 'em
Analysts would love to see Kinder Morgan sell its carbon dioxide business since they don't think it's a good fit for the company's portfolio, which mainly consists of fee-based pipelines and terminals. Kinder Morgan, however, believes it fits just fine since it's an integrated business that generates strong returns. That's why it plans to continue holding unless it gets an irresistible offer, which doesn't seem likely given the lack of logical buyers. That should be just fine with investors since they'll continue to benefit from the high returns the business generates.