Carbon dioxide gets a bad rap. As a byproduct of burning fossil fuels, it receives most of the blame for climate change. However, it actually has a lot of value to oil companies, especially when it comes to getting more oil out of the ground. When used to enhance the recovery of oil, carbon dioxide is actually the star of the show.
Carbon's important footprint
The greenhouse gas is key to unlocking oil that's still trapped in places like the Permian Basin, which is where 20% of our oil production comes from. Occidental Petroleum (NYSE:OXY), which is the largest oil producer in the Permian Basin, notes that 60% of its production in the Permian is due to carbon dioxide-related enhanced oil recovery projects. Not only is it Occidental's most profitable business, but it sees it as being the key to pulling another 2.5 billion barrels of oil equivalent out of the Permian Basin. This is oil that likely would have stayed trapped underground as it didn't come out during the initial production phase.
Carbon dioxide is especially valuable to Kinder Morgan (NYSE:KMI) and Kinder Morgan Partners (UNKNOWN:KMP.DL). Kinder Morgan is the leading transporter and marketer of carbon dioxide in North America. It delivers about 1.3 billion cubic feet of carbon dioxide each day through its more than 1,300 miles of pipelines. Further, Kinder Morgan, like Occidental Petroleum, is also a leading producer of oil from carbon dioxide-enhanced oil recovery projects. In fact, it's the second-largest oil producer in the state of Texas because of carbon dioxide.
Carbon's future at Kinder Morgan
Because of its importance in enhanced oil recovery, Kinder Morgan sees carbon dioxide being an even a bigger part of its future. Just last month, the company committed about $1 billion to expand its vast carbon dioxide network. The company is planning to build and operate a new 213-mile pipeline to transport carbon dioxide from a company-owned source field in Arizona to producers in the Permian.
Once in service in 2016 that pipeline will have the capacity to transport 300 million cubic feet of carbon dioxide per day. It will be used to support current and future enhanced oil recovery projects in the Permian Basin that are owned by Kinder Morgan and other operators.
Ensuring a steady supply of carbon dioxide to the Permian Basin is important. It gives smaller operators like Legacy Reserves (NASDAQ:LGCY) the confidence to continue growing the footprint of carbon projects within its portfolio. That's why just a few weeks ago Legacy Reserves was able to make another small bolt-on acquisition of an enhanced oil recovery project in the Permian Basin. That deal was made possible due to the fact that Legacy has a long-term supply agreement with Kinder Morgan for the carbon dioxide it needs to support the project. Legacy isn't big enough to support its own carbon dioxide infrastructure value chain, so the services provided by Kinder Morgan are critical to its ability to acquire and operate additional projects in the future.
Carbon dioxide continues to be a strong cash flow generator for Kinder Morgan. Not only does it supply its own enhanced oil recovery projects, but its position in the Permian Basin enables it to supply smaller producers like Legacy Reserves. This helps America's energy companies to get as much oil as possible out of our legacy oil fields. Because of that, carbon dioxide should continue to fuel strong returns for Kinder Morgan's investors for years to come.
Matt DiLallo has the following options: short January 2016 $32.5 puts on Kinder Morgan and long January 2016 $32.5 calls on Kinder Morgan. The Motley Fool recommends and owns shares of Kinder Morgan. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.