Late last year Kinder Morgan Energy Partners (NYSE: KMP) announced that it was buying two oil tanker companies for a combined $960 million. It was a deal designed to profit from a century-old law that's increasingly coming into play thanks to America's oil boom. The law, officially called the Merchant Marine Act but more commonly known as the Jones Act, is one that's forcing refiners like Phillips 66 (PSX +1.93%) and Valero (VLO +1.99%) to look for the cheapest ways to access American oil as there just aren't enough pipelines to get this oil to refineries.
Reversing the flow of crude
For decades American refineries received oil from overseas. But America's oil boom is pushing out this pricier crude and replacing it with cheaper oil from the Bakken and Eagle Ford Shale plays. The issues is in getting that oil to refineries as there isn't pipeline infrastructure to move the oil. While rail is becoming an important logistic option, so is moving the oil by boat. But according to the Jones Act, when cargo is moving from one U.S. port to another American port it must be carried on a ship that not only was constructed in the country but is also owned, flagged, and crewed by U.S. citizens or permanent residents. Those limitations are forcing refiners like Phillips 66 and Valero to find shippers that meet the strict criteria in order to access cheap crude oil by boat.
As the following slide points out, Phillips 66 has even acquired its own Jones Act ships to move crude oil to its refineries.
Source: Phillips 66 Investor Presentation (link opens a PDF)
The purchase of these vessels is part of Phillips 66's plan to process as much cheap oil as possible. By enhancing its own logistical capabilities the company can ensure that its getting the best prices on oil, which is enhancing its profits.
Meanwhile, Valero is also investing to increase its access to cheap oil. One of its projects is to expand its crude oil export dock in Corpus Christi and by the first quarter of next year Valero will be able to export 50,000 barrels per day. But what's unique about Valero's situation is that it owns a refinery in Canada and can actually skirt past the Jones Act and use cheaper foreign flagged ships to send this oil to Canada.
How Kinder Morgan Energy Partners plans to profit
Kinder Morgan Energy Partners wants to ensure that its profiting from this new movement of crude oil. One of the steps it took was to acquire five Jones Act shipping tankers last year in its deal for American Petroleum Tankers. But at the same time, the company also bought State Class Tankers, which had already commissioned the construction of four Jones Act qualified tankers. Once these ships are complete Kinder Morgan Energy Partners will see $140 million in annual EBITDA from its fleet. As the following slide points out the deal was not only accretive to distributable cash flow when complete, but these additional vessels add built-in long-term profit growth.
Source: Kinder Morgan Energy Partners Investor Presentation (link opens a PDF)
As that slide points out these ships provide Kinder Morgan Energy Partners with long-term, fee-based income. Further, not only does the business have built in growth from the four ships currently under construction, but the company recently announced it is adding another new build. The ship, which is a sister tanker to the four currently under construction, is expected to be delivered in 2017. Like the rest of its fleet it's already supposed by a long-term charter with a major shipper, so the income from the vessel is already locked in.
With America overflowing with oil there's plenty of opportunity for Kinder Morgan Energy Partners to continue growing its Jones Act fleet. The company noted in the press release announcing the new build that it continues to see increasing demand for waterborne transportation to move petroleum products, so we're likely to see Kinder Morgan Energy Partners to continue expanding its fleet.
Investor takeaway
Kinder Morgan Energy Partners is very adept to finding the best ways to take advantage of American laws to increase profits to investors. Its growing Jones Act fleet is just one of the ways it's taking advantage of a profitable situation to deliver more income to its investors. Given that the current energy boom is showing no end in sight, Kinder Morgan Energy Partners continue to find ways to extract profits from being one of the main logistical solution providers to the boom.
