With fresh access to capital after chopping its dividend, pipeline giant Kinder Morgan (NYSE:KMI) is putting some of that cash to work on a new ethanol hub in North Carolina. The company is joining forces with Archer Daniels Midland (NYSE:ADM) and Bailey Feed Mill to construct a new unit train rail facility and ethanol offloading system in the state. It's a project geared toward capturing what's expected to be record demand for ethanol.
Details on the deal
Kinder Morgan will invest in and construct the new facilities, which will be located at the Bailey Feed Mill. The company will also build a new 2.6-mile pipeline that will connect the unit train offload system to its tank farm. The project, which will be complete by the end of next year, will improve the efficiency of Archer Daniels Midland's ethanol delivery. Furthermore, by working together the three partners are able to put together a cost- and capital-efficient project.
While natural gas is its core focus, Kinder Morgan is no stranger to working with biofuels. Last year the company's terminals business had throughput of more than 70 million barrels of fuel-grade ethanol or biodiesel. Moreover, it expects throughput to be up 2% this year. Furthermore, its product pipeline segment expects to handle more than 45 million barrels of biofuels this year and its biofuel revenue has been growing by a compound annual rate of 4.2% since 2011. In addition to that it continues to add to its ethanol assets, with the company investing $8.4 million to expand its ethanol terminal capacity in Chicago, and it has been pursuing ethanol distribution networks in the southeast to drive future growth, which is where this project comes into play.
Why ethanol demand is growing
The reason this project is necessary is because ethanol demand in the U.S. is expected to surge to a new record this year. According to the EIA, ethanol is expected to make up more than 10% of U.S. gasoline in 2016 for the first time and is up from just 3% a decade ago. This is partially due to surging gasoline demand, but it's also the result of a new mandate from the Obama administration that says refiners must use ethanol in amounts exceeding 10% of U.S. motor fuel demand. With cheap gas fueling demand for 140 billion gallons of gasoline this year according to the EIA, it's expected to lead to a record 14 billion gallons for ethanol.
Despite expected record demand, it will be interesting to see how this impacts the bottom line for both refiners and ethanol producers. Valero Energy (NYSE:VLO), which produces both gasoline and ethanol, has really benefited from the impact of low oil prices on its refining business. Last quarter, for example, its refining business enjoyed a $600 million year-over-year boost in operating income due to a higher margin per barrel amid low oil prices and stronger gasoline demand. That said, Valero's ethanol business struggled, with its operating income plummeting from $198 million in last year's third quarter to just $35 million this past quarter. That weakness was due to lower gross margin per barrel amid weak ethanol prices. In other words, despite strong demand for gasoline and ethanol, its price has remained weak.
All that being said, ethanol pricing is not really of much concern to Kinder Morgan because its business is on the fee-based side of operating pipelines and terminals that ship and store the ethanol. So, it benefits from the growing demand for the product, not from the ebb and flow of its price, and demand is expected to be robust and could keep growing alongside increased demand for cheap gasoline.
While this is a small project in the grand scheme of things, it still represents another step forward in a market where demand is clearly growing. That's key because demand-driven projects benefit from weak commodity prices -- meaning continued growth. Even better, as far as ethanol is concerned, is that it has the additional catalyst of higher mandates fueling even more demand. That makes ethanol is a good place for Kinder Morgan to be investing in right now.
Matt DiLallo owns shares of Kinder Morgan and has the following options: short January 2018 $30 puts on Kinder Morgan and long January 2018 $30 calls on Kinder Morgan. The Motley Fool owns shares of and recommends 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.