The Value Of Kinder Morgan’s CO2 Business

Kinder Morgan Energy Partners‘ (NYSE: KMP) CO2 division has been one of the company’s strongest performing segments. Although the division is the second largest in terms of revenue behind the natural gas pipelines business, it is by far the most profitable with EBITDA margins of around 67% last year. The division accounts for about 30% of the firm’s Trefis price estimate.

The CO2 division primarily produces, markets and transports carbon dioxide (CO2) that is used to improve the production from mature oil wells. Besides this, it also operates oil fields and a gas pipeline in West Texas (oil production accounted for less than half the division’s 2011 revenues). In this article, we will explore the division’s activities and some of the opportunities and risks that the business could face going forward.

What Is CO2 flooding and why Is It Important?

Oil wells typically have the highest production rates in the primary phase of their lives. Production gradually declines with time due to a decrease in reservoir pressure, making it difficult for the oil to flow towards the well head. To solve this problem, enhanced oil recovery (EOR) operations are used by inducing pressure inside the wells by pumping carbon dioxide, enabling more oil to flow out through the well head. The process is quite expensive, however, higher oil prices are beginning to justify the high cost.

Production enhancement is critical to optimally harness the world’s crude oil resources. According to oil field services major Halliburton, about 70% of the world’s oil wells are in their mature stages, and a 1% increase in oil recovery factor in these wells could produce enough oil to feed the world’s oil needs for 2 years.

Where Does Kinder Morgan Stand In This Space?

The firm’s CO2 business primarily caters to oil fields in the Permian basin. Kinder Morgan is a leading carbon dioxide supplier in the region with daily production of about 1.3 billion cubic feet. ^[1] It owns or has interests in a total of about 8 billion cubic feet of carbon dioxide reserves located in New Mexico and Colorado and also operates the pipeline infrastructure required to transport its production. The firm also has strong experience in the field of EOR, having operated one of the oldest EOR projects in the region, the SACROC oil field.

What Are The Opportunities?

The Permian basin contains several legacy oil fields that saw their production peak in the 197o’s and have fallen significantly since. This has caused an increase in demand for production enhancement. About half the country’s EOR projects are located in the region. ((The Future of Co2, Permian Basin Petroleum Association Magazine))

However, the oil production from the basin’s EOR fields has been flat over the past five years due to a shortage of CO2.  ((ref:1)) Mature wells in the basin use up to 1.8 bcf of new CO2 every day which is not adequate. In order to feed the shortfall and growing demand, the firm has announced several investments towards expanding its CO2 operations, including the expansion of production at its Doe Canyon unit in Colorado.

Another opportunity for Kinder Morgan’s CO2 business is in residual oil zone (ROZ). A bulk of the basin’s remaining oil reserves lie in  ROZs which lie under the primary oil zones, which can sometimes go deeper than 15,000 feet. ^[2]  The implementation of CO2 based recovery for oil production has been successful in the Permian region and could further boost the demand for Kinder Morgan’s CO2.

Potential Risks To The Business

Unlike Kinder Morgan’s pipelines business where prices are decided by volumes transported, the CO2 division is exposed to oil prices. Many of the firm’s contracts for CO2 are tied to the prices of crude oil with a floor price, and a decline in oil prices could impact the business. Another risk is that the business operations are not geographically diversified since they cater primarily to wells located in the Permian basin. Any adverse conditions like inclement weather or a change in regulations influencing production in the region could impact Kinder Morgan’s CO2 business.

We have a price estimate of about $90 for Kinder Morgan, which is about 10% ahead of the current market price.

Understand how a company’s products impact its stock price on Trefis

1. Kinder Morgan CO2 [↩]
2. The Oil Beneath The Oil, Fiscal Notes [↩]