How Is Kinder Morgan's CO2 Business Doing?

| About: Kinder Morgan (KMP)

Kinder Morgan Energy Partners' (NYSE:KMP) CO2 business segment produces oil and gas as well as produces, transports, and markets carbon dioxide that is used in enhanced oil recovery (EOR) operations. The division remains one of KMP's most profitable segments and accounts for around 25% of the firm's Trefis price estimate. The division has been doing reasonably well of late thanks to higher oil production and price realizations, although capacity constraints for the firm's CO2 supply business haven't allowed the business to grow at its full potential. During Q2 2013, the segment's revenues grew by around 11% over the same quarter last year to $460 million while earnings before depreciation, depletion, and amortization grew by around 10% to $358 million. Here is a brief overview of some factors driving the performance of this business.

Higher Oil Production and Better Price Realizations

We estimate that around two-thirds of the CO2 division's revenues come from oil and gas production. Kinder Morgan produces oil from its SACROC, Yates, and Katz fields, which are all located in Texas. Oil production has seen some growth this year with daily production averaging around 53 thousand barrels (MBbl), up by around 6% since last year. We believe this is quite commendable considering that all three fields use CO2 flooding technology and carbon dioxide has been in relatively short supply of late. Price realizations for crude oil have been better this year, with average prices during Q2 2013 rising to around $94 per barrel from around $86 per barrel last year. WTI crude prices have been trending higher, rising from around $90 in January to current levels of around $106. Although Kinder Morgan has hedged a bulk of its oil production for this year, it should earn better prices on its unhedged volumes.

CO2 Capacity Expansion Is Key to Long-Term Growth of the Business

KMP provides carbon dioxide for enhanced oil recovery from mature oil wells located in the Permian basin in Texas. The Permian basin contains several legacy oil fields that saw their production peak in the 1970s, and have fallen significantly since. This has caused an increase in demand for production enhancement services and around half the country's EOR projects are located in the region. While demand for CO2 has remained strong, KMP has been facing capacity constraints with CO2 production and sales having flattened out at around 1.2 billion cubic feet (bcf) per day over the last several quarters. The shortage of carbon dioxide could also prove to be a bottleneck for the company's oil production activity given that it is largely based on CO2 flooding.

Given the strong demand, KMP is working on expanding its CO2 production capacity. The company will boost capacity in its Colorado unit from around 1.2 bcf a day to about 1.4 bcf per day by 2014 and also mentioned that it was working on a new source field on the Arizona/New Mexico border that should add an additional 200 million cubic feet a day in supply. KMP also says that it is also exploring the possibility of boosting its capacity further to around 2 bcf per day by 2017 given the strong demand.

We have a price estimate of around $92 for Kinder Morgan, which is about 12% ahead of the market price.

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