Kinder Morgan Cash Flow Engines

A couple years ago I suggested that Kinder Morgan (NYSE:KMI) could doublefrom the middle teens within about five years. About one-third of that journey has been completed. I still expect the stock to reach around $30 per share the next several years, as well as, continue to provide income via dividends and potentially special dividends.

What Is The Plan With Kinder Morgan Canada?

The next phase for Kinder Morgan Canada (OTCPK:KMLGF) now that they’ve dumped their Trans Mountain pipeline expansion on the Canadian government is to continue to find a way forward, or over, or away. 

The subsidiary, which Kinder Morgan (KMI) owns 70% of, still regains a significant portion of the cash from the Trans Mountain sale – the rest paid to Kinder Morgan as a special dividend in January.

The company’s assets lie in Western Canada and include terminals in Edmonton, the Cochin Pipeline and terminal in Vancouver. None of the assets are significant growth drivers.

Kinder Morgan is expected to announce a plan for their shares of KML. They could merge the company with another, sell it outright (optimal), take it private or leave it public. 

Selling the company outright would allow Kinder to further improve its balance sheet and return more cash to shareholders. A merger might enable it to grow, however, that is a risky proposition that I don’t believe the market would like.

I suspect a sale to Chevron (CVX) which uses parts of their capacity or a Canadian pipeline company is in the offing. Enbridge (ENB) makes some sense as they have substantial Canadian operations and would value the Cochin natural gas liquids capacity. 

Kinder Morgan’s second best choice if it can’t fetch a price would appear to be to take the company private, keep Cochin and sell off the terminals. We’ll see, there are no real bad options, just better.11

National Energy Office national Board de l’énergie Major Pipeline Systems and Frontier Activities Beaufort Sea Baffin Bay Regulated by the National Energy Board Geophysical Programs Undertaken in 2013 (2) Wells Drilled and Re-entered in 2013 (9) NORTHWEST TERRITORIES YUKON 7 Whitehorse Labrador Sea Iqaluit NUNAVUT Enbridge Pipelines (NW) Inc. Yellowknife 1 Westcoast Energy Inc., carrying on business as 1 Spectra Energy Transmission NEWFOUNDLAND AND LABRADOR NOVA Gas Transmission Ltd. Alliance Pipeline Ltd. ALBERTA Hudson Bay Pacific Ocean BRITISH St. John's COLUMBIA SASKATCHEWAN MANITOBA QUEBEC Edmonton Enbridge Southern Lights GP Inc. on behalf of Enbridge Southern Lights LP PRINCE EDWARD Victoria Enbridge Pipelines Inc. ONTARIO Maritimes & Northeast ISLAND Pipeline Management Ltd. CharlottetownxonMobil Canada Properties Kinder Morgan Cochin ULC NEW Trans Mountain Pipeline ULC TransCanada PipeLines Limited BRUNSWICK Foothills Pipe Lines Ltd. Winnipeg Trans Québec and Fredericton Regina Maritimes Pipeline inc. NOVA Halifax Encana Corporation Express Pipeline Ltd. Quebec SCOTIA Emera Brunswick Pipeline Company Ltd. TransCanada Keystone Pipeline GP Ltd. Montreal Pipe Line Limited Ottawa USA TransCanada Trans-Northern Pipelines Inc. Toronto PipeLines Limited Enbridge Pipelines Inc. Atlantic Kinder Morgan Cochin ULC Ocean Plains Midstream Canada ULC

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Carbon Dioxide Is Ignored, But High On Potential

One of the biggest problems facing mankind is climate change. In order to prevent catastrophic impacts on the global climate, methods of reducing man’s carbon footprint is required. Environmentalist demonstrators aren’t the only ones who know this.

Billionaires, corporations, foundations and financial institutions are all on board with reducing man’s carbon dioxide and methane output. And, there’s the Paris Climate Accord for what that’s currently worth, an agreement of over 190 nations that reducing man’s carbon footprint is imperative. 

Kinder Morgan is the largest transporter of carbon dioxide in America. It moves over 1.2 billion cubic feet of CO2 per day. Most of that is in the Permian Basin.

Because the Permian Basin is the source of most U.S. oil production growth and very significant natural gas output, Kinder Morgan has a golden opportunity to take part in reducing the impact of greenhouse gases in America’s most important oil field. 

Occidental Petroleum (OXY) is also taking the hint as they ramp up their EOR (enhanced oil recovery) activities and sequestration of carbon dioxide in underground reservoirs. 

Kinder Morgan is using CO2 in their own EOR activities, as well as, selling to other customers. A rumor persists that Kinder Morgan is trying to sell its CO2 unit for upwards of $5 billion. This is a misunderstood idea. 

Kinder Morgan could very well be looking to sell its last oil fields where it engages in EOR. However, it is unlikely looking to sell its CO2 pipes. And, with their experience in EOR, it makes them a strong partner for companies engaged in EOR or looking to expand.

Expansion of EOR activities and sequestration of CO2 could become compelling from a regulatory standpoint in the 2020s. The Department of Energy is actively looking to expand EOR to more oil fields where it believes up to 60 billion barrels of oil could be produced. According to the IEA, over two-thirds of carbon capture and storage projects are associated with EOR.  

In its most recent Investor Day presentation, the company identified the value of CO2 transport for mitigating climate change. The CO2 segment will generate over $400 million of free cash flow in 2019 with an internal rate of return of about 28%. EOR CO2 growth from 2018 to 2019 will be approximately 15%. 

Kinder Morgan is identified as a leader in EOR and CO2 solutions along with Occidental, Chevron (CVX), ConocoPhillips (COP), ExxonMobile (XOM) and Hess (HES) in a recent analysis by Global Info Research. The CO2 EOR growth rate is likely to exceed 19% through 2024 according to the EIA.

It Matters That Richard Kinder Is Buying Heavily

There are investors who blame Richard Kinder for the slump that Kinder Morgan shares have had the past several years. Nevermind the oil and gas crash. Nevermind a once in a generation event. Reduce their dividend and you are the devil. Whatever. 

Richard Kinder gets one dollar per year of pay from Kinder Morgan. No stock options, no grants and no bonus (I presume he gets health insurance, maybe a car and company paid transportation). That’s a pretty thin payment for a Chairman and co-founder. 

How does he get paid then? Well, he buys Kinder Morgan shares. He’s completely invested in the outcome of this company. Recently he has bought over 3 million shares of Kinder Morgan with his own cash this year. 

Kinder now owns directly or indirectly over a quarter billion shares of Kinder Morgan stock for about a 12% stake. That’s about as aligned with shareholders as it gets.

Investor Thesis

Markets are relatively efficient most of the time. When there is an inefficiency, whether bullish or bearish, is where investors can make hay.

Consider the articles you have read on Kinder Morgan, how many have discussed Kinder Morgan Canada and the CO2 business? Very few, if any. If there is value to be had in Kinder Morgan, that’s where it is, the underfollowed, unloved portion of the company. The rest is priced in. 

The analysts that have started cheerleading recently are know-nothings who are regurgitating. Real analysis is understanding that parts of a company are not valued by the market right now or are dramatically overvalued. 

In Kinder Morgan’s case, the Canadian assets and CO2 business are getting almost no attention. I would submit that the Canadian subsidiary offers a one time drop down to the bottom line. The CO2 business is a legitimate growth driver that climate change deniers and superficial analysis ignore. 

Richard Kinder who gets a buck a year of compensation obviously sees value somewhere. I’d bet it’s the CO2, but the money to come from a Canada decision is good too. 

I rate Kinder Morgan a buy and am buying more shares of Kinder Morgan after having taken some profits last autumn. 

Option Trades

I am also selling cash-secured puts near the money a few months out, as well as, buying a handful of short-term calls in case the stock really rallies on a bigger cash drop down from Canada than folks expect or higher than forecast growth. I am also buying a few puts below the strike prices I am selling at.

Specific options I am looking to add:

Selling September $19 puts.

I am happy to pick up more shares with a net cost below $19.

Buying May $20 calls.

Buying May $17 puts.

Buying the calls and puts is speculative on a large move in either direction. It should be a small trade as both options could go to zero quickly. Do not buy those calls if you cannot stomach a total loss. 

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