Kinder Morgan’s Foray into Marine Transportation of Oil Should Boost its Profitability

Kinder Morgan Energy Partners (NYSE:KMP), the largest midstream company in North America, announced last month that it was ordering the construction of one more Jones Act qualified vessel for its tanker fleet. ^[1] In December 2013, the firm had acquired American Petroleum Tankers (APT) and State Class Tankers (SCT) from affiliates of PE firms Blackstone Group and Cerebrus Capital for $962 million. ^[2] The APT acquisition added five medium range Jones Act qualified tankers with a capacity of 330,000 barrels of cargo capacity tied up in four-year contracts, with an option of extension by two years, with counter parties including highly integrated oil companies, major refiners and the U.S. Navy. Meanwhile, the SCT had already commissioned the construction of four medium range qualified vessels with a capacity of 330 barrels of cargo capacity, which will now accrue to KMP’s asset base. These vessels are currently under construction in General Dynamics’ NASSCO shipyard in San Diego and expected to be delivered in 2015 and 2016. ^[2] The new Jones Act qualified vessel is also being constructed at the NASSCO shipyard and will be delivered in the second quarter of fiscal 2017.

Trefis has a price estimate of $83 for KMP, which is slightly ahead of the current market price.

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Why is KMP purchasing Jones Act Qualified vessels?

For decades U.S. based refineries have been getting their oil from overseas. But America’s oil boom is now replacing this pricier crude with cheaper oil from the Bakken and Eagle Ford Shale plays. The issue lies in the transportation of all this crude. Pipelines in certain key areas, like the Gulf Coast and Mid-Continent, are at full capacity and cannot be utilized for the shipping of any more oil. Other areas such as California and the East Coast, are receiving insufficient oil supply via pipelines, and require transportation via rail or boats. The latter has resulted in a sudden surge in demand for Jones Act qualified vessels. The Merchant Marine Act, also known as the Jones Act, is a legal statute designed in 1920 to promote and protect the American merchant marine industry. The law requires all goods transported between U.S. ports to be carried on flagships constructed in the U.S., owned by U.S. citizens and crewed by U.S. citizens. The acquisition of APT and SCT qualified vessels allows KMP to take advantage of this law and add a new tributary to its revenue stream.

Financial Implications for KMP

Kinder Morgan’s business has previously been centered on the transportation of oil, natural gas and natural gas liquids via its pipelines. With the acquisition of these tankers, the company will now be moving into marine transportation of oil. With the booming oil production in the United States and the high costs associated with the construction of new pipelines and expansion of already existing pipelines, shipping oil via Jones Act qualified tankers offers KMP a low cost alternative to add more cash profits to its bottom line. Moreover, Kinder Morgan is taking on very little risk in building the vessels. The company has already locked-in multi-year contracts with major oil producers, securing years of fee-based cash flows. ^[3]

The company did not reveal the costs for construction of these ships in its press release. It is, however, possible to approximate how much this new venture will cost the company. As noted above, Kinder Morgan bought nine tankers last year for $962 million. Additionally, the company stated that it needed to spend a further $214 million to complete construction of the vessels that were still not in operation. This implies that the company will be spending around $130 million per vessel. The company has previously pointed out that once fully operational, these nine vessels would add about $140 million in EBITDA each. Assuming a similar rate of profitability for the tenth vessel, we can expect the figure to increase to $155 million.

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1. KMP to Build Additional Product Tanker for Growing Fleet, Businesswire, June 2014 [↩]
2. Kinder Morgan Announces Acquisition of Jones Act Shipping Tankers in U.S. for Approximately $962 Million, Businesswire, December 2013 [↩] [↩]
3. Kinder Morgan Investor Presentation, kindermorgan.com,June 2014[PDF] [↩]