Delivering oil, gas and petroleum products takes tremendous amount of infrastructure and capital investments. The smooth burning natural gas stove and clicking gasoline pump are results of decades-long investment in oil producing assets, processing plants and the interconnecting infrastructure. And in this brokerage business, Kinder Morgan is the undisputed leader in North America.
Founded in 1997 by Richard D. Kindler and William V. Morgan, Kinder Morgan (NYSE: KMI) is an example of an effective operator in the capital-intensive business of oil and gas transport, storage and processing. As North America’s largest energy infrastructure company, Kinder Morgan commands over 60,000 miles of complementary natural gas infrastructure, crude and petroleum product pipelines, storage tanks and terminals. In 2015, the company has transported 2.3 mbpd of products across the continent and its revenue per employee is 30% higher than sector average and is triple the average S&P 500 company .
Toll Collector Business Model
Kinder Morgan’s core business model takes advantage of the separation between producers of energy commodities and the demand markets. Analogous to a toll-way collector, Kinder Morgan generates revenue from collecting fixed fees from its customers on either end of a transmission line. Kinder Morgan adeptly controls the so-called midstream infrastructure and takes a predictable slice of value creation. Its revenue in 2014 topped $16 billion dollars  driven by record volumes of natural gas and petroleum transfers.
With its predictable cash flow and consistent revenue stream through long-term take or pay contracts, Kinder Morgan returns cash to its shareholders by a healthy dividend payout. The remaining cash flow and additional capital is then reinvested to expand or acquire more transmission capacity in a virtuous cycle.
Operating Model and Strategy
Kinder Morgan serves the energy industries’ broad range of customers, from the largest integrated oil and gas companies to smaller shale operators. Through construction and strategic acquisition of midstream infrastructure, Kinder Morgan’s operating model supports its business model in three key aspects:
Tremendous economies of scale
Natural gas an oil pipelines are much more efficient transmission method and has one of the lowest cost per volume of oil. The economies of scale are more pronounced as increased oil and gas supply in North America calls for more transmission capacity. As shown, pipelines are significantly cheaper for long distance transport compared to crude transport by rail.
The drawbacks, of course, include significant upfront capital outlay and lengthy regulatory approval process. As a result, Kinder Morgan has also grown inorganically, acquiring El Paso Corp. for $28 billion in 2012 and paid $3 billion for Hiland Partners’ pipeline assets in 2015. With its vast and flexible network, Kinder Morgan’s pipelines become a base transport mechanism in a customer’s supply chain, resulting in high pipeline utilization and guaranteeing the company predictable streams of income.
Asset Strategy: Ownership of infrastructure, not products
Kinder Morgan operates the pipelines, pumping stations and terminals that move natural gas, crude oil and products. It, however, does not take ownership of the energy products. As a result, its revenue stream is largely shielded from the volatility of the commodities market. A case in point is the last decade’s revolution in shale gas and oil extraction; while producers have been hurt by the supply-driven plunge in prices, Kinder Morgan, through its fixed price arrangements, is set to enjoy swelling revenue on rising oil production that is projected to exceed 10 billion barrels in 2016 .
Although pipelines are immobile, Kinder Morgan is able to invest relatively small capital expenditure to convert pipelines to service different products. For example, with the recent boom in natural gas liquids extraction in the US Eagle Ford and Marcellus basins, Kinder Morgan has retrofitted strategically located crude pipelines to service NGLs and condensates and converted natural gas import terminals to support U.S. exports.
Supply chain information integration and optimization
To support its business model of predictable revenue and a high payout ratio to shareholders, Kinder Morgan collaborates with its customers in the nomination procedure for its pipeline capacity at least 15 days in advance . Additionally, Kinder Morgan has proven to be adept at optimizing line pipeline operating strategy to match the constraints. An example is the Trans Mountain Pipeline which runs between the oil-rich region of Alberta, Canada to western Canadian markets. Due to the pipeline’s limited capacity of 350,000 bpd, Kinder Morgan has devised a way to co-transfer crude oil and petroleum products in one line, a first in North America. In combination with its advanced nominations from producers and customers, Kinder Morgan operators can optimize the scheduling of products and batching sequence, as shown below. The strategy of sequencing  compatible products minimizes wasteful interface material and maximizes revenue-generating utilization of the pipeline asset by both producers and refiners.
Too big, too fast?
Despite its solid coupling of business and operating models, Kinder Morgan is still heavily impacted by the recent supply-driven crash in oil and gas prices. Skeptics of the company’s high payout ratio and aggressive use of leverage to fund its expansion in the boom year are calling into question the sustainability of Kinder Morgan’s dividend  in light of unfavourable debt market. It remains to be seen how the sustained depression in energy commodity prices will impact the customer base and Kinder Morgan’s fees in the long run. But with a solid base of operating assets and reliable business model, Kinder Morgan is likely to weather the storm and emerge stronger as the industry consolidates around the prized transmission assets.
- 1986 U.S. Department of Justice Oil Pipeline Deregulation Report. https://www.ferc.gov/industries/oil/indus-act/handbooks/volume-I/doj-report.pdf