When completed, the splitter facility will process 100,000 barrels a day.
Photograph by Benjamin Rasmussen for Fortune
By Ken Otterbourg
June 2, 2014

Rich Kinder is the wealthiest man in Houston. That is no small feat. He is worth around $9 billion, and sometimes people joke — though not to his face — that Rich is really Kinder’s middle name and his first name is Very. He is the chairman and chief executive of Kinder Morgan Inc., (KMI) which he co-founded and then built from a sprout into a colossus through vision, dealmaking, and discipline. Kinder Morgan owns and operates a vast web of natural gas, oil, and carbon dioxide pipelines; oil wells, terminals, and rail yards; processing plants; and lately a few tankers. The term for all this steel and concrete that connects producers with consumers is “midstream infrastructure,” which, along with being perhaps the least sexy combination of words in the English language, is a beautiful way to cash in on the energy boom that has reshaped America’s economy and is now poised to become the tip of the spear for our foreign policy.

Kinder owns just under 24% of the company’s stock. He receives a salary of $1 a year, which is a magnanimous gesture and also a little silly, since he receives annual dividends of close to $400 million. Kinder Morgan Inc. had revenue of $14.1 billion last year, ranking it No. 206 on the Fortune 500 list. A third of the natural gas in the U.S. moves through the Kinder system. It is the largest transporter of carbon dioxide, and outside of the major oil companies, it is the largest carrier of petroleum products. Generally speaking, Kinder Morgan doesn’t own the products in its pipelines or on its terminals and docks; its clout is mostly based on the principle of the toll road. The company just gets a fee for moving the traffic along. When done right, as it has been by Kinder Morgan and Rich Kinder, it is a business that is very predictable and very rewarding.

There shouldn’t be a problem, but there is, and Rich Kinder is frustrated. For the past year, the stocks in the Kinder Morgan family of companies have been dragging like a dredge in the Houston Ship Channel. The company has been Twitter-bombed by an upstart analyst urging a selloff. Shareholders have sued, claiming in essence that the company’s accounting favors the house. Many traditional market analysts wonder whether the empire has gotten too big to grow at the pace to which investors have become accustomed.

Photo Editor: Neil Harris Assignment: © Benjamin Rasmussen

 

The last time Rich Kinder fought with Wall Street over the value of his companies was in 2006, and he responded by going private. When Kinder Morgan went public again in early 2011, it emerged as a bigger and badder beast, with the resources to engineer two expansive deals, the $21.1 billion purchase of El Paso Pipeline Partners that same year and the $5 billion purchase last year of Copano Energy. Including dividend reinvestment, Kinder Morgan has had about a 10% annual rate of return since going public.

“It was just a disconnect in value,” Kinder says. “We have that disconnect now. That’s not to say we’re going to take it private. That’s not to say that at all. But it’s just to say as the largest shareholder, it’s very disappointing that the market is not recognizing the value.”

You can put a price tag on value. But there’s more than dollars and cents involved. “It’s not just about money,” says Curt Launer, a former analyst with Deutsche Bank who has known Rich Kinder for years. What Kinder wants, says Launer, is what he has always wanted — and usually, eventually, received. “He also wants respect.” That is the lament of the tollbooth attendant. We live in a world where the middlemen are frequently seen as shrewd but rarely seen as bold. Kinder, in truth, has been both, and he wants to keep it that way.

Photo Editor: Neil Harris Assignment: © Benjamin Rasmussen

 

Houston, where Kinder Morgan is clustered with much of the midstream industry along Louisiana Street, loves a good energy story. And for a place where fortunes can soar and sink in step with the price of crude oil, it also can’t resist a tale of rebirth tweaked with just a hint of constructive redemption. The Kinder Morgan story offers the full buffet. Kinder Morgan began in 1997, shortly after Kinder left Enron because he had been passed over for CEO. He and Bill Morgan, another former Enron executive whom Kinder also knew from college days at the University of Missouri, bought control of a small pipeline system and a few terminals that Enron no longer wanted. By 2001, when Enron imploded in scandal, Kinder Morgan was well on its way to reshaping the pipeline business.

Kinder Morgan today is essentially four companies with a constellation of projects and partnerships and joint ventures that own and operate its sizable piece of our fuel grid. Kinder Morgan Energy Partners (KMP) and El Paso Pipeline (EPB) are both publicly traded master limited partnerships (MLPs). Kinder Morgan Inc. is the general partner, receiving healthy chunks of the cash flow from both MLPs. Kinder Morgan Management (KMR) is an LLC that manages one of the general partnerships. It can be confusing to keep the names and responsibilities straight. MLPs generally own assets, and their profits are passed through directly to unit holders. The management company and the publicly traded general partner were both established as a way to bring institutional investors into the fold.

But that’s only part of the story behind the rise of Kinder Morgan and, indeed, the entire gang of midstream MLPs. The pipeline business used to be pretty vanilla. Energy flowed out of the Gulf Coast, and the money flowed in. Now the fuel goes every which way, a boom largely due to new production centers, such as those in the Bakken and the Marcellus fields, brought to life by the twin technologies of horizontal drilling and fracking. Energy investment house Simmons forecasts oil production in the U.S. to hit 9.6 million barrels a day next year and push past the 10 million level in 2016. Those levels were last seen in the 1970s. Gas production is surging, pushed and pulled by utilities shutting down coal plants and turning to natural-gas generators. Simply put, we are awash in hydrocarbons.

One place to start understanding the logistics and economics of the new flow is in the Eagle Ford, which most people in Texas pronounce as one word. It sprawls over 27,000 square miles in a slash running south and west from the scrubland between Houston and San Antonio; it’s hot and dusty country where the hawks on the power lines give you a good once-over when you step out of the car. The Eagle Ford is also close to becoming the new oil center of the U.S. Five years ago, oil production there was almost nonexistent. Now, it’s at nearly 1.4 million barrels a day, and the region is at full throttle, with man camps and lines of rig hands at the Whataburgers.

Photo Editor: Neil Harris Assignment: © Benjamin Rasmussen

 

The challenge is in getting this light oil, known as condensate, to market. The local refineries can’t use it all because many of the facilities in and around Houston are built to run heavier crude. So finding new outlets has created something of a reverse scavenger hunt. Kinder Morgan’s part of the solution illustrates the reach of its distribution system and the value added when all of the company’s far-flung parts work together. First, the company spent $220 million to convert a redundant El Paso gas pipeline to run oil back to terminals along the Houston Ship Channel, among other places. Eventually, much of the condensate will go to a low-end refinery, known as a splitter, that Kinder is building on BP’s behalf at a cost of $360 million. That will turn the oil to low-sulfur diesel and other products, with an eye toward export markets.

Much of the rest will head north — way north. First it will move to Kankakee, Ill., joining a propane line that Kinder Morgan ran out of Canada. That business is being abandoned because U.S. propane production has boomed. (We can now grill with American pride.) Kinder Morgan will spend $310 million to convert that line to run the Eagle Ford condensate north to Edmonton, Alberta. There, the oil will be used to thin out the viscous Canadian crude that is extracted from the Alberta sand mines. Some of that blended oil will move through Kinder Morgan’s Canadian pipeline to ports in British Columbia for export to Asia and West Coast markets. And if the Keystone XL pipeline is ever built, there’s a good chance that the condensate-Canadian blend will wind up back in Texas, where refineries are eager to get their hands on more of the Canadian crude. It’s a 5,200-mile roundtrip — i.e., one big toll road.

Photo Editor: Neil Harris Assignment: © Benjamin Rasmussen

 

“People think that a guy drills a well and people just hand him some money at the well site, and he just spends it at the local grocery store,” Kinder says. “But to make that money he’s got to get that stuff that comes out of the ground — whether it’s crude oil or natural gas or NGLs [natural-gas liquids] or condensate — he’s got to get it to market, and that’s where we come in.”

In the ship channel alone, Kinder Morgan is spending $1.5 billion on terminals and related improvements. The crown jewel is a $500 million terminal for black oil and other residuals, built as a joint venture with TransMontaigne Partners (TLP), an operator of oil and gas terminals that is controlled through Morgan Stanley (MS). But the expenditure goes beyond oil and gas and also includes bulked-up terminals for exporting coal and petcoke, the über-polluting leavings from oil refining. Global demand for both, particularly coal, is up, a development that has been a bright spot for U.S. coal companies as utilities keep shifting to natural gas. Kinder Morgan isn’t investing just on land; its newest pipeline essentially moves on water. Late last year it spent $962 million to buy five tankers, each capable of carrying 330,000 barrels of oil.

The build-out is enormous, and not just for Kinder Morgan. The Interstate Natural Gas Association of America said in a report this year that U.S. companies need to build more than $600 billion of pipeline, storage, and related equipment during the next 20 years. Much of the construction radiates from the Marcellus, centered in Pennsylvania and West Virginia. There is the need to build more gas lines north and east into New England, where this winter’s brutal cold sent prices soaring on the spot market. But there are also more gas and gas liquids coming from the Marcellus than the local markets can use. The result is a dance between producers and the pipeline companies over the terms to ship the fuel back to the Gulf and the gas-hungry petrochemical industry.

Photo Editor: Neil Harris Assignment: © Benjamin Rasmussen

 

There’s already been one casualty. Boardwalk Pipeline Partners (BWP), which operates about 14,000 miles of pipeline and whose general partner is Loews Corp. (L), has had trouble getting contractual commitments on its Bluegrass Pipeline, designed to bring natural-gas liquids south from the Marcellus. Its stock dropped 40% in February after it slashed its dividend, citing sluggish market conditions. Kinder Morgan is also extending the sign-up period on its Utopia gas liquids pipeline, which runs in the same general direction as the Bluegrass, hoping to find more producers willing to sign long-term contracts. Until that happens, construction doesn’t start.

Michelle Michot Foss, the chief energy economist at the University of Texas’s Jackson School of Geosciences, says that the pressing need for more pipelines disguises the challenges of figuring out the right route for any particular pipeline so that it connects enough producers at a cost at which both sides can make the returns their investors demand: “These plays are extremely unpredictable, and they are in places where the terrain makes it extremely difficult to build infrastructure.” MLPs are built on secure assets, she says, and those surer bets may become harder to find as the map gets more jumbled.

When he was at Enron, Rich Kinder’s reputation was that of a killjoy, or maybe just the adult in the room. He was the guy who pinched pennies, dogged the details, and preferred hard assets to the ephemera of the futures markets. Not much has changed. His management team still trails its competitors in base pay, and at most meetings Kinder shows up with a yellow pad for jotting down notes and problems. Items on his list stay on the list until they are resolved. And he loves his projects, the sweat and the sweep of tens of thousands of miles of pipelines and tanks, of trying to get the parts to work together, and of figuring out what customers want before somebody else figures it out first.

Kinder Morgan has identified nearly $15 billion worth of construction projects for the next five years. Roughly a third is for a job that would triple capacity on its Trans Mountain pipeline in Canada, which is now under review before the National Energy Board. The MLP model requires this constant investment to generate growth, in part because long-term contracts lock in capacity and revenues for years at a time. In addition, the Kinder Morgan MLP has to work harder than some of its peers because a greater percentage of its incremental cash flow winds up with the general partner as incentive payments instead of as distributions to limited partners. A recent investor lawsuit filed in Delaware claims that the company misstates expenses, including in its carbon-dioxide business, which allows it to funnel even more money upstream. It’s an allegation that Kinder Morgan strongly denies. That said, the company is giving up $41 million in incentive payments from the tanker purchases to make that deal click.

 

Because Kinder Morgan is at the top of the midstream pyramid, the company and its founder are bellwethers for the industry, and virtually everybody I talked with voiced the same concern about whether the empire can grow its cash flow at an aggressive pace solely through more pipelines and terminals. This being Houston, there’s lots of advice on what to do, everything from splitting the company into cleaner, more defined business segments to combining the limited partners and general partner and aligning all parties more clearly.

“Kinder Morgan has a world-class set of assets, and a lot of people think he’s the best operator,” says Chris Jones, a partner in Haddington Ventures, a more specialized midstream player. The challenge is one of size and scope: As companies grow bigger, it’s harder to find projects that move the needle the same degree. “Can they redeploy capital fast enough? He needs to put billions to work, not millions,” Jones says.

Kimberly Dang, the company’s chief financial officer, says Kinder Morgan will evaluate all alternatives to keep the enterprise healthy and growing, but “you don’t want to do anything that strategically compromises the long term. The backlog tells a lot of the story. The future is very bright, so we have to focus on delivering that backlog.”

Rich Kinder, not surprisingly, gets touchy when questioned about whether his companies are on the downside of their boom years. What he likes to focus on instead is the breadth of the company’s assets and Kinder Morgan’s ability to deliver what it promises, both in energy and distributions. In the long run, he says, markets are rational, and investors will come around.

“I look out there,” Kinder told analysts a few months back, “and I see this huge damn footprint across North America. And every time we turn around, we see more ability to extract value out of it, but I guess I haven’t been successful in convincing the rest of the world of that, because a lot of people don’t see it. That’s where we think we have such an advantage and such a growth profile for the future. That’s why I’ve never sold a share, and I just keep on stupidly buying more.”

In the past 12 months, Kinder has purchased about 2.2 million shares at a cost of $76 million. That sounds like a lot, but only to the rest of us. It comes out to less than 1% of his stake, a side bet against the rest of his holdings.

Click to enlarge.

The U.S. still imports about half of its petroleum, including a large amount that comes from Canada. For natural gas, we’re entering a point where domestic supply and demand are starting to intersect, and when you treat North America as a single resource, it becomes easy to speculate about where all this fuel that can’t run a power station or be converted to petrochemicals and plastics has to go. The answer, of course, is overseas.

When I spoke with the Kinder Morgan team in Houston, it was just a few days after the U.S. Senate had held a hearing on increasing exports of liquefied natural gas, which is gas that has been chilled until it turns liquid. The process dramatically reduces its volume and allows more BTUs to go on each ship. LNG exports have traditionally been extremely low because a waiver from the U.S. Energy Department is needed to ship the fuel to countries where there isn’t a free-trade agreement. That list of excluded countries includes Japan and all of Western Europe. Since Vladimir Putin’s land grab in Ukraine, Europe’s reliance on Russian natural gas has captured headlines. There’s a long list of companies eager to build export terminals for LNGs, and the approval process has brought out plenty of fist-pounding from both sides of the aisle in Washington about the need to speed it up and quickly offer Europe a pilot light of energy security.

“This bounty could enhance our national power by positioning our nation as a reliable supplier of natural gas to regions of the world that suffer from intimidation from their suppliers,” said David Goldwyn, an energy consultant and fellow at the Brookings Institution, when he testified before the Senate in late March. “The question before us is not whether we have this geopolitical potential, but whether we will realize it in time to help our friends and allies.”

LNG export terminals are expensive and complicated projects with long lead times. Although the federal government has approved seven terminals for export to the broader list of potential customers, none have been completed, and the earliest terminal — on the Sabine Pass along the Texas-Louisiana border — won’t open until 2016.

There’s a diverse collection of environmental and business interests opposed to these wider deals, from the Sierra Club to big users of natural gas such as the steel and aluminum industries, where there’s worry that exports will lead to higher domestic prices for fuel. But geopolitics has reframed the debate, and the producers for now have the upper hand.

Russia can and will act with impunity, Kinder says, unless the market dynamics change. “The federal government should be using this newfound energy production that we have as a push in foreign affairs.”

Kinder Morgan and Shell are spending $500 million to retrofit an LNG terminal near Savannah that was built to handle imports. The project already has approval to export gas to free-trade countries, but the larger pool is still uncertain. And regardless of whether that happens, the company’s pipelines feed most of the other export terminals going up along the Gulf Coast. Either way, it will collect its toll.

Kinder Morgan keeps a low profile. That is by design. There are no stadiums or arenas with its corporate logo of a lightning bolt out front. The company lacks a political action committee. Kinder and his wife, Nancy, give plenty, mostly to Republican political causes, but he’s also aligned himself with Warren Buffett and joined the Giving Pledge movement; the bulk of his wealth will eventually go to charity. The Kinder Foundation is already hard at work on a range of issues, including public education, but the one that seemed most connected to the business at hand was the $30 million it has spent to lead the effort to reclaim the beauty of the Buffalo Bayou, which wanders across central Houston until it disappears into the commercial embrace of the ship channel.

Late one afternoon I took the Lynchburg Ferry across the channel. It is a route that the small boats have run since 1822, at a time when Texas was still part of Mexico and fossil fuels were just beginning to power our lives. Traffic in the channel is often so busy that the ferry has to heave to, waiting for a break before scooting to the other side. The ride is free and offers a superb view of the midstream world, where Kinder Morgan and the others jostle for space and for their cut in the action.

When we talked earlier that week, Kinder had told me that surveys have suggested that there is a sizable percentage of Americans who think there are oil wells under each gas station. Although he made the remark half in jest, the reality is prosaic and profound. We may know that there’s no gusher beneath the convenience store, but that obscures the larger point: Most of us have no idea of what it takes to get oil or natural gas from the ground into our lives. It’s only when you take in the spaghetti of pipelines along the water here or when you make the short drive to Mont Belvieu, where the underground salt domes have been washed away to create storage tanks, that you get a sense of the physical nature of wresting energy from the earth and of the investment needed to store it and then get it to somewhere else, a place where the value is higher and the profit is greater.

This story is from the June 16, 2014 issue of  Fortune.

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