Lackluster interest in Texas-to-California oil pipeline shifts Kinder Morgan toward rail

Citing a lackluster open season, Kinder Morgan Energy Partners LP has decided not move forward with its proposed Freedom pipeline project to ship crude oil from the Permian Basin shale play in Texas to refineries in Southern California, saying it will instead focus on a plan to ship the crude by rail.

The Freedom project, announced in October 2012, was intended to repurpose some natural gas transmission assets that Kinder Morgan acquired when it bought El Paso Corp. in 2011. Kinder Morgan planned to extend the existing system farther into the Texas oil patch and to build a lateral line that would reach the Emidio oil terminal near Bakersfield, Calif., as well as other facilities operated by Southern California refiners, including Phillips 66 Co., Valero Marketing and Supply Co., and Tesoro Corp.-

The pipeline giant held an open season for Freedom from April 2 to May 30, but not enough crude oil shippers and refiners signed on to support the pipeline, said the company, which declined to speculate on the lack of market interest.

Crude-by-rail "At Kinder Morgan, we don't believe in the concept of build it and they will come," Mark Kissel, president of Kinder Morgan's western gas pipelines division, said in a May 31 statement announcing the shelving of the Freedom project. "We stated at the outset that we would not move forward with the project without customer support, and we did not receive enough interest for us to commit to building the project at this time." However, he said the company would consider ramping up its crude-by-rail operations to deliver the Texas oil to California refineries.

"Kinder Morgan's plan is to focus our attention in the short run on providing crude-by-rail at various West Coast and Texas locations, and we are committed to providing service into and out of these key markets in whatever form our customers wish," Kissel said.

Further, Kissel said Kinder Morgan has not written off the Freedom project completely, saying the company was ready "to work with those customers who supported the project within the broader market to see if sufficient interest develops in the future."

Kinder Morgan's interest in shipping oil by rail continues a trend seen in some new shale oil plays that lack the pipeline infrastructure needed to take away sharply growing production. For example, more than half the oil produced in the red-hot Bakken Shale in North Dakota is shipped to market via rail due to insufficient pipe capacity.

Some energy industry analysts see crude-by-rail as a stopgap measure that will eventually be replaced by permanent pipelines, which can offer lower cost transportation services, but others note that rail shipment holds advantages for shippers.

Though it is more costly than using pipelines, transporting crude oil by rail offers shippers and consumers more flexibility since most of the track infrastructure is already built and freight rail operators do not require lengthy contracts for 20 or more years of service, as many pipelines do.

Kinder Morgan in February announced a major rail project with Watco Companies LLC in which they will build the first major crude-by-rail offloading facility in the Houston area. The project will bring crude oil from the glutted oil hub at Cushing, Okla., and the Permian Basin to the Houston Ship Channel, where barges and local pipelines will provide access to the region's refineries.

To complete the proposed Freedom project, Kinder Morgan would have converted at least 740 miles of natural gas transmission pipeline to oil service to provide delivery capacity of about 277,000 barrels per day.

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.