Does Collapse of the Brent-WTI Spread Threaten Crude-by-Rail?

Over the past few months, the price difference between the two most heavily traded grades of crude oil -- Brent and WTI -- has plunged. This price gap -- known as the Brent-WTI spread -- has fallen from $23 per barrel seen in early February to just under $5 a barrel now.

While the biggest impact has been on U.S. refiners, for whom the spread is a crucial gauge of profitability, many are concerned that the narrowing differentials could also negatively impact railroad shipments of crude oil. Let's take a closer look.

Impact of narrowing Brent-WTI spread on crude-by-rail
The reason the price gap between Brent and WTI matters for the continued growth of rail-based crude oil shipments is because a lower spread makes it less profitable to ship crude by train and makes other options, such as pipelines and even foreign oil imports, relatively more attractive.

A couple of refiners are already finding it more profitable to use foreign crude slates rather than domestically produced oil at some of their facilities. Phillips 66 (NYSE: PSX  ) recently said it has modified the crude slate at its Bayway Refinery in New Jersey to use less oil shipped from the Bakken and more foreign oil. Similarly, PBF Energy (NYSE: PBF  ) has also said it plans to replace some Bakken crude shipments with imported oil at its refinery in Delaware.

This is already having an impact on some companies' crude-by-rail shipment volumes. Union Pacific (NYSE: UNP  )  said that lower differentials in the second quarter had an impact on its short-haul crude business in Texas, where a number of major pipelines have gone into service this year, drawing market share away from rail.

Also, Global Partners (NYSE: GLP  ) , an oil storage and transport firm that ships crude from the Bakken via train to refining facilities owned by the likes of Phillips 66, reduced its profit expectations for the second half of the year partially because of lower-than-anticipated crude shipments to coastal refineries.

A mixed bag
On the other hand, Norfolk Southern (NYSE: NSC  ) said the recent Brent-WTI spread compression hasn't so far impacted pricing or volumes for its crude-by-rail business, which saw a whopping 51% sequential increase in shipments during the quarter.

As these examples highlight, contracting differentials are indeed having a noticeable impact on crude-by-rail volumes in certain parts of the country, especially Texas and other regions that are relatively well served by pipelines. They're also affecting crude-by-rail volumes to some coastal refineries, where shipment costs are much higher.

For instance, shipping crude from the Bakken to an East Coast refinery currently costs roughly $17 per barrel on average, compared to $2 a barrel for importing foreign crudes. In this light, it shouldn't come as a surprise that refiners such as Phillips 66 and PBF Energy are reducing crude-by-rail Bakken shipments and boosting their use of foreign oil.

The bottom line
Looking ahead, however, I don't expect crude-by-rail shipment volumes to fall sharply, though I do suspect they probably won't grow as fast as they have over the past couple of years. Rail still remains one of the most attractive alternatives to pipelines and, in some cases, the only viable option for shipping crude from remote oil-producing regions of the country.

When compared to pipelines, rail frequently offers  greater flexibility since it allows shippers to more easily reroute oil based on price differentials, which are constantly in flux. It also offers a much speedier time to market, sometimes two or three weeks faster than pipelines. Lastly, rail features shorter-term contracts than pipelines and lower regulatory risk -- factors prized by many customers.

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