Why Crude-by-Rail Will Keep on Rolling

The recent collapse of the Brent-WTI spread -- the price difference between the two most heavily traded grades of crude oil -- has reduced the netbacks shippers earn for shipping crude oil via rail, raising concerns that continued tightness, or further contraction, of the spread could cause the growth of crude-by-rail to stall.

But as I've discussed previously, netbacks aren't the only factor customers consider when deciding between rail and pipeline. In fact, there are a host of other considerations that suggest crude-by-rail volumes should remain strong in the near future. Let's take a look at some of the main ones.

Flexibility to reach remote markets
One of the biggest advantages railroads have over pipelines is the flexibility to reach remote markets that are underserved by pipelines. Take the Bakken, for instance, where around three-fourths of crude oil production is currently shipped via rail, up from just 39% a year earlier, according to data from the North Dakota Pipeline Authority.

EOG Resources (NYSE: EOG  ) , a major operator in the Bakken, now ships 100% of its Bakken crude oil via rail, while Continental Resources (NYSE: CLR  ) , the play's leading producer, transports about 80% of its output via rail. Even a handful of U.S. refiners have invested heavily in new rail facilities and tank cars to take advantage of the flexibility rail offers in accessing remote markets such as the Bakken.

Phillips 66 (NYSE: PSX  ) , for instance, last year ordered 2,000 railcars to transport crude oil from the Bakken to its coastal refineries, while Valero (NYSE: VLO  ) similarly said that it plans to purchase 2,000 railcars to deliver crude to its refineries. Meanwhile, BP (NYSE: BP  ) and Tesoro (NYSE: TSO  ) are pursuing major rail projects on the U.S. West Coast to boost their access to Bakken crude.

BP is constructing a two-mile-long rail loop at its Cherry Point refinery in Washington state, while Tesoro's Anacortes refinery is already accepting crude deliveries from the Bakken after completing a $50 million rail unloading system. Both companies are essentially looking to diversify their oil supply away from more expensive grades, such as Alaska North Slope crude oil, and improving access to cheaper feedstocks from the Bakken.  

Speed to market and other advantages
In addition to being able to reach distant regions that are poorly served by pipelines, trains have the advantage of speedy time to market. Many railroads can deliver crude oil to remote markets in the U.S. in as little as a week or even a few days. By comparison, pipelines can often take more than a month.

Rail also offers additional benefits including scalability, lower capital investment requirements, less regulatory risk, and shorter contract terms as compared to pipelines. Furthermore, rail shipments of crude oil are also less likely to be commingled with other, lower-quality grades, which means customers don't have to worry as much about their shipment losing value.

The bottom line
Overall, while the narrowing Brent-WTI spread is certainly a headwind to the continued growth of crude-by-rail, railroads still offer a number of advantages that should continue to bolster demand for their services. Indeed, despite the collapse of the Brent-WTI spread and the flurry of new pipelines popping up this year, rail shipments of oil and petroleum products are up 38% year over year.

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