A series of explosions that occurred in Casselton, North Dakota, last month, after a train carrying crude oil from North Dakota's Bakken shale crashed into a derailed train carrying soybeans, has led to increased scrutiny over the safety of transporting crude oil by rail.
With some lawmakers pushing for more stringent regulations on trains transporting Bakken crude, let's take a closer look at what impact this could have on Bakken producers and crude-by-rail volumes in the region.
Increased scrutiny of Bakken crude
The Casselton incident involved two trains operated by Berkshire Hathaway's Burlington Northern Santa Fe LLC, or BNSF, the largest rail carrier of Bakken crude oil, and was the fourth major North American crude-by-rail derailment in the past six months. The worst of these disasters occurred on July 6, when a train carrying 72 carloads of crude oil from North Dakota to a Quebec refinery caught on fire, rolled several miles downhill, and triggered a massive explosion in the town of Lac-Megantic in rural Quebec.
The trains involved in both accidents had one thing in common: they were shipping crude oil from North Dakota's Bakken shale formation. In the wake of the Casselton derailment, the U.S. Department of Transportation's Pipeline and Hazardous Materials Safety Administration (PHMSA) issued a safety alert warning that Bakken crude may be more flammable than other grades of crude and should therefore be handled more carefully.
Furthermore, federal regulators, including the PHMSA and the Federal Railroad Administration, have jointly embarked on a compliance initiative known as "Operation Classification", which will involve an increased number of unannounced inspections of trains shipping Bakken crude to ensure compliance with safety regulations. The Casselton accident could also prompt lawmakers to step up their efforts to phase out or require upgrades on the Class 111 tank car, the most commonly used tank car to transport Bakken crude.
Impact on Bakken producers and volumes
Though new rules requiring older tank cars to be upgraded or phased out likely won't be finalized until at least next year, they threaten to reduce the profitability of transporting crude by rail even further. Shipping crude by rail already costs roughly $4 to $5 more per barrel than shipping it via pipeline, so if margins are squeezed further due to new regulations it could have a material impact on netbacks for Bakken producers.
The markets are already privy to the possibility. On the day the PHMSA issued its safety alert, shares of Continental Resources (NYSE:CLR), the Bakken's top producer, fell 4%, while shares of EOG Resources (NYSE:EOG), another major Bakken driller, slumped 2%. Both companies rely overwhelming on rail to ship their Bakken output, with EOG transporting nearly 100% of its crude oil from the play by train and Continental shipping roughly 80% of its Bakken output via rail.
But while more stringent permitting processes for rail could lower the profitability of shipping crude via rail for these and other Bakken producers, they are unlikely to have a major impact on crude-by-rail volumes in the play, at least in the near term. To put it simply, most Bakken producers simply have no option other than rail.
In fact, with Bakken production poised to surpass a million barrels per day this year, crude-by-rail traffic in North Dakota is actually expected to grow sharply this year. According to Lynn Helms, director of North Dakota's Department of Mineral Resources, rail could account for as much as 90% of the state's crude oil traffic by the end of 2014, up from roughly 60% currently.
The bottom line
While new safety regulations could further reduce shipping margins for Bakken producers, they are unlikely to result in a meaningful reduction of Bakken crude-by-rail volumes in the near term. There's simply too much crude oil to be transported and not enough pipelines to do it.
Over the next several years, however, pipelines could capture a great deal of market share from railroads as new ones are built and existing ones expanded to serve remote resource plays like the Bakken. For instance, TransCanada's (NYSE:TRP) proposed Keystone XL pipeline could transport some 100,000 barrels a day of Bakken crude, representing two-thirds of current U.S. rail capacity.
Fool contributor Arjun Sreekumar has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway and EOG Resources. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.