How Rail Can Cash in on Crude

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Union Pacific (NYSE: UNP  ) , CSX (NYSE: CSX  ) , and Burlington Northern transport Bakken crude by rail from terminals in North Dakota to unloading facilities in Washington state and California to the Gulf Coast and East Coast. They are cashing in on crude oil pipeline undercapacity. They also face increased congestion with trucking, environmental, and safety liabilities with the transport of highly combustible light, tight crude oil.

By November 2013, over 900,000 barrels per day, or bpd, are moving by rail out of the Bakken compared with 583,000 bpd by pipeline. Projections are for almost 2 million bpd by rail with pipelines lagging at 783,000 bpd in 2014. Pipelines catch up with rail transport by 2015 at 1.398 million bpd capacity. Rail appears to have a window of opportunity here.

East and west
Bakken field production has expanded beyond pipeline, rail, and truck transportation infrastructure. This supply constraint is mostly responsible for any Bakken discount to West Texas Intermediate, or WTI, crude. North Dakota is now second to Texas in oil production across all states in the U.S. Bakken crude by pipeline competes with Canadian crude. 

To cover the pipeline shortfall, railheads have increased their car loading capacity by over 600,000 bpd. Over 350,000 bpd of added loading capacity is expected by the end of 2014. The construction of a high-speed rail unloader in Philadelphia to handle Bakken feedstock suggests that Bakken crude is expected to continue to be cheaper than Brent-linked Atlantic Basin crude on the East Coast. Imports of Nigerian crude continue to decline on the East Coast in favor of Bakken.

On the West Coast, Tesoro and Savage Services, a logistics provider, have teamed to build additions to the Anacortes, WA, rail port to the tune of $100 million. With five miles of new tracks and 21 switches this facility will be able to unload over 50,000 bpd at the 120,000 bpd refinery.

Royal Dutch Shell's Puget Sound refinery in Washington state has capacity for 145,000 bpd, mostly from declining imports of West Canada Sweet by pipeline and Alaskan North Slope, or ANS, by tanker. Shell is developing a spur from the Burlington North rail trunk to Tesoro's Anacortes refinery. It plans to unload daily a 100 unit train carrying 50,000 to 60,000 bpd.

Safety first
The Bakken produces "bubbling crude" due to the high vapor content of dissolved natural gas in the liquid. This property makes it volatile to transport. On July 7, 2013, a parked train carrying Bakken crude released its air brakes, ran away from its parking location, derailed, and exploded, killing 47 people and incinerating over 30 buildings in Lac-Megantic east of Montreal.

On January 20, 2014, a train carrying Bakken crude derailed alongside the Schuylkill Expressway in Philadelphia. On December 30, 2013, another Bakken rail train collided with a grain train in Casselton, North Dakota.

North American railroads delivered more than 2.47 million carloads of hazardous materials, including Bakken crude, ethanol, and spent nuclear fuel. A report by the Nuclear Regulatory Commission calculates a declining trend in freight train accidents from over 10 per million train-miles in 1975 to under 3 per million train-miles in 2008. So train accidents will obviously continue to occur. Those releasing hazardous materials declined from 0.15 to 0.04 per million train-miles over the same period.

Prudent risk management will require further investments by the railroads and their shareholders. Upgrades to 2011 standards will act on reports going back to 1991 that cite the inadequacy of existing rail stock to handle materials like Bakken light, tight crude and ethanol. Bypass rail routes along with speed reductions through communities will all help prevent further disasters.

Further thoughts for railroad investors
CSX just reported fourth quarter earnings with a 13% increase in merchandise and a 6% decline in coal revenues. Crude oil shipments lead the merchandise growth. Quarter-on-quarter train accidents are flat and personal injuries are up from 2012. Management plans to deliver $130 million in efficiency savings in 2014. Highway-to-rail transport conversions are higher than ever.

With reported highway-to-rail conversion growth, more crude oil growth, more operating efficiency, and more safety investments, CSX may be a buy. Union Pacific 2013 earnings will be released on January 23, 2014.

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Bill Foote

I scour physical and financial commodities globally to uncover the political, economic and financial reasons for value creation and destruction globally.

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