Is a Major Derailment Looming for Our Nation's Railroads?

Many investors, including Warren Buffett, are now more bullish than ever on the growth opportunities for railroad operators as they haul crude out of the Bakken and other shale plays across the U.S. The problem with this idea is that carrying crude by train isn't nearly as safe or effective as allowing a pipeline to gently guide crude to where it needs to go. This could prove very dangerous for raildroad companies like Burlington Northern Santa Fe, but it offers upstream and downstream players in the oil and gas sector a good cost-saving opportunity. 

Cheaper
According to Kodiak Oil & Gas'  (NYSE: KOG  ) presentation, it costs $5 per barrel to transport crude from North Dakota to Cushing, OK, via pipeline. From the Cushing oil hub, it costs roughly $4 a barrel to transport crude via the Seaway pipeline to the Gulf. By rail, it costs $10 to $12 a barrel to transport crude down to the Gulf from North Dakota. Factoring it all together, it is between $1-$3 cheaper to transport crude from North Dakota to the Gulf via pipeline versus rail. 

To get a better idea of just what's at stake take a look at this hypothetical example. Assume for a moment that the average cost savings by moving crude by pipeline versus rail is $2 per barrel when transporting crude from North Dakota to the Gulf. If North Dakotan oil producers were to export 1 million bpd of crude down to the Gulf by rail, upstream and downstream companies would shoulder an additional transportation cost of $730 million annually. While crude from North Dakota is shipped all over the country by various means, this paints a clear picture of just how much is being lost due to lack of pipeline capacity.

This opens up huge opportunities for midstream pipeline operators. For a company like Kodiak Oil & Gas that ships 80% of its output by rail and 20% by pipelines, if there was a chance to lower transportation costs via pipelines while still fetching high prices, Kodiak Oil & Gas would jump at that opportunity. 

Over the past five quarters, Kodiak Oil & Gas paid on average $2.27 per barrel in transportation and gathering costs while receiving a cash margin of $62.52 per barrel of oil equivalent. If Kodiak lowered its transportation costs by using pipelines as a larger share of its transportation methods, Kodiak could slightly increase its cash margin per BOE and boost its free cash flow. In order to fully realize the benefits of pipelines, there needs to be an intricate pipeline system in place for Kodiak Oil & Gas to use.

See a need, build a pipeline
A midstream operator that plans on boosting its crude transportation capacity from nothing in 2009 to over 2.5 million bpd in 2015 may offer Bakken players like Kodiak Oil & Gas an amazing opportunity. Energy Transfer Partners (NYSE: ETP  ) has plans to build a pipeline that would carry crude from North Dakota down to Midwest and Gulf refineries. Other midstream operators scrapped their plans to build Bakken pipelines, but not Energy Transfer Partners. 

If Energy Transfer Partners is able to generate enough demand for its proposed pipeline, Bakken operators will be able to save on transportation costs and fatten the bottom line. Energy Transfer Partners will update investors soon on how much interest they were able to gather for the proposed pipeline, which will be a strong catalyst for its unit holders if it decides to build it. 

This isn't the only Bakken project Energy Transfer Partners is working on, it also plans on converting the natural gas Trunkline pipeline. The new Trunkline pipeline will carry Bakken crude from Patoka, IL, to Boyce, LA. Enbridge and Enbridge Energy Partners carry the crude from the Bakken to Patoka on their own crude pipelines, and Energy Transfer Partners plans on coming in and doing the rest starting in 2016, when the conversion and build out is supposed to be completed. 

Foolish conclusion
The rise in freight train shipments of crude is going to stay around for a while, as it will take years to build out pipeline systems that can deliver crude from any shale play to all the major markets in America. But once those pipeline systems are completed, railroad operators will need to brace themselves as oil producers opt for the cheaper transportation method. Energy Transfer Partners has the ability to steal the show from the railroads, as long as it doesn't back away like the other pipeline operators and continues to build out infrastructure in the Bakken.

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  • Report this Comment On April 15, 2014, at 7:35 PM, arbtrdr wrote:

    OKS and others did not build a pipeline because the producers would not commit their production. A pipeline is not going to happen at a cost of billions until the pipeline company gets companies like KOG to put their oil forward. The difference is about $3bbl now, but looks like shipping via rail to get more expensive from more regulation and new cars that are more resistant to spillage/burning. Time will tell as to when shippers will give up the flexability that rail offers for a lower locked in delivery.

  • Report this Comment On April 21, 2014, at 11:14 AM, Pablomike wrote:

    But they aren't railing it to the Gulf. They are railing it wherever they get more money than the Gulf

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