Rail Woes May Benefit These Pipeline Stocks

Shipping oil by train has problems, and that may benefit pipeline MLP investors.

May 28, 2014 at 9:23AM

Increasing U.S. oil production has created a pipeline gap, so shippers are turning to railroads. But moving oil by rail has raised safety concerns and caused supply bottlenecks for other products. Pipeline companies are eager to expand their capacity, but they often meet resistance from regulators and even shippers.

However, as problems continue with rail transport, resistance to pipelines may crumble like a diet plan in a donut shop.

If that happens, midstream pipeline companies like TransCanada Corporation (NYSE:TRP), Enbridge Energy Partners, L.P. (NYSE:EEP), and Oneok Partners LP (NYSE:OKS) could move more quickly through their project backlogs. Such master limited partnerships, or MLPs, grow organically through such projects, leading to higher cash distributions for MLP investors.

Increasing problems with rail
Ask someone to name a concern with moving oil by train and they're likely to answer with one word, and it's not "plastics." It's "safety." Public pressure is rising in the wake of recent derailments like the one in Quebec where 47 people were killed.

According to a recent New York Times story, the shortage of pipelines means that more than 10% of the nation's oil production moves by rail. The story quoted Brigham A. McCown, a former administrator of the Pipeline and Hazardous Materials Safety Administration, as saying, "There was no political pressure to address this issue in the past, but there clearly is now." He went on to say that rail-car safety could become an impediment to oil production.

But safety isn't the only concern. The oil is crowding out loads from farmers and other shippers, creating media pressure on the railroads.

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Courtesy of Andreas Ravn Moller

An editorial in The Forum of Fargo-Moorhead cites a North Dakota State University study concluding that rail delays have cost North Dakota farmers nearly $67 million this year, a figure that could reach as high as $100 million. The editorial focused on the increasing presence of oil trains, which are crowding out agricultural loads. "Railroads make more money hauling crude oil than they do shipping wheat. Smart business, maybe. Lousy public relations, certainly," the editorial concluded.

And it didn't end there. On May 19, a report by National Public Radio's David Schaper also focused on oil's role in the rail bottlenecks, an indication that the issue is gaining media traction.

Resistance to pipelines
So if shipping oil by rail causes all these problems, why do the shippers and railroads do it? One reason is the lack of pipeline capacity. After all, the oil has to move somehow. So the real question is, why aren't pipeline companies building like crazy to close the gap?

Common reasons are regulatory delays and environmental concerns, with the best known example probably being TransCanada's Keystone XL pipeline. The Keystone XL and Bakken ML projects represent a planned capital investment of $5.4 billion, of which TransCanada has only spent $2.3 billion, with no expected in-service date in sight. TransCanada has $36 billion in its capital expenditure backlog, of which it has only spent $4.8 billion.

The $36 billion project backlog of Enbridge Energy Partners holds other examples. A Reuters report in April notes that Enbridge's Alberta Clipper Expansion project is awaiting several regulatory hurdles, including an environmental impact statement and a presidential permit. According to Reuters, CEO Mark Maki said that the project will be delayed until July, 2015. Based on a company report, Enbridge has also managed to spend only $100 million of its $2.6 billion Sandpiper project, which is expected to add 225,000 bpd to the Bakken takeaway capacity. This project has come under fire from Honor the Earth, a group concerned with environmental issues in Minnesota.

But regulators and environmental lobbies aren't always the culprits. Sometimes it's the oil producing shippers themselves.

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Table from Morgan Stanley

As the above data shows, rail doesn't face the political and permitting challenges that pipelines do. Rail is also cheaper to build and more flexible for shippers. That's because while oil and gas producers usually must sign a long-term contract for pipeline access, rail contracts are generally shorter. Also, shippers can send loads to varying destinations, taking advantage of better market prices. So shippers may opt for rail instead of pipelines, leaving the pipeline builder with little or no interest in its project.

Take the decision in late 2012 by Oneok Partners not to proceed with its Bakken Crude Express project, citing insufficient long-term binding transportation commitments. A report by Amy Dalrymple of the Forum News Service quotes Oneok spokesman Brad Borrer as saying, "At that time, rail was, and still is continuing to be, the viable option."

A Foolish look forward
Trains are great for delivering bulky things like coal, grain and flat-screen TVs. But plugging the pipeline gap with rail is like shoving televisions and teddy bears through pipelines. It just doesn't work as well.

As oil shipments increase, the problems with rail may only get worse. Accidents may drive up safety costs while media pressure from farmers could divert trains away from oil shippers. The result? Pipelines may become a lot more attractive. Growing safety concerns with rail could also lower resistance to pipelines on the regulatory front.

We Fools prefer to take the long view, so I'm not suggesting that all this will happen overnight. But as public policy trends shift, companies like Oneok, Enbridge, and TransCanada will find it easier to build out their pipeline infrastructure. Watch for news of project approvals and pipeline MLPs accelerating their capital expenditures. This could lead to more distribution growth for unitholders, and that's good for any Fool's bottom line.

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Scott Percival has no position in any stocks mentioned. The Motley Fool recommends Enbridge Energy Partners and Oneok Partners. 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.

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