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Companies Team up to Send Canadian Crude to Texas

The Gulf of Mexico is awash with oil right now, and there's more on the way. Kansas City Southern (NYSE: KSU  ) and Global Partners (NYSE: GLP  ) are planning a new rail terminal at Port Arthur, a plan with both good points and potential drawbacks.

Global and KCS announced the plan on July 8, saying the site would initially be a destination for heavy crude from Western Canada. The terminal, which still requires regulatory approval, could store up to 340,000 barrels of oil and could serve two unit trains per day. KCS will lease the 200-acre parcel to Global.

Global Partners sees multiple benefits
Global Partners is a master limited partnership (MLP) with one of the largest fuel terminal networks in the Northeast. It distributes gasoline and other petroleum products throughout the area, and transports oil by rail from the mid-continent region of the U.S. and Canada to both coasts. Global also has about 900 gas stations and convenience stores in the Northeast.

Source: Global Partners.

The announcement quoted Global President and CEO Eric Slifka as saying, "The addition of a crude destination terminal on the U.S. Gulf Coast will broaden and strengthen our logistics network." He added, "Situated within a 100-mile radius of nearly five million barrels of Gulf Coast refining capacity and an expansive pipeline network, Port Arthur is a prime destination for crude and refined products. The terminal complements our assets on the East and West Coasts, expanding optionality for our customers."

Mr. Slifka had a similar message in the company's last earnings release, where he talked about providing customers with flexibility by growing and enhancing Global's asset base. So, the planned terminal is a logical move in the direction of the company's strategic vision.

A report by Platts noted two other advantages of the plan. First, in order to ship heavy crude through a pipeline, it must be diluted, or it won't flow. Canadian heavy sour crude needs up to 15% diluent in the summer, and up to 33% in winter. But those diluents must be refined out, increasing costs. Shipping by rail reduces this problem, requiring less than 5% diluents, and sometimes none at all. According to Platts, unit trains have up to 120 rail cars and can haul up to 72,000 barrels of oil.

The other advantage to shipping by rail is that the Canadian crude isn't commingled with U.S. domestic crude, as it might be if shipped via pipeline. According to the report, this is important because the U.S. now permits the reexport of Canadian crude, provided it is not commingled or blended with domestic U.S. crude.

Oil is good to KCS, too
Kansas City Southern, with railroad investments in the U.S., Mexico, and Panama, operates primarily throughout the southern U.S. and northern Mexico.

The company serves the port cities of Lázaro Cárdenas, Tampico, and Veracruz, and holds a 50% interest in Panama Canal Railway Company, which provides ocean-to-ocean freight and passenger service along the Panama Canal.

Revenue from Kansas City Southern's petroleum shipments accounted for about 4.7% of total sales in the quarter ended March 31, with revenue per petroleum carload up 11% from the same quarter last year. The average revenue for a petroleum carload was $1,756 versus an average of only $1,095 for all shipments.

It's clear that oil carloads put a smile on the company's face, and the planned Port Arthur terminal stands to make that smile wider. It delivered 16,400 carloads of petroleum during the last reported quarter. At two-unit trains, each with 120 cars per day, the new terminal could more than double that demand at full capacity.

Some possible drawbacks
The U.S. Gulf Coast is swimming in oil right now, which could dampen the demand for additional shipments. Of course, that also means the Gulf Coast can use the extra storage the terminal will provide.

Also, increasing problems with shipping oil by rail can put pressure on companies like KCS and Global to reduce this practice. A heavy sour crude spill somewhere between Canada and the Gulf Coast would hurt both companies.

Should Fools rush in?
Global Partners could be a good turnaround story, but it's a mixed bag. Although revenue has dropped, net income has come back. Also, margins are razor thin, and the company is carrying a heavy debt load.

KCS has a better balance sheet and rising revenues, and demand from the new terminal alone could boost sales by several percentage points. Reductions in margins and earnings have caused lackluster performance, though, so keep an eye on those.

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Scott Percival

Scott has been a trading instructor at Fidelity Investments and has traded for his own account since 1989. He currently contributes Foolish articles on the energy industry.

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