The surge in U.S. oil production since 2008 has created tremendous opportunities for the midstream companies involved in oil storage and transportation. Many continue to invest record amounts of cash into new projects to help alleviate regional supply bottlenecks and get the crude oil to those who demand it.
But despite midstream companies' best efforts, they've lost a great deal of market share to railroads, which have rapidly emerged as their biggest competitors over the past couple of years. Let's take a look at how railroads have turned the logistics of crude oil transport on its head and what the future may hold for crude-by-rail.
The staggering growth of crude by rail
Today, the rail industry is transporting more oil than it has since the days of John D. Rockefeller's Standard Oil. In the first quarter of 2013, railways shipped a record 97,135 carloads of crude oil, according to the Association of American Railroads. That represents a 166% increase over the first quarter of 2012 and a 922% gain over crude rail shipments during the entirety of 2008.
Not surprisingly, Union Pacific (NYSE:UNP), one of largest rail companies in the U.S., tripled the amount of crude oil it shipped last year, while Berkshire Hathaway's (NYSE:BRK-B) Burlington Northern Santa Fe, or BNSF, another rail giant, is currently moving about 650,000 barrels of crude oil per day, up from next to nothing just five years ago. And Canadian Pacific Railway (NYSE:CP) expects to ship some 70,000 carloads of crude this year, up from just 500 in 2009.
So why is rail in such high demand?
One of the main reasons is flexibility. Unlike pipelines, which can only haul oil between two pre-specified locations, rail allows energy companies to deliver oil to virtually any market in the United States. Furthermore, with the sharp variation in regional crude oil prices over the past few years, this flexibility has allowed oil companies much better access to some of the most lucrative markets nationwide, such as North Dakota's Bakken shale. Rail also offers an additional advantage because oil companies don't need to hammer out long-term contracts with rail carriers as they do with pipelines.
Indeed, a handful of U.S. refiners have even invested directly into the crude-by-rail boom by plowing hundreds of millions of dollars into new rail terminals and tank cars. Phillips 66 (NYSE:PSX) last year ordered 2,000 rail cars to move crude from the Bakken to its refineries along the U.S. east and west coasts, and it will also construct a crude oil unloading facility at its Ferndale, Wash., refinery.
And Valero (NYSE:VLO) revealed earlier this year its intentions to purchase 2,000 railcars to boost rail shipments to its refineries and also said it plans to construct a new crude oil "topper" unit at its Houston refinery in order to process more light crude oil. The main reason these companies have been expanding their crude-by-rail capabilities is that the price gap between North American crudes and Brent, the international crude oil benchmark, has more than compensated for the additional expenses involved with rail.
The future of crude-by-rail
Going forward, however, the pace of rail-based crude shipments could slow because of a couple of major reasons. First, U.S. benchmark crude oil prices have risen significantly this year, with the spread between Brent and WTI currently less than $5 a barrel. This means lower profits for the companies that benefited so handsomely from the price arbitrage opportunities they exploited by shipping oil to remote locations accessible only through rail.
And second, despite heavy investment in rail cars by several refineries, there simply may not be enough of them. According to the EIA, there is a current backlog of about 60,000 rail cars, which effectively reduces U.S. crude-by-rail capacity by about 115,000 barrels per day.
Still, this is not to say that crude-by-rail shipments will fall off a cliff. It just suggests that rail shipments may not grow as rapidly as they have over the past year or so. Going forward, it will also be interesting to see whether rail's advantages of flexibility, consistency, reliability, and speed to market will be enough to overcome growing competition from the numerous new pipeline projects set to go into service by the end of next year.
Fool contributor Arjun Sreekumar has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.