We all have a friendship that isn't necessarily healthy. For oil producers in the Bakken, it is becoming more and more apparent that oil via rail is one of those unhealthy friendships. Sure, companies like Continental Resources (NYSE: CLR), Hess (NYSE:HES), and Oasis Petroleum (NYSE:OAS) have used oil via rail to move their product to places where it can get the best price, but recent accidents have made it more apparent that moving Bakken crude could be a dangerous dance that could lead to big issues. Let's take a look at why this is a very Bakken problem and what it could mean for the companies involved.
Railway to the Danger Zone
The case can certainly be made that the ability to move oil via rail is one of the biggest reasons that oil production in the Bakken region has taken off as much as it has in the past couple of years. Not only has it increased the total volume that can be moved away from the region, but it also allows producers to access centers of demand that are not served by pipelines like the East and West coast. On its most recent earnings call, Continental boasted that all of its Bakken production moves via rail to these centers of demand, which has allowed the company to get $98 per barrel of oil from a region that has some of the highest transportation costs in the U.S. Both Hess and Oasis have also said recently that they move 50% and 80% of their oil via rail, respectively.
Today, the Bakken has become extremely dependent upon oil via rail. Without it, the region would not be able to move about 30% of its product to market. Furthermore, there doesn't appear to be any indication that the proposed pipelines for the region will ever be enough to meet production projections.
Unfortunately, moving Bakken oil via rail is proving to be a risky bet. In the past several months there have been three major train incidents that have resulted in oil fires. One in Lac Megantic, Quebec, one outside of Casselton, North Dakota, and another near the U.S. border in New Brunswick. Bakken crude is extremely light crude, so it is more volatile and thus more likely to catch fire in the event of an accident in comparison to other crudes such as bitumen from Canadian oil sands.
With rail running through population centers and these stories getting national attention, it is possible oil transportation could lead to some major reforms and regulations. Estimates from the Association of American Railroads estimates it would take over $1 billion to improve the safety of the existing tanker fleet to reduce the chance of oil fires. These costs would most likely be passed down to the oil companies and could reduce the competitive advantage that oil via rail gives.
A wake up call
The responsibility for these incidents probably lies at the feet of the rail industry much more than the oil companies using rail to move their product, but companies like Continental and Oasis should seriously reconsider their transportation strategies in light of these incidents. These train incidents will likely result in these rail lines going offline for a time, which could restrict the amount of oil that these companies can move out of the region.
Sure, all companies that use rail will suffer, but Continental and Oasis would disproportionately suffer because they are so dependent on rail to move oil. If the two companies were to commit more of their oil to pipelines, they would take a small hit on realized prices, but reduce the risk of disrupting their takeaway capacity.
This could also be a very opportune time for pipeline companies such as Enbridge Energy Partners (NYSE:EEP) and Plains All American (NYSE:PAA) to increase their pipeline offerings in the region. Enbridge is currently running an open season for its 225,000 barrel per day Sandpiper pipeline that would transport oil from the Bakken to its mainline in Clearbrook, Monnesota. With oil via rail looking more vulnerable, Enbridge could even look to expand the capacity of that pipeline and lock in volumes for longer term contracts.
What a Fool believes
As much as oil via rail has aided the development of the Bakken, these incidents should point out to major producers in the region that they cannot have their cake and eat it too. There is no perfect way to move oil, but striking a balance between pipeline and rail will help to reduce transportation risks.