With the inevitability of rising fuel costs and stricter emissions standards for locomotives set to take effect in 2015, class 1 railroad companies such as Berkshire Hathaway's Burlington Northern Santa Fe LLC, Union Pacific (NYSE:UNP)Canadian National Railway (TSX:CNR), and CSX Corp. (NASDAQ:CSX) are researching alternatives to manage their expenses. One of the alternatives the railroad companies are exploring is switching from diesel to liquefied natural gas, or LNG, as the main source of power for their locomotives.

The idea of LNG in the transportation industry is not a new one, as the trucking industry has been using LNG since the mid-'90s. Railroad companies also flirted with the idea in the late 1980's and early 1990's, but these ideas were shelved in part due to the rising costs of natural gas.

Sparked by the significant price decline of LNG In 2008 and the shale revolution currently underway in North America, the idea of using LNG as a main source of fuel has been reignited. According to Lorenzo Simonelli, CEO of General Electric's (NYSE:GE) transportation unit, "If you believe the price advantage over diesel is going to stay here for the next 10 to 15 years, then LNG is a revolutionary fuel."

At this point in time, railroad companies have many questions that need to be answered before proceeding with a massive industry change. Questions regarding locomotive engine performance, including fuel efficiency and emissions, have not been thoroughly evaluated and answered. Another set of questions that need to be explored cover the issues surrounding infrastructure. The infrastructure issue includes converting fuel facilities, as well as funding adjustments to railroad operations, including interchanges that connect railroads.

Further research shows that if railway companies decide that the advantages of a fuel transition outweigh the disadvantages, short-term capital costs look to be immense. A company expects between 15 and 20 years out of a locomotive, and they cost around $2 million each to make; conversion costs for locomotives less than 10 years old are estimated to be between $600,000 to $1,000,000. Conversion costs for older locomotives (10 years +) are estimated to be between $400,000 and $600,000. According to Railway Age, at current natural gas prices the savings associated with the conversion are around $200,000 per locomotive per year. Based on the age and viability of the locomotive it would take between two and five years for a company to make a positive return on its investment.

Caterpillar (NYSE:CAT) and General Electric are currently teaming up with Union Pacific to begin field testing liquid natural gas-fueled locomotives. Union Pacific indicates that it is still very much in the early analysis phase. "We are working closely with locomotive and engine manufacturers, cryogenic fuel-tank suppliers and natural gas/LNG suppliers to complete our analysis." Final results from these tests are expected to come out in at least one to two years, and, according to railway magazine, if these tests are positive, "LNG locomotives could be in widespread use by 2016 or 2017." 

Setting themselves up to take advantage of the potential behind the industry change is General Electric. GE Transportation offers a retrofit kit that enables existing Evolution Series locomotives to operate on both diesel and LNG. These kits are designed to substitute up to 80% of diesel fuel with LNG. Even with the two sources, GE states its use can reduce fuel costs by 50% without diminishing performance. These retrofit models currently meet EPA Tier 3 emission standards, and also allow a fully loaded train to travel further distances without refueling stops.

Foolish conclusion
Currently, railroad companies such as Union Pacific, CSX, and Canadian National Railway are exploring opportunities behind converting diesel fueled locomotives to LNG. At this time there are many questions that need to be explored before a massive industry change begins to take place -- but as recent data suggests, at current natural gas prices, the savings associated with the conversion are around $200,000 per locomotive per year. At that price point it is estimated that a company will make its money back within two to five years. An alternative way to play the anticipated change is through GE and Caterpilllar. Both companies are working with the railroad companies and are on the cutting edge of the innovation and technology that will foster the change from diesel to LNG.