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Buffett Railroad Beats Coal Slump With 75% Gain in Oil

Buffett Railroad Beats Coal Slump With 75% Gain in Oil
Buffett’s Berkshire Hathaway Inc. spent $26.5 billion in 2010 to acquire the 77.5 percent of BNSF it didn’t already own in the billionaire investor’s biggest takeover. Photographer: Mike Fuentes/Bloomberg

Warren Buffett’s Burlington Northern Santa Fe railroad and Union Pacific Corp. are combating a drop in coal cargoes by catering to the industry responsible: the hydraulic fracturing of shale formations.

BNSF, Union Pacific and their peers are hauling in energy producers’ gear to extract crude oil and gas from shale, then shipping out petroleum products. BNSF’s petroleum carloads rose 75 percent in the second quarter from a year earlier while Union Pacific saw a 12 percent gain in the unit where it groups fracking-related freight.

“This is a whole industry that just sprung up on all the rail properties,” Jeffrey Kauffman, an analyst at Sterne Agee & Leach Inc., said in a telephone interview. “It’s a new growth source that helps to mitigate what’s probably a temporary dislocation of an old energy source.”

The dislocation has come with a hefty cost, as many North American utilities stopped generating power from coal in favor of cheaper natural gas released by fracking. Coal cargoes at Class I railroads, North America’s largest, dropped 11 percent in the second quarter. Neither Union Pacific’s chemicals segment nor BNSF’s petroleum shipments rival their coal volumes.

“The shale opportunity has been a double-edged sword for the rails,” Ben Hartford, a Robert W. Baird & Co. analyst in Milwaukee, said in a telephone interview. “The abundance of natural gas domestically has pressured prices, and the resulting degradation to the coal demand has been palpable.”

‘Double-Edged Sword’

Union Pacific’s shale business will probably grow to almost 400,000 carloads in 2012, Chief Executive Officer Jack Koraleski said on a July 19 conference call. That’s roughly double the number of carloads the Omaha, Nebraska-based company moved from the Bakken shale formation in the northern U.S. in 2011.

“While the coal business, which is our largest book of business, has softened, we’ve been able to offset that with strength in crude oil, in frack sand, in automobiles, in pipes and domestic intermodal,” Koraleski said in a telephone interview last month.

The trend holds across the industry. Petroleum-product shipments at major U.S. railroads have gained 40 percent this year from the same period in 2011, while coal cargoes have dropped 9.6 percent, according to a report today by the Association of American Railroads.

BNSF and Union Pacific transport most of their Bakken region crude shipments to Oklahoma, California, Louisiana, New Mexico and Texas. The companies are more insulated from risk associated with the abundance of natural gas than eastern rails since coal in the Powder River Basin of Wyoming and Montana costs less to mine than in the Appalachian region.

Stock Performance

Union Pacific climbed 0.2 percent to $121.80 at the close in New York. The stock’s advance of 15 percent this year has surpassed gains of 7.3 percent by CSX Corp., the biggest eastern U.S. railroad, 0.7 percent by Norfolk Southern Corp. and 5.2 percent by the Standard & Poor’s 500 Industrials Index.

Union Pacific, the biggest North American railroad, lacks direct access to the Bakken shale oil field. It benefits from interchanges with traffic originated by BNSF and Canadian Pacific Railway Ltd. bound for Louisiana and Texas terminals.

The largest contiguous oil deposit in the continental U.S., the Bakken includes parts of North Dakota, South Dakota and Montana in the U.S. and Saskatchewan and Manitoba in Canada.

“People are just getting their heads around how large the opportunity will be for the next year or two,” David Vernon, a New York-based analyst with Sanford C. Bernstein & Co., said in a telephone interview.

‘It’s Phenomenal’

BNSF is “seeing strong double-digit type growth” in all markets related to shale fracturing, CEO Matt Rose said in an interview in May. Buffett’s Berkshire Hathaway Inc. spent $26.5 billion in 2010 to acquire the 77.5 percent of Fort Worth, Texas-based BNSF it didn’t already own in the billionaire investor’s biggest takeover.

“Everything to do with drilling, horizontal drilling, frack sand, pipe, oil, it’s phenomenal,” Rose said.

Once more pipeline capacity comes online, in part through the reversal of the 150,000-barrel-a-day Seaway pipeline to carry crude south, rails will be hauling less out of the Bakken region.

“You are seeing a huge amount of growth right now, but as that pipeline capacity increases, the cost advantage of pipe to rail will take some of it back by 2014, 2015,” Vernon said.

Railroads should still see some growth from natural gas drilling, said Lee Klaskow, a Bloomberg Industries analyst in Skillman, New Jersey.

“The pipelines can take out oil but they can’t bring in sand and water,” he said.

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