Riding the Rails With Ethanol
With the rising prominence of ethanol as a major energy alternative, many industries are likely to profit from this long-term phenomenon. Railroads and related industries are especially on track to benefit.
The idea behind ethanol is to reduce oil consumption, and thus reduce its negative environmental impact, so it seems trains would be the best way to transport the corn-based fuel. Trains are used to transport corn from grain bins to the production plants, and ultimately to markets across the country. According to the American Coalition for Ethanol, more than 75% of the ethanol produced in the United States is shipped by rail.
High diesel-fuel prices certainly make it a no-brainer for businesses to use the rails. As of June 25 the average price of on-highway diesel in the United States was $2.835 per gallon, according to the Energy Information Administration.
S&P equity analyst Kevin Kirkeby says shippers of bulk commodities, like coal and grain, are largely dependent on railroads for long-distance transportation. Ethanol is another product likely to rely heavily on the rails, as it is hard to transport ethanol any other way. One might think that piping ethanol would be the most cost-efficient way to transport ethanol, but that is not the case.
A typical pipeline carries a number of different kinds of petroleum products. A pipeline might ship several thousand gallons of gasoline, followed by a shipment of diesel fuel. Unfortunately, petroleum products leave deposits in the pipes—deposits that ethanol can dissolve, contaminating the shipment. Water can also get into pipelines (condensation is the main culprit), and ethanol can blend with it. These factors make pipeline transport a risky proposition.
Kirkeby says that of the large-scale Class I railroads, Burlington Northern Santa Fe (BNI; 2 STARS, sell) appears to have the greatest exposure to ethanol, with its network serving the western half of the country. It can transport ethanol fuel to large consumption centers in Texas, California, and, to a lesser extent, the Pacific Northwest. Burlington Northern expects ethanol to generate $100 million in revenues in 2007; it contributed $32 million in the first quarter. However it's important to note Burlington Northern's revenues in the first quarter totaled $3.54 billion.
Other railroads have varying degrees of exposure to ethanol—but in all cases it is relatively small, Kirkeby points out. Norfolk Southern (NSC; 3 STARS, hold) is one of the primary shippers of ethanol from the Midwest to the East.
In Kirkeby's view, the ethanol business generates quite favorable returns, taking into account the limited investment capital required from the rails. However the business is unlikely to contribute much to earnings in the next few years.
But there are lots of plans for ethanol underway. According to an April, 2007, article from Progressive Railroading.com, Riverstone Holdings,, The Carlyle Group,, and Dominion Energy Services (D) hope to complete a 100-million-gallon-capacity ethanol plant in Innisfail, Alberta, by the fall of 2008. VeraSun Energy (VSE; 2 STARS) and CSX Corp. (CSX; 3 STARS) announced plans to build a 110-million-gallon-capacity ethanol plant in Indiana, which would be served by CSX Transportation and the Toledo, Peoria & Western Railway. This plant is expected to be ready for operation in the fourth quarter of 2008.
Trinity Industries (TRN; 5 STARS, strong buy), a leading railcar producer, is certain to benefit from the trend toward ethanol. S&P equity analyst Stewart Scharf says Trinity has been shifting some production to tank cars to meet the strong demand for ethanol transport, and will likely manufacture additional railcars as demand for the fuel increases.
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