Railroads Look Past U.S. Oil-Move Costs Helping PipelinesVictoria Stilwell
As 57,000 miles of U.S. crude pipelines threaten to lure business from railroads, Burlington Northern Santa Fe LLC and Union Pacific Corp. are sticking to their bet on the nation’s energy boom.
Domestic oil that was significantly cheaper than imported crude for the last two years allowed refiners to pay rail service’s higher transportation costs rather than use slower, less expensive pipelines. With the oil price difference now narrowing, the share of crude shipped by rail from Williston Basin region in and around North Dakota has decreased for three consecutive months, the longest string of declines since 2011.
That hasn’t stopped railroads such as Warren Buffett’s Burlington Northern and Union Pacific from planning more capacity, a sign they’re optimistic the business will keep boosting revenue even with the risk of stiffer regulations following this year’s deadly train crash in Quebec. Union Pacific, the largest U.S. railroad, plans to invest $3.65 billion this year in its network and infrastructure.
“You’re witnessing the long-term perspective of railroads, which invest capital on a 20- to 30-year basis, and the short-term myopic view of hedge funds, which invest on a two- to three-minute basis,” said Matt Troy, an analyst at Susquehanna Financial Group in New York. “Spreads go up, spreads go down, but just looking at the geography of oil production and refining capacity, railroads will play a strategic role in moving crude from the shale for years to come.”
It generally costs an additional $12 to $15 to ship a barrel of oil via rail versus slower pipelines, depending on factors such as origin, destination and the type of oil being moved, Troy said. Once the difference between domestic and imported crude prices falls below that range, the immediate economics aren’t as attractive.
Brent crude, the benchmark for U.S. imports, traded at a premium to domestic West Texas Intermediate oil by as much as almost $28 a barrel in October 2011. In March, the spread began to narrow and is currently almost $3 a barrel.
The share of crude shipped by rail from Williston Basin fell to 67 percent in July, the lowest level this year, according to data from the North Dakota Pipeline Authority.
Even so, railroads are building up track capacity, a primary way of investing in the crude boom, said Logan Purk, an analyst at Edward Jones in St. Louis. A lack of pipeline capacity is giving rails an advantage as refiners look to move oil quickly and efficiently.
While rising domestic crude prices are something railroads should be mindful of, “if you’re looking for a place to deploy capital, that seems to be the screaming choice,” he said.
That demand may help shield railroads from the effects of tighter regulations stemming from a July 6 derailment and subsequent explosion in Lac-Megantic, Quebec, that killed 47 people.
The U.S. Transportation Department’s Pipeline and Hazardous Materials Safety Administration on Sept. 4 took the first step in rulemaking for DOT-111 rail tank cars, the type that was hauling crude in the crash. Transportation safety investigators have criticized those as rupture-prone.
“Now is the time to make sure safety regulations are robust enough for the increased hazmat movement on our rails, roads and in our pipelines,” PHMSA Administrator Cynthia Quarterman said in an e-mailed statement.
A report from the administration showed recommendations for enhanced tank head and shell puncture resistance systems for those types of tank cars. Stiffer rules could raise the cost of transporting crude.
Union Pacific will continue to “double-down” on safety following the crash, chief financial officer Robert Knight said at the RBC Capital Markets Global Industrials Conference in Las Vegas on Sept. 10. “This just causes all of us and everybody in the pipeline to be extra diligent. I don’t think it’s going to change the production curve.”
The narrowing of the oil-price spread resulted in “some lumpiness in our volumes” of crude shipments that will do little to stop the momentum the Omaha, Nebraska-based railroad will see from the domestic energy boom, Knight said. “In the longer term, we still think it’s a very positive story for Union Pacific.”
In addition to the billions it plans to spend this year, Union Pacific invested about $18 billion in its network and infrastructure from 2007 to 2012, spokesman Tom Lange said in an e-mail. Because the expenditures benefit multiple industries and commodities, it’s not practical to break out investments specific to the crude oil business, he said.
The Bakken oil formation, part of a larger geologic area called the Williston Basin, turned North Dakota into America’s second-largest crude producer after Texas. Output rose to 821,000 barrels a day in June, almost five times what it was in 2008, according to Energy Department data.
About 80 percent of the Bakken crude-by-rail loading terminal capacity is on the rail lines of Fort Worth, Texas-based Burlington Northern, according to Troy. The share of carloads carrying crude oil at the railroad, owned by Buffett’s Berkshire Hathaway Inc., may reach 4.2 percent this year, up from 3 percent in 2012, New York-based Wolfe Research estimates.
Burlington Northern has spent more than $1 billion this year on maintenance and capacity expansion projects, with more works to come, spokeswoman Roxanne Butler said in an e-mail Sept. 9.
“Our investments clearly reflect our vision of bringing flexibility and reliability to crude shippers in the long term,” Butler said.
The differences in crude prices were affected this summer by short-term issues, including maintenance at the Syncrude oil-sands project in Alberta that reduced supplies of Canadian synthetic light oil, Butler said. The railroad expects oil production trends to remain strong.
WTI briefly traded above parity to Brent on July 19 for the first time in almost three years as better pipeline networks and the use of rail helped to unlock a supply glut at Cushing, Oklahoma, the delivery point for New York futures.
While rails seem to be largely ignoring the price tightening, “they would certainly have to adjust” their fees should the trend continue because crude business has become important to them, Thomas O’Malley, chairman of PBF Energy Inc., a Parsippany, New Jersey-based independent refiner, said on an Aug. 1 conference call. Still, “as best I can tell for the next couple of years, anyhow, Bakken must move by rail,” he said.
Investors agree. The Standard & Poor’s Railroads Index has gained 12.6 percent even as the spread between WTI and Brent has narrowed about 84 percent since the end of February through yesterday.
New technology has made drilling faster, cheaper and better at releasing oil from rock formations, called hydraulic fracturing, or fracking. Many of those production areas still aren’t adequately served by pipelines.
Railroad crude shipments in the second quarter more than doubled from 2012, according to an Aug. 29 statement from the Association of American Railroads. While that growth may slow and the segment is still a relatively small part of overall traffic, railroads will see the benefits of the energy renaissance and its effect on the U.S. manufacturing industry for years to come, said Donald Broughton, an analyst at Avondale Partners LLC in St. Louis.
“People that hyper-obsess about is the spread $2 or $6 miss the broader point, which is what it’s doing to industrial America,” Broughton said. “A strong, robust industrial America is going to benefit every part of their business. In the short-term, yeah the spreads are interesting. In the medium- to longer-term, it becomes less and less relevant.”