Will the marriage of rail and oil be everlasting?

The Financial Times today reports that Phillips 66, a refining spinoff from ConocoPhillips, is ordering 2,000 tank cars able to carry some 120,000 barrels of crude oil a day out of the Bakken Shale oil fields in North Dakota. This is just the latest sign (although the biggest one yet, costing $200 million) that the oil industry badly needs railroads, at least for the short term.

Producers, refiners, and pipelines were all caught by surprise by the strength of the oil boom in western North Dakota, eastern Montana and southern Saskatchewan. Output is skyrocketing (576,000 barrels a day in March and growing by the hour) whereas pipeline capacity is perhaps half that today, with no big additions expected for a couple of years.

Greg Garland, chief executive of Phillips, told the Financial Times that it is more cost effective for the company’s refineries in California to take delivery of oil by rail from North Dakota, paying the West Texas intermediate price (currently $85 a barrel) than to import it from aboard at the international benchmark price (currently $100 a barrel).

Tank car leasing companies may be placing larger orders, but this is the biggest I’ve heard about from a refiner. Last year, for example, Hess Co. ordered 1,000 tankers to get its oil out of North Dakota on BNSF Railway trains. And Garland says Phillips is anxious for fast delivery of its cars. “If you go in with an order for 500, they put you in line,” he told the newspaper. “If you go in with an order for 2,000, you get people’s attention.”

BNSF is believed to be loading about three trains of Bakken crude oil a day at present, Canadian Pacific about half that number. But the rate of loadings could easily double within the year. I was told by an executive of Continental Resources, the biggest producer in North Dakota, that every incremental barrel of oil it brings out of the ground now must leave the state by rail.

Within three years, any number of new pipelines will probably poke their noses into North Dakota. What happens then? When I spoke to BNSF and CP people late last year, they were confident that rail would remain a viable competitor to pipelines, perhaps handling as much as 20 percent of the Bakken output.  

But when I put the question to Harold Hamm, the founder and chief executive of Continental Resources, a few weeks ago, Hamm shook his head. “The pipelines will get almost all of it by 2015,” he said. “Railroads will be a marginal presence.”

Get that, Calgary and Fort Worth? You have two or three years to come up with combinations of service and price that will be attractive to oil buyers, and prove Harold Hamm wrong. That two refiners, Phillips and Hess, will invest in tank cars to the tune of $100 million to $200 million suggests they see a longer life span for their new assets. Let’s hope they are right.—Fred W. Frailey