North Dakota oil in the balance

I want to bring you up to date on the economics of crude oil by rail. As you know, most of it flows out of the Bakken Shale oil fields in North Dakota and neighboring eastern Montana—by my reckoning, eight or more loaded trains a day on BNSF Railway and three or so on Canadian Pacific Railway. (Both CP and Canadian National also load oil, mostly in less-than-trainload lots, in Alberta.)

What got railroads into the crude oil business for the first time in more than half a century were two phenomena. One was that little pipeline capacity existed to take the oil out of North Dakota. BNSF and CP and their connections were only too happy to fill that void. The other was the huge price discounting of Bakken crude because of the difficulty of getting it to places it could be refined into retail products, such as Louisiana and South Texas. Delivery by rail, as you know, is more expensive than pipeline, but the discounting allowed buyers to use rail and still get the oil to market for less than the international benchmark (Brent) and domestic benchmark (West Texas Intermediate, or WTI) prices.

Now one of those advantages has disappeared and the other may go away as well within two or three years. So where do railroad stand?

In the past several months, the price for inland oil from North Dakota has moved closer and closer to the WTI price and to Brent benchmark as well. All three benchmarks are converging, in other words. No longer can discounts on North Dakota crude hide the higher cost of rail transportation. RBN Energy LLC, an energy-information company, reported in June that railcar loadings of crude in North Dakota were actually declining as buyers opted for unused pipeline capacity out of that state. In fact, the North Dakota Pipeline Authority says rail shipments declined from 78 percent of the state’s output in April to 69 percent in May.

Even if discounting of Bakken crude ceases, that doesn’t mean the end of rail transport. Refineries on the Atlantic and Pacific coasts aren’t served by pipelines and may never be, and perhaps rail will remain competitive versus oil from overseas that arrives by ship and sells at the Brent benchmark. Plus, more oil is coming out of North Dakota every day, and even if buyers used every bit of pipeline capacity, they’d still need railroads today. Railroads don’t lock crude oil shippers into long term contracts, and shippers can route the product just about anywhere and on short notice. These are advantages pipelines don’t possess.

But now the other prop holding up crude by rail from the Bakken region may be disappearing. In its online blog today, RBN Energy reports that pipeline capacity from the Bakken oil fields may catch up with oil production by 2016. (To read RBN’s blog, go here). On July 1, Koch Pipeline Company began a 45-day “open season” to measure shipper support for a 250,000-barrel-per-day pipeline, called the Dakota Express, that would allow oil to ultimately reach the Gulf Coast. If interest is great enough, Koch will then seek formal long-term commitments, with a goal of opening the pipeline by 2016. Should the Dakota Express come to pass, it and other pipeline additions (including the Keystone XL out of Canada, which would pass through North Dakota and lift 100,000 barrels of oil a day from that state) could make railroads redundant by 2016.

Note that I used the word could. The XL pipeline’s future is a political football and may not be licensed by the federal government. Last year, ONEOK Partners abandoned plans to build a 200,000-barrel-a-day pipeline to take oil from North Dakota to Cushing, Okla., for lack of interest.

So keep your eyes open. Concludes RBN Energy’s Sandy Fielden: “The crude by rail adventure has changed the world of crude transportation for good, and producers still have plenty of optionality in the large rail terminal capacity that has been built in North Dakota. That would seem to indicate that Koch will have to overcome producer commitment phobias—by offering shorter terms. If shippers and producers say no to the Dakota Express then it will be a good indication that rail flexibility still holds a few cards even when crude price spreads between the Bakken and the Coasts evaporate.”—Fred W. Frailey