Oil by rail: The real opportunities

Posted by Fred Frailey
on Wednesday, August 21, 2013

Let me give you two numbers. First, 10 percent of the crude oil produced in the U.S. now moves by rail (this according to Cowen & Company). Second, crude oil accounts for about 1 percent of railroad carloads. That tells you that even if railroads carried all of the oil that comes out of the ground in this country, it would still not have the bottom line impact of coal, which accounts for almost one-quarter of railway revenues. But as coal loadings go into a possible long term decline, that oil business is a godsend to railroads.

I’ve been attending a crude-by-rail conference in suburban Dallas, the speakers largely being from the oil producing and refining companies. The questions that seem to be on everyone’s mind are these: Is there really a meaningful future for railroads in this field, competing against the long-dominant oil pipelines? And if there is, in what markets? Despite a sea of uncertainty, some answers now seem obvious.

Railroads are going to hold onto a lot of crude oil business, no matter what. A lot of the new production is coming from places not well served by pipelines. That is because, until the recent advent of hydraulic fracturing and horizontal drilling, not much potential volume was seen in places like North Dakota, Montana, Colorado, and Utah. Now North Dakota and eastern Montana production is closing in on 1 million barrels per day (bpd), and 70 percent of that oil is heading out by rail, for lack of any alternative.

True, the pipeline companies are feverishly building into North Dakota. In fact, Stephen Bradley of Continental Resources, the biggest producer in North Dakota, figures that by the end of next year, pipeline takeaway capacity will grow from 575,000 barrels a day (bpd) to 850,000 bpd. That will be on top of 970,000 bpd of railroad takeaway capacity available then. “That’s a lot of takeaway,” he adds, particularly since oil production in the region by late 2014 will be about 1.3 million barrels, or far less than the takeaway capabilities of the two modes. Obviously, these new pipelines will bite into the railroad market share.

Here’s another sobering fact: Today railroads take a lot of this oil to the Gulf coast, where it is piped to refineries in Louisiana and Texas. But most refineries in the Gulf region are configured to refine heavy crude oil, whereas that from North Dakota is light crude. By 2014, conference participants predicted, light crude from new oil fields in Texas will crowd out the North Dakota oil because it’s closer to the refineries and cheaper to transport.

So where are the reliable railroad customers for North Dakota crude? The answer is on the east and west coasts. East coast refiners traditionally imported oil from West Africa, whereas West Coast refiners bought oil from the Alaska North Slope or from Asia. In fact, there is virtually no oil pipeline to either coast from the oil fields in the center of the U.S. It’s this vacuum that railroads are rushing to fill.

The East Coast has 1.2 million bpd of refining capacity, 900,000 of it in the Philadelphia area, and the Pacific Northwest and California 2.75 million bpd. On both coasts, refiners are learning that it’s a lot cheaper to buy oil in North Dakota or southern Canada and ship it by rail than it is to import the stuff from abroad at present world oil prices. (As for Alaska, production has fallen to a small fraction of its peak a quarter century ago.)

So the story to follow is the buildup of rail unloading capacity in the east and west. It is pretty frenetic. BNSF Railway is already bringing about one train a day of oil to a Tesoro refinery in Anacortes, Wash., on Puget Sound. Tesoro and Savage Companies are jointly developing an oil terminal at the Port of Vancouver in Washington, across the Columbia River from Portland, Ore., that initially will have the capacity to unload 120,000 bpd, or two unit trains. This oil will be loaded onto barges or U.S. flagged ships for delivery to California refineries, a couple of which Tesoro owns. Mark Smith, Tesoro’s vice president for development supply and logistics, expects this and other rail movements to totally replace imports of light sweet crude. Meanwhile, according to Railway Age, Canadian Pacific and Union Pacific are planning all-rail movements of light sweet from southern Alberta or Saskatchewan to southern California. Tesoro’s Smith says a rail-water movement centered on Vancouver, Wash., makes more sense because it maximizes rail car utilization and avoids rail congestion problems in California.

Well, time will tell whether BNSF-Tesoro or CP-UP has the better idea. But the bottom line is that railroads will soon own the west coast oil business.

On the other side of the country, refineries were going broke importing expensive slight crude from West Africa and elsewhere. Now it's as if Lazarus has risen from the dead. Now the refineries have new owners and a new source for crude oil, namely North Dakota. BNSF and CP at one end, and CSX and Norfolk Southern at the other, are the beneficiaries. Where the Baldwin Locomotive Works once stood in Philadelphia, a joint venture by Canopy Prospecting and Eddystone Enbridge will have a terminal able to unload 160,000 bpd by next year, equal to three unit trains. “We think it [the east coast] will be a positive market for railroads,” says Erik Johnson, Canopy’s VP and general manager. “Why? Frankly, where else can North Dakota oil go? The Gulf is already flooded by light sweet crude. But you now have east coast refineries that would prefer to deal with North Americans. It will be interesting to see how much the refineries will expand.”

There's also oil in Colorado and Utah, on both sides of the Rocky Mountains, that lacks pipeline access. Imagine, please, the frustration of producers of black wax and yellow wax petroleum in oil fields southeast of Salt Lake City. Black wax looks just like shoe polish and won't pour at a temperature below 105 degrees Farenheit. Yellow wax is even less porous, requiring a temperature of 120 degrees. You'd never get this stuff through a pipeline, even if there were one. Salt Lake City's five refineries use about 50,000 bpd per day of the stuff, brought 150 miles heated inside trucks, but that's the extent of the market so far. Newfield Exploration has delivered 250,000 barrels of wax oil to distant refineries by rail in "test" movements, inside coil insulated tank cars. "Now the challenge is to convince refiners," Randy Hairre, Newfield's director of marketing. He thinks rail transportation could easily allow production to double. "The stuff is easy to get out of the ground," he says.

I’ll leave you with one tantalizing development. Rumors abound that Kansas City Southern Railway is on the cusp of a major oil-movement coup. It won’t be from North Dakota via Canadian Pacific to Kansas City. As I said, Texas production of light sweet crude will close the door along the Gulf coast to North Dakota production. The KCS opportunity appears to be for heavy crude from northern Alberta. Yes, the Keystone XL pipeline, if approved by president Obama, is designed to move 750,000 or so bpd of the so-called tar sands oil to the Gulf coast refiners. But it is so thick that a dilutant is required for the oil to flow, thus reducing the real capacity substantially. Meanwhile, refining capacity in just the Beaumont and Port Arthur, Tex., area near KCS is 1.7 million bpd.

So the rumor is that KCS will soon ink a long term agreement to handle several trains a day to Beaumont from Canada, either via Canadian Pacific through Kansas City or Canadian National through Jackson, Miss. Insulated, coil-heated tank cars would be used. Making the deal even more attractive to refiners is that the cars would be backloaded to Alberta with dilutants for use by pipelines. Imagine the ironies of this.—Fred W. Frailey

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