The oil party hasn't ended

One thing I’ve learned about crude oil on railroads is that the long term is the middle of next month. What’s here today can be gone before you know it. Decisions made in Riyadh yesterday or events in the Ukraine today can turn the economics of oil transportation on its head tomorrow.

With that said, I’ve been looking . . . and looking . . . for signs that this new line of business has topped off. All I come up with is evidence that the business, if anything, is booming.

Let’s start with North Dakota, by far the biggest source of oil for railroads. Through September production was almost 1.2 million barrels a day (closer to 1.3 million if you include eastern Montana), and the North Dakota Pipeline Authority estimates that BNSF Railway and Canadian Pacific Railway handled just over 801,000 of those barrels, give or take 30,000 barrels. This amounts to roughly 11 unit trains every 24 hours.

The numbers ebb and flow month to month. In November 2013 rail takeaway topped off at 799,000 barrels a day and fell every month thereafter until reaching 700,000 in May. Then the rail numbers rebounded strongly each month since. Oil production in the Bakken region rose steadily all year, so I’m left to wonder why the rail numbers fell those six months. I suspect BNSF and CP were simply unable to move product fast enough early in 2014—they had this winter weather thing, you may recall. At any rate, these snapshots at the rail takeaway provide some perspective:

September 2010          90,000 barrels

September 2011          94,000 barrels

September 2012          437,000 barrels

September 2013          671,000 barrels

September 2014          801,000 barrels

One side note: Rail capacity in North Dakota stands at 1.3 million barrels a day, so about two-thirds of it is being used. Pipeline capacity, according to NDPA, is about 775,000 barrels, and my seat-of-the-pants estimate is that only about 250,000 barrels of that capacity was being used in September.

Where is the oil going? BNSF has been loading eight or nine trains a day of Bakken shale oil and Canadian Pacific two or three. I looked at BNSF loading data for a four-week period ending in mid-October. It showed that about four trains per day go through Chicago en route to refineries or distributors in the Philadelphia area, Delaware City, Del.; Yorktown, Va., and Albany, N.Y., on CSX Transportation or Norfolk Southern. Two to three trains head to the west coast, primarily Washington (precisely two trains in this 28-day period went to California). Three trains a day are destined to places in the Midwest or Gulf Coast (the biggest destination by far is the distribution hub in St. James, La., on Union Pacific).

CP occasionally routes a train to the Gulf Coast via UP or Kansas City Southern. Most of its oil loaded in North Dakota interchanges with CSX or NS in Chicago or stays with CP for Albany, N.Y., or to Irving Oil in St. John, N.B., via either the U.S. or Canada. (BNSF supplies Irving, too, via CSX to Albany, N.Y., and then barges).

BNSF is also loading almost two trains per day at places like Tampa, Colo.; Cheyenne, Douglas, Fort Laramie and Pronghorn, Wyo., and Carlsbad, N.M. These unit trains all made their way east or south.

Getting back to underutilization of pipelines: From North Dakota, pipelines tend to head toward the Gulf Coast, and that is where the light sweet crude from Bakken shale is being squeezed out by similar oil produced in the Eagle Ford field in South Texas. To state it another way, I don’t think there is too much demand for Bakken crude in Texas and Louisiana.

Perhaps someone should build pipelines to the east and west coast refineries. To date, nobody has, and until such time there should continue to be robust demand for railroad transportation of crude in those two directions from North Dakota. In fact, the west coast refiners in Washington and California are fertile ground for crude by rail not just from North Dakota, but at some point also from new production in Colorado, Wyoming, and Utah. To date, however, those refiners have often met their match from environmental groups opposed to permits being issued for rail unloading terminals.

None of what I’ve just written reflects the decline in crude oil prices. With OPEC in disarray, prices are in freefall, dipping Friday to $66.15 a barrel for benchmark U.S. oil, the lowest in half a decade. Does this portend a drop in production in the Bakken region? I don’t know, but at some point, if prices continue to drift down, of course. A panel of experts convened by analyst Jason Seidl of Cowen & Company predicted the pace of drilling in the U.S. can be maintained unless prices fall below $55 a barrel, and some producers can make money at even $40. It is another matter altogether in Canada. Coaxing bitumen, the heavy tar sands oil, from the earth is expensive, and I've read that a world price of $85 a barrel is necessary to make this extraction profitable. If so, then the producers in Alberta must be suffering. In any event, not an awful lot of bitumen is moving by rail, although rail has the potential to move raw bitumen, whereas pipelines require that it be diluted about 30 percent.

I’ll conclude by enumerating some things that threaten to spoil the party. First, a further decline in oil prices. Second, continued pipeline construction; by definition, rail gets a chance from producers in new fields where pipelines aren’t well developed. But what happens when the pipelines are there in abundance? Third, competition from U.S. ships at Philadelphia and Delaware refineries; at a conference in Houston a few weeks ago, I was told that 30,000 barrels a day head for the East Coast from Corpus Christi, Tex. Fourth, continued narrow discounts for U.S. oil versus that from overseas. When spreads are greater than $10 or $12 a barrel, producers can pay the higher cost of getting oil by rail to the east or west coasts and still underbid suppliers from Africa, South America, or the Middle East; right now, however spreads are in the $4 range. Finally, new tank car regulations that will make rail an even more expensive option and that could conceivably price it out of the market.

Yes, there are lots of things to worry about. But today there are even more things about railroads and crude oil to celebrate. — Fred W. Frailey