Cheap crude and oil trains

Posted by Fred Frailey
on Friday, December 5, 2014

Oil producers in North Dakota are feeling the pain today. And so, within the year, might BNSF and Canadian Pacific railways, which carry most North Dakota oil to refineries.

The collapse of crude oil prices began last summer and accelerated last week after the Organization of the Petroleum Exporting Countries decided not to curtail production. And look what is happening to oil prices in North Dakota: At the peak, in June, prices for North Dakota crude averaged $92 a barrel, reports Plains Marketing LP. Thursday morning buyers offered $50. That’s a $12-a-barrel discount to the benchmark West Texas Intermediate price and reflects the cost of moving the Bakken shale oil to refiners, most of them located along the three U.S. coasts.

The paradox is that predictions far and wide are for more U.S. oil output in 2015 rather than less. Says energy economist Philip Verleger: “Production will likely be higher in 2015 even if prices average $40 or $50 in the field, which implies a Brent [world benchmark] price of around $60.” But Verleger adds that if the shakeout continues, the Brent price could sink to $50 per barrel by the end of next year. That translates to $35 a barrel for a North Dakota oil driller. Talk about a boom and bust business, with emphasis on bust . . .

Facing this kind of future, how can production not just hold its own but increase? Part of the answer is sheer momentum. For shale output to begin falling in North Dakota and Texas, capital budgets would have to be slashed 50 percent, says analyst Mark Hanson at Morningstar. As he puts it: “When prices collapse, you concentrate on your best stuff.” Indeed, some shale wells can be drilled profitably if crude goes as low as $25 a barrel, according to Manuj Nikhanj of ITG Investment Research. Plus, once you’ve drilled the well, your costs go way down.

So in this dismal pricing environment, Continental Resources still expects its oil production, primarily in North Dakota, to rise between 23 and 29 percent in 2015, thanks to a capital budget unchanged from 2014 and 350 new wells. Continental is the biggest driller in North Dakota. Bloomberg reports that Continental’s cost of production once a well is drilled is $5.50 a barrel, and a cool 99 cents in what is known as the South Central Oklahoma Oil Play (aka SCOOP). So it seems the pattern across the Bakken formation is for drillers to concentrate on their best, most prolific bets and try to ride out the storm.

But this won’t last forever. Verleger expects the frequency of oil trains leaving North Dakota to top off in nine to 12 months and begin trending down. “Many producers are hedged,” he says. “Their cash flow is guaranteed for six to nine months. Then they have to start worrying.”

In the meantime, what is the pace of oil train originations? For the four-week period encompassing almost all of November, BNSF dispatched 223 oil trains from North Dakota, or 7.4 per day. That is down from a pace of 8.3 trains per day in the four weeks ending in mid October. Half (49 percent) were destined to the East Coast, whereas 20 percent headed to West Coast refiners and 31 percent to the Midwest and Gulf Coast. Canadian Pacific is believed to originate about two trains per day in North Dakota, most destined for the East Coast.

In the past 15 months, deliveries of BNSF unit oil trains to the East Coast refiners have about doubled. West Coast oil train deliveries have risen about 20 percent. Deliveries to the Midwest and Gulf Coast, which used to comprise half of the oil trains, have essentially stood still, reflecting greater pipeline capacity to the Gulf from North Dakota as well as cheaper light sweet crude coming to the Texas and Louisiana refineries from close-in South Texas.—Fred W. Frailey

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