The demise of crude by rail is greatly exaggerated

Posted by Fred Frailey
on Monday, July 28, 2014

Some of my correspondents — smart people, all — have gotten a case of the jitters regarding crude oil by rail. They point to the North Dakota Pipeline Authority, the keeper of statistics for Bakken shale production, which says rail’s market share of oil leaving the state fell from a peak of about 75 percent last November to 60 percent in May. They quote the respected Sandy Fielden of energy-information company RBN Energy as saying pipelines are grabbing more of the oil going from North Dakota to refineries in the Midwest and Gulf Coast. They fear new government regulations to ensure safer tank cars will increase the cost of doing business with railroads. All of these facts, by the way, are true.

Here’s what I say: Bartender, can you open a new bottle of Chardonnay? My friends need to relax. I want to present a really brief analysis that puts the facts in perspective, as I see it.

First, market share: That 60 percent figure was almost three months ago. Market share for rail and pipeline waxes and wanes. Early in 2013 it waned, only to surge to that 75% level and then decline. Now, to judge by Association of American Railroads traffic reports, which are quite current, rail loadings are surging again. BNSF Railway, by far the biggest originator of oil in North Dakota, last week reported record loadings of petroleum products, of which crude oil is a large component. The numbers are startling in terms of magnitude — 25 percent greater than the same week a year ago and 50 percent ahead of two years ago. The numbers for the other Bakken railroad, Canadian Pacific Railway, are also up smartly, although not quite so much.

Takeaway: The sky is not falling.

But what the heck is happening? Here’s my nickel seminar (you get what you pay for, right? You can pay $2,000 to go to real seminars and learn what I’m about to tell you.)

Railroaders take it as a given they are going to lose most of the business they had between North Dakota, the oil-gathering center of Cushing, Okla., and the Gulf Coast. Unit trains are in the ballpark versus pipelines on rates to the Gulf Coast, but it is advantage pipes.

Plus, I question whether this is market share worth fighting for, at present. Gulf Coast refineries are tuned to process heavy crude, and North Dakota produces decidedly light crude. What light crude these refineries need can be bought more cheaply from Texas producers, who have lower transportation costs and are pipeline-connected anyway.

This could all change if the federal government permits the exportation of crude oil, which has been banned since the 1970s. The U.S. has more light sweet crude than it knows what to do with. Were exports to be allowed, maybe it would be worth their while for railroads to sharpen their pencils and fight to get Bakken-Gulf Coast business headed for export terminals. But until then, no.

The real payoff for railroads from North Dakota is to the east and west coasts. There are no pipelines from the nation’s producing areas in the midsection to either coast. The refiners on the coasts have been dependent upon foreign oil or that from the Alaska North Slope, and both sources have been decidedly more expensive than what North Dakota oil goes for. Small wonder, then, that East Coast refiners gobble up every barrel of Bakken oil they can lay hands on and ask for more. West Coast refiners are equally receptive, but it takes time to build up crude-by-rail supply networks to the region.

Bottom line: BNSF, CP, and their connections can do quite well for years and years to come concentrating on the east and west coasts. These are still growth markets, despite all the ifs, ands, and buts that my friends with twitches like to cite.

Quite apart from all this is the Alberta oil field in Canada. This oil is thick and gooey, so much so that to ship it by pipeline requires that it be diluted almost 30 percent to flow through a pipeline. There are pipelines that serve Northern Alberta and more are in the wings, including ones to both coasts from the Edmonton area. But the biggest North American market for the tar sands oil is Texas and Louisiana, whose refineries are made for this stuff.

So here is the challenge to CP and Canadian National and their U.S. connections (CN makes it to the Gulf all on its own rails, actually): Railroads may hold a cost advantage over pipelines if producers in Alberta and buyers along the Gulf Coast build terminals that can heat the oil going into the specialty tank cars and heat it coming out, because no diluent would be required. It’s a huge competitive advantage for railroads, if facilities can be developed that allow all the tank car’s capacity to be used.

Those terminals will be developed, I suspect. But Canadians are years behind U.S. producers in developing rail alternatives to move their oil. They were blinded by their hubris toward pipelines and are paying the piper.

Crude by rail on the wane? I’m not buying it. — Fred W. Frailey

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