Oil by rail dodges all bullets

Fireball explosions, dozens of deaths, congressional hearings, emergency orders by regulators, potentially unsafe tank cars, incendiary stories by the score in newspapers . . . none of this has seemed to affect the ardor of crude oil producers and refiners for shipping their product by rail. I'm just back from attending a crude-by-rail meeting in Glendale, Calif., put on by American Business Conferences. I arrived curious how much the negative events of recent months had affected the new-found commitment of producers and refiners for using rail. The answer is, no impact at all that I can detect.

Oil customers are resigned that safer handling of oil on railroads is going to increase costs, but only marginally. Face it: They are running businesses, and to stay in business they have to get the oil to market (and in the case of refiners, have access to inexpensive oil). Sometimes rail is the only option, and even when rail competes with pipe, the math often works in favor of rail. Consider these two facts: The North Dakota Pipeline Authority expects the rail share of oil leaving that state in 2014 to be in the range of 90 percent (if so, about a million barrels a day via steel wheel), up from about 65 percent last year. And a Koch Industries subsidiary cancelled plans for a major pipeline to the Midwest from North Dakota for lack of interest by producers.

Across the international border in northern Alberta, dozens of crude-by-rail terminals are going up or being expanded. By one expert's calculation, 169 billion barrels are recoverable, which comes to about 100 years of production, and by then as much more may be extractable. "The emerging opportunity for us is the U.S. Gulf Coast, a massive market," says the vp-marketing of a Canadian producer. "Almost every refiner there has a coker" to extract carbon from the bitumen, which is what the tar sands oil is called.

But let's get back to North Dakota. Why is the rail share increasing? One reason may be that not much new pipe capacity will come on line in 2014, while production in that state and eastern Montana surges past the million-barrel-per-day level. More telling is where that oil increasingly wants to go: to the Atlantic and Pacific coasts, which no pipeline reaches directly. Dependent upon high-priced imported oil, east coast refiners "were on the brink of death in 2010," says Mark Smith of refining company Tesoro. "The shale revolution saved thousands of jobs in Pennsylvania and Delaware. Those refineries were ready to shut their doors for good."

My best guess is that in early 2014 as many as six unit trainloads of oil a day are being delivered by Canadian Pacific, CSX, and Norfolk Southern to Albany, N.Y. (for transloading to barges), the Delaware River refineries near Philly, and to a new Plains All American Pipeline oil distribution hub in Yorktown, Va. As infrastructure is developed further, that number could double. The east coast refineries are mostly configured to handle the light sweet crude coming out of the Bakken shale formations in North Dakota.

Erik Johnson, vice president and general manager of Canopy Prospecting, says there is 1.1 million barrels a day of refining capacity on the east coast, the vast majority of it between Philadelphia and Delaware City, Del. "It's a great place for crude by rail, with lots of infrastructure. CSX comes down from Albany on a route they are double-tracking. NS is another high-traffic route. Both are doing significant maintenance, building sidings to hold unit trains, adapting their infrastructure. They have been out in front talking to local communities and their emergency responders. The responders tell us a thick-skinned tank car is better than an aluminun-skinned truck."

Plus (unlike the Pacific coast), the public has been responsive, Johnson says. "When refineries were shutting down, you'd see signs in front yards saying, 'Support our oil workers.' People are pretty convinced this is safe. Railroads have been there a long time." Canopy is a partner in Eddystone Rail, which is about to open an oil-transfer facility in the Philly suburb of that name, on property once belonging to Baldwin Locomotive Works. It will be reachable by unit oil trains belonging to both CSX and NS. Ultimately Eddystone wants to connect to all the regional refineries by pipeline and to develop a "Philly blend" of crude oil that will become tradable on commodity markets.

By the way, TransCanada, which wants to build the Keystone XL pipeline to reach the U.S. Gulf coast, also plans to build a high-capacity pipeline from Alberta to New Brunswick. From there, diluted bitumen could be shipped down the coast to the Philadelphia area. "I'm not terribly concerned by it," says Canopy's Johnson. Another conference participant relates that the cost of getting the oil to New Brunswick in TransCanada's pipeline will be $7 a barrel, not counting removal of the diluent, but then you must pay to transload it to ships for delivery in the U.S., and the total price will be $10 or higher. Compare that to the $9-10 producers pay to get their barrels to the east coast by rail.

The west coast story is a bit different. There's lots of opportunity. Tesoro's Smith says refiners in California will ultimately need 500,000 barrels a day of light crude to replace imports. That works out to about six unit trains a day to that state. But right now, according to another presenter, the demand for light crude in California is limited to about 10 percent of the refining capacity. The appetite of refineries now is for heavier oil, although that could change if justified by lower prices for light sweet crude. Plus, there are few facilities today to unload unit trains, and every refiner's attempt to obtain permitting for crude-by-rail facilities has been met by an avalanche of opposition from environmental groups (witness the futile attempt, so far, by refiner Valero Energy to build such a terminal in Benecia, Calif., in the East Bay area). Finally, California is a long way from North Dakota. Look for Union Pacific and BNSF Railway both to seek ways to get oil to Southern California from the Permian Basin and Eagle Ford shale deposits in south and west Texas. Both oil fields are extracting light sweet crude similar to that found in the Bakken formation, and both are served by the western rail giants.

Smith told the conference that the Pacific Northwest, that is, Washington and Oregon, are the best-advantaged landing spots for North Dakota crude. He figures oil can get to Oregon by rail for $5.50 to $6.50 per barrel and to Washington for $6 to $7. "That's good for Tesoro," he adds. Tesoro, by the way, watched and waited a couple of years before embracing rail delivery. Then it jumped in, and in a matter of months built an unloading facility, initially for 50,000 barrels a day, at its refinery in Anacortes, Wash., on BNSF's line from Seattle to Vancouver, B.C. He says it paid for itself in a matter of months. By the way, Canadian Pacific and Union Pacific can team up to deliver Bakken oil to the PNW and California, but this will probably be BNSF's plum to chew.

Finally, let's look closer at oil coming out of Alberta, from north of Edmonton. There is already one pipeline to the the Vancouver, B.C., area, which its owner wants to expand from 300,000 barrels a day to 890,000 barrels, if opposition from First Nation (Indian) groups can be overcome. Another proposed pipeline to the Prince Rupert, B.C., area faces First Nation objections, too.

The pressure to move bitumen to Asia (supertanker rates are dirt cheap) is enormous. An educated assumption is that one or two things will happen. One is that CN and/or CP will strike a deal to become a pipeline-by-rail to either Vancouver or Prince Rupert. The hitch here is that neither place has a terminal to transfer oil from train to ship -- "there's a piece of the puzzle missing," to quote Ed Koshka of E-T Energy -- and CN officials told me last fall that nothing was in the works on this front. And if that isn't done, enough political pressure will be brought to bear to clear one or both of those pipelines to the Pacific Ocean.

But put aside those projects and TransCanada's pipeline from Alberta to New Brunswick. The destination that Canadian producers ache to reach is the U.S. Gulf coast. Two reasons: First, there are 9 million barrels a day of refining capacity, and second, most of it is set up to refine heavy oil, and no oil is heavier than bitumen.

As I've explained before, railroads will be 100 percent competitive with pipes on getting bitumen to the Gulf. That's because the oil sludge (bitumen) has to be diluted by almost 30 with a condensate to make the stuff flowable, making pipelines almost 30 percent inefficient right off the top, versus rail. The type of tank cars rolling out of the builders today has insulation and steam-coil fittings to heat up the bitumen for unloading, meaning no diluent is required. Says Brian Freed, VP of crude logistics for Crestwood Midstream Partners: "If you can get your hands on raw bitumen, you have a great product. The refineries want it." But Freed goes on to state the problem: "The number of places to get your hands on it are limited." That's true. Only a few loading and unloading terminals in Alberta and the Gulf region can handle raw bitumen, the tank cars you need are not yet in plentiful supply, and as for loading raw bitumen onto unit trains in Canada, forget it.

There yet another selling point for shipping bitumen by rail to the Gulf: The stuff that arrives by pipeline will be loaded with condensate the refiners don't want. The condensate will need to go back to Alberta to feed into pipelines again, and so railroads potentially have a nice backhaul product for their empty tank cars. One conference participant complained that not all railroads are willing to give significant discounts -- "They're getting better, but they aren't there yet." For what it's worth, Kansas City Southern's Darin Selby says his railroad favors these discounts and is ready to bargain.

Alberta producers are two to three years behind their brothers in North Dakota in developing rail infrastructure, but they will, and when that day comes, buy stock in Canadian National. It's the only railroad that goes from Alberta to the Gulf coast. Again and again this week, I heard oil producers say: If you can get get your oil to the refinery on one railroad, do it! Add a second (or a third) railroad and the handoffs get sloppy and the price goes up. Canadian National's rep at the meeting said the same thing, of course. Canadian Pacific will share in the bounty, perhaps handing off to Kansas City Southern in Kansas City (or to UP or BNSF in Chicago).

But to go back to my thesis at the beginning, crude by rail is teflon: All the bad news you throw at it just rolls right off. Meanwhile, the east coast destinations for North Dakota oil are being developed nicely, while the west coast refineries (particularly those in California) struggle to get facilities permitted and built. But they will, given time. Now the interesting thing to watch is in which directions and how that bitumen flows from Alberta. You know by now what I think: Keystone XL or no Keystone XL, a big bunch will come south in undiluted form to Louisiana and Texas inside insulated, steam-coil tank cars, and what a sight they will be.--Fred W. Frailey