EOG Resources Inc (EOG), Continental Resources, Inc. (CLR): Could Railroad Companies Lose Their Fastest-Growing Client?

The North American rail industry has been a life raft for oil production. In almost every major shale oil play in the U.S., production has steadily outpaced pipeline capacity. Without enough room in the pipe, many producers have relied on rail to get crude oil to market. This has not only helped bring the U.S. shale boom to where it is today, but it has also padded the balance sheets of several rail companies.

Will oil continue to hop on the train and ride it to profitability? Or will pipelines regain their place as the only place for oil to call home? Let’s take a look at some of the developments in the rail business to see where it may be headed.

Getting hitched up
The lack of pipeline is an obvious reason for oil producers to choose rail, but to pin all of rail’s success on the oil business on that wouldn’t do railroads justice. Rail also provides another element that pipe never has been able to do: a wide array of destination options. EOG Resources Inc (NYSE:EOG), one of the pioneers of moving oil via rail, starting using the rail option back in 2009 to deliver Bakken crude oil. The idea really took off when Bakken crude started going to East and West Coast refineries, where prices for foreign oil were way more expensive than for Bakken. It was a match made in heaven. Refineries got access to cheaper crude, Bakken producers didn’t need to compete with the bloated spot markets in the U.S. Gulf Coast, and rail got an additional revenue source.

This idea has taken off like a bottle rocket. According to the Association of American Railroads, total crude shipped this past quarter was 97,135 carloads, a 166% jump from this quarter last year and the largest jump in crude shipments in over a decade. The largest sources of rail’s success has come from a few select places, most notably the Bakken formation and Canadian oil sands. EOG Resources Inc (NYSE:EOG) ships 100% of its Bakken crude via rail, and Continental Resources, Inc. (NYSE:CLR), the top producer in the Bakken, now transports approximately 80% of its crude via rail.

As much as it has changed the game for refiners, it is also slightly changing the way rail does business as well. Two of the largest crude via rail transporters, Canadian Pacific Railway Limited (USA) (NYSE:CP) and Canadian National Railway (USA) (NYSE:CNI), both expect to see crude shipments double for the respective companies in 2013, and Canadian Pacific Railway Limited (USA) (NYSE:CP) anticipates another doubling to 140,000 carloads by 2015. Canadian National Railway (USA) (NYSE:CNI) is also planning on bringing trains dedicated to transporting oil exclusively.

Don’t go full steam ahead just yet
While both of these rail companies’ plans my sound ambitious, they are also tempering expectations because they realize the weaknesses that rail has over pipelines. Compared to pipelines, rail shipments are like first-class tickets for oil. According to research firm Wolfe Trahan, oil shipments by rail cost about $10-$15 per barrel, depending on the destination vs. $5 per barrel for oil moved by pipe. When rail shipments were taking off, producers and refiners were willing to pay a premium because it still was less than foreign crude prices. As the price spread between domestic and foreign crudes narrows, though, the advantage of oil via rail diminishes.