Unconventional oil shales have provided critical revenue for the large US independents at a time when weak gas pricing might otherwise be disastrous. Getting that oil to market however, is a challenge. Bakken production is log jammed because of a lack of pipeline infrastructure. Similar issues have hamstrung western Canadian syncrude producers. Rail shipping has been critical to getting this off-the-beaten-trail production to market and its contribution is still expanding.
Berkshire-Hathaway gives its shareholders a peek into virtually every corner of the economy. The relatively recent addition of Burlington Northern Santa Fe extends that look even further. With the slowdown in coal shipments to China, there was some concern that rail revenue might be impacted. In his annual letter, Buffett disclosed that BNSF’s moving a lot of oil that’s more than picking up the slack.
Canadian Pacific Railway Limited (USA) (NYSE:CP) is just beginning build-out of its Bakken crude loading depots, and expects to be operating 70,000 oil tankers annually, up from 13,000 in 2011. Altogether, approximately a third of current Bakken production is shipped by rail.
With environmental impact studies still red-lighting the controversial Keystone XL pipeline, Canadian syncrude producers are looking to copy the rail success in the Bakken. Canadian Pacific Railway Limited (USA) (NYSE:CP) is now gearing up its facilities in Alberta to carry oil sands syncrude. The combined weight of Bakken and Canadian demand has created a production backlog for railcar tankers.
Berkshire-Hathaway’s Union Tank Car unit is backlogged through 2014. Another manufacturer, Greenbrier Companies Inc (NYSE:GBX), is reportedly now booking its 2015 orders. Carl Icahn recently disclosed a 9.9% stake in Greenbrier, so the heavyweights are taking notice and making their bets. Trinity Industries, Inc. (NYSE:TRN) is a third way to play the high railcar demand, for those keeping score.
In contrast to the Bakken, only a small portion of Alberta oil sands production is now shipped by rail. That could increase significantly if Keystone XL is held back longer. In fact, the successful utilization of rail for Bakken oil shipment has been highlighted by US officials that question the need for the controversial pipeline.
Rail shipping is becoming cool again. EOG Resources Inc (NYSE:EOG) first started using it to move its Bakken crude in 2009. The project was so successful that EOG expanded its rail shipping capacity to 70 MBbld. It’s currently rail shipping the bulk of its Bakken production to its St. James, LA rail terminal.
That means that EOG nets Louisiana Light Sweet prices on its Bakken crude, rather than West Texas Intermediate prices that prevail at Cushing, OK or Enbridge’s terminal at Clearbrook, MN. Since LLS prices off Brent due to its easy access to east coast refiners, the spread can top $20 a barrel. For many producers, shipping costs eat up that spread, since rail shipments are estimated at $16-$18 per barrel, about 3 times the cost of pipeline transport.
EOG leases its own railcars though, and its loading and offloading facilities are company owned. Its first mover status and company owned infrastructure enhance net backs to EOG making the whole system more profitable. It’s also more flexible, since EOG can take oil to whatever market’s pricing best.
The company is starting to rail ship directly to east coast refineries and is working to expand its facilities out east. Rail allows EOG to bring its oil to whatever US market brings the highest price, bypassing as much of the midstream carriers as possible, meaning higher margins on its crude. ‘Got crude, will travel’ is EOG’s theme for the day.
It’s a unique advantage that EOG has over the competition. The only other producer currently rail shipping its own product is Hess Corp. (NYSE:HES), which opened its own loading terminal in Q1 of 2012. The new rail terminal has 120 MBbld capacity and will be a key component in Hess’ efforts to build out its expanding Bakken interest.
One question is how long can the rail story last? How long can the rails expect to ride the wave of demand? That’s unclear, but some oil producers like EOG and Hess seem to prefer the rail model and its flexibility.
In addition, unconventional shales pop up in out of the way places by their very nature. That’s the issue in the Bakken. The Williston Basin was not a strong basin prior to the Bakken and its infrastructure was too sparse to cope with the boom. Ditto for the Athabasca oil sands of Alberta. They just can’t find a way to move all the stuff that’s there.
Then there’s the east coast. Direct shipment of light sweet crude to east coast refiners could provide the greatest price spread. EOG sure thinks so, but building out midstream assets in the more densely populated east presents problems. The rail infrastructure needed is already in place and bypasses the need to procure costly easements and obtain regulatory approval.
These kinds of problems could be recurrent with new plays in the future. Rail’s flexibility is key. It’s worth noting that even midstreams have joined the party. NuStar Energy L.P.’s partnered up with EOG on its St. James, LA terminal and KinderMorgan is investing in Watco Industries, the largest closely-held short-line US railroad.
The jury’s still out. Even without the political and environmental resistance to the Keystone XL pipeline factored in, rail may prove to be the cheapest and most flexible solution to the midstream problem that the shale revolution has created. There are a lot of ways to play the trend, from producers that have leveraged the strategy, to the railroads and their suppliers. Next time you’re sifting through the oil patch for ideas, it may be worth your while to turn an eye to the rails.
The article To Market, To Market, To Fetch a Fat Spread originally appeared on Fool.com and is written by Peter Horn.
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