The Pipeline Alternative: Shale by Rail

Oil train 2

Improvements in hydraulic fracturing and horizontal drilling have unleashed a flow of U.S. oil faster than pipelines can be built to carry it, creating a bounty of business for good, old-fashioned railroads.


Even though sending oil through pipelines is cheaper than shipping it by rail, the number of carloads of crude oil hauled on the rails has increased roughly 20-fold since 2008, according to the American Association of Railroads. The trade group estimates that rails will soon carry as much as 600,000 barrels per day – roughly 10 percent of the country’s total oil production.


“The crude market is developing and changing so fast that energy companies simply cannot afford to wait for pipeline infrastructure to catch up,” Credit Suisse analyst Chris Ceraso writes in a recent research note.


Ceraso, who covers the U.S. transportation and automotive sector, says the result has been and will likely continue to be a windfall for rail companies. Union Pacific, for example, said in its earnings release last month that the volume of crude oil shipments increased by 160 percent in the fourth quarter and was likely to remain a key part of the rail line’s business. Norfolk-Southern Railroad saw a 9 percent growth in the volume of chemical shipments, driven almost entirely by crude oil shipments.


The pace of rail transport began to pick up in 2009, driven by growing production in the Bakken shale formation.  Over the past four years, producers working the play, which spreads across North Dakota, Montana and Canada, more than tripled output from about 150,000 barrels per day to about 617,000, Ceraso writes.


Most pipelines out of North Dakota lead to the oil hub of Cushing, Okla., before moving to the refineries on the Gulf Coast. Railroads provide a way to easily transport oil to West Coast and East Coast markets, but their role in providing an alternate route to the Gulf has become increasingly important as well. In 2010, a glut of oil in Cushing pushed prices of West Texas Intermediate oil down dramatically compared to Brent crude oil imported from the North Sea.


“Rail terminals can be built significantly faster than pipeline,” Ceraso writes. “Additionally, transit times are faster – it takes 40 days for crude to reach the Gulf via pipeline from the Bakken, while unit trains are roughly 90 hours each way.”


Ceraso points out that railroads service every refinery in the country – something that can’t be said for pipelines. Construction of new rail loading facilities also face fewer regulatory fights than pipeline construction projects. Environmental concerns, for example, have held up federal approval of the northern portion of the Keystone XL pipeline, which would start in Canada.


But perhaps the most important selling point for transporting crude oil by rail is that existing railroad line infrastructure allows oil producers to adjust quickly to the rapidly shifting landscape of an industry in expansion mode. Production is expected to grow significantly over the next few years in the Permian and Eagle Ford basins in Texas, Colorado’s Niobrara formation, the Utica play in New York, Pennsylvania and Ohio and the Canadian oil sands.


Ceraso points out that the dramatic increase in domestic demand could set the stage for an oversupply problem at oil transport hubs in Louisiana and Chicago, which would depress the price of oil in those areas.


Refineries are trying to position themselves to cash in on any drops in the price of domestic oil. Phillips 66 has said it plans to add additional rail cars to transport crude oil, Ceraso writes, and the company signed a contract last month with Global Partners to use rail to bring oil from the Bakken to a major refinery in New Jersey. Tesoro has also said it will start relying more heavily on rail transport to bring crude oil from North Dakota and Canada to refineries in Washington state and California.


The immediate advantages of shipping by train mean the rails are likely to play an important part in moving crude oil around even after a host of new pipelines come online over the next five years.


“The enormous flexibility that the rails have to respond to rapidly changing and unforeseeable market conditions is a tremendous asset that should ensure the industry’s long-term sustainability in the shale revolution,” Ceraso writes.


Photo courtesy of Flickr – roy.luck