Amid U.S. Oil Boom, Railroads Are Beating Pipelines in Crude Transport

By Matthew Philips and Asjylyn Loder 

 

Last October, Kinder Morgan Energy Partners, the biggest U.S. pipeline operator, announced plans to build a 740-mile pipeline from the oil fields of West Texas to a refining hub outside Los Angeles. Dubbed the Freedom Pipeline, the $2 billion project would deliver 277,000 barrels a day of cheap Texas crude to West Coast refineries that had long relied on expensive oil shipped from Alaska’s North Slope or even foreign markets. All Kinder Morgan needed was to get regulatory approval and long-term contracts with large California refiners, including Valero Energy(VLO) and Tesoro (TSO).

In April, Kinder Morgan began negotiating agreements with refiners, who normally commit to buy predetermined amounts of oil for as long as 10 years. On May 31, however, Kinder Morgan announced it was canceling the project after Valero and Tesoro said they weren’t interested in buying the pipe’s oil on a long-term basis. They’d found a better way to get their hands on domestic crude: railroads.

America’s energy boom has left the middle of the country awash in cheap oil. But as pipeline companies scramble to spend billions of dollars to build new pipes to tap these hot new fields, they’re discovering that railroads have beaten them to the punch. By laying a few extra miles of track and building new loading facilities, oil and gas operators are quickly connecting remote areas of oil production with the existing networks of big railroads such as Union Pacific (UNP) and BNSF Railway(BRK/A). On the other end, they’re running tracks directly into refining complexes as far away as Philadelphia and Puget Sound. These rail projects can often be finished in a matter of months at a cost that’s usually in the millions, not billions.

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The rail industry is now hauling more crude than at any time since the days of John D. Rockefeller’s Standard Oil. According to the Association of American Railroads, trains transported a record 97,135 carloads of crude oil in the first quarter of 2013. That’s 166 percent more than during the first quarter of 2012 and 922 percent more than trains hauled during all of 2008. “This is a revolutionary change in crude oil logistics that has rarely happened before,” says Julius Walker, an energy strategist at UBS Securities (UBS). “Very quickly, railing crude has become much more competitive.”

While moving crude by pipeline still costs about half to one-third what it does to move it by rail, trains don’t require long-term contracts or need to wait for pipelines to be built. And while pipes stretch only from point A to point B, refiners can access nearly any market in the U.S. by rail.

That flexibility to target the most lucrative markets has been particularly useful over the past few years as regional prices have varied substantially. Oil sold on the Gulf Coast fetches about $9 more per barrel than the same grade of crude sold in Cushing, Okla. Three months ago it fetched $23 more. The ability to easily shift delivery markets to maximize revenue is why “oil companies are leasing rail cars like drunken sailors,” says Oppenheimer energy analyst Fadel Gheit.

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Union Pacific, the nation’s largest railroad, tripled the amount of crude it moved last year, helping boost its profits to a record $3.9 billion for fiscal year 2012. BNSF, the No. 2 rail company, which Warren Buffett bought in 2010, is now transporting about 650,000 barrels of crude per day, vs. almost none five years ago.Canadian Pacific Railway (CP) expects to haul 70,000 carloads of crude in 2013, up from 500 in 2009.

Much of this increase has come from the Bakken shale formation in North Dakota, where crude production has jumped about 250 percent since 2009. BNSF and Canadian Pacific have invested heavily there over the past few years. Together they carry about 400,000 barrels out of the Bakken each day. According to a June report by Bloomberg Industries, 71 percent of all Bakken crude now leaves the region by train, compared with 25 percent in January 2012. Only 20 percent travels by pipeline, down from 61 percent in 2011.

The crude boom has helped railroads weather the hit they’ve taken to their coal business. As utilities have switched to cleaner-burning natural gas, coal shipments have fallen 23 percent since 2008. Hauling crude can sometimes be more lucrative; according to David Vernon, a transportation analyst at Sanford C. Bernstein (AB), Union Pacific generates about $2,500 per carload of crude vs. $2,200 for a carload of coal because of the high demand for crude by rail.

Culled from Bloomberg.com