Bloomberg News

Oil Industry Beats Buffett in Railroad Investments Surge: Energy

January 14, 2013

Oil Industry Beats Buffett in Railroad Investments Surge

Rail tanker cars sit lined up in Corpus Christi, Texas. Photographer: Eddie Seal/Bloomberg

North American energy companies are starting to invest more in railroad terminals than the railroads themselves.

A group of oil and natural gas pipeline operators led by Plains All American Pipeline LP (PAA:US) announced plans just in the past three months to spend about $1 billion on rail depot projects to help move more crude from inland fields to refineries on the coasts. Warren Buffett’s Burlington Northern Santa Fe LLC, the largest U.S. railroad, spent $400 million on terminals in 2012.

For the first time, energy companies that traditionally rented rail capacity are buying the assets because swelling output from Alberta’s oil sands and shale fields in North Dakota’s Bakken region and Eagle Ford in Texas has overwhelmed pipelines. Producers and refiners such as Devon Energy Corp. (DVN:US) and Irving Oil Corp. say they’ll turn even more to rail to get domestically pumped crude to the highest-paying refineries.

“If a refiner in Philadelphia is paying $110 for Nigerian crude and could replace it with cheap Bakken crude, they’ll be willing to pay up to $109.99 to replace that,” said Bradley Olsen, an analyst with Tudor Pickering Holt & Co. in Houston.

With domestic crude at least 20 percent cheaper than imports, the profit potential is obvious.

Refiners on the coast pay prices linked to Brent, the benchmark grade for more than half the world’s oil. Brent futures averaged $110.13 a barrel on the New York Mercantile Exchange during the fourth quarter, while the U.S. benchmark grade, West Texas Intermediate, averaged $88.23.

Record Discount

Western Canada Select, the benchmark for oil-sands crude, averaged $61.23 on the spot market in the fourth quarter, down as much as $42.50 below WTI in December, a record discount.

More than 200,000 train cars of oil will be shipped in 2012, the most since World War II, according to forecasts from the American Association of Railroads. About 1 million barrels a day of rail-unloading capacity is being built in the U.S., Olsen wrote in a note. That’s more than double the current level of shipments, which averaged about 456,000 barrels a day in the third quarter, according to the Railroad Association.

Burlington Northern, which handles about 35 percent of U.S. oil shipments, itself plans to spend “a couple hundred million dollars” on capital improvements to help haul 40 percent more crude in 2013, Chief Executive Officer Matt Rose said Jan. 8. The carrier was bought by Buffett’s Berkshire Hathaway Inc. (A:US) about two years ago for $36 billion including debt.

Urban Advantage

While rail transport is more expensive than pipelines, it already reaches into metropolitan areas like Los Angeles and Philadelphia, where new pipes are hard to lay and refineries are paying the highest price.

Rail transport is set to become cheaper as infrastructure expands. The system relies on 1.2-mile trains of tank cars that carry as much as 762 barrels each. At 120 cars per train, each shipment can be worth $8 to $10 million.

“Rail used to be a stopgap for the short term,” said Kevin Goins, president of Strobel Starostka Transfer, a closely- held company that builds and operates rail terminals. As drilling pushes into new places, rail “can get into different areas where pipelines never existed before.”

Higher Profit

Crescent Point Energy Corp. (CPG), based in Calgary, earned an extra $10 a barrel by shipping some of its Saskatchewan oil to the U.S. Gulf Coast, Chief Executive Officer Scott Saxberg said in an Oct. 18 interview. It pipes most of its oil to the Midwest.

Canadian railroads moved 35 percent more petroleum and refined products in November than the same month of 2011.

Plains bought four oil-handling terminals, plus a terminal under construction and shipping contracts across the U.S. in December for $500 million. Pipeline company Inergy Midstream LP (NRGM:US) spent $425 million in November to buy a North Dakota terminal from Rangeland Resources LP.

Rail is “effectively a pipeline on wheels,” filling the gaps in the transportation system, Plains CEO Greg Armstrong said at a Nov. 29 conference. Plains shares rose 23 percent last year, beating the 1.2 percent decline in the period of the Alerian MLP index of energy master limited partnerships that includes pipeline companies as members.

Plains competitor Enbridge Inc. (ENB) and Canopy Prospecting Inc. are building a $68 million terminal that will be able to transfer 80,000 barrels a day onto rail cars starting in the third quarter, for delivery to Philadelphia-area refineries, the companies said in a statement.

Enbridge, which is expanding pipeline capacity out of the Bakken, plans to take its oil as far east as possible by pipe and use rail for the end of the journey, Vice President Vern Yu said in an interview.

Plains fell 1.2 percent to $49.30 at the close in New York. Enbridge lost 0.1 percent to C$44.02 in Toronto. Plains gained 23 percent in 2012 and Enbridge gained 13 percent, according to data compiled by Bloomberg.

Refiners’ Investment

Irving Oil is accepting more than 90,000 barrels a day from the Bakken and Canada by rail at its Saint John, New Brunswick refinery, Canada’s largest, a person familiar with the plans said on Dec. 26. Phillips 66 (PSX:US), whose Bayway refinery in New Jersey is the second-biggest on the East Coast, is building an unloading station to increase train deliveries, CEO Greg Garland said on a Dec. 13 conference call.

“We’re buying 2,000 railcars so we’re using rail, pipe, ships, barge, trucks, you name it,” Garland said.

Oil production in the U.S. is projected to increase about 24 percent to 7.9 million barrels a day by 2014, the most since 1988, according to the U.S. Energy Department. Canadian oil output will rise 57 percent to 4.7 million barrels a day by 2020, according to the Canadian Association of Petroleum Producers.

Bottleneck Surplus

Much of the production comes from places such as Alberta’s oil sands and North Dakota’s Bakken formation, far from refining centers. A lack of pipelines to carry the crude to market has created bottlenecks that pushed down the price of oil from those regions.

The higher prices fetched on the coast justify the higher cost of shipping by rail. Sending Bakken oil through a pipeline to U.S. Midwest markets costs about a third of the $15 a barrel expense of carrying it by train to the East Coast, Tudor Pickering’s Olsen said in a note.

Rail has carved out a role alongside pipe over the long haul, said Chris Seasons, the president of Devon’s Canadian unit. While pipelines are cheaper and more efficient, it’s faster to build the tracks, unloading terminals and storage tanks to expand rail capacity, he said.

“On the rail side of the business, you can effect change quite quickly,” Seasons said. Devon, which moves 4,000 barrels of heavy oil a day by rail from Alberta to the U.S. Gulf Coast, plans to buy more rail cars, he said.

Environmental Hurdles

Some landowners and environmental groups such as the Sierra Club may further slow pipe projects over the risk of spills and air pollution from Canadian crudes. TransCanada Corp. (TRP)’s Keystone XL from Alberta to the U.S. Gulf Coast and Enbridge Inc.’s Northern Gateway from Alberta to the British Columbia coast already face delays from protests and increased regulatory scrutiny.

TransCanada expects U.S. regulators to decide Keystone XL’s fate in early 2013, the line’s original start time. Another half-million barrels a day in new rail capacity may be built if Keystone XL is blocked, estimates Steven Paget, an analyst at FirstEnergy Capital Corp. in Calgary.

Railroads will become more efficient crude handlers as producers and refiners build a system that moves oil from hub to hub around the continent, Paget said. Once planned new infrastructure is built, coastal markets should be able to absorb the increases in production from the Bakken and the Niobrara field in Colorado for several years, Olsen wrote in a Jan. 2 note.

Slowing Growth

Railroads face their own constraints, in addition to higher costs. A shortage of rail cars capable of carrying crude is slowing growth in the sector, with delivery times of new cars two years out, Seasons said.

Spills are a bigger risk with trains than pipes, according to the Manhattan Institute, a New York-based policy research organization. A U.S. railway is about 34 times more likely to spill hazardous materials, including oil, than a pipeline transporting the same volume an identical distance, according to the Institute’s June analysis of data from the U.S. Transportation Department and the Pipeline and Hazardous Materials Safety Administration.

Railroads have an accident rate just two to three times higher than pipelines, Patti Reilly, a spokeswoman for the American Association of Railroads trade group, said in an interview. Railroad spills tend to involve smaller amounts in each incident, since trains carry far smaller amounts of oil than pipelines, she said.

Solidifying Role

Still, trains’ ability to reach higher-priced markets more quickly has solidified their role in crude transportation. There are already existing tracks serving areas where pipelines are harder to build, such as the congested urban areas surrounding Philadelphia and California, the most populous U.S. state.

“It’s probably unlikely that somebody’s going to build a big new pipeline from North Dakota to LA or San Francisco,” Ethan Bellamy, an analyst with Robert W. Baird & Co. in Denver, said.

That advantage could make it attractive to build a rail link from booming production fields in Texas to California, Chris Keene, Chief Executive Officer of terminal operator Rangeland Energy LLC, said in an interview.

“It’s definitely here to stay,” he said.

To contact the reporters on this story: Mike Lee in Dallas at mlee326@bloomberg.net; Rebecca Penty in Calgary at rpenty@bloomberg.net

To contact the editor responsible for this story: Susan Warren at susanwarren@bloomberg.net


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Companies Mentioned

  • PAA
    (Plains All American Pipeline LP)
    • $59.82 USD
    • 0.30
    • 0.5%
  • DVN
    (Devon Energy Corp)
    • $78.15 USD
    • 1.03
    • 1.32%
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