TRANSPORT

Railroads hauling oil plant their flags in pipeline territory

For a U.S. oil industry transformed in recent years by new drilling technology, freight trains seem like a decidedly old-fashioned way of shipping crude.

But the nation's dominant railroads, including Warren Buffett's Burlington Northern Santa Fe LLC (BNSF), are rapidly becoming a long-term competitor to oil pipelines, driven by Midwestern refineries desperate for supplies of cheaper oil out of expanding production fields in the Great Plains.

"The U.S. unconventional oil and gas revolution is also generating a rail revolution," said Paul Sankey, lead oil analyst at Deutsche Bank in New York.

A coal train snaking out of coal country in Montana and Wyoming is an enduring image of the American West. Yet BNSF, owned by Berkshire Hathaway Inc., and smaller train car operators are expanding their profits by filling in gaps left by oil pipeline shortages and the aggressive pursuit of customers in the oil refining business.

With oil production surging out of North Dakota's Bakken field, refineries from Washington state to New Jersey say they'll pay a premium to get oil shipments from the Bakken.

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Independent refineries, integrated oil giants and traders are putting a premium on logistical versatility, Sankey said, including into and out of the nation's biggest oil storage hub in Cushing, Okla.

Pressure-packed oil trading and tight refining margins are opening doors for the rail companies, and competitive rail contracts are eroding the pipeline industry's dominant position.

An Enbridge Inc. pipeline in North Dakota ran below capacity in November 2012, according to a Federal Energy Regulatory Commission filing by Flint Hills Resources LLC, a Wichita, Kan.-based subsidiary of Koch Industries Inc. Flint Hills told FERC officials that "rail transportation is becoming more competitive and will continue to take barrels away from the Enbridge North Dakota system."

"Volumes on our North Dakota system will significantly increase as our regional market access projects begin to come online later this year," Enbridge spokesman Larry Springer said in an email.

In 2008, petroleum products filled just 9,500 carloads of rail, according to the Association of American Railroads (AAR). When 2012 figures are out, that number is expected to climb to 200,000 carloads. Although pipelines still represent the bulk of the nation's crude transport, they're seeing more competition from railways.

"Rail can come up quickly to meet a short-term gap, and we're seeing that in the market," said John Stoody, director of public and government relations at the Association of Oil Pipe Lines (AOPL).

Rail's resurgence is "almost all from the fracking boom," Stoody said, referring to the oil industry's expanding use of advanced horizontal drilling and hydraulic fracturing technology to tap tight oil formations. The industrial process is criticized by environmental groups concerned about air pollution and groundwater contamination near fracking sites.

The technique is widespread in North Dakota, where crude oil production has averaged above 700,000 barrels per day in recent months, according to the Energy Information Administration (EIA). Energy prices in the region have plunged in response to the glut of shale oil and natural gas.

'Game-changing' supply solution?

Meanwhile, pipeline infrastructure has failed to meet the sudden rise in demand.

North America's major freight operators have rushed to fill the void, hoping to make up for sharp declines in coal shipments over the past few years. And the rail companies don't see themselves disappearing from the picture after more pipelines expand or open.

"We do not see this as temporary," said John Miller, vice president of industrial products sales at BNSF Railway Co. "We see this as a long-term, game-changing supply solution, and that's evidenced by actual capital investment by [oil] companies into this network."

EIA announced this month it plans to start collecting data on crude shipments by rail, which for decades commanded just a sliver of the petroleum pie compared with pipelines and barges.

"This is definitely a gap in our data collection," said Doug MacIntyre, director of petroleum and biofuels statistics at the EIA. "There's a lot of increased transport of crude oil from the Bakken area to other parts of the country."

For light, sweet crude extracted from the Bakken Shale play in North Dakota, a single rail car can carry nearly 1,000 barrels of oil, according to figures from the AAR. ("Sweet" crude contains less sulfur than its "sour" counterpart and requires less processing.)

But for eager oil companies, most of the country's 290,000 tank cars are tied up in other commodities, from sulfuric acid to vegetable oil. That hasn't stopped refiners such as Phillips 66 and Valero Energy Corp. from buying thousands of rail cars.

Valero recently ordered 2,000 tank cars for shipping crude to inland refineries. The San Antonio-based company's fleet will number about 9,000 cars when the new arrivals come online in the next year or two.

"A lot of the new domestic oil production is happening in areas that are not served by pipelines or other infrastructures for moving crude in large volumes, so we've looked at other ways to get the crude," said Valero spokesman Bill Day. "If you don't have pipelines and you don't have waterborne access, rail is the best option."

Valero's Memphis, Tenn., facility -- one of 16 refineries it operates worldwide -- receives about 40,000 barrels per day of Bakken crude. The oil is shipped by train from extraction sites in North Dakota to the St. James terminal in Louisiana, where it is transferred to a pipeline and pumped up to Memphis.

But even when additional pipelines open in the Midwest, Day expects rail cars to remain valuable assets. "The more flexibility we have, the better," he said. "That gives us the ability to react to market conditions."

Oil producers and refiners can turn to locomotives to avoid committing to the 15- or 20-year contracts often requested by pipeline operators (EnergyWire, Nov. 29, 2012). Phillips 66 recently finalized a five-year agreement with energy supplier Global Partners LP to ship 50,000 barrels a day of Bakken crude to its New Jersey refinery by train in a deal worth an estimated $1 billion. Tesoro Corp. has a 40,000-barrel-per-day minimum commitment to transfer crude from an Anacortes, Wash., unloading facility acquired by Tesoro Logistics LP for $180 million in November.

Afraid of commitment

Short-term rail deals are not without risk. If the price gap that separates oil imports and the West Texas Intermediate (WTI) benchmark price closes, oil refiners could feel the burn from rail's higher price. Bakken crude often sells even cheaper than the WTI price, which is trading at around $95 per barrel. Adding a premium of $10 to $15 per barrel for rail transport still yields favorable returns compared with buying foreign Brent crude, marked at $110.61 per barrel Thursday.

Ultimately, the economics of rail transport over the next few years could hinge on pennies on the barrel.

Rail's future in the petroleum industry also depends on the progress of pipeline infrastructure.

Pipelines provide a less expensive option and represent the bulk of crude transport nationwide, particularly in well-established markets such as Texas. A pipeline shipment from Houston to New York costs about $2 per barrel.

"Pipelines are always going to be much cheaper than rail," said Stoody of the AOPL. He pointed out that the roughly 2.5 million barrels per day of pipeline projects under construction will start to siphon business back away from the rails in places such as North Dakota and Oklahoma.

However, pipelines often face greater political and environmental push-back than railways. The Northern Gateway project from Alberta to British Columbia and the controversial Keystone XL project are prime examples.

"The delays to the Keystone XL are ironically forcing more oil onto rail, which we believe safety statistics show is a riskier way to move," noted Sankey at Deutsche Bank.

The Federal Railroad Administration has said it is taking steps to address traffic increases in the Bakken oil region, including conducting additional safety inspections, according to a spokesman. But oil companies hoping to ship by rail must still contend with accident rates more than five times higher than steel pipelines, based on calculations from 2010 Department of Transportation data.

Proponents of shipping crude by train are quick to observe that pipeline accidents, though rarer, typically involve bigger spills.

"We wouldn't move crude by rail if we didn't think it could be done safely and efficiently," said Day, spokesman for Valero.

Efficiency will be key for rail's long-term survival in the capital-intensive oil industry. Although oil companies' recent asset acquisitions bode well for railroads' prospects, their flexibility can only go so far.

"It's clearly a risk that pipelines will in due course undermine rail profitability, because it's cheaper to move by pipeline," Sankey said.

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