MLPs: The Economics of Crude by Rail
In the previous issue of MLP Investing Insider, I wrote about how energy producers and shippers are overcoming the limitations of existing pipeline infrastructure by turning to the rail system to ensure that crude oil gets to key markets. That prompted one worried subscriber to wonder how this would affect the growth of midstream master limited partnerships (MLP) that have made significant investments in building pipelines to serve prolific US shale plays.
As I noted in my earlier article, pipelines should remain the dominant mode of shipping energy products, while the crude-by-rail trend could diminish as additional takeaway capacity is added to midstream infrastructure. For context, Barclays analysts estimate that crude by rail accounts for just 2 percent of overall industry volume.
But in landlocked areas such as the Upper Midwest’s Bakken Shale formation, 71 percent of crude is now transported by rail, while 20 percent is carried by pipeline, according to estimates from the North Dakota Pipeline Authority. And with crude oil production in the Bakken accounting for almost 11 percent of total US production in February (month for which most recent data were available), the importance of crude by rail can’t be ignored.
The good news is that midstream MLPs are already part of the crude-by-rail story. Indeed, we identified several such names in the last issue of MLPII (linked above), but there are numerous others with at least some exposure to the crude-by-rail trend, including Enterprise Products Partners LP (NYSE: EPD), Kinder Morgan Energy Partners LP (NYSE: KMP), Genesis Energy LP (NYSE: GEL), and Oiltanking Partners LP (NYSE: OILT), among others. Barclays estimates that MLPs have already invested $2 billion in railroad terminals, including acquisitions.
Though railroads obviously do the heavy lifting of actually moving the crude to market, MLPs participate in this process by building or investing in railroad terminals and transloading facilities that can accommodate crude shipments.
Rail terminals are cheaper and easier to build or acquire than pipelines, but the actual transportation of crude by rail is far more expensive than moving it to refineries via pipelines. One of the reasons the former is even an option is because of the substantial price differential between light, sweet crude produced in the Bakken relative to the global benchmark Brent.
While Gulf Coast refineries are the beneficiaries of rising output from nearby shale plays in the Eagle Ford and Permian, in addition to shipments from the Bakken, refineries on the East and West Coasts each import about 1 million barrels per day from overseas. That gives Bakken producers a pricing advantage relative to imports. But it also requires creative logistics, given the lack of midstream infrastructure connecting the Bakken to coastal refineries.
Splitting the Differentials
The price differential was at its widest in March of last year, when Bakken US High Sweet Crude (UHC) averaged $90.26 per barrel versus $126.31 per barrel for Brent crude, a difference of $36.04 per barrel and a substantial 28.5 percent discount. Since then, that differential has narrowed thanks in part to railroads’ “virtual pipelines.” Even so, at the end of last week, it was still $14.30 per barrel.
Bakken UHC has also traded at a discount to US benchmark West Texas Intermediate (WTI), which itself is cheaper than Brent. That differential was at its widest in February 2012, when Bakken UHC fetched $86.21 per barrel versus $102.21 for WTI, a $16.00 difference, or a 15.7 percent discount. More recently, the differential has narrowed to just $3.35 per barrel.
These differentials persist because limited takeaway capacity has resulted in a glut of supply. But as crude by rail continues to ramp up and more midstream infrastructure is built with each passing year, then presumably these differentials will diminish further. The question is whether that will eventually make it uneconomic to ship crude by rail, particularly as pipeline capacity comes closer to meeting supply.
The Bakken/Brent price differential will, of course, be key in that determination. If the spread narrows too much, then it’s no longer profitable to move crude by rail. For instance, Morgan Stanley estimates that the cost of shipping crude by rail from the Bakken to Gulf Coast refineries runs around $18 per barrel versus $12 per barrel for delivery via pipeline. That’s a huge difference in percentage terms, but not so much in dollars when you’re dealing with volatile energy commodities.
Of course, those figures don’t include the cost of building or acquiring the respective infrastructure necessary for each mode of transportation. So that also must be taken into consideration.
On the other hand, East and West Coast refineries are situated near densely populated areas where regulators might be loath to add new pipeline infrastructure. That means crude by rail could remain an important option for these markets during periods when it’s profitable to do so.
Stock Talk
Robert Zeller
Which railroads will benefit the most?
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Investing Daily Service
Hi Mr. Zeller:
Although there are no railroads that are MLPs, Ari Charney recently wrote an article in the free ezine
MLM regarding railroads benefiting from Canadian oil. The article is shown below:
Canadian Crude Gets Railroaded
By Ari Charney on April 2, 2013
Print Friendly
One of the most difficult aspects of investing is anticipating how and when businesses or industries will adjust to operational hurdles. After all, even some of the worst setbacks can be overcome with a little human ingenuity–or just a bit of common sense. That means investors must distinguish between those situations that are likely to persist well into the future and those that are merely transitory.
The latest such example is the volatility in Canada’s oil-price differential. Canadian crude oil has long traded at a discount to the North American benchmark West Texas Intermediate crude (WTI). Indeed, over the four years spanning 2008 through 2011, Canada’s benchmark Western Canada Select crude (WCS) sold for an average of $15.21 per barrel less than WTI–a discount of about 17.9 percent.
Part of this long-term differential stems from the fact that crude produced from Alberta’s oil sands is a heavier grade than US crude, which makes it’s more expensive to refine than the light, sweet crude represented by WTI. Though Canada does produce lighter grades of oil, heavy crude accounts for roughly two-thirds of its oil exports.
Late last year, the oil-price differential widened significantly, as rising light crude production from prolific US shale plays caused a bottleneck at key pipelines. The resulting traffic jam crowded out Canadian crude from reaching US refineries. That situation worsened toward the end of the year, as takeaway and refining capacity became even more scarce due to maintenance problems at pipelines and refineries.
The good news is the oil-price differential appears to have peaked in December, when WCS sold for $33.63 per barrel less than WTI, a 38.1 percent discount. Then in February, the spread quickly began to narrow until it fell to a low of $14.25 last week. That’s just 14.7 percent less than WTI, a spread that’s 3.2 percentage points less than the average discount that prevailed in the aforementioned four-year period that ended in 2011.
So what happened? Faced with limited pipeline access and rising inventories, Canadian oil producers began transporting crude south via railroad and trucks. According to National Bank Financial chief economist Stefane Marion, crude shipments by rail were up 47 percent during the first three months of 2013 versus the prior-year period. And this activity is expected to ramp up as the year progresses. In fact, analysts forecast that trains could be moving more than 250,000 barrels of crude per day from Canada to US refineries by the end of the year.
Unfortunately, this surge in energy shipments has already been largely priced into the stocks of the two Canadian railroads benefitting from it. Shares of Canadian Pacific Railway Ltd (TSX: CP, NYSE: CP) have jumped 31.7 percent year to date, while Canadian National Railway Co’s (TSX: CNR, NYSE: CNI) stock has gained 13.5 percent since the beginning of the year.
Canadian National transported more than 30,000 carloads of crude last year, and management believes that number could double in 2013. As such, the company plans to spend CAD1.9 billion this year on capital expenditures, part of which will go toward maximizing its opportunities in the energy market. Thus far, revenue ton miles for petroleum products have increased 12.1 percent year to date versus a year ago.
While Canadian National’s network has strong exposure to the oil-producing region of Northern Alberta, Canadian Pacific has a similar advantage in the Bakken. The latter company shipped 53,000 carloads of crude in 2012, and management believes that number could rise to 70,000 carloads by the end of this year. By 2016, Canadian Pacific expects current volumes could double or even triple.
Eventually, of course, pipeline infrastructure will catch up to the glut of production, so the mode of transportation used to export Canadian crude to the US could shift once again. But growth in Canadian oil production could still mean that railroads will remain an important part of getting energy commodities to key US markets. ITG, a New York-based brokerage, predicts that crude shipments by rail will still increase by about 600,000 barrels per day over the next four years, even if major pipeline projects, such as Keystone XL, are finally built.
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Investing Daily Service
MLM is short for our ezine Maple Leaf Memo in the last response.
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Investing Daily Service
Hi Mr. Zeller:
Although there are no railroads that are MLPs, Ari Charney recently wrote an article in the free ezine
Maple Leaf Memo regarding railroads benefiting from Canadian oil. The article is shown below:
Canadian Crude Gets Railroaded
By Ari Charney on April 2, 2013
Print Friendly
One of the most difficult aspects of investing is anticipating how and when businesses or industries will adjust to operational hurdles. After all, even some of the worst setbacks can be overcome with a little human ingenuity–or just a bit of common sense. That means investors must distinguish between those situations that are likely to persist well into the future and those that are merely transitory.
The latest such example is the volatility in Canada’s oil-price differential. Canadian crude oil has long traded at a discount to the North American benchmark West Texas Intermediate crude (WTI). Indeed, over the four years spanning 2008 through 2011, Canada’s benchmark Western Canada Select crude (WCS) sold for an average of $15.21 per barrel less than WTI–a discount of about 17.9 percent.
Part of this long-term differential stems from the fact that crude produced from Alberta’s oil sands is a heavier grade than US crude, which makes it’s more expensive to refine than the light, sweet crude represented by WTI. Though Canada does produce lighter grades of oil, heavy crude accounts for roughly two-thirds of its oil exports.
Late last year, the oil-price differential widened significantly, as rising light crude production from prolific US shale plays caused a bottleneck at key pipelines. The resulting traffic jam crowded out Canadian crude from reaching US refineries. That situation worsened toward the end of the year, as takeaway and refining capacity became even more scarce due to maintenance problems at pipelines and refineries.
The good news is the oil-price differential appears to have peaked in December, when WCS sold for $33.63 per barrel less than WTI, a 38.1 percent discount. Then in February, the spread quickly began to narrow until it fell to a low of $14.25 last week. That’s just 14.7 percent less than WTI, a spread that’s 3.2 percentage points less than the average discount that prevailed in the aforementioned four-year period that ended in 2011.
So what happened? Faced with limited pipeline access and rising inventories, Canadian oil producers began transporting crude south via railroad and trucks. According to National Bank Financial chief economist Stefane Marion, crude shipments by rail were up 47 percent during the first three months of 2013 versus the prior-year period. And this activity is expected to ramp up as the year progresses. In fact, analysts forecast that trains could be moving more than 250,000 barrels of crude per day from Canada to US refineries by the end of the year.
Unfortunately, this surge in energy shipments has already been largely priced into the stocks of the two Canadian railroads benefitting from it. Shares of Canadian Pacific Railway Ltd (TSX: CP, NYSE: CP) have jumped 31.7 percent year to date, while Canadian National Railway Co’s (TSX: CNR, NYSE: CNI) stock has gained 13.5 percent since the beginning of the year.
Canadian National transported more than 30,000 carloads of crude last year, and management believes that number could double in 2013. As such, the company plans to spend CAD1.9 billion this year on capital expenditures, part of which will go toward maximizing its opportunities in the energy market. Thus far, revenue ton miles for petroleum products have increased 12.1 percent year to date versus a year ago.
While Canadian National’s network has strong exposure to the oil-producing region of Northern Alberta, Canadian Pacific has a similar advantage in the Bakken. The latter company shipped 53,000 carloads of crude in 2012, and management believes that number could rise to 70,000 carloads by the end of this year. By 2016, Canadian Pacific expects current volumes could double or even triple.
Eventually, of course, pipeline infrastructure will catch up to the glut of production, so the mode of transportation used to export Canadian crude to the US could shift once again. But growth in Canadian oil production could still mean that railroads will remain an important part of getting energy commodities to key US markets. ITG, a New York-based brokerage, predicts that crude shipments by rail will still increase by about 600,000 barrels per day over the next four years, even if major pipeline projects, such as Keystone XL, are finally built.
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Jason Burack
Warren Buffett already bought out the railroad that will benefit the most from the shale boom. He took it off the stock market over a year ago. There is over $100 billion over the next 5+ years supposed to be invested in US energy infrastructure into pipelines, etc for US natural gas, oil, NGLs, etc. This may reduce the profit margins of rail.
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Munroe Jones
Given the lack of pipeline infrastructure in the N.D. Bakken, why was OKE’s proposed crude oil pipeline undersubscribed and abandoned? Any insight?
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