How Rail is Reshaping America’s Energy System


Railroads, that 19th-century technology, are having a 21st-century impact on the U.S. crude oil industry. The swift growth in U.S. petroleum production left the energy industry with a lot of crude oil and nowhere to send it. With pipelines full, energy companies began to look at shipping crude oil via rail, the way it was transported when the U.S. energy industry was in its infancy over 100 years ago.

What was first seen as a stop-gap measure to deal with extra output is now being considered a viable complement to pipelines and a permanent part of the energy infrastructure in the U.S. Since the U.S. Energy Department forecast U.S. crude production to grow to 8.15 million barrels a day by December 2014, from the 6.89 million produced in November 2012, the U.S. will rely on even more on rail.

“Pipelines will fail to keep pace with North American crude production,” say analysts at Morgan Stanley. “Rails are needed to move trapped inland crude from Williston and Alberta basin and Eagle Ford shale.”

In 2012, the Association of American Railroads said it moved a record amount of crude oil: 233,811 Class 1 carloads, up 256 percent from the 65,671 carloads moved in 2011. That’s equivalent to about 350,000 barrels a day, says Rusty Braziel, president, RBN Energy, who has extensively analyzed the growing use of rail in the energy industry.

By 2014, Morgan Stanley estimated these carloads can grow to about 450,000 annually.

That’s still a fraction of the oil sent by pipeline, but the 2012 data shows how quickly the energy industry embraced rail to ship crude oil. “Railroads have made a significant impact,” Braziel says.

The tremendous growth in oil production in North Dakota’s Bakken region spurred rail use, Braziel said, as there weren’t enough pipelines to accommodate output. There are three reasons why the energy industry remains interested in this transport method: unit rail car trains, the opportunity for producers to sell to a variety of destinations, and the shorter-dated contract times railroads offer versus pipelines.

A Demand for More Rail Cars

Nothing beats the efficiency and convenience of pipelines, but the use of unit rail car trains, where 100 cars or more are dedicated to one product, helped to significantly lower the cost of using rail, Braziel says. And that’s led to a boom in the rail industry.

Burlington Northern, which owns the majority of the tracks in the Bakken region, says it is planning a 13 percent rise in capital improvements of approximately $4.1 billion in 2013, with “expansion and efficiency projects … primarily focused on capacity expansion to accommodate Bakken Shale related industrial products growth.”

The rail car industry is also seeing a jump in demand. “In the first two weeks of January 2013 manufacturers received orders for more than 2,500 new tank cars and there is a backlog of 40,000 cars on order. If you buy a rail tank car today the wait for delivery is 18 months,” Braziel says.

Pipeline companies are also investing in rail, with Kinder Morgan announcing in February that it and Mercuria Energy Trading are planning to build a rail project to handle 210,000 barrels per day.

In all, for 2013, Morgan Stanley said roughly 1 million barrels per day of new rail-unloading capacity is being built or is in the planning stages in the U.S., three times the current shipping level. Additionally, “sizeable investments,” defined as between $100 million to $500 million, are and will continue to be made by master limited partnerships through acquisitions and/or organic buildouts of rail terminal footprints, they say.

“Rail has grown materially over the last few years and can grow again over the next three to five years before reaching a plateau,” they said.

A Variety of Destinations

Braziel says producers who use rail can respond to market forces and send crude oil where prices are higher, rather than being stuck with where the pipeline ends, opening new domestic markets.

“Because of the discount between Cushing (Oklahoma, where much crude oil is stored) and because of the surplus of crude in the Mid-Continent, you started seeing crude go to from North Dakota to the East Coast, Gulf Coast and West Coast,” Braziel says.

The Morgan Stanley analysts said in a head-to-head competition to the same destination, pipelines typically are more affordable on a tariff cost basis versus rail. New pipeline projects will have trouble competing with rail because of the cost to build the pipeline in new areas, along with pipelines not being practical for certain routes.

Displacing Imports

The third benefit of rail is that rail companies offer shorter-dated contracts of one to four years, versus pipelines, which were 10 to 15 year contracts, Braziel says.

Until the U.S. lifts its restriction on crude oil exports, U.S. production will stay stateside, so there are limits to how much the U.S. might affect global markets. Yet Braziel says that Canadian oil production may move overseas as rail routes to the West Coast already exist and there are proposals to build export terminals in Canada and the U.S.

The U.S. might not export output anytime soon, but Morgan Stanley says it sees the U.S. starting to cease use of imports quickly.

“Shale-driven crude production (will) displace 100 percent of imported light sweet crude starting with the Gulf Coast (in the second half of 2013) and subsequently the East and West Coasts.”

Debbie Carlson has focused on commodities for much of her writing career. She spent more than a decade at Dow Jones covering the Chicago-based futures exchanges. As a Dow Jones editor, she worked closely with The Wall Street Journal and Barron's in planning commodities coverage.

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