Riding to the city of New Orleans

August 12th, 2013
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My Letter from Calgary column from the February 2013 issue of the Investment Executive newspaper:

Oil producers are turning to the railway as an alternative to expensive pipelines

Alberta’s oil and natural gas industry is nothing if not adaptable. Huge technical risks, geographical and weather challenges, fickle capital markets, shifting regulations and taxes, and, of course, volatile commodities prices have made it so. Even on the latest challenge – the refusal of governments in the U.S. and British Columbia to grant pipeline permits to export Alberta’s growing oil production – there are early signs of a solution: the railways.

If you can’t push more oil into a pipeline, then why not pour it into railcars? It’s technically very simple. A typical railcar could hold about 500 barrels; a 120-car unit train, about 60,000 barrels. That means 10 trains a day can move the same amount of oil as a major pipeline. Other commodities have travelled by rail for decades, including natural-gas liquids, such as propane and butane. However, moving oil by rail does cost more than by pipeline and, statistically, is slightly more likely to result in a spill.

But it’s viable. More and more, Canadian oil producers are quietly turning to the railways to get their product to U.S. refineries. Quantifying the phenomenon is hard: as a relatively new practice, it’s being done through numerous marketing intermediaries and seems to be changing by the week. In fact, Houston-based EOG Resources Inc. says it intends to move about 100,000 barrels a day of its own production by rail.

The incentives are simple and powerful. It’s increasingly difficult to gain access to the major export pipelines, especially for smaller producers with little influence. This sharply discounts crude oil pricing in Alberta from the prevailing West Texas intermediate (WTI) benchmark. Meanwhile, bottlenecks at pipeline end points in the U.S. are, in turn, discounting WTI by about US$20 a barrel vs the higher-priced North Sea Brent, as well as the less well-known Louisiana light crude (LLC). The LLC benchmark, reflecting the huge arc of refineries, petrochemical plants and ports along the U.S. Gulf Coast, is the true oil price. Crude oil isn’t so much riding on New Orleans as riding to it – or close by.

But Canada’s railways aren’t exactly leading the way. Oil producers and a web of innovative intermediaries are coming up with almost all the answers: building new railcars; financing and leasing them; providing electronic, GPS-based and web-enabled management of railcar fleets; doing automated customs clearance; building superfast terminals that can load or unload multiple railcars at once; and making all of the marketing arrangements. It’s complicated and the costs are considerable, but Crescent Point Energy Corp., a major player in Saskatchewan’s Bakken play, has said that shipping by railway increases revenue by $10 a barrel, net of all costs.

An even bolder vision is to build an entirely new railway linking Fort McMurray, the hub of Alberta’s oilsands, with the Trans-Alaska pipeline system. The 2,400-kilometre route would run across northern Alberta, northeastern B.C., the Yukon and into Alaska, linking up with both Alaska’s rail system and the pipeline, which has plenty of spare capacity to ship crude to the state’s port of Valdez. From there, all of Asia beckons. This $10-billion-plus project is a much tougher engineering challenge than the Northern Gateway pipeline; but, ironically, it would face fewer regulatory hurdles.

Either way, Alberta’s growing oil production is straining to access world markets, and producers are trying some ingenious approaches. All aboard!

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By George Koch