Buffett beat in railroad investments

Pipeline firms to spend $1 billion to move crude

Sunday, January 20, 2013

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

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

Energy companies that traditionally rented rail capacity are buying the assets for the first time because swelling output from Alberta’s oil sands and shale fields in North Dakota’s Bakken region and Eagle Ford in Texas has overwhelmed existing pipelines. Producers and refiners such as Devon Energy and Irving Oil say they likely will 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.

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 West Texas Intermediate in December - a record discount.

The American Association of Railroads, an industry trade group, estimated that more than 200,000 train cars of oil were shipped in 2012, the most since World War II. About 1 million barrels a day of rail-unloading capacity is being built in the U.S., Olsen wrote. 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, 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 about two years ago for $36 billion including debt.

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

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

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

In December, Plains bought four oil-handling terminals, plus a terminal under construction and shipping contracts across the United States for $500 million. Pipeline company Inergy Midstream 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 Chief Executive 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 competitors Enbridge and Canopy Prospecting 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 of 2013, for delivery to Philadelphia-area refineries, the companies said in a Nov. 27 statement.

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

U.S. oil production 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.

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.

However, 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.’s Keystone XL from Alberta to the U.S. Gulf Coast and Enbridge’s Northern Gateway from Alberta to the British Columbia coast already face delays and increased regulatory scrutiny.

Railroads face other 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.

And, 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.

Patti Reilly, a spokesman for the American Association of Railroads, said railroad spills tend to involve smaller amounts in each incident, since trains carry far smaller amounts of oil than pipelines.

Still, trains’ ability to reach higher-priced markets more quickly has solidified their role in crude transportation.

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, said in an interview.

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

Information for this report was contributed by Edward Welsch and Noah Buhayar of Bloomberg News.

Business, Pages 65 on 01/20/2013