It’s back to the future for shipping crude by rail.
John D. Rockefeller first made money 150 years ago shipping oil on trains. He no doubt would recognize some of the same railroad routes used today to ship crude. Rockefeller invested in pipelines after the railroads tried to raise his shipping rates.
Today’s phenomenal increase in railed crude reflects not so much competition in rates but location. It costs roughly 2 to 3 times more to ship a barrel of crude via train than pipeline, but paying the higher cost makes sense if the end user pays more than the difference.
Recently proposed federal regulations may once again change the economics of the crude oil shipping decision.
Location, location, location
The unconventional revolution has quickly changed the midstream and downstream economics of the North American crude flow. Building and retrofitting refineries takes years of work and, in many cases, billions of dollars. Because unconventional plays are producing relatively light sweet crude, refineries designed to use this type of crude can make the most money refining it.
The Gulf Coast comprises over 50% of US refining capacity. After US oil production began to decline in the 1970’s, this refinery infrastructure was rebuilt to process imported heavy, high sulfur crude from the Middle East and Latin America. Although the Gulf Coast enjoys the best hydrocarbon pipeline infrastructure in North America, unconventional crude cannot take full advantage of this network because Gulf Coast refineries typically make more money processing heavier crude.
Older refineries on the East and West Coasts were originally built to process light, sweet crude. As US production declined, these refineries more often opted to import light sweet crude rather than undertake the expensive retrofit upgrade embraced by the Gulf Coast refineries. When the unconventional revolution unfolded, these refineries were left at a disadvantage because pipeline infrastructure did not exist to bring the newly available crude to these refineries.
Railroads, however, had built and operated lines connecting these refineries to the rest of the United States. Suddenly returning to the past business of shipping crude oil along these routes made sense.
Light crude by rail problems
Several unfortunate and tragic rail accidents have caused US and Canadian regulators to look more closely at rail safety regulations. The proposed regulations will likely cause retrofitting or replacing all crude oil tank cars currently in service.
Because of location and infrastructure, the new regulations will affect Bakken crude oil production more than other formations. Unlike the Eagle Ford and Permian basins, the Bakken did not have significant legacy pipeline infrastructure from previous exploration and production booms. Rail infrastructure, on the other hand, had been extensively built to carry agricultural products from the Great Plains to cities throughout North America. Adding terminals to ship crude therefore made good economic sense.
The new federal rail safety regulations could have two significant effects:
- Make a stronger economic case for pipeline development in the Bakken; and
- Create an incentive for unconventional crude oil to be railed from the Eagle Ford and Permian basins to East and West Coast refineries.
There are at least two reasons why railing crude from Texas to the East and West Coast refineries may make sense, at least until the Bakken pipeline infrastructure is built out.
- Unconventional Texas crude is largely stabilized and therefore likely meets current commercial standards for rail shipment;
- The large volume of Texas production has created a crude surplus on the Gulf Coast, so Texas producers may sell for a higher profit to refineries elsewhere in North America.
Next steps in crude by rail regulations
The North Dakota Petroleum Council (NDPC) has responded to the proposed safety regulations with a study showing that Bakken crude oil is as safe as other light sweet crudes and meets all of the current regulations. This week the North Dakota Industrial Commission announced plans to hold a public hearing on potential “stabilization” regulations for North Dakota crude. Stabilization is a (relatively) simple distillation process that reduces volatility in crude oil by removing Hydrogen Sulfide – the rotten egg smelling compound (“sweetening” sour crude) – and reducing overall vapor pressure. These developments may factor into the final regulations as well as the current commercial standards for shipping crude via rail.
Of course, another pathway to railway safety could be to enhance the sturdiness of the tanker cars themselves, although retrofitting the current fleet might cost up to $1 billion, and would like result in tens of thousands of cars being scrapped.
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