Crude Oil Glut Putting Breaks on Rail

January 2016, Vol. 243, No. 1

It’s been several months since an oil train accident grabbed big headlines – but not because there haven’t been any. A single weekend in November saw two trains derail in Wisconsin. The first spilled about 20,000 gallons of ethanol into the Mississippi River, followed a day later by a spill of about 1,000 gallons of North Dakota Bakken crude.

This year has already been the costliest by far for crude train explosions. Derailments in 2015 have caused $29.7 million in damage, according to data from the U.S. Department of Transportation, a huge increase from $7.5 million in 2014.

Most of this price tag can be attributed to two crashes within a three-week span. The Feb. 16 derailment of a CSX train in West Virginia triggered a massive explosion near a cluster of homes along the Kanawha River and led to more than $23 million in damage. A BNSF train that derailed and exploded in Illinois on March 5 caused an additional $5.5 million in damage. Both trains were carrying highly explosive crude from North Dakota.

The lesser-noticed recent accidents haven’t come with explosions or towering fireballs. At least some of the ruptured tank cars were the newer-model CPC-1232, which are supposed to be less likely to split open. The U.S. and Canada announced stricter tank car standards, mandating further improvements in the future. Those rules will cost companies – mostly those that ship crude – an estimated $2.5 billion from 2015 to 2034; government estimates suggest the benefits will range from $912 million to $2.9 billion, presumably from fewer accidents.

But even without changing safety standards, there’s reason to suspect that costly train accidents will decline. While 2015 will go down as the worst year for crude train disasters, it’s also shaping up to be the year crude-by-rail hit the brakes.

The crash in prices has slowed activity in the oil patch and reduced the amount of petroleum riding the rails. The number of train carloads carrying petroleum has fallen 30% through Nov. 20 since peaking in December 2014, according to the American Association of Railroads. The monthly data on crude-by-rail shipments kept by the U.S. government lags a few months behind, but as of September those shipments had dropped 21% from their peak in January 2015.

This marks the first sustained decline in crude-by-rail traffic since it took off in 2009, jumping an astounding 5,000% in a little over five years. Putting oil on trains was never the most efficient way to move it. It’s expensive and slow, not to mention dangerous. But in the places where the shale boom has unlocked the biggest amounts of crude, trains were often the only option.

That’s especially true in North Dakota, home to the Bakken formation, where oil production has risen from about 200,000 bpd to over 1 million. By 2013, 71% of Bakken crude was transported by train. North Dakota has almost single-handedly driven the crude-by-rail boom, accounting for 80% of all oil train traffic in the U.S. by early 2015.

Since the third quarter of 2014, however, two pipeline projects have been completed in North Dakota, increasing the amount of oil that can be piped out of the state by nearly 200,000 bpd. There’s also a new refinery that opened, reducing the amount of oil that needs to be railed down to the large refineries outside Chicago. Since 2011, North Dakota’s combined pipeline and refining capacity has doubled, from 400,000 bpd to 800,000. By the end of 2017 it’s scheduled to double again, to 1.5 million bpd.

Oil traders now have options for how to move oil out of North Dakota. But there’s another reason they’re pulling back on the amount they put on the rails: it’s not as profitable as it used to be. Early on, the shale boom created an enormous glut of crude that ended up stuck in the middle of the country.

Getting it to market meant putting it on trucks and trains and barges, which was expensive and slow. So the price of U.S. crude fell compared with international prices. By October 2011 a barrel of U.S. oil pegged to the West Texas Intermediate contract that trades in New York was $27 cheaper than an equivalent barrel priced against the Brent contract trading in London.

That differential led to one of the biggest arbitrage opportunities the oil market has ever seen. Savvy traders could buy cheap oil in the middle of the U.S., find a way to move it, and sell it for higher prices along the coasts, where the market is more exposed to Brent prices. The price to send a barrel of oil by rail from North Dakota down to the U.S. Gulf Coast was about $9-10; the rest became profit. Over the past few years, millions of barrels of oil in North Dakota got loaded onto trains bound for the East Coast and the Gulf.

But as the U.S. oil infrastructure reoriented around the shale boom and pipelines began moving domestic oil to the coasts, instead of moving imports into the heartland, the spread between WTI and Brent has narrowed. The crash in global oil prices has closed the gap even further, to the point that a barrel of WTI crude is now just $3 cheaper than a barrel of Brent. That’s not enough to make money if you have to ship it hundreds of miles on a train. Refineries in Texas and Louisiana have switched from railing oil from North Dakota to importing more crude from West Africa.

As a result, there’s now a glut of tank cars on the market. According to energy research firm Genscape, lease rates have fallen from $2,500 a month to about $500. Big refining companies, which are among the largest crude-by-rail shippers, are shifting their strategy and trying to lock in prices for three and four years rather than just a few months.

David Vernon, a transportation analyst at Sanford C. Bernstein, thinks crude-by-rail traffic has peaked. “The heyday is over,” he said. “The high-water mark has likely been set in terms of volumes.”

Canada  could be a different story. Although the country’s oil sands industry is struggling against low prices, there are projects under construction that will be finished over the next few years. That extra oil will have to move somehow, and as of now, trains are looking like a strong candidate.

Canada’s oil production is forecast to grow faster than pipelines can be built, especially with Keystone XL officially dead. So while the number of trains loaded with crude crisscrossing the U.S. may diminish in the next few years, rail may remain a viable option in Canada.

Written by EnergyNow Media