Production for Baaken and the Canadian oil sands continues to increase faster than pipeline and transportation capacity. E&Ps like Continental Resources (CLR) and Oasis Petroleum are all trying to find increased transportation capacity. The lack of transportation capacity crated a discount between oil from this region and WTI. Bakken crude trades at around $89 per barrel versus about $110 for WTI, the price to may California refiners.
With pipeline capacity still lacking and not keeping up with demand, railcars have filled much of the need. Terminal capacity out of Bakken and Canada have increased over the past few years to fill tank cars. Railcar stocks and leasing companies have benefited from the high levels of demand.
While capacity out of these Canada and Bakken via rail has grown, offloading terminal capacity also need to grow by the refineries. A lack of capacity on this end along with pipelines facing environmental opposition have led California refiners to import oil, often from foreign sources, via ship and pay a higher price for doing it.
California Growth Opportunity for Oil via Rail
California has refining capacity of 1.63 million barrels per day, third after Texas and Louisiana. Declines in instate production and from Alaska along with the higher cost of foreign imports has led to plans for 500,000 barrels per day to come in via rail by 2015 according to comments from Tesoro Corporation (NYSE: TSO) last week. Indications are that Alon USA Energy (NYSE: ALJ) and Valero Energy (NYSE: VLO) are also eager to bring more oil West on the rails. This is good for traffic levels and revenue ton miles at Union Pacific (NYSE: UNP) and Berkshire Hathaway’s Burlington Northern (NYSE: BRK-A), who carry western rail traffic.
Transport costs are $9 per barrel to move oil from Bakken in North Dakota to Washington and another $4-$5 to move it by ship from Washington to California based on estimates from Valero. Tesoro estimates $9-10 per barrel to do it by rail straight to California, a savings of about a third. Rail is more efficient and California has only begun to tap into this. Imports by rail were just over 700,000 barrels all of December 2013, a very small percentage of its refineries monthly needs. Total oil by rail volumes in California almost doubled in 4Q13 versus 3Q13 to 2.83 million barrels. The project discussed above would increase capacity to around 15 million barrels per month.
There are of course hurdles otherwise it would not be California. Valero’s plans to build a 170,000 barrel per day offloading station for a refinery in the region was delayed due to an environmental review. The projects expected completion went for 4Q14 to 1Q15 as a result. There could be are larger issue looming. Recent safety concerns were raised from an accident in Canada that killed 42 people by railcars that were transporting crude. The FTA is reviewing safety rules and implement new safety rules for the cars. These could require changes that limit the availability of railcars to transport the crude. While expectations are that the new rules will go into place over time and not impact the transportation of oil, regulatory implementations are not always smooth. In addition, the cost to retrofit old cars could be too prohibitive depending on the actual new safety rules. This could lead to scrapping of old cars and pulling them out of oil service.
Winners of More Oil via Rail
The railcar manufacturers in the tank car business, Trinity Industries (NYSE: TRN), American Railcar (NASDAQ: ARII), Greenbrier (NYSE: GBX) and Union Tank Car, a lessor/manufacture also part of Berkshire Hathaway have all had a flood of orders and deliveries based on oil demand.
While the new capacity in California is another incremental positive, investors should be weary of buying the railcar manufactures close to a peak. Builds have been strong and slowly pipelines are replacing rail while the rail transport system is also becoming more efficient. The degree greater efficiency will cause is uncertain and new demand out of regions like California can keep cars in service. But this new demand does not necessarily translate to additional railcar demand.
However, on the positive side, manufactures like GBX, TRN and ARII can all participate in the retrofitting of older cars with the new safety equipment that will likely be mandated. Additional demand can also come from other car types and the petrochemical industry, although barge will play a large role in the latter. Taking the high levels of demand and the deep cyclicality of the industry and their stock prices, it is hard to see enough upside to earnings to justify buying. A hiccup at this point could cause to concern by the Street the cycle is rolling over and lead to a selloff. This could be an opportunity to buy the shares of some of the railcar stocks for that second leg of non-oil based demand.
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John has seven years of experience as an equity analyst following various stocks and sectors. As a senior equity analyst, he received awards from the Wall Street Journal and Financial Times for his writing.