Canadian Pacific rides the crude-oil wave

— by Julie Sneider, assistant editor

Canadian Pacific is riding the wave of North American oil producers' increasing reliance on rail to transport their crude oil to U.S. Gulf Coast and Northeast refineries.

To get a sense of how quickly the crude-by-rail business has grown for the Class I, consider this: CP moved 500 carloads of crude oil in 2009, 13,000 in 2011 and more than 53,000 in 2012. In January, the railroad reached a 70,000 annual carload run rate for crude oil, a rate met earlier than initially anticipated. With each car holding about 650 barrels, that's a lot of crude.

"We're expecting the growth to continue throughout this year," says CP spokesman Ed Greenberg. "Beyond 2013, our railway has a line of sight that is two to three times present volume going forward. So, it is a very positive story for our company."

As CP executives reported during the Class I's fourth-quarter 2012 earnings teleconference on Jan. 29, crude by rail represents the Class I's strongest opportunity for traffic and revenue growth.

A Boost To Industrial, Consumer Products Business

In fourth-quarter 2012, CP's revenue for the industrial and consumer products line of business, which includes oil movements, jumped 19 percent, producing double-digit growth for the seventh consecutive quarter. Energy-related traffic represents about 50 percent of industrial and consumer products revenue, which totaled $1.3 billion in 2012 compared with $1 billion in 2011.

"We continue to work on our strategy that sees us working with customers, investing in crude by rail, and improving and creating diversity in our origin and destinations," Chief Marketing Officer and Executive Vice President Jane O'Hagan said during the earnings teleconference with analysts. "We are on course to achieve our targets."

It's a course North American railroads will continue to pursue for at least the next several years. U.S. crude oil production increased by 790,999 barrels per day between 2011 and 2012, which was the largest increase in annual output since the beginning of U.S. commercial crude oil production in 1859, the U.S. Energy Information Administration (EIA) reported in its February Short-term Energy Outlook.

U.S. crude oil output is forecast to increase this year by 815,000 barrels per day to 7.25 million. In 2014, the EIA estimates production will rise by another 570,000 barrels per day to 7.82 million, which would be the highest annual average since 1988. Thanks to horizontal drilling technology and hydraulic fracturing, most of that production growth will be coming out of the tight-rock formations in North Dakota and Texas, the report stated.

The surge in oil production is reflected in railroads' carload traffic, as a lack of adequate pipeline infrastructure prompted energy companies to turn to rail to get their product to refineries. Crude oil and petroleum products accounted for the biggest increase in rail-car loadings among commodities in 2012, according to the EIA, citing Association of American Railroads' traffic data.

Reaching Targets Early

For CP, reaching the 70,000-carload point earlier than expected was due in part to a new, five-year deal between Phillips 66 and Global Partners L.P. Announced Jan. 8, the contract calls for Global Partners to provide rail transloading, logistics and transportation services to deliver crude oil from the Bakken Shale in North Dakota to Phillips 66's refinery in Bayway, N.J. Phillips 66 anticipates receiving about 91 million barrels of crude oil, or about 50,000 barrels a day, over the contract term.

The Bakken crude will be transloaded at Basin Transload L.L.C.'s rail facilities in North Dakota. Global Partners agreed to purchase a 60 percent interest in Basin Transload under a transaction that's expected to close in the first quarter. As part of a continuing partnership with CP, the railroad will transport crude oil from the Bakken to Global Partner's terminal in Albany, N.Y.

Moving Oil South, East

The direct rail service from North Dakota to the U.S. Northeast represents the "advantages of CP's strategic rail network and experience in moving energy products," O'Hagan said in a prepared statement issued at the time of the announcement, adding that CP is the only North American railroad that serves the Bakken, Alberta Industrial Heartland and other energy formations in the United States and Canada directly to the northeast United States.

CP transports crude oil out of the Bakken in North Dakota and Saskatchewan, with the majority of it heading south to the U.S. Gulf Coast. CP also hauls shipments to the northeastern United States and eastern Canada. Currently, CP has 17 transload facilities designed for crude-by-rail business — 12 in Canada and five in North Dakota — and is working on securing additional transload locations, Greenberg says.

CP continues to invest in resources and infrastructure to accommodate crude-oil business. In March 2011, the Class I announced it would spend up to $100 million (in Canadian dollars) in North Dakota between 2011 and 2012 to improve network capacity and upgrade track and other infrastructure to handle energy-by-rail as well as other lines of business.

With a capex budget of up to $1 billion for 2013, CP will keep devoting dollars to capacity for a range of business lines, energy included, says Greenberg.

How long the rapid crude-by-rail growth will last remains to be seen, especially after planned pipeline expansions open up more capacity. Regardless, CP Chief Executive Officer E. Hunter Harrison is cautiously optimistic that rail will have an ongoing place in the crude-shipping business.

"I think rail will have a part to play that wouldn't have been thought of 10, 15 — maybe even a couple of years ago," he said in a Feb. 6 interview with Canada's Business News Network. "Rail affords the flexibility that pipelines don't afford. … It's got a lot of potential, and clearly it's going to be the driver of our growth this year, which we talked about would be in the high single digits. But I'm not sure that everything is going to fall exactly in place as some would suggest."

Fluctuations in oil supply and natural gas prices, uncertainty over environmental and regulatory issues, new technology that could come into play and whether the Keystone XL Pipeline gets built make the energy business a "moving target," Harrison said.

For now, at least, it's a target CP execs are more than pleased to pursue.