Crude by rail has a long-term role in petrochemical logistics — by Tony Hatch

I recently was in Houston, the epicenter of the current and future energy world, site of over $45 billion in industrial capex and launch point for the growth of Mexican imports. I was there to present at the ShaleRail 2014 Summit, which was held June 25-26 and organized by Information Forecast Inc. The conference served to highlight the confusion in the marketplace and the lasting role that crude by rail (CBR) will have in energy logistics — and hinted at the potential long-term growth component that will come from refined products and petrochemicals.

While at the summit, we learned that the U.S. Supreme Court upheld the U.S Environmental Protection Agency's so-called "war on coal" regulations and that the government was beginning to allow some form of energy exports, which will add more tailwind to existing energy trends. Much of what I learned in Texas confirmed earlier assumptions on CBR's long-term potential based in part on three “Bakken Blitz” trips I've taken to North Dakota (my most recent trip was in May) with co-host Watco Cos. L.L.C., the short-line holding company. In Houston, I had the opportunity to take a few folks to visit Watco's Greens Port Industrial Park, a tremendous asset currently handling pipe, sand and industrial products — and ready to be further developed with partner Kinder Morgan Energy Partners L.P. into a CBR port.
 
Here are some key takeaways from the ShaleRail Summit and my most recent trip to the Bakken:

• CBR clearly has a long-term structural role in crude and petrochemical logistics. This is the most important takeaway.

• Remember: So, far the new energy world has been a negative for rails as the coal drop, now mostly over, has vastly outweighed the whole CBR segment gain.
 
• CBR is complicated — only ag can compare as a rail commodity in terms of having daily data, often seemingly contradictory, that serves at times to take one’s eye off the intermediate-to-longer-term ball: daily oil prices for West Texas Intermediate and Brent crude; information on shale production and logistics capabilities in Texas, Colorado and North Dakota and, soon, perhaps, Mexico, along with foreign oil issues; rail safety and regulatory issues; pipeline development or lack of same; etc.

• The tank-car story can’t be resolved, of course, until new regs are announced. In the meantime, there is an 18-month wait for new cars, which make up some two-thirds of the current backlog. Car guru Dick Kloster also questions whether there is enough capacity for the supposed coming retrofit market, which could make the Watco-Greenbrier Cos. joint venture to own and operate the companies' respective rail-car repair, refurbishment and maintenance businesses a stroke of genius.

• Western Canada is the new opportunity, following several years behind North Dakota.  Oils Sands development was radically different from the Bakken — huge companies and huge investment — and a demand for a payout supported by the Canadian government.  The market is big: about 5 million barrels (mm/bl). Obviously, pipeline development (XL and otherwise) is critical here, but this market is ripe for CBR, as the cost differential between rail without diluent and pipeline (P/L) is only about $1/bl, per Oliver Wyman.

• Rail share remains over 70 percent from the Bakken, with BNSF Railway having some 85 percent origination share, Canadian Pacific the remainder. With unit trains, two-rail transport only adds about $1/bl to the cost (again, per Oliver Wyman). Bakken production continues to grow — from about 1mm/bl today to over 2mm in two years? With some P/L development and Permian Basin share growth, what is the future?
 
• Risks remain — political, regulatory, environmental — and in the case of rails, safety (the biggest wild card).


• PLG Consulting predicts a steady increase in total CBR rail carloads through 2017, and then a rather precipitous (10 percent) drop in 2018 as started pipelines open. Our friends at PLG know their business but that seems a rather too harsh judgment. Even so, revenue-ton-miles are expected to increase faster than carloads as origin/destination pairs and distances grow (including opening the Pacific Northwest as the new frontier). In addition to increased mileage (and thus, revenues) and sand business, I continue to believe that as rail routes become more regular and less a form of arbitrage, there is an opportunity to raise rates.

• And in the distance is Mexico, post-Pemex reform.

• But the big story will come from rail participation in the coming industrial revival fueled by cheap and plentiful natural gas, with Houston as the epicenter — though not the only spot: The Louisiana/Mississippi River region is the site of some $30 billion in related capex. Chemical production is expected to double by 2020; the United States has already inflected from net importer to exporter. Rails make good money moving chemicals, where some $100 billion-plus is being spent on capacity additions, according to the American Chemistry Council.
 
•  Rails to cash in on chemicals: One of the ShaleRail Summit presenters — WorleyParsons' Larry Shughart, a past RailTrends® presenter — used his costing model to demonstrate that if the average North American freight railroad has an operating margin (the opposite of the operating ratio — OR — that transport analysts typically look at) of 25 percent to 30 percent, its (unreported but estimated) margin on the chemical business runs from 30 percent to 47 percent, with Union Pacific Railroad (of course) at the very upper end.

• Setting up the mother of all re-reg battles to come at the end of the decade!
 
Tony Hatch is an independent transportation analyst and consultant, and a program consultant for Progressive Railroading's RailTrends® conference. Email him at abh18@mindspring.com.