Wednesday, October 3, 2012

US Railroads: Great Plays on Shale

The boom in US shale gas and oil is now a fact of life for investors. But the best way to play that boom is not directly through oil and gas companies. Look at how many of them have suffered thanks to an excess of supply and the resulting plunging prices for both natural gas and natural gas liquids (NGLs).

The best way to play shale is from owning the beneficiaries of low gas prices – petrochemical companies – and the beneficiaries of transporting shale oil across North America – the railroad industry.

The fact is that increased oil production, from both Canada and North Dakota, have nearly overwhelmed the existing transportation system in that part of North America. Drilling techniques such as hydraulic fracturing have increased oil production in North Dakota sevenfold to more than 600,000 barrels a day, moving the state to second behind only Texas in U.S. oil production. The U.S. Energy Information Administration forecasts production there will surpass 1 one million barrels a day next year. Even in Canada, oil production is expected to top 4.1 million barrels of oil a day next year, up from just 3 million barrels a day in 2005.

The drilling in areas like North Dakota is occurring in a region with few refineries and a limited pipeline network. So that leaves one alternative to transporting the oil taken out of the ground in North Dakota – railroads. According to the Association of American Railroads, overall U.S. rail shipments of oil have almost quadrupled to 88,026 rail car loads in the first half of 2012 from only 22,714 in the first half of last year. In 2008, there were less than 10,000 carloads annually.

The key here for investors is that this is not a blip, but part of a long-term trend. Just take a look at what two of the country's major refining companies – Tesoro (NYSE: TSO) and Phillips 66 (NYSE: PSX) have done in recent months. Tesoro this month will complete a rail facility at its west coast refinery in Washington to receive Bakken crude from North Dakota from 800 rail cars it had ordered previously. In June, Phillips 66 ordered 2,000 rail cars at a cost of $200 million to transport shale oil from North Dakota fields to its refineries.

All of this is great news for the railroads and should bring smiles to the faces of shareholders in railroads including CSX (NYSE: CSX), Canadian Pacific (NYSE: CP) and BNSF, which is now owned by Warren Buffett's Berkhsire Hathaway (NYSE: BRK-B). Canadian Pacific, for example, recently told attendees at an investor conference that the company expected oil shipments it carries to rise from 13,000 carloads last year to leap to at least 70,000 carloads sometime in 2013.

Burlington Northern SantaFe (BNSF) is a particular beneficiary of the Bakken shale oil boom since it carries 44 percent of the region's oil exports. It has built terminals along its routes throughout the region which are capable of handling 1 million barrels of oil a day, well above the current 290,000 barrels a day it handles. The company expects that, even after planned pipelines are built, that it will still handle between 25 and 37 percent of the Bakken's oil exports.

Of course, it's not all gravy for the railroad companies. Take CSX, for instance. The shale boom has hit the coal industry hard and therefore coal shipments are down sharply. CSX coal shipments were down 28 percent in the first quarter of 2012, though earnings were up marginally. Coal has traditionally accounted for 20-25 percent of of traffic for big rail companies like CSX.

So the question remains whether transporting oil from the Bakken and elsewhere – after a large investment into tank cars which CSX CFO Frederik Eliasson calls a “risk” - will offset the decline in railroads' coal business. For now, the railroads think the answer is yes. They are planning to at least triple capacity to move oil in the months and years ahead. With cheaper domestic crude oil from the Bakken luring the refineries to use cheaper domestic oil instead of expensive imported crude oil, the railroads seem to be sitting in the perfect spot as the transporter of that oil.

This article originally appeared on the Motley Fool Blog Network. Make sure to read all of my articles for the Motley Fool at


  1. The railroads are so huge that is these companies cannot really grow a whole lot from here on in. Theirs like two or three major railroads. Theirs better places to put money railroads will not do bad. I just do not think their great investments.

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  3. I guess theirs always something for the railroads to haul.

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