Rail Fails, Pipelines Prevail

On July 6, 72 rail cars filled to their brims with crude oil derailed, ruptured and exploded in the small town of Lac-Megantic in Quebec. Much of the town was incinerated… and 47 people were killed — some of them vaporized.

It took days to extinguish the flames. By then, some 30 buildings in the town had been destroyed. And with little hope of finding survivors, it was time to piece together what had gone so terribly wrong.

Authorities now believe that the rail operator parking the train did not set the brakes firmly before leaving for the night. The train slowly rolled away, but quickly picked up speed.

The tanker car was owned by Montreal, Maine and Atlantic Railway (a subsidiary of privately held U.S.-based Rail World). It was transporting petrol from North Dakota to Irving Oil’s massive refinery in Saint John, New Brunswick.

The Saint John refinery is one of the 10 largest in North America. It’s situated near the Canaport Crude Receiving Terminal, which also receives ultra large crude carrier (ULCC) tankers transporting oil primarily from Saudi Arabia and the North Sea.

In fact, the reason oil was traveling to Irving’s refinery by train reveals something very telling about this industry. The Lac-Megantic disaster could mean the end of an era in oil transport… and an opportunity to ride the shifting winds to some nice dividends at a great price.

Train Derails With Crude Oil

Tanker Cars Doomed

Trains have recently become a great solution for producers in expanding fields to get their petrol to refiners where existing pipelines have limited additional capacity.

Back in 2000, crude oil shipments by train were a mere 9,000 carloads. By 2012, that amount had surged some 25 times, to over 233,811.

This quick ramp-up is resulting also in a surge of accidents. According to the U.S. National Transportation Safety Board (NTSB), rail accidents are on the rise. In fact, over the past few years, people have been killed from oil tanker explosions in Illinois, Wisconsin and Pennsylvania.

But the problem isn’t just the amount of oil traveling by railroad through our cities… it’s the cars that oil is riding in. A full 70% of North American tanker cars are DOT-111 cars. While they’re certified by the U.S. Department of Transportation, they are also more prone to rupturing during accidents. In fact, the National Safety Transportation Board has noted that an accident involving a DOT-111 is 87% more likely to result in death than with some newer tanker cars being developed.

That’s not a very comforting thought… especially if you live anywhere near railroad tracks. There’s no quick fix, either. Phasing out the DOT-111s would take years and cost companies a fortune. Even then, the newer cars would still be susceptible to operator error.

It’s the kind of headache rail companies can’t afford. And I mean that literally, since the market is pricing trains out of contention for economical shipping of crude oil.

Crude Facts on Oil

To understand how that train wreck is setting the stage for you to profit big, you need to understand the pricing of crude oil.

As you probably know, crude oil itself is fairly useless until it’s refined. Refiners buy the crude oil and turn it into usable forms that it can sell.

But some oil is easier and less expensive to refine than others. Oil known as West Texas Intermediate (WTI), taken from Texas and other parts of the United States, has qualities that make it cheaper to refine. Brent oil, which comes from the Middle East and the North Sea, is slightly more expensive to refine. Then there’s the crude coming from fracking, such as the Bakken shale crude. Its properties are closely in line with WTI.

While refiners can typically deal with all types of oil, they can lower their refining costs by using the “sweeter” WTI and Bakken oil. When they sell the refined petrol, they enjoy a bigger profit. The difference in costs to refine the various types of crude creates a profit spread per barrel known as the “crack spread.”

The trick is getting the oil to the refiners. As I said, the Canaport terminal receives tanker ships filled with Brent oil from all over the world. Meanwhile, Bakken oil production has increased at such a rapid pace that the pipelines have struggled to keep up.

So refiners have been forced to buy the Brent crude even though it has been selling for as much as $48 more than a barrel of Bakken crude.

But that huge price differential created an opportunity for Bakken oil producers. They couldn’t get to the refiners by pipeline, but they could get to them by train.

It costs approximately $15 per barrel to send oil by rail — compared with $1 a barrel by pipeline and $2 a barrel by ship. However, the steep premium for Brent made up for the huge shipping costs. Bakken oil sent by train was still cheaper than Brent oil carried by ship.

Unfortunately for trains, though, prices are now shifting. The price advantage Bakken enjoys over Brent has fallen to only about $10–12 a barrel.

Suddenly, spending $15 a barrel to ship Bakken by train doesn’t make sense. Instead, refiners are finding buying Brent is a better and safer deal.

But all this talk about ships versus trains leaves out a very important part of the story — the best solution for crude oil transport.

Goodbye, Glut

As I mentioned earlier, part of the appeal of transporting oil by train comes from the fact that pipelines just weren’t able to keep up with production.

The heart of the U.S. pipeline system is Cushing, Okla. Its network connects every major oil-producing area around the nation. Plus, it’s home to the nation’s largest concentration of massive storage tanks for oil awaiting transport.

While Bakken and other shale were stressing existing transport systems to deliver crude to refineries — they really were stressing the hub of crude oil pipeline transport and storage in Cushing. With the surging production from all over, crude was pouring in, and there just wasn’t an immediate means to pump it back out on the network of pipes.

This caused a glut of oil that was trapped in the hub. There was a huge supply, but only limited outlets to satisfy demand. Naturally, prices fell. And producers were able to take advantage of that artificially low price to ship their oil in ways that would otherwise be cost prohibitive — namely, rail.

But now the glut is coming to an end… inventories in Cushing are down some 11% this year, and WTI’s discount to Brent oil is disappearing, taking the Bakken discount with it.

What caused this dramatic change? More pipes.

U.S. pipeline capacity has surged up some 38.5% in 2013, to some 900,000 barrels per day. That’s given more refiners access to the cheaper-to-refine WTI and Bakken petrol. And it costs only $1 a barrel to ship oil via pipeline, making it more attractive than Brent.

It’s a good time to be a pipeline company… or invest in them.

All my best,

Neil George
Original article posted on Daily Resource Hunter

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Neil George

Neil George is the editor of Lifetime Income Report and Income on Demand — investment advisories dedicated to finding Wall Street’s best yields.

Before joining Agora Financial, Neil was the editor of Personal Finance and oversaw investment journals in the United States, Germany and other countries. He’s been featured in the Wall...

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