All Aboard! …The Rail Revival

After many decades of deterioration, there’s a new boom happening in the rail industry.

In large part, it’s being driven by the need to move oil from fracking operations. It’s part of that re-industrialization of America theme that I’ve been developing here.

There’s a story behind these great big CSX locomotives and what they’re hauling.

Working on the Railroad…

I spent a day last week down by the tracks — a rail yard in Hagerstown, Md. — watching CSX trains roll by. Indeed, some of those tracks have been around for a while — such as this set of rails with a date-stamp of 1948 on the steel, and in need of repair, I’d say.

Railroad Revival Tracks

These tracks are on a siding, where rail cars move during switching operations at very low speeds. The main “trunk” lines are made of long stretches of new, welded rail. But these old tracks illustrate a point.

Moving the New Oil

Let’s get specific about what’s happening. In just the past three years, more and more oil has been moving around North America by train. In 2010, fewer than 10,000 carloads of oil moved on U.S. railways. In 2012, that number was well over 600,000, and it’s growing strongly.

Basically, new oil supplies from the “shale gale” have far outstripped the ability of established pipelines to move product. When you look back, much of the U.S. oil infrastructure of the past half-century was built to import oil, refine it at the coasts, and send product inland.

Today, however, we’re producing more and more oil in the nation’s interior (North Dakota, south Texas, Pennsylvania, etc.) But the country lacks a pipeline system to move raw crude from the wellhead to the coastal refineries. So absent some means of transporting oil, the product is stranded in remote locales.

Lately, oil operators and refiners have gone back to the original method that people used back in the days of Edwin Drake at Titusville in the 1860s and which made John D. Rockefeller a very wealthy man by the turn of the 19th/20th century. That is, they’re shipping oil by rail.

Rail shipment offers advantages, as well as drawbacks. On the positive side, rail gives operators new flexibility in terms of destinations. That is, with a pipeline from Point A to Point B, you’re stuck moving product from A to B. But with rail, the seller can shop around, find the best price and ship product to where the market values it the most. All you need is a track routing slip and the railway traffic manager will handle the rest.

For example, oil from the Bakken formation in North Dakota goes by rail as far west as Anacortes, Wash. It goes to Long Beach, Calif. It goes to the Gulf Coast. It goes to the East Coast, such as the Trainer refinery near Philadelphia, where Delta Airlines turns it into jet fuel. Try doing that with oil in a pipeline… if you have a pipeline.

Let’s think it through. The fact is that tracks are where they are. Railroads can move cars in or out if the roadbed is safe. So rail is a fast way to move oil, certainly compared with building a new pipeline, which requires many years of effort.

Also consider that the cost of a pipeline comes upfront, in the form of land acquisition, permitting, design and building. But with rail shipment, the tracks are there and the main “new” requirements are loading and unloading terminals, as well as storage facilities. As for new rail cars? Well, that’s a good story as well — for another time.

CSX Trains America's Rail Revival

It helps that rail is flexible in terms of the oil operator’s scope of commitment. Often, pipeline operators demand as much as a 20-year agreement from a shipper in order to amortize the costs of building a line. But with rail shipment, the transport cars lease out in terms of months or a few years. And of course, railroads can ship product wherever track is laid.

While we’re on the subject of built-in advantages, rail shipment for oil tends to be faster to the destination. For example, a train hauling oil can move from, say, North Dakota to the Gulf Coast in under a week. By pipeline, those same barrels could require up to 40 days in transit.

Forty days versus a week? Consider that a producer might have hundreds of thousands (or even millions) of barrels of oil in inventory. Now multiply that by, say, $100 per barrel. It equates to tens or hundreds of millions of dollars’ worth of inventory.

When you think it through, you start to see how those extra three or four weeks for a trip in a pipeline start to add up to serious carrying costs. This is still the case even though shipment by train is more costly per barrel than in a pipeline.

Here’s another point to consider. Oil sellers commit to quality in terms of API number (the “API” number measures energy content, sulfur content and other chemical aspects of the oil.) But different rock formations yield different kinds of oil. Pipeline transport of oil from shale tends to mix different kinds of oil as part of the pumping and flow process. The problem is that the buyer at the end of the line may receive barrels that are different from what’s on the purchase agreement. You don’t have that problem with oil shipped in a rail tank car.

Let’s take this a step further. Up in Canada, the oil sand product from the ground — a substance called bitumen — is so thick that operators have to dilute it with another oil-based substance called “diluent.” Operators have to buy diluent from refineries, and then pay to haul it up to the oil fields and mix it with the bitumen.

After adding diluent to bitumen, the extra fluid takes up 30% or more of the volume of a pipeline. In essence, the oil owner is paying to ship product that isn’t being sold — even worse, to ship it both ways! But with rail cars hauling oil, the operator can fill the tank with 100% bitumen and ship it down to the refinery.

As you can see, there’s a strong economic and logistic case for shipping oil by rail. This is despite the tendency for rail cost per barrel to be higher than with pipelines. But the fact is that rail shipment is still very economic under many circumstances. It’ll be around for a long while, I suspect.

One major downside with rail is safety. Trains derail more often than pipelines spring big leaks. Just a few weeks ago, the point was illustrated by a terrible accident in Quebec, which killed 47 people and destroyed much of a town along the rail line. From what we know, there was no “one” reason. It was a cascade of errors that tripped over into catastrophe.

The answer is that we need both pipelines and rail lines to move oil, and the people who do the job must be totally focused on safety at every level, every day, week, month and year.

Of course, looking back, we experienced the risks and dangers of offshore development in 2010, when the BP (BP: NYSE) well exploded in the Gulf of Mexico. When you boil it down, there’s only one way to operate, and that’s with a complete culture of safety. In that respect, rail shipment has a ways to go — and surely a handful of rail service companies, like the deep-water service folks, will be busy at work.

For now, I’ll park this locomotive on a siding and return to other tasks.

Best wishes…

Byron W. King
Original article posted on Daily Resource Hunter

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Byron King

A Harvard-trained geologist and former aide to the United States Chief of Naval Operations, Byron King is our resident gold and mining expert, and we are proud to have him on board as the managing editor of Whiskey & Gunpowder.

This “old rock hound” uses his expertise and connections in global resource industries to bring...

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