Back in February, I wrote the Seeking Alpha article The Bakken Crude Discount: A Reversal of Fortune Coming Soon. The thinking (albeit incorrect) was the Bakken crude discount would narrow as the Seaway pipeline reversal came online. Well, the Seaway pipeline began pumping crude in May of this year, yet the Bakken discount has remained virtually unchanged (see chart below).
Crude Oil Prices (As of August 8 Pre-market Open)
The Bakken discount to Brent as of this morning (August 8) was $20.60, which is almost exactly what it was on the date I wrote the prior article. This begs the question: why didn't the discount narrow after the 150,000 bpd Seaway pipeline came online?
Bakken crude is discounted to Brent because the Cushing market is oversupplied and pipeline capacity between the Bakken and Cushing is maxed out. The oversupply is caused by the combination of rapidly expanding Bakken production, growing Canadian imports, and limited escape routes out of Cushing to the large refining Gulf markets. The current producer price pain will only subside when the supply glut in Cushing evaporates. That probably won't happen until there is more takeaway infrastructure out of the Bakken and Cushing down to the U.S. Gulf refining market.
Lynn Helms, director of North Dakota's mineral resources department, recently said on the "Platts Energy Week" television show that the Bakken Shale formation in the Western part of his state produced about 640,000 barrels of oil per day in May. Helms emphasized that oil production in the Bakken is consistently increasing by 15,000 to 20,000 bpd every month, and that thousands of additional wells will be drilled there in the coming years. "We're seeing back-to-back 5% increases in production," Helms said. "And we've got 35,000 wells left to drill in this Bakken reserve." Helms said it will likely take 16 to 18 more years to fully develop the Bakken Shale formation. This document shows historical Bakken production rates. Bakken production could reach 1,000,000 bpd or perhaps even double by 2015.
The magnitude of the problem is clear. Since February, Bakken production has increased roughly 150,000 bpd, which happens to be the exact capacity of the first phase of the Seaway reversal. Therefore, there was no narrowing of the discount.
Obviously, there is a lot of money at stake here: a discount of $20/barrel @600,000 bpd equates to $20 million per day, or nearly $1.8 billion per quarter. That ain't chump change! As a result, there are many companies working to capitalize on this bottleneck.
There are three major ways to get Bakken crude to market: pipelines, trains, and trucks. And at least one company is shipping via barge down the Mississippi River. But pipelines are the most efficient and economical way of transporting oil. They are much safer than transport via rail or truck. That said, pipelines are also the most capital intensive and take the most time. So today, let's take a look at some of the major pipeline projects affecting Bakken producer prices.
The Seaway Pipeline
Historically, the 669-mile Seaway system had flowed from Houston and Freeport, TX to Cushing, OK. With the surge in Canadian oil sands and growing U.S. shale oil production, the south-to-north flow was unnecessary. Inventory at Cushing was at record levels. Last fall, ConocoPhillips (NYSE:COP) sold its 50 percent interest in the line to Enbridge, which then agreed with co-owner Enterprise to reverse Seaway.
The Seaway pipeline began pumping crude from oil tanks in Cushing to the heart of the U.S. refining industry in Houston in mid-May 2012. The reversal was an historic shift in the way oil flows across the U.S. The pipeline has an initial capacity of 150,000 bpd. A new pump station is under construction at the Cushing end to allow flows to reach 400,000 bpd by early 2013. Ultimately, Enbridge and Enterprise plan to more than double the line's capacity to 850,000 bpd.
Analysts had mixed opinions whether the first crude down Seaway would be light sweet or heavy sour or a mix. The type of oil makes a difference to refiners as well as pipeliners. Much of the stored oil at Cushing is now Canadian heavy sour. Light oil is easier to handle at pipeline startup than heavy, making light the likely choice. Again, Gulf coast refiners are geared for the cheaper heavy. Bets are mixed, but my guess is more heavy than light will be flowing through the Seaway. This would be beneficial to Canadian oil sands producers like Suncor Energy (NYSE:SU).
The Keystone Pipeline
The Keystone Pipeline consists of four phases. The first two stages are online. Phases 3 and 4 are proposed and part of what is called the "Keystone XL" pipeline.
Phase 1 runs from Hardisty, Alberta to U.S. refineries in Wood River and Patoka, Illinois and is 2,147 miles long. The Canadian section involved conversion of an existing 35" natural gas pipeline to crude oil service and a new 232-mile section of 30" diameter pipe and 16 pump stations. The U.S. portion includes 1,084 miles of new 30" pipe with 23 pump stations. Phase 1 went online in 2010 and has a capacity of 435,000 bpd.
Phase 2 was a 298-mile extension from Steele City, Nebraska to Cushing, Oklahoma and 11 new pump stations. It went online in 2011 and increased the pipeline's capacity to 591,000 bpd.
Phase 3 is known as "Cushing MarketLink" and is part of the Keystone XL pipeline. This proposed phase starts in Cushing, OK where domestic oil will be added to the pipeline, then it would run 435 miles to a delivery point near terminals in Nederland, TX to serve Port Arthur, TX refineries. Also proposed is an approximate 47 miles (76 km) previous pipeline to transport crude oil from the pipeline in Liberty County, TX to the Houston area
Phase 4 is part of the Keystone XL pipeline and would start from the same area in Alberta, Canada as the main pipeline. The Canadian section would consist of 327 miles of new pipeline. It would enter the U.S. at Morgan, Montana and travel through Baker, MT where domestic oil would be added to the pipeline. Then it would travel through South Dakota and Nebraska, where it would join the existing Keystone pipelines at Steele City, Nebraska. This phase has generated the greatest controversy because of its routing over the top of the Ogallala Aquifer in Nebraska and President Obama's decision to postpone final permitting.
When completed, phases 3 and 4 (the Keystone "XL" section) will add 510,000 bpd increasing the total capacity of the Keystone pipeline system to 1.1 million bpd. The "XL" pipeline will carry more domestic crude, which would be bullish for Bakken producers like Whiting Petroleum (NYSE:WLL) and Continental Resources (NYSE:CLR).
The Steelman Pipeline
In December of last year, Canadian regulators approved Enbridge Inc.'s (NYSE:ENB) plans to build a new pipeline to move oil out of the Bakken and Three Forks oilfields. The 76-mile Steelman pipeline project will carry 145,000 barrels of oil a day from Steelman, Saskatchewan, to a link with the company's mainline system at Cromer, Manitoba. The U.S. portion of Steelman, which has yet to receive final approvals, will ship oil from North Dakota and Montana north to Steelman.
Bakken Crude Express Pipeline
ONEOK Partners (NYSE:OKS) has announced plans to build a 1,300-mile crude-oil pipeline with the capacity to transport 200,000 barrels per day. The Bakken Crude Express Pipeline will transport light-sweet crude oil from the Bakken Shale in the Williston Basin in North Dakota to the Cushing, OK hub. Construction is expected to begin in late 2013 or early 2014 and be completed by early 2015.
In addition, ONEOK is planning to construct a 525-mile natural gas liquids pipeline that will transport raw, unfractionated NGLs from the Bakken in North Dakota and Montana to the company's 50-percent owned Overland Pass Pipeline. The 12-inch pipeline, the first carrying NGL out of the Williston basin, will have an initial capacity of 60,000 barrels per day of raw, unfractionated NGLs. However, that capacity can be expanded to 110,000 barrels with additional pumping stations. Construction is presently underway on four of five spreads in Montana and Wyoming and should be operational in the first half of 2013.
The Bakken North Pipeline
Plains All American Pipeline, LP (NYSE:PAA) has announced plans to reverse its Wascana pipeline system and build a new pipeline, Bakken North, to provide additional takeaway capacity for growing Bakken crude production. The Bakken North Project would provide crude oil transportation service from Trenton, ND, north to Regina, Sask. At Regina, Plains would connect to third-party carriers providing access to Cushing, OK. The 12'' diameter Bakken North pipeline will extend 103 miles from Trenton to the southern terminus of Plains' Wascana system at an initial design capacity of 50,000 bpd (expandable to 75,000 bpd). Subject to permitting, Plains anticipates placing the Bakken North Project into service in fourth-quarter 2012.
ND - MN Pipeline
In June it was reported two companies are feuding over a proposed pipeline that would increase Bakken takeaway. High Prairie Pipeline alleges that its plans to build a pipeline from the Bakken oil fields in North Dakota to a terminal at Clearbrook, MN are stalled because Enbridge Energy, which owns the terminal, refuses to allow the connection. High Prairie says Enbridge is favoring Canadian oil. But Enbridge's North Dakota head of operations Mike Moeller said the terminal is already running at its capacity. The proposed pipeline would carry 150,000 barrels of oil per day.
Pipelines to Wood River, IL
A more roundabout pipeline route out of the Bakken is west and south on the Belle Fourche and Butte pipelines to the Guernsey, Wyoming hub. From Guernsey crude can be shipped to the large refining center at Wood River, IL via the Kinder Morgan Platte pipeline.
The list above is by no means a complete list of all Bakken related pipeline activity. But it is a good enough summary to get an overview of the scope of investment taking place in building America's new mid-continent pipeline infrastructure. Plans have been announced to build, expand or reverse roughly 20-odd pipelines in the past year. The total cost of these projects is north of $20 billion.
How can the investor profit?
An obvious investment vehicle is the pipeline builders/operators themselves. These would include companies like Enbridge Inc., ONEOK Partners, and Plains All American Pipeline, LP.
Another obvious investment strategy would be to own the oil producers who are growing production now and will profit even more when the Cushing bottleneck is relieved. These would include Suncor Energy, Continental Resources (CLR), and Whiting Petroleum.
Just because these investments are "obvious", by no means does that imply they will underperform. I myself own WLL.
The lack of mid-continent takeaway infrastructure is real, but there could be a bottleneck of another sort: key pipeline components. In particular, the large valves (some as large as 10-ton) and pumps essential to the efficient operation of these massive pipelines.
"The supply chain hasn't quite caught up," said Terry McGill, president of Enbridge Energy Co. Inc., the U.S. division of Canadian pipeline giant Enbridge Inc., which has around $4 billion worth of U.S. pipeline projects on its books. Executives say they are building in plenty of lead time to produce dozens of multi-ton valves and massive pumps essential for maintaining pipeline flow. Under utilized steel mills are revving up furnaces to forge the pipes - some of which have a diameter of up to 42 inches.
Each of the dozens of valves required on something like TransCanada Corp.'s (NYSE:TRP) proposed $7.6 billion Keystone XL pipeline -- which has a 36-inch diameter -- usually must be custom-made. "We definitely consider ours an 'engineered to spec' product," said John Starck, vice president of sales for M&J Valve, a division of multi-industry manufacturer SPX Corp. that operators say is a leading valve maker for liquids pipelines."We do not actually build the product and keep it on the shelf because each customer has their own unique set of specs."
SPX Corporation (SPW) could be an excellent way to invest in the buildout of America's new pipeline infrastructure.
SPX Corporation (SPW)
Market Cap: $3.27B
P/E (ttm): 17.92
EPS (ttm): $3.60
Div / Yield: $1.00 (1.60%)
Companies which are profiting right now from the large Bakken discount include refiners like Phillips 66 (NYSE:PSX) and Marathon Petroleum (NYSE:MPC). Indeed, PSX even has a nice midstream unit that dovetails in nicely with the midstream pipeline infrastructure discussed in this article.
Another opportunity exists in railroad takeaway. But that is a big topic and will be saved for another day.
Additional disclosure: I may initiate a position in PSW in the near future.