I Hear The Train A Comin'

Includes: TRP, UNP, USO
by: Luke Nagell

In Johnny Cash's "Folsom Prison Blues," prisoners in Folsom prison would get the blues as they heard trains roll by, wishing they could escape and ride the train as far away from Folsom as they could. Today, prisoners locked up in jailhouses along railroad tracks linked to the oil boom have been singing more and more blues each day. According to the September 2012 Rail Time Indicators report, railcar shipments of crude oil in the U.S. have increased 67% since August 2010. At the core of this increase in petroleum shipments by railcar is the oversupply of crude oil into the largest crude oil trading hub in North America, located in Cushing, Oklahoma. As long as there is an oversupply of crude oil in Cushing, the demand for shipping by railcar will continue to be high.

There are two primary prices for oil across the globe, West Texas Intermediate (WTI) and Brent. Basically, WTI is the benchmark used to reflect the price in the U.S. and Brent is the benchmark used to reflect the price in Europe. Today, there is one of the largest disparities between the two benchmark prices in history with WTI trading around $96 and Brent trading around $113 per barrel. The reason for the disparity is a direct result of an oversupply of oil where WTI is traded, in Cushing. The chart below shows this correlation between the spread of Brent vs. WTI (red line) and the increase in weekly stockpiles of crude oil in Cushing (blue line) since early 2004.

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The record level spread between the two oil prices is one of the primary drivers for the increase in demand for shipping crude oil by railcar. Crude that is imported from around the world is imported into the U.S. gulf and eastern coastal refineries at the higher Brent price. Generally speaking, when a producer in North Dakota has a barrel of oil sitting in the local storage facility, he has two options: 1. Ship the barrel via pipeline to Cushing for a selling price of $96. 2. Ship by railcar to a coastal refinery for a selling price of $113. All else equal, this is a no-brainer.

A single tank car can carry approximately 660-720 barrels of crude oil. This amounts to a revenue of between $74,500 and $81,000 per tank car based on the Brent price and $63,000 and $70,000 per tank car based on the WTI price. Price alone is not the only consideration when considering the shipment vehicle. It costs as little as $5.20 to ship a barrel of crude by pipeline and as much as $8.70 to ship by railcar. Currently, North Dakota is producing 640,000 barrels per day relative to 100,000 barrels per day in 2007. Companies like BNSF Railway see this continued increased production as an opportunity and have made adjustments as needed. As a result, BNSF recently announced that it has increased its capacity within the North Dakota region to haul 1,000,000 barrels per day. The chart below depicts the growth rate of the combined shipments BNSF and Union Pacific (NYSE:UNP) relative to oil production growth throughout select areas in the U.S.

(Click to enlarge)

A portion of the oversupply within Cushing will begin to ease as a result of the recent approval to begin construction on the lower-end of the Keystone XL pipeline. According to the project developer TransCanada (NYSE:TRP), the portion that received approval will run from Cushing (middle of Oklahoma) to the Gulf Coast and began construction in August with an estimated completion around mid-to-late 2013. The pipeline will initially relieve the glut of supply by 700,000 barrels per day. However, with project completion still a year away and production within the U.S. increasing at an exponential rate, it will not be enough to relieve the price pressure back to par with Brent.

Although it may seem that railways would be the place to let your money ride for the next few years, this may not be the case. According to the September 2012 Rail Time Indicators report, total carloads for the railroad industry are down -1.7% since 2010. One of the primary shipping categories, coal, has seen a steady decline as more utilities are switching from coal fired power plants to natural gas as a result of record low natural gas prices. In addition, growth continues to remain weak throughout the U.S. and the rest of the developed economies resulting in muted demand for other goods shipped by rail.

If railcar shipments for crude continues to increase at the same or at a higher rate than production, than it should be a bullish event for WTI prices. This is a direct result of being able to ease the supply shock in Cushing and since rail can transport the crude to places other than Cushing where it will demand a higher price. The increased rail shipments combined with the lower portion of the Keystone pipeline should begin to narrow the spread between WTI and Brent prices. Even as the spread begins to narrow, the flexibility to ship to locations where supply may be lacking will continue to be a boon to the rail transport industry. As a result, prisoners located along the rails will continue to sing the blues.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.