Light oil from the Bakken. Heavy oil from the Canadian oil sands. Oil and condensate from the Eagle Ford. Oil from West Texas. It all adds up to an enormous glut of oil right in the middle of North America. Pipeline and storage infrastructure is overwhelmed. But, as always, where there are big problems there are big profit opportunities for investors.
According to Reuters North Dakota oil production is now at 730,000 bopd (up from 100,000 bopd in 2006) while Texas production has doubled over the last 3 years and is now over 2,200,000 bopd. Add in increases in Canada (primarily oil sands) and other states and you have a huge gusher of oil unleashed in the Mid-continent region.
The glut has driven North American prices well below global prices (Brent). As I write this, West Texas Intermediate -- WTI is selling for $21 less than Brent. You can compare current WTI/Brent prices here. Even more surprising: Western Canadian Select (WCS) a heavy grade oil from the Canadian oil sands recently sold for a staggering $64/barrel less than Brent.
The huge spreads (or differentials as they are called in the trade) offer refiners fantastic profit opportunities if they can access the low priced Mid-continent oil for feedstock. Not surprisingly, they are pulling out all the stops to order to get the stuff. This in turn has set off a secondary boom in the pipeline, rail, barge, and trucking industries -- opening up many profit opportunities for investors.
One sector not benefiting: The E&Ps. Low prices have reduced both their profits and reserve values. E&Ps, however, will benefit when spreads decline. It's just a matter of time. I will look at them in a future article.
All across the U.S. Mid-continent oil is stimulating the economy. Here are some of the profiting sectors and publicly traded companies.
Keep in mind that this article is intended to be only an overview. It is not "in depth analysis." Readers are strongly urged to do further research before investing in the companies mentioned.
Refiners Now Running At Capacity
The refiners are hot. Very hot. Maybe too hot. The large crack spread and profits has ignited an explosion (I know, poor choice of words) under refinery stocks -- most are up 100% or more. Valero Energy (NYSE:VLO), one of the U.S.'s largest refiners, has seen its shares more than double since last June. Phillips 66 (NYSE:PSX), Marathon Petroleum (NYSE:MPC), Tesoro (TSO), PBF Energy (NYSE:PBF), and others boast similar gains.
As noted above, refiners are profiting because they are switching from high priced international grades of oil such as Brent to low priced Mid-continent grades. Whether it's by pipeline, rail, barge, or trucks (usually a combination) low priced North American crude and gas is increasingly making its way to distant U.S. refineries.
In light of the recent share price run ups, are the refiners still good investments? For now ... maybe. Mid-continent oil production has expanded so quickly it will take some time before infrastructure build out catches up so spreads will likely remain high for a couple of years. Geopolitical events overseas which drive up the price of Brent may widen them even further.
Keep an eye on the WTI/Brent spread -- prices are of secondary importance. When spreads narrow refinery profits and share prices will likely fall. Refinery profits are cyclical, refinery stocks are not a "buy and forget" investment unless you can tolerate the volatility.
The glut may overwhelm storage and refining capacity across the U.S. -- keeping WTI/Brent spreads wide for some time yet.
Pipeline Construction Is Booming
Pipeline construction is also booming and a rush is on to build/revamp pipeline capacity flow out of Cushing and the Mid-continent region to refineries.
Within the last year the Seaway pipeline, owned by Enterprise Products Partners (EPD) and Enbridge (ENB), was reversed and now 400,000 bopd flow out of Cushing to Texas and Gulf Coast refineries. A twin line, which is scheduled for completion in 2014, will up the Seaway flow out of Cushing to 850,000 bopd.
Enbridge's Light Oil Market Access Program: This program consists of several pipeline enhancement projects across southern Canada and the upper U.S. Midwest. The projects will improve oil flow to Midwest and Eastern refineries -- eventually adding some 400,000 bopd to outflow from Canada and North Dakota. Estimated completion dates are spread out over the next few years.
TransCanada has now started construction on the southern leg of the Keystone Pipeline which it calls the Gulf Coast Pipeline Project. This pipeline, like the Seaway, will move oil out of Cushing to Gulf Coast refineries. Capacity is estimated at 700,000 bopd when completed in late 2013.
Rail And Barge Crude Transport
Since pipeline infrastructure is inadequate, rail transport is helping fill the gap. The heavily populated U.S. East and West coasts seem unlikely beneficiaries of Bakken oil. But look what's happening.
Last year Sunoco -- recently acquired by Energy Transfer Partners(ETP) -- was ready to mothball its Philadelphia refinery, one of the oldest and largest in the country. Now, partnering with Carlyle Group (CG), the refinery will take rail delivery of 180,000 bopd of Bakken oil by the end of 2013. This will retain some 800 badly needed jobs in the Philadelphia area.
Then there is this: PBF Energy announced in early February that it is now taking delivery by rail of 110,000 bopd of Bakken crude at its Delaware refinery.
Over on the west coast, California and Alaska oil production has declined in recent years leaving refineries on the coast operating under capacity. Tesoro, however, is now looking at sending Bakken oil by rail to its Washington state and Southern California refineries.
Rail's new found popularity delivering crude benefits companies such as American Railcar Industries (ARII) and Trinity Industries (NYSE:TRN). Both companies manufacture rail cars. Trinity also manufactures wind towers, tank containers. and barges. Rail transport of crude costs more than pipelines but provides much better destination flexibility.
Kirby Corporation (KEX) is the largest barge owner in the U.S. Kirby is now working with Bakken oil companies to move crude down the Mississippi via barge to Louisiana refineries. Continued low river levels due to the worst drought in decades is a major concern though.
I worked in the Dakotas in the 1970's. All I saw outside of the small sleepy towns was prairie, dust, and an occasional rancher in a pickup. The only sound was the wind in the grass.
Two years ago I was back in North Dakota. What a difference! Trucks and noise are everywhere. Trucks hauling oil. Trucks hauling water (for fracking). Trucks hauling who knows what. Every gas station had a line of 10 or more of them.
The rapid expansion of North American oil (and gas) production has caught many by surprise. Infrastructure limits have resulted in a bottleneck of oil in Mid-continent regions causing wide price differentials between areas of surplus in central North America compared to areas of relative scarcity along the East and West coasts and internationally.
Energy service sectors such as refineries, pipelines, rail, trucking, and barge traffic are finding profitable niches arbitraging the spread.
Sectors and companies mentioned here profit from wide WTI/Brent and WCS/Brent price spreads so investors need to monitor these numbers closely.
Disclaimer: This article is only an overview and is purely informational. It is not a recommendation for any of the companies mentioned. Investors need to do further research before deciding if any of the companies mentioned fit their goals and are worthy of their investments.
Disclosure: I am long VLO, PBF, ENB, ETP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.