Is Obama Right To Deny Keystone XL? The Advantages Of Oil By Rail

Includes: CNI, CP, ENB, TRP
by: Davin Research

First, this article is not going to make the claim that moving crude is cheaper by rail than pipeline, that would be absurd. Generally it costs$12 to $15 more per barrel to move oil by rail than by pipeline. This article will only support the conclusion that despite high profile accidents such as Lac-Megantic in Quebec, Canada the transport of oil by rail is in fact environmentally safer than pipeline, and that with increasing environmental regulations, the best plays on increased North American crude transport may lie in railways and not pipelines.

In writing this, I am not taking a stance against investing in "sin" stocks, the meaning of which has extreme political undertones. A stereotypical "left" investor would consider a defense stock such as Lockheed Martin (NYSE:LMT) a "sin" stock while a "right" investor would consider it part of essential national defense and as such, not a "sin" stock. Other stocks such as Sturm, Ruger & Co (NYSE:RGR) or Philip Morris (NYSE:PM) divide investors along collective vs. group rights or self-determination vs. 'being told what is best for oneself' lines, and naturally political parties have traditionally aligned with opposing beliefs on these issues. I am also not taking a stance on the environmental movement, beyond the unequivocal statement that in recent history environmental concerns are increasingly a part of business, and that companies with environmentally-friendly business practices will have a distinct advantage in the future as the public becomes increasingly concerned with environmental issues.

Several of the largest oil plays in North America currently are the oil sands of Alberta, Canada, producing synthetic crude and dilbit, and the Bakken region in Montana and North Dakota producing synthetic crude and light crude. One of the major prospective pipelines carrying these hydrocarbons to the gulf coast is the Keystone XL pipeline by TransCanada Corporation (NYSE:TRP) which has met with stiff opposition from environmentalists and politicians, notably the Obama administration. As a result, a current 150,000 b/d of oil is transported by rail from Alberta into the United States, and this is only expected to grow reaching up a predicted 700,000 b/d by 2016 if the proposed 830,000 b/d Keystone XL is not approved.

This hesitancy towards pipeline approval may be warranted and rail transportation may be safer than by pipeline, in the case of hazardous liquids pipelines. Hazardous liquid pipelines are pipelines that carry petroleum products, other than natural gas gathering, transmission, and distribution lines, and are what Keystone XL would be classified as. This is the same situation for Enbridge's (NYSE:ENB) Northern Gateway pipeline, carrying Alberta hydrocarbons to the Pacific coast. Pipelines do have fewer incidents than oil by rail; from 2005 to 2009, hazardous liquids pipelines had only 0.58 incidents per billion ton-miles (i/btm) compared to railway which had 2.08 i/btm over the same period; approximately four times as many. (For those that are following the reference links, I am aware I am taking data to support the case I am making from a paper reaching the opposite position as mine. I am as amused as you are.) Compare these values to that for road, where almost 20 i/btm occurred, making road transportation by far the most incident prone. However, number of incidents is a poor metric for the determination of environmental safety; for that we must look at relative amounts released. The advantages of oil by rail is seen when release rates are compared; a pipeline can continuously release until noticed, but the discrete nature of rail cars offers some confinement in the case of a breach and as such railway transport released (from 2005-2009) 3,504 gallons per billion ton-miles (g/btm), less than a third of that released by pipelines (11,286 g/btm). The average release per incident from a railway incident is 1,688 gallons, and from a hazardous liquids pipeline the average release is over ten times greater at 19,412 gallons.

Furthermore, the nature of the oil flowing through these prospective pipelines or transported in railcars is different from the light, sweet crude people are most familiar with. The higher viscosity of crude recovered from unconventional deposits such as the Alberta Sands or the Bakken means that for pipeline transport the viscosity must be reduced by the addition of diluents. The diluents can range from 25-55% of the bulk volume transported and can consist of naphtha or natural gas condensate. In both cases the low molecular weight hydrocarbon mixtures contain between five and twelve carbon atoms and can contain a significant aromatic content, including benzene and other carcinogens.

A spill of diluted viscous oil, known as dilbit, behaves unlike a traditional crude spill. A traditional spill will generally be less dense than water and will be able to be cleaned up as it remains on the surface of a body of water. Dilbit, on the other hand will initially remain on the surface, however as the volatiles evaporate the remaining crude is denser than water and will sink. The environmental impacts of this are twofold; the first is that denser-than-water hydrocarbon spills are more difficult to clean up and a lower percentage of the spill is recovered. Secondly, in the area around a dilbit spill, the evaporated volatiles can pose an immediate health hazard. The EPA report on Keystone XL references an Enbridge spill in Michigan in 2010 in which evaporated diluents elevated the benzene concentration in the surrounding air to the point where a voluntary evacuation order was issued, and the report uses this to point to the additional risks of dilbit compared to other crudes. The advantage of rail is easily seen here when the lower release rates rail-transported crude are combined with the fact that rail-transported viscous crude can use less or even no diluents. From the price side, the lack of diluents can narrow the gap between pipeline and rail transport as ~30% more barrels can be shipped when diluents are not added.

Finally, there is one factor that needs to be addressed in this discussion. I have been defining the safety of each transport in terms of amount released into the environment. The earlier-cited Manhattan Institute paper takes a differing position and defines it by the number of fatalities per billion ton-miles, in which pipeline comes out safer (by their definition of safe) than rail. I have to disagree with this methodology; this is a short-term metric and does not account for the potential long-term impacts of the larger volumes lost by pipeline. As environmental damages are attracting increasing litigation with the green movement, the fact that pipelines release far greater amounts of benzene and other carcinogenic aromatics into the environment could attract increasing litigation in the future as a result of long-term health effects. This litigation risk could, in the future, exceed the litigation risk of immediate accidental deaths.

As a result of the above, there are two reasons investors could be drawn to railway transport over pipeline. The first is the socially-responsible class who consider environmental damage above all else, and the second would realize the effect of an increasingly environmentally-conscientious public, leading to denial of pipeline construction approval and underperformance of pipeline stocks relative to rail-transport stocks. This is what we have seen in recent years, where railway stocks have soared on increasing transport of oil by rail; for example, Canadian National Railway (NYSE:CNI) and Canadian Pacific Railway (NYSE:CP) have returned 150 and 250% respectively over the past five years. An interesting comparison is that of CNI's rail map, to the potential path of the Keystone XL pipeline; they both offer a path from the Alberta oil sands to the gulf coast, but in the past 5 years CNI has appreciated 150% compared to TRP's 50%.

Another play on the environmentally-friendly trend is to focus on pipelines that operate in pipeline-friendly jurisdictions over those that operate in multiple jurisdictions or more environmentalist jurisdictions. For example Inter Pipeline (OTC:IPPLF), my current favorite pipeline play, operates within pipeline-friendly Alberta and Saskatchewan and connects to the TransCanada main line as well as offering ample connections to rail facilities including those on Canadian National or Canadian Pacific lines so they will move volume regardless of which method wins in the long run. Conversely, I am no longer an Enbridge shareholder, as their proposed Northern Gateway pipeline must go through British Columbia, one of Canada's most environmentally-responsible provinces. Beyond investing in railway stocks directly, investing in the terminalling companies for the loading of hydrocarbons on train cars is another strategy; for example Canexus (OTC:CXUSF) has terminal business on both CNI and CP's lines, and is pipeline connected.


Transporting crude by rail is environmentally safer than by pipeline. Those interested in investing in hydrocarbon transport would be better served by investing in railways, regional pipelines in friendly jurisdictions, or terminals when compared to large multi-jurisdictional pipelines.

Disclosure: I am long CNI, CP, OTC:OTCPK:IPPLF. 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.

Additional disclosure: I may initiate a position in CXUSF in the coming days.