Railroad stocks recently declined -5% to -10% due to concerns that low oil prices will hurt their crude-by-rail business.
All Class I railroads haul crude that comes from shale plays in North America. Railroads with the highest exposure to this business are Canadian Pacific Railway (NYSE:CP), BNSF Railway (NYSE:BRK.B) and Canadian National Railway (NYSE:CNI). Hauling crude and related frac sand represent about 5% to 9% of their total volumes. The BNSF and CP crude trains from the Bakken Basin in North Dakota often interchange with other railroads that carry them to their final destinations.
Union Pacific Corp. (NYSE:UNP) may see no growth in crude-by-rail volumes in 2015 due to various changes in the marketplace.
About 4.5% of UP's total volumes are related to crude-by-rail and frac sand for shale drilling plays in the United States. About half of those volumes are frac sand, said Rob Knight, chief financial officer for Union Pacific. Knight said:
Our crude-by-rail volumes are down -18% through the third quarter. Spread differentials and growing Gulf crude supply has displaced some of the crude previously moving to St. James, LA., which is now moving to the East Coast.
Knight said there is a potential for new crude-by-rail business in the Niobrara formation and Canadian crude, as well as West Coast destinations. He said:
However, we do not expect to see much growth in crude-by-rail volumes over the next few years as the Bakken volumes will likely continue shipping away from the Gulf. And these new potential opportunities will likely not grow fast enough to offset that displacement.
UP's Knight was one of several speakers at the Credit Suisse Global Industrials Conference in New York on Wednesday, Dec. 3, 2014. E. Hunter Harrison, Chief Executive Officer, Canadian Pacific, also was a speaker at the conference.
Knight said no UP customers have called to reduce shipping of frac sand. He said hauling frac sand is a great business, much of it comes from Wisconsin. Frac sand is used in shale drilling for oil or gas. Drillers in the Eagle Ford shale play use frac sand hauled by UP.
We're still pretty bullish on our sand territories, but we are in uncharted territory, we'll see how this unfolds.
Robert W. Baird Equity Research estimated that $73 per barrel was the weighted average break-even point for U.S. shale production, Reuters reported. On Tuesday, the price of crude was $63.40 per barrel. Prices slid to a five-year low on Monday, amid fears a global oil glut will persist into next year.
Harrison said crude-by-rail and related frac sand represent about 7% to 8% of volumes at Canadian Pacific. Harrison said:
I don't think we're going to see any knee-jerk reaction. I don't think we're going to see anything stopped in the Bakken. You just can't cap a well and shut it down without a lot of damage.
He said the drop in oil prices could be a non-event or a positive depending where crude price settles.
He said Canadian Pacific has not altered its guidance for 2015, "we're proceeding on course."
In my previous article on this issue, I suggested that if oil prices remain below $70 per barrel for a year, we may see some shale plays in North America implode.
It's difficult to predict where oil prices will go in 2015. Remember, oil went to $12 per barrel in 1998 and 1999. If oil supply remains flush, oil could stay down for a long time.
Lower fuel prices reduce operating expenses for railroads. At Union Pacific, the company spent $882 million in the third quarter on fuel. The average quarterly diesel fuel price of $3.01 per gallon for Union Pacific in the third quarter 2014 was down 5% compared to the third quarter 2013. The company saved about $45 million in fuel expenses in the quarter. This helped Union Pacific achieve an operating ratio of 62.3% -- an all-time quarterly record. Other business categories are improving for Union Pacific, including coal volumes, intermodal, grain, autos, chemicals and trade with Mexico.
Low oil prices will put more money into U.S. households. If consumers have more discretionary dollars, they may buy a truck or fix up their house, Knight said. That might be a positive for the overall economy.
U.S. GDP grew 3.5% in the third quarter, and November job growth was 321,000.
I remain bullish on North American railroads because they have more business than they can handle right now. A reduction in crude-by-rail volumes may relieve congestion on the rail network. Union Pacific's 4.5% exposure to crude-by-rail is lower than some of its competitors. Investors should look at the downturn in rail stocks as an opportunity. On Tuesday, I purchased a few more shares of Union Pacific at $112.75 per share. I sold some shares of Canadian Pacific at $195 per share, but plan to buy them back at a cheaper price.
Disclosure: The author is long UNP, BRK.B, CP, CNI, NSC.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.