Boom Clap – The Sound of My Netback? The Bakken Crude 2014 Roller Coaster

It’s been a big year for oil production from the Bakken formation in North Dakota with output passing the 1 MMb/d mark in April and expected to close out 2014 at 1.25 MMb/d. Crude netbacks (market price less transport cost from the wellhead) suffered during the first half of the year from narrowing coastal price differentials - denting the economics of crude-by-rail - the most popular option to get Bakken crude to market. Rail freight costs look set to increase in 2015 with new tank car regulations and requirements for wellhead treatment to remove volatile components. But those changes pale into insignificance compared to the recent crude price nosedive. That threatens to reduce producer revenues by billions of dollars in 2015 and puts the spotlight on higher transport costs to get crude to market from North Dakota. Today we look at the financial impact lower netbacks could have on Bakken producers.

RBN has tracked crude production and transportation trends in the Bakken closely over the past three years - a period of rapid output growth – up 270% from 343 Mb/d in January 2011 to 935 Mb/d in January of 2014 (data from the North Dakota Pipeline Authority - NDPA). During that period of continuous growth, the greatest challenge for producers has been finding markets for their crude and securing transportation to deliver it competitively to refineries. That’s because North Dakota’s small population consumes little oil and the state is located far from large coastal refining centers.

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As production took off in 2011, Midwest refinery demand for light sweet Bakken crude was quickly saturated (many Midwest refineries are configured to process heavier Canadian crude) leaving Bakken crude supplies backed up on limited pipeline infrastructure and causing an inventory glut at the Cushing, OK trading hub resulting in heavy price discounting for Bakken crudes.  During 2011 and 2012 the pipeline congestion at Cushing combined with constrained pipeline take-away capacity in the Bakken encouraged a build out of rail loading terminals to deliver crude past the logjam and direct to coastal refineries (see The Year of the Tank Car). Railing Bakken crude to coastal refineries allowed the latter to take advantage of competitive prices for domestic crude versus imported alternatives (see On The Rails Again). Railroads appeared to be solving the North Dakota crude transport challenge while producers waited for slower pipeline infrastructure to be built out. And for East and West Coast markets where pipeline infrastructure seems unlikely to get built because of geography (the Rockies) or population density (East Coast) rail provided a “pipeline on wheels” to get stranded crude to refineries.

But during 2014 a good deal of rain began to fall on the Bakken crude-by-rail parade – first of all because of concerns about rail tank car safety after several fiery accidents (see The Trains They Are A Changin’) that seem likely to constrain the volume of crude moved by rail in the long run as well as raising freight and wellhead treatment costs. And second because the economics of railing crude from North Dakota to coastal markets took a hit from narrowing price differentials between midcontinent crude benchmark West Texas Intermediate (WTI) priced at Cushing, OK and coastal crudes such as Light Louisiana Sweet (LLS) at the Gulf Coast and international crude Brent, which sets the market price at the East Coast (see I Can’t Stand The Train? and Under Pressure).  When coastal crude prices were much higher than WTI it made sense to pay higher rail freight costs to ship crude to those markets. As the difference between WTI and coastal crudes narrowed, so did the incentive to use rail transport. On the plus side for Bakken producers there was an expansion in outbound pipeline capacity from North Dakota to Cushing and to the Gulf Coast during 2014. That new capacity encouraged producers to get off the rails and to ship by pipeline. But although moving Bakken crude to the Gulf Coast by pipe is typically less expensive than railing it to East or West Coasts, crude delivered to the Gulf from North Dakota struggled to compete with booming output from the West Texas Permian and South Texas Eagle Ford basins. Those shale crudes have less distance to travel to the Gulf Coast so their freight costs are lower. Bottom line – transport costs weigh heavier on North Dakota producers – reducing their netbacks. Producers closer to market usually make more money.

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