Narrowing price differentials between inland crudes tied to West Texas Intermediate (WTI) and coastal crudes tied to Brent are resulting in a move away from rail shipments and back towards pipelines by producers in North Dakota. The switch away from rail is already having an impact on the lease rates for rail tank cars. Which could call into question the huge backlog of orders for new tank cars. Today we ponder the possibility of a bust in crude-by-rail shipments.
At the end of May we noted that rail tank car loadings of Bakken crude from North Dakota were down by as much as 25 percent versus April and that pipeline receipts for the same period were up substantially (see To the Pipelines, Robin). The change in shipper sentiment occurred at the same time that differentials between inland crude priced against the domestic benchmark West Texas Intermediate (WTI) and coastal crude priced against Brent (the international benchmark) or Light Louisiana Sweet (LLS) crude sourced at the US Gulf Coast, narrowed from around $17/Bbl in March 2013 to $9/Bbl today (June 11, 2013). The narrowing differentials mean that producers with the right transportation options can achieve higher crude netbacks by shipping crude by pipeline to the Midwest Cushing, OK hub than they can by using more expensive rail transportation to the Gulf Coast (see Crude Loves Rock’n’Rail – Brent, WTI and the Impact on Bakken Netbacks).
Our latest netback analysis indicates that based on crude prices for June 11, 2013 the wellhead netback in North Dakota is still virtually the same (~$85/Bbl after gathering, transportation and railcar costs) whether a producer ships crude by pipeline to Cushing or by rail to St. James, LA or to the East Coast. In other words the incentive to move Bakken crude by rail to the East or Gulf coasts has diminished. In the past few days, prices for Bakken crude at pipeline receipt points in Clearbrook, MN and Guernsey, WY have been higher than the price for WTI at Cushing. This means producers in North Dakota need only ship their crude to Clearbrook or Guernsey for resale at these hubs to realize a higher netback than shipping further to Cushing or by rail to Gulf or East Coast destinations. The evidence suggests that if these price differentials are sustained we will see continued transfer of North Dakota crude barrels from rail to pipeline.
A significant move away from crude-by-rail transportation back onto pipelines – and we believe that there are signs that it is already happening – will likely have some unpleasant consequences for the rail industry and crude shippers using rail. Those with long memories in the rail business have been conscious throughout the recent boom in crude-by-rail of the bust in the ethanol-by-rail tank car market in 2008. That bust followed a boom in ethanol-by-rail movements after Energy Policy Act regulations in 2005 mandated increased ethanol blending into gasoline and diesel (see A Market of Contradictions). Since ethanol cannot be carried by pipeline after it has been blended with gasoline (because it attracts water), it is shipped by rail to final blending terminals. The sudden demand for ethanol led to a boom in rail tank car lease rates and a boom in tank car manufacture. When ethanol demand leveled off as US consumers used less gasoline in the recession, the ethanol-by-rail boom turned to bust in 2008 and lease rates for tank cars fell through the floor.
So what are the consequences if the crude-by-rail boom loses steam as more producers switch to pipeline transportation?
First to feel the pain would be rail tank car leasing companies. We recently covered the red hot market for rail tank car leasing that has seen a boom in the past two years as crude producers, marketers and shippers scramble to secure the equipment they need to ship their crude (see I Can See Them for Miles & Miles & Miles). Currently there are approximately 315,000 tank cars in use for petroleum shipments in North America and 53,000 tank cars on back order (source: Strobel Starostka). That’s up from a backlog of 48,000 in January 2013. The backlog means that manufacturers can’t deliver a new car for 24 - 30 months. Because of the new build backlog and the dramatic expansion in demand as producers and refiners build out rail terminals (see Crude Loves Rock’nRail – 154 Terminals Operating) there is a shortage of rail tank cars. As a result, rates for leasing rail tank cars for 1-year terms increased to over $3,000/month. Back in February 2013 we reported lease rates at $2,500/month – nearly four times as high as they were before the current boom started in 2011. If there is a sudden drop in the demand for rail tank cars for short-term lease then expect that monthly lease cost to fall sharply. We heard unsubstantiated rumors from reputable producers that short-term lease rates are already falling in response to a slackening in rail tank car demand. Numbers like $1,500/month and $1,200 have been heard on the street, but at this point are unsubstantiated.
The only lease rates for rail tank cars that are less vulnerable to falling demand are those for coiled and insulated (C&I) cars. The C&I tank cars are smaller than general purpose (GP) tank cars (550 Bbl volume vs. 650 Bbl) and they contain special insulation and coils that are used to keep the cargo warm in transit and to heat up viscous material such as heavy Canadian bitumen crude so that it can be offloaded (see Crude Loves Rock’n’Rail Heat It!). These tank cars are still in high demand as Canadian crude producers are building out new terminals to load and offload bitumen crude. It is also the case that these cars may have more value long term than GP cars. That is because it is widely believed that current industry discussion of safety standards for carrying hazardous materials (hazmat) like crude oil will lead to new regulations from the Federal Railroad Administration (FRA) and the Department of Transport governing rail tank car construction, requiring insulated thermal protection to reduce the risk of fire in an accident. If that turns out to be the case it is likely that C&I tank cars will still be usable. The implication for owners of GP cars is that they may have a shorter shelf life for use carrying crude oil.
Another obvious consequence of a fall in demand for rail tank cars would be an increase in cancellations of some of the backlog of cars waiting to get built. Our understanding is that many manufacturers that were burned during the ethanol boom and bust in 2008 have made new rail tank car orders non-cancelable – meaning that the customer has to take delivery come hell or high water and bears the risk going forward. It is unknown how many rail tank car orders are covered by this kind of manufacturer insurance.
For the railroads the big consequence of a slow down in the crude-by-rail boom would be the loss of freight rate income. However the railroads will potentially benefit from additional charges that arise from railcars waiting at terminals or on tracks outside the terminal because crude is not available to fill them immediately. These charges are known as demurrage fees. The topic of demurrage deserves a blog in its own right but what it means in this case is that you pay the railroad a $/day fee for rail tank cars that sit on their tracks waiting to load beyond an allowance time based on a prompt turnaround. Demurrage fees may be paid to all Class 1 railroad (eg BNSF, CP, etc) as well as to the short haul railroads that are often used to link loading or unloading terminals to Class 1 lines (depending on the shipper's contract). Demurrage charges are not insignificant. We found published charges online for one railroad (CSX) that cited $60/day for a privately owned rail tank car. Demurrage costs for a locomotive are much higher. These charges apply even when tank cars are loaded and waiting to unload outside a terminal.
And those costs bring us to the impact of lower utilization on the economics of unit trains. All the way through our narrative on crude-by-rail we have stressed the economics of using unit trains of 80-120 rail cars operated as a single unit with two locomotives, compared to single tank cars in a manifest shipment (see A Tank Car Train for Hire). Unit trains cost less to operate because they are more efficient and travel more quickly than manifest shipments. Those economic advantages are positive when unit trains are filled and turned around quickly. Unfortunately the economics deteriorate if a unit train operator has to wait to fill their cars with crude because shipping volumes are down because producers are switching to pipelines. Then the unit train operator has to pay demurrage charges every day for each unused car.