Pipelines are chasing crude-by-rail shipments out of most US markets, but the Bakken-to-Atlantic-Coast route has managed to keep a hold on its market share, making the spread between domestic and international crudes more important than ever to profitability on the rails.
Rail used to have a key advantage in the midstream market; namely, it was already there. When the US started producing massive quantities of crude oil from shale wells about six years ago, the volumes quickly overwhelmed the market’s ability to move it around with traditional infrastructure. Huge amounts of crude oil were piling up in the Bakken, hundreds or even thousands of miles from the major coastal refining regions, and no one had the space to move it.
That volume eventually found its way onto trains, though, which moved it to the coasts, where it could compete with imported crudes. That’s a key point: crude by rail competes with imports, because that’s all it can compete with in most cases. Pipelines are cheaper than train cars, and when there’s enough capacity along a certain route, like from the Bakken to the Gulf Coast, rail shipments along that same route are choked out.
Movements between the Midwest and the USAC represented an average of 11% of the total US crude-by-rail movements in 2012. By 2013, that had increased to 27%, and then 36% in 2014. USAC shipments have averaged 41% of the US total so far in 2015. Volumes from the Midwest to the Gulf Coast have declined from a 2012 average of 47% to 8% in 2015.
And the Atlantic Coast is unlikely to lose its dominant status in the market any time soon. Rail has been in large part run out of the Gulf Coast by the pipelines, and volumes haven’t been able to find much purchase on the West Coast because any form of overland midstream infrastructure faces a regulatory beat down in California.
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But rail hasn’t had nearly that kind of trouble setting up shop on the USAC, where US producers have been happily competing with West African imported crude for years. Any pipelines trying to get to that market would have to cross Pennsylvania, New Jersey and the Delaware River, regulatory barriers that are probably too high to hurdle, so it’s a safe haven for rail right now.
And that’s why rail volumes are so sensitive now to the spread between the international Brent crude benchmark and the domestic West Texas Intermediate crude. When that spread is narrow, suddenly those imports look pretty competitive, because while rail shipping is fast and flexible, it isn’t actually that cheap. It costs about $12/b or $13/b to move from the Bakken to the coast, compared to about $3.20/b on a Suezmax from Africa. Sure, using a Suezmax means the shipper has to move a million barrels at a time, and it’s going to take longer to react to pricing shifts, but that’s still nearly a $9/b advantage.
So crude-by-rail profits are more sensitive to the Bent/WTI spread, but what about volumes? Thus far, there doesn’t seem to be a particularly strong correlation between rail volume and the spread. In January of this year, the spread averaged $2.5435/b, but even isolating the Midwest-to-USAC barrels, January represents the single highest volume shipped — 13.60 million barrels — since the US Energy Information Administration began recording the data in 2010. The next month, when the average spread climbed to $8.21/b, volumes slipped to 10.65 million barrels, the lowest volume since the prior February.
There are a few reasons why this might be, said Lipow Oil Associates President Andy Lipow.
For one, there are probably a significant number of shippers who are under contract to ship. They’re going to have to pay for the trains anyway, so they might as well fill them even if it would otherwise be uneconomical.
“All this committed shipper stuff kind of obscures the apparent economics,” Lipow said.
Another issue is that even if a producer decides against shipping, they still have to pay for storage, Lipow said, which can further incentivize shipping and selling at a loss, as long as that loss is less than the cost of not shipping.
Even now, with the Brent/WTI spread having averaged $4.4316/b thus far for the third quarter, crude continues to move on the rail to the USAC, where cracking margins for Bakken crude have averaged less than a dollar this week, and even dipped into negative values the week before that.
“This is due to numerous volumes being termed up under contract,” said Anthony Starkey, the energy analysis manager at Bentek, a unit of Platts. “We can fairly safely assume it is roughly the amount being railed of late, given the narrow WTI-Brent spread. The Platts Bakken assessment reflects spot activity which is clearly not economical for rail to the USEC at this time.”