Business

Rail companies poised to keep on chugging despite oil swoon

The stunning collapse in oil prices over the past several months won't derail the railroads' profit engine even if it does slow the tremendous growth in crude shipments seen in recent years.

Oil by rail has been growing, but still a small part of overall business

Rail companies could actually benefit from slumping oil prices, some experts say. (Jeff McIntosh/The Canadian Press)

The stunning collapse in oil prices over the past several months won't derail the railroads' profit engine even if it does slow the tremendous growth in crude shipments seen in recent years.

Carloads of crude oil spiked well over 4000 per cent between 2008 and last year — from 9,500 carloads to 435,560 — as production boomed and the cost for a barrel of oil soared into the triple digits.

Oil is a small part of rail network

Those prices have tumbled severely, to just above $50 per barrel Friday, and that has rattled some of the investors who have plowed money into companies like Union Pacific, Norfolk Southern and CSX.

All three of those companies have seen their stock prices slip over the past month, along with major U.S. stock markets.

But even with oil prices falling off a cliff, industry analysts and railroad executives point out that crude shipments still make up just a sliver of the overall freight delivered by rail. What's more, because fuel is such a huge cost in the industry, railroads are a direct beneficiary of those falling prices.

Crude oil shipments remain less than 2 per cent of all the carloads major U.S. railroads deliver. Sub-$60 oil might force producers to rein in spending but railroads — which spend hundreds of million of dollars every quarter on fuel— will see their costs fall away.

Oil drops to 5-year low

Those falling energy prices have also proven to be the equivalent of a massive tax cut for both consumers and businesses, and railroads stand to benefit from that as well.

Fueled by a rebounding employment as well as rising consumer and business confidence, U.S. economic growth reached a sizzling 5 per cent annual rate last quarter, the government reported this month. The rebounding economy is likely to drive even greater demand for shipping.

Edward Jones analyst Logan Purk says the importance of crude oil shipments by rail seems to have been inflated by investors.

"It seems like whatever loss in business they see will be offset by the drop in fuel costs," Purk said.

The crude oil business has provided a nice boost for railroads at a time when coal shipments were declining. Profits at the major U.S. railroads have been improving steadily along with the economy, reaching $13.4 billion in 2013, up from $11.9 billion in 2012 and $10.9 billion in 2011.

Officials from Union Pacific Corp, Norfolk Southern Corp., CSX Corp. and Canadian Pacific all tried to reassure investors about crude oil shipments during their latest investment conferences.

"I don't think that we are going to see any knee-jerk reaction. I don't think we are going to see anything stopped in the Bakken," said Canadian Pacific CEO Hunter Harrison said of the massive oil and gas fields that stretch from North Dakota and Montana into Canada.

The Bakken region is one of the places where railroads are hauling the majority of the oil because pipeline capacity hasn't been able to keep up with production.

Through the fall, North Dakota oil drillers remained on pace to set a sixth consecutive annual record for crude oil production.

Justin Kringstad, director of the North Dakota Pipeline Authority, said the lower prices will prompt oil companies to look for ways to reduce costs, but he's not yet sure how much of an effect it will have on production in the region.

"It's still a little early to make any firm assessments," Kringstad said.

Shale oil boom

It helps that the cost of producing oil in the Bakken region is lower than in other places, so oil producers can still profit even when oil prices fall, said Don Seale, Norfolk Southern railroad's chief marketing officer.

"Oil is being produced. The oil will have to move, and the assets have been invested in tank cars, loop tracks, infrastructure to support crude by rail," Seale said during a recent investor conference call.

Regardless of what happens with oil production, there are reasons to believe that railroads will continue hauling oil from places like the Bakken that only recently began producing in large quantities.

The railroads — which are now delivering 59 per cent of the roughly 1.2 million barrels of oil produced each day in North Dakota — expanded capacity quickly to handle the surge.

Because the price of oil varies by market, railroads provide one of the best avenues for buyers and sellers to get crude to places where the price makes it economical.

"Rail is definitely required to get all of the Bakken's production out to market," said Jonathan Garrett, a senior analyst at Wood Mackenzie senior, even if falling prices cut into the margins for producers.

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