Crude-by-Rail and Other Logistical Wonders

Regular readers of this column know how much I enjoy attending the transportation and logistics conference held each year in Miami and sponsored by a major investment firm. This year was no different. There were 40 company presentations, including all the major truckers, rails and airfreight carriers, and a smattering of maritime – Kirby Corp., Matson and Rand Logistics among them. There was a Port Panel (trivia question: what was the fastest growing port in the U.S. last year?), an Intermodal Panel, a Natural Gas Panel, a Shipper Panel and an e-Commerce Panel – all the hot-button topics you want to know about.

But the real star of the show was a recent development called crude-by-rail, a term I had never heard before and a logistical wonder that has sprung up virtually overnight in response to the shale oil boom in places like North Dakota and Texas.

Not Enough Pipelines
Picture mile-long unit trains of 125 tank cars each snaking their way south from the Bakken Formation in North Dakota to places like Haynesville, Louisiana and Cushing, Oklahoma, or from the Eagle Ford Formation in South Texas to Gulf Coast refineries and ports. Each tank car holds about 700 barrels of crude. Do the math and it comes to roughly 88,000 barrels of crude per train. Last year Union Pacific’s crude-by-rail shipments tripled – to 275,000 barrels per day – or the equivalent of three unit trains per day. So far this year they’ve doubled again, and there’s no end in sight. North Dakota production alone has soared to over 700,000 barrels per day, making it the number-two producing state in the U.S., ahead of Alaska (!) and behind only Texas. The biggest crude-by-rail shipper out of North Dakota is not Union Pacific, however. It is Burlington Northern, now a part of Warren Buffett’s Berkshire Hathaway.

Even CSX, whose network does not extend to places like North Dakota and Texas and is located entirely east of the Mississippi, is benefiting. Last year it averaged eight “crude-by-rail” unit trains a week, up from zero the year before. And it expects continued growth as domestic crude replaces higher-priced foreign imports as feedstock for East Coast refineries.

North of the border, Canadian Pacific is also cashing in. It’s got a stake in the Bakken, but more significant is oil sands production in Alberta and Saskatchewan. This “heavy oil” is also moving by rail, east to refineries along the Great Lakes and west to Vancouver, British Columbia. CP shipped 53,500 carloads last year and expects fully half its future growth to come from crude-by-rail shipments.

Why all the activity? Because the shale oil boom has overwhelmed existing pipeline capacity. In most cases there is no pipeline capacity, and it can take years to build a new pipeline, or to connect with an existing one. Drillers are left with two choices: truck or rail. A single tank truck can carry about 6,000 gallons or 140 barrels of oil. Five tank trucks equal one rail car. Which would you rather have – 625 trucks polluting the road or one 125-car unit train? And guess which is cheaper, much cheaper.

So it’s a fairly easy choice in the short term. In the long term, rail executives argue that even when the pipelines are built there will be room for crude-by-rail. They see the two modes as complementary – you need both to handle all the output, the argument goes – and they are busy making crude-by-rail a “sustainable business model” that will carry them for many years to come. The oil industry seems to agree as it has invested more than $1 billion in new rail terminals and added 20,000 new tank cars to handle the load. Among the advantages it sees in rail are flexibility, speed, faster permitting and construction, and lower capital costs.

Timing Is Everything
For the railroads, at least, the shale oil boom couldn’t have come at a better time. Coal shipments slipped precipitously in 2012 as another shale product – natural gas – dramatically increased its share of the domestic power market. It used to be that coal generated 60 percent of the nation’s electricity. Now it’s 40 percent. In the same period natural gas-fired plants have gone from less than 20 percent of the nation’s electricity-generating capacity to 30 percent today and rising fast. The rest is oil, nuclear, and wind.

Why the changeover? Because gas has become so abundant and cheap it can now compete favorably with coal on a dollars-and-cents basis. And of course gas is much cleaner, much more environmentally friendly, so it’s really a no-brainer. As a result, no new coal plants are being built, but lots of natural gas plants are. CSX, a major shipper of coal, stated unequivocally that 2012 marked the definitive switch from coal to natural gas as the fuel of choice for the nation’s utilities.

Crude-by-rail won’t entirely replace coal as a revenue source for the rails. But it’s gone a long way toward easing the pain from the decline in coal shipments. And in a somewhat ironic twist, coal exports – particularly of higher-priced metallurgical coal, or “met coal,” used in the steel-making process – from the U.S. to places like China and even Europe are rising. If you can’t use it at home, might as well export it!

Where Is Maritime?
OK, so where does maritime fit in all of this? Crude-by-rail may be a bonanza for the railroads, but what about the struggling maritime industry? Not to worry. There’s more than enough good news to go around.

Let’s start with Kirby Corp. of Houston (NYSE: KEX), the nation’s leading operator of both inland and coastal tank barges. Kirby is already barging shale oil from the Eagle Ford Formation to refineries along the Texas-Louisiana coast. Most of it arrives by rail in Corpus Christi, where a portion is refined right there into gasoline and jet fuel and fuel oil while the rest is shipped by barge to other Gulf Coast refineries or by coastal tanker to East Coast refineries. Either way, you’re using a Kirby vessel. Kirby barges the refined products too, of course, either along America’s inland waterways (the so-called “marine highway”) or by tanker to East Coast destinations.

There’s a market for Bakken crude too. Much of it goes by rail to Anacortes, Washington, where it is refined into byproducts or transported by coastal barge (Kirby’s and others’) to other West Coast destinations. The refined products are then consumed domestically or exported.

A standard river barge holds about 28,000 barrels of crude, equivalent to 40 rail cars or 200 tank trucks. String 15 of them together in a typical barge tow and you have the equivalent of 600 rail cars (five unit trains) or 3,000 tank trucks. That’s a lot of capacity, and that’s a lot of efficiency too, not to mention the environmental savings from using water in terms of noise and air pollution.

It won’t be long before the U.S. is once again king of the hill in terms of energy production. Estimated reserves of shale oil and gas keep going up, and as production increases the need for imports will gradually decline. The long-awaited dream of “energy independence is within reach.

Panama Canal Update
Among the more interesting panel presentations was the one on ports, which focused mainly on the Panama Canal expansion. Only two East Coast ports are ready right now for post-Panamax ships (12,000 TEUs) – Baltimore and Virginia (Norfolk). They have the 50-foot channels required to handle these behemoths. New York/New Jersey and Miami are close behind and will be ready in 2013 and 2014, respectively.

Savannah and Charleston are in the mix, too. But really, are they both needed? The Port of Charleston is investing $300 million to deepen its harbor from 45 to 50 feet, part of an overall 10-year, $1.3 billion infrastructure investment plan, and Savannah is investing more than $600 million in its port-deepening project.

The sweet spot for the new canal are 7,000-12,000 TEU vessels (current maximum is 5,600 TEUs). The hope is that these larger ships will bring more container cargoes directly to East Coast ports and, in the process, bypass LA/Long Beach and other West Coast ports and thereby save both time and money. The current slowdown in containerized traffic, however, along with a surplus of vessels and an increased emphasis on slow-steaming, may cast a shadow over these prospects. And the largest container ships – those with 14,000 and 16,000-TEU capacity – can’t use the new canal anyway. They’ll continue to dock at West Coast ports.

More promising is the potential of LNG exports through the expanded canal to destinations in Asia and the Far East, where natural gas sells for four times what it does in the U.S. The explosion is shale gas production has showered the U.S. with an abundance of natural gas, and operators are scrambling to build liquefaction terminals to turn it into a liquid and ship it to Asia and Europe, where both demand and prices are high. So far only one operator, Cheniere Energy of Houston, has actually broken ground, and its facility in Sabine Pass, Louisiana, is scheduled to come online sometime in 2015, just in time for the canal’s opening.

But many more LNG facilities are on the drawing board and in the process of being permitted – as many as 20 at latest count. These new facilities could boost U.S. LNG production to as much as 50 million tons annually by 2020, according to a report from Morgan Stanley, up from zero today. What a bonanza that would be for canal traffic!

Interestingly enough, these two topics – the expanded Panama Canal and U.S. LNG – will be the focus of a September 2013 conference sponsored by this magazine. To find out more, visit our website at www.maritime-executive.com.

Tidbits
If the conference gave an award to the company with the highest return on equity, it would go to CAI International of San Francisco (NYSE: CAP), one of those container-leasing companies we have talked about in this column before and which seem to fly below the radar of most investors. Its ratios are off the charts. EBITDA margins are above 90 percent! Operating income margins are in the high 50 percent range, and net income of some $63 million last year came in at 36 percent of revenue, which totaled $174 million. That compares favorably with Apple or any other stock you can think of.

Stay on Top of the Daily Maritime News The maritime news
that matters most

Get the latest maritime news delivered to your inbox daily.

Subscribe Now

One final takeaway: Because natural gas is now so abundant and cheap in the U.S., chemical companies are flourishing. They use natural gas as feedstock for everything from plastics to fertilizers. Chemical shipments by rail and on America’s inland waterways have ballooned, benefiting companies like UP, CSX and Kirby. For the first time in a generation, new chemical plants are being built, and this too bodes well for the transportation industry and the economy as a whole.

And now, since you’ve been so patient, here’s the answer to the fastest-growing-port-in-America question I started out with: the Port of Virginia. Surprised? I was. The panel experts (one of whom was the Deputy Port Director) attributed the growth to privatization initiatives and increased investment in intermodal rail facilities by CSX and Norfolk Southern. Who’d 'a' thought?