Investors in U.S. railway companies are in for a treat as demand for domestic crude oil transportation increases exponentially against the backdrop of an unprecedented surge in shale oil production. While the huge increase in supply of shale oil from the Bakken formation (spanning across the states of North Dakota, South Dakota, Montana and Saskatchewen) has hurt oil producers as prices adjust downwards, railway companies have benefitted as refiners on the East Coast and the Gulf Coast replace relatively pricier imported crude oil with domestic supply.
Traditionally, U.S. refineries have largely relied on imported crude oil pegged to internationally traded crude oil prices. The largest concentration of refineries in the U.S. are based in the Gulf Coast and the typical product chain has always been to import foreign crude oil as raw materials and subsequently transporting the processed oil products by pipeline to customers in the North.
However, new drilling methods and technical capabilities in shale oil production have dramatically increased the production and supply of crude oil on continental U.S. in a very short span of time. As a result, prices of domestic crude oil have tumbled and then decoupled from prices of internationally traded crude oil. To illustrate the difference, the U.S. domestic oil benchmark, West Texas Intermediate, traded yesterday at US$96.91 while the internationally traded Brent crude oil benchmark stood at US$115.53.
This significant difference (or ‘spread’ in industry parlance) between the prices of domestic and imported crude oil has driven many U.S. refineries to look for ways to transport the relatively cheaper crude oil from the Midwest. Because there are no existing pipelines connecting the shale oil production zones such as the Bakken formation to the refinery centers, railroad has emerged as the favorite form of transportation for many companies. This sudden change in market dynamics has in turn driven up demand for railway companies to transport crude oil internally within the United States.
For example, the Association of American Railroads reported that the biggest U.S. railway operators have seen an increase of more than 30 percent in carloads of crude oil carried just from 2011 to the first half of 2012. To further illustrate the point, the first six month of 2012 saw operators moving 88,026 carloads of crude oil compared to less than 10,000 carloads in 2008.
In another positive sign for the industry, BNSF Railway announced in the first week of September that it plans to expand its crude oil transportation capacity in 2012 to a million barrels per day from the Williston Basin in North Dakota and Montana. CSX Corp, another major rail player, reported earnings growth in its second quarter ending June 30th despite decreasing demand for other forms of energy transportation such as coal.
Business Section: Investing Ideas
The resilience of the industry despite the poor economic backdrop and the potential growth in domestic crude oil transportation should entice investors to take a closer look at the domestic railway companies. Here are some names that could potentially profit from this new trend:
2. Union Pacific Corporation (UNP, Earnings, Analysts, Financials): Through its subsidiary, Union Pacific Railroad Company, provides rail transportation services in North America. Market cap at $59.17B, most recent closing price at $124.94.
3. Canadian National Railway Company (CNI, Earnings, Analysts, Financials): Engages in the rail and related transportation business in North America. Market cap at $40.5B, most recent closing price at $93.08.
4. Norfolk Southern Corp. (NSC, Earnings, Analysts, Financials): Engages in the rail transportation of raw materials, intermediate products, and finished goods primarily in the United States. Market cap at $23.65B, most recent closing price at $74.02.
Written by SiHien Goh
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- CSX Corp. (CSX, Chart, Download SEC Filings)
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- Canadian Pacific Railway Limited (CP, Chart, Download SEC Filings)
- Kansas City Southern (KSU, Chart, Download SEC Filings)
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