Crude by rail: does it really make sense?

January 15, 2013

NOTE: Images in this archived article have been removed.

Image RemovedBloomberg published an article regarding the new frenzy of shipping domestic crude, particularly tight oil from shales, by rail rather than pipeline. This decision by shale operators is interesting for various reasons but most especially for the economics behind it. While industry touts shipping by rail as their latest great idea, there is, of course, another possibility as to why shipping by rail rather than pipeline makes sense. And it has more to do with unprofitability than great opportunity.

According to Bloomberg:

“A group of oil and gas pipeline operators led by Plains All American Pipeline LP (PAA) announced plans just in the past three months to spend about $1 billion on rail depot projects to help move more crude from inland fields to refineries on the coasts.”

Now there are several things wrong with this. Firstly, everyone in the oil and gas business knows that pipelines are cash cows once upfront costs have been recouped. They are particularly good money machines if a field is long lived. Secondly, pipelines are currently very lucrative places to have your money.
To give an example, Oil and Gas Journal reported in September 2012:

“Oil pipeline operators’ net income soared to an all-time high of $6.1 billion, a 33.3% increase from 2010 achieved on the back of a nearly 12% increase in operating revenues.”

And yet in the Bakken play in North Dakota, Oneok Partners couldn’t get enough interest from operators to build a pipeline to carry Bakken crude.
According to the WSJ MarketWatch:

“Oneok cancelled its Bakken Oil Express plans…citing insufficient shipper interest.”

Now record profits are being made on oil pipeline assets in the U.S. and industry touts the Bakken as one of the two hottest oil shale plays in the US and yet there is “insufficient shipper interest”.

Further, it costs about three times as much to transport oil by rail than by pipeline. That adds considerably to the overall costs. Tight oil production isn’t cheap by any measure to drill and complete so shipping by rail is merely adding additional burden. Three times the additional burden. Bloomberg quotes Tudor, Pickering and Holt, an energy investment bank based in Houston:

“Sending Bakken oil through a pipeline to U.S. Midwest markets costs about a third of the $15 a barrel expense of carrying it by train to the East Coast.”

So let’s examine another possible scenario. One the oil and gas industry isn’t putting forward.
The USGS examined well data for every shale play in the US and extrapolated EUR’s, or reserve estimates, based on actual production. Reserve estimates were slashed significantly from operators prior overly optimistic assumptions and claims. In fact, operators have overestimated reserves by a minimum of 100% to as much as 400-500% on shale gas and tight oil. These figures are now being corroborated by other independent geologists as well.
Add to this mix extremely steep decline curves for both shale gas and tight oil. A paper presented to the Society of Petroleum Engineers which researched well data in the Eagle Ford shale of South Texas found that first year decline rates were about 80-93%! Shale gas overall yearly field declines are in excess of 40%. The Haynesville is in excess of 50%. In other words, wells are playing out much quicker than expected.
And this segues nicely into the heart of the matter. If operators thought that shale assets would be long-lived and highly productive they would build pipeline infrastructure to ensure equally long lived profits. But that is not the case. They have chosen instead to ship by rail for three times the cost of a pipeline. It is more likely that industry recognizes the short lives of shale wells and are not prepared to invest the capital needed to build the infrastructure.
That is the beautiful thing about numbers. Profitability either exists or it doesn’t. Just AskChesapeake!

Railroad tank car via shutterstock. Reproduced at with permission.

Deborah Lawrence

Deborah Lawrence (formerly Deborah Rogers) worked as a financial consultant for several major Wall Street firms, including Merrill Lynch and Smith Barney. Ms. Rogers was appointed as a primary member to the U.S. Extractive Industries Transparency Initiative (USEITI), an advisory committee within the Department of Interior, in 2013 for a three-year term. She also served on the Advisory Council for the Federal Reserve Bank of Dallas from 2008-2011. She is a Member of the Board of Earthworks/OGAP (Oil and Gas Accountability Project). She is also the founder of Energy Policy Forum, a consultancy and educational forum dedicated to policy and financial issues regarding shale gas and renewable energy. 

Tags: Industry, tight oil, Transport