Crude Oil & Warren Buffett On The Same Page?

If you’ve been paying attention, railroads have slowly but surely become the preferred option of shipping for the US in increasing crude oil production. In 2012 alone, delivery of petroleum and crude oil products by railroad increased by more than 30%. Mainly, this increase is due to the added production coming out of the Bakken region in North Dakota.

Continental Resources, a Bakken producer, seemed to really enjoy using the railroads as their favorite mode of transportation. This company and many of its peers have been producing a lot more oil than the current infrastructure and pipeline was capable of handling. That created a very wide differential in the price of crude oil produced out of Bakken and that of the United States benchmark West Texas intermediate. Thanks for the railways, the differential has come down quite a bit recently.

In what may be the best quote from the previous year, Rick Bott, COO and President of Continental told his investors that “We’ve recently seen a significant improvement in Bakken oil price differentials, reflecting higher volumes being shipped by rail to the coasts and the anticipation of increased pipeline capacity… We now have excess transportation capacity in both pipe and rail, and, with additional infrastructure projects in the planning and construction stages, capacity should remain ahead of Bakken production growth.”

This is fantastic news for specific railroad owners and certain producers of crude oil. But in reality, this may be bad news for the future of pipelines.

When dealing with the investment world, we often speak about terms in regards to accompany as having “first mover” status because it takes over and has a large, sustainable advantage over the competition. This tends to be great in regards to future profits.

It’s quite noticeable that the railroads have a major advantage over pipelines. If it’s any indication, the rails are here to stay as the Bakken crude oil vehicle of choice. Since it’s quite obvious that this advantage exists, it’s making it a lot more difficult for the pipelines to compete in this territory. They’re having a difficult time moving in.

The main advantage is quite simple – it’s very easy to transport crude oil with the railways from coast to coast. The pipeline is not currently capable of doing that. Even with the extra shipping costs, domestic oil is a lot cheaper than the oil that we import. That’s why it’s very noticeable that refiners like Phillips 66 are starting to step up their game. They are looking to gain access to crude oil by any means necessary, and that includes the railways.

Since this advantage is so prevalent, it’s highly likely that the railways are going to stick around. This is a lot more than a short-term solution. Pipeline projects are already being affected by the railways. Last year, we learned that ONEOK Partners was not going to move forward with their proposed Bakken Crude Express pipeline project. The company was unable to secure the proper and necessary long-term commitments from crude oil producers. Don’t be surprised if other proposed pipeline projects end up getting scrapped. Since there is ample rail capacity, it wouldn’t be surprising if crude oil producers continue to stick with the rails.

Who’s the big winner in this situation? Berkshire Hathaway’s Burlington Northern Santa Fe Railway, which is a subsidiary of the company. They are currently transporting around one third of the oil produced out of Bakken. This provided the railway company with a 60’s percent jump in petroleum and crude oil product shipments over the first part of 2012. The CEO of the company said that it probably moved about 350 million barrels of crude oil during 2012 alone. Having such a major presence in the area, Warren Buffett’s railroad is strategically positioned to continue to benefit from this new trend.

The other big winner of crude oil being shipped by railway is Plains All American Pipeline. At the end of last year, this company spent over $500 million to purchase five terminals that will complement their existing facilities. All in all, this company is expected to have about 250,000 barrels per day of loading capacity. They will also have about 335,000 barrels per day of unloading capacity. Since there is limited connectivity to the East and West Coast by pipeline, Plains All American has the existing facilities that are going to enable them to deliver cheap Bakken crude oil to the refineries on the coast.

The key takeaway is simple…

Railways will most likely be part of a permanent solution to move crude oil from production basins to market centers. As we have all noticed in the Keystone XL debate, it is not easy to build a major pipeline in the United States of America. That will make it less likely that an east or west coast pipeline will ever be built. So, more than likely, crude oil will continue to keep being shipped through the rails, and Warren Buffett is going to continue to be the conductor of choice.

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