Despite oil patch woes, railroads likely to keep rolling

The stunning collapse in oil prices the past several months won’t halt 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 4,000 percent between 2008 and last year — from 9,500 to 435,560 — as production boomed and the cost of a barrel of oil soared into the triple digits.

Those prices have tumbled, 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 have seen their stock prices slip the past month.

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

Crude shipments make up less than 2 percent of carloads delivered by major U.S. railroads. Sub-$60 oil might force producers to rein in spending, but railroads — which spend hundreds of millions of dollars every quarter on fuel — will see their costs fall away.

Those falling energy prices have also proved 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 rebound in employment and rising consumer and business confidence, U.S. economic growth reached a sizzling 5 percent annual rate last quarter. The rebounding economy is likely to drive even greater demand for shipping.

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

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

Profits chugging along

The crude-oil business provided a nice boost for railroads as coal shipments declined. Profits at major U.S. railroads have improved steadily along with the economy, reaching $13.4 billion in 2013, up from $11.9 billion in 2012 and $10.9 billion in 2011.

During their latest investment conferences, officials from Union Pacific, Norfolk Southern, CSX and Canadian Pacific all tried to reassure investors about crude-oil shipments.

“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,” Canadian Pacific CEO Hunter Harrison said of the 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 most of the oil because pipeline capacity hasn’t kept up with production.

Through the fall, North Dakota 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 to reduce costs, but he’s not sure how much it will affect production in the region.

“It’s still a little early to make any firm assessments,” Kringstad said.

Bakken fuels activity

It helps that the cost of producing oil in the Bakken region is lower than in other places, so producers can still profit even when prices fall, said Don Seale, Norfolk Southern’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 production, railroads appear poised to continue hauling oil from places like the Bakken that only recently began producing large quantities.

The railroads — now delivering 59 percent 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, even if falling prices cut into margins for producers.

This story was originally published January 2, 2015 at 1:57 PM with the headline "Despite oil patch woes, railroads likely to keep rolling."