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Rail plugs the gaps in North America’s oil network

Oil deliveries have been pushed onto flexible forms of transport, like rail and barges, which are able to cater for changing dynamics of production

The battle over the Keystone XL pipeline is just one manifestation of a realignment of North America’s oil transport infrastructure, triggered by marked regional differences in refining and pipeline capacity and which is having a profound effect on the strategies of both producers and refiners.

The Obama administration continues to mull the environmental implications of building Keystone XL across the Canada-US border to complete a pipeline route to move heavy oil from Canadian oil sands to refineries capable of handling it on the US Gulf coast. But, as the deliberations continue,  the companies involved are seeking new ways to transport their oil to market.

Calgary-based Suncor Energy said in late November that it planned to boost its oil production by 10% in 2014, despite the uncertainty over Keystone, confident that it can use a combination of a new pipeline within Canada and rail transport across the border to feed its oil into the US network. Others involved in the region have made similar commitments.      
This move encapsulates a trend across North America to push oil deliveries on to more flexible forms of transport, such as rail and barges, where the pipeline network does not cater for the changing dynamics of the continent’s oil production.

The rapid growth in output of Canadian heavy oil and lighter crude from the Bakken shale of North Dakota means the bulk of new production is located in areas with limited pipeline links to the refineries in the biggest demand centres and which are best able to process it. In the case of oil-sands production, this means the Gulf coast and US west coast refineries already geared up to handle domestic and imported heavy crude. For Bakken output, it means the refineries near the major population centres on both the east and west coasts.

The result of this transport blockage is that the limited refining capacity in and around North Dakota, Wyoming and Canada is awash with supply that cannot easily be shifted out of the region. This, in turn, means oil prices in these areas are heavily discounted compared to traditional centres of production, where prices are more closely pegged the WTI benchmark. This differential was highlighted by the $50-$55 a barrel being paid locally for Western Canada Select in mid-November, a discount of more than $40/b to WTI, the largest gap for five years.

In a report entitled Pipelines, Trains and Trucks: Moving Rising North American Oil Production to Market, the Washington-based Energy Policy Research Foundation (EPRINC) notes that such discounts not only cost governments millions of dollars of income – royalties estimated at around $1 million a day for Canada – they could also jeopardise production. If world oil prices fall, then those in areas where the price is discounted could fall to levels that make production uneconomic.

Given the lost revenue and the risk, producers and refiners are eager to exploit the alternatives. Some new pipelines are being built, but not fast enough to handle the short-term glut. They are also expensive, requiring heavy finance and long-term commitments from their potential users. Meanwhile, pipeline switching – reversing oil flow so producing regions that had once been importers can send their production out – is only a partial solution, dependent on the patterns and capacity of the existing network.  

Rail provides a more flexible solution to transport needs that make use of an existing transport infrastructure and can be arranged in short-term deals. The cost of using rail is higher than pipeline transportation, but the increased choice of refineries and the ability to avoid using saturated pipeline hubs is making the premium worthwhile for many.

There is also less regulatory scrutiny – and thus reduced potential for hold-ups. While Keystone XL, as a cross-border pipeline, requires US federal government approval, shipments by rail do not. Likewise, rail facilities do not require the Environmental Protection Agency review to which pipelines within the US are subject. 
Some 870,000 barrels a day (b/d) of crude is moved by rail in the US and Canada, of which around 650,000 b/d is Bakken crude moving out of the Williston basin area, EPRF estimates. In October, the US as a whole produced 7.7m b/d of oil. Already, the refining sector on the US east coast, ailing for years, is showing signs of recovery as light oil from Bakken finds its way there by rail, though there is room for more to be processed at the expense of foreign imports.

In Canada, producers would be prepared to sign up for the sort of 20-year deals to supply Gulf refineries with heavy oil that would underwrite the development of the Keystone XL pipeline, but are proving just as happy to invest in the alternatives if it gets oil to market faster. Rail transport also has the advantage for oil sands producers of being able to carry undiluted bitumen, while bitumen despatched by pipeline needs to be thinned to enable it to flow. That saves on cost of the diluting fluid (diluents) and reduces the volume of that oil by almost a third.

Investment in new rail loading terminals and other infrastructure has rocketed in recent months. Rail shipments of oil from western Canada have grown from close to zero in early 2012 to 150,000 b/d in 2013 and perhaps 450,000 b/d by the end of 2014, according to IHS. If Keystone – which is designed to handle 800,000 b/d – is not built, then 700,000 b/d or more could be moving out of western Canada using rail by 2016.

The dangers of transporting oil by rail were highlighted by an accident in July 2013, when a train pulling 72 tanks of crude crashed and exploded in Lac-Mégantic, Quebec, killing 47 people and destroying much of the centre of the town. Some proponents of Keystone argue that pipeline shipments would be much safer, but the debate over Keystone is complicated by the fact that much opposition is motivated by a desire to stop Canadian oil-sands developments – an aim that has yet to be achieved – rather than by opposition to pipelines in themselves.

The growth in rail transport of oil has been such that some previously saturated pipeline capacity has now been opened up, but rail remains the easiest way to get oil to refineries with the largest demand. It also makes it easier to get oil to ports providing a way to diversify into overseas markets.

Approval of Keystone XL would still be a boon for North America’s new producers, speeding up delivery and cutting costs, but they are doing their best to ensure that their oil gets to market whatever happens. 

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