Crude-by-rail remains shippers’ ace in the hole

Less-than-attractive arbitrage opportunities for US crude-by-rail movements–driven primarily by the narrowing of the Brent-WTI spread–recently have enticed shippers back to pipelines. But crude-by-rail enthusiasts should fear not: there remain plenty of reasons to send oil the old-fashioned way besides hefty netbacks.
When crude-by-rail began as a force several years ago, it was pushed by two factors. One was arbitrage, where you could take, say, a Bakken barrel, put it on a railcar and sell it into Cushing or, better yet, St. James, at a premium price that more than covered the cost of rail. That spread to such unusual movements (unusual, at least, a few years ago) as moving crude to Albany, NY and then barging it down to the Philadelphia area.
But as CBR grew, it became obvious to the industry that arbitrage opportunities weren’t the only things CBR provided them. There were benefits in speed…route flexibility…and keeping the quality of the oil relatively pure, all of them combining to keep CBR in a lot of companies’ game plan.
Cowen and Company analysts, in a recent report, refer to these incentives as the “rail option,” essentially a trump card for crude shippers.
Besides the aforementioned reasons to rail, shippers have found that CBR also offers scalability, less regulatory uncertainty, lower capital investment requirements and shorter contract terms relative to pipelines.
Some of these benefits can even outrank physical arbitrage incentives, especially when timeliness and flexibility are of extreme importance, the analysts at Cowen said.
Pipelines typically require more than 30 days to ship crude to faraway markets, but rail transport times range from a week to a couple of days. Railroads can also reach multiple markets simultaneously through an extensive network that’s still growing fast.
It used to be said in various newspaper reports years ago that a cargo of crude oil could change hands dozens of times as it crossed the ocean. That really wasn’t true, with media confusing daisy chain trading of paper contracts that could become “wet” with physical oil.
But with rail, shippers have found that it is providing flexibility to adjust to today’s volatile pricing dynamics and that they can reroute oil to somewhere else, if the netbacks are better.
Shippers are also enamored of the fact that CBR eliminates or greatly reduces the chance that a high quality crude will be commingled with other grades, with the producer/shipper losing value in an imperfect quality bank.
Instead, what goes in the tank at the origination point is the same quality when it comes out from the rail car on a siding next to the refinery.
Despite this, interest in railing crude has seemingly declined after wide shipping arbs closed on the narrowing of the Brent-WTI spread. Many sources have noted this recent slowdown in CBR spot movements, and one analyst said that shippers would be “crazy” to ship on only one route to market.
With that said, shippers, who are still ready to jump the tracks onto pipelines full time, may think twice. Spot price arbitrage opportunities could resurface intermittently under the right conditions.
For example, the recent turmoil in the Middle East could provide a tailwind for US crude-by-rail margins, if the Brent/WTI spread widens out enough, Cowen analysts said.
The Brent/WTI spread, which is an indicator for the way crude moves around North America, has narrowed considerably in recent months, from levels above $20/b. On July 19, it inverted, before widening again. On Friday, as the week ended, Brent/WTI was near $6.40/b, on strong Brent prices.
Brent crude futures have reached six-month highs in recent days due in part to the expectation of military action in Syria. Friday’s spread is relatively wide considering that Brent/WTI was about $1.65/b on Aug 1.
“The escalating tension in the Middle East could indeed widen the spreads again, and although such potential widening may not be enough to materially improve rail economics versus pipe, it is a stark reminder of the volatility of oil price dynamics,” Cowen analysts said.
Source: Platts