It’s Time to Climb Aboard the Oil by Rail Boom

by | published July 25th, 2013

Rail transit is about to make you some big money…in oil.

That’s why I’ll be headed to Dallas in late August and Calgary mid-September for extensive meetings with all of the key players.

I can promise you, that in a hurry this is going to get a lot bigger.

As it happens, I’ll be providing all of the details for average investors to profit from this monumental change.

Let me explain to you how all of this has suddenly come about…

It’s because a new price spread is emerging as the new engine for North American profits. The Brent-WTI spread may be the best known, but it’s not the only one.

The spread I’m talking about is the difference between the cost of West Texas Intermediate (WTI) and Western Canadian Select (WCS).

As its name suggests, WCS is the Canadian benchmark. It’s derived from the Western Canadian Sedimentary Basin where over 90% of Canadian oil and gas is sourced. Since this Canadian oil is lower in quality, it sells at a steep discount to WTI.

There’s only one problem: It’s moving all of that oil south out of Canada.

Pipeline capacity is virtually filled and the prospects for the Keystone network expansion across the border are still in the grip of Washington politics. That’s not mention the time and expense of involved in building new pipelines anyway.

Fortunately, there is a simple and profitable answer: It’s the nation’s railroads.

The New Oil Connection

Using railroads to move Canadian crude to the U.S. for processing has become one of the industry’s biggest trends. It’s literally transforming how crude is moved across the border.

This is especially true in places like Albany, New York and northwestern Washington State–both of which are quickly becoming major new hubs for the transport of Canadian oil to the U.S.

Loading stations are increasing north of the border as well as these shipments accelerate, with major railroad service providers anticipating heavier near term volume as the network expands.

But there’s another major development in the works…

The WCS-WTI spread is also about to provide a major boost to refinery margins (and profitability) across the border.

Here’s why: While the narrowing of the Brent-WTI spread, that I discussed earlier this week, is squeezing refinery margins big time in the U.S., it’s having no effect at all on the WTI-WCS spread.

That means the ongoing WCS discount (which has been in excess of $20 a barrel) will provide a way for U.S. refiners to introduce a new factor in improving profit margins.

As I noted earlier this month, that margin is critical for a refiner’s profits since it provides the difference between what it costs to produce oil products and would can be obtained at the initial wholesale point.

But there’s another more important factor. It’s called netbacking.

A Big Boom for Refineries

Netbacking is an approach that began to appear in the 1980s. It eliminates the uncertainty in the upstream (drilling)-midstream (transport)-downstream cost versus price sequence.

Here’s an example of how this pricing sequence works in the real world.

A producer needs a way to predict how much it can charge for its oil (the so-called wellhead price), while a refiner needs to offset its cost (the oil coming from the upstream producer) with the wholesale price it can charge. Meanwhile, at the end of the line, the distributor needs to be able to offset its cost (the price commanded by the refiner) with the retail price it can charge.

In this case the price of one becomes the next segment’s cost. Reliability in this chain is crucial to making a profit.

The inability to determine what that cost-price relationship is in another segment can become a major impediment to the application of working capital by each participant in the sequence.

Netbacks overcome this shortcoming by using the cost-price relationship at the refiner as a way of determining the same relationship further upstream or downstream.

All the costs of getting the crude to the market, such as shipment and refining costs are subtracted from the total revenues from the sale of the oil products. The net-figure produced is the netback price of the crude.

The cost-price adjustments made based on the netback simply allow the producer, refiner, and distributor to know what their margins are.

In this case, the refiner becomes the barometer and the netback emerges as a way of decreasing uncertainty.

From the refiner’s point of view, the spread between WCS and WTI allows for a more detailed determination of refinery margins (and profitability). That determination also serves as a foundation for activity further up and down the chain.

The New Age of Rail

That’s why the combination of the WTI-WCS spread and netbacking at U.S. refiners with guaranteed access to Canadian oil at a known discount is now about to become a much larger part of the American railroad picture.

As this trend develops, of course, we are going to be interested in which companies are going to benefit from this move of volume from the pipelines to the rail cars.

The first stage of this process is already in. In fact, Canadian National Railway (NYSE: CNI), one of the primary early beneficiaries of crude-by rail announced last week that its most recent quarterly revenues from crude transports were up 150% over last year.

The good news for investors is that the second stage has just begun and it promises to be even more profitable. And the meetings I’m consulting on over the next two months will give you a front row seat to all of the profits. So stay tuned…

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  1. Bill Lindsay
    July 25th, 2013 at 13:33 | #1

    I would suggest that the main reason for the $20 discount is not the slightly lower quality crude but the lack of competition due to no east-west pipeline capacity. I notice that no notice was made of the recent train accident in Quebec. Carrying oil on trains is not without significant risks.

  2. Paul Schmitt
    July 25th, 2013 at 14:39 | #2

    I don’t understand why the refinery margins are being squeezed. Why don’t they pass on the increased cost of the product to the consumer?
    Don’t we pay more for gasoline every time the cost of a barrel of oil goes up?

  3. July 25th, 2013 at 15:45 | #3

    As a resident of Burleson, TX adjacent to a major rail line (formally the KATI) I note large number of tanker cars coming north but few moving south as the 100 car trains pass daily.

    Is much if any Canadian oil moving through Fort Worth on its way to Texas costal refineries?

    Have the Texas refineries been upgraded to handle the heaver Canadian crude?

  4. Dave R. Telford
    July 26th, 2013 at 17:52 | #4

    I was also curious about the rail tankers that were derailed and caused the gigantic explosion near the center of the Canadian city named Lac-Megantic. They were transporting crude oil from QC, Canada to Maine, US.

    Are there any other routes that will be used to carry oil crude from Canada to the US refineries?

  5. Paul
    July 30th, 2013 at 13:17 | #5

    The rail owners are often mentioned as “friends” of politicians(i.e. Buffet/Obama). Why would the feds bite the hand that feeds by opening competition by pipelines? Would politicians allow pipelines because they are safer and more efficient? After all bureaucracy loves efficiency.

  6. July 30th, 2013 at 15:18 | #6

    The OBAMA/WARREN OIL TRAIN will keep rolling like Rockefeller did they control the transportation rates not to mention that Warren build the OIL TANKER CARS that would be a fun auction to go to when the country is littered with them. Right through the main streets of Major Cities, I guess next is the High Speed Oil Train instead of a pipeline with a shuT off valve and safety that has out paced the RR TRACKS. OBAMA NEEDS TO WAIT TILL ONE OF HIS BROTHERHOOD OF MUSLIMS IS THE ENGINEER. How stupid is running oil buy train which is $10 more a barrel so Warren can pay his secretary’s taxes. He pays none delivers the oil and the American people blame big oil who pay more in taxes than there profit margin. Do not worry China will get a bargin from Obama for his bowing to the YUAN, WHAT DO YOU MEAN THEY DON’T EXCEPT THE US Dollar for imports and exports between China and S Korea anymore. No it is Gold or the Chines Yuan no mo US DOLLAR, WHO HAS THE BASES IN S KOREA NOT CHINA but who is under the table there pushing the US Dollar to hyper inflation. Show me a train and turn on an old west tv show show me progress that is America and Canada using our resources not giving them to China from the interest Obama borrowed.Clean fuel is right here why give it to them send them our coal they will pay if you play hardball with them, watch them laugh when Obama bows. Trains-(Rail Road Commission control all the transportation rates) unless you are maritime you have a new game. Keep it here give them at a fair price what we don’t use. Don’t worry you will be able to plug your car into every telephone pole if Obama’s green tea buddies have there way.

  7. David Dilley
    August 6th, 2013 at 12:08 | #7

    Any news about refineries being built in this country(Louisiana) to process natural gas into diesel fuel, which is rumored to be cheaper than making it from crud oil……?

  8. RC Ellsworth
    August 13th, 2013 at 13:55 | #8

    Without a pipeline, your appraisal of using rail for transporting crude to markets here in the US, is inevitable. What about Tanker Rail cars? Do we have sufficient to accommodate the demand? Should we be considering a move on companies such as, Trinity, or other rail car manufacturers? We already have a shortage of tanker rail cars.
    Appreciate your emails and reports.

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