U.S. crude producers have taken it upon themselves to find a way around the sharply discounted WTI prices by finding alternate ways to sell their crude.
Many years ago before pipelines crisscrossed the country the main method for shipping oil was in railroad tank cars. With all pipelines heading for Cushing Oklahoma full and storage at Cushing full many producers have decided to deliver their oil elsewhere.
Shipment of oil by railcar has doubled over the last year as production increased in places where pipelines were either nonexistent or already full. With oil coming into the Midwest from Canada and flowing down into Cushing the excess storage of the past has disappeared.
Add in production from places like the Bakken shale and the problems with delivering that oil and prices have been falling rather than rising. Light crude sold for $81 a barrel in North Dakota's Bakken shale last week. This is $10 less than WTI at Cushing and $20 less than Brent or Louisiana Light Sweet on the Gulf coast.
So how do producers get their oil to places where the actual market price mirrors reality? The key is railroad tank cars, not pipelines. Once oil is loaded into tankers and inserted into the various rail systems it can be delivered anywhere for a price. The price to ship Bakken crude to Louisiana is roughly $7 per barrel but they can sell it for the $100 price of Louisiana Sweet and not the $81 Bakken price or the $89 WTI price at Cushing.
Cushing tanks held a record 38 million barrels last week and the prospects of it dwindling any time soon are slim.
Shipments by rail are exploding. Major producers and some enterprising transportation companies are building up to a dozen crude-by-rail terminals to pickup the oil in places where it is being produced and then deliver it to wherever the price is the best.
U.S. Development Corp just completed a new 60,000 bpd (One train load or 100 cars) terminal in St James Louisiana. They are planning on expanding to 120,000 bpd later this year. The cost to take Bakken oil to St James is $7 for a full train or $11 per barrel for smaller volumes. With light crude in Louisiana selling for $100 last week that is a bargain trip.
This wide spread from $81 to $101 creates opportunities for large traders to arbitrage by purchasing the oil at the Bakken and then selling it at the best location.
However, large producers are not willing to give up these profits. EOG Resources (EOG) has already built one 60,000 bpd terminal in the Bakken and will have another operational by year end. There are as many as 10 more crude-by-rail terminals being built by producers around the Bakken and other shale plays.
The railroads are going to reap the benefits of this switch back to crude-by-rail and this could have been a major factor in Warren Buffett's purchase of Burlington Northern last year. BNSF is a major carrier to the Gulf coast.
The next problem is coming up with enough tank cars. Adding twelve terminals will take a lot of cars. If all the terminals were full train loadings that would be 60,000 bpd. Fortunately some of those terminals will be smaller. Since the trip from North Dakota takes up to three days that means a minimum of 600-800 cars for each terminal in order to account for four trains in route to the coast and four returning at all times for each terminal.
Rangeland LLS said it was building a 60,000 bpd terminal in the Bakken with 210,000 barrels of storage. This would connect to the BNSF rail and will be operating this year.
Hess is building a 130,000 bpd terminal and hub in North Dakota to be completed in early 2012.
What I see as another problem is the delivery terminals and storage at those locations. These are immense logistical problems but nowhere near as difficult as building a pipeline. The terminals in the producing areas can be built relatively quickly but the culmination of all that oil in the same location on the coast is going to be a logistics problem.
There are also plans to move some oil to the West Coast.
This new surge of crude by rail may eventually rescue the WTI contract from oblivion by removing the crush of new oil all headed for Cushing. Once storage levels decline to normal ranges the discount for WTI crude will disappear. This may not happen until 2012 unless the economy really accelerates and refiners begin refining additional crude.
Until then the real price of oil will be determined by the Brent contract.
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