U.S. market is so oversupplied with oil that traders are experimenting with a new place for storing excess crude
By Nicole Friedman and Bob Tita, Feb. 28, 2016 9:09 p.m. ET
The U.S. is so awash in crude oil that traders are experimenting with new places to store it: empty railcars.
Thousands of railcars ordered up to transport oil are now sitting idle because current ultralow crude prices have made shipping by train unprofitable. Meanwhile, traditional storage tanks are running out of room as U.S. oil inventories swell to their highest level since the 1930s.
Some industry participants are calling the new practice “rolling storage”—a landlocked spin on the “floating storage” producers use to hold crude on giant oil tankers when inventories run high.
The combination of cheap oil and surplus railcars has created a budding new side business for traders. J.P. Fjeld-Hansen, a managing director for trading company Musket Corp., tested using railcars for storage last year and found he could profit by putting the oil aside while locking in a higher price to deliver it in a later month.
The company built a rail terminal in Windsor, Colo., in 2012 to load oil shipments during a boom in U.S. oil production. Now, Mr. Fjeld-Hansen says, “The focus has shifted from a loading terminal to an oil-storage and railcar-storage business.”
Energy Midstream, a trading company based in The Woodlands, Texas, stored an ultralight oil known as condensate on Ohio railcars last month for about 15 days before shipping it to a buyer in Canada.
Dennis Hoskins, a managing partner at Energy Midstream, says there are so many unused tank cars that he is constantly hearing from railcar owners hoping to put them to use. “We get offers everyday for railcars,” he said.
The use of railcars for storage could be limited by the cost of track space and safety and liability concerns that have followed a string of high-profile transport accidents. Issues range from leaky cars to the risk of collisions and fires.
Federal regulations require railroads that store cars loaded with hazardous materials like oil to comply with strict storage and security measures to keep the cars away from daily rail traffic. Railroads and users face responsibility for leaks, collisions or other mishaps.
“I don’t want the liability,” said Judy Petry, president of Oklahoma rail operator Farmrail System Inc. “We prefer not to hold a loaded car.”
Still, the oil has to go somewhere. The surge in shale-oil production has created a massive glut that the industry is struggling to absorb. BP PLC Chief Executive Bob Dudley joked in a speech this month that by midyear, “every storage tank and swimming pool in the world will be filled with oil.”
Khory Ramage, president of Ironhorse Permian Basin LLC, which operates a rail terminal in Artesia, N.M., said he hears regularly from traders looking to store crude in his railcars.
Crude-storage costs “have been accelerating, just due to the demand for it and less room,” he said. “You’ll probably start seeing this kick up more and more.”
U.S. crude inventories rose above 500 million barrels in late January for the first time since 1930, according to the Energy Information Administration.
The cheapest form of storage—underground salt caverns—can cost 25 cents a barrel each month, while storing crude on railcars costs about 50 cents a barrel and floating storage can cost 75 cents or more. The cost estimates don’t include loading and transportation.
Railcars hold between 500 and 700 barrels of oil, less than a cavern, tank or ship can store.
The use of U.S. railcars to transport large volumes of oil picked up steam a few years ago as a byproduct of the fracking boom. Fields sprung up faster than pipelines could be laid, so producers improvised and shipped their output to market by rail. Companies soon realized railroads offered greater flexibility to transfer oil to whomever offered the best price. Some pipeline companies even joined the rail business, building terminals to load and unload oil. U.S. oil settled Friday at $32.78 a barrel, down nearly 70% from mid-2014.
The plunge in oil prices brought that activity to a halt. Analysts estimate there are now as many as 20,000 tank cars—about one-third of the North American fleet for hauling oil—parked out of the way in storage yards or along unused stretches of tracks in rural areas.
Producers and shippers who signed long-term leases for the cars during the boom are stuck paying monthly rates that typically run $1,500 to $1,700 per car. Traders can pay those prices and still profit. Oil bought at the April price and sold through the futures market for delivery a year later could net a trader $8.07 a barrel, not including storage or transportation costs.
As central storage hubs fill up, oil companies are more willing to pay for expensive and remote types of storage, said Ernie Barsamian, principal of the Tank Tiger, which keeps a database of companies looking to buy and sell oil storage space.
The Tank Tiger posted an inquiry Wednesday on behalf of a client seeking 75,000 barrels of crude-oil storage or space to park 100 to 120 railcars loaded with crude.
Mr. Barsamian likened the disappearance of available storage to a coloring book where nearly all the white space has been filled in.
Repost from The Wall Street Journal [Editor: A good summary of recent history and market players in the emergence and future of crude by rail. Interesting quote: “…if all the railcars loaded with crude on one day were hitched to a single locomotive, the resulting train would be about 29 miles long.” – RS]
Dangers Aside, Railways Reshape Crude Market
Shipping Crude by Rail Expands as New Pipelines Hit Headwinds and Train Companies Reap Revenue
By Russell Gold and Chester Dawson, Sept. 21, 2014
In May 2008, a locomotive with a grizzly bear painted on its side pulled into a railroad siding next to an abandoned grain elevator in the ghost town of Dore, N.D. The engine, property of the Yellowstone Valley Railroad, hitched up a couple of tank cars of crude from nearby oil wells and set off on a thousand-mile journey to Oklahoma.
Dore would never be the same—and neither would the U.S. energy industry. Until then, most oil pumped in North America moved around the continent in pipelines. Suddenly, and just as the oil industry began a period of unprecedented growth, there was an alternative: “crude by rail.”
Today, 1.6 million barrels of oil a day are riding the rails, close to 20% of the total pumped in the U.S., according to the Energy Information Administration, chugging across plains and over bridges, rumbling through cities and towns on their way to refineries on the coasts and along the Gulf of Mexico. If all the railcars loaded with crude on one day were hitched to a single locomotive, the resulting train would be about 29 miles long.
Initially conceived of as a stopgap measure until pipelines could be constructed, and plagued by high-profile safety problems, crude by rail has nevertheless become a permanent part of the nation’s energy infrastructure, experts say. Even pipeline companies have jumped into the rail business, building terminals to load and unload crude.
Behind the new industry are powerful economics. While it costs a bit more to ship petroleum on trains than through pipelines, railroads have the flexibility to deliver it to wherever it will fetch the highest prices. And capital expenses are far lower. Major railroads’ revenue for hauling crude has jumped from $25.8 million in 2008 to $2.15 billion in 2013, according to federal data.
The oil and rail industries have developed “a mutual dependence likely to continue for a long time,” said Ed Morse, global head of commodities research for Citigroup.
It is a similar story in Canada: the amount of crude moving by rail has quadrupled since 2012, and is forecast to more than triple between now and 2016.
The swift growth of crude by rail has been embraced by drillers in new oil fields in North Dakota, Texas and Colorado eager to move their product to the highest bidders. It was also welcomed, at least initially, by railroads looking for new customers after the recession sent traditional shipments tumbling.
But it has frightened communities across the country where first responders fear the fireballs that have erupted in the past year after some oil-train derailments. Federal regulators recently proposed new rules to require sturdier cars to carry oil, lower speed limits on some shipments and testing of the volatility of the crude transported by train.
But pipelines, especially new pipelines, face a lot of problems these days. They draw protests from communities worried about spills and unhappy with the use of eminent domain to take rights of way from local landowners.
Activists opposed to the use of fossil fuels have focused on blocking pipelines in hopes of keeping oil in the ground. The Keystone XL pipeline, which requires federal approval because it crosses the U.S. border from Canada, has been seeking a permit since 2008 amid fierce political fighting, pro and con.
Railroads, by contrast, already own 140,000 miles of track in the U.S., according federal statistics, in a system that can send cargo from coast to coast, north to Canada and south to Mexico. By law, railroads don’t have the ability to turn down cargo, even if they want to, so all oil shippers had to do is to figure out how to get oil on and off the trains.
A big loading terminal might cost about $50 million—equal to the estimated cost of building just one mile of the Keystone pipeline.
With a terminal, “You can build it and have it under contract in 12 months and pay it off in five years,” said Steve Kean, president and chief operating officer of Kinder Morgan Inc., thtte operator of 80,000 miles of pipeline in North America and a growing network of rail terminals. The company has spent $290 million to date building up a crude-by-rail business.
To justify the massive investments needed for pipelines, their builders usually require drillers and refiners to sign long-term shipping contracts before they start laying pipe. That has been a problem for new oil fields without a track record, and for the mostly independent energy companies that developed those fields using hydraulic fracturing, said Adam Sieminski, who runs the federal government’s Energy Information Administration. Railroads don’t require such lengthy contracts.
The new way of moving crude was born out of frustration and need. In 2006, North Dakota faced what it called, in a report, a “crude oil transportation crisis.” Oil production was rising, but the few pipelines that served the state were full.
Enter Musket Corp., a privately held Houston company owned by the family that also owns Love’s Travel Stops & Country Stores. Musket bought inexpensive diesel from refineries along the Gulf Coast and moved it by rail to locations close to the Love’s service stations, developing and patenting a portable pump for loading and unloading the fuel.
In 2007, Musket tried using its pump to load a couple of tank cars with crude oil rather than diesel. When that worked, the company sent employees driving around North Dakota with binoculars to find an unused railroad siding to lease. They spotted Dore.
“Pretty soon, we knew it was going to be big,” said J.P. Fjeld-Hansen, a managing director of Musket. Trains could deliver Bakken crude to wherever it could fetch the highest prices, including Philadelphia, California, Louisiana or the giant Houston petrochemical complex.
The first loads from Dore were carried to Oklahoma, home to a giant oil-trading hub, by BNSF Railway Co., now owned by Berkshire Hathaway Inc. It picked up the cars from Yellowstone Valley Railroad, a so-called short line railroad that now operates on just one mile of track — specializing in hauling freight from shippers’ yards to connections with the bigger railroads. The company that owns the railroad, Watco Companies Inc., didn’t respond to requests for comment.
“Crude is a growing part of our business,” said Michael Treviño, a spokesman for BNSF, which now moves more oil than any other major North American railroad and spent $200 million last year on crude-by-rail projects.
The Dore project caught the attention of EOG Resources Inc., a big oil and gas company based in Houston. By the end of 2009, EOG had built an industrial-scale rail-loading terminal in Stanley, N.D., including a 1.3-mile loop of track where trains could be loaded with 60,000 barrels a day.
“We brought the project to fruition in an eight-month period,” Mark Papa, the former chairman of the company, said in a conference call with analysts in 2010. The company declined to comment.
The terminal cost $50 million, according to Wilson & Company Inc., an engineering firm involved in the project. Its chairman, Kenny Hancock, said his firm needed to work out kinks with this first-of-its-kind facility.
One problem was that when tank cars were loaded, hydrocarbon fumes would leak out and, since they were heavier than air, settle in the long open-ended loading shed. “The first seal we tried didn’t work and our explosive limit alarms went off,” he said. New seals and ventilation fans eventually solved the problem, the company said.
The relative ease and low cost of building loading and unloading terminals soon attracted a range of companies. Great Western Railroad, a Saskatchewan short line mostly owned by the province’s farmers in a cooperative agreement, hauled more carloads of crude last year than carloads of grain.
In 2011, Dakota Plains Holding Co. built a loading terminal, acquired a Utah tanning salon business that traded on the OTC Bulletin Board, renamed the business and issued shares to raise funds to expand.
There was also a surge in facilities for unloading oil and transferring it to refineries; such terminals are operating or planned in nearly two dozen states and Canadian provinces. Mile-long trains of oil tankers became familiar sights in cities across the country.
The crude-by-rail phenomenon has spread beyond the Bakken Shale in North Dakota and Montana to the Permian Basin in Texas, the Niobrara in Colorado and to western Canada. In July, Global Partners said they planned to build a rail terminal in the heart of the Gulf Coast petrochemical complex that can handle more than 100,000 barrels a day of crude, including Canadian oil sands.
“It is not a layup to build a pipeline to the Gulf Coast,” said Mark Romaine, chief operating officer of Global Partners, a Waltham, Mass., fuel logistics firm. “Look at the Keystone XL.”
But a year ago, those strings of black train cars took on an ominous look after an unattended oil train in Lac-Mégantic, Quebec, derailed and exploded, killing 47 people. Several other derailments were followed by fireballs as Bakken crude burst into towering flames.
Those accidents have given railroads second thoughts about hauling crude, said consultant Anthony Hatch. While companies don’t break out the data, hauling crude is believed to be very profitable for railroads, so “they were excited” at first, he said. But now that business, which makes up only about 3.5% of rail shipments, according to federal data, has attracted unwelcome attention in communities that previously ignored the freight trains rumbling through town. And even some of the largest North American railroads are concerned they might not survive the costs of cleanup and lawsuits if a train exploded in a crowded city.
Regulators are imposing new rules that industry executives fear could slow the entire rail system, cut capacity and cause congestion. Federal regulators recently concluded that Bakken oil contains a high level of combustible compounds, known as light ends, as The Wall Street Journal reported earlier this year. The U.S. Department of Transportation’s proposed new rules on crude by rail will require companies to test crude before putting it into appropriately sturdy tank cars, among other measures being imposed on the little-regulated industry.
Harold Hamm, chairman and chief executive of Continental Resources Inc., a leading exploration and production company in the Bakken, said that the problem isn’t with the oil, but with railroad safety. “There would not be any problems with oil movements in America as long as Mr. Buffett keeps the trains on the track,” said Mr. Hamm, referring to Warren Buffett, the chairman and chief executive of Berkshire Hathaway, the owner of BNSF.
Mr. Treviño, the BNSF spokesman, said that “the facts are that 99.997% of rail industry shipments of hazardous materials reach their destination without a release caused by a train accident,” and that BNSF had a lower percentage of derailments last year than anytime in company history.
Two BNSF trains were involved in a derailment near Casselton, N.D., in 2013 that released more than 400,000 gallons of crude and set off a several-story tall explosion, leading to the evacuation of 1,400 people from Casselton.
The Association of American Railroads said it has increased inspections, decreased speeds and is using more technology to prevent derailments.
But Mr. Hamm said he thinks the situation will be short lived. “Rail is still a temporary thing,” he said. “If rail hadn’t been available, there would have been pipelines built.”
And some are in the works. Enbridge Inc. recently received approval form North Dakota regulators to start construction on a $2.6 billion, 225,000-barrel a day and 600-mile project called the Sandpiper pipeline, which would move oil from Tioga, N.D., to Wisconsin.
In Dore, Musket says it isn’t worried about business drying up with the addition of pipelines. The company’s terminal in the town can now handle 60,000 barrels a day and employs 50 people; the company has built another rail-loading facility in Dickinson, a two-hour drive to the south, and one in the Niobrara Shale in Colorado.
“I don’t think it’s either/or,” Mr. Fjeld-Hansen said. “I think rail and pipe will coexist for a long time.”
—Betsy Morris and David George-Cosh contributed to this article.