Buffett like Icahn reaping tank car boom from shale oil

Warren Buffett and Carl Icahn are reaping the benefits of surging demand for railroad tank cars to haul shale oil from beyond the reach of existing pipelines.

Buffett’s Union Tank Car Co. is working at full capacity and Icahn’s American Railcar Industries Inc. (ARII) has a backlog through 2014. Trinity Industries Inc. (TRN), the biggest railcar producer, began converting wind-tower factories last year to help meet demand for train cars that can transport the petroleum product.

All three are getting a boost from a shale-oil boom that’s poised to make the U.S. the world’s largest crude producer by 2020. Rail carloads of crude tripled last year to more than 200,000, and demand for tanks designed for it soared, helping both Trinity and American Railcar outstrip the Standard & Poor’s 500 Index.

“People who want to ship oil can’t get them,” Toby Kolstad, president of the consultant firm Rail Theory Forecasts LLC said, referring to railcars. “They’re desperate to get anything to move crude oil.”

The shortage is exacerbated by makers who are keeping many of the tank cars they produce to supply their own leasing businesses, where rates in some cases have more than quadrupled to $2,500 a month. The manufacturers also are wary of boosting production too much and getting caught with unsold cars as they did in an earlier coal boom.

Costly Pipelines

Rail shipping has become the method of choice at new production sites because obtaining permits and rights-of-way can slow pipeline construction and make it more costly, said Brad Delco, an analyst with Stephens Inc. in Little Rock, Arkansas.

Oil produced from hydraulic fracturing allowed the U.S. to expand oil production last year by the most since the first commercial well was drilled in 1859. Domestic output grew to the highest level in 15 years, while carloads carried by Union Pacific Corp. (UNP), the country’s biggest railroad, surged to 140,000 last year from 2,400 in 2010.

“It still feels very much like an emerging market,” said Beth Whited, vice president and general manager of Union Pacific’s chemicals business. “There are large numbers of requests coming in really every week to our crude oil team here” asking for service to new locations.

The resulting jump in railcar demand helped drive shares of Trinity up 23 percent in the past year, outstripping a 16 percent increase in the Standard & Poor’s 500 Index. Greenbrier Cos. (GBX), which makes railcars and equipment as well as freight barges, gained 16 percent since Nov. 12, the day before American Railcar-owner Icahn disclosed a 9.99 percent stake and began takeover talks. Those negotiations fell apart in December.

Failed Bid

A combination of American Railcar and Greenbrier would have created the largest railcar producer in the U.S., surpassing Trinity, which now accounts for about 31 percent of U.S. deliveries.

Railcars and leasing comprised more than half of Trinity’s $3.8 billion of sales for the 12 months ending in September, the company said in a November presentation. The Dallas-based manufacturer began converting factories that made towers for wind turbines to tank-car plants in the third quarter, executives said in an Oct. 25 conference call.

“Customers are very anxious to see us increase capacity, and those who have driving needs for that have been willing to pay a premium,” Stephen Menzies, group president for Trinity’s rail and railcar leasing units, said on the conference call. The company projected full-year earnings would climb as much as 91 percent, and analysts estimate revenue may increase as much as 28 percent to $3.94 billion.

Order Backlog

American Railcar said third-quarter orders for tank cars reached 8,800 industrywide, almost double deliveries. The industry’s backlog was about 46,700 at the end of that period, making up more than 75 percent of its total unfilled orders.

The company’s own backlog of 7,630 total railcars was the largest since 2008’s second quarter and its production schedule included tank orders through the first three months of 2014, Chief Executive Officer James Cowan said on an Oct. 25 conference call. Icahn holds a stake of about 56 percent in the St. Charles, Missouri-based company.

“The investment thesis of oil by rail will be something that will continue for many years because of the fact that infrastructure doesn’t exist in many of these newer areas,” Eric Marshall, the director of research at Dallas-based Hodges Capital Management Inc., said in a telephone interview. He helps oversee $750 million of assets, including Trinity shares.

Many tank-car makers have been cautious about adding capacity because they don’t want rates to fall at their leasing businesses, Arthur Hatfield, a Memphis, Tennessee-based analyst with Raymond James & Associates, said in a telephone interview.

Lease Fleets

“All these companies have a lot of lease fleets that have a lot of value attached to them,” he said. “They don’t want to add a lot of capacity, flood the market with cars and then have those cars sit in the marketplace trying to get leased.”

Short-term lease rates have jumped as high as $2,500 a month, more than four times the normal rate, said Kolstad, of Portland, Oregon-based Rail Theory. To limit risk if the boom doesn’t last, leasing companies are seeking five-year paybacks on cars instead of 30 years, he said in a telephone interview.

“Leasing rates aren’t based on traditional models right now,” Kolstad said. “They’re basically looking at the probability of a pipeline and a short-term phenomenon. Nobody is taking a risk beyond five or six years.”

Union Tank Car, a unit of Buffett’s Berkshire Hathaway Inc. (BRK/A) that once formed part of John D. Rockefeller’s Standard Oil, is keeping all the cars it produces and leasing them, rather than selling to third parties, said Bruce Winslow, a company spokesman.

‘Cyclical’ Industry

The company’s two plants near Houston and in Alexandria, Louisiana, are running at full capacity, which is about 6,240 a year combined, he said. Union Tank Car, whose parent company also profits from shale-oil shipments through its Burlington Northern Santa Fe railroad, isn’t planning to expand production, Winslow said.

“We see the industry as very cyclical,” he said. “Within the memory of most any tank-car guy, he can say, ‘I remember when we didn’t know where to park them all.’ ”

Railcar makers don’t want to risk repeating the boom in production of coal cars, which are now gathering dust as energy producers fuel operations with cheaper natural gas, also found in shale formations. Coal carloads at the largest North American rail carriers fell 8.6 percent to 4.89 million in the first three months of 2012.

Excess Production

Tank cars probably won’t suffer the market downturn that coal cars now face any time soon, Salvatore Vitale, a New York- based analyst with Sterne Agee & Leach, Inc., said in a telephone interview.

“There’s so much continued demand for crude by rail coming out of the shale plays, especially the Bakken, we’re years away from” excess production, Vitale said.

Indeed, demand for crude-carrying cars may surpass an ethanol-driven surge for tank cars from 2005 to 2007, Kolstad said. Deliveries peaked at 5,100 cars per quarter during that period, about double normal demand, he said.

In the third quarter of 2012, deliveries reached about 4,700, he said. Because ethanol production was capped at 10 percent of gasoline consumption, manufacturers could calculate precisely the demand for tank cars. The opposite is true for shale-oil production, he said.

“How far does this go?” he asked. “That’s the big question.”