Rail will be a lasting competitor against pipelines, EY says

The transport of crude by rail will become a permanent option for moving domestic oil to coastal refineries, even as pipeline construction catches up with the U.S. oil boom, according to an EY Oil & Gas report released this week.

The shale boom has reshaped the United States in unexpected ways, changing once forgotten corners into centers of industrial activities, such as North Dakota. Yet refineries eager to access their cheaper oil were severely limited by inadequate pipelines. Railroads have increasingly filled the gap, with crude-by-rail transport growing to 450,000 barrels per day in 2012 from 18,000 barrels per day in 2008.

The introduction of several new pipelines in the next year will lessen the demand, but the flexibility of railroads will give them a permanent role in energy infrastructure, EY said.

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“Rail is here to stay,” said Foster Mellen, a senior oil and gas analyst with EY. “You can reroute a train and move it to places where you can’t have a pipeline. The economics of pipelines are almost always going to be superior to rail, but to move that crude from the Bakken to Washington State’s Cherry Point refinery, you don’t have viable options.”

Several refiners, including Valero Energy Corp. and Phillips 66, have purchased or leased rail cars to move crude to their refineries.

Whether it makes sense to move crude by rail depends on both the price and availability of pipeline infrastructure for a given play. Transport between the Bakken Shale in North Dakota and the Gulf Coast is available via pipeline, but is about $6 more expensive per barrel than rail. In 2012, the price difference made rail transport a better deal than pipelines for Gulf Coast refineries, helping further spur its growth.

While that price difference has largely closed, rail transport will help refiners take advantage of price spreads for other up-and-coming shale plays, EY said.

“Rail is very much a viable and strategic complement to pipelines,” Mellen said, noting that rail reaches nearly every refinery in the United States. “It allows producers and refiners alternatives that did not exist before and they can work this to their advantage.”

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Rail transport has additional economic benefits for refiners: pipeline companies require commitments of five to ten years, while a typical rail contract can be as short as one year. It is also quicker to ramp up new transport – an important issue for new operators, who may have high upfront costs and are in need of more rapid cash flow.

Rail also provides faster transit times, taking about four to five days for transit from the Bakken Shale in North Dakota to the Gulf Coast, while pipeline transit takes about 35 to 40 days.

However, rail transport also has its risks, grimly illustrated by a recent train derailment disaster in Quebec, which killed dozens as its crude oil cars ignited in the town of Lac-Megantic.

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