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EOG Resources Inc (EOG), Continental Resources, Inc. (CLR): Will the Canadian Train Disaster Kill Oil by Rail?

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The recent derailment of the Montreal, Maine, and Atlantic Railway train in Lac Megantic, Quebec, caused irrevocable damage on a small town just 10 miles from the U.S.-Canada border. The primary cargo of that train, crude from the Bakken region, has led to many questions regarding the practice of moving oil by rail. A recent report from Moody’s Corporation (NYSE:MCO) says this accident could lead to several new restrictions that could drastically hurt rail shipments. This probably isn’t a revelation, but let’slook at where the oil-by-rail story started and who will see the worst effects of a slowdown.

For lack of a better form of transportation

The recent surge in rail shipments of oil got its start back in 2009, when EOG Resources Inc (NYSE:EOG) announced a deal with Burlington Northern Santa Fe to move crude away from the Bakken region to markets such as Cushing, Okla. At that time, only 110,000 barrels of oil per day could be moved away from the region through pipeline, and the expansion of production there meant that other methods would need to happen. While trucking to other markets was deemed uneconomical, the differences in spot prices between Bakken crude and West Texas intermediate made it worth the extra costs to ship by rail.

What several oil companies realized, though, is that moving oil by rail did one thing that pipelines could not: reach the East Coast and West Coast markets. Less than six months ago, the price spread between Bakken crude and imported Brent crude — the primary source for East Coast refiners — was over $20. So despite the premium to move by rail versus by pipeline, it was still well worth it for the refineries. Refiners and producers from the Bakken region have thus begun to move massive amounts of oil by rail. Continental Resources, Inc. (NYSE:CLR), the largest producer of crude from the Bakken, now transports about 80% of all its crude by rail, and Phillips 66 (NYSE:PSX) signed on to a five-year contract to receive 50,000 barrels per day of Bakken crude that will get there mostly by rail.

ource: US Energy Information Administration.

Shipments of oil by rail have more than doubled in the past three years, and the inability of pipelines to keep up with production for regions like the Bakken have translated into a bright future for rail shipments. Then this happened:

Source: wikicommons.org/Personalmountains.

Where do we go from here?

The recent tragedy in Lac Megantic has exposed some of the rails’ most glaring problems as a mode of transportation for oil. Not only does rail move through population centers, but it also has a higher frequency of spills in comparison with pipelines. According to the International Energy Agency, the occurrence of oil spills from rail shipments between 2004 and 2012 was six times greater than from pipelines.

To be fair, the volume of a rail spill is generally much smaller than a pipeline spill. But it’s very likely that the Quebec incident will lead to investigations into how to make rail transportation safer, and increased regulations will also more than likely play a part in the rail business as well. For companies that have a stake in oil-by-rail, the viability of rail transportation will depend greatly on any new regulations. For example, to retrofit the existing U.S. tanker car fleet with additional safety measures would cost more than $1 billion, according to the Association of American Railroads. These kinds of expenses will lead to higher costs to move oil by rail, and regions that have relied on rail could lose their competitive advantage.

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