Union Pacific Corporation (UNP), CSX Corporation (CSX): Will Buffett’s Big Bet on Railroads Pay off?

Since 2008, domestic crude oil production has soared. In fact, the U.S. pumped out more oil last year than it has in at least two decades.

Union Pacific Corporation (NYSE:UNP)Production has grown so rapidly that midstream companies, which are working tirelessly to build out the pipeline infrastructure necessary to support the domestic oil boom, just can’t seem to keep up. We’re simply pumping out way too much oil.

That’s why railroads and other alternative transport methods have become increasingly important in recent years, giving pipelines a run for their money. And if recent developments are any indication, rail-based crude shipments should continue to grow over the next several years.

That’s good news for Warren Buffett’s Berkshire Hathaway Inc. (NYSE:BRK), which bought out the nation’s largest railroad company more than three years ago. Let’s see how that bet might turn out.

Buffett’s BNSF optimistic about crude shipments
Buffett’s decision to take over Burlington Northern Santa Fe LLC, or BNSF, in 2009 was predicated largely upon his belief that a recovering U.S. economy would boost growth in the highly cyclical rail industry. While the bet has turned out to be a great one so far, its future success will likely be driven by further growth in crude oil shipments.

Though crude shipments accounted for less than 0.1% of the company’s overall traffic in 2010, that figure increased sharply, to 1.7% in 2012 and to 2.7% in January this year. BNSF’s CEO Matt Rose said he expects his company to ship some 700,000 barrels a day by year’s end, up from 525,000 currently.

In fact, he reckons BNSF’s crude shipment volumes could eventually surpass a million barrels per day. BNSF expects to spend some $200 million this year to add tracks and new siding near North Dakota’s Bakken oil field, a region with tremendous demand for crude rail shipments.

Similarly, Union Pacific Corporation (NYSE:UNP) plans to spend about $250 million on assets primarily related to its crude oil business. The company, which shipped 300,000 barrels per day in February, said that current crude shipment volumes are twice what they were a year ago. Both companies are bullish about the outlook for crude shipment demand, suggesting that it will remain strong for years to come.

Crude oil cushions against coal shipment fall-off
Union Pacific Corporation (NYSE:UNP) and BNSF’s capital spending plans and outlooks for crude shipment growth highlight an important trend. Rail-based crude oil traffic has exploded over the past couple of years, representing one of the most radical changes to grip the U.S. rail industry since the Staggers Rail Act of 1980 deregulated it.

The surge in demand for crude rail shipments has been a lifesaver for U.S. rail companies, many of which have seen shipments of coal – traditionally their main commodity by volume – plunge, as cheap natural gas has radically altered the industry’s fundamentals.