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Union Pacific Corporation (UNP), General Electric Company (GE), Caterpillar Inc. (CAT) & Locomotives: The Next Big Source of Demand for Natural Gas?

The massive supply of natural gas that has resulted from new drilling technologies applied to U.S. shale fields over the past few years has been a boon not only to consumers who use gas for heating their homes, but also to a variety of companies, including chemical, steel and fertilizer manufacturers, for whom energy costs are substantial.

The U.S. has been inundated with so much cheap natural gas, in fact, that trucking companies are increasingly switching over to gas-powered engines for their fleets, while auto manufactures are offering hybrid vehicles that have the ability to burn both compressed natural gas and gasoline.

And now, the next logical step of the natural gas-fueled transformation of the transport industry — gas-powered locomotives — looks to be in its early stages.

U.S. railroads show interest in natural gas
Since the 1950s, U.S. locomotives have been powered mainly by diesel. But with the combination of relatively low natural gas prices and the threat of more stringent emissions standards for locomotives slated to take effect in 2015, many of the nation’s biggest rail companies are reconsidering their traditional fuel of choice.

Berkshire Hathaway Inc. (NYSE:BRK.B)‘s Burlington Northern Santa Fe, or BNSF, Union Pacific Corporation (NYSE:UNP), and Norfolk Southern Corp. (NYSE:NSC) all carefully assessing the benefits of converting their freight trains’ engines to run on natural gas.

General Electric Company (NYSE:GE) and Caterpillar Inc. (NYSE:CAT), the biggest manufacturers of locomotives in the world, are all too eager to take part. If the transition gains momentum, it could mark the most radical change in the industry since the 1950s, when diesel replaced steam as the fuel of choice.

Union Pacific Corporation (NYSE:UNP)BNSF plans on beginning tests in the third quarter, using units from both GE and Caterpillar, to help it decide whether to convert its fleet to engines that use a mix of natural gas and diesel. The company’s CEO, Matt Rose, said the company will make a decision next year on converting its entire fleet — a process that could take several years.

Benefits of making the switch
The biggest benefits of converting locomotives to run on liquefied natural gas instead of diesel are major cost savings and the reduction of greenhouse-gas emissions. Excluding wage costs, fuel costs are the single largest expense for American railroad companies, whose locomotives burn staggering amounts of diesel each year.

Union Pacific Corporation (NYSE:UNP), for instance, spent roughly $3.5 billion on fuel last year, with its vast network of trains using up around 1.1 billion gallons of fuel at an average price of $3.22 a gallon. And BNSF reckons that, after the U.S. Navy, it’s the second largest consumer of diesel in the nation.

Compare that with the cost of liquefied natural gas. Truckers can buy LNG that has the same energy content as a gallon of diesel for around $3 at Clean Energy Fuels Corp (NASDAQ:CLNE)‘ Port of Long Beach LNG refueling station. And that’s not including volume discounts, which can reduce the total price for LNG by as much as 30%, according to Gary Foster, a spokesman for the Seal Beach, Calif.-based company.

This price disparity has been enough to convince rail companies, many of which have already calculated the size of the savings a switch to natural gas would generate. Now all that’s left is working with locomotive makers like General Electric Company (NYSE:GE) and Caterpillar Inc. (NYSE:CAT) to develop the engines necessary to take advantage of that price gap.

Hurdles remain
Still, the technology that will be used to power engines running on a combination of LNG and diesel is still in its early developmental stage, according to Tom Lange, a spokesman for Union Pacific Corporation (NYSE:UNP). The Omaha-based rail giant says it’s working closely not only with engine manufacturers, but also with cryogenic fuel-tank and LNG suppliers to help it reach a decision.

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