How The Alberta Oil Sands Are Fuelling A Rail Renaissance

On July 6, 2013, disaster struck Lac-Mégantic, Quebec, Canada, when a 74-car train carrying crude oil derailed and exploded.  Forty-two people were killed and half of the town was flattened by the blast and enduring blazes. This event highlighted the dangers of shipping volatile substances like petroleum in large quantities via rail, yet it hasn’t stopped rail companies from reaping in record profits.

This issue is therefore of considerable concern to Canada, an oil-exporting nation that has seen a 400% increase in the volume of oil being shipped by rail since 2005.  Thousands of rail cars are loaded every day with oil sands bitumen and other petroleum products and sent across the continent on their way to markets. The rail business, in short, is riding on the back of Canada’s number one economic development story of the 21st century.

Oil Sands Investment Frenzy

The massive increase of oil-by-rail shipping could not have been possible without the unprecedented growth of capital investment flowing into the Alberta Oil Sands, currently estimated to be holding an astounding 170 billion barrels of oil. Over $20 billion of foreign direct investment is injected into the development of oil sands extraction infrastructure each year, resulting in a beehive of construction that has radically transformed an area the size of Florida, and that can be seen from space.

With current daily crude bitumen production of around 2 million barrels, the industry has desperately been trying to find ways to get the oil to where it’s needed: the US and China. Although thousands of kilometres of pipelines are the most efficient way to move large quantities of oil, pipeline proposals face lengthy approval processes and numerous regulatory hurdles.

Two of Canada’s highest-profile multi-billion dollar pipeline proposals, Enbridge Corp.’s “Northern Gateway” and TransCanada’s “Keystone XL” are both mired in environmental opposition, aboriginal protest and NIMBY-ism. US President Barack Obama has been continually delaying his approval of the $5.5 billion Keystone XL pipeline proposal because of its potentially huge political repercussions. Some of the biggest benefactors standing on the sidelines of this controversial battle are the rail companies.

Rail Renaissance Through Oil

Shares of Canadian National Railways (CNR on TSX) have almost tripled in value since 2005, due in large part to the increased business from shipping bitumen and petroleum products out of the Alberta Oil Sands. A short look at Canadian Pacific’s stock performance over the same period reveals a similar tripling of its market valuation since 2005.

Smart investors are betting on this growth to continue as oil sands production is expected to double within the next ten years. Kinder Morgan and Imperial Oil also recently announced the construction of a $170 million oil-by-rail loading facility near Edmonton capable of loading three full trains daily with over 100,000 barrels of oil.

Even if Northern Gateway and Keystone XL are constructed within the next five years, their combined capacities (1.3 million bpd) will not be able to handle the explosive growth in oil production expected to hit over 5 million barrels per day by 2030. There is simply too much money being continually poured into the oil sands, making a product that has limited ways of reaching distant markets.

The oil sands extraction region is located almost 2000 km from the nearest coast, and 4000 km from major refining hubs in Texas. Some companies have even considered shipping their bitumen using semi-trailer trucks, possibly the least energy efficient way of moving oil. Oil-by-Rail shipping also has an inherent advantage over pipelines due to its flexibility in terms of being able to quickly respond to market fluctuations and global economic changes.

Other new oil producing areas in North America, such as the lucrative Bakken shale in North Dakota, also rely heavily on using trains to respond to the explosive growth of production that fracking and SAGD technology has opened up. For instance, the deadly blazes at Lac-Mégantic were ignited by oil that originated in North Dakota fields and was on its way to refineries in New Brunswick.

Profits Trump Safety Concerns

Despite recent rail accidents making headlines, CN is actively pursuing an aggressive expansion of petroleum shipping. Derailments of oil-laden trains near Gainsford, Alberta in October 2013 and near Plaster Rock, New Brunswick in January 2014 raised bad memories of the Lac-Mégantic disaster, as fires forced evacuations of nearby homes.

In terms of the effects of pollution from spilt oil, the debate extends to pipelines as well. Environmental analysts are currently discussing whether pipeline spills or train derailments present the most serious negative effects on the environment. Certainly, trains are less efficient in terms of carbon emissions per barrel, not to mention the air pollution that comes with feeding the huge diesel engines required to pull a train full of oil.  To counteract criticism, CN has actively been touting its safety and inspection record in order to convince investors that the bad press covering accidents will not affect its overall performance.

In an interview given in December 2013, Claude Mongeau (CEO of CN with a yearly salary of over $7 million) plans to double the amount of oil being moved by CN over the next two years. He also maintained that over 99% of dangerous goods moved by CN reach their destination safely. With petroleum and petroleum products shipping alone comprising the single largest segment of CN’s revenue for 2013, it is easy to see why betting on CN as Canada’s number one rail company will put investors on the right track to receiving increasingly handsome quarterly dividends in the coming years.

It will be interesting to see in the coming years whether or not pipelines will grab a significant portion of the continental oil shipping market share. Regardless, there is no stopping explosive oil sands expansion providing enough oil for rail companies to experience the revival they’ve been dreaming about for decades.

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