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Oil Shipment Implications Embedded in Proposed Rail Merger

Canadian Pacific Railway's (CP) unsolicited $28 billion move to acquire a larger U.S. counterpart, Norfolk Southern Railroad, this week stirs questions and implications for the U.S. oil industry, which in the midst of the shale boom has increasingly relied on rail to move crude oil and other liquids to market.

While financial analysts on both sides of the U.S.-Canada border are skeptical that the deal would ever gain regulatory approval, from the oil industry's perspective in both countries a marriage of the two railroads would increase the access for western Canadian and Midwestern U.S. oil supplies to reach eastern refineries, given the Virginia-based Norfolk's deep links to the East.

In Canada, a Royal Bank of Canada equities analyst Walter Spracklin was quoted by the Globe & Mail as saying the marriage of the two makes good operational and financial sense, but the combined company would have to convince regulators that it would result in lower rates to shippers, including crude oil shippers.

While characterizing the unsolicited offer as "low-premium, nonbinding, and highly conditional," Norfolk's board said it would evaluate the offer "in the context of [our] strategic plans" and possibility for creating shareholder value. It also recognized that "any consolidation among Class I railroads in North America would face significant regulatory hurdles."

In a letter from CP CEO Hunter Harrison, one of the points for Norfolk CEO Jim Squires' consideration was that the combined railroad would be faster growing and more diversified, making the new company "less dependent on volatile commodities such as crude oil or thermal coal."

CP is a major rail shipper, along with BNSF Railroad in the Bakken, which has more than 40% of its 1.1 million b/d production shipped by rail (see Shale Daily, June 10).

With this year's plunge of global crude oil prices came the current decline in unconventional oil and natural gas drilling in shale fields across the country, cutting into the benefits for the nation's leading railroads, with everything from crude-by-rail to oilfield supply shipments curtailed through the first quarter of this year (see Shale DailyMay 22).

The steep drop in commodity prices since mid-2014 and the cost-cutting measures that have led to a more than 50% decline in the U.S. rig count since roughly that time are expected to keep shale-related rail shipments flat for the remainder of this year. That trend comes after more than five years of impressive segment growth for the rail industry.

"We expect that crude oil prices will remain a significant headwind for crude-by-rail shipments for the rest of the year," said Union Pacific Corp. Executive Vice President Eric Butler during a first quarter earnings conference call in May. "Lower crude oil prices will also impact some of our industrial products markets. We expect metals to continue to experience headwinds as capital investments for new drilling activities are reduced."

While it may be a long shot, as the analysts think, a CP-Norfolk combination would no doubt provide a rail network covering west to east, and that means oil producers on either side of the continent and the border would better be able to move their liquid energy products by rail to the Atlantic and Pacific coasts. It could lessen the need for the XL Pipeline by providing an outlet for Canadian oilsands.

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