Rail's new oil rush: Calgary firm will ship via CN to U.S

Date of Article: November 10, 2012

Source: Calgary Herald

Author: Dave Cooper

In a market that is short on pipeline space and heavy crude sells at a big discount, one oilsands producer has found a way around the bottleneck.

Southern Pacific Resources, which began trucking out initial production from its new McKay Thermal Project three weeks ago, will open a dedicated rail terminal in a few weeks just south of Fort McMurray and ship its product in leased tanker cars via CN Rail all the way to Natchez, Miss.

From there, it's just a short barge ride down the Mississippi River to one of the eight refineries in Louisiana, where the crude will fetch $20 to $30 a barrel more than it could at the congested terminal hub in Cushing, Okla.

While Canadian and U.S. railways are scrambling to meet demand, opening small terminals close to production in locations such as the Bakken area of southern Saskatchewan and North Dakota, the Athabasca oilsands have not been part of the rush. Until now.

"I think Canadians are going to have a much more difficult time getting crude to market than we may expect and that's because of the delays in the (Northern) Gateway and Keystone (pipelines)," said Byron Lutes, chief executive of Southern Pacific.

He said that using the CN line will demonstrate "another safe and viable alternative for transporting bitumen."

Unlike pipelines, that means no public hearings and no environmental protests.

Railways have been carrying oil for a century and were the only way to move crude before major pipelines were developed beginning in the 1940s. But the rail option isn't cheap and wasn't viable until two things changed.

First, the price spread widened after 2010 when bitumen production began to climb faster than pipelines could be built to refineries in the Midwest and Gulf of Mexico. So not only are bitumen prices in Alberta low, the prices of all crudes stored at Cushing, fell in comparison to the West Texas Intermediate (WTI) price. That gap, or differential, is now about $22 but has been much higher. Plus, heavy crude can trade higher than WTI on the U.S. Gulf Coast.

Second, the demand for diluent that must be added to bitumen to make it flow through pipelines like oil has climbed. Producers are paying more for the varsol-like diluent than they get for the bitumen - called dilbit when thinned with 30 per cent diluent.

Southern Pacific estimates it will pay $31 a barrel to move its product to a Louisiana refinery by rail and barge compared with $8 for pipeline shipping. But once the $20 differential is added and one considers the fact Southern Pacific needs just 20 per cent diluent for rail transport - and is able to import less expensive U.S. diluent in the cars on the return trip - the deal makes economic sense.

To get a clearer picture of the size of the growing rail option, consider this year in the U.S., railroads will carry 340,000 bpd. Added to the estimated 60,000 bpd in Canada, that equals 400,000 bpd - equal to a new pipeline. But not even railroaders expect the rapid growth to continue forever; the companies must weigh how much to invest in oil-hauling operations against the risk future pipelines will move the crude.

"It's really hard to gauge the long-term prospects of demand because a lot of this is being driven by lack of pipeline capacity," David Tyerman, a Canaccord Genuity Inc. analyst in Toronto told Bloomberg. "Even the rail industry is trying to temper its expectations because it doesn't want to build its business plans around something and then have that not happen." As recently as two years ago, CN didn't haul any crude. It now projects moving 30,000 carloads in 2012. This week it announced its latest project with partner Arc Terminals LP to build an off-loading facility in Mobile, Ala., for crude destined for Gulf Coast refineries.

Canadian Pacific moved 500 tank car loads a year in North Dakota in 2009, but now expects an annual rate of 70,000 carloads, 46 million barrels by 2013 throughout its system.

"Canadian Pacific believes rail and pipelines are complimentary, with rail having a permanent role to play as a transportation solution for energy producers," said spokesman Ed Greenberg, who is based at CP's American headquarters in Minneapolis. "Rail is a flexible option for transporting crude oil, and rail is scalable, which allows CP to scale its operations" to match customer needs, he added.

The firm behind Southern Pacific's project is Calgary-based Altex Energy, which at one time was promoting a pipeline between Alberta and Texas. It is now building rail terminals, an idea that appeals to small firms that don't want to sign 20-year pipeline contracts.

With its new project, Southern Pacific is slowly ramping up. McKay expects produce up to 12,000 barrels per day of bitumen and a 6,000 bpd expansion is being planned.

Under the contract with Altex, CN and Genesis Energy in the U.S., more than 12,000 car loads each year will be heading to Mississippi in the 500 rail cars Southern Pacific has leased, equal to about 10 crude unit trains per month on a two-week return trip.

Initially the bitumen will be trucked to Southern Pacific's new terminal, but it is hoped a rail spur might eventually be built to the McKay site, which is 45 kilometres northwest of Fort McMurray.

The target for Southern Pacific and perhaps other small steam assisted gravity drainage (SAGD) oil producers is the Gulf Coast, where refineries can handle two million bpd of crude, including 400,000 bpd of heavy crudes like Alberta's.

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