The business case for shipping crude oil by rail was outlined in the previous blog. The rapid growth in the production of oil in Canada and the United States coupled with the flexibility and efficiency of shipping crude oil by rail has seen the volumes moving via this mode increase 5000 percent growth rate over the past 5 years. Crude oil by rail has grown from almost zero to eleven percent of the revenue of the class 1 railroads during this period. Two things have had a dramatic impact on this business model. They are the rapid and huge drop in the price of a barrel of oil and the level of derailments that have made this a major safety hazard. This blog will focus on the current economics of moving oil by rail.
The Cost of Producing Crude Oil
The cost required to lift crude oil and maintain oil wells, equipment, and facilities is called production cost or lifting cost. A Market Realist article published in January 2015 draws information from the EIA’s (Energy Information Administration) 2009 report that shows the production cost of crude oil was ~$12 per barrel for the United States and ~$10 per barrel for the Middle East. But recent consensus says these costs could range from $20 to $25 per barrel.
The Cost of Shipping Crude Oil by Rail
The cost to transport a barrel of crude oil ranges between $10 and $20 depending on the origin and destination locations. It must be kept in mind that some of the major rails in the U.S. and Canada have been adding a $1000 surcharge per tanker car in cases where old DOT-111 cars are used. This adds about $1.50 to the per barrel cost. An article published in the February 2 Toronto Globe & Mail stated that recent developments are casting doubt on the business case for shipping crude oil by rail. Since rail costs are about double the cost of shipping via pipeline, “it is unclear if high costs make shipping by rail a money-making mode of transport for producers.” It should be noted that the above-mentioned breakeven analysis doesn’t reflect the additional costs that will come from the necessary upgrades to improve rail safety (as outlined in the next blog). These improvements are expected to add billions of dollars to shipping costs.
Revenue minus Expenses
The breakeven price of crude oil includes production costs, exploring or finding costs, oil well development costs, transportation costs, and selling and general administration expenses. The cost of producing a barrel of crude oil varies depending on the method of extraction. The same Market Realist report indicates that Middle Eastern countries have the lowest breakeven price at $27 per barrel. US shale oil producers have a breakeven price of $65 per barrel. The breakeven price for a barrel of crude oil from the Alberta oil sands is $75. These estimates are average breakeven prices. The costs may vary depending on the oil well and its location. Nevertheless, there is a significant gap between the breakeven cost and the market price under both methods of extraction.
Currency Fluctuations
Crude oil declines as the U.S. dollar rises. The U.S. Federal Reserve is likely to increase interest rates in 2015. The Bank of Canada has lowered its prime interest rate and may lower it again. Rising interest rates in the U.S. coupled with interest rate decreases in Canada will further strengthen the value of the U.S. dollar and further decrease crude oil prices. One benefit of the currency fluctuation for Canada is that a declining Canadian dollar will help reduce its production costs.
Is Shipping Crude Oil by Rail Financially Sustainable?
If the cost estimates outlined above are correct and if the price per barrel remains at current levels (mid-$45 range) or lower, this raises questions about the sustainability of shipping crude oil by rail. If shipping costs increase, this will make the business case more problematic. The next blog will focus on what needs to be done to improve rail safety and improve the economics of shipping crude oil by rail.
Dan Goodwill & Associates (www.dantranscon.com) provides freight transportation consulting services to shippers and carriers throughout North America. Follow Dan on Twitter @DanGoodwill. To stay up to date on the latest developments in energy and transportation, obtain a free subscription to Dan’s Transportation Newspaper (http://paper.li/DanGoodwill/1342211466 ).