Delivering the Goods

Shale plays like the Eagle Ford in South Texas and the Bakken in North Dakota—coupled with an influx of Canadian oil sands production in the Midwest—have pushed a surplus of oil all the way to Oklahoma.

At the key Cushing, Oklahoma, delivery hub for U.S. crude future contracts, inventories surged to 47.8 million barrels (bbl.) in June—the highest level since Energy Information Administration (EIA) records for the hub began in 2004. As a result, in October 2011, the West Texas Intermediate (WTI)-Brent spread widened to a record $27.88 bbl. in favor of the North Sea benchmark. It has averaged $17 per bbl. to $19 per bbl. in recent months.

In a perfect market, where WTI is stronger than Brent, the oil could be moved quickly and easily to take advantage of trans-Atlantic arbitrage opportunities and changing market dynamics. To capture the highest profit margins, the oil needs to penetrate the Gulf Coast refining market, where the core of the U.S. refining industry lies. Sounds simple in theory.

Advances in drilling technology have unlocked more oil and natural gas liquids (NGLs) from U.S. shale formations than the current country's infrastructure—namely pipelines—can handle. It is hoped that TransCanada Corp.'s Keystone XL pipeline project will eventually be completed and a link to it from the Bakken will help alleviate the current bottleneck. In the interim, however, transportation firms are scrambling to get their products to market.

The shale boom has also driven the cost of U.S. Gulf Coast light, sweet oil to its lowest level versus the European benchmark Brent crude in almost a quarter century, Stephen Schork, president of the Schork Group Inc. in Villanova, Pennsylvania, tells Midstream Business.

BNSF locomotives head out of the Bakken on a crisp day with another load of crude oil. The railroad recently announced plans to expand its system in North Dakota and Montana to accommodate shipments of 1 million bbl. per day. Source: BNSF Railway Co.

This year to-date, Light Louisiana Sweet, the benchmark Gulf Coast grade known as LLS, has averaged $0.15 per bbl. more than Brent on the spot market has—the smallest premium since at least 1988, Schork says.

LLS is considered an attractive grade, because its low-sulfur content and density make it easier to process into fuels such as gasoline.

The tighter spread has allowed refiners in Texas and Louisiana—that account for 45% of U.S. capacity—to replace competing shipments mainly from West Africa, according to the EIA. In fact, Gulf imports of light, sweet crude have fallen 56% since 2010, EIA data shows. Moreover, a shale-oil influx from the Eagle Ford and Bakken shale plays—among others—may accelerate that trend, Schork said.

"We have all these sweet barrels in the Midwest that need to find a home, and they're getting to the market by planes, trains and automobiles—you name it," Schork says. "You compound that with increased production in west Texas and the Eagle Ford, and you have a template for LLS to move to a discount."

However, with most of the country's shale plays located in remote areas, the most successful oil and gas producers and marketers will need to exploit the flexible nature of truck, rail and barge to deliver their goods to the most profitable markets, industry observers say.

"The shale plays have changed how midstream companies deploy capital in order to keep up with high-deliverability wells that have higher pressures and volume output. The level of activity is the highest it has been in many years," says Bill Waldheim, president and general partner of Denver-based DCP Midstream LLC.

Whether by train, ship or truck, production from the country's major shale plays is getting to its intended destinations, he says.

"This is the free enterprise market at work, and it's actually a nice way to increase overall production that would have normally been shut and becomes available until permanent distributions systems become operational," Waldheim adds. "These alternative methods of product distribution are at the high end of the cost curve and will be significantly reduced once infrastructure comes online.

"Still, there will always be a role for rail/truck/barge to satisfy niche markets or capture price basis between two locations," he says.

A tale of two shales

Among the most prolific U.S. shale plays—the Eagle Ford, Maverick Basin, in South Texas and the Bakken, Williston Basin, underlying parts of Montana, North Dakota and Saskatchewan—produce the majority of shale oil in the U.S., ahead of formations such as the Niobrara in Wyoming and Colorado, Bone Spring in Texas and New Mexico, and Monterey in California.

Justin Kringstad, director of the North Dakota Pipeline Authority, says the state's crude oil production averaged 660,000 bbl. per day in June—up 3% from the previous month and 71% over June 2011 volumes.

Of the June 2012 production total, 325,000 bbl., or 44%, moved by rail, Kringstad says. That compares with an estimated Williston Basin rail-export volume of 68,000 bbl. per day or 15%, in June 2011. "Those numbers include Williston Basin production from eastern Montana, North Dakota and South Dakota," he notes.

In the hydrocarbons-rich Eagle Ford shale formation in Texas, oil production tripled in May from a year earlier, data from state regulators shows. The nine fields that make up the majority of the 400-mile-long formation—spanning 23 counties from the Texas-Mexico border up into East Texas—produced 262,563 bbl. per day, according to the Railroad Commission of Texas. Those fields produced just 84,495 bbl. per day for the comparable period in 2011.

For Texas, the growth has been part of a larger comeback in the oil business, analysts say.

In April 2008—six months before Petrohawk Energy Corp. drilled the first well—the Eagle Ford produced no oil. This April, it accounted for 4.6% of U.S. tight-oil output, commission data shows.

The Railroad Commission oversees oil and gas drilling in Texas. It collects monthly production reports from sites on which it permits drilling, and then groups those reports into larger geographic fields and districts. The commission updates the data once a month.

On the fast track

Among the biggest beneficiaries of the demand for transport of crude oil out of the Bakken-shale region is BNSF Railway Co., a subsidiary of Warren Buffet's Berkshire Hathaway Inc.

The Fort Worth-based private railway company is exploiting the lack of pipeline capacity needed to ship the region's skyrocketing crude production to refineries thousands of miles away. And, the demand from thirsty refiners is serving to more than offset expected weakness from BNSF Railway's shipment of agricultural products due to the Midwest drought and lower coal shipments as utilities shift to cleaner-burning, cheaper natural gas.

"BNSF has been hauling crude out of the Williston Basin area for over five years. In that time, we have seen the volume increase nearly 7,000%—from 1.3 million bbl. in 2008 to 88.9 million so far in 2012," says Denis Smith, vice president, industrial products. "In fact, since 2010 we have moved more than 100 million bbl. of crude."

Rail-traffic reports from the American Association of Railroads (AAR) show that the number of carloads transporting oil this year will likely be at least 35% ahead of last year. Rail shipments of oil year-to-date are 41% ahead of last year, AAR data shows. For the month of August, carloads carrying crude and oil products were 49% above the same month last year and up 67.3% from August 2010.

"The commodity category 'petroleum and petroleum products' once again led all other commodity categories in August in terms of carload gains—continuing its torrid growth," the AAR noted in its latest monthly Rail-Time Indicators report.

In early September, BNSF announced that it has expanded its rail capacity out of North Dakota and Montana to be able to haul up to 1 million bbl. per day of oil out of the Bakken, illustrating the breakneck pace of U.S. domestic crude production.

What's more, the company's $197-million investment has increased rail capacity out of the Williston Basin—from 1.3 million bbl. in 2008 to 88.9 million bbl. over the past year, Smith says.

The investment also will allow BNSF to expand train sizes to up to 118 tank cars from 100, hire 560 new employees in North Dakota and Montana, build two new terminals and replace at least 121 miles of rail.

BNSF currently serves 30% of U.S. refineries in 14 states. The company has 1,000 miles of rail line in the Williston Basin area and serves eight originating terminals with two more scheduled to come online by the end of the year, according to Smith.

"Rail has successfully relieved the U.S. shale-oil transportation bottlenecks; it's readily accessible and offers a faster-to-market option that allows producers to capture optimal returns," he adds.

BNSF customers seem to agree with that sentiment.

"Upstream and midstream companies are making significant investments in rail, indicating that rail, along with pipelines, will continue to be an important piece of the U.S. energy transportation puzzle," Smith says. "Our customers have spent nearly $1 billion developing 10 new crude facilities and purchasing necessary equipment."

Up and down the river

Mounting oil production in North Dakota has also found an outlet on one of America's earliest highways—the Mississippi River.

Earlier this year, Houston-based Kirby Corp. began shipping crude from the Bakken shale play to refiners in Louisiana using barges on the Mississippi. The company is said to have been the first major U.S. barge operator to do so.

No doubt, the oil has been welcome at the 19 refineries in Louisiana, many of which are large facilities operated by ExxonMobil Corp., Phillips 66 Co. and Marathon Petroleum Corp. Louisiana is the second-largest refining state in the U.S. after Texas, according to the EIA.

Throughout most of its 90-year existence, Kirby has conducted oil and gas exploration and production activities. Through its marine-transportation subsidiary, Kirby is best known as the largest operator of tank barges in the U.S., transporting bulk-liquid products via the Mississippi River system, the Gulf Intracoastal Waterway, along all three coasts and in Alaska and Hawaii.

Currently, Kirby operates some 827 inland tank barges with the capacity to carry 16.3 million bbl. of liquids; about 235 inland towboats, 59 coastal tank barges and 65 coastal tugboats.

Just four years ago, the Mississippi oil trade barely even existed—with fewer than 100 barges operated by mostly small, private companies, Kirby chairman and chief executive Joe Pyne told analysts during the company's third-quarter 2011 conference call.

In October 2011, between 140 and 150 barges industry-wide were transporting crude oil—more than 10 times the number in operation a decade earlier, Pyne said. "We used to be able to count on less than two hands the number of crude barges."

Gregory Lewis, a shipping and oil-services analyst at Credit Suisse, told Midstream Business that Bakken oil-barge volumes are expected to rise.

"The medium term looks positive for crude barge volumes on the Mississippi as we expect Bakken oil volumes to continue to increase over the next few years. Additionally, barge volumes should pick up from the Utica in the near term (destination Baton Rouge area)," Lewis says. "We also note that overall crude volumes are off-of-nil levels and are a supplement to Kirby's core business (refined products)."

In late July, Kirby loaded a unit-train of Bakken oil that had arrived by rail onto its barges at St. Louis. The barges typically take a week to travel down the Mississippi River to bring the oil to the Baton Rouge, Louisiana, area, according to the company.

And, conveniently, the barges, which transport the crude down the Mississippi to the refineries, could be used to carry refined products, such as gasoline and diesel fuel, north on the return trip. It makes economic sense—they get paid both ways.

However, Lewis emphasizes that barges carrying crude downriver cannot transport refined products back upriver without being cleaned first.

"They can transport crude after refined products without cleaning, but not the other way. Crude oil and refined products have vastly different chemical properties—one would have to clean the tanks for $50,000-plus in order to transport products after transporting crude," he notes. "That type of cleaning does not happen often, because equipment owners usually make longer-term decisions to focus on one or the other."

On the road again

Another beneficiary of the transport demand for crude out of the Bakken is Gold Spur Trucking, which touts itself as the "Home of the Hardest Working Trucks in the Oilfield."

The San Antonio-based company provides both in-house dedicated fleet services and call-out services in Montana, North Dakota, Texas and Utah.

"We are active almost exclusively in new shale plays, and are active in those regions for that reason," company co-founder Brady McClellan says. "In 2009-2010, we made a shift from natural gas-focused fields to fields targeting liquids due to better global demand and a more stable market for liquids."

Gold Spur believes in the long-term future of natural gas, and in the near and mid term, "natural gas is a victim of its own success," says McClellan, who established the trucking firm with his brother, Andrew. "It's extremely abundant, and we are too good at producing it. That scenario is compounded by the fact that natural gas is also a byproduct of liquids plays, which are also seeing huge growth."

Since Gold Spur emerged on the scene in March 2008, McClellan says there has been an industry-wide shift from dry gas to liquids plays. "There was a brief downturn in 2009, but recovery in oil prices came quickly, whereas natural gas never followed. Wise players in the industry, such as EOG (Resources Inc.), quickly moved to pursue liquids to offset the loss of value in natural gas, others followed later—including Chesapeake Energy Corp.

"Through all the transition, roughly the same number of rotary rigs are drilling now as they were in 2008, but with an entirely different product in their sights and with improved efficiency to drill more wells per month, per rig," he adds.

Some industry observers contend that in the short term, at least, rail, trucking and barge companies will continue to help fill the gap until more permanent infrastructure is built. McClellan said he wouldn't limit the discussion to "short term."

"The most successful oil and gas producers and marketers will need to exploit the flexible nature of truck, rail and barge to deliver their goods to the most profitable markets," he says. "Pipelines may be a more cost-effective solution on a long-time table, but it's a one-way street to a fixed destination.

"In a dynamic market such as we have now, the guys utilizing flexible logistics are winning out while pipelines are trying to guess what the future looks like," McClellan continues. "With the rapid discovery of new hot-growth areas, both the origin and destination of the crude oil is a rapidly changing picture, which is served well by the modes of transportation that can adapt quickly."

Others have suggested that transportation firms will have a role to play even after the needed pipeline infrastructure is completed—mainly because of the sheer production volumes.

"I agree, but not because of the sheer volume; but rather the nature of the wells at the forefront of the growth," McClellan says. "New wells in new areas don't lend themselves to quick pipe connection. We have sufficient takeaway capacity both on rail and pipe in all of the major shale plays, and the forecast for build-out continues to project well ahead of production growth.

"The long-term necessity of barge, rail and truck is more centered on market-pricing factors and logistics, as well as areas of new growth to replace the natural depletion of production. E&P companies must constantly drill new lease areas in order to keep production rate on the level—let alone their growth projections," he notes. "There is a necessary lag in pipe connection of these new areas, which of course necessitates trucking to provide the last-mile service.

"As long as E&P companies are maintaining current production levels or hopefully growing, trucks will always be a necessary part of the logistics picture, if nothing more than to provide service to leases drilled to offset production declines," McClellan says.