Why Are Oil Companies Investing Millions In This Old-School Infrastructure?

Due to a wealth of crude oil coming up in Alberta, Canada, and Bakken, North Dakota, oil and natural gas companies are investing hundreds of millions of dollars in rail projects to get the oil flowing as soon as possible.

What’s special about the oil?

While more than half the world’s oil averaged $110.13 a barrel in the fourth quarter on the New York Mercantile Exchange, and the West Texas Intermediate benchmark grade averaged $88.23 a barrel, Canada’s Western Canada Select benchmark showed $61.23 per barrel of oil-sands crude. In December, the Western Canada Select value was at a record discount to the West Texas Intermediate, with as much as a $42.50 gap between the two.

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What does it mean for the oil industry?

The oil in Alberta and Bakken is bountiful — almost too bountiful — as there is a bottleneck in the distribution of that oil, which is part of the reason the price is so low. Since the oil coming out of those regions is at such a high discount, refineries are taking measures to get their hands on it quickly, and since pipelines take time to build, many are investing in the rails…

How are the rails being changed?

Specifically, many in the oil industry are investing in rail depots, with more than $1 billion planned to go into such projects, according to Plains All American Pipeline LP (NYSE:PAA). Depots are especially significant for increasing the rate at which crude oil can come out of Alberta and Bakken, as the current rate is limited in part by how fast oil can be loaded and unloaded from trains at the current depots. Some companies are simply buying rail terminals, as Inergy Midstream LP (NYSE:NRGM) spent $425 million to do in November, while others, like Enbridge Inc. (NYSE:ENB), are building their own terminals. Some will also be investing in additional railcars.

The future..

Right now, the investment in the railways is something of a stopgap to quickly get the cheaper crude oil to the refineries. And it will be important, as U.S. oil production is projected to increase to 7.9 million barrels a day by 2014 — the highest rate since 1988 — and Canadian oil production to 4.7 million barrels a day by 2020. Over time, pipelines may be developed to handle more of the oil, because they are cheaper and more efficient, but beefing up the rail infrastructure is the most viable method for the short term, particularly because pipelines are facing scrutiny from environmental groups.

The United States Oil (NYSEARCA:USO) ETF is trading down 0.12 percent at 2:02 p.m. on Monday afternoon. The S&P 500 is down 0.26 percent.

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