Can Crude Oil Price Declines End Railroads’ Bull Run?

+2.03%
Upside
246
Market
251
Trefis
UNP: Union Pacific logo
UNP
Union Pacific

Crude oil hit its five year low price on Monday, December 8, under pressure from growing production in the U.S. and the unwillingness of the Organization of Petroleum Exporting Countries (OPEC) to cut production. West Texas Intermediate (WTI), the U.S. crude benchmark, declined 4.3% to $63.05 per barrel and Brent crude, which reflects the global market, fell 4.2% to $66.10 per barrel.

Amid fears of a continuing decline in crude prices, railroad stock prices have also sunk. The Dow Jones U.S. Railroad Index (INDEXDJR: DJUSRR), which is based on 8 U.S. railroads, had gained 34.7% during the year through November 26. [1] However, following the news of the OPEC disagreeing on production cuts, the DJUSRR declined 7.4% through December 8. Investors are clearly worried about the impact of the crude oil price decline on railroads. In this article we take a look at railroads’ crude oil shipments and assess whether crude prices may have an adverse impact on railroads’ volumes and revenue.

See our full analysis of Norfolk Southern | CSX | Union Pacific

Relevant Articles
  1. Should You Pick Union Pacific Stock At $250 After 20% Gains Last Year And Q4 Beat?
  2. Up Over 2x In 2023 Is AMD A Better Pick Over Union Pacific Stock?
  3. Should You Pick Union Pacific Stock After An 18% Fall In Q3 Earnings?
  4. What To Expect From Union Pacific’s Q3 After Stock Up Only 2% This Year?
  5. Should You Pick Union Pacific Stock Over McDonald’s?
  6. Earnings Beat Ahead For Union Pacific Stock?

Crude-By-Rail: The Growth Story

In the U.S., hydraulic fracturing and horizontal drilling has allowed access to earlier untapped crude oil and natural gas deposits within non-permeable shale rock. This led to an increase in crude oil output from 5 million barrels per day in 2008 to 7.5 million barrels per day in 2013 and is expected to cross 8.5 million barrels per day in 2014. [2] According to the Energy Information Administration’s forecast, crude oil production may rise to 9.4 million barrels per day in 2015.

Since most of the growth in crude production was witnessed in regions with limited pipeline accessibility and capacity, such as North Dakota, the need rose for an alternative means to transport crude oil to refineries located near traditional crude oil production areas such as Texas and Oklahoma. Railroads, with their vast networks, offered the flexibility and capacity to handle the large volumes of crude oil coming from shale basins, including the Bakken in North Dakota, and could therefore fill the gap created by a lacking pipeline infrastructure. Class I railroad originated crude oil shipments increased from 9,500 in 2008 to 233,698 in 2012, and then to 407,761 in 2013. By the first half of 2014, crude oil carloads reached 229,798. According to the Association of American Railroads, U.S. Class I railroads accounted for the movement of around 11% of the crude oil produced in the U.S. in the first half of 2014.

Originated Carloads of Crude Oil on U.S. Class I Railroads

Originated Carloads of Crude Oil on U.S. Class I Railroads

Can Railroads Survive Without Crude Oil?

According to analyst estimates on Reuters, the average breakeven price for U.S. shale lies within the range of $70-80 per barrel. [3] This means that the current price levels of WTI and Brent make crude oil production from North American shale unsustainable, which raises the possibility of railroads losing out on one of their fastest growing commodity shipments. However, does that mean that railroads cannot survive without the commodity? Is the decline in railroad stock prices really justified? Given the fact that crude oil carloads accounted for only 1.6% of total Class I originated carloads in the first half of 2014, the decline in the DJUSRR index does not seem justified. [4]

With the exception of a few, railroads generally do not provide volumes of their crude oil shipments, instead reporting it as a part of their chemicals shipments. Union Pacific is one such railroad that provides information regarding its crude oil carloads. In the nine months ended September 2014, crude oil accounted for around 1.5% of its total volumes and 12.8% of chemicals volumes. [5] [6] If we assume that Union Pacific generated revenue from its crude oil shipments at the rate of its chemicals’ average revenue per unit, then crude oil likely accounted for only 2.1% of its total revenues for the first nine months of 2014. This means that even if Union Pacific’s crude oil shipments were to vanish overnight, it would lose out on just a very small portion of its revenues. Though other railroads do not provide their crude oil shipment volume, we can try to infer what it adds up to by comparing with Union Pacific’s chemical shipment volume and revenue.

First Nine Months 2014 UNP NSC CSX
Chemicals Volume (in 000’s units) 841 370 462
Contribution to Total Volume 11.7% 6.4% 9.0%
Chemicals Revenue (in $ Mil) $ 2,742 $ 1,386 $ 1,630
Contribution to Total Revenue 16.4% 15.8% 17.2%

Apart from the direct impact on crude oil shipments, railroads will likely lose out on shipments of frac sand and pipes as well, which are used for building rigs and the extraction of crude oil, due to the decline in crude oil price. However, these commodities form a negligible component of overall volumes and revenues, and therefore we have excluded these from our analysis.

Looking at the bigger picture, we also need to consider growth in other commodities that may offset the loss of crude oil shipments. In the first nine months of 2014, railroads’ grain carloads increased by 17.7% year-on-year, accounting for 3.6% of total U.S. railroad traffic, primarily due to the bumper harvests of corn and soybean in 2013 and 2014. [7] Automotive carloads grew 4.3% over the same period, contributing 3.0% towards total traffic. Intermodal carloads increased 5.5% due to capacity constraints in the trucking industry. Intermodal carloads accounted for 47.1% of the total U.S rail traffic. Housing and construction-related carloads such as cement, gravel and lumber have also grown significantly driven by the rise in commercial and residential construction in the U.S. The only commodity to show a decline in carloads in the first nine months of 2014 was coal. Therefore, it is evident that U.S. railroads can bank on many other commodities to compensate for the revenue and volume loss, if crude oil carloads were to decline.

View Interactive Institutional Research (Powered by Trefis):

Global Large CapU.S. Mid & Small CapEuropean Large & Mid Cap
More Trefis Research

 

Notes:
  1. Dow Jones U.S. Railroad Index, www.google.com/finance []
  2. EIA Short Term Energy Outlook, November 12, 2014, www.eia.gov []
  3. FACTBOX-Breakeven oil prices for U.S. shale: analyst estimates, www.reuters.com []
  4. AAR Background Papers – Crude By Rail, September 2014, www.aar.org []
  5. Union Pacific’s 2014 Q1, Q2 & Q3 slides, www.up.com []
  6. Union Pacific’s 2014 Q3 2014 Financials, www.up.com []
  7. U.S. Rail Traffic Week 39, www.aar.org []