by Aaron Levitt | January 14, 2014 2:42 pm
Record and surging oil production volumes in places like the Bakken have been a boon to an unexpected group: railroad stocks.
That’s because many of today’s hottest shale regions — where fracking is making all of this production possible — sit outside of the thousands of miles of existing pipelines crisscrossing our country.
And rather than see their production go to waste, E&P firms like Continental Resources (CLR) have secured other means of transportation. Shipping crude oil via railcars — commonly referred to as crude-by-rail — has become the go-to means for getting energy out of the Bakken and other shale plays.
That is, until recently.
A series of high-profile derailments and crashes had regulators and pundits rethinking the rules on shipping crude via tank car. As such, shares of the leading railroad stocks that ship Bakken crude have fallen. However, crude-by-rail is simply too big of a trend to be chucked away.
And for investors, any cold-water thrown on the crude-by-rail movement can be seen as an opportunity to buy a handful of railroad stocks for the long-term.
Despite the record amounts of crude being shipped over our railways, there have been a few serious crude-by-rail incidents as of late. The most recent occurred two weeks ago, when two trains collided in North Dakota, causing a massive fire. Before that, there was a derailment in Alabama and before that was the deadliest accident so far.
In the beginning of July, a train carrying 73 tank cars of crude oil lost control, barreled downhill, derailed and exploded in downtown Lac-Megantic, Quebec. That explosion leveled the small town and killed 47 people.
All of these incidents has prompted officials to begin looking at the crude-by-rail movement in a serious manner.
The Pipeline and Hazardous Materials Safety Administration put out a new report saying that Bakken crude was more risky to transport due to its flammability vs. traditional heavy crude oil. Meanwhile, U.S. and Canadian regulators are considering imposing tougher rules on railcar construction. Many argue that Bakken crude oil is too rich in hydrogen sulfide and will cause faster corrosion of the current tank car fleet. Many of the DOT-111 tank cars in operation wouldn’t be able to handle the more corrosive oil over the longer haul.
All in all, these potential rules could increase the cost of moving Bakken crude to market. But it won’t kill the movement like some environmental pundits are predicting. It’s just too darn big.
How big? According to the Association of American Railroads, volumes of crude-by-rail shipments have surged 31% over the course of the year to reach around 150,000 barrels of oil per day. And as production continues to surge in the Bakken, industry experts predict that crude-by-rail capacity and volumes will leap to an astonishing 700,000 to 750,000 barrels of crude a day this year.
Because of those potential volume numbers going over rail, many pipeline projects in the region have actually been canceled. And with the energy sector and the Bakken being one of the few real bright spots in the U.S. economy, crude-by-rail will be here to stay.
And a few specific railroad stocks are a great way to play that trend.
The first whistle stop for investors could be Canadian National (CNI). As the owner of the two trains that collided in North Dakota, CNI shares fell pretty hard on the crude-by-rail accident and aftermath. However, Canadian National is the largest operator of railways in Canada, giving it unprecedented access to not only Bakken-based crude-by-rail shipments, but oil sands shipments as well. And that makes it one of the best railroad stocks to consider.
See, that fact has already boosted overall CNI carloads by 3% in 2013 and profits by 13% in 2013 — mostly due to rising crude-by-rail volumes. Another win for Canadian National stock? The company’s rail lines also head straight through frac-sand mining country. Shipments of frac-sand at CNI have grown by 300% throughout the past year.
Overall, CNI could be one of the best railroad stocks to play crude-by-rail. Canadian National stock can currently be had for a forward P/E of 15.
Another prime choice in the world of railroad stocks could be the chief Canadian rival of CNI: Canadian Pacific (CP). Like CNI, CP has made crude-by-rail a top contributor to its revenues and profits. Canadian Pacific has expanded into new terminal partnerships and projects, and its crude shipments should reach 70,000 oil-tank cars by the end of the year. Oh, and that number will expand roughly to 140,000 by the end of 2015.
That should continue to boost profits at Canadian Pacific, and is part of the reason CP is one of the top railroad stocks. Not that it really needs any help there, though. Canadian Pacific managed to increase profits in the third quarter by 45% versus a year ago. And CP stock can be had for a forward P/E of under 18.
Finally, any new tank-car regulation will benefit those firms that actually build and supply all those new cars. So our last pick in the wide world of railroad stocks is Trinity Industries (TRN). The firm already has seen its tank-car order backlog surge so much — currently sitting at 40,000 cars — that it has shifted much of its capacity at its wind turbine tower business towards the manufacture of rail cars.
TRN may also be a play on another growing energy nich: barges. Shipping via crude-by-barge is also growing by leaps and bounds and Trinity Industries is one of the largest manufacturers of tank barges as well. Overall, energy now makes up about 72% of the company’s total revenues. Meanwhile, shares of TRN stock are still dirt cheap at a Forward P/E of just 9.
All in all, crude-by-rail is here to stay … and railroad stocks are a great way to play it.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
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