All Aboard the Bakken Shale Railroad Plays


Covering nearly 200,000 square miles, North Dakota’s Bakken Shale formation is helping rewrite America’s energy history. While first discovered in 1951, it wasn’t until recently that the Bakken really got cooking. Using the advances in horizontal drilling and other modern extraction techniques, exploration and production (E&P) firms like Continental Resources () have been able to tap the region’s vast reserves of shale oil. Production continues to surge, and analysts now predict the Bakken will be pumping more than a million barrels a day by 2020.

However, getting that bounty to consumers and end users hasn’t been as easy as extracting it. As we’ve said before,  logistics are key for the energy industry. And poor pipeline infrastructure in this fertile field is creating vast difficulties.

While plenty of plans are on the drawing board to increase the number of pipelines in and out of the Bakken, they’ll take years to complete. In the meantime, a select group of firms is poised to continue benefiting from the Bakken’s rising production: railroads

For investors, betting on them could be a great win.

Aside from carrying freight and coal (though less of it) across the countryside, railroads are quickly emerging as the transport mode of choice for producers in the Bakken. According to data compiled by the North Dakota Pipeline Commission, pipelines accounted for 62% of shipments out of the Bakken this past November. However, railways carried more than 25% of Bakken crude to refineries in November. That’s up from 18% the month before.

Historically, less than 1% of crude has been delivered to U.S. refineries by rail.

But with major southbound and Gulf Coast pipeline projects pushed back to 2013 or beyond, rail shipments are growing despite their higher cost. E&P firms in the region have recently begun expediting plans to build or expand terminals that can load 95- to 118-car trains, which can transport between 60,000 to 68,000 barrels per trip, in order to reach refineries and bypass the Cushing, Okla., storage depot.

Backups at Cushing have resulted in huge storage glut of oil that isn’t getting to refiners. By using rails, that crude can go exactly where it’s needed.

The refiners seem bullish on the idea of these “pipelines on wheels” because it allows them to buy crude oil feedstock quickly and shift around opportunities. Recent Conoco (NYSE:COP) spin-off, refiner Phillips 66 (NYSE:PSX) announced that it’s looking into buying as many as 2,000 tank cars to ship crude produced from Bakken to its facilities on the East and West Coasts.

Railroads are also benefiting from inbound Bakken traffic. The increased amount of drilling has created a huge demand for materials such as pipes, cement, guar gum and lumber. According to Bloomberg, each well requires roughly 23 railcars of inbound material. Analysts predict that the North Dakota shale will see roughly 1,800 new wells drilled annually for the next 10 to 20 years.

All of this inbound and outbound traffic directly benefits those railroads that have or own track in the Bakken.

On Track to Profit

Given the Bakken’s long-term potential as an energy game changer for the U.S., investors may want to consider adding some exposure to the rails in the region. With more than 1,000 miles of track there, Berkshire Hathaway‘s (NYSE:BRK-A, BRK-B) BNSF is already major shipper of Bakken crude to refineries.

However, the company says its dominance will grow as more facilities are built. BNSF estimates that it could ship roughly 730,000 barrels of crude daily out of North Dakota. Likewise, competitor Union Pacific (NYSE:UNP) has plans in the works to quadruple its Bakken-to-Gulf rail delivery volumes this year.

While both represent great plays, the best option could be Canadian Pacific (NYSE:CP). The railway owns one of only two with tracks in the North Dakota part of the Bakken, and it has been seeing growth in both in- and outbound volumes. The Calgary-based company predicts by 2014 it will be carrying more than 70,000 carloads of crude out toward refineries.

Having direct access to the shale field means CP won’t have to share its shipments — or more important, its revenues — with other railways. Analysts at BMO predict that the Bakken’s strong growth will boost revenue for the railroad by more C$400 million annually over the next two to three years.

So far, the stock has rallied about 25% this year, but over the longer term, the Bakken boost should help spur revenues and share prices higher. Investors looking for another way to play the shale field should consider hopping aboard these railroads.

As of this writing, Aaron Levitt doesn’t own any securities mentioned here.

Aaron Levitt is an investment journalist living in Ohio. With nearly two decades of experience, his work appears in several high-profile publications in both print and on the web. Also likes a good Reuben sandwich. Follow his picks and pans on Twitter at @AaronLevitt.

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