U.S. energy companies are forcing a restructuring of the global gas and oil trades with new production methods able to produce previously unreachable oil.
But efforts to deliver that oil to refiners has hit some roadblocks. The new shale fields, with names like Bakken, Eagle Ford and Niobrara, are often located outside the traditional U.S. network of pipelines. New lines are being built. But as the Keystone XL pipeline debate shows, approval and permitting — not to mention construction — take time and are uncertain.
Railroads have picked up much of the slack, hauling oil from south Texas, Montana and North Dakota to refineries across the U.S. Most of these shipments get to their destination without mishap. But several high-profile accidents have regulators and railroads working to improve safety standards for shipping oil by rail.
The result has propelled orders for transportation equipment from manufacturers like Greenbrier Companies (GBX), Trinity Industries (TRN) and Westinghouse Air Brake Technologies (WAB) (Wabtec). A central theme of the surge: Railroads are investing in new or refurbished tank cars to meet upgraded requirements being discussed by authorities to regulate the transportation of oil and other hazardous cargoes.
Institutional investors didn't miss the cue. They have pushed transportation equipment makers ahead 14% as a group since the start of February — one of the three best gains among the 197 industry groups tracked by IBD.
Trinity, which makes, sells and leases rail cars and inland barges, is the group's largest company. Shares have risen 30% since the start of the year. Greenbrier, which makes a wide range of railcars from intermodal to conventional, has soared 36% since Jan. 1.
Other major players in the group include Wabtec, the maker of compressors, breaks, couplings and other train parts, and FreightCar American (RAIL), which focuses on coal transport cars.
Declines in coal shipments in recent years cut sharply into profits and revenue for large railroads like CSX (CSX), Norfolk Southern (NSC) and Union Pacific (UNP). Oil transport has helped make up much of that loss.
"Crude by rail has been on a tremendous boom," said Bascome Majors, an equity analyst for Susquehanna Financial. "Building tank cars as well as covered hopper cars that can carry fracking sands have driven a significant amount of rail car demand since 2011.
Class I railroads, or railroads reporting revenue above $433.2 million in 2011, saw crude oil carloads jump 74% to 407,642 carloads in 2013 vs. 2012, according to a March 13 release from the Association of American Railroads. For the year, crude oil accounted for 1.4% of all Class I originations.
"Tank cars, the type that carry crude oil, are about 75% of industry's backlog," but only about a quarter of the existing fleet, Majors said.
On March 24, GATX Corp. (GMT) announced it bought more than 18,500 boxcars from General Electric (GE) Capital Rail Services unit for $340 million.
Earlier this month, Greenbrier announced it received orders for 5,600 railroad cars, valued at about $460 million, during the quarter that ended Feb. 28. Intermodal cars were also a popular order last quarter as the domestic auto industry bounces back.
Greenbrier is also working on a next-generation tank car to transport flammable crude oil and ethanol. In addition to new, higher spec cars, the company offers retrofits for current tankers that include high-flow pressure relief valves, head shields (which offer extra protection if a train derails), top fittings protection and thermal protection. As of Nov. 30, 47% of Greenbrier's backlog was the more advanced tank cars. It no longer makes an older model car for use with flammable materials.
The Rail-Vs.-Pipeline Debate
Shipping by rail has advantages. It offers flexibility over pipelines, moving a wider variety of products to different markets, based on a number of factors — according to Holly Arthur, spokesperson for the Association of American Railroads. Each tank car can haul a different type of oil. Pipelines either mix oil or have to be segmented, as only one type of oil can travel down the line at a time. Railroads service virtually every refinery in North America, so various types of oil can be sent to different markets based on price and other considerations. Even pipeline companies use railroads to move oil to different lines.
A 2013 report by Association of American Railroads, based on Department of Transportation data, noted the "spill rate" for railroads from 2002 to 2012 was 2.2 gallons per million ton-miles, vs. 6.3 gallons for pipelines.
But recent accidents have changed the equation.
In December, a Berkshire Hathaway (BRK) owned BNSF train derailed in a fiery crash in Casselton, N.D., spilling a reported 400,000 gallons of crude oil. Five months earlier, 47 people were killed when a crude tank train jumped its rails in Lac-Megantic, Quebec, erupted in flames, destroying 40 buildings and spilling 1.5 million gallons of oil.
On March 24, Quebec's police force turned over its investigation into the July 6 crash to prosecutors. Sources cited by a Canadian news outlet said that criminal negligence charges were expected to be filed as a result of the investigation.
The Department of Transportation in late February announced an emergency order requiring all shippers moving oil from the Bakken shale production region to test their equipment for safety and package the crude using the two strongest safety packing groups. The new rules are set to be in place by July 1 and shippers run the risk of being penalized $175,000 per incident for not complying. But no official long-term rules have been established for shipping crude by rail.
Regulations May Be Win-Win
If and when regulation is approved, analysts say, it could be a positive for equipment makers.
Regulation "creates some replacement demand on fairly young equipment that wouldn't have been there without these regulations," Majors said.
While official regulations are still being debated, Majors argues that manufacturers are self regulating and place overwhelming emphasis on safety.
But the cost of complying with the new standards could weigh on the railroads already challenged by lower coal demand. Despite its high profile, crude shipped by rail accounts for only 1.4% of total rail traffic, according to Arthur.
Majors warns the rise of regulations risks pushing some railroads out of transporting oil.
In addition, a recent report from the Wall Street Journal said the rise in demand for rail oil capacity has delayed or driven up the cost of shipments of other core railroad products, including coal and grains.
But Arthur said the backlog was caused by the cold winter, as removing snow and fixing infrastructure slowed shipping.
Majors expects "signs of a broader, healthier, more robust car cycle to emerge.
Intermodal freight has been improving and a broader range of rail cars will be wanted.
"Barring a downgrade in rail traffic, I expect things to carry into 2015 and have a couple good years," Majors said.