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Oil By Rail On Track Due To Flexibility, Pipeline Red Tape

Despite Canada's deadly train derailment, the U.S. energy industry's economic and political climates are expected to keep rail delivery as an attractive option.

U.S. crude shipments by train shot up to 233,811 carloads last year from 9,500 in 2008, the Association of American Railroads said, as production of shale oil ramped up faster than pipeline capacity could expand.

That's helped rail giants like Union Pacific (UNP), CSX (CSX) and Berkshire Hathaway's (BRKB) BNSF offset falling coal shipments.

Pipelines still transport about 90% of crude and petroleum products within the U.S., according to the Energy Department. They are also considered safer and less costly than train deliveries.

But the shale boom and political constraints on pipelines like Keystone XL should continue to funnel oil over rails.

"It's viewed as something with longer-term legs to it," said Randy Ollenberger, BMO Capital Markets' top North American oil and gas analyst.

Trains can vary the types of oil they transport better than pipeline can, allowing refineries to produce special blends tailored to their local markets, he said.

Many coastal refineries lack pipeline access, having relied on overseas imports via ship, he added. But the shale boom suddenly provided cheaper oil that could widen their margins.

The lower-cost fuel has eroded pipeline's cost edge too. A plan to build a Texas-to-California line was met with muted interest from West Coast refiners, who can obtain oil from North Dakota at a similar total cost.

The sharp drop in output after a shale field's early burst also makes refiners hesitant to sign long-term pipeline contracts.

The permitting required to build new pipelines adds to delays in expanding capacity. Meantime, rail companies can attach more cars onto trains.

The Keystone pipeline would bring Midwest shale oil and Canadian tar sands oil to Gulf Coast refineries, which currently rely more on overseas imports.

But the economic case for new pipelines to the East and West Coasts, which have fewer refineries, makes less sense, said David Bouckhout, a senior commodity strategist at TD Securities. Political and regulatory obstacles won't get easier either.

The rail industry has enjoyed less regulation than pipeline firms do, but "we're going to see that change," he added.

The weekend derailment may lead to tighter oversight of train shipments in the U.S. and Canada and increase transport costs.

Even with more regulation, rail deliveries will continue to rise, given their superior flexibility, Bouckhout said. Recent Arkansas and Michigan spills highlighted pipeline risks. But pipelines tend to be farther from population centers and leaks lead to explosions less often, said James Williams, an energy analyst at WTRG Economics.

"Trains go through town," he said. "Pipelines, not necessarily."