Pdfgetting Crude to Market: Central U.S. Oil Transportation Challenges

THE THEECONOMIST:Main Street ECONOMISTEconomic information Agricultural for the and Cornhusker Rural Analysis State

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Getting Crude to Market: Central U.S. Oil Transportation Challenges By Chad Wilkerson, Vice President and Oklahoma City Branch Executive, and Nida Cakir Melek, Economist

rude oil production in the able to handle the added volume. The environmental and political United States is booming. bottleneck has both pushed down pushback, as well as other challenges CFrom early 2010, when the central U.S. crude prices relative associated with a rapidly evolving current surge started, to the end of to world prices and significantly U.S. oil industry. 2013, U.S. production of crude oil increased the use of alternate modes rose nearly 40 percent. By 2016, of oil transport. The boom and bottleneck in production is expected to increase This article examines the central U.S. oil production another 25 percent, which would evolution of oil transportation Prior to 2010, less than half of make the United States the world’s networks and the challenges faced U.S. oil production occurred onshore largest oil producer.1 Most of this in moving ever-increasing amounts between the Mississippi River and the increase is occurring in the middle of crude from the central United Rocky Mountains. But by the end of the country, in places that did not States. Two key recent trends are a of 2013, production in this area had previously have much production. boom in construction of pipelines increased to more than two-thirds of Areas of North Dakota and some and other infrastructure and a the nation’s total, with new oil plays untapped areas of Texas, Wyoming surge in transporting oil by rail in this area accounting for all of the and Oklahoma have recently become (and to a lesser extent trucks and rise in U.S. production since 2010 accessible because of high oil prices barges). Both trends hold promise (Chart 1). Specifically, the two most and advanced horizontal drilling for eliminating or greatly reducing productive recent oil plays—the Eagle techniques. However, increased the bottlenecks, while also boosting Ford Shale in south Texas and the production from these new “plays” has employment and income in areas Bakken Shale in North Dakota— created a supply bottleneck because where networks are expanding. These together account for more than three- most existing oil pipelines are not two trends, however, face regulatory, quarters of the overall increase. Other

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plays in the midcontinent region— Chart 1: Monthly U.S. Production of Crude Oil including the Permian Basin in West Million Barrels Per Day 9 Texas and New Mexico, the Niobrara 8 Central U.S. Onshore Shale in Colorado and Wyoming, Other U.S. Onshore 7 U.S. Offshore and smaller plays in Oklahoma and

6 Kansas—account for another third of the increase in U.S. oil production, 5 offsetting some production declines in 4 Alaska and U.S. offshore wells. 3 This production surge has led to

2 a glut of oil, especially at Cushing,

1 Oklahoma, where most central U.S. oil pipelines meet and where the price Jan.‘90 Jan.‘92 Jan.‘94 Jan.‘96 Jan.‘98 Jan.‘00 Jan.‘02 Jan.‘04 Jan.‘06 Jan.‘08 Jan.‘10 Jan.‘12 is set for U.S. benchmark West Texas Source: Energy Information Administration. Intermediate (WTI) crude. From 2009 to 2013, petroleum stocks at U.S. storage facilities increased 10 Chart 2: WTI and Brent Crude Oil Prices percent, with two-thirds of the increase Dollars Per Barrel Dollars Per Barrel $160 $160 occurring at Cushing alone. Stocks at

$140 $140 Cushing increased 50 percent in the period as it received more oil from the $120 WTI Crude Oil Spot Price $120 north and southwest than it was able to Brent Crude Oil Spot Price $100 $100 ship by pipeline to refiners on the Gulf $80 $80 Coast or elsewhere.

$60 $60 By 2011, the glut of oil had produced the first sizable spread between $40 $40 the prices of WTI and Brent North $20 $20 Sea oil, the international benchmark, with WTI trading at a considerable Jan.‘90 Jan. ‘92 Jan. ‘94 Jan. ‘96 Jan. ‘98 Jan. ‘00 Jan. ‘02 Jan. ‘04 Jan. ‘06 Jan. ‘08 Jan. ‘10 Jan. ‘12 Jan. ‘14

Source: The Wall Street Journal. discount as opposed to a slight premium historically (Chart 2). From 1990 to 2010, WTI averaged $1.38 more per barrel than Brent, and only traded below Brent 10 percent of the time and never by as much as $5. But since January 2011, WTI has averaged nearly $15 less per barrel than Brent.

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The recent evolution of U.S. oil Map: Location of U.S. Oil Wells, Crude Oil Pipelines, transportation infrastructure and Refineries, February 2014 As the supply bottleneck and price discounting intensified at Cushing, it became clear the nation’s oil pipeline, storage and refining infrastructure needed upgrading. Bakken Much of this infrastructure is far from the most productive oil plays, and some is configured to receive flows

from a different direction, or simply Cushing is outdated. Even today, pipelines and refineries are largely situated Eagle near either the traditional oil fields of Ford Oklahoma, West Texas and Louisiana, Oil Wells Crude Oil Pipeline Petroleum Refinery or near population centers on the • Atlantic and Pacific Coasts, where Source: Energy Information Administration. international crude imports arrive to Gulf Coast. Refineries likewise have to obtain given the nature of the be refined in the United States (Map). added some capacity, along with a few current oil boom. Wells in the shale In contrast, there is little permanent small new facilities to refine crude to a and tight oil plays that account for infrastructure near the Bakken fields point that it can be exported.3 the bulk of recent production growth in North Dakota and Montana or the These new pipelines and facilities, typically have much faster rates of Eagle Ford play in far south Texas. and changes in the direction of decline than traditional fields, and thus To address these infrastructure flows, have begun to loosen some of may not be as long-lasting. As such, needs, billions of dollars’ worth of the bottlenecks, and early evidence alternate modes of oil transportation— new projects—primarily pipelines and suggests that process may continue. with higher operating costs but lower storage facilities—are planned or have For example, the spread between capital costs and greater flexibility— started. For example, 1,165 miles of oil central U.S. and world oil prices, have emerged to take advantage of pipeline and related projects were set while still sizable, has been somewhat the price spread. These modes include to be completed in the United States smaller in 2013 and early 2014 than barge, truck and rail transportation in 2013; completion of 2,597 miles is in 2011 and 2012. However, these (Table). 2 expected in 2014. An additional 1,734 projects—especially new pipelines As price arbitrage opportunities miles of pipeline are planned to start in and refineries—beyond requiring from the oil glut oil emerged in 2011, 2014 and be finished in 2015 or later. significant investment and time, are by each alternate mode of transportation Storage facility construction has also their nature fixed in place. They also showed a significant increase in boomed in Cushing and elsewhere, typically require long-term contracts domestic deliveries to U.S. refineries and the flow direction of some major with producers to ensure cash flow for (Chart 3). Barge transportation, pipelines has been reversed to send oil the duration of an expensive project. the alternate mode with the lowest from the central United States to the Such assurances are somewhat difficult operating costs and only moderate

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thus much of the future growth of oil Table: Transportation Methods in the United States traffic by barge may be limited to niche Pipeline Rail Barge Truck markets. Capital Cost Very High High Moderate Low Oil transportation by truck, Operating Cost Very Low Moderate Low Very High the alternative with the lowest Geographic Coverage Limited to build Limited to rail Limited to Unlimited network network navigable channels startup costs and broadest potential Shipment Size Very Large Small to moderate Moderate to Large Very Small geographic coverage, grew more than 30 percent in 2011. Despite Chart 3: Oil Price Spread and Alternate Modes offering a short-term solution, Of Oil Transportation truck transportation has the highest operating costs of the alternate Dollars Per Barrel Percent Change From Previous Year 40 400 modes and, given its small capacity 35 350 Barge (right) per shipment, is the most energy- 30 Rail (right) 300 intensive mode. Even though Truck (right) 25 250 oil-by-truck transport grew another Brent-WTI spread (left) 30 percent in 2012, it didn’t surge 20 200 like other modes, and thus may 15 150 be destined to remain primarily a 10 100 provider of oil to other modes of 5 50 transportation rather than refineries.

0 0 The fastest-growing alternate

-5 -50 mode of oil transportation has been 2000 2002 2004 2006 2008 2010 2012 railroads. Rail transportation is Source: Energy Information Administration. somewhat more expensive than barges, capital costs, was the fastest-growing alternate mode in and not quite as flexible as trucks. But 2011. And in 2012, barge usage doubled from 2011. overall, as an option during pipeline construction and While barges historically have carried little crude oil, vessels periods of high oil-price differential, rail may have the outfitted to transport chemicals can be refitted relatively best combination of attributes of the alternative modes. easily to transport oil. The use of rail grew much faster than either barges or Initially, much of the oil-by-barge traffic was on the trucks in 2012 and that strong growth continued in Mississippi River, taking oil from the northern Plains to the 2013, according to industry data. And as other shale plays Gulf of Mexico. Barge traffic now is also increasing on the emerge, especially if they are far from the coasts, rail may Intracoastal Waterway in Texas, taking Eagle Ford Shale oil from its nearest port—Corpus Christi—north to refineries become even more important to the oil transportation on the Texas coast and in Louisiana. In fact, domestic crude network. oil transported by barge to refineries in the Gulf Coast more While most oil by rail is transported directly than tripled from 2010 to 2012. Barges, however, much to refineries in the Midwest or the coasts, some rail like pipelines on fixed routes, are constrained to navigable transportation—like truck transportation—is used to waterways that largely are inflexible to expansion. And connect with other less expensive modes with limited

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geographic flexibility, including have shifted to oil-by-rail transport. changes to U.S. laws that restrict ocean pipelines but also barges. For example, This follows several recent oil train shipments of petroleum and petroleum some rail cars from North Dakota go derailments, most notably on July 6, products. U.S. exports of crude oil to Mississippi River ports where barges 2013, in Lac-Mégantic, Quebec— have been prohibited since the 1970s, take the oil to the Gulf of Mexico; just north of Maine—that caused and coastal shipments between U.S. others go to ports in Washington an explosion and killed 47 people. ports must be made by U.S. ships where tankers take oil to San Francisco This incident has called into question carrying just U.S. products. As such, area refineries. the safety of older rail cars—known some analysts expect a glut of U.S. oil as DOT-111s—that still handle a to persist until refineries are able to Environmental, safety and majority of oil-by-rail transport in the refine all of the oil coming out of the political uncertainties United States. central United States. Although there As each mode of oil transportation Responses to concerns about oil- have been congressional hearings this has grown, so have concerns about by-rail safety have come recently from year about easing restrictions, most safety and the effect of each on the analysts do not expect any significant the rail industry and governments. environment. One project that has changes in 2014.4 received significant scrutiny is the Rail car manufacturers have greatly Keystone XL pipeline. Proposed in ramped up production of safer cars, Implications for households and 2008, the pipeline would extend and some railroads have raised their the economy from Canada’s tar sands through the own standards for the cars they use to Even with the continued Plains states to the Gulf of Mexico. carry oil. In addition, in January 2014, discounting of central U.S. oil prices Keystone’s southern leg, from Cushing relative to world oil prices, there has transportation safety boards in both the to the Gulf, became operational been no measurable effect on Midwest United States and Canada suggested in January 2014. But construction gasoline prices relative to other regions of the northern leg, which crosses enhanced safety rules for oil rail cars. of the country. U.S. gasoline prices have the international border and thus Then in February, the U.S. Department closely tracked Brent oil rather than requires presidential approval, remains of Transportation issued an emergency WTI in recent years, and wholesale delayed due to concerns about the order requiring stricter classifications gasoline prices in the Midwest have relatively carbon-heavy quality of the and closer scrutiny of petroleum carried not differed notably from prices across oil transported, disputes over possible the country. However, consumers in by rail cars. Some officials now expect paths it might take through the Plains the central United States do not appear new standards for oil tank cars to be and how frequently spills might occur. to have captured any of the potential Analysts generally expect a decision implemented by the end of 2014. These benefit of the region’s lower oil prices. sometime in 2014. actions may affect rail transportation of Despite lower oil prices in the In addition to the Keystone oil in the near term, as well as modify region, recent studies have shown project, other pipelines have been how refineries receive crude oil or Midwest gasoline prices have not delayed or rerouted due to landowners’ even temporarily disrupt its flow— varied from other regions because some concerns about spills on their potentially affecting gasoline prices. gasoline in the Midwest is still imported properties. But more recently, the Refineries and oil transporters from refineries on the coasts.5 Midwest environmental and safety debates also face uncertainty over possible refineries have been operating at or near

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capacity, causing much of the region’s and other infrastructure construction or increased pipeline capacity. crude oil to be transported out of the manufacturing, oil transportation ports, But even as pipeline capacity has region and then returned as gasoline. as well as central U.S. cities with oil and risen, continual growth in oil production Refineries on the coasts, meanwhile, gas headquarters or large regional offices, has caused the oil glut and the price largely pay the world price for crude such as Houston, Dallas, Oklahoma spread to persist. As such, usage of since the United States is still a large net City, Tulsa and Denver. alternate transport modes has grown, importer of oil. This should mean that providing a boost to economic activity Summary and conclusion even when central U.S. oil prices return in areas where it occurs. And if new Oil transportation in the central to or near international levels, gasoline shale plays are tapped in other places not United States is undergoing an historic prices in the Midwest will not rise more connected to pipelines, the trend in the realignment in response to the recent than other places. shale oil boom. Rising oil production usage of alternate transport modes could Although the central U.S. oil boom in the middle of the country increased continue for some time. Meanwhile, has not resulted in lower gasoline prices, inventories due to inadequate pipeline some safety and environmental concerns the regional economy has benefited capacity, which caused a spread between have emerged about both pipelines and from increased employment and the benchmark U.S. crude oil price in oil-by-rail transport. These concerns, incomes in areas with direct or indirect Cushing, Oklahoma, and the global along with restrictions on U.S. oil involvement in oil and gas production benchmark, Brent. These motivated the exports, have created some uncertainty or transportation.6 This includes areas usage of alternate but costlier modes of about how long the central U.S. oil glut with heavy drilling activity, pipeline transportation, such as rail, as well as might persist.

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Endnotes 1Energy Information Administration, 2014 Annual Energy Outlook, Early Release, Dec. 16, 2013. 2Oil & Gas Journal, Feb. 3, 2014. 3The United States has prohibited exports of pure crude oil since 1973, when controls were implemented to help prevent energy shortages and price spikes. Exports of more refined petroleum are allowed, and some small facilities have recently been constructed to refine crude oil to just the minimum standards for export. 4For example, The Rapidan Group, “Senate Holds Hearing on Crude Oil Exports,” Jan. 31, 2014 5For example, S. Borenstein and R. Kellogg, “The Incidence of an Oil Glut: Who Benefits from Cheap Crude Oil in the Midwest?” Energy Journal, 35 (Jan. 2014), pp. 15-33. 6As found, for example, by IHS Consulting, “America’s New Energy Future: The Unconventional Oil and Gas Revolution and the U.S. Economy, Volume 2: State Report”

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