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Canadian oil producers are desperate to get more oil out of Alberta, and they are turning to railways for help. What is the upside here for Canadian National Railway Co. and Canadian Pacific Railway Ltd. as they haul more crude?
The question lands amid tremendous concern about the impact of low oil prices. As a result of years-long delays in constructing new pipelines, an oil glut is weighing on the price of heavy bitumen produced in the oil sands.
Western Canadian Select (WCS), a benchmark crude, trades at just US$21.93 per barrel – well below US$50.49 per barrel for West Texas Intermediate (WTI), a U.S. benchmark. At this price for WCS, some observers believe the Canadian economy is suffering losses ranging between $50-million and $80-million per day, putting pressure on energy executives and politicians to find a solution.
The most popular idea: Put more crude on trains. While moving oil along rails costs more than sending it along pipelines, railways can satisfy demand relatively quickly.
But investors who are wondering if they should boost their exposure to railway stocks might want to temper their enthusiasm.
Hauling crude is going to boost railway profits only marginally – perhaps by just 2 per cent, according to a recent analysis by CIBC World Markets. Even railway executives acknowledge that their pivotal role in easing the oil glut will likely be short-lived.
“The pipelines will come. It’s not a matter of if – it’s when,” Keith Creel, CP’s chief executive officer, said during a conference call with analysts in October.
The railway’s quarterly numbers show why the prospect of hauling more crude looks like an incremental benefit rather than an entirely new corridor to profits.
In its third-quarter results for the three-month period ended Sept. 30, CN reported total rail freight revenue of nearly $3.5-billion. But CN is diversified. Within this total revenue, the petroleum and chemicals division produced revenue of $665-million or slightly more than 19 per cent of the total. And crude oil is only an unspecified slice within this number.
CP’s third-quarter results suggest a similar role for crude oil. The railway’s energy, chemicals and plastics division generated $339-million in revenue in the three-month period, or about 18 per cent of total freight revenue.
“It’s positive, but it’s not really changing the big picture,” Amaury Baudouin, an analyst at DBRS, said in an interview.
The good news here is that the numbers for these crude oil-related divisions are rising – by 25 per cent year-over-year in the case of CN, compared with just 8 per cent for gains in intermodal revenue and 3 per cent for automotive revenue.
But gains from here are likely to be limited. When Alberta Premier Rachel Notley floated the idea of buying 7,000 rail cars to transport 120,000 barrels of oil per day, commodity producers warned that the additional traffic on the Canadian rail network could cause delays in shipping everything from grain to lumber.
In other words, crude-by-rail has limits on its growth. What’s more, railways have learned from their experiences several years ago that demand for their services can turn quickly – encouraging them to seek longer-term deals.
According to DBRS, drawing from National Energy Board data, Canadian crude oil exports by rail fell to just 43,000 barrels per day in June, 2016, from a high of 176,000 barrels per day in December, 2014 – a 76-per-cent reversal.
Kevin Chiang, an analyst at CIBC World Markets, said that demand for crude-by-rail could top 400,000 barrels per day, based on CIBC production forecasts. But even if the railways meet this surge in demand, it would translate into per-share profit growth of about 2 per cent in 2019.
“While not overly significant, it does support our view that the rails continue to see a strong earnings growth profile across their portfolio of commodities,” Mr. Chiang said in a Nov. 18 note to clients.
That may be the best takeaway here. Demand for exporting crude oil is not a compelling reason to buy a railway stock right now, but it underscores why railways make excellent long-term investments: They are indispensable.
This article first appeared on www.theglobeandmail.com
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