Rail Versus Pipeline Investment
The last several years has seen a tremendous growth in rail
shipments into and out of North Dakota and southern Canada. These shipments
were oil outbound and water, sand, and other operating materials inbound. This
growth was caused by OPEC’s decision to hold steady their oil production
volumes, which made U.S. fracking and oil well development in those two areas
very profitable. This growth in rail shipments was also caused by the lack of
oil and gas pipeline capacity outbound from those two areas to U.S. processing
plants. In fact, the growth in volume was so high that the railroads serving
those areas ran out of both car and track capacity.
With volumes increasing at a steady rate, the obvious
solution would be for the railroads to build more track and acquire more
operating equipment. However, investments in equipment and track are long-term,
with equipment and track lasting decades with proper care. As such, these types
of investments require a steady volume over their life.
The railroads serving these areas were faced with a
difficult decision. To adequately meet demand would require billions of dollars
of capital investment but, short term, could produce billions of dollars in
additional revenue. However, the railroads were cautious of OPEC’s influence on
the price of oil. OPEC had announced that its members would be increasing the
production of crude, thus driving down the world price. With the small oil and
gas operators in North Dakota and Southern Canada having a much higher marginal
operating cost than the OPEC countries, a declining world price for crude could
force many of them to leave the industry. The negative impact of these exits
could be substantial for the railroads.
1. If you were president of one of these railroads, what
decision would you make? Maintain current capacity and forgo additional
revenue? Make the investment in additional capacity with the assumption that
volume will continue to increase? Explain your answer.
2. Could there be a shorter term solution for the railroads
other than acquiring more equipment and building more track that would allow
them to generate revenue without making significant investments?