North Dakota Bakken Crude Oil

[jstolberg]

Canada is only considering one tank car design.
1. 9/16" steel with rollover protection and electronically controlled pneumatic (ECP) brakes

http://www.reuters.com/article/2014/07/ ... 3P20140723" onclick="window.open(this.href);return false;

Fair use quote:

The additional information from Canadian regulators said new tank car standards, which they named TC-140, should have 9/16 inch (14.3 mm) steel thickness and mandatory electronically controlled pneumatic (ECP) brakes.

The next generation tank car would also require full head shields, as well as mandatory top fitting protection, bottom outlet valves, thermal protection and head and shell puncture resistance that must all exceed the current standards voluntarily adopted by the industry in 2011.

[Gilbert B Norman]

From Hyatt Regency Greenwich

Today's Wall Street Journal has a comprehensive and optimistic article regarding railroad handling of crude. A link will have to wait until I return home on Thursday. I only joined the 21st century about three months ago with a Samsung Galaxy S5 and I have yet to figure out how to paste a URL link.

All here participating in this discussion will find the noted material to be interesting.

[gokeefe]

Worth noting:

In the latest "Director's Cut" from the North Dakota Department of Mineral Resources, Oil and Gas Division, August production for the Bakken was at 1.132 M barrels of oil per day. A new "all time high". Although the drilling rig counts are below the historic high of 218 they have been stable in the mid 190s now for some time. (Sep count was 195).

There was some mention of a potential new discovery of gas in Emmons County and current work to increase capture rates of gas should greatly improve the flare rate in the near future. This would appear likely to have a beneficial effect on U.S. gas prices as significant additional supply will be added to the mix.

While some have predicted problems for the Bakken due to the decrease in crude prices more recent analysis that I have seen seems to indicate the "bottom" is around $60/barrel, if not lower in some cases due to improvements in extraction techniques. Shale drilling does in fact consume some significant quantities of fuel and other indications are that the corresponding decrease in crude prices also leads to a corresponding decrease in production costs. While the relationship is not necessarily linear per se I find it interesting to consider that the price of shale oil production may move in step downwards with the price of crude.

[Gilbert B Norman]

The New York Times is printing a series of articles regarding a "cozy" political environment in which North Dakota oil producers certainly appear beneficiaries. The first installment gives railroad transportation a pass; can't say same for the second. Who knows what future installments (if any) hold to what extent BNSF and SOO - the predominant railroads handling crude from the Bakken region - will be included within the "cozy" cabal:

November 23

November 24

The articles are lengthy - as is any investigative journalism circulated by The Times.

[gokeefe]

Here are my observations on the latest market activity and it's significance to the crude by rail market.

First and foremost there has been near saturation coverage by the business and financial media of the effect of the recent price crash for crude oil. Mr. Norman has often wondered what would happen if the Saudis "opened up the taps" much as they did in the mid 80s. In this case the situation is a little different. The best analogy is simply "the tap is being left on" but the intended effect, a price crash, is very similar.

In short despite a supply glut the Kingdom has chosen to keep oil flowing into the market and not act as the "central bank of oil" as I read in one article.

The reasons for this are complex but on the surface the first problem appears to have been concerns about a loss of market share by the Saudis. This was followed by a possible attempt to shake out the shale oil industry in the U.S.

I find the second possibility to be nearly absurd for two reasons and therein lies the basis for continued optimism regarding crude by rail. First and foremost declines in the price of crude have a direct correlation to declines in the price of producing shale oil. While it is energy intensive, this pricing is also directly linked to the cost of diesel. Diesel does not gave a long lead time for price changes to take effect and for the purposes of this concept it might as well be happening in real time. In short as the Saudis continue to allow the price of crude to fall they also make production in the U.S. shale fields even cheaper.

Second, the Saudis understand that the shale field developments are market driven. The oil has been there for millions of years and will still be there in a few years a decade or whenever they decide to let the price of oil start to rise again. When that happens production and development activity would simply return to previous levels.

For these two fundamental reasons, which are likely very well understood by the Saudis, we can be nearly certain that their latest strategic choice for the markets has little if anything to do with curtailing U.S. shale and everything to do with holding their own against the other members of the OPEC cartel.

If the Saudis really wanted to destroy U.S. shale production they would have let the price rise to astronomical heights, think above $200-$250/barrel. The immediate effect would have eaten up available capital on the credit markets for new production and would have ultimately strangled the U.S. supply of diesel fuel. The resulting strain would have made it nearly impossible to drill at the current pace due to the need to preserve fuel for domestic transporration needs.

They could have done this but, wisely, chose not to. Instead they chose the positive alternative which will both stimulate global demand and improve their market share while shaking out other OPEC members.

I see no slowdown in Bakken production unless crude goes below $40/barrel and even that level might be economical for a lot more drillers than people might imagine.

Even then the recovery from a price crash of that magnitude could take years and I am not convinced that the Saudis want to take that kind of risk.

This overall picture leads to a general outlook that is very stable for crude by rail. Naturally, due to the current situation, the price of transportation is cheaper as well.

The U.S. economy is going to reap the benefits of this in spades. GDP growth at annual rates in excess of 5% in the second quarter of 2015 would not surprise me at all. Job growth is probably going to be very strong and I think we'll see significant declines in the number of long term unemployed. Expect an increase in work force participation in Q3 and Q4, if not sooner, and the beginning of real wage growth and perhaps even some mild inflation (greater than 1% annual rate).

The railroads stand to reap the rewards of all of this and their increased business investment spending will join the trend of other U.S. economic sectors as they gear up for what is likely to be the biggest economic expansion in about 60 years.

[Gilbert B Norman]

Mr. O'Keefe, I definitely respect your thoughts that production costs of Bakken crude will be reduced arising from the price reduction of Diesel fuel used both to extract such and to haul it away.

Unfortunately, the markets seem to have other ideas; for when I took a peak at my portfolio after the admittedly "very thin" partial trading day on Friday, I looked aghast that my rails and oils lost collectively over 5% of their value.

But we both know that Middle East crude is "easy oil" (about 1000ft down drilling through sand), and no doubt why long about "mid-fifties" when North American "easy oil" was essentially "tapped out", the producers turned en mass to the Middle East - the political instability of the region notwithstanding.

Now I think I have been at self-directed investing long enough to know that "anything goes" on these "thin" holiday period trading days, but at this time (tune in Monday of course), the market simply holds a contrary view.

[gokeefe]

Mr. Norman, I would expect to see a split in the medium term trend. As it stands the Dow Jones Transportation Average is at record highs and likely not going down anytime soon. I think oil securities are going to provide an excellent buying opportunity in a year or maybe two. I would be watching the dividend yields on ExxonMobil in particular. With XOM specifically anything above 6% is probably a significant opportunity.

[Cowford]

GO'K, I do not understand your contentions. Your arguments imply that diesel fuel is essentially the ONLY cost input for a horizontal well. Not counting the fuel consumed in trucking material to/from the wellhead, on-site fuel consumption for drilling/fracking only consumes something on the order of 30,000 gallons of diesel/well. (This number can vary drastically from well-to-well.) The cost of that fuel is a fraction of a well's total development cost, which is in the millions of dollars.

With respect, your logic - that shale play development is hurt by high crude prices and helped by low crude prices - seems backward to me. BNSF last week cautioned that ~$60 crude prices will eliminate production growth and that further price drops will cause production declines.

[gokeefe]

Your arguments imply that diesel fuel is essentially the ONLY cost input for a horizontal well.

No such implication intended. Rather that it is a very significant part of the cost, perhaps as much as 50%, or so I have concluded, perhaps without justification.

Not counting the fuel consumed in trucking material to/from the wellhead, on-site fuel consumption for drilling/fracking only consumes something on the order of 30,000 gallons of diesel/well. (This number can vary drastically from well-to-well.) The cost of that fuel is a fraction of a well's total development cost, which is in the millions of dollars.

I took a look through available material and feel that your estimate of 30,000 gallons per well may actually be on the generous side. Even at field prices of $5/gallon it would only be $150,000 out of a total cost ranging on average between $2,500,000 to more than $10,000,000.

With respect, your logic - that shale play development is hurt by high crude prices and helped by low crude prices - seems backward to me. BNSF last week cautioned that ~$60 crude prices will eliminate production growth and that further price drops will cause production declines.

I conclude that you are in fact correct in this respect with the sole caveat being that I continue to see indications that the actual price for production per barrel apparently is significantly lower than most current market estimates. While I respect BNSF's position I would maintain that my best guess of a problematic price is closer to $40/barrel. I am not at all certain that the Saudis are willing to let prices go this low for any period of time.

[Cowford]

I do agree that well development costs are declining; that appears to be the result of new techniques (so-called "pad" drilling) and processes/technology. Of course, the break-even costs vary wildly from well-to-well, let alone shale play-to-shale play.

Considering WTI is now trading below $70/bbl and Brent not far behind (and with both looking poised to head lower), we may find out sooner than later what break-evens are, where.

[gokeefe]

I do agree that well development costs are declining; that appears to be the result of new techniques (so-called "pad" drilling) and processes/technology. Of course, the break-even costs vary wildly from well-to-well, let alone shale play-to-shale play.

Another not-so-well understood factor is what happens when the wells get refracked. My understanding of this option is that the owner can come in and crack the formation again, which apparently can increase yields substantially at minimal expense.

[Cowford]

The crude price impact on rig counts in the Williston Basin is becoming pretty dramatic. Rigs have declined from 191 to 184 since October. ND Dept of Mineral Resources expect as many 50 will be mothballed by March; industry estimates put the number as high as 90... a 50% reduction in activity. Curious to know if this will have a direct correlation on frac sand activity, or if the surviving drilling projects will be high sand consumption pad wells, which would somewhat soften the blow.

[gokeefe]

I think it will be interesting to watch the rest of the world wake up to the realization that they may not see $80+/barrel oil again for a few decades. In the meantime "It's morning again in America." (feel free to substitute "energy" for "inflation").

I remain confident that changes to exploration patterns for Bakken Oil will have minimal effect on the demands for crude transit rail traffic for the foreseeable future. Oil traffic should remain stable through 2015 and 2016. Will demand taper off? I don't know but I don't think that will happen until 2017 at the earliest.

[dowlingm]

A demand slowdown wouldn't be any harm if it meant it gave railroads a chance to catch up where they are currently trying to push more trains through than capacity and contingency can cope with, and allowed old tank cars to be scrapped at a faster rate.

[gokeefe]

A demand slowdown wouldn't be any harm if it meant it gave railroads a chance to catch up where they are currently trying to push more trains through than capacity and contingency can cope with, and allowed old tank cars to be scrapped at a faster rate.

The problem here is that this seems unlikely to happen. As the economy continues to heat up into 2015 demand for other classes of freight will go up, possibly way up. I agree that if the specific crude by rail segment sees a tapering then we could see a window of opportunity for faster retirement of older tank cars but even that may not be much at all as the current fleet is insufficient to meet present demand.