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.
CASE QUESTIONS
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?