The Rise of North Dakota

Since 2007, oil production in North Dakota has rocketed from 124,000 BPD to the current level of just over 930,000 BPD. The boom in North Dakota has been so rapid that over that time frame, the state rose from the nation’s 8th largest oil producer to become the nation’s 2nd largest oil producer, behind only Texas.

North Dakota sits on top of the Williston Basin that also lies underneath parts of South Dakota, Montana, and southern Saskatchewan. Within the Williston Basin is the Bakken Formation, which is to date the source of most of region’s rapid oil production growth. But underneath the Bakken Formation is the Three Forks Formation, which has begun to produce oil.

The US Geological Survey (USGS) recently provided the first update of oil and gas resources in the Williston Basin since 2008. The new estimate included the Three Forks Formation because of the rise in drilling and production in the formation. Inclusion of Three Forks added an estimated mean resource of 3.73 billion barrels of oil to the estimated 3.65 billion barrels of oil in the Bakken for a total estimated resource of 7.4 billion barrels of undiscovered, technically recoverable oil in the two formations. At the current price of oil, the value of what the USGS considers to be undiscovered oil is $700 billion.

The two formations were also estimated to contain a mean of 6.7 trillion cubic feet (tcf) of undiscovered, technically recoverable natural gas and 0.53 billion barrels of undiscovered, technically recoverable natural gas liquids (NGLs).

The Glut of Crude Creates a Price Gap

Historically, internationally-traded Brent crude could be bought at a $1 to $3 per barrel discount to the more logistically-constrained but higher quality West Texas Intermediate (WTI) crude. But the rapid increase in oil production created a glut of oil in the midcontinent portion of the US, and WTI prices began to be depressed against Brent a few years ago as a result of the logistical constraints in getting rapidly growing shale oil production to market.

In 2011 the Brent-WTI price differential increased to more than $25/bbl, and it remained historically high in 2012. Bakken crude is generally priced relative to WTI, but Bakken crude is even more logistically constrained than WTI and trades at an additional discount of roughly $5/bbl (although this spread has increased to $15/bbl at times).

Source: Energy Information Administration

Given the rapidly growing production in the Bakken, the enormous value of the total resource, and the discount between high quality Bakken crudes and world markets, there is enormous incentive to transport Bakken crudes to coastal markets.

Shippers Turn to Rail

Pipelines are normally the cheapest option for getting crude oil to market. A rough rule of thumb is that shipping by rail to distant markets can cost ~$5-$10/bbl more than shipping by pipeline. While the numbers are constantly changing, earlier this year Bakken crude could be shipped to the Gulf Coast by rail for $15/bbl, versus $10/bbl for the pipeline option.

Source: Professional Logistics Group

Of course most shippers would opt for the cheaper pipeline option, but crude production in North Dakota has grown at a much faster rate than pipeline capacity. Given a Brent-Bakken differential that has spent lots of time north of $20/bbl over the past couple of years, rail became a very attractive option for Bakken crude transport.
Bakken oil is now being shipped by rail to refineries on the East Coast, West Coast, and Gulf Coast — and various refiners have indicated that they plan to continue expanding this practice. Four years ago there was essentially no oil being shipped by rail from the Bakken. Two years ago, approximately 100,000 bpd was being shipped by rail. This year that number reached 700,000 bpd — three quarters of the crude oil production in North Dakota.

Source: North Dakota Pipeline Authority

The decision to move crude oil by rail comes down to the cost of rail shipping versus the differential in the price of crude at the origin and the destination. The Bakken-Brent differential averaged about $20/bbl in 2012, and this drove the rapid growth in rail shipments. But pipeline capacity is racing to catch up, and as it does so it is inevitable that the differentials will revert to levels that will swing the pendulum back to the pipeline companies.

The Bakken Pipelines

Source: North Dakota Pipeline Authority

At present the North Dakota Pipeline Authority lists 583,000 bpd of pipeline export capacity from the Bakken. Of that, 68,000 bpd feeds Tesoro’s refinery in Mandan, North Dakota. The Butte Pipeline is a 160,000 bpd crude oil pipeline system from Baker, Montana to Ft. Laramie and Guernsey, Wyoming. The Butte Pipeline is operated by Bridger Pipeline LLC, part of the privately held and family owned True Companies which also control the Belle Fourche pipeline system.

But today if you wanted to invest in Bakken pipeline capacity, Enbridge Energy Partners (NYSE: EEB) is the only publicly traded game in town. Enbridge’s North Dakota mainline moves 210,000 bpd from the Williston Basin to a terminal in Clearbrook, Minnesota.  Enbridge’s Bakken Pipeline Expansion consisted of two projects that added another 145,000 bpd of pipeline capacity out of the Bakken. Thus, of the 583,000 bpd of pipeline export capacity from the Bakken, Enbridge owns a total of 355,000 bpd (61 percent).

2014 will see an erosion of Enbridge’s market share as three projects are scheduled to add a total of 200,000 bpd of export capacity. The largest is the Butte Loop pipeline project, which would add another 110,000 bpd of export capacity to the system. Plains All American Pipeline (NYSE: PAA) will join Enbridge as the second publicly traded MLP that offers export services from the Bakken with its Bakken North pipeline project. 2014 volumes are expected to be 40,000 bpd. Finally Hiland Partners — a private midstream energy partnership founded by Continental Resources (NYSE: CLR) CEO and chairman Harold Hamm — is scheduled to bring on the 50,000 bpd Double H pipeline. This $300 million pipeline will connect with the Pony Express Pipeline to ultimately move crude to Cushing, Oklahoma.

In 2015, there are a number of private pipelines scheduled to come onstream, as well as the now notorious Keystone XL pipeline from TransCanada (NYSE: TRP) that would offer 100,000 bpd of takeaway capacity from the Bakken.

At this point, it is doubtful that the Keystone XL will gain approval, but 2016 will see Enbridge regain market share when its $2.6 billion Sandpiper Pipeline Project is scheduled to come online. The 225,000 bpd Sandpiper will expand and extend the partnership’s North Dakota pipeline system. The expansion will involve construction of a 24-inch diameter line from Beaver Lodge, N.D., to Clearbrook, Minn., and a 30-inch diameter line from Clearbrook to the Superior, Wis., mainline system terminal. The new line will serve as a twin to the existing 210,000 bpd North Dakota System main line, which terminates at the Clearbrook Terminal, and add 225,000 bpd of capacity on the twin line between Beaver Lodge and Clearbrook and 375,000 bpd between Clearbrook and Superior.

Beyond crude oil transportation, Oneok Partners (NYSE: OKS) has a 600-mile Bakken natural gas liquids (NGL) pipeline that moves unfractionated liquids from the Williston Basin to an interconnection with the Overland Pass Pipeline in northern Colorado. The Bakken NGL pipeline came online in April of 2013 with an originally planned capacity of 60,000 bpd and is currently being expanded to 135,000 bpd. Oneok recently announced that it will spend another $100 million to expand the Bakken NGL pipeline to 160,000 bpd.

Conclusion

If all of the crude oil export projects that are being planned were actually constructed, rail would hold the advantage until 2016 for Bakken exports. However, the transport options are a function of the price differential between Bakken and coastal crudes. As pipeline projects are commissioned, this will help alleviate the glut of Bakken crude and shrink the differentials, which will shift the favorable economics away from rail over time. But Bakken crude production growth won’t stand still either, and at the rate it is increasing there will be enough business for pipelines and railroads alike.