What Will Transportation’s Emergency Order Mean for Warren Buffet’s Railways?

The Burlington Northern Santa Fe Railway company, owned by Warren Buffet’s Berkshire Hathaway ($BRK.A), announced last week that it was looking to purchase its own fleet of some 5,000 new crude oil transportation tanks, equipped with safety features far surpassing the latest industry standards. The announcement was one whose timing could not have been better.

Train derailments

On Tuesday, Feb 25, the Department of Transportation said that a majority of crude oil from North Dakota’s mighty Bakken shale has likely been misclassified, and is actually more combustible than was previously thought, prompting the issuance of an emergency order to implement much stricter testing and safety procedures.

The risks are not negligible; the July 2013 derailment and subsequent explosion of 70 oil tankers in Lac-Megantic, Quebec destroyed most of the small town, killing 47 people and resulting in $1 billion in damages besides. The tankers were transporting just a fraction of the diluvian torrent of crude that has been spilling out of the Bakken in recent years, and were simply not adequate to the task of carrying such volatile cargo.

The Department of Transportation’s Tuesday statement is directly relevant to BNSF’s business for a couple of reasons. On Dec 30 of last year, a BNSF train carrying the spoils of the Bakken production boom collided with another derailed train on its way through North Dakota, resulting in an enormous fireball that swallowed ten railcars and forced some 2,000 residents of the small town of Casselton to be evacuated to nearby Fargo.

The US has been moving oil by railcar for at least a century, but trains have proven to be not only dangerous, but also a far more costly means of transport than pipelines. The recent uptick in oil tanker accidents on North American railways can be traced to the astronomical increase in US oil production from previously neglected low-permeability rock formations, a phenomenon that has also transformed North Dakota into a classic boom-town.

Insufficient pipeline infrastructure favors rail

More accidents have also been the result of an ailing oil pipeline infrastructure in the US. Of the 2.6 millions miles of pipeline that transports oil and gas around the country, less than one-fifth of it is used specifically for crude oil. The infrastructure that does exist is notoriously decrepit, much of it having been installed prior to the 1970’s, and is shockingly non-existent for the relatively more rare (and valuable) shale oil plays. Indeed, in just a few short years, activity in the Bakken has swelled from a well-count in the low hundreds to the present day’s figure at around 7,000 operating wells. Production is currently exceeding storage/transport capacity by some 200,000 barrels per day.

The Federal transportation regulator also said that at least 3 percent of tankers used to move crude are simply not up to the task. BNSF is perhaps wise to have made its move public prior to the DOT’s announcement this week; in 2013, crude was the railway operator’s number-two cargo behind coal. The enormous cost of its proposed tanker purchase means that the company is confident about its growing role in the midstream oil business.

Buffet surprised the financial community in Feb 2010 with his purchase of the trains, perhaps a testament to his prescience as an investor. The same could be said of the 40 million shares of industry giant ExxonMobil (XOM) Berkshire purchased for $3.5 billion last Nov, given the company’s conspicuous presence in the Bakken.