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As Kinder Morgan Scraps Plan for Pipeline, Under-the-Radar Rail Stocks Are Poised for Growth

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Railway companies stand to benefit as demand for crude oil transportation expands.

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Last Friday, Kinder Morgan (NYSE:KMP) announced that it was scrapping its plan to build a $2 billion oil pipeline that could have ferried West Texas crude to refiners in California.

The firm said that Valero Energy (NYSE:VLO), Tesoro (NYSE:TSO), Phillips 66 (NYSE:PSX), and other West Coast refiners were not interested in taking oil from the proposed Freedom pipeline.

"At Kinder Morgan, we don't believe in the concept of build it and they will come," said Mark Kissel, Kinder Morgan's West Region Gas Pipelines President, in a statement. "We stated at the outset that we would not move forward with the project without customer support, and we did not receive enough interest for us to commit to building the project at this time."

With the scrapping of Kinder Morgan's pipeline, and with the Keystone XL pipeline approval still up in the air, rail has quietly become a popular mode of oil transportation in North America -- especially as production has been overwhelming existing pipeline capacities. In the first quarter of this year, a record 97,135 carloads of crude were shipped across the US, which was an eye-popping 166% year-on-year increase.

A Canadian National rail unit in Chicago, Illinois. Source: Wikipedia
"There's no question rail is growing very rapidly by every single company and part of it is because of some of the uncertainty with the pipelines," said Valero Chairman and CEO Bill Klesse in a recent call with investors, according to The Reporter.

In fact, while environmentalist continue with their fight to block Keystone, many US refiners have already begun shipping crude from the Canadian tar sands via rail. Valero, for example, applied for a permit to build a rail project at its Benicia, California, refinery that would allow it to obtain Canadian crude.

"We're talking about moving some of the lowest-priced crude on the planet to our refineries," said Valero spokesman Bill Day, according to Fuel Fix. "The reason is that there isn't the infrastructure to move it in great quantities. So it's trading at a discount, and it's not near markets where it's processed."

Rail is more flexible, Day added, and also "significantly faster than moving by pipeline." Rail cars achieve top speeds of around 50 to 60 mph while pipelines typically ferry crude at 10 to 20 mph.

"The flexibility that rail provides energy producers is the ability to quickly access a broad range of markets at reasonable terms and is a good complement to traditional pipeline offerings," explained Canadian Pacific Railways (NYSE:CP) spokesman Ed Greenberg to QMI Agency.

Refineries in the Northeast are also making heavy use of railcars to receive North American crude. At the start of 2013, Phillips 66 said it had reached a five-year deal with Global Partners LP (NYSE:GLP) to transport some 50,000 barrels of Bakken crude each day to its Bayway, NJ, refinery so as to cut down its reliance on foreign Brent crude.

"Rail is the fastest way to provide increased export capacity out of the Bakken, creating a near-term solution to transportation bottlenecks and the resulting crude oil pricing differentials," said Stephen Wuori, Enbridge's (NYSE:ENB) president of liquids pipelines. His company is also developing a $68 million unit-train facility to rail in Bakken crude to refineries in Philadelphia.

Since late 2011, NuStar Asphalt, a joint venture of NuStar Energy (NYSE:NS) and private equity firm Lindsay Goldberg, has also been transporting Western Canadian heavy crude to its two East Coast asphalt facilities.

The boom in rail transportation of crude has helped rail companies to cushion the blow caused by declining coal shipments.

"In the coal market, railways have certainly proven their ability to move enormous quantities of that commodity," Jack Galloway, president of Canopy Prospecting, told Environment & Energy Publishing. "So they said [to refiners], 'Hey, look us over carefully. See if we make sense.'"

Railway companies like Canadian Pacific Railway, Burlington Northern Santa Fe, which is owned by Berkshire Hathaway (NYSE:BRK.B) and Union Pacific (NYSE:UNP) have received a boost from the growing demand for Bakken crude shipments.

But the rail company most poised for growth is Canadian National Railway (NYSE:CNI), which owns Athabasca Northern Railway, the key and sole link to the Athabasca oil sands in Alberta.

JPMorgan said in a recent report that Canadian National Railway was poised for strong growth and upgraded the stock to Neutral from Underweight, upping its price target to $110 from $96.

"Due to its greater reach North into the oil sands and South to US Gulf Coast refineries, CNI has one of the strongest crude by rail growth stories over the next several years," wrote JPMorgan analyst Thomas Wadewitz.

Twitter: @sterlingwong
No positions in stocks mentioned.
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