The sudden, dramatic drop in crude oil prices, which initially looked like a bad thing, could actually be good news for CP Rail, says CEO Hunter Harrison.
“We think this could be a non-event and could be a positive, depending on what happens and where crude settles in,” said Harrison at Credit Suisse meeting with analysts in New York on Wednesday.
“It’s all happened pretty quick,” he said, referring to oil prices that have fallen 35 per cent this year. “As we look at it, it will be good overall for the economy, and it will be good for Canadian exports.”
While CP could benefit if the economy improves and more exports need to be shipped, its aggressive plan counts on growth in crude-by-rail shipments.
CP wants to see revenue climb to $10 billion in 2018 from last year’s $6.1 billion. Much of that growth is contingent on increasing oil shipments.
In recent years, crude by rail has steadily increased due to a lack of pipeline capacity, especially with no approval yet for the Keystone XL pipeline in the United States.
While it’s more costly to ship crude by rail, higher oil prices compensated for the added expense. Now with lower oil prices, the question is whether producers will still choose the rails.
Harrison dismissed such speculation, noting CP signed a five-year oil shipment contract on Tuesday. “People are beating on the door wanting more trains for next month,” he said.
Despite speculation that oil prices might make it cost-prohibitive to operate certain light crude oil projects in the Bakken region, Harrison doesn’t think projects will shut down.
“I don’t think we’re going to see any knee-jerk reaction. I don’t think we’re going to see anything stopped in the Bakken,” he said.
CN Rail, Canada’s largest railway, which doesn’t disclose its crude-by-rail revenues, serves both the Bakken region and western Canada.
CN spokesman Mark Hallman says heavy crude oil from western Canada makes up 60 per cent of that railway’s volumes. Those projects are designed for long-term production, and are thus less likely to be affected by lower prices.
Furthermore, in the absence of new pipeline construction, crude-by-rail will continue to grow, as it continues to play a complementary role in getting crude to market, said Hallman in an email.
For the first nine months of 2014, CN moved about 90,000 carloads of crude, representing 2 per cent of total CN’s carloads. It anticipates it will move 150,000 carloads of crude oil by 2015.
For CP, crude-by-rail including frack sand represents about 7 per cent of the business. By the end of the third quarter, crude revenues had grown by $124 million, year over year, compared with overall growth of $439 million, in the previous 12 months.
Canaccord Genuity analyst David Tyerman notes that 28 per cent of CP’s revenue growth has come from crude by rail. “Although it’s not a big, giant part of the overall company, it’s a huge part of the growth of the company,” Tyerman said.
He believes lower oil prices could actually spur consumption, with consumers travelling more, or buying bigger cars or SUVs because gas is cheaper.
“There could be more demand for oil. It’s still got to come from somewhere,” he said. “There actually could be more demand for moving the stuff around.”
At the conference, Harrison blasted the Canadian government’s move to bring in legislation mandating minimum grain shipments that CP and CN must move.
The legislation was introduced in March, when farmers complained about a record crop trapped on the Prairies amid a bitterly cold winter. The government extended the rules for the summer, and last weekend introduced new thresholds through next March, though it lowered the minimums that must be moved.
If the railways don’t meet set levels, they could face fines of up to $100,000 per day. According to Transport Canada, CN has missed targets on a few occasions and the government is still reviewing information, though no notice of violation or fines have been levied.
Harrison scoffed at the threat of fines. “Do you think us, missing the mandate and paying a $100,000 fine for a billion dollar company is going to affect our business plan?” Harrison asked analysts, accusing the government of opening a can of worms.
He conceded efforts are under way to fix the situation, saying “there are some people trying to get the worms back in the can.”
In an email, Hallman said CN has met and continues to meet its pledge to move as much grain as possible, arguing the government should have focused on encouraging greater supply chain collaboration. He added Ottawa should have lifted, not re-imposed, minimum weekly grain volumes.