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Why markets don’t watch pipeline debates

Headlines and social media are alight with pipeline talk.

Last week, more fuel was added to an already fiery national debate after Northern Gateway representatives took the hot seat at federal review hearings.

The temperature isn't likely to cool in the coming weeks and months. Environmental protectionism, aboriginal disputes, interprovincial geopolitics and even the spectre of Chinese foreign investment will test the anxiety threshold of all those lobbying for and against getting more Canadian oil to a global marketplace.

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If you're caught up in pipeline talk, however, you're missing the boat; or more specifically, the train.

Those in the oil business that are caught in dislocated, discounted markets are taking their cue from baseball philosopher Yogi Berra's wisdom: "I knew I was going to take the wrong train, so I left early."

Right now, the biggest megatrend in the North American oil business is moving ever-greater volumes of crude to market with railroad tankers.

Data from the Association of American Railroads shows a 55 per cent rise in the amount of petroleum shipped by rail over the past 12 months (see attached chart). The number of weekly carloads of oil in Canada and the U.S. has risen from a historically steady 10,000 to 11,000 to 17,200 in August. These volumes are significant: Each carload holds between 600 and 700 barrels, so the equivalent of 1.6 million barrels a day is now on the rails, which equals about 8.5 per cent of U.S. and Canadian consumption.

Much of the growth in the transportation of oil by rail in North America is originating at the wellhead, such as the pipeline-constrained Bakken in North Dakota. But rail traffic out of Western Canadian oil fields is also increasing as locomotives haul price-discounted loads to refineries in all directions on the compass, save North. A refinery on the U.S. Gulf Coast is the preferred destination.

More oil on the rails is not a short-term trend, especially in Canada. Anecdotally, domestic producers have been aggressively contracting loads over the past few weeks. So, when the rail statistics for September come out they are likely to reaffirm the impressive trajectory in the attached chart. A recent narrowing of the price difference between U.S. and Canadian oil benchmarks is indirect confirmation that the rails are easing the pressure on the pipes.

Free-market forces driving this oil-on-rails trend are powerful. One of the many compelling characteristics of oil is that it is easily transportable via multiple modes. Like a bear sniffing out a campground full of hamburger meat, petroleum products always have a tendency to find higher-value markets. The only question is whether the barrels are going to flow through pipes, float on water or roll on wheels.

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None of this suggests that rail is the most efficient, environmentally appealing way of moving large quantities of oil. Far from it. Nor does pulling carloads of oil to inland refineries and tidewater ports deliver optimal financial returns. Upstream producers must absorb the higher marginal cost of transportation, which translates into less revenue at wellheads. By direct association, royalties and taxes to provincial and federal governments are diminished.

Pipelines are by far the cheapest and best option. Paradoxically, the optimal mode of oil transportation has become the most contentious and acridly debated. That's where all the focus is right now. But market forces don't debate and they don't wait to "take the wrong train."

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