NATHAN VANDERKLIPPE

CALGARY Published Monday, Jan. 24, 2011

Although Enbridge Inc. (ENB-T56.310.761.37%) has attracted the most attention for its planned Northern Gateway pipeline, which would create a Pacific outlet for Alberta’s oil sands, Canadian National Railway Co. (CNR-T68.451.001.48%) has also received a favourable response to its plan for a “pipeline on rail” that would also deliver oil to West Coast tanker ships.

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For decades, Canada has been almost solely reliant on the United States as a purchaser of Canadian crude. Yet political and industry leaders have increasingly called for a change, with hopes that adding more buyers will increase the value of one of Canada’s most important export products, thereby boosting the fortunes of both the country’s oil patch and government coffers.

The rising fortunes of a growing Asian middle class are now a major force propelling global oil demand. As they seek to satisfy that energy thirst, Chinese companies are “interested in every alternative” for moving Canadian crude, said Glen Perry, president of Altex Energy Ltd., which has partnered with CN to create and market the rail idea. “They’re looking at the economics.”

But that interest, he added, has yet to result in a signed shipping contract as the lure of opening a new crude export market draws proposals from a group of companies vying to be the favoured transportation option.

Enbridge, which was one of the first to raise the idea of shipping oil sands crude over the Rockies, has since been joined by Kinder Morgan Canada, (KMP-N72.700.821.14%) with a competing pipeline alternative into Vancouver, and both CN and Canadian Pacific Railway Ltd., (CP-T66.830.120.18%) which confirmed Monday it is working on a similar proposal.

“It’s kind of a competitive situation now,” Mr. Perry said in an interview Monday.

The CN idea is the latest oil transport proposal to attract attention.

“We believe this has a real potential,” Saskatchewan Energy and Resources Minister Bill Boyd told The Wall Street Journal after meeting with CN officials Sunday in China.

He cautioned, however, that the railroad’s discussions remain at “a very early stage.”

Building a West Coast outlet has proven to be a major challenge for Canada’s oil industry. Enbridge has spent more than a decade pursuing the $5.5-billion Gateway project, which would add 525,000 barrels-a-day of capacity and create a major reconfiguration of Canadian crude flows. Though it has won a $100-million initial investment from a coalition of Asian and Canadian interests, including Chinese state oil firm Sinopec, it has encountered pitched opposition among B.C. native communities and environmental groups, and remains years from construction.

CN’s pipeline alternative offers a potentially simpler option that could be placed into service using existing infrastructure. Proponents of the rail alternative say it can compete on both timeline – crude moves more than five times faster on tracks than in a pipe – and price. Take West Coast exports, for example. For bitumen to flow to Kitimat, B.C., as Enbridge has proposed, it must be thinned with a product called condensate, in a ratio that includes only 70 per cent bitumen. That condensate must then be brought back to Fort McMurray, doubling the transportation costs.

Rail cars, by contrast, can ship pure bitumen. And rather than the $5.5-billion price tag for Gateway, rail cars with enough capacity to move 55,000 barrels per day – a reasonable initial flow – would cost $100-million, Altex’s Mr. Perry.

That makes rail a more cost-effective way to stir up better prices for Canadian crude, he argued.

“What you’re doing is buying an option on an alternative market,” he said. “The cost of the option with the pipeline is [close to] $6-billion. The cost of the option with rail is [close to] zero. Would you rather spend $6-billion or zero?”

CN would also have to build a West Coast terminal for roughly $200-million to $500-million – a cost that CN, which declined comment, is not likely to commit to until it has solid shipper support, which may not materialize for years.

But shipping by rail is not just an idea: several oil sands companies have already tested the service by sending crude in CN cars to the Gulf Coast. Rail can provide a good alternative when, for example, pipeline outages make it difficult to find enough available space to transport oil, or lower the price of what is shipped.

“It’s a way of getting around current problems,” said Cameron Todd, senior vice-president of operations, refining and marketing with Connacher Oil and Gas Ltd., an early supporter of the CN idea that has shipped bitumen to the southern U.S. by rail.

Yet the idea is limited by the difficulty in getting crude in and out of rail cars, and the fact that some refineries are set up to only receive product by pipe.

“There are some logistical challenges to doing it, and it costs a lot of money to pay for the cost of railing it down,” Mr. Todd said. “I’m not bullish on this. But I think it’s a reasonable alternative.”

Even Mr. Perry acknowledges that West Coast exports – by rail or otherwise – are not likely imminent. For now, strong demand among Midwestern and Gulf Coast refiners has made the U.S. the best market for Canadian product.

“I don’t think right today the producers are desperately seeking an alternative,” he said. “What they’re seeking is an alternative that might kick in three, four, five years from now.”

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A PIPELINE ON RAILS

Benefits

Uses existing rail lines from Fort McMurray, Alta., to Prince Rupert, B.C., skirting opposition to Pacific crude exports via new pipeline(s).

Low capital costs. Each 550-barrel tanker car costs roughly $100,000; given a 10-day transit time from Fort McMurray to the West Coast, 55,000 barrels per day of capacity would cost $100-million for 1,000 rail cars, running in 100-car trains every day. CN would also need to build a terminal on the coast, at a cost of $200-million to $500-million.

Could be put in place quickly, and scaled up or down rapidly.

Rail, by CN’s calculation, is less greenhouse-gas intensive than pipelines.

Downsides

Rail is generally less efficient than pipe on large volumes.

Canadian oil patch is built around pipe. Shipping by rail would require creation of new facilities to on-load and off-load crude, creating potential logistical problems.

Pipelines generally have a better safety record than rail lines.

Is as vulnerable to a proposed tanker ship ban as a pipeline, since both would load onto ships.

Cheers; Scott