How to Profit From the Re-Emergence of Canada’s Crude-by-Rail Strategy

With Canada’s heavy oil trading at large discounts again, crude-by-rail activity is starting to heat up in 2018. Will it be a second coming for shares in Canadian National Railway (TSX:CNR)(NYSE:CNI)?

railroad

The price of Canadian heavy oil has become heavily discounted to U.S. benchmarks since the end of last year.

While that may not be welcome news for oil sands producers such as Cenovus Energy Inc. (TSX: CVE)(NYSE: CVE) and Baytex Energy Corp. (TSX: BTE)(NYSE: BTE), what it has done is make transporting crude oil by rail a viable option again.

That is very good news for Canada’s two rail companies, Canadian National Railway (TSX: CNR)(NYSE: CNI) and Canadian Pacific Railway (TSX: CP)(NYSE: CP).

Understanding what makes a crude-by-rail strategy work

The U.S. energy market happens to be a lot bigger than Canada’s, partly because of the number of people and also because the economy there is a lot larger than Canada’s.

On top of all that, there are more refineries in the U.S. than there are in Canada.

Refineries are an essential part of the energy market, as it’s the refineries that ultimately convert crude oil into consumable products, like gasoline, diesel fuel, and certain chemical products.

All this means that a large percentage of Canada’s energy output needs to make it into the U.S. in some way or another.

The cheapest way to accomplish this is by transporting crude liquids via pipelines — like the ones owned by companies like TransCanada Corporation (TSX: TRP)(NYSE: TRP), Pembina Pipeline Corp. (TSX: PPL)(NYSE: PBA), and Enbridge Inc. (TSX: ENB)(NYSE: ENB).

Because pipelines are the cheapest mode of transportation, they are the first choice for producers.

But right now, there is so much excess oil being pumped out of Canada’s oil sands that the pipelines simply don’t have the capacity to handle it all.

It’s times like these that when the crude-by-rail strategy becomes a viable option.

Reports suggest that when the discount to Canada’s heavy oil, as measured by the Western Canadian Select (WCS) benchmark, exceeds $15-20 per barrel versus the U.S. benchmark, West Texas Intermediate (WTI), it then becomes economical to ship by rail.

Today, that gap between WCS and WTI sits just shy of $29 per barrel, so it’s easy to envision a scenario where Canada’s producers may be shipping product through Canada’s two railways for some time.

Canada’s pipelines are already at capacity

There are several projects underway right now that could help address the capacity issue, but none of them are expected to come online in time to deal with the problem in 2018.

Kinder Morgan Canada Ltd. (TSX:KML) is planning its $7.4 billion Trans Mountain expansion, but that project isn’t expected to be completed until 2019.

TransCanada has big plans for its Keystone XL project, and Enbridge is planning its biggest expansion project ever with the Line 3 replacement plan, but both of those still need to get past regulators.

Meanwhile, on its fourth-quarter conference call, Enbridge CEO Al Monaco said that even after its Line 3 project is completed, the company expects its pipelines to be at full capacity through 2020.

Bottom line

The railway industry has been on a “roll” for the past decade, raking in records sales and profits and handsomely rewarding shareholders along the way.

So, it’s not as though they even needed a boost, but 2018 may be as good a time as any to add to your holdings in rail companies.

Fool contributor Jason Phillips owns shares in Cenovus Energy Inc. David Gardner owns shares of Canadian National Railway. The Motley Fool owns shares of Canadian National Railway, Enbridge, and Kinder Morgan. Canadian National Railway and Enbridge are recommendations of Stock Advisor Canada. Pembina is a recommendation of Dividend Investor Canada.

More on Dividend Stocks

jar with coins and plant
Dividend Stocks

Dividend Stocks or Annuities for Retirement Income?

Here's how Canadian dividend stocks and annuities compare as retirement income sources

Read more »

Investor wonders if it's safe to buy stocks now
Dividend Stocks

Is TELUS a Good Stock to Buy After Finally Cutting its Dividend?

TELUS cut its dividend 55%, but still offers you a tasty dividend yield of 6.3%. Is the Canadian blue-chip stock…

Read more »

Real estate investment concept with person pointing on growth graph and coin stacking to get profit from property
Dividend Stocks

Mortgage Rates Are Rising: The Bank of Canada Hasn’t Moved

Fixed mortgage rates can rise without a central-bank move, adding real monthly costs while also testing lenders' funding and credit…

Read more »

Blocks conceptualizing Canada's Tax Free Savings Account
Dividend Stocks

How I’d Structure My $14,000 TFSA for Constant Income

If you have $14,000 saved in your TFSA, here is one easy investment strategy to earn $50 of tax-free monthly…

Read more »

woman looks at iPhone
Dividend Stocks

I’m Not Selling Telus After the 55% Dividend Cut: Here’s Why

Contrary to what the market seems to be saying, Telus Corporation (TSX: T) still has a lot going for it.…

Read more »

monthly calendar with clock
Dividend Stocks

A No-Nonsense 3.7% Dividend Stock That Can Pay Retirees Monthly

This no-nonsense dividend stock has returned more than $3.4 billion to shareholders through dividends since 2013.

Read more »

dreaming of financial success
Dividend Stocks

3 Questions to Ask Before Buying a Dividend Stock

Buying a dividend stock? Here are three questions to help you look beyond the yield, with examples from Enbridge, Fortis…

Read more »

Woman in private jet airplane
Dividend Stocks

Make $100 a Month Tax-Free: How Much to Invest in Diversified Royalty and Where

The TFSA is the ultimate investment account to place your money and earn tax-free income.

Read more »