3 October 2007
Canadian Pacific Bets on Energy
For years, Canadian Pacific Railway Ltd. has hauled its
traditional trainloads of potash, grain, and shipping containers.
But these days the Calgary, Alberta, railroad company is at the forefront of a multibillion-dollar industry investment
trend: North America's fast-growing energy plays, from Midwestern ethanol, to Wyoming coal, to Canada's oil sands.
Supplying tracks and trains to these far-flung places could fatten the bottom line at Canadian Pacific and at other
railroads as U.S. energy consumption grows. Still, the strategies of the companies face threats, ranging from
antiglobal-warming efforts to the high cost of tapping new sources of energy.
Canadian Pacific, the sixth-largest railroad in North America by revenue, laid out plans in May to put new tracks into
Alberta's oil-sands processing area, where vast reserves of a tar-like substance are tapped to make synthetic
crude. Last month, it said it will pay $1.48 billion to buy Dakota, Minnesota & Eastern Railroad Corp., a regional line based in
Sioux Falls, South Dakota, that ships grain to ethanol producers, then ships ethanol back to markets.
In the last 10 years, DM&E has secured U.S. government approvals to build tracks into the huge coal fields of Wyoming's Powder
River Basin. Canadian Pacific said it will undertake a comprehensive study in the next few years to determine whether to go ahead with
the project.
Other railroads have been doing much the same thing. Union Pacific Corp. and Burlington Northern Santa Fe Corp., the two largest North
American railroads by revenue, already serve the Powder River Basin and are boosting capacity to haul increasing amounts of coal from
it. BNSF, for example, spent US$626 million in 2006 for additional track, locomotives, and cars for carrying coal, double what it
invested in 2005.
The energy play has inherent risks. Squeezing energy from oil sands is complex, energy-intensive, messy, and expensive.
The boom in corn ethanol has depended on political support and government subsidies that may not be there in the future.
And coal-fired power plants are under attack by environmentalists who blame carbon emissions from burning coal for
contributing to global warming. Lately, some of the many coal-fired plants now on the drawing board have been canceled.
Some energy experts also question railroads' timing. "Certainly, they are investing at the top of the energy cycle, which would
expose them to significant risks in the event of a major downturn," says Alex Gorbansky, managing director of Frontier Strategy
Group, a Washington-based research firm.
A Canadian Pacific spokesman said the moves mark the railroad's effort to seek out opportunity in general, not a targeted move toward
energy. He said Fred Green, who took over as Canadian Pacific's chief executive in May 2006, was unwilling to comment until the
DM&E transaction closes, which could come as soon as this week. Canadian Pacific's plan to combine the railroads will then face
review by the U.S. Surface Transportation Board, a process that could take as long as a year.
Generally, the railroads say their energy investment strategies are conservative and keep long-term trends in mind. For
example, railroad officials say they are confident that coal's abundance and relatively low cost, compared with other energy sources
such as natural gas, will keep it in demand. New technologies may overcome some of coal's environmental drawbacks. And rising rail
rates for coal shipments are making it more feasible for railroads to boost capacity.
"Coal is going to play a major role in electric generation for years to come," said Jack Koraleski, executive vice president
of marketing and sales at Union Pacific, based in Omaha, Nebraska.
Major railroads will generate more than US$13.5 billion in revenue hauling coal in 2007, according to Donald Broughton, an analyst at
A.G. Edwards in St. Louis. Coal is 13% of total revenue of Canadian Pacific, compared with 19% at Burlington Northern Santa Fe and 20%
at Union Pacific. The two big Eastern U.S. railroads, CSX Corp., and Norfolk Southern Corp., receive about 26% of their revenue from
coal.
The biggest moves lately are coming from Canadian Pacific, where Mr. Green is trying to make his mark as an
expansion-minded leader. In addition to expanding in energy-related traffic, the company lately is building
new yards to handle containers and automobiles.
"Canadian Pacific has been the least aggressive of the major North American railroads, but this [DM&E] transaction changes
that," said Henry Posner III, chairman of Railroad Development Corp., a closely held railroad investment and management company in
Pittsburgh.
Canadian Pacific lately is showing strong financial performance fueled by growth in bulk commodities and shipping containers, said Tom
Wadewitz, an analyst at J.P. Morgan Chase & Co. Net income in 2006 rose 46% to 796.3 million dollars, or $5.02 a share, from $543
million, or $3.39 a share, in 2005. Revenue rose 4.4% to $4.58 billion.
The company's expansion plans include penetrating the oil-sands processing region northeast of Edmonton, Alberta. The area
is home to the majority of downstream upgrading and processing facilities for the oil sands. Canadian Pacific is already moving
construction materials such as pipe and steel to the area to build the facilities, which process bitumen from oil sands into various
fuels. as well as byproducts such as sulfur, some of which will eventually move by rail.
Acquiring the DM&E will give Canadian Pacific an expanded presence in ethanol. Kevin Schieffer, president and CEO of DM&E, said
ethanol shipments on the railroad have surged to more than 5,000 carloads last year from 500 carloads in 2003. "Ethanol is by far
and away our fastest-growing commodity right now," he said.
Building the line into the Powder River Basin faces big hurdles and would take years. Canadian Pacific will want to line up contract
commitments from the utility industry before going ahead, Mr. Schieffer said. The project could put Canadian Pacific on a collision
course with BNSF and Union Pacific, which now have a lock on coal shipments from the Basin and could oppose Canadian Pacific's entry.
BNSF and Union Pacific declined to comment.
Skeptics worry about the acquisition's price and the potential costs of upgrading the DM&E and then extending it 260 miles into the
Powder River Basin. About 100 miles of the DM&E in South Dakota is built on wet, shifting clay, for example, restricting trains to
10 miles an hour.
Some analysts think the cost of the Powder River Basin project could top $5 billion, including contingency payments to DM&E's
current owners, but Mr. Schieffer said it's too early to know. "There is everything from the Chevy to the Cadillac version,"
he said.
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