Special Report: Will Natural Gas Fuel BNSF’s Future?

(BRK.A), (BRK.B)

The diesel locomotive is one of the most efficient transporters of freight, with decided cost advantages over moving similar goods by truck. According to CSX, moving goods by train is three times more fuel efficient than truck transport, and the Association of American Railroads (AAR) estimates that freight railroads move a ton of freight an average of 476 miles on just one gallon of fuel. Still, despite this advantage, BNSF and other long-haul freight railroads are looking for even greater efficiency and cost savings with the development of locomotives that run not on diesel but on liquefied natural gas.

A Game Changer

The switch to liquefied natural gas would be the biggest change since railroads shifted from steam-powered locomotives to diesel-powered back in the 1950s.

According to the U.S. Department of Transportation, Class 1 railroads, which include BNSF, used a combined 3.6 billion gallons of diesel fuel in 2012. In total the seven Class 1 railroads accounted for 7% of all diesel consumed in the U.S. during 2012.

Of those railroads, Berkshire Hathaway’s BNSF was the single largest consumer, using 1,335,417,552 gallons of diesel at a cost of $4,273,779,000. This almost $4.3 billion in fuel cost was one of BNSF’s primary expenses, representing 29% of BNSF’s total operating expense.

Here Comes Natural Gas

Using liquefied natural gas to power locomotives is hardly a new concept. Burlington Northern tested it in the 1980s, and Union Pacific looked at it again in the 1990s. The difference today is the tremendous domestic natural gas boom that has driven down natural gas prices even as oil prices have neared all-time highs.

In addition, pollution and global warming concerns make liquefied natural gas all the more attractive. Natural gas is the cleanest burning of all fossil fuels, and would not only help railroads meet the EPA’s Tier 4 air emission regulatory standards, but would also significantly reduce CO2 emissions.

Burning natural gas creates far lower amounts of sulfur dioxide and nitrous oxides than burning diesel fuel, and natural gas produces only 117 pounds of CO2 emitted per million BTUs of energy, as compared to a far heftier 161.3 pounds of CO2 for diesel.

Potential for Enormous Savings

While the environmental benefits are compelling, it is the cost savings that has railroads most excited. Natural gas production is booming and prices have dropped to roughly one-third of their 2005 price levels. Goldman Sachs estimates that for the next two decades natural gas will trade in the range of $4 to $5 per million BTUs, down from over $15 in 2005.

In 2012, energy equivalent pricing of Brent Crude oil, which is the global price benchmark for Atlantic basin crude oil, was roughly seven times the Henry Hub natural gas spot price, which is the pricing point for natural gas futures on the New York Mercantile Exchange. And the U.S. Energy Information Administration (EIA) is currently projecting that a substantial gap will continue to exist between oil and natural gas prices through year 2040 and perhaps beyond.

This isn’t about pennies, it’s about dollars. Lots of dollars. At current price levels, BNSF could save as much as $3 billion per year.

Fuel Supply Security

Liquefied natural gas also gives railroads and the U.S. fuel supply security, as it is a purely domestic product unaffected by Middle-East conflict. Currently, two-thirds of diesel fuel is imported. And, while Middle-East oil supplies dwindle, domestic natural gas production is growing.

For example, the 104,000 square-mile Marcellus field, which includes Pennsylvania, West Virginia and southeast Ohio, has seen its output grow by a whopping 10-times in just the past five years.

Cost of Conversion

Diesel locomotives cost roughly $2 million each and the cost of converting a locomotive to liquefied natural gas is approximately an additional $1 million. This cost may drop if liquefied natural gas becomes the standard rather than the exception, but even at current costs the average 20-year lifespan of a locomotive means substantial operating cost savings. BNSF has 6,700 locomotives, so some of Berkshire’s tens of billions in cash could be invested in-house to produce a mountain of cash over the next century.

Additional Hurdles

Besides conversion costs, the two other big hurdles are government regulations and upgrades to fuel delivery infrastructure.

The government has been moving slowly. The Federal Railroad Administration (FRA) is still developing the regulations for liquefied natural gas locomotives, with a particular focus on tender-car safety.

The other hurdle is the need for a new fuel delivery infrastructure to provide liquefied natural gas to train depots.

Neither of these hurdles looks to be prohibitive, as important environmental benefits provide the incentive to craft workable regulations, and railroads previously converted their infrastructures from handling coal to diesel fuel without much problem.

The big question is whether natural gas powered locomotives can really do the work of a diesel locomotive under all conditions. BNSF is working hard to find out. Four natural gas powered locomotives are being tested in high-stress environments, including the California dessert and the cold weather of the northern tier.

Summary

Despite higher initial capital costs, the long-term operating cost savings and environmental benefits of liquefied natural gas locomotives make them the likely kings of the rails well into the next century. BNSF should reap billions in cost saving over that period, which would make Berkshire Hathaway and its shareholders very happy.

(This article has been updated with new information.)

© 2014 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.