One analyst’s take on LNG caught my eye, and I thought I’d share it with a wider audience. In “Locomotives: The Next Big Source of Demand for Natural Gas?” analyst Arjun Sreekumar opines that the industry may be poised to adopt LNG in a big way. Following is his assessment:
“The massive supply of natural gas that has resulted from new drilling technologies applied to U.S. shale fields over the past few years has been a boon not only to consumers who use gas for heating their homes, but also to a variety of companies, including chemical, steel, and fertilizer manufacturers, for whom energy costs are substantial.
“The U.S. has been inundated with so much cheap natural gas, in fact, that trucking companies are increasingly switching over to gas-powered engines for their fleets, while auto manufacturers are offering hybrid vehicles that have the ability to burn both compressed natural gas and gasoline. And now, the next logical step of the natural gas-fueled transformation of the transport industry—natural-gas-powered locomotives—looks to be in its early stages.
“Since the 1950s, U.S. locomotives have been powered mainly by diesel. But with the combination of relatively low natural gas prices and the threat of more stringent emissions standards for locomotives slated to take effect in 2015, many of the nation's biggest rail companies are reconsidering their traditional fuel of choice. Berkshire Hathaway’s BNSF, Union Pacific, and Norfolk Southern are all carefully assessing the benefits of converting their [locomotives] to run on natural gas. General Electric and Caterpillar [Progress Rail Services/EMD], the biggest manufacturers of locomotives in the world, are all too eager to take part.
“If the transition gains momentum, it could mark the most radical change in the industry since the 1950s, when diesel replaced steam as the fuel of choice. (Editor’s note: That transition, lengthened by World War II, actually began around 1930 and took about 30 years.) BNSF plans on beginning tests in the third quarter, using units from both GE and Caterpillar, to help it decide whether to convert its fleet to [locomotives] that use a mix of natural gas and diesel. The company’s CEO, Matt Rose, said the company will make a decision next year on converting its entire fleet— a process that could take several years.
“The biggest benefits of converting locomotives to run on LNG instead of diesel are major cost savings and the reduction of greenhouse-gas emissions. Excluding wage costs, fuel costs are the single- largest expense for American railroad companies, whose locomotives burn staggering amounts of diesel each year. Union Pacific, for instance, spent roughly $3.5 billion on fuel last year, with its vast network of trains using up around 1.1 billion gallons of fuel at an average price of $3.22 a gallon. And BNSF reckons that, after the U.S. Navy, it’s the second largest consumer of diesel in the nation.
“Compare that with the cost of liquefied natural gas. Truckers can buy LNG that has the same energy content as a gallon of diesel for around $3 at Clean Energy Fuels’ Port of Long Beach LNG refueling station. And that’s not including volume discounts, which can reduce the total price for LNG by as much as 30%, according to Gary Foster, a spokesman for the Seal Beach, Calif.-based company.
“This price disparity has been enough to convince rail companies, many of which have already calculated the size of the savings a switch to natural gas would generate. Now all that’s left is working with locomotive makers like GE and Caterpillar to develop the engines necessary to take advantage of that price gap.
“Still, the technology that will be used to power [locomotives] running on a combination of LNG and diesel is still in its early developmental stage, according to Tom Lange, a spokesman for Union Pacific. The Omaha-based rail giant says it’s working closely not only with engine manufacturers, but also with cryogenic fuel-tank and LNG suppliers to help it reach a decision. But even if the engine technology can be developed and seamlessly integrated across locomotives, other challenges remain. Logistical constraints are one of the biggest. How will LNG be delivered to the vast network of locomotives these companies have? (Editor’s note: Not to mention run-through power and other operating scenarios that send locomotives into “foreign” territory. And what about the short lines?)
“That may provide an enticing opportunity for third-party suppliers. GE may already have a leg up. The company manufactures units that can liquefy natural gas at any point along a distribution network. It has already sold the equipment—called MicroLNG units—to Clean Energy Fuels to help develop a vast network of LNG fueling stations for trucks.
“Whether or not BNSF and others decide to make the switch to natural gas, natural gas will almost certainly be the fastest-growing transport fuel over the coming years. As the movement toward alternative energy gains momentum, Clean Energy Fuels, with its vast nationwide network of refueling stations, stands out as one of the biggest and potentially most lucrative opportunities. It’s a first mover that’s poised to make a big impact on an essential industry.”
Sounds like a plug for Clean Energy Fuels, doesn’t it? (Well, it is. That’s what analysts do). But investment recommendations aside, Sreekumar is essentially correct in his assessment of LNG’s potential.
His enthusiasm, though, needs a bit of a reality check. Railroads don’t adopt new technologies overnight. The transition to diesel-electric locomotives, air brakes, automatic couplers, and roller bearings took years. And how long has the industry been working on some form of advanced train control? Thirty years?
You could point to a.c.-traction locomotives as a change that took place rapidly after the Burlington Northern, in 1993, after several months of revenue-service testing and cost-benefit analysis, acquired 350 SD70MACs from EMD. But there’s a big difference between transitioning to a different type of traction motor and transitioning to a different type of fuel, with all the associated equipment and infrastructure costs. Diesel-electric locomotives, their fueling stations, and their repair and maintenance facilities represent a huge sunk investment. LNG will require its own enormous investment.
The bottom line is just that—the bottom line. Unless they are legislated to do so (think PTC and EPA emissions regulations), the railroads aren’t going to make any radical technological changes unless there is at least a reasonable return on investment. That’s just good business. A.c. traction was relatively easy—who could argue with three a.c. locomotives doing the work of what used to require five d.c. units?
It remains to be seen whether widespread deployment of LNG—beyond the specialized class-yard applications on captive switcher locomotives—makes good business sense.
Even Warren Buffett, who invests for long-term, stable growth (that’s why he bought BNSF), knows that.