Canadian Pacific acquiring Kansas City Southern in $25 billion rail deal

Houston — Canadian Pacific Railway is scooping up Kansas City Southern in a $25 billion deal that would create more seamless transportation of Canadian crude to the US Gulf Coast and of refined products from the USGC into Mexico.

The stock-and-cash deal would create the merged, Calgary-based "Canadian Pacific Kansas City" that is touted as the first rail network connecting the US, Mexico and Canada. While the merged railroad would still represent the smallest of the six US Class 1 railroads by revenue, the integrated company would count 20,000 miles of rail network stretching from the Alberta oil sands down past central Mexico.

Canadian Pacific CEO Keith Creel said the deal would "level the playing field," especially since neither of the rail firms overlap their services at all. The idea is for them to "join seamlessly" in Kansas City, Missouri.

The Kansas City Southern network stretches from Illinois and Missouri down to the Texas Gulf Coast and past central Mexico. The Canadian Pacific map goes from Vancouver to New York, including dipping down into Missouri. So the argument is they make a natural pairing without any crossover or duplication.

"The new competition we will inject into the North American transportation market cannot happen soon enough, as the new USMCA Trade Agreement among these three countries makes the efficient integration of the continent's supply chains more important than ever before," Creel said in a March 21 conference call.

The integration is not expected to occur until mid-2022 following approval from the US Surface Transportation Board.

The merger is expected to improve the transportation of everything from petroleum to grain to auto parts, said Kansas City Southern CEO Patrick Ottensmeyer. "This opportunity will connect Canadian Pacific's powerful origination network with Kansas City Southern's powerful destination network to create increased options for our customers and shippers," he added.

Crude and fuel views

In recent years, Canadian Pacific has focused on improving oil sands crude transportation into the US, while a key source of Kansas City Southern's growth was its increased movements of refined products into Mexico.

"For the last several years, many of you know, refined products have been a large driver of our growth in cross-border traffic, and that represents gasoline, diesel, other refined petroleum products moving from US Gulf Coast refineries down into Mexico, and we see continued extraordinary growth in that business for years to come," Ottensmeyer said.

And Canadian Pacific is really banking on that improved energy diversification.

"As you think about the energy, chemical, plastics and merchandise side of our business, with the strong franchise that KCS has on their side, this carload type of business will really help diversify our book which, as we've talked about in the past, is bulk heavy," said CP Executive Vice President John Brooks.

Mexico relies on imports to meet its demand of refined products. Most of those imports are transported by rail, although that is likely to change in 2022 when Valero completes its 6 million barrel refined products storage network in the country.

Kansas City Southern cross border business reported revenues of roughly $900 million in 2020, which has shown annual increases of 10% since 2009, according to the company. Refined products revenues in 2020 were $190.8 million, a 47% year-on-year increase.

In one project that both railways were working on even before the merger deal, the US Development Group is nearing a mid-year completion of its rail terminal network to move heavy Canadian crude from Alberta to the Texas Gulf Coast along the Canadian Pacific and Kansas City Southern networks. The project is designed to move Canadian crude specifically for long-haul rail transport.

The USD Group-Gibson Energy joint venture includes building a diluent recovery unit at its Hardisty terminal hub and a new Port Arthur terminal in Texas that would receive the oil sands crude by rail. The diluent recovery unit removes the diluent from the Canadian bitumen. The resulting crude is called DRUbit, a proprietary heavy Canadian crude oil specifically designed for safer rail transport.

Canadian oil production has recovered from its pre-pandemic volumes of about 5 million b/d of crude oil, condensate and diluent, while US production is still down by at least 2 million b/d from its pre-COVID-19 volumes.

Imports of Canadian crude to the US Midwest and USGC combined were expected to recover to around 2.9 million b/d in March from less than 2.6 million b/d in May 2020, according to S&P Global Platts Analytics.

However, crude-by-rail volumes are not yet recovered and may take quite some time.

Canadian crude-by-rail exports plunged from an all-time high of 411,991 b/d in February 2020 to an eight-year low of 38,867 b/d in July as the pandemic took hold. Exports have since rebounded to 190,454 b/d in December, according to the Canada Energy Regulator.

But, since December, the price spread between Western Canadian Select at Hardisty, Alberta, and the USGC has narrowed to levels that make most spot rail shipments uneconomical. Shipping crude by rail from Hardisty to the USGC can cost anywhere between $12/b and $18/b, traders say.

The crude-by-rail networks are buoyed by pipeline shortages, including US President Joe Biden's de facto cancellation of the Keystone XL Pipeline project, and the potential closure this year of the Dakota Access Pipeline.

However, by the end of 2021, new Canadian crude pipeline capacity is still expected to come online through Enbridge's Line 3 Replacement project, which is currently under construction in Minnesota, and through optimization expansion efforts in TC Energy's base Keystone system.