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November 2011



Norfolk Southern Railway Article
Marcellus Shale gas exploration, ethanol production net new-business growth for Norfolk Southern



Norfolk Southern Railway

By Julie Sneider, Assistant Editor

From Jim Schaaf’s perspective, few opportunities hold as much potential for new-business growth than natural gas exploration in the Marcellus Shale.

As group vice president of metals and construction for Norfolk Southern Railway, Schaaf is in a position to know. His group is responsible for moving carloads of sand, cement, pipe and other materials that NS’ customers need for drilling operations in the geological formation, which stretches deep underground from Ohio to West Virginia, across most of Pennsylvania and into southern New York.

Geologists have known for a long time about the vast amount of natural gas trapped under the Marcellus Shale, so why the excitement about it now? Recent technological advancements in horizontal drilling and hydraudlic fracturing have enabled drilling companies to break through the shale to reach the natural gas reserves. As part of the fracturing process, water, sand and chemicals are pumped into the well bores under pressure to crack the rock and release the gas deposits. Hauling those materials to drill sites is where NS and a number of its short-line partners enter the picture, says Schaaf.

Much of the current drilling in the shale area is in NS territory, and most of what the Class I and its short-line partners are hauling is the so-called “frac sand” used in the fracturing process. But NS executives believe there will be an increasing potential to haul more sand and other materials as the drilling expands across Pennsylvania and into other states.

Since the Marcellus Shale gas exploration took off in 2008, shale-related traffic growth for NS has been “unprecedented,” says Schaaf, adding: “The last market that we’ve seen this explosive on the carload side of things was probably ethanol.”

Both ethanol production and Marcellus gas exploration have been among NS’ fastest-growing traffic opportunities — ethanol over the past decade and the shale-related activity just since 2008 — as a result of U.S. efforts to develop new or alternative sources of domestic energy, NS execs say.

They believe the U.S. appetite for developing domestic sources will intensify — both for clean environment (natural gas is a cleaner source of energy than petroleum) and national security reasons. And that desire for cleaner-burning fuels and energy independence from foreign oil will continue to feed the shale and ethanol opportunities.

Particularly the Marcellus Shale related moves. For NS, they’ve grown from 6,000 carloads in 2009 to 24,000 in 2010 — an “absolutely startling” 300 percent increase, says NS Chairman, President and Chief Executive Officer Wick Moorman.

“And by August of this year, we already exceeded 2010 by 3,000 carloads,” he adds. “So, we’re really seeing explosive growth up there [in Pennsylvania]. And there is still a lot of shale that is untapped.”

Moreover, the long-term potential for what amounts to a brand-new line of business also is promising. Scientists estimate there are enough shale deposits in the Marcellus to produce natural gas reserves that could support at least 30 years of gas extraction activity, as NS reported in its BizNS magazine in October 2010.

“The Marcellus Shale is the second-largest natural gas formation in the world,” Schaaf says. “The potential [for new business] for us is very bright.”

With assistance from short lines, NS has hauled sand and other materials to well-drilling sites across northern West Virginia, as well as northeastern, central and southwestern Pennsylvania.

But for now, most of the drilling is occurring in the Keystone State, which has been the most “progressive” among the Marcellus Shale states when it comes to issuing well-drilling permits, says Rob Robinson, NS assistant vice president for commercial development and the railroad’s short-line marketing manager. In 2010, 3,300 permits were issued in Pennsylvania and 1,400 wells were drilled; as of July 2011, 2,000 more permits had been issued and another 1,000 wells had been drilled, he says.

About 85 percent of the Marcellus Shale carload volume that NS moves is frac sand, with each drilled well requiring about 20 to 30 carloads of the material, says Schaaf.

“We are north of 3 million tons annually and growing in terms of the frac sand” that NS transports to Marcellus Shale drilling sites from the Midwest — primarily Illinois and Wisconsin, where it is mined, he says.

The list of NS’ larger customers involved in the shale’s gas exploration business is “exhaustive,” according to Schaaf, but includes companies such as Schlumberger Technologies Corp., Unimin Corp., Fairmount Minerals, D&I Silica, U.S. Silica Co., Halliburton, Weatherford International, Frac Tech International, and Preferred Sands.

In Pennsylvania, much of the drilling is occurring in the northeastern counties of Tioga, Bradford and Susquehanna. Once the state started issuing permits in 2008, the need to haul materials to exploration sites fell right into “the heart of NS territory,” requiring the Class I to ramp up operations in a hurry to meet the demand for sand, says Schaaf.

“What it really took was us starting to work with manufacturers on the sand side of things, and setting up unloading facilities and distribution operations at the various destinations,” he says. “Where the sand needs to go is not necessarily rail-served: These are remote locations where the sites and drills are. What needed to occur was the establishment of laydown operations, where we could bring the product to or bring product from those locations.”

Since 2008, NS has established connections at 57 terminals in the Marcellus Shale region that the Class I can reach directly or through one of its short-line railroad partners, Schaaf says.

Coordination and contact with the short lines occurs daily. In Pennsylvania alone, 18 short lines are working with NS on Marcellus Shale business, including Lycoming Valley Railroad; Lehigh Railway; Wellsboro & Corning Railroad; Reading, Blue Mountain and Northern Railroad; Owego Harford Railway; Southwest Pennsylvania Railroad; and the Buffalo & Pittsburgh Railroad, says Robinson.

Meeting customers’ needs

Although sand is the primary commodity NS is transporting to drill sites, the Class I also is hauling water, pipe, drill rig parts, crane mats, chemicals, cement and rocks. In addition, NS and the short lines are hauling drilling-process waste and debris from the drill sites. Whatever customers need to do their work, NS and its short-line partners are ready to handle it, NS officials say.

“We try to be like Walmart,” says Robinson. “We try to get out ahead of where the gas companies are going to be, and when we hear they’re ready to begin drilling and need materials, we’ve got the site prepared and ready to go. And that’s really been the success of NS so far, and why we have been able to grow this [operation] so quickly.”

Keeping up with that growth has required NS to invest in infrastructure and equipment.

For example, the Class I refurbished and modified about 1,000 covered hopper cars to transport frac sand; upgraded track to accommodate heavier traffic; and increased locomotive power in some territories.

The railroad also has been recruiting workers. In Pennsylvania, NS hired 114 conductors and 87 mechanical employees as of early October, and was seeking to fill 91 conductor positions and 48 mechanical positions, with more of the latter likely to open soon, according to NS spokesman Robin Chapman.

Meanwhile, the pace of shale- related business isn’t expected to slow down any time soon. NS officials point out that drilling is getting under way in West Virginia, and Marcellus Shale gas exploration hasn’t even begun yet in the state of New York, which has a moratorium on drilling until environmental concerns are addressed and regulatory issues are hammered out. But when that time comes, NS will be ready.

“The good thing from the Norfolk Southern perspective is that we, with our short-line partners, have a very expansive footprint in all of Pennsylvania and much of New York, so we expect to see a lot of drilling activity for it,” says Moorman.

Plus, it’s not just the Marcellus Shale NS officials have their collective eye on: There’s also the Utica Shale, a slay play that sits a few thousand feet below the Marcellus and stretches across eastern Ohio, Pennsylvania, most of West Virginia and a large part of New York. Some scientists believe the Utica has the potential to become an even bigger source of energy (natural gas and oil) than the Marcellus, “but that has yet to be determined,” says Schaaf.

Not yet at ethanol’s pace

While NS executives’ enthusiasm over the Marcellus Shale gas exploration is understandable, shale-related moves have a way to go before they match ethanol production-related moves, says Toby Kolstad, president of Rail Theory Forecasts L.L.C.

As annual ethanol production zoomed from 2 billion gallons to 13 billion gallons during the past decade, the railroad industry responded by building 35,000 rail cars to handle the growth, he says.

“Now, in the last 12 months or so, close to 18,000 covered hoppers have been scheduled for hauling the industrial sand used for hydrofracking, which is maybe half of where ethanol was,” says Kolstad.

But the increase in U.S. natural gas production since July 2008 is indeed astounding, Kolstad acknowledges, noting that most of the increase is coming out of Pennsylvania.

“The average natural gas production in the U.S., as late as July 2008, was only 1.4 billion cubic feet per day,” he says. “And In July 2011, it was 4.5 billion cubic feet per day.”

With that amount of production growth, Kolstad and other forecasters are asking whether more rail cars are needed to handle the Marcellus Shale business growth.

“Some people think we need another 10,000 sand cars, which would get the total number up to about 30,000 — which would get us in the same traffic area as we were” when the industry ramped up for ethanol production, Kolstad says.

Moving billions of gallons

Of the 13 billion to 14 billion gallons of ethanol currently produced annually in the United States today, NS moves about 2 billion gallons of it on its network, says John Kraemer, NS group vice president-agriculture, fertilizer and consumer products. Even though the growth rate in U.S. ethanol consumption and production at the current blend level of 10 percent has leveled off, NS executives believe there still is room for growth in the Class I’s ethanol business.

“There are new facilities still being constructed for ethanol distribution as well as ethanol production,” says Moorman. “So, we have a very targeted effort to put those facilities on line. We have about 22 [production facilities] right now. We handle about 16 percent of U.S. ethanol production, and we tend to think there is still more opportunity for increased production out there.”

The number of NS’ ethanol carloads rose 124 percent between 2000 and 2005, and soared 226 percent between 2005 and 2010, according to information NS executives shared at an investor event in June.

Going forward, the ethanol growth rate may not be as high as it’s been the past few years, “but in terms of our capability to deliver the product to the right distribution center to make the most efficient supply chain, we think there is ample opportunity there,” Moorman says.

To tap into that opportunity, the railroad is targeting the entire ethanol supply chain.

“What we’ve done to try to grow our ethanol business is to develop a strategic partnership with the entire blend of [ethanol] producers, refiners, distributors, marketers and terminal companies,” says Kraemer.

In addition to 22 ethanol production facilities, NS serves 73 distribution terminals on its lines. By next year, Kraemer anticipates the terminal count could increase by as many as six.

“And we’re also constantly looking for opportunities to expand our existing facilities from single-car facilities to unit-train destinations,” adds Kraemer.

There’s also the possibility that the 10 percent blend of ethanol in gasoline — as established under the U.S. Energy Act of 2005 — could be increased to 12 percent or 15 percent in the future, which would boost production. In addition, European countries are looking to reduce their use of fossil fuels, which increases the potential for ethanol exports — and potentially more business for NS.

“All of our shippers, all the customers that produce ethanol as well as those that are users are constantly looking for better supply chain solutions,” says Kraemer. “So that represents a significant opportunity for all of us.”

And as long as U.S. policymakers see a need for a more comprehensive renewable fuel strategy, NS officials will position the railroad to support that strategy, Kraemer says.

In Moorman’s view, the country has no choice but to pursue alternate sources of energy in all forms. But for NS truly to benefit from that alternate energy sourcing, the country needs a sound energy policy that relies on all forms of energy — including ethanol and natural gas from the Marcellus Shale, he says.

Moorman is optimistic U.S. political leaders eventually will sanction such a policy because doing so would benefit the nation’s economy, environment and national security.

“I’m optimistic that, regardless of the outcome of the 2012 elections, we’ll have good energy policies, by which I mean that all energy sources are considered in a rational way and regulated in a rational way,” he says. “We need to have them all, and we need to aggressively promote the use of all of them.”



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