In this week’s MLP Investing Insider, I discussed my recent trip to the oil fields of the Bakken in North Dakota and eastern Montana. This area really epitomizes the shale boom in the U.S. When oil producers figured out how to unlock the tight oil and gas locked up in the Bakken’s shale formations, oil and gas production rose rapidly, with both increasing by more than an order of magnitude in under a decade.

The Bakken is primarily an oil-bearing formation; the gas that is produced is primarily a byproduct of oil production. Thus, the proportional impact on U.S. oil production was much greater than on U.S. gas production. The Bakken would ultimately contribute more than 10% of the country’s overall oil production.

Onsite at an oil production facility in the Montana Bakken

For MLP investors, this created a great opportunity because the region was not historically a major producer of oil and gas. So the infrastructure to move that oil and gas to market had to be built.

Because pipelines take years to construct, the early surge of production proved a boon to railroads. The rails already criss-crossed the area, and ramping up was simply a matter of adding the right kind of railcars and loading terminals. In fact, one of our big successes in The Energy Strategist portfolios was recommending shares of railcar maker American Railcar Industries (NASDAQ: ARII), and subsequently encouraging subscribers to take profits after a 40% gain in 11 months.  

Rail expanded rapidly to accommodate this surge of crude oil, adding over 700,000 bpd of capacity in less than three years. (Of course natural gas isn’t suitable for shipping in a railcar, so much of the associated gas production was flared.)

Source: North Dakota Pipeline Authority

But the sharp growth rates in oil-by-rail suddenly stalled in early 2013, even before the rail disaster in Lac-Mégantic, Quebec reminded everyone that rail isn’t the safest way to move oil around. It also isn’t the cheapest way to move oil, so as pipeline capacity was built out it began to pull business away from the railroads. In 2013 and 2014 the region’s crude shipping capacity expanded dramatically as major projects from Bridger Pipeline LLC (which owns the Butte Pipeline), Enbridge (NYSE, TSE: ENB) and Plains All American Pipeline (NYSE: PAA) came online. These companies are among the dominant players today in moving North Dakota’s oil around and out of the region:

Source: North Dakota Pipeline Authority

Note that TransCanada’s (NYSE, TSE: TRP) Keystone Pipeline runs through eastern North Dakota. This is outside the core Bakken, but if the Keystone XL Pipeline is ever approved (which I deem doubtful at this point) the plan would be to connect pipeline capacity from the Bakken to the Keystone.

Major pipeline projects are either being planned or built by Enbridge (the 225,000 bpd Sandpiper Pipeline), Energy Transfer Partners (NYSE: ETP) (the 450,000 bpd Dakota Access Pipeline), and TransCanada (100,000 bpd from the Keystone XL Pipeline and 220,000 bpd from the Upland Pipeline).

Despite the challenges, rail loading terminals continue to be built. Currently, major rail loading facilities are owned by EOG (NYSE: EOG), Hess (NYSE: HES), Enbridge, Phillips 66 Partners (NYSE: PSXP) and Plains All American. The PSXP facility was just completed last year. It has an initial capacity of 100,000 barrels per day, with the flexibility to be expanded to 200,000 barrels per day. However, the buildout of rail loading terminals is forecast to slow dramatically relative to the projected additions of pipeline capacity.

As I mentioned previously, the reason I was in the Bakken was to work on the problem of natural gas flaring. This problem is being addressed along multiple fronts, one of which is a buildout of natural gas pipelines, natural gas processing plants, and natural gas liquids (NGL) pipelines.

Source: North Dakota Pipeline Authority

The natural gas infrastructure is dominated by an entirely different set of companies than those that control the oil infrastructure. ONEOK (NYSE: OKE) is the dominant player among natural gas processors, with nearly 50% of the natural gas processing capacity in North Dakota. There are a number of natural gas pipeline operators in addition to ONEOK, including Hess and Whiting (NYSE: WLL). These companies also all own natural gas processing facilities, as do Kinder Morgan (NYSE: KMI) and Targa Resources Partners (NYSE: NGLS).

In addition to the oil and gas pipelines, North Dakota does have two refineries. Tesoro’s (NYSE: TSO) Mandan refinery began operations in 1954, and currently has a capacity of 71,000 bpd. It ships its output via a fuel pipeline owned by NuStar Energy (NYSE: NS). The second refinery, Dakota Prairie Refining, is the first new one to be built in the U.S. in over 30 years. This refinery is jointly owned and operated by WBI Energy, part of MDU Resources Group (NYSE: MDU), and Calumet Specialty Products Partners (NASDAQ: CLMT).

Although the Bakken remains a key oil-producing shale basin, it has suffered more from plunging oil prices than the Permian and the Eagle Ford over the last year. Those Texas basins are much closer to the Gulf Coast’s many large refineries, and as a consequence enjoy lower shipping costs, along with the advantages of operating in a traditional oil-producing region with lower costs and plenty of legacy infrastructure.

The Bakken wells also tend to offer lower return profiles than the shale ones in Texas, another factor that’s weighed on capital spending in the region. Just this week, Occidental Petroleum (NYSE: OXY) became the first major driller to exit the Bakken, selling its leases on 300,000 acres to a private equity fund for $500 million, down from Wall Street estimates of as much as $3 billion a year ago, according to Reuters. A senior Occidental executive recently told analysts the Bakken acreage, which sits outside the play’s core, could never match the return profile of Occidental’s turf in the Permian, Reuters reported.

The leading operators still drilling in the Bakken, notably Whiting and Continental Resources (NYSE: CLR), are also much more leveraged than Permian pacesetters EOG and Pioneer Natural Resources (NYSE: PXD), and as a result have less financial flexibility to outspend dwindling cash flow.

So far that hasn’t stopped key midstream players from adding exposure to the basin. Kinder Morgan likely overpaid last January when it spend $3 billion on the Hiland Partners crude and gas pipeline network privately owned by Continental chief Harold Hamm. Energy Transfer has said it has sufficient commitments to proceed with its huge pipeline, though it remains to be seen how these hold up as crude output begins to decline as a result of the clampdown on spending.

Until oil prices move meaningfully higher, we prefer midstream infrastructure projects in the Permian and the Eagle Ford and to avoid companies like Oneok over-exposed to output trends in the Bakken.

According to the U.S. Energy Information Administration, production in the basin has now declined for four straight months. November’s projected production volume based on the number of working rigs, their productivity and the decline rate of legacy wells is expected by the EIA to be down 9% from last December’s record.    

North Dakota is still pumping more than 1.1 million bpd of crude that’s reaching distant markets at a lower transit cost than in the past. But the number of working drilling rigs in the Williston Basin is down 66% from a year ago, and while the consequences are only starting to be felt, things are likely to get worse before they get better.