Stakeholders are all aboard the issue of safety in transporting crude by rail. Figuring out how to reach that destination is where their tracks diverge.

Is the tank car’s design the critical factor? Speed of the train? Volatility of the oil?

“The industry wants the same thing that the government regulators want, which is the same thing that the railroads want, the same thing that everybody wants: they want the safe transportation of crude oil by rail and pipelines,” Wendy Buckley, president and founder of Bensalem, Pa.-based Specialty Transportation and Regulatory Services, said during a recent webinar on developments in rail safety hosted by the King & Spalding law firm. "The problem is this is all new for us and we don't really know what the solution is. We've tried a few things that haven't worked out well, and I think everyone's kind of saying, what is the next step, how much further do we go on the tank cars or do we go a different route?"

Between 2009 and 2013, the number of carloads of crude oil increased from 10,800 to 400,000 per year. Most of the roughly 1 million barrels per day (bbl/d) of crude oil produced in the Bakken Shale play moves by rail, and it is Bakken crude that was being hauled by the former Montreal, Maine & Atlantic Railway when its train derailed and the cars exploded in 2013 in Lac-Mégantic, Quebec, killing 47. A first responder became the 48th victim when he committed suicide a few months later.

A final rule regulating safety of crude oil rail transport is expected from the Department of Transportation, Pipeline and Hazardous Materials Safety Administration (PHMSA) in early May. The rule is expected to echo a proposal already floated by Transport Canada, with the exception of brake safety.

“We want [the rule to be] risk-based,” said Mike Friedberg, staff director for the U.S. House subcommittee on railroads, pipelines and hazardous materials of the Committee on Transportation and Infrastructure, during the King & Spalding webinar.

Safety is a priority, he emphasized, but it is also important to not restrict commerce. Lower speed limits, for example, might be effective in a unit train carrying only crude oil or other hazardous materials. In a manifest train carrying a variety of goods, however, it would only slow the movement of products unnecessarily, creating “unintended consequences of a well-meaning rule.”

Meanwhile, PHMSA and the Federal Railroad Administration (FRA) issued an order in April requiring trains hauling crude to slow to 40 miles per hour or less in heavily populated areas. Also, the agencies said railroads must supply important information on shipments to first-responder agencies serving localities alongside train tracks.

FRA said it had determined a March derailment and fire on the BNSF Railway near Galena, Ill., was caused by a broken wheel that had not been detected by trackside monitoring equipment. It requested railroads use their most experienced car inspectors to check crude trains and to lower the bad-wheel reporting threshold for trackside monitors.

Tank car design

Converting an existing tank car to meet new standards is neither cheap nor easy. Transport Canada’s new standard, known as TC-117, would require a tank car used to transport flammable liquids to be jacketed, thermally protected, with thicker steel, full head shields, top fitting protection and a new bottom outlet valve.

The Canadian ministry estimates that there are about 147,000 TC-111 (DOT-111 in the U.S.) tank cars in North American flammable liquids service, about 80,000 of which were built prior to 2011. It estimates that an additional 7,500 CPC-1232 jacketed tank cars will be built in 2015.

The newer-design CPC-1232 is regarded as safer than the DOT-111 and viewed as a model for an updated standard. But to complicate the issue, four crude oil unit train derailments occurred in the U.S. and Canada in the first quarter. All four involved CPC- 1232-standard cars and three of the four derailments resulted in fires, according to press reports.

“You cannot layer a car to make it 9/16-inch,” Robert Pickel, senior vice president of marketing and sales for Hamilton, Ontario-based National Steel Car Ltd., said during a Cowen and Co. webinar on the status of crude by rail in North America. “You can mimic with jackets, etc., and we don’t know if that is going to be accepted. My point here is, we have about 130,000 tank cars in play that could be passed out of service and the economics of that has to be questioned.”

The U.S. National Transportation Safety Board (NTSB) demanded significant strengthening to CPC-1232 cars, including ceramic thermal blankets and increased capacity for pressure relief valves. The NTSB wants the cars to re- sist rupture following a derailment, but conversion is not a simple matter.

“We looked at a couple of opportunities to convert cars into that space and the cost to do that has been $10,000 to
$15,000 to clean and prep a car to convert,” said Bryan Smalley, president, commercial, of Woodlands, Texas-based eRail Commerce Inc., during the Cowen and Co. webinar. “The second part of that is repair. One of the big things we’re seeing on the repair side—there’s no repair availability.”

Here’s the math as Smalley calculated it: There are about 58,000 cars that need to be certified to the new standards.
Even a big shop can only handle 3,000 to 5,000 conversions a year and several of the facilities are already busy for five to six months.

“I’ve got three or four shops that I’ve worked with extensively in the past, and they’ve told me to come on back at the beginning of Q3 [third quarter] to see if they have any more availability,” he said.

But will the enhanced tank car design enhance safety? Many are doubtful.

“They’re focusing on the tank car design primarily, and it’s probably not warranted because none of the derailments have been caused by tank car design,” Robert Pickel, senior vice president of marketing and sales for National Steel Car, said during the Cowen webinar. “But it’s the most visi- ble—optics being the key word now. Everyone sees these cars blowing up on TV and on videos so they think the tank car design is going to be the solution.”

Buckley’s research revealed that track failures and human factors accounted for 75% of rail accidents in the U.S.

“One of the guys who works for me always says, ‘safety first, no excuses,’” she said. “And I always add to that: ‘Hazmat doesn’t cause accidents, it just makes them newsworthy.”

And if the newer car specs don’t con- vince the industry that risk is reduced, then the economics could have troubling implications for the future of moving crude by rail.

“People invest a lot of money in these cars,” Pickel said. “I have a number of $51 billion just for the CPC-1232 fleet. That’s about 50,000 cars. Are they going to write these assets off after only 10 to 15 years of service when they may have amortized them originally at the 30-, 35-year rate?

“If you can salvage these cars, at least the CPC-1232 cars, I think you’ll see rail still competitive,” he said. “If they obso- lete those cars, I don’t know that people are going to risk investing. So I think there’s a lot of uncertainty on the railcar side as to what to build except, build what comes out in May from the U.S. DOT [Department of Transportation] and pray to God that’s the car that’s going to last 40 to 50 years.”

Long-term sustainability?

The viability of rail hinges on the spread between Brent (the waterborne crude market) and oil from the inland crude market. Early in 2015, this spread was quite narrow, even reversing for a short time in which WTI was more valuable than Brent.

“There’s nothing like weather in Texas and oil prices in Texas—just wait a day and it’ll change,” Greg Haas, director, Hart Energy’s Stratas Advisors, told Midstream Business. “The spreads are now near the $10 mark between WTI [West Texas Intermediate] and waterborne Brent. Not only current day but also into the futures curves.

“That’s sort of an interesting development,” he said. “The year started looking very negative for crude by rail in the sense that, how can you possibly afford to spend $10, $12, railing crude oil from one location to another location, which is at parity with the price you started out with? It was an absolute money-losing proposition early in the year. Now, looking out at the futures curves, it looks like it will definitely be a continuation of some level of economic benefit of railing crude from the inland plays to those coastal markets, which are priced along with coastal Brent. Into the future, the widening of the Brent-to- WTI spread has shown that maybe there’s a more sustainable long-term utilization future for rail.”

Location is also critical to rail’s outlook. In western Canada and the Bakken Shale play, rail is perceived by Enbridge Inc. as viable in the short run but not long term. Enbridge operates a major rail terminal in Pampa, Texas, and transports NGL through a railcar fleet of 190.

“Rail will tend to be the swing mode even with differentials widening back out again somewhat,” Guy Jarvis, president of the company’s liquids pipelines division, told analysts during a recent call. “Rail will flex up as required unless and until pipeline capacity is available and then will tend to swing down as that capacity does become available.

“In western Canada, we expect rail volume to expand for a few years where the pipeline capacity remains apportioned, but then disappears as the large new export projects come into service at the end of the decade,” he added. “If the lower supply scenario prevails, the near-term impact would be just less rail while the pipes would remain full. A similar picture applies to the Bakken where rail should also shrink to minimal levels by the end of the decade.”

Fast track

Pickel’s time line is similar.

“I think the pipeline competition for East and West Coasts is still far out,” he said. “There’s a lot of uncertainty, so I would say five to 10 years of rail service that will hit the East and West Coasts and there’s still a market for North-South. Even if the Keystone [XL Pipeline] is approved, the rail cars provide a lot more versatility of where to go. With the pipelines, as you know, you generally have to sign a contract for a long-term commitment to provide volume. That still is in play here where it hamstrings investors.”

Speed is also an asset in rail’s favor.

“When you look at the competing logistical solutions of pipeline, not only do you have to look at destination, but you have to look at time to market, too,” Smalley said. “If you’re trying to capture arbitrage and it takes you 10, 30, 40 days to get your product down, that’s a different risk factor for each of those time markers. And if you can get a train of crude oil down, and you have less risk in capturing the arbitrage as it stands, that’s going to be a very effective means of transportation because it allows you that speed to market.

“I’ve actually seen companies that want to get railcars to offset any maintenance or supply issues with pipelines so they can better control their inbound supply into their refineries,” he said.

But beyond comparative arguments, the reality is that pipes just don’t go everywhere.

“There’s not enough pipeline infrastructure to take up all of the volume of the crude by rail right now,” Buckley said. “The second problem is, there are not enough alternative tank cars. There also are not nearly enough DOT-112s, which is a pressure car designed for things like liquefied petroleum gas.”

Buckley doesn’t oppose discussions about improving tank cars as long as there is no misconception that a redesigned car will be the answer to a complicated problem.

“Bottom line is, we really don’t need to do that,” she said. “[The DOT-111s] are not inherently unsafe. They’ve been in operation since 1963 with a tremendous safety record.”

PHMSA, tasked with taking a comprehensive look at the rail safety issue, is not ready to dismiss any aspect.

“We don’t believe there’s only one fix to this problem,” said Vasiliki Tsaganos, PHMSA’s deputy chief counsel, during the King & Spalding webinar. “There’s not only one thing we can do. It’s a very complex problem. We’re focused on preventing the rail incident from happening in the first place and then reducing the consequences if and when the incidents do occur.”

Infrastructure investment

Freight railroads are expected to spend $29 billion on infrastructure in 2015, according to the Association of American Railroads. That’s on top of the $575 billion spent from 1980 to 2014. It’s also more than the value of the energy being transported.

“If you look at a capex budget of $29 billion, that’s certainly going to have an impact,” said Richard Flynn, principal, Framingham, Mass.-based NorthEast Logistics Systems LLC, during the Cowen webinar. “You’ve had two back-to-back [very cold] winters. We’ve got a lot of improvements in unit train operations showing up. I think there are going to be some increased returns on those assets. So I think there’s kind of a good news story coming out of this.”

The industry is burdened with uncertainty at the moment, Flynn said, but he likened the tank car issue to the challenge of building a railcar to haul motor vehicles. It took 30 years for a solution to evolve, incorporating not just a redesign of equipment, but significant changes in operational characteristics. Flynn doesn’t expect this issue to take as long and he’s heartened by the investment in infrastructure. He also expects an anticipated uptick in demand for asphalt—a derivative product—in the second and third quarters to help stimulate business.

The industry anxiously awaits the upcoming release of safety regulations if for no other reason that it wishes an end to uncertainty. Whether they agree with the decisions, companies need to know the rules to be able to comply and move forward.

PHMSA is well aware of the issue’s complexity and importance.

“We don’t want to have conflicting regulations,” Tsaganos said. “That makes transportation more complex and has risks for the regulated community trying to navigate the differing laws and regulations from the federal government and also from states. We really want to make sure that there is consistency because that actually goes to the ultimate safety.”

And attention to safety is good business practice.

“That’s the No. 1 concern, first and foremost,” Buckley said. “People’s lives are involved, families, but also, it’s just good business. It’s good for companies’ reputations, it’s good for public percep- tion, it’s good for the bottom line. Let’s be honest—accidents are costly.

“We want a solution that means that our money being spent is really going to achieve that bottom line.”