Shipping Crude Oil by Rail - Will Economics Trump Safety? Part 3 – What can be done to improve the Safety and Profitability of Shipping Crude Oil by Rail?

The two previous blogs in this series highlighted the critical role that the rails play in transporting crude oil. They also noted that the surge in derailments is raising serious questions about the safety of using rail transportation. In addition, as a result the large drop in the price per barrel, below the estimated breakeven cost level, this raises concerns about the ongoing economic viability of moving crude oil by rail. This blog will focus on what can be done to improve rail safety and the economics of rail transportation.

Improve the Safety of Rail Transportation

The key stakeholders on this issue are tank car manufacturers, energy producers, railroads and governments. They each have a responsibility to protect the safety of the public. It should be pointed out that Lac Megantic, Quebec, the site of the worst crude oil rail disaster, has a population of less than 6000 people. There were 47 people who perished in that rail disaster and the cost to clean up and rebuild the downtown where the train hit is projected to be $400 million. In other words, if a disaster of this nature was to hit a mid-size or major city, the cost in lives and dollars could be of an extraordinary magnitude. Since these large stakeholders collectively are deriving billions of dollars in revenue, profits and taxes from this sector, they have a major responsibility to address the safety issue. The following is a summary of what has been done, how these changes are working out and what still needs to be done.

Change the Composition of the Oil

Under regulations adopted last year and to be put into effect in April, oil companies in North Dakota will have to remove volatile gases such as propane from their crude before pumping it into a rail car. This is estimated to add another 10 cents a barrel to the cost. In April, a regulation in North Dakota requires oil to be kept at a vapor pressure below 13.7 pounds per square inch goes into effect. This process known as conditioning, which companies can use to meet that standard, is the “bare minimum” step to lower volatility.

Change the Crude Oil Extraction Process

This is an absolutely critical step. Innovation has been a key to the growth in energy production in Canada and the United States. Fracking and oil sands energy extraction are still relatively new technologies. It is essential that some of the brightest minds in the industry be applied to extracting crude oil as efficiently and cost effectively as possible. The best way to protect the industry in North America is by driving down the cost of production and transportation in a responsible manner.

Change the Tank Car Design

There have been several initiatives in this area. A major effort has been made to retrofit the DOT-111 cars. In addition, the newer CPC-1232 tank car was outfitted with a reinforced body and tougher valves, to keep from leaking during a wreck. Unfortunately, neither the retrofitted DOT-111s nor the CPC-1232 has demonstrated the necessary structure to withstand a derailment. The recent derailments around North America suggest that the CPC-1232 cars are no safer than the DOT-111 cars. The issues are that unit trains carrying 100+ crude cars can run up to 40 MPH and the crude oil may contain combustible gases. It remains unclear whether the stricter safety standards will truly prevent explosions and fireballs in the event of a derailment at full speed.

Many experts question whether retrofitting tank cars to comply with safety regulations makes economic sense for a large portion of the fleet in flammable liquid service. Under the latest version of the draft regulation being developed by the U.S. Department of Transportation, tank cars would have thicker walls and better brakes and valves. “You could make tank cars resemble Army tanks and it still isn’t going to stop accidents,” says Brigham McCown, a former administrator at the Pipeline and Hazardous Material Safety Administration.

Last summer the DOT predicted that trains hauling crude oil or ethanol could derail 10 times a year over the next 20 years, causing $4.5 billion in damage. Based on events over the past few months, these estimates appear to be a bit low. Since no one can truly predict where the trains will derail or the potential loss of lives, there is clearly a lot of work to be done in rail design. The Railway Supply Institute estimates that making the proposed design changes will add about $13.6 billion in shipping costs that will have to be paid by the rail car lessors. May 2017 has been set as the date to take non-jacketed DOT-111 cars out of flammable liquid service before taking CPC-1232 cars out of service. The timeline for when the safer cars will need to be in service in the U.S. has been much debated with the industry suggesting anywhere from 2 years to 6 years as reasonable. Transport Canada’s regulations suggest that there will also likely be a phase-in period in the U.S., given the importance of regulatory parity with Canada.

A tank car costs about $100,000 to manufacture. There is a cost to add reinforced hulls, breakaway handles, pressure relief valves and protective shields to stop the car from crumpling during a collision. A great deal of work needs to go into designing safer, cost-effective cars.

Slow Railing and Rerouting of Crude Oil Unit Trains

Railroads last year agreed to slow trains to 40 mph from 50 mph when carrying crude through High Urban Threat Areas, a designation that covers more than three dozen U.S. communities. Speeds higher than 25 mph were “irresponsible” given the known weakness of the tank cars carrying the crude, Jim Hall, a former chairman of the National Transportation Safety Board, said in written comments to the Transportation Department. But lower speed limits for railroads may be ineffective at keeping oil trains on the tracks and preventing massive fireballs, such as those triggered in a series of recent derailments, the chief U.S. railroad regulator said. “If you’re going to slow trains down, you’re going to have to slow them down to 12 miles an hour,” Sarah Feinberg, acting chief of the Federal Railroad Administration, told reporters in Washington March 13. The Federal Railroad Administration is also studying whether slower speeds can cause a sloshing effect in tank cars, making it harder to prevent the rolling stock from wobbling off the tracks, Feinberg said. If slow railing isn’t the answer, it may be necessary to reroute the trains in some locations.

Add More Rail Inspectors

This has become a political football. The question is whether it is reasonable to inspect the industry to self-regulate or if employing more inspectors (at a higher cost) is the answer. This should at least be evaluated along with the other variables outlined above.

Maintain surcharges on older tank cars to create an incentive to switch to safer cars

This is also a hotly contested item at the present time. The American Fuel & Petrochemical Manufactures, a trade group of 400 U.S. refining and petrochemical companies, filed suit against Class I Railway Burlington Northern Santa Fe, the North American railway that moves crude oil in the greatest volume. In the lawsuit, the shippers are objecting to Burlington Northern’s $1,000 per unit surcharge on the older DOT-111 tank cars that the railway imposed beginning this year. This adds between $1.40 and a $1.50 per barrel to the cost of shipping crude oil. CP and CN also add a similar surcharge. The surcharge does steer shippers in the direction of using newer cars but the current evidence suggests that the newer cars are no safer than the old ones. At the present time there is not enough manufacturing capacity to produce more of the supposedly safer cars.

Final Comments

The rapid decline in the price of crude oil can be looked at in several ways. In the short term, it is inflicting terrible pain on the North American energy industry. If recent reports on inventory levels of crude oil are correct, this may cause more producers to curtail operations or the price per barrel could go even lower.

This is an industry that is essential to the economies of Canada and the United States. While the economic model for producing and shipping crude oil in North America needs some tweaks, the need for oil won’t go away any time soon. This is the time for all of the industry stakeholders to seek innovative solutions to extracting and shipping crude oil. North America can regain the upper hand if it can become the low cost producer and shipper.

The mother of all crude oil rail disasters has not happened and hopefully will not happen if these safety measures are put into effect. While some of the suggestions above for improving rail safety may sound like hash medicine, this is far preferable to a massive explosion in a heavily populated area that causes huge damage and loss of life. The laws of supply and demand will likely play out in the months ahead. As supplies go down, prices should start to rise again. A focus on innovation, cost reduction and safety will allow North America to regain its footing in this very important industry sector.

Dan Goodwill & Associates (www.dantranscon.com) provides freight transportation consulting services to shippers and carriers throughout North America. Follow Dan on Twitter @DanGoodwill. To stay up to date on the latest developments in energy and transportation, obtain a free subscription to Dan’s Transportation Newspaper (http://paper.li/DanGoodwill/1342211466 ).