Government Regulation of the Rail Industry - Investment Opportunities

In the United States and Canada, a series of events have led the public to question the current approach to rail safety: the adequacy of regulations and methods for their enforcement. In Canada, two derailments in urban areas have brought these matters into the spotlight: 

•  a derailed CP tanker train which almost slipped into the Bow River on a flood-weakened bridge in Calgary, Alberta  CBC News Report
• the disaster in Lac-Megantic, Quebec when a Bakken oil laden train operated by the Montreal, Maine & Atlantic Railway derailed and exploded destroying the downtown and killing 47 residents.  A revealing account of the disaster and its implications is presented here Chronology and Impacts

Upon further investigation by the Transportation Safety Board of Canada, it was determined that the petroleum aboard the tankers which derailed in Lac-Megantic was far more flammable than indicated on the waybill.  It also made the following observation:

The lower flash point of the crude oil explains in part why it ignited so quickly once the Class 111 tank cars were breached. Since product characteristics are one of the factors to consider when selecting a container for the transport of dangerous goods, this also brings into question the adequacy of Class 111 tank cars for use in transporting large quantities of low flash–point flammable liquids (PG I and PG II).

September 11, 2013 Rail Safety Advisory Letter

Two outcomes are likely:

• tighter regulations/procedures for the labelling of tanker-borne petroleum products;
• a thorough review of standards for tanker cars with the prospect that specifications for new cars will be tightened and the possibility that retrofits may be required for older cars which carry more flammable liquids. 

Predictably, railroad companies will rail against tighter standards, but the reality is that the public is not prepared to accept major accidents as a cost of doing business.  In their competition with other modes of transportation, chiefly pipelines, rail companies will be forced to adapt. 

The transport of petroleum products, especially crude oil, has increased dramatically in recent years.  

With the advent of fracking technology, vast new supplies of crude oil have dramatically changed the business of moving oil to refineries.  North Dakota is now the second largest producer of oil in the U.S.  The flood of oil has overwhelmed existing pipeline capacity with the result that rail transport has stepped into the breach. 

Why?

• local refineries do not have the capacity to process the crude with the result that it has to be shipped to large refinery complexes elsewhere;
• there is insufficient pipeline capacity to move crude to refineries in other areas;
• pipelines take time to develop and given the tendency for "fracked fields" to deplete more quickly, a well developed network of intermediate and major lines may not be a viable long-term economic proposition (my conjecture);
• existing rail networks are well-developed and adaptable;
• capacity can be increased quickly by adding new cars and loading facilities;
• the networks serve the dual purpose of moving fracking sand and other materials to well sites and moving product to markets;
• the rail networks provide sellers with the flexibility to exploit and respond quickly to price differentials in different geographic markets;
• oil can be moved quickly;
• competing modes of transport (truck or barge) cannot compete for a variety of reasons: trucks are too expensive over anything but the shortest distances and barges are limited by geography and undependable water levels.

The following link provides an excellent overview of the seismic shift in rail transport caused by new oil and gas extraction technologies: Moving Crude Petroleum by Rail

Investment Opportunities

The Lac-Megantic disaster has raised disturbing questions about the safety of the existing fleet of tanker cars, especially the older stock. Regulators are being pressured to upgrade technical specifications for a variety of reasons:

• it is suspected that many of the chemicals used in the fracking process are contaminating the extracted crude with corrosive materials which, over time, have the potential to weaken tank walls (producers are reluctant to reveal their formulae - trade secrets - so the extent of the problem is not well characterized);
• a significant percentage of the existing fleet is estimated to have a high incidence of failure in the event of an accident;
• there is a continued concern about staffing levels and monitoring during all phases of the rail transport cycle: loading, transport (both while rolling and idle when loaded) and unloading.

To my mind, this presents a few themes for further investigation.

1.  Construction of New Rail Cars to Renew the Fleet

This is rather obvious.  There are several major tanker car manufacturers.  Before the Lac-Megantic disaster, I considered that future deliveries were built into the price of tank car manufacturers; however, the imposition of new, more stringent specifications may be on the horizon despite intense lobbying by the industry.  

The following article identifies some of the major rail car manufacturers in North America: Trinity Industries, Union Tank Car, Greenbrier Companies, FreightCar America, and American Rail Car. Most of them have done well recently. 
Rail Car Manufacturers


Estimates of future production will hinge on the U.S. Department of Transportation's decision of whether or not to upgrade the standards for tanker cars.  The crux of the issue is as follows (extracts from the following article: Tanker Car Standards

The DOT-111 tank car makes up more than two-thirds of the rail fleet carrying crude oil ...

The soda-can shaped car, known as the DOT-111, has come under scrutiny from safety experts because of its tendency to split open during derailments and other major accidents ... The DOT-111 car’s steel shell is too thin to resist puncture in accidents, the NTSB said, and the ends of the car are vulnerable to ruptures. Valves used for unloading and other exposed fittings on the tops of the tankers can also break during rollovers.

The AP had reviewed 20 years of federal rail accident data involving DOT-111 cars used to haul ethanol and found that the cars had been breached in at least 40 serious accidents since 2000. In the previous decade, there were just two breaches...

The Obama administration has delayed by nearly a year a plan to boost safety standards for the type of rail car involved in a fiery explosion that killed at least 47 people in Lac-Megantic, Quebec in July.

The Rail industry has lobbied vigorously to delay and modify the proposed regulations, contending that compliance costs could be in the range of $1 billion. 

2.  Monitoring

There are many aspects to this, including: loading levels, enhanced monitoring of rail cars when underway, security while loaded cars are at rest, and so on.  

Least you think that monitoring the level of liquids in tanker cars is a trivial issue, read this:
Road and Rail Tankers with Level Gauging

3.  Chemical Analysis and Threat Mitigation 

This is critical, especially given that previous assumptions about the low volatility of crude went up in flames due to the experience of Lac-Megantic.  There are several dimensions to this: the chemical composition of crude about to be loaded; monitoring temperatures while on board, analyzing the chemical composition of residue in empty tank cars and so on.  Added to this are measures to reduce or eliminate hazards once they are identified. 

It is not generally appreciated, but employment in the transport equipment manufacturing sector in the U.S. has increased substantially in recent years. 

The fastest growth has occurred in the railroad stock manufacturing sector. In three short years, the workforce grew by an impressive 36%, adding 6,500 jobs to total 25,000. As a result, the total workforce is only 3,000 fewer what it was in 2001.

Employment Patterns in Transportation Manufacturing

To my mind, the increase is symptomatic of the economic recovery and the resilience of American managers.  There are investment opportunities as this trend is not a short-term phenomenon.  

There are other themes which warrant further investigation; notably the logistics of moving petroleum. When researching potential investments, I often review the agendas of industry conventions to "take the pulse": to get a sense of key themes of interest; to identify key players (personalities, companies); to get leads for further research.  

The agenda for the following conference, The Crude Markets & Rail Takeaway Summit 2013, provided a treasure-trove of information ... and some key leads for what I hope will be profitable investments.  Conference Agenda

In later posts, I will report on of some of my activity along the theme of rail transport, especially the movement of petroleum products.  My experience with Trinity Industries (TRN) since establishing a position in January 2013 has been positive: a gain of 17 percent plus receipt of quarterly dividends.  

Further background on trends in the rail industry are presented in the following article http://www.railwayage.com/index.php/finance-leasing/railroad-financial-desk-book-2013.html


The article provides a comprehensive overview of trends in rail car use and explores the all-important facet of financing e.g. purchasing/leasing arrangements.  Savvy investors are well advised to read this closely.