Fatal Oil Train Disaster Brings Scrutiny to Oil-by-Rail Boom

Firefighters battle blazes after a freight train loaded with oil derailed in Lac-Megantic, Quebec, on July 6, 2013.
François Laplante-Delagrave | AFP | Getty Images
Firefighters battle blazes after a freight train loaded with oil derailed in Lac-Megantic, Quebec, on July 6, 2013.

The catastrophic crash of an oil-laden freight train in a small Quebec town last weekend will bring more scrutiny to the railroad industry's transport of oil and may boost the case for pipeline development.

But it is unlikely to slow the momentum of rail shipments of oil in North America, which has grown dramatically from about 100,000 barrels a day in 2010 to about 900,000 barrels a day by the first quarter of this year, according to IHS CERA estimates.

"This was a freak accident. The record of this industry in safety overall in moving a lot of hazardous product has shown steady improvement over the last decade, and I'm very convinced that there will be steps taken to continue this trend," said Tom Petrie, chairman of Petrie Partners. "This is a horrible tragedy without question. It's such a freak accident. Trying to diminish its import is not something I would do in a minute, but the nature of what's going on in my view is one that there's a powerful incentive to do it well, to do it right and to do it safely, and I think the industry is going to go to great lengths to do that."

"On the margin, it probably helps the case for the XL pipeline … but not the elimination of the railroads," he said. The Keystone XL pipeline, an extension of TransCanada's system that would link the Canadian oil sands with Gulf Coast refineries, has been delayed by the Obama administration and is still under review for its potential greenhouse gas impact.

The Canadian oil sands in Alberta are an important piece of the North American energy picture, and together with growing U.S. oil production, will essentially make the continent independent of foreign oil before the end of this decade, industry experts have said. The U.S. currently is producing 7.3 million barrels of oil a day, up 20 percent from year-ago levels.

"I think the Keystone pipeline proponents will cite this as a reason why pipelines are safer than rail. There's no doubt in my mind that they will point to it," said Andrew Lipow, president of Lipow Oil Associates."Rail, I believe, is going to continue to grow as North Dakota oil production continues to climb. We're growing train operations in places like Wyoming, Colorado as well as to a lesser extent, Ohio, where we have the Utica shale."

Analysts do not believe the accident means Keystone will get approved, but it will certainly bring it back into focus.

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"It will revive the debate, and that's good so people talk about it instead of just pushing it under the rug because it's really needed," said Oppenheimer energy analyst Fadel Gheit. "We went to rails because the pipeline option wasn't available. Need is the mother of invention."

Gheit does expect to see a push for safety on railroads, from companies and governments, and he expects to see more government safety checks. "It will tighten the rules on rail... People think it's an old horse and it's not going to hurt anyone," he said, adding even an old horse can kick.

Another pipeline project that might find support after the tragic train derailment is the proposed TransCanada Energy East pipeline, which would transform an existing natural gas pipeline to oil. The pipeline goes from Edmonton, Alberta, to Quebec and could be extended to St. Johns, the location of the Irving refinery where the derailed train was heading. "The rail accident might actually help that project proceed," Lipow said.

"I do expect continued growth (of rail) in Canada. We're still not building any pipeline," Lipow said. "You can get train service up quickly."

The accident occurred early Saturday when an unmanned train hauling 72 tanker cars of oil sped seven miles into the town of Lac-Megantic, before derailing, exploding and bursting into flames. Thirteen people were killed and dozens were reported missing. Montreal, Maine & Atlantic Railway, owned by privately held Rail World Inc. of Chicago, was the operator of the train.

On Monday, Montreal, Maine & Atlantic Chairman Ed Burkhardt told Reuters that air brakes that could have prevented the disaster failed because the engine that powered them was shut off. Local firemen dealing with a fire just before the accident occurred had shut off the engine. The Wall Street Journal reported Tuesday that MM&A has an accident and incident rate in the U.S. much higher than the national average.

In 2012, the company's rate was 36.1 occurrences per million miles, while the national average was 14.6. The Journal notes it is difficult to gauge safety among different railroad companies because many incidents reported aren't the fault of train operators, and can be caused by contractors or the public.

On Tuesday, Burkhardt denied allegations that the company had a spotty safety record, The Associated Press reported, He said Saturday's crash was the only significant derailment involving MM&A.

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The runaway train had been parked on a slope near the Quebectown of Nantes, awaiting a crew change, when it started rolling toward Lac-Megantic. The explosions destroyed about 30 buildings, including a music bar filled with a weekend crowd.

"Clearly, a train this big and this heavy gathering seven miles of momentum before it derailed is a significant amount of force," said Chris Wetherbee, Citigroup railroad analyst. "This is the worst case occurrences all lining up together, where you have a runaway train carrying a relatively volatile commodity on board."

Wetherbee said the North American railroad industry makes about 3 to 4 percent of its revenues from hauling oil, a tiny amount but a big jump from about a half percent just a few years ago. He also said the industry is investing about 18 percent of its revenues in infrastructure, up from an average of about 15 percent in 2001 to 2008.

"I think the rail infrastructure in the U.S. is top notch.The capital investment running at 18 percent of revenue over the course of the last several years has resulted in a significant improvement and enhancement of infrastructure."

The U.S. government said it has offered to work with Canada, but that it has no jurisdiction over the crash even though the rail company is American and oil shipped out of the Bakken in North Dakota.

"Safety is our number one priority at the Federal Railroad Administration. 2012 was the safest year in the history of rail in the United States, and we are continuing to push to make sure our rail network is the safest it can possibly be," FRA spokesman Kevin Thompson, said in an emailed statement. "The accident in Quebec Province is being investigated by Canadian authorities, and the FRA does not have jurisdiction outside of the United States. We are closely monitoring the situation in Canada and have offered to assist Canadian officials in any way necessary."

The safety debate may be louder in Canada, since already this year there have been a string of accidents and derailments involving Canadian Pacific, one of the biggest haulers of crude. In June, four rail cars carrying flammable petrochemicals used to dilute oil were derailed on a flood-damaged bridge over Calgary's Bow River. There was also an incident in April when 22 cars derailed near White River, Ontario, leaking 400 barrels of oil. In March, a Canadian Pacific train derailed in western Minnesota, leaking thousands of gallons of fuel into a ditch and field 150 miles northwest of Minneapolis.

Wetherbee said the deadly accident could result in calls for more regulation. "It is possible, although it probably shouldn't be the response. You have to look at the confluence of data to suggest that the rails are very safe. You don't need additional regulation to address something like this," he said.

Rail transport of crude has quietly grown as the increase in U.S. energy production resulted in an abundance of oil, especially from inland fields. "To tell you today that the railroad industry is moving almost a million barrels a day is an astounding fact to me. There's been a broad embracing of the value added, not just by the companies shipping oil but by the recipients of that, which are refiners and that multiplicity of delivery points is a huge transformation," said Petrie.

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The increase in transport of North American crude, both with new pipeline capacity coming on line and rail transport, has helped drive the price of West Texas Intermediate crude price closer to international bench mark Brent crude. It has also made an impact on U.S. imports.

"It's already reduced reliance. You can see from the import numbers that we're reducing our total amount of imports, and the increased amount of production in the U.S. is clearly displacing crude oil imports from places like Algeria, Libya and Nigeria," said Lipow. "The expectation is that in 2014, we will be importing hardly any oil from these three countries. The Canadian oil that's coming out of Canada will begin to displace crude oil imports from places like Iraq, Venezuela and other nations from OPEC."

Analysts say the boost to pipelines from the rail accident will be marginal, at best. There is a flexibility that rail has provided. Kinder Morgan, for instance, recently scrapped a plan to convert a natural gas pipeline to carry crude from West Texas to Southern California because of a lack of interest among refiners who found it easier to bring in crude by rail.

"Initially, I think everyone thought that rail was a passing fancy to bridge the gap before pipelines" (were built), said Wetherbee. "The railroads may ask for a one-to-three-year deal, where a pipeline can ask for a [deal of] five to 10 or more years."

Wetherbee said there is a backlog of more than 50,000 tank cars on order, many to carry oil or other petroleum products. "You can't get another car for 18 to 24 months," said Wetherbee. Refiners and oil producers buy the tank cars, while railroad companies own the engines and tracks. Customers, like refineries, also own the terminals.

"Crude by rail has reinvigorated or found a second life for some of these assets. You can't understate the importance of the shale development over the last couple of years, and what it means to our country going forward. I think it's largely under appreciated," said Wetherbee.

—By CNBC's Patti Domm. Follow her on Twitter @pattidomm.