Advances in extraction technology and favorable economics have led to dramatic and ongoing growth in domestic oil production, particularly from newly explored regions such as the Bakken Formation in North Dakota.  The locations of and limits on existing pipeline capacity, and lengthy permitting and related procedures for new pipeline construction, have led E&Ps, refiners and other end-users to turn to the railroads to move new Midwest U.S. petroleum resources to refineries on the East and Gulf Coasts.  “Crude by rail” shipments, in turn, are one of the fastest rising sources of new revenues and profits for the nation’s major rail carriers.  For developers and refinery operators unaccustomed to the often arcane world of bulk commodity rail transportation, this emerging market presents new risks and challenges along with opportunity.

From the railroads’ perspective, the movement of dedicated trains of 80-100+ tank cars of crude oil over long distances fits relatively easily into existing cost and pricing models for unit train shipments of other products, including coal and chemicals.  The railroads’ advanced knowledge and experience in negotiating contracts and other arrangements for the transportation of these commodities generally is not matched by the customers’ logistics managers, who may be more accustomed to the economics and service parameters of pipeline transportation.  Addressing this imbalance is a critical step for the shipper seeking to secure reliable transportation at reasonable and predictable rates while effectively managing risk.

Economic issues may start with base rates per carload – which should be benchmarked both to an accurate analysis of the railroad’s cost of providing service and a detailed assessment of market conditions and delivered costs on comparable routes – but the challenge does not end there.  Especially if a shipper is considering a longer term commitment (e.g., more than three years), negotiation of a rate adjustment structure that compensates the railroad for inflationary cost impacts without enhancing profits under the guise of cost recovery can be equally important. Likewise, customized features such as “most favored nations” adjustments or periodic market-based re-pricing can be employed in order to ensure that the delivered economics of a crude-by-rail movement can respond to changing market conditions that affect or determine the shipper’s resource purchase patterns.

The acquisition and maintenance of tank cars is another critical component of crude-by-rail planning. Railroads for the most part do not maintain fleets of tank cars, which shifts responsibility for these essential assets to the shipper. Decisions whether to purchase or lease cars, the procurement of maintenance and repair services, and protocols for regulatory compliance all require careful attention, as they can be significant drivers of cost and risk. Recent moves by the Federal Railroad Administration to tighten rules on the types of tank cars and car linings that can be used to transport different blends of crude will add to the complexity of these important elements of the overall transportation arrangement.

Whether domestic crude is viewed as a primary resource or a hedge against the competing cost of imports, a refiner will expect and depend on regular deliveries at a pace that matches the optimal capacity of its facilities. In most cases, the traditional common carrier tariff service standard of “reasonable dispatch” will be inadequate to provide the desired assurances of timely supply.  In these circumstances, the shipper will benefit from a contract scheduling and delivery structure that can be coordinated with purchase and loading schedules at the origins, and the unloading or transloading (e.g., from tank car to pipe to storage tank) facilities and capacity at the refinery or terminal. An understanding of reasonably expected transit times, potential route congestion points and likely causes of loading and unloading delays are essential to ensuring that contract terms covering loading and unloading free times, locomotive detention charges, constructive placement and loading or unloading disabilities beyond the shipper’s control complement the shipper’s operating needs and asset configurations. Similarly, reasonable contract commitments by the railroad to handle tendered shipments in a manner consistent with schedules and offer additional cycles or supplemental equipment to make-up shipment shortfalls provide stability on the service-side that justifies the shipper’s commitment of volume and tank car supply.

Another key consideration for the crude-by-rail shipper is the allocation of liability and indemnification for commodity losses and third party loss and damage attributable to shipments en route, and during the loading and unloading processes. Railroads generally treat crude oil as a hazardous commodity, and obviously would prefer to shift as much liability risk as possible to the shipper. Several recent, high profile accidents have illuminated the potential for exposure in this area, and highlighted the importance of risk allocation and management in rail contract negotiations. As with economics, service and other principal elements of the contractual relationship, the shipper’s interests will be served best by an in-depth appreciation of the most likely potential hazards, and the legal principles governing liability that would apply in the absence of alternative contract terms.

Proper investment in education, expert counsel and sound strategic planning will pay valuable dividends to any purchaser of crude-by-rail transportation service.     

By: Kelvin J. Dowd, Esq.