Accidental spills from rail tanker cars hauling crude oil have grown at what seems like an alarming rate over the past several years. In 2013, it was estimated that more than 1.1 million gallons of crude were spilled from trains in the U.S. This total represented more than the documented total from the prior 37 years combined, and it doesn't include the more than 1.5 million gallons of crude spilled in the town of Lac-Megantic, Canada, that July, an accident that left more than 40 dead and half of the town center destroyed. 2014 saw incidents continue to rise, with 141 so-called "unintentional releases" of oil.
While both the rail and oil industries have responded with voluntary moves to implement newer and safer cars, Berkshire Hathaway Inc (NYSE:BRK-A) (NYSE:BRK-B) subsidiary BNSF Railways is taking it one step further, adding a $1,000 surcharge to oil shipments using its older cars.
In response, The American Fuel & Petrochemical Manufacturers trade association, which represents essentially all of the refiners in the U.S., filed a lawsuit against BNSF recently, claiming that the $1,000 surcharge -- which works out to about $1.50 per barrel of crude -- is an overreach of the company's authority. According to the complaint, the group claims that "BNSF's assertion of unilateral regulatory authority over crude oil tank car standards conflicts with the pending PHMSA rule-making on such standards."
So, the question is this: Is Warren Buffett's subsidiary taking advantage of a "captive audience" with its refiner customers and forcing them to pay up for new cars? Is the company overstepping its legal bounds with the surcharge? On the other hand, are refiners simply looking for a way to bump their profits? Let's take a deeper look.
Berkshire: A lot of skin in this game
To start, it's important to understand the dynamics of rail shipping. Typically, railways own the tracks and the locomotives, while the shippers own or lease the rail cars, meaning BNSF's surcharge isn't intended to cover its costs to replace older ones since it doesn't own very many. However, a recent move by the company to order some 5,000 new and updated tanker cars changes the story a little bit.
According to BNSF, the company is taking this step to move the industry forward toward safer cars, and those 5,000 cars would represent about 13% of the current fleet of DOT-111 cars that carry crude on North American railways. The company would surely get some financial gain from owning a significant fleet of these updated cars that it could then lease to crude shippers.
Furthermore, Union Tank Car Co. (also known as UTLX), one of the largest manufacturers of rail cars, is part of the Marmon Group, one of Berkshire's "Powerhouse Five" non-insurance businesses with a major rail car leasing business.
While BNSF's move is in no small part tied to safety, when you follow the money, there's a financial benefit for BNSF's parent company. However what's less clear is just how much. As Buffett stated in his annual shareholder letter, less than 8% of Marmon's 105,000 car fleet hauls crude oil. Having fewer cars exposed to oil shipping -- and potentially falling short of new safety regulations before their 30-year lifecycle ends -- is a good thing.
Refiners: Safety, profits, or keeping BNSF from "playing cop"?
U.S. refiners that can process American crude, versus imported oil from the Middle East, enjoy a substantial cost benefit today, with the spread between Brent -- the international benchmark -- and West Texas Intermediate and other regional benchmarks at nearly $9 per barrel at recent prices. However, shipping costs can close this spread, and the $1.50 per barrel surcharge on older rail cars cuts into refiner's margins.
This is especially important to refiners like Valero Energy Corporation (NYSE:VLO), the largest independent U.S. refiner, with 11 refineries located in areas with access to rail-supplied cheap crude. Marathon Petroleum Corp. (NYSE:MPC) -- a top-five U.S. refiner -- similarly benefits, with its large presence in the midwest.
However, integrated oil companies like ExxonMobil (NYSE:XOM) and Phillips 66 (NYSE:PSX), both of which have larger refining operations than either of the two above companies, are likely more affected by the surcharge since more of the U.S. crude they source would have to be shipped by rail, to their east- and west-coast refineries, because of the lack of major pipelines east or west from shale plays in North Dakota and Texas.
Looking beyond the financial impact, what can we make of the industry's suit against BNSF? While it's clear Berkshire Hathaway would benefit from refiners acquiring newer cars that exceed the current DOT-111 standards, that doesn't mean it's an unnecessary move. At the end of the day, the railways like BNSF carry the bulk of the liability when these accidents do occur. What does matter is whether or not the surcharge is legal, and that's the refining industry's primary contention in the lawsuit. BNSF released the following in a statement on March 18, responding to the lawsuit:
We believe that our rate structure appropriately supports customers who are working to move to a safer car, which is in the interest of rail shippers, BNSF employees and the communities we serve. This rate structure is also consistent with BNSF's ongoing efforts to ensure the safe transport of crude on our network, including voluntary adoption of enhanced operating practices around crude oil shipments and requesting the federal government to make newer, safer tank cars the new standard for crude-by-rail shipments, replacing the older DOT-111 and non-modified CPC-1232 cars.
The interesting spin here is that BNSF is claiming that its new rate structure includes incentives for shippers to use newer, safer cars, while the AFPM is clearly aiming at the "punitive" aspect of the surcharge, and not any discounts BNSF may be offering for shipping in newer cars.
Furthermore, AFPM is clearly trying to shift the regulatory response away from the oil industry and rail cars, and back to the rail operators. A recent letter from AFPM's president to the U.S. Secretary of Transportation followed comments from Federal Railroad Administration head Sarah Feinberg that, "We are running out of things that I think we can ask the railroads to do." The letter said:
We believe that comments such as these show a fundamental misunderstanding of the root cause of rail accidents. FRA's own data shows that there were over 1,100 Class 1 derailments in 2014, averaging more than three each day; the number one cause being the result of poor track conditions. We cannot believe that you and the rest of the DOT staff believe that these results are acceptable and that a more robust track integrity program would not have an impact on reducing derailments of any kind.
Lies, damned lies, and statistics
Context is key when numbers get bandied about. Yes -- the number of incidents involving trains carrying crude oil has growth dramatically in recent years, but so has the amount of oil shipped via rail -- by 40-fold over the past decade, actually. Over the same period, the number of derailments involving trains carrying hazardous materials like crude oil has actually fallen.
Furthermore, two Canadian railways have also recently added surcharges for shippers using older model cars, and it's unclear what -- if any -- response AFPM will make to that.
Looking at the bigger picture
The reality is, this is about both profits and safety, and it looks like both the railways and petrochemical companies are trying to establish the balance of responsibility. And while BNSF's parent stands to benefit from the surcharge and the potential for more updated tanker cars being bought by refiners, that doesn't mean it's not still beneficial to public safety. At the same time, AFPM has an obligation to its members to challenge this surcharge if it feels it is illegal or unfair, and frankly, whether their motivation is the regulatory precedent, or purely the bottom line, really doesn't matter.
At the end of the day, safety is incredibly important, and whether the groups settle or this goes to court, it's important that the focus be kept on continuing to improve on the safety of crude by rail. After all, it's not going to stop anytime soon, and there's too much at stake to not continue to reduce the risk to communities near these rail lines. It's the right thing to do, and it's great for the bottom line, too.