Crude oil prices are now approaching what pundits believe is likely to be the bottom phase in the current market cycle. Due to the price downturn, the arbitrage window that drives a substantial portion of crude-by-rail (“CBR”) shipping volumes is closed. Yet once the price recovery begins, producers and refiners will again avail themselves of CBR’s speed and flexibility, and the market will see oil carload volumes recover accordingly. As such, we believe the current time presents an ideal opportunity to assess CBR risk and liability issues to help guide operators, shippers, and regulators as they prepare for an upswing in activity likely to begin in late 2016.

This article is the first in a three-part series and will address the primary factors that influence CBR liability: from factors that influence relatively ordinary fines to the factors that arise in the worst-case scenario. Part Two in the series will analyze the monetary magnitude of liability risks that accompany the liability factors outlined in Part One. And Part Three will offer insights into how BakerHostetler can help railroads, terminal operators, and crude oil shippers fine-tune their risk management strategies and reduce legal exposure as CBR activity begins to recover.

Our analysis provides an industry-wide perspective and reflects the robust and improving safety records of railroads that haul crude oil. It also provides objective data that contradict inaccurate portrayals purveyed by the CBR industry’s detractors. The data instead tell a different, and positive, story: how the rail industry rapidly responded to a new oil logistics need, successfully supported the development of multibillion-dollar shale oil plays whose resources would otherwise have been stranded by the lack of transport options, coped with often harsh and arbitrary regulatory requirements, and through all this displayed world-class operational excellence.

The Liability Factors:

• Compliance with federal or state regulations
• Amount of commodity released
• Location of release
• Population density
• Fire
• Human injury and fatalities

Compliance With Federal or State Regulations

One of the most basic factors that will impact liability is whether the CBR operations are conducted in compliance with federal and, if applicable, state regulations. Often, violations are discovered in the course of ordinary business by safety-conscious companies and by regulatory inspections unrelated to a large release or derailment. When found by regulators, such situations usually result in fines.

But where significant noncompliance or documented violations underlie an undesirable incident, such noncompliance or violation could increase liability significantly. A potential plaintiff will likely attempt to use the noncompliance or violation as evidence against the responsible parties throughout the CBR supply chain, according to the applicable evidentiary laws of the forum.^[1]

For example, in the Lac-Mégantic derailment, problems with the classification of the crude oil occurred along the supply chain, violating the applicable hazardous materials regulations—i.e., the crude oil entered rail transportation as Packing Group III when it should have been Packing Group II.^[2] And such noncompliance along the supply chain was likely a contributing factor in many of the upstream companies’ decision to contribute to the settlement.

Amount of Commodity Released

We compiled data from the Pipeline and Hazardous Materials Safety Administration (“PHMSA”) for reported incidents involving the release of hazardous materials from rail tank cars between October 2009 and June 2015. Of the 384 incidents we identified as involving crude oil, only five involved the release of more than 1,000 barrels of crude: roughly 1.5 tank cars’ worth (Exhibit 1).

Exhibit 1: Most U.S. CBR Spills Involve Less Than One Barrel of Oil

Barrels Spilled—red bars and left axis, Annual average ’000 barrels per day of crude carried by rail—gray-shaded, right axis

Source: EIA, PHMSA, Authors’ Analysis

The largest U.S. CBR spill to date, a train collision and derailment near Casselton, North Dakota, released approximately 11,300 barrels. It bears noting that even in 2013, a tough year relative to others, 13,000 barrels of oil safely reached its destination for each barrel lost in a spill. For context, the CBR industry’s 99.992 percent transport success rate that year still very nearly attained Six Sigma quality levels (99.99966% percentage yield). This reflects the industry’s relentless focus on ensuring that oil cargoes safely reach their destinations.

Location of Release

Although compliance with applicable regulations and the volume of oil released in CBR incidents have a place in the liability equation, the location of an incident is perhaps even more important. The location of the release will directly influence liability for (1) environmental damage, (2) property damage, and (3) human impacts.

A release incident near environmentally sensitive locations will compound liability. A responsible party will often face investigative and cleanup liability under a variety of federal and state laws. A ready example is surface or groundwater. Unfortunately, the nature of the U.S. rail infrastructure is that many destinations cannot be reached without traveling on rail line that abuts or crosses environmentally sensitive areas.

Population Density

In terms of location, the U.S. has been fortunate thus far because the handful of large-scale oil train incidents have occurred in sparsely populated rural areas (Exhibit 2). Most crude oil leaks from railcars generally involve small volumes of oil and are lower-risk events because they occur as a product of valve leakages (often caused by the simple failure to close a valve completely), overfilling of tanks, and other such events that occur when a train is stationary, and are relatively self-limiting. In addition, these are often human-error events that rail operators can, and do, rapidly and effectively address.

As tighter federal regulations prompt further modernization of the tank car fleet, we expect that the number of small equipment-related releases will continue to decline per unit of crude hauled. To date these small spills have not involved ignition – a noteworthy point because fires involving railcars in urban settings have the potential to create very significant liability.

Exhibit 2: Location of Crude Oil Spills/Releases From Oil Trains

Source: Census Bureau, PHMSA, Authors’ Analysis

Fire

When stacked upon the previously discussed factors, a fire catapults liability to another level. Even with no injuries or fatalities, a fire can still create formidable liabilities – especially in a densely populated area, where a fire is likely to cause significant disruption and property damage to homes and businesses. This often invokes tort law, which can entail large damages awards. Although fires are involved in very few releases, they are common in serious derailments of both crude oil and ethanol, as the basic physics of a sliding railcar often weighing more than 40 tons lends itself to creating sparks. Through June 2015, the PHMSA data show six instances where derailed crude oil cars caught fire (Exhibit 3).

Exhibit 3: Locations of Crude Oil Derailments Involving Subsequent Ignition of Cargo

Source: GADM, PHMSA, Authors’ Analysis

Human Injuries and Fatalities

Human injuries and fatalities instantly transport a case from the realm of environmental and property damage liability to the much higher-stakes arena of personal injury law. And as our subsequent articles will show, damages and settlement sums tend to reflect this reality.

Conclusion

Despite CBR’s strong overall safety record, a few major incidents have marred its reputation. To continue improving operational safety, it is necessary to understand the factors that contribute to liability, the potential monetary value of liability, and risk-mitigation measures that can be enacted to decrease those liability risks. It is important for all participants in the supply chain to know their exposure to these factors. As demonstrated by the Lac-Mégantic settlement, a potential plaintiff will pursue claims not only against the railroad but also against the owner of the crude oil, the broker, the transloading facilities, the tank car owner, and the end user. Our next piece in this series will analyze the potential monetary exposure that these liability factors create for CBR participants.

^[1] A plaintiff will face various hurdles to the manner in which this type of evidence can be presented in the courtroom. For example, National Transportation Safety Board Reports are not admissible as evidence in a civil action to recover damages. 49 U.S.C. 1154(b) (“No part of a report of the [NTSB], related to an accident or an investigation of an accident, may be admitted into evidence or used in a civil action for damages resulting from a matter mentioned in the report.”).

^[2] Transp. Safety Bd. of Can., Railway Investigation Report R13D0054 at 112 (2014), available at http://www.tsb.gc.ca/eng/rapports-reports/rail/2013/r13d0054/r13d0054.pdf (analyzing the Lac-Mégantic derailment).