02 May 2023 3 min read

What does the US Railway Safety Act mean for investors?

By Steven Marszalek

New legislation tabled after February's derailment in Ohio is set to significantly increase the regulatory obligations of American railroads. We examine the details of the plans, and explain why we remain constructive on railroad credit.

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Following the Norfolk Southern train derailment in February in East Palestine, Ohio, US legislators introduced the Railway Safety Act of 2023 in the Senate. The bill contains several provisions aiming to improve railroad safety and increase the financial penalties against railroads in the event of derailment.

President Biden has signaled his approval of the bill, but both the House of Representatives and the Senate must first approve the bill. The bill is currently in committees to be brought to the floor for debate, and timing is unknown. Some legislators are urging patience until the full National Transportation Safety Board accident report is completed, which will take several months.

We do not take a view on the likelihood of the bill passing, but this blog explores the financial impacts if it does.

Hotboxes: Positive Train Control 2.0?

Wayside detector systems, commonly called hotboxes, are temperature-measurement devices installed alongside tracks to collect and communicate railcar temperature information. When railcar temperatures rise, hotboxes send an overheat signal to the conductor to stop the train before temperatures rise to the point of posing derailment risk. As witnessed in East Palestine, long gaps in hotbox systems leave train cars susceptible to rapid temperature increases and derailment risk.

The act would require railroads to install hotboxes every 10 miles on tracks carrying hazardous materials. While limited data is available on hotbox coverage, it’s estimated Norfolk Southern may need to install up to 1,000 new hotboxes, with each one costing $100,000-250,000. The potential $240 million cost for Norfolk Southern would equal 2% of its 2022 revenue.

This spending requirement would be similar to 2008's Positive Train Control mandates, which cost railroads 1-2% of annual revenue over multiple years. The sector expanded operating margins throughout that spending period, and we expect railroads to continue making returns on their capital investments. Railroads spend 15-20% of annual revenue on capital expenditures, and as a one-time requirement this would not be a material long-term financial impact for railroads.

Train crew requirements: already in place

The new act mandates two-person crews for every train operating above 25 miles per hour. This requirement is already being met via collective bargaining agreements; the new law would only affirm this requirement. Therefore, this aspect of the law would not financially impact railroads.

Railroads have been exploring one-person crews as a potential avenue for additional operating margin improvement, but the act would eliminate this margin opportunity.

Higher fines: tough but manageable

Another change is the proposed maximum fine increase for derailments. Currently, The Federal Railroad Administration can only levy fines up to roughly $225,000 per derailment. The act increases this penalty up to 1% of a railroad's annual operating income.

For Norfolk Southern, a derailment under the new Act could cost up to $48 million. While this represents a steep increase, it would remain manageable as the six Class 1 railroads carry derailment insurance and generate operating margins north of 35%.

Tank car retirements: customers will shoulder the burden

The act would accelerate the retirement of DOT-111 tank cars, which have been a popular target for regulators given recent technology and safety improvements. The 2016 FAST Act already requires the retirement of these cars by 2029, and the act would bring this forward to May 2025.

Most tank cars are owned by railroad customers, and thus the rule change would have a limited financial impact for the railroad, if any. There could be volume limitations until full adoption of new tank cars occurs, but customers are already in the process of transitioning to newer tank cars.

Train length limits: the critical unknown

The act grants the Secretary of Transportation the ability to set maximum train lengths. While we do not yet know what limits may be set, limits could reduce railroad operational flexibility and profitability. Several studies reveal correlations between train length and operating margins as railroads gain operating leverage on longer trains.

Train length limits could be the most critical piece of the legislation, and we will need to monitor this as the Department of Transportation releases further details. Railroads would be able to mitigate some of the impact through their strong pricing power, but some impact will be felt if train length limits are imposed.

In closing, we see the railroad sector facing minor financial impacts from the proposed legislation. However, in our view the sector has quite strong operating profitability and pricing power, and we see the industry mitigating the majority of financial impacts. While there will doubtless be more political headlines, we believe railroad credit will not be materially affected by the act and we remain constructive.

Steven Marszalek

Research Analyst

Steve is a Research Analyst on the Investment Grade Credit Research team in Chicago. Steve covers the Aerospace/Defense, Capital Goods, Municipals, and Transportation sectors.

Steven Marszalek