A directive issued by President Biden a few months ago has transformed how freight railroads are regulated and may have completely upended the balance of power over shippers the rail industry has long enjoyed.
Until now, Class I railroads could count on a relatively somnolent Surface Transportation Board (STB), which operated timidly and—when on occasion it chose to bestir itself—moved at a tortoise-like pace. Shippers not only found little recourse there, they had resigned themselves to the realization that they also could obtain small relief from a Congress where their rail adversaries deployed massive war chests and commanded small armies of high-priced attorneys.
The most widely reported recent development was how the STB scuttled the proposed merger of Canadian National Railway and Kansas City Southern. The board voted 5-0 not to allow KCS shares to be placed into a voting trust while the merger agreement was under government review, an action requested by CN as a preliminary step to finalizing the merger.
The board vote was seen as definitive evidence that eventual STB approval of the merger would not be forthcoming, and CN’s board of directors voted to withdraw from the merger soon afterwards.
The KCS board then voted to approve a $31 billion merger offer from Canadian Pacific, which earlier this year had made a $28 billion offer that was accepted by KCS, only to be supplanted shortly thereafter by CN’s $33.6 billion offer, which the KCS board was forced to accept because of its fiduciary duty to shareholders to maximize their stock value.
The newly combined system will stretch from Canada to Mexico over about 20,000 miles of track stretching from Canada throughout the Midwest but will be the smallest of the North American Class I railroads in terms of revenue. The new company will be called Canadian Pacific Kansas City (CPKC) with head offices in Calgary and U.S. headquarters in Kansas City.
“While we are disappointed that we will not be able to deliver the many compelling benefits of this transaction to our stakeholders, the decision to bid for KCS was a bold and strategic move that still resulted in positive outcomes for CN,” said CN’s CEO Jean-Jacques Ruest.
Unfortunately, his remarks failed to impress a British hedge fund manager who is hunting for his scalp. TCI Fund Management Ltd. already holds a 5% stock ownership position in CN and is waging a proxy fight to oust Ruest and replace him with former Union Pacific chief operating officer Jim Vena.
“The [CN] board consistently misjudged the STB and displayed flawed decision making, committing billions of dollars to an ill-conceived pursuit of an unattainable asset,” declared Chris Hohn, founder and managing partner of TCI, which is proposing a slate of new board members who, like Vena, are experienced freight transportation executives.
Just Getting Started
Biden’s July executive order directing the STB to encourage rail competition has been fully embraced by the board’s leadership. Chairman Martin J. Oberman was present at the July ceremony where the President signed his executive order and immediately issued a statement expressing his strong support for it.
Speaking earlier this month at the North American Rail Shippers Association (NARS) annual meeting, Oberman made it clear that he believes the big freight railroads have wandered down the wrong path when most of them chose to embrace the Precision Scheduled Railroad (PSR) operations model in recent years.
“The strategies pursued by the railroad industries as a whole, and it is not the same among all the Class 1s, have serious implications as to whether the ‘common carrier mandate’ is being carried out as intended and as required by statute. This is a subject that may warrant further exploration by the STB,” he told the assembled shippers.
This is a very serious charge that strikes at the very heart of government regulation of railroads—the common carrier obligation. This may seem to be a bit of legalistic arcana left over from the era of strict economic regulation enforced by the old Interstate Commerce Commission (the STB’s predecessor organization), but it reaches back to the earliest days of English common law and remains in full force as a legal doctrine.
The basis is really quite simple. If you are going to use the king’s highway to transport goods, you must abide by the king’s rules, which forbid you to discriminate against different shippers for arbitrary reasons simply because you can. This was inscribed in U.S. law when railroads were given land grants by the government to build their regional and nationwide systems and were expected to abide by the common carrier obligation in return.
The unfettered pursuit of profit under the principles of free market capitalism never completely applied to this industry after Congress imposed economic regulation in the 1880s. Since then, in one way or another, the federal government has had a role in regulating railroad rates, practices and fees, and that never went completely away even when Congress “deregulated” the industry in 1980 when it passed the Staggers Rail Act.
In fact, it was not too long ago after local and city governments sought to ban outright or strictly regulate rail hazardous materials shipments, and the affected railroads sought to solve that problem by announcing they would stop hauling hazardous materials. The STB, citing the common carrier obligation, then told the railroads: No, you won’t.
But the binds loosened by the Staggers Act had another impact. A wave of rail mergers in the 1990s saw the creation of regional monopolies, leading to poor service and high rates that became the source of anger for shippers. In more recent years, shippers started to become more outraged by widespread adoption of the PSR model that calls for the ruthless slashing of costs and raising rates, fees and demurrage charges to drive profits to shareholders at the expense of everyone else, including labor and rail customers.
Oberman told the shippers at the NARS meeting, “In the last 15 years, since 2006, our economy has grown by more than 50%—nearly $8 trillion of enhanced economic activity, and yet railroads are carrying less freight today than they were in 2006 while rates have gone up. There just might be a connection.”
Profit at All Costs?
This has implications for other national priorities, he asserted, including the goal of taking freight off trucks and onto more fuel-efficient railroads. “It is clear that as a whole, railroads have foregone many kinds of carloads that they could carry profitably, only not at operating ratios as low as 55%, and instead have focused only on the most profitable traffic,” Oberman observed.
“No one is asking the railroads to focus on traffic that would only be carried at a loss. But surely it is not asking too much for railroads to actively seek profitable traffic, even if not as profitable as others.”
Over the past 10 years, the five U.S.-based Class I railroads—through stock buyback programs and dividends—have paid $191 billion to investors but only spent only $138 billion on capital investments, he pointed out.
“That’s all well and good for the owners, but where would rail customers, rail workers, and the public be if a meaningful portion of that $191 billion had been reinvested in expanding service and making service more predictable, reliable and on time?” Oberman asked.
The answer is clear, he explained. “We would have more freight moved, more quickly, and at lower rates. We would have more employment with better working conditions. And the public would be better served with a boost to the economy, lower consumer prices, and far cleaner air and safer and better conditioned highways.”
Until recently, the STB had only taken a few baby steps in this direction, such as requiring more explicit wording on shipping documents about demurrage fees and accessorial charges. However, the KCS vote may have been a signal that the old quiescent board used to casting a blind eye on rail rates and practices may be a creature of the past.
Last June, Oberman told another shipper gathering that the issue of reciprocal switching “is near and dear to me,” which suggests the board may be ready to mandate the practice, which allows railroads to operate on each other’s systems. This is a goal shippers have chased for decades without avail.
On Sept. 2, the board opened an official investigation seeking comment on railroad first-mile, last-mile (FMLM) practices, which refers to the movement of railcars between a local railroad serving yard and a shipper or receiver facility, a sore subject for shippers who have complained in recent years of serious deterioration in the quality and sometimes utter lack of this kind of service.
The PSR model recognizes that the lowest cost, highest profit rail transportation services are linehaul operations: driving a long train from one city to another. All of the other services, like loading and unloading, separate cars out and deliver them to local customers’ rail spurs. Much of this service has been abandoned or turned over to short haul railroads, and the rest is being strongly discouraged via bad service.
If the STB intends to address this issue, it needs to get a better handle on what is actually going on beyond anecdotal reports from shippers. As the old saying goes: You can’t manage what you can’t measure. The STB is still able to regulate rail rates and practices, but it needs the numbers to do so, which is why it opened the FMLM proceeding.
Also seeking improved measurements of FMLM service failures are the Rail Customer Coalition, Freight Rail Customer Alliance, National Coal Transportation Association, National Industrial Transportation League, Private Railcar Food and Beverage Association, American Chemistry Council, and the Fertilizer Institute.
In earlier hearings dealing with demurrage and accessorial charges, shippers also accused the railroads of exploiting FMLM practices to increase the amount of fees customers are required to pay by making it impossible to return rail equipment in the shortened time periods imposed by the rail lines. The practices include rail-created delays and overburdening shipper facilities by delivering a larger number of cars than expected and that turned around promptly.
The Class I railroads may need to take a second look at their over-enthusiastic embrace of PSR, or face the wrath of a newly muscular STB that has the full backing of the President.
