Renaissance Angst: Shippers, railroads and policy-shapers struggle to address the what-to-do-about-capacity? question

By Pat Foran, Editor

Despite a dramatic traffic drop-off during the year’s first five months, the prospects for growth in the North American rail industry are still good. Really good. This “Railroad Renaissance” is real and it’s sustainable — presuming railroads, rail shippers, policy-shapers and other stakeholders can find and finance the capacity that’ll be needed to meet the burgeoning demand to come during the next decade.

How are they faring? Are railroads and shippers working together on this — or, at least, talking about jointly combating capacity constraints?

If railroaders, shippers and other stakeholders are talking constructively in terms of coming to grips with the “What-to-do-about-capacity?” question, they haven’t been doing it publicly in recent months. If anything, they seem to be working at cross purposes. Shippers are screaming that revenue-adequate railroads have been jacking their rates way too high; some investors insist the rails haven’t been raising rates high enough. Meanwhile, shippers, railroaders and policy-shapers are beginning to grapple with the capacity question but they’re hardly grappling collectively.

How will the various stakeholders interact? Will there be at least a modicum of much-needed dialogue? How will the players attempt to solve problems? Will their inability to work together prompt Congress to step in and do the solving for them?

Welcome to the anxiety-ridden initial phase of The Railroad Renaissance. And the anxiety levels are only going to increase as the stakeholders hold their ground and/or demand to be heard, and as the various inter-relationships in play here — railroads and shippers, railroads and investors, railroads and regulators, rail management and rail labor — evolve in the months ahead.

“We’re definitely in a different time than we’ve been in before,” says Michael McBride, a partner in law firm LeBoeuf, Lamb, Greene & MacRae L.L.P.’s Washington, D.C., office, who represents shippers in litigation involving transportation, environmental issues and rate-making. “But there are opportunities for all sides to make some progress.”

It’d help if all stakeholders were on the same “progress” page, or at least near it. But they aren’t.

New era, new anxieties
Evidence of the disconnect began to surface early last year, as rail traffic and fuel prices surged — and as railroads continued to raise their rates.

In January 2007, the Surface Transportation Board (STB) issued a rule prohibiting railroads from assessing fuel surcharges as a percentage calculation of a shipper’s base rate — a manner that doesn’t correlate with actual fuel costs for specific rail shipments, the STB said. The rule also prohibits “double dipping,” a practice through which railroads apply a fuel surcharge and rate increase to the same traffic based on a cost index with a fuel component.

Shipper organizations such as the American Chemistry Council (ACC) hailed the rule but added that more needed to be done on Capitol Hill to provide regulatory relief. “We will continue to press Congress and all appropriate regulatory agencies for fairness in every aspect of our relationship with the railroads,” said ACC Senior Director for Distribution Tom Schick.

Particularly Congress — especially since some shippers are convinced that the STB rate-regulatory process is of no use to them. “Cost plus a fair return — that’s what we were promised once the railroads were revenue adequate,” says attorney

McBride, who earlier this year authored an article on the subject (“After Otter Tail, Most Rate Regulation is Kaput”) for the Journal of Transportation Law, Logistics and Policy. “Well, they’re revenue adequate. And we got a higher rate standard.”

And if there’s no regulatory relief, shippers will seek a legislative solution. “It’s the only alternative,” McBride says.

It’s certainly one that rail customers have attempted several times since the mega-merger-meltdown days of the 1990s, but there’s growing sentiment among shippers that with a Democratic-controlled Congress, they just might get there this time. This go-round’s entry? The Railroad Competition and Service Improvement Act of 2007 (H.R. 2125), which was introduced in the House in early May.

A companion bill to S. 953, which was introduced in the Senate in March, H.R. 2125 proposes to amend title 49 of the U.S. code to “ensure rail industry competition, enable rail customers to obtain reliable rail service and provide those customers with a reasonable process for challenging rate and service disputes,” according to the bill’s text. The legislation would clarify rail transportation policy and provide implementation directives; require railroads to provide transportation rates; eliminate competition barriers between Class Is, IIs and IIIs; improve the rate reasonableness standard and arbitration of rail disputes; and authorize the STB to investigate and suspend certain railroad actions.

Backers of H.R. 2125 include rail customer advocacy groups the Alliance for Rail Competition (ARC) and Consumers United For Rail Equity (CURE) — and one notable rail labor organization: The United Transportation Union (UTU).

“H.R. 2125 ... is a step in the right direction,” reads a May 21 form letter UTU suggests members send to their congressmen. “It requires additional competition between railroads. This competition should result in more shipments and an increase in shipments would mean more railroad jobs.”

The bill — which was referred to the House Committee on Transportation and Infrastructure — and S. 953 join the Railroad Antitrust Enforcement Acts of 2007 (H.R. 1650 and S. 772) among what the rail lobby refers to as “re-regulation bills” in Congress. Introduced in March, H.R. 1650 and S. 772 propose to amend federal antitrust laws to expand coverage and eliminate exemptions that are “contrary to the public interest with respect to railroads.”

Railroads reject the notion that they enjoy wide-ranging immunity from anti-trust laws, giving them freedom from government oversight. They also steadfastly oppose any and all re-regulation proposals, which the Association of American Railroads (AAR) says would force railroads to “transfer billions of dollars in revenue via lower-than-market rates to certain favored rail shippers at the expense of other shippers, rail employees, rail investors and the public at large.” If enacted, re-regulatory proposals would devastate the freight-rail system, making it “virtually impossible” for railroads to make the infrastructure investments necessary to meet growing transportation demand, AAR says.

Shippers aren’t convinced.

“We’re seeing an unprecedented amount of investment flowing in the rail industry, so it’s a little hard to figure out what the problem is,” McBride says. “A little bit of regulation — what the current law is supposed to be providing — isn’t going to hurt. The railroads’ claims are just completely overstated.”

A chilling effect
Historically, the “re-regulation” debate has ended in a “he said/she said” stalemate with minimal (if any) fall-out. This time, it could be different.

In addition to the potential for legislation to actually see the light of day, the tenor of the debate has chilled the momentum of a proposal many transportation policy-shapers believe could help bridge the infrastructure capacity gap: investment tax credits.

Introduced in the Senate in April, the AAR-backed Freight Rail Infrastructure Capacity Expansion Act (S. 1125) proposes to provide a 25 percent tax credit for capital expenditures made by railroads, shippers, ports, trucking companies and other transportation businesses to build or expand track, intermodal facilities, yards or other rail infrastructure, or to acquire locomotives. The Freight Rail Infrastructure Act of 2007 (H.R. 2116) — a companion bill to S. 1123 — was introduced in the House on May 3.

“This legislation ... offers a proactive approach to dealing with the central challenge of how to move more freight without causing more gridlock on our highways,” said AAR President and Chief Executive Officer Edward Hamberger.

Numerous transportation policy-shapers support the tax-credit concept.

“If Congress and DOT are serious about creating an up-to-date transportation network, they will begin by working with the private sector to create a seamless intermodal infrastructure,” Intermodal Transportation Institute (ITI) Chairman Thomas Finkbiner said during a speech at the Mississippi Development Authority’s 2007 Global Logistics Conference in March. “Passing the proposed 25 percent tax credit for freight railroad capital investments would be a good first step.”

‘New code words’
But shippers aren’t so sure. To United Parcel Service (UPS), federal tax incentives that enable railroads to purchase locomotives “does little to improve consistency and reliability of rail service,” UPS Vice President Tom Jensen said in testimony during an April 11 STB hearing on capacity and infrastructure requirements. “Any investment tax credit should be focused on improving fluidity of the franchise.”

What’s more, UPS believes railroads should support alternative capacity initiatives, including public-private partnerships and the establishment of a railroad trust fund “financed by the very users of the system,” Jensen said, characterizing railroads’ refusal to consider the option as “disappointing.”

Other shipper organizations fear “rail infrastructure investment will become new code words for more and higher rate increases for captive shippers,” ARC Executive Director Michael Snovitch said during the April 11 STB hearing.

And although the National Industrial Transportation League (NITL) generally has supported the investment tax credit concept, it didn’t back the bill that died last year and has not commented publicly on the ‘07 version.

Bottom line: The investment tax credit proposal’s fate is anything but certain.

“Railroads have some hope for progress on the investment tax credit, but at the same time, UTU’s support of [H.R. 2125] gives the shippers a much-improved prognosis for our proposals going somewhere, as well,” McBride says.

Indeed, UTU’s decision to enter the “re-regulation/competition” fray suggests, at the very least, a disconnect between rail management and a union that represents 40,000 train and engine-service workers — at worst, an unbridgeable gap that could require federal fixing at policy-shaping time.

“For all practical purposes, today’s American railroads are essentially a duopoly,” reads UTU’s May 21 form letter. “They have raised rates much faster than inflation. Their stocks are even being sought by Warren Buffett.”

The Buffett factor
In April, Buffett told CNBC that Berkshire Hathaway Inc., a company in which Buffett has a 40 percent stake, now owned 39 million shares of Burlington Northern Santa Fe Corp. stock, or 10.9 percent — becoming BNSF’s largest shareholder. A few weeks later, Berkshire Hathaway disclosed that as of March 31, it held 6.4 million shares in Norfolk Southern Corp. and 10.5 million in Union Pacific Corp.

By beginning to invest in railroads late last year, Buffett demonstrated that he, too, recognized that The Rail Renaissance is real, and that there’s money to be made in this industry over the longer haul — which, of course, only served to prompt shippers and UTU to reaffirm their resolve to pursue legislative relief.

Buffett hasn’t been the only high-profile investor to buy in. Last month, London-based hedge fund TCI Fund Management L.L.P. announced it, too, was buying rail stocks. As of March 31, TCI owned 17.8 million shares, or 4.1 percent, of CSX Corp.’s stock; 2.1 million of UP’s and 6.4 million of NS’ stock. Also last month, another billionaire — Carl Icahn — purchased 2.7 million shares of CSX Corp.

But when high-profile investors buy in in such big numbers, they expect their concerns to be heard and heeded — another reason there’s potential for angst in railroad board rooms.

Witness the warning TCI partner Snehal Amin issued during last month’s Bear Stearns Global Transportation Conference. Essentially, Amin told rail management to stop coddling customers and raise rates, figure out how to become more productive, change the capital structure — and watch their backs if they don’t get the job done (for more details, see “From The Renaissance to The Reformation?” — independent analyst Tony Hatch’s take on the Bear Stearns event — sidebar).

So there’s plenty of fear and loathing to go around — and will be for awhile. In the meantime, shippers expect to move slightly more freight from rail to truck and “less from truck to rail in 2007 than we have seen for several years,” noted research analysts in Bear Stearns & Co. Inc.’s first-quarter shipper survey. Shippers cited pricing, as opposed to service, for the change, which “bucks the longer-term secular trends toward railroads,” shippers told Bear Stearns.

Even so, rail rates are still lower than truck’s, according to the survey.

“We’ve seen the last of cheap fuel. Customers are going to have to get used to the new prices,” says ITI Senior Chairman Gil Carmichael, a former Federal Railroad Administrator. “The manufacturers, the Wal-Marts — they’re going to have to be real smart to make money in the new era.”

Rail management, too, is going to have to get smarter to stay the profitability course. They’ll need to know how to respond when the TCIs of the world zero in on them — and to find new ways to squeeze more capacity out of a rail system that’s carrying only 25 percent of its capacity, Carmichael says.

“If we go back to double- or triple-tracking, grade separation and GPS, it would equal three times more capacity — and this right-of-way already is in place and paid for,” he says.

Eventually, though, it’d behoove the stakeholders to join forces to promote and fund a coherent national transportation policy, something the federal government has failed to do, says ITI’s Finkbiner.

Unfortunately, there’s little out there to suggest that could happen anytime soon. Except for this: a nagging belief that the primary stakeholders really do get it ... and that they’ll get to the table, roll up the sleeves and figure out how to work together. Later rather than sooner, perhaps. But eventually.

NITL officials in the not-too-distant past have talked about “building bridges with rail carriers” to boost capacity. The pledge still holds — no matter the level of angst. Railroads, too — rail CEOs have said too many times (and said it soberly) that they cannot stay the growth course without collaborating — with each other, as well as customers.

It’s all part of the evolution and the rebirth (i.e., “renaissance”) experience. And it’s just something the stakeholders are going to have to work through — at some point, together.