Last week’s public hearing before the Surface Transportation Board on the proposed merger of Canadian Pacific and Kansas City Southern consisted of three days of testimony spanning over 25 hours on why or why not the merger should proceed.
And the hearing isn’t over yet. Shippers and other stakeholders provided oral testimonies to STB on Monday and Tuesday, while CP (NYSE: CP) is expected to respond to them during a hearing Thursday.
Shareholders of CP and KCS approved the $31 billion merger in December and the deal is now before STB for review. CP has said it hopes for the agency’s approval by early 2023. CP and KCS maintain the merger would create a single rail system known as Canadian Pacific Kansas City, or CPKC, whose network would extend from Canada into the U.S. and Mexico.
Here are seven takeaways from last week’s hearing, which focused mostly on the Class I railroads’ responses to the proposed merger:
1. Transcontinental railroad supports future manufacturing and export needs, CP says
CP and KCS justify the merger as a reflection of current and future North American manufacturing trends. For instance, vehicle parts can be made in the U.S. and Canada, automobile sections can be assembled in Mexico and finished vehicles can go to dealerships throughout North America or ports for export.
A railroad connecting Canada, the U.S. and Mexico would facilitate that manufacturing process as well as give companies increased access to new geographical markets and provide more port options for exporting goods, CPS and KCS have argued.
A CPKC network traversing north and south would function as a “superhighway,” linking producers and consumers across three nations and creating service options that “just don’t flat out exist today,” CP Chief Marketing Officer John Brooks said.
CP is working with some customers to test how intermodal service would function between the three North American countries, according to Brooks. One way it could operate would be for customers to haul goods via truck to Monterrey, Mexico, load them into equipment such as refrigerated containers and then have those travel north to Chicago, where the products would then be delivered to Upper Midwest markets.
That northbound equipment could then be “repositioned to a southbound movement. All that freight today is also moving via truck,” Brooks said.
A CPKC network could also provide vessel operators and beneficial cargo owners (BCOs) with 11 port options spanning Canada, the U.S. and Mexico, giving them opportunities to turn assets faster, according to Brooks.
2. CP-KCS merger should follow merger precedents, railroads argue
The Class I railroads and other stakeholders argued that the merger should have conditions and that CP and KCS are responsible for suggesting what some of those should be.
CP rival CN (NYSE: CNI) noted that past major mergers, such as between Union Pacific and Southern Pacific and CSX and Northern Southern’s acquisition of Conrail, resulted in the acquiring company offering numerous conditions.
“If you look at the major mergers in the past, the applicants understood that the benefits they sought nonetheless posed potential risks to service, competition and local communities,” said Ray Atkins, a transportation attorney providing counsel for CN. “And they worked/solved through [those issues] so that the merger would clearly be in the public’s interest.”
Atkins added that in the recent transaction where CSX sought to acquire New New England short line Pan Am Railways that it “bent over backwards” to address stakeholder concerns.
CN contended its largest concern with the proposed merger is that it would bear the brunt of any service disruptions or meltdowns since it is the largest interchange partner of CP. Atkins pointed out that the merger is expected to divert only approximately 0.1% of CN’s annual carloads.
Past mergers have also included service arrangements between railroads and shippers to ensure the continuation of adequate service. Such deals included a settlement agreement with the National Industrial Transportation League that came out of the Conrail acquisition and another settlement guaranteeing service levels for 10 years for some shippers when CN acquired the Illinois Central Railroad.
But CP’s application has yet to propose such arrangements, CN argued.
“The information submitted thus far is sorely lacking,” said Rob Reilly, CN chief operating officer. “The board should require submitting a service assurance plan to avoid making the mistakes of the past. A service assurance plan is especially critical, given the service issues in the United States rail network this year.”
3. Will Houston hold up post-merger?
Kansas City Southern trains currently pass through Houston. Also operating in the region are Union Pacific (NYSE: UNP) and BNSF (NYSE: BRK.B). Those attending last week’s hearing questioned whether Houston has enough capacity to handle an increased volume of trains, especially since the area is already prone to service issues.
KCS said it already has been working with UP and BNSF to resolve operational and service issues. All three railroads operate at a joint dispatch center in Texas, where they monitor the dispatching of trains over KCS tracks. KCS sports sufficient network capacity to handle existing and future rail operations based on KCS’ observations, according to John Orr, KCS executive vice president for operations. The three railroads have also made significant investments in Houston.
Furthermore, CPKC trains would only run through Houston and would not stop and switch traffic at area yards, unlike UP and BNSF, CP officials said.
CP President and CEO Keith Creel said CPKC would support five years of oversight by STB and that the merged railway would keep affected gateways open on commercially reasonable terms and honor its service promise.
“[CPKC] will collaborate with all users of Texas lines shared with CPKC to support coordinated operations and necessary infrastructure additions,” Creel said.
Creel also contended that capacity is also not just the physical infrastructure but how it is managed.
“Capacity, theoretical capacity and actual capacity are determined by a couple of factors: It’s train speed. It’s train length. It’s also track length,” Creel said. “If you have a disconnect between length of track and length of train, and you’re dependent upon a speed on the track that goes through, then you’re going to have unintended consequences.”
But UP and BNSF disagreed. They maintain that CPKC has not dedicated any transaction-related investments to the Houston area.
CP has said it plans to invest $276 million in the north-south corridor to support improved velocity and reliability.
“Applicants have failed to take responsibility for studying the step-level impact on both the increase of train traffic counts and train size through Houston,” said Jon Gabriel, BNSF vice president for performance, network design and strategy. “A comprehensive study is critical to help us assess the costs and the need for infrastructure improvements to handle these longer trains for this long-haul traffic.”
Gabriel pointed out that the merger would result in an increase of eight to 10 trains per day passing through Houston, which translates to about 3,000 to 4,000 per year.
Already, one out of every 30 carloads or intermodal containers shipped in the U.S. originates and terminates in Houston. Shipments passing through the region are coming from or going to 1,300 locations in 45 states, eight Canadian provinces and 40 stations in Mexico, according to BNSF.
4. Will Chicago hold up post-merger?
Chicago is a key to the U.S. rail network, with a quarter of American freight and over 40% of intermodal traffic touching the region.
In anticipation of increased traffic, CP plans to invest $56 million in the region, including the construction of three new sidings in the Marquette subdivision. It would also be making improvements to the Bensenville Yard in Illinois.
CP also said it would not use the Elgin (Illinois) subdivision, which commuter rail line Metra utilizes for passenger rail service between Chicago and the western suburbs.
“We’re not going to oversubscribe that network,” Creel said in response to questions about how CP and Metra will work together in ensuring that Metra trains run on time and neither company blocks rail crossings for too long.
But Metra has “serious concerns” about the impacts of the merger because six of the seven Class I railroads operate in Chicago and any CP-related service issues could spill onto the rest of the freight and passenger rail network there.
Metra pointed to CP’s “spotty cooperation” in dispatching trains in the past, saying CP tends to look out for its own interests first.
“Dispatching from a passenger-freight Chicagoland viewpoint is vital because all the other carriers in Chicago think along those lines,” said Greg Godfrey, director for the Metra Consolidated Control Center. “Respectful of CP … we’re not there with train dispatching, and putting [dispatchers] in the same room is not going to make a change.”
Metra also said it was concerned about insufficient capacity on the Marquette subdivision. The subdivision is single tracked and doesn’t have a lot of physical space to build out beyond the proposed three sidings, according to Robert Mulholland of L.E. Peabody & Associates, who was testifying on behalf of Metra.
Metra also argued that CP relied on an insufficient capacity analysis to gauge regional capacity needs, and it failed to perform rail traffic controller simulations to test and demonstrate operating plan feasibility. Without further capacity improvements or operational changes, delays could arise for CPKC’s intermodal, manifest and bulk trains, both on a regional basis and for the Marquette subdivision.
To address these concerns, Metra is asking to turn over CP’s dispatching responsibilities to Metra.
“We’ve presented a great deal of information that we only touched on,” said Eric Pilsk, a transportation attorney providing counsel for Metra. “Information showing a current and persistent pattern of dispatching problems, of interference by CP’s dispatchers [and] information from CP’s dispatchers that lead to delays and interference with Metra trains.”
Add increased traffic but no additional infrastructure for that traffic and “you’re going to have more and more pressure to make the system work,” Pilsk said.
5. Keeping gateways open
BNSF and UP insisted CPKC should keep international gateways open through STB-imposed conditions.
BNSF Chief Legal Officer Roger Nober defined open gateways as providing competing railroads with access to serve locations in Mexico, particularly with the KCS-operated network through Laredo, Texas.
KCS and BNSF compete for business north of the Laredo gateway, but only KCS has access in Mexico south of it, and past mergers have focused on how to preserve competition there, according to Nober.
Nober also expressed concern that the combined network would prompt CPKC to manipulate rates because of how the markets are set up in the U.S. versus Mexico. He recommended requiring a proportional rate mechanism or “prop rate” to keep market manipulation in check.
Michael Rosenthal, who provided counsel for UP, suggested STB have the merged railroad set up a rule in which a shipper could ask for a gateway rate. That rate would be a mileage-based prorate of a single-line rate to create an interline rate.
This choice would give shippers the ability not only to request a gateway rate but to check whether it is calculated correctly, according to UP.
6. Railroads ask for other operational changes
In addition to the question of open gateways, last week’s hearings also delved into two other operational issues.
First, the board heard CN’s request for KCS to divest its Springfield line running between Chicago and Kansas City, Missouri, as a merger condition. CN has said it would invest $250 million on the line.
Both CP and CN continued to maintain their stances about the potential divestiture.
“There is almost no traffic that interlines with CN, [and the line doesn’t compete with automotive or intermodal movements],” said KCS President and CEO Pat Ottensmeyer, adding that divestiture would create significant and substantial harm and no customers support it.
When asked by STB Chairman Marty Oberman why CN can’t ask for trackage rights instead, CN responded that a divestiture would enable the company to invest in the asset. CN also tried to work with KCS before the merger was proposed in order to bring more volumes to the line, but the arrangement didn’t pan out, CN representatives said.
Second, STB heard from Norfolk Southern’s (NYSE: NSC) request for contingent trackage rights on a stretch of the Meridian Speedway between Shreveport, Louisiana, and Wylie, Texas.
The Meridian Speedway runs between the Southeast and the central Texas markets and the Southeast and Southwest markets in California and Arizona. It starts in Meridian, Mississippi, and heads west. NS relies on access to the section of the route owned by KCS running from Shreveport to Wylie.
Should the merger proceed, CPKC could operate longer trains and NS also wouldn’t have access to a shipping program that UP utilizes, NS argued. CPKC also appears to want more volumes to go to Wylie, which has limited capacity.
If service deteriorates on that stretch of the speedway, trackage rights would enable NS to step in to maintain a level of service that customers would require, according to NS counsel Carrie Mahan.
Meanwhile, CSX (NASDAQ: CSX) countered that STB should scrutinize the arrangement between CSX and KCS in the first place, arguing that the agreement contains anticompetitive harms and prevents CSX from having access to gateways along the Meridian Speedway.
“The Speedway gateways and Laredo are key to taking Mexico truck traffic off the highways,” CSX said. “[The Speedway gateways are] only partially open to some carriers and some traffic.”
CSX wants CPKC to fully open those gateways.
7. Community leaders respond
While the bulk of last week’s hearings focused on the merger conditions requested by the other Class I railroads, portions focused on the effects that additional trains could have on local communities in Texas, Minnesota and Illinois, both in terms of traffic and air quality.
Texas officials testified that their concerns about air pollution and blocked rail crossings weren’t addressed by CP and KCS and even the board itself. They estimate that 5 million live along the lines, and an STB public hearing conducted locally was located too far away from where the most vulnerable populations resided.
It is “morally imperative” that CP and KCS study the impact that additional trains would have on this community, said Harris County Commissioner Rodney Ellis. Problems that arise from existing train traffic include waste removal being hindered from delivering to landfills and children hopping through stalled cars to reach school. Ellis said the Harris County Commissioners Court recently passed a resolution seeking equitable and proportional mitigation strategies should the merger be approved.
The Coalition to Stop CPKC, a group representing eight communities in Chicago’s western suburbs, are proposing STB require crossing-delay-mitigation measures similar to what the agency suggested when CN acquired the Elgin, Joliet & Eastern Railway in Illinois.
The coalition estimates that of the 54 at-grade crossings in the communities, 30 involve roadways that carry in excess of 250,000 vehicles daily. The merger could result in 4 million vehicles blocked per year because of downed gates, according to Christopher Snyder, director of transportation for DuPage County, Illinois.
“The applicants have called the coalition members NIMBYs,” said Stop CPKC counsel Thomas Wilcox, referring to the acronym for the phrase “not in my back yard.” “But freight trains are already in the coalition’s backyard. They already have problems with existing traffic. And so the applicants must not be given a free reign to put their economic interests over the public interest of the communities.”