Defining what it means to provide rail shippers with robust competitive options could be the lens that the Surface Transportation Board uses as it responds to an order from President Joe Biden aimed at promoting competition within the freight railroad and maritime industries.
But it remains to be seen how exactly the STB, the independent federal regulatory agency responsible for handling rail rate and service matters, will balance shipper concerns with ensuring that the freight railroads can maintain and invest in their infrastructure and compete with other transportation modes.
“At a time when the rails need volume growth to drive earnings for the first time in years, this would be an unwelcome development,” said Morgan Stanley (NYSE: MS) transportation analyst Ravi Shanker in a research note last Thursday on Biden’s efforts. “After years of cutting costs faster than their volumes have been declining under the PSR [precision scheduled railroading] umbrella, the U.S. rails are now at a point where they need to actually grow volumes and revenue to drive growth because they have likely hit a wall on how much cost/resources they can cut.”
Biden’s order and STB’s response
To “promote competition and economic opportunity and to resist monopolization,” the Biden order from Friday uges STB Chairman Marty Oberman to work with fellow board members on the following:
- Begin a rulemaking or reinvigorate an earlier proceeding to encourage reciprocal switching, which aims to provide captive shippers with access to nearby competing railroads.
- Consider introducing or reexamining rulemakings related to competitive access, such as bottleneck rates and interchange commitments.
- Ensure that passenger rail service, including Amtrak, isn’t subject to unwarranted delays or interruptions in service because host railroads failed to give passenger trains priority. The order also enforces new on-time performance requirements.
- Ensure that a merger or acquisition is considered with the public interest in mind. This would include determining whether the merger or acquisition would give passenger rail preferential treatment on the U.S. rail network, as Class I railroads are federally mandated to do so.
Oberman responded Friday that the board has been actively looking at the issues raised in the Biden order. Oberman said he would urge fellow board members to prioritize issues related to competitive access, shipper visibility into first-mile/last-mile service and accessible and practical rate relief options.
“During my time on the board, I have been continually concerned with the significant consolidation in the rail industry that happened as a result of a series of mergers decades ago, which dramatically reduced the number of Class I carriers,” Oberman said. “It is apparent that while consolidation may be beneficial under certain circumstances, it has also created the potential for monopolistic pricing and reductions in service to captive rail customers. Since consolidation, productivity gains often have been retained by carriers in lieu of being passed on to consumers, as would be expected in a truly competitive marketplace.”
He continued, “For these reasons, I have previously stated my concerns with the sufficiency of competition in the rail industry and my interest in exploring ways the board can improve the rail industry’s competitive landscape in order to ensure fairer pricing. In my opinion, competition in the freight marketplace is paramount. In the absence of a truly competitive marketplace, the board can and should focus on using its competition-related authorities where feasible and reforming its competition policies where necessary.”
Oberman also noted that STB would soon be announcing how the board expects to investigate and enforce on-time performance standards.
Could the order harm the railroads?
Freight rail proponents view the Biden order as being a “negative” for the freight rail industry and one that could potentially find its way to the courts should the industry perceive that the regulations are too heavy-handed, according to Wall Street analysts.
Reciprocal switching “in theory gives shippers more optionality, but as we have noted in the past, switching often comes with declining rail service levels due to delays,” said Jason Seidl, transportation analyst for investment firm Cowen (NASDAQ: COWN), in a Thursday note. He added that reciprocal switching already exists in Canada.
The challenge for the freight rail industry is that the order comes at a time when the railroads need to grow their volumes, according to Shanker.
“If the rails were looking to flex pricing muscle to offset structural volume weakness, regulatory scrutiny on their pricing power is ill-timed,” Shanker said. “Much of the recent shipper angst has stemmed from the service disruptions driven by the PSR resource cutting but the new regulatory environment will give shippers more runway to be vocal complaining about price as well.”
Although the order doesn’t have an immediate impact on the freight rail industry, the board is poised to add a Democratic member to replace current board member and former chairman Ann Begeman, whose term will end at the end of this year. If the board can add a Democrat to its five-person roster, the Democrats would have the majority and the Biden order could influence the shape of how STB takes up issues, according to Shankar.
The Association of American Railroads (AAR) came out against the order, calling it a “misguided direction to interfere with functioning freight markets that could ultimately undermine railroads’ ability to reliably serve customers.”
The trade association, which counts the Class I railroads as well as Amtrak as its members, argued that large corporations have been dissatisfied with fair-market rates and have been lobbying for years to force the railroads to “hand over traffic to competitors” so that these companies can get lower rates. Such measures would benefit select shippers at the expense of making the whole rail network, including passenger operations, less efficient, according to AAR.
“Any STB action mandating forced switching would put railroads at a severe disadvantage to freight transportation providers that depend upon taxpayer-funded infrastructure,” AAR President and CEO Ian Jefferies said. “Such a rule would degrade rail’s significant benefits to both customers and the public by throttling network fluidity, disincentivizing investment, increasing costs to shippers and consumers, and ultimately diverting traffic onto trucks and the nation’s already troubled highways.”
Although analysts noted that the order addresses freight rail M&As, the order doesn’t explicitly call out efforts by Kansas City Southern (NYSE: KSU) to merge with CN (NYSE: CNI) or even Canadian Pacific (NYSE: CP). Both CN and CP have been vying to acquire KCS, although KCS opted to accept CN’s bid in May after previously saying that it would merge with CP.
Rail shippers rally in support of the order
Rail shipper coalitions praised Biden’s order, viewing it as an opportunity not only to promote competitiveness but also to ensure efficiency within the supply chain, especially since the order also discussed regulating the maritime industry.
“The National Industrial Transportation League (NITL) has long championed improvements in competition in both ocean and freight rail transportation and we applaud the administration for recognizing that current business practices in each sector are disrupting and delaying delivery of goods and services, adding unnecessary costs for businesses, and ultimately creating higher costs for consumers,” said NITL Executive Director Jennifer Hedrick. “The issuance of this order will not only address these major challenges but also bolster American businesses.”
She continued, “We’re especially pleased to see the administration’s calls for vigorous enforcement toward ending unfair detention and demurrage practices that are crippling the maritime supply chain, and its request that the Surface Transportation Board proceed with the open rulemaking on competitive rail switching, originally filed by NITL with the STB 10 years ago this week.”
The Freight Rail Customer Alliance (FRCA) said it was “encouraged” by Oberman’s statement on Biden’s order, which the group said “embraces the spirit” of the order.
FRCA “applauds and greatly appreciates President Biden’s continued commitment in helping to strengthen our nation’s international competitiveness, foster competition in varied and numerous sectors of the economy, and address noncompetitive rate and service practices,” said FRCA President Shelley Sahling-Zart.
FRCA wants the board to implement the April 2019 recommendations of STB’s rate reform task force and address revenue adequacy determination criteria, in addition to moving forward with reciprocal switching, scrutinizing M&A proposals and requiring the collection of on-time performance data at the first mile and last mile as as a way to provide shipper visibility.
Meanwhile, the American Chemistry Council (ACC) also supported the order’s directive for STB to pursue a rulemaking on reciprocal switching.
“Transportation costs for many large and small businesses are rising sharply as a result of consolidation and lack of competitive service, especially when it comes to freight rail,” ACC said.