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A slump in North American rail volumes, record Canadian grain rail shipments and an active Surface Transportation Board were just some of the prominent themes in 2019. Here’s a list — far from exhaustive — of some of the key issues that faced the rail industry this year.
Lower rail volumes in North America
Perhaps the most visible theme in 2019 was the weekly year-over-year decline in rail volumes, which resulted in the readjusting of earnings guidance by some of the Class I railroads.
In the first half of the year, severe floods stymied Midwest freight rail operations, with Union Pacific (NYSE: UNP), BNSF (NYSE: BRK), Kansas City Southern (NYSE: KSU) and even Eastern U.S. railroad Norfolk Southern (NYSE: NSC) needing to reroute service and/or repair damaged sections of track in states such as Nebraska, Iowa and Missouri.
But as the year progressed, rail volumes continued to trend lower as a result of a variety of factors, which deserve their own heading:
“The question of whether intermodal will resume as a growth area depends on the rails’ behavior, the railroad marketplace and railroad regulations,” Baudendistel said. “Will the rails reach a point at which their operating ratios flatten out, necessitating a growth avenue? Or will regulators and a relatively uncompetitive market continue to allow railroads’ operating ratios to march ever lower, making intermodal volume growth an afterthought?”
Image: Benjamin Wagner/Unsplash
An active Surface Transportation Board
The addition of two board members to the Surface Transportation Board (STB) this year has brought about a renewed interest to review longstanding rail rate-related issues, such as revenue adequacy and whether some commodities should remain exempt from being regulated by the board.
The board is considering many of the suggestions listed in an April report by its Rate Reform Task Force, some of which are considered to be shipper friendly because they aim to make the process to contest rail rates easier. The board recently held a two-day hearing (Day 1 coverage and Day 2 coverage) on revenue adequacy. Board members also held a hearing in May on demurrage and accessorial charges (Day 1 coverage and Day 2 coverage). Some of the Class I railroads have modified their policies governing the charges as a way to incentivize shippers to return railcars faster. The railroads modified their policies as they took steps to further integrate precision scheduled railroading (PSR, see below) into their operating models. PSR seeks to streamline rail operations by running trains on a fixed schedule. But some shippers have argued that they are being penalized unfairly for delays that were caused by the railroads.
The tenor of the debates between the railroads and shippers has caused some to question whether the relationship has broken down and needs to be repaired.
Operational ratios reach record lows
With all the Class I railroads except BNSF deploying PSR, the railroads have cut costs and looked at how best to utilize their assets from a PSR standpoint. The result has been record low quarterly operating ratios (OR) even in spite of lower rail volumes. A falling OR, which is often calculated by dividing operating expenses by revenues, can indicate a company’s increasing profitability to investors.
Union Pacific, Norfolk Southern (NS) and Kansas City Southern implemented or completed the first phases of their versions of PSR in 2019, while executives from CSX (NASDAQ: CSX) and the Canadian railroads reminded investors in quarterly earnings calls that they have employed PSR for several years running.
“We believe we’ll see the fruits of our efforts in the form of a resumption of growth. … But if we don’t, we’ll push even harder on efficiency measures [and] on productivity measures to get to the 60[%] OR,” said NS CEO Jim Squires during the company’s third-quarter earnings call on Oct. 23.
Image courtesy of Canadian Pacific
Canadian grain shipments reach record highs
Although U.S. grail volumes via rail slumped amid severe floods in the Midwest and Chinese tariffs on grain products such as soybeans, Canadian Pacific (NYSE: CP) and Canadian National (NYSE: CNI) hauled record-high grain volumes for the agricultural year running from Aug. 1, 2018, to July 31, 2019.
CP and Canadian National (CN) were able to move so much grain and grain products in part because of incentives in the Transportation Modernization Act of 2018 that encouraged the railways to invest in capital infrastructure and rail equipment. That, coupled with private investments by grain stakeholders, enabled the railways to support more export-bound grain movements.
Strike at Canadian National and labor relations
The eight-day strike at CN in November by members of the Teamsters Canada Rail Conference sent ripples across the Canadian supply chain. Trade associations representing chemical, grain and mining interests said the strike disrupted operations, while the union Unifor confirmed that its members received layoff notices as a result of the strike. Those notices were later rescinded. Meanwhile, CN said the strike would trim about C$0.15/share from fourth-quarter profits.
As CN and the Teamsters working toward ratifying their agreement over the next several months, the rail unions and the U.S. operations of the freight railroads started a new collective bargaining round in November. That process will likely continue through 2020.
More than 3,000 Canadian National rail workers represented by the Teamsters went on strike on Nov. 19. Photo: Teamsters Canada Rail Conference
Mergers and acquisitions within the short line industry
This year saw a number of mergers and acquisitions (M&As) within the short line industry. Among the most notable was the acquisition of Genesee & Wyoming by Brookfield Infrastructure (NYSE: BIP) and GIC in a deal worth $8.4 billion. But other M&As occurred throughout the year, including acquisitions by short line operator OmniTRAX. Experts anticipate that more M&A activity might occur in 2020 as private equity firms continue to see infrastructure as a viable long-term investment.
“Infrastructure is hot, firms have resources to chase these deals and these are assets that they think fit well into their investment profile,” said Bill Kucera, a partner at law firm Mayer Brown in Chicago. Kucera represents companies involved in short line M&As.
Meanwhile, the short line industry applauded congressional efforts to pass legislation that would modify the U.S. tax code so that short lines can receive a tax credit for investing in their infrastructure. President Donald Trump signed into law on Dec. 20 the bill H.R. 1865, which extends that tax credit through 2022.
Extending the tax credit would “be a tremendous victory for the thousands of agricultural, energy, industrial and manufacturing shippers that rely on short line railroad service every day to connect them to the domestic and global economies,” said Chuck Baker, president of the American Short Line and Regional Railroad Association, prior to Trump signing H.R. 1865 into law.
This article first appeared on www.freightwaves.com
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