- Customers often `don't have any other options,' analyst says
- Railroads say high maintenance costs force price increases
Kevin Acker has both savored and suffered the pricing power of freight railroads.
The manager at Chemours Co. depends on a single railroad that serves 80 percent of the chemical maker’s facilities, hauling bulky cargo that trucks can’t move efficiently. In his previous career as a railroad executive, he had the upper hand in shipper contract talks.
“On this side of the fence, I’m begging,” said Acker, who had worked 15 years for Norfolk Southern Corp. and Consolidated Rail Corp. “On the other side of the fence, I’m telling.”
All major North American railroads pushed through rate increases earlier this year even as freight fell the most since 2009. Limited competition and favorable regulations provide pricing power -- the envy of truckers and maritime shippers -- that’s helped them reverse a share slide despite tumbling oil, coal and intermodal shipments.
Rail companies “benefit from the market power that they wield, which is different from other modes of transportation,” said Mark Levin, an analyst with BB&T Capital Markets. “In many cases, customers have to take the price that’s offered when they don’t have any other options.”
Railroads counter that freight rates remain about 40 percent lower than before the current regulations were enacted in 1980 to save the industry, which was teetering on bankruptcy. The new rules sparked investments that have topped $600 billion in the last 35 years and improved service and safety on a rail system where the tracks were so shoddy trains would tip over while not even moving.
“By and large, most of our customers feel they’re getting good value,” Mike Ward, chief executive officer of CSX Corp., which operates in the east. “You’ll find that it’s a fairly small vocal minority that has those concerns.”
Freight tariffs jumped 27 percent after adjusting for inflation in the 11 years ending in 2013, ending an era of declining prices that began in 1980, according to a study by the Transportation Research Board.
In the first quarter of this year, CSX boosted average freight prices 3.1 percent while its carloads tumbled 5.1 percent. Union Pacific Corp., the largest publicly traded railroad, raised rates by 2.5 percent even as cargo sank 8.4 percent.
The ability to increase prices even as shipments decline has bolstered railroad earnings and helped mitigate the drop in their shares, said David Vernon, an analyst with Sanford C. Bernstein. That’s led to renewed interest from investors who are more used to industries that have to reduce rates to stem a drop in business. A Standard & Poor’s index tracking the four largest publicly-traded U.S. railroads has climbed 26 percent since hitting a three-year low on Jan. 25, more than doubling the return of the S&P 500.
“Investors are increasingly comfortable that price isn’t going to come rattling down because of a volume decline,” Vernon said.
The high cost of laying track keeps out new rail competition, unlike maritime shippers and trucking companies that can see rivals add vessels or vehicles fairly easily. The result is a North American rail network that operates three regional duopolies, with two carriers in the eastern U.S., two in the west and two in Canada. The seventh major rail company, Kansas City Southern, runs a line from the Midwest to the Gulf Coast and into Mexico.
Railroads can boost spot rates with 20 days’ notice. Customers can challenge the increases by appealing to the Surface Transportation Board, which regulates the rail industry. But it can take years and millions of dollars to pursue a case. DuPont Co. disputed rates from Norfolk Southern in October 2010 and the board ruled in favor of the railroad in March 2014. The case wasn’t finalized until December.
Railroads need to charge prices that enable them to maintain the North American rail freight system, which is the “the envy of the world,” Vernon said. In 2015, the railroads invested 42 cents of every dollar of revenue back into operations, according to the Association of American Railroads.
“We’ve got a special service offering,” said Hunter Harrison, chief executive officer of Canadian Pacific Railway Ltd. “We don’t have to go into the marketplace and discount it to sell it.”
The railroad is playing catch up with rate increases ranging from 2.5 percent to 5 percent after going decades without higher prices, he said. That has enabled Canadian Pacific to extend side tracks that allow for longer trains and to invest in centralized traffic control technology, leading to the fastest average speeds this year since 2012.
Rail service isn’t always improving, said Randy Gordon, chief executive of the National Grain and Feed Association. In 2013 and 2014 a surge of volume left grain shippers waiting weeks for trains, said Gordon, who called the price increases amid traffic declines a market “anomaly.”
“The rail carriers are using their pricing power to keep prices stable or increasing primarily for the benefit of shareholders and Wall Street,” he said.
Some railroads also are now charging fees for services that once were free, such as moving empty tank cars or storing railcars at rail yards, said Acker, whose company spent $154 million on rail transportation last year. Large companies such as Chemours, the world’s biggest producer of titanium-dioxide pigment, have teams armed with data to push against the railroads’ demands during contract talks. Small shippers are more vulnerable, he said.
Even so, Chemours agreed to rate increases of about 5 percent last year, when U.S. consumer prices rose less than 1 percent and U.S. rail traffic fell 2.5 percent.
“There’s the real world and then there’s the rail world,” Acker said.