Issue Date: April 29, 2013
Shippers Seek Rail Rate Relief
Lack of competition among freight railroads, chemical companies complain, is forcing them to pay unfair rates to ship products. Most chemical shipments are charged nearly twice what it costs railroads to move the goods, they say.
Consequently, the chemical industry has begun a push to prevent carriers from locking in a single rate for a shipment, and to allow shippers to switch railroads during the journey. Industry representatives have taken their case to federal regulators, saying their proposal will drive costs down. Rail operators, however, argue that they set prices based on market conditions and demand for services, and claim they already have the lowest unsubsidized rates in the world.
“Addressing this issue is particularly important now that affordable natural gas is helping to rejuvenate America’s chemistry industry, strengthen U.S. manufacturing, boost exports, and create jobs,” says Calvin M. Dooley, chief executive officer of the American Chemistry Council (ACC), an industry trade association. “By ensuring a competitive freight rail system, policymakers can help maximize this advantage for the U.S. economy.”
Chemical manufacturers and other shippers of high-volume bulk commodities, such as coal and grain, have long said that consolidation in the freight rail industry and lax oversight of anticompetitive business practices have given railroads an immense amount of market power.
The trouble started with a congressional attempt to fix a national railroad system in financial decline and physical disrepair. To help it out, Congress passed the Staggers Rail Act in 1980. The legislation essentially deregulated the freight rail industry, replacing a regulatory structure that gave the government significant control over rail rates.
The Staggers Rail Act put freight rail back on a financially sound basis. For the first time in nearly a century, railroads were permitted to determine where they routed trains and how much to charge, with few regulatory constraints. The law also allowed freight railroads to get rid of unprofitable lines and to consolidate their operations.
In 1980, more than three dozen large freight rail companies operated throughout the U.S. But after a wave of mergers and acquisitions in the 1980s and ’90s, four giant railroads now control about 90% of the long-haul freight market.
Shippers say this consolidation has resulted in regional monopolies that virtually eliminated effective rail-to-rail competition, leaving many rail customers “captive” to a single railroad. They argue that the freight haulers use this lack of choice to raise rates unfairly and arbitrarily.
More than two-thirds of U.S. chemical production facilities that rely on rail to receive raw materials and ship out chemical products are served by only one carrier and are thus considered captive, according to a survey recently released by ACC.
The survey, conducted by Veris Consulting, also found that when chemical companies compared their captive and noncaptive facilities and considered comparable volumes, distances, and service, they estimated that on average, rail rates for their captive plants are 30% higher.
The Staggers Rail Act allows railroads to engage in “differential pricing”—charging some shippers higher rates than others to achieve revenue adequacy. But Congress included a regulatory backstop in the law to protect captive shippers from unreasonable pricing.
As the backstop, a shipper can seek rate relief from the Surface Transportation Board (STB)—the federal agency that oversees the freight rail industry—if the shipper can demonstrate that the rate produces revenues above 180% of the railroad’s variable costs. Those are the expenses a carrier incurs in the course of a particular shipment of goods, whereas fixed costs are expenses railroads incur to maintain their networks. For STB to intervene, the shipper also has to show that it has no other transportation alternatives.
ACC says another new study published by Escalation Consultants shows that in 2010, three-quarters of all chemical traffic in the U.S. moved at rates that exceeded the 180% revenue-to-variable-cost ratio STB uses.
“There were almost $4 billion in rate charges in 2010 that were in excess of that 180% threshold,” Dooley says. “What also concerns us is the trend line.” In 2005, 60% of chemical industry shipments moved at rates above the statutory threshold, according to the report.
The Association of American Railroads (AAR), which represents the freight rail industry, says there is no validity to ACC’s claim that its members are paying unfair rates for rail transportation. “The rates being charged today are based on the marketplace, just like chemical prices are based on their marketplace,” says AAR Senior Vice President of Communications Patricia M. Reilly.
Rail rates, on average, have dropped about 45% since 1980 for all shippers, Reilly points out. “Moreover, federal regulations do not give railroads an unfettered ability to raise their rates.” She notes that rail rates are subject to challenge for reasonableness, and there are regulations in place that allow shippers to ask the federal government to review those rail rates.
In response to long-standing complaints lodged by captive shippers about pricing, STB held a series of hearings in 2011 to examine the state of competition in the U.S. freight rail system. Last July, the agency announced that it had decided to pursue reforms.
STB is now considering changes to rules that currently give originating carriers the power to lock in control over shipments all the way to the final destination. This prevents shippers from getting bids from competing railroads at terminals and other connecting points along the route.
“We continue to explore whether there are policy changes the board could adopt that would promote more rail-to-rail competition and thereby allow competition and the demand for services to establish reasonable rates for transportation by rail, and thus minimize the need for federal regulatory control,” STB says.
Specifically, the board is examining a petition regarding “reciprocal switching” agreements among the nation’s four major railroads. This petition was submitted by the National Industrial Transportation League (NITL), the nation’s largest freight transportation organization, representing more than 500 companies.
Under NITL’s proposal, railroads serving captive shippers would be required to offer to carry freight to or from the nearest connection to a competing railroad and transfer it there. They could not insist on providing the long haul themselves. The switch would not occur if the affected railroad could prove the practice would be unsafe or be unfeasible or harmful to existing rail service.
The rule change, the group notes, would give shippers the opportunity to seek competing bids at interchange points from other rail companies to move their products, which would take pricing power away from the originating carrier.
According to NITL’s analysis, approximately 400,000 carloads of chemical products would gain access to multiple railroads, resulting in total annual rate reductions of about $500 million. U.S. railroads carry about 2 million carloads of chemicals in a typical year, according to AAR.
The Staggers Rail Act requires the establishment of switching arrangements that are “practicable and in the public interest” or “necessary to provide competitive rail service.” But NITL officials say that STB has set the bar so high that no shipper has ever succeeded in gaining access to a second potentially competitive rail carrier under the existing rules.
The NITL petition has the support of more than two dozen trade associations, and individual companies such as Dow Chemical, Dupont, and PPG. Notably, mandatory rail switching could give chemical companies in the Houston-Gulf Coast region that are now captive to Union Pacific access to new service from BNSF.
In comments filed with STB last month, ACC and a host of industrial shippers urged the board to move forward and issue new rules based on NITL’s proposed switching reforms. “We are in no way asking for reregulation of the rail industry,” Dooley says. “We are asking that they operate in a manner that ensures there is competition, and that they are not unduly and inappropriately taking advantage of their customers in the chemical industry.”
The board should go further, he adds, and resolve another access issue not addressed by NITL’s petition. Railroads should be required to quote a rate over a bottleneck segment, Dooley says. Currently, a railroad that serves a captive shipper and interconnects near the shipper with a competing railroad is required to offer a discounted rate over the bottleneck portion only if the shipper has a signed contract with another carrier for the remainder of the route. In practice, however, competing railroads have rarely signed such contracts.
Railroad industry officials strongly oppose the proposal for mandatory switching and other regulatory changes sought by captive shippers. If new regulations are imposed on railroads, the industry will reduce its spending on track and equipment that helps fuel the economy, they say. And jobs will be lost.
STB should maintain the current “balanced regulatory framework” because it has benefited both rail customers and the public, says AAR Chief Executive Officer Edward R. Hamberger.
Changing rail regulations and “forcing the railroads to provide other carriers with access to their networks and property” would make the nation’s rail network less efficient and affect service, according to Hamberger.
If adopted, NITL’s plan “will trigger serious service failures” on the nationwide rail system and “wipe out the efficiencies U.S. businesses have come to expect and rely on,” Hamberger says. Those failures will be caused by a “substantial and unnecessary increase in the handling of loaded and empty freight railcars,” he points out.
“At a time when American businesses are just beginning to turn the corner, NITL is ignoring the needs of the vast majority of U.S. shippers,” Hamberger asserts.
But Dooley maintains that increased rail competition would allow free markets to determine fair rates, reducing the burden on STB, which is currently forced to adjudicate rate disputes between shippers and carriers.
There is no set time frame for STB to act, which could mean chemical companies are stuck with a situation they don’t like. “We absolutely need a healthy, vibrant freight rail system. But we don’t think that’s incompatible with ensuring that we have an effectively functioning marketplace in the transportation of goods over U.S. rail lines,” Dooley remarks.
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