Railroads Face Government Scrutiny Over Mergers, Service And Competition

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Includes: BRK.B, CNI, CP, CSX, NSC, UNP
by: Michael Hooper

Summary

Here is my exclusive interview with a member of the U.S. Surface Transportation Board. Read Deb Miller's views on railroad mergers, congestion, hiring and training, and the economy.

Any merger proposal would have to include ways to mitigate service problems on the rail network.

America needs a freight policy to address the lack of rail infrastructure. Choke points are creating lags in the U.S. economy.

If two Class I railroads want to merge into one, they must have a detailed plan that would mitigate service problems on the rail network.

Railroads would need to engage in an extensive planning process if they were to consider a merger. The U.S. Surface Transportation Board has the authority to approve or disapprove mergers.

"Should there be a merger proposal, the board would study it very carefully," said Deb Miller, vice chairman of the U.S. Surface Transportation Board. The STB would look hard at whether the merger would improve service and competition.

"We would be very reluctant to do anything to make service issues worse," Miller said.

Planning might make the difference in a merger, Miller said.

"How well planned are they to mitigate service issues?" she said. "There is often a time period of chaos after a merger."

On Friday, Nov. 21, 2014, I conducted an exclusive interview with Deb Miller. No other media has done this story. I've known Deb Miller for many years. I used to interview her when she was Secretary of the Department of Transportation in Kansas, where I live and work. We talked about railroads, shipper complaints, the grain harvest and the economy. Miller was appointed by President Barack Obama to the STB and was confirmed by the Senate and sworn in April 2014.

In October, E. Hunter Harrison, chief executive officer of Canadian Pacific Railway (NYSE:CP), proposed a merger with CSX Corp (NYSE:CSX), but CSX officials turned him down.

Harrison believes that the rail industry is approaching a gridlock, and that CP is trying to get ahead of the problem by pointing out the benefits that mergers could provide in enhancing network rail service, fluidity, and competition in North America.

Other rail managers believe they can improve service by hiring new employees and spending more money on capital improvements.

One of the deficiencies with railroads is the lack of train crews to run out and pick up additional freight. Railroads are hiring thousands of new employees and adding locomotives in 2014 and 2015.

Miller said she went to Atlanta to visit a CSX training facility.

"They are training 24 hours a day," Miller said. "They are aggressively recruiting. They are trying to get new locomotives to move commodities."

In a conference call last month, Michael Ward, CSX chairman, president and CEO, said, "all railroads are increasing their capacity similar to what we are doing. And I think those (efforts) will produce the capacity needed to move America's freight."

Consolidation, he said, might actually take railroads a step back. "As you know, in the past mergers there have been severe service disruptors after one of those transactions," he said.

Recent rail history
The Surface Transportation Board was created in the ICC Termination Act of 1995 and is the successor agency to the Interstate Commerce Commission. The STB is an economic regulatory agency that Congress charged with resolving railroad rate and service disputes and reviewing proposed railroad mergers. The STB is decisionally independent, although it is administratively affiliated with the U.S. Department of Transportation.

My previous article discussed the STB's handling of a proposed merger between BNSF Railway and Canadian National Railway (NYSE:CNI) in 1999 and 2000. The companies called off the merger in 2000 due to the STB's 15-month moratorium on rail mergers. Back then shippers complained that past mergers - Union Pacific's (NYSE:UNP) 1996 acquisition of Southern Pacific Rail Corp. and 1999's splitting of Conrail Inc. between Norfolk Southern Corp. (NYSE:NSC) and CSX - had caused massive delays and poor service.

Miller said she has participated in many meetings this year with people interested in rail congestion issues, including a meeting in Fargo, N.D., that was standing room only with farmers, utility managers and other shippers.

"There are a lot of unhappy shippers out there," Miller said. "It is also clear that railroads are working hard to improve service."

Miller said the most pressing issue facing the Surface Transportation Board today is the quality of service in both freight and passenger trains.

"We're still hearing complaints but it is not as bad as last winter and summer," Miller said.

"For a long time there was sufficient capacity," she said. "Now there isn't and shippers are not happy."

Miller said the growth of oil-by-rail combined with the need to move a record grain harvest in 2013 resulted in big delays for shippers in winter 2014. The extreme cold and snow in January and February 2014 slowed traffic to a near halt as snow had to be removed from tracks. Canadian Pacific Railway and BNSF Railway, owned by Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) fell behind last winter and spent the rest of the year trying to catch up. Both railroads are planning additional improvements on the Northern Transcontinental railway.

"Both railroads are being very pro-active to improve traffic through the Twin Cities," Miller said.

She said Chicago is congested, partly because it has always been the major point of exchange. Western railroads exchange trains with Eastern railroads in Chicago.

It will take public and private partnerships to improve the infrastructure though Chicago. Enormously short-sighted policy has created a boondoggle.

"Nobody is doing enough in Chicago," she said. "We're paying the price. We need the infrastructure right."

One of the advantages of Canadian National Railway is its direct line through Chicago. In early 2009, CN acquired The Elgin, Joliet and Eastern Railway, making CN the only train with the ability to pass through Chicago on its own tracks. The STB approved that deal 15 months after it was initially announced.

Miller said five years ago hardly any oil moved on rail. Now the oil-by-rail business is huge.

Delays in freight due to these "choke points" on the system create big lags in the U.S. economy, Miller said.

Miller said congressional leaders need a freight policy to address the problems associated with inadequate rail infrastructure.

Conclusion
My takeaway from Deb Miller is that the Surface Transportation Board would consider a Class I railway merger only if there was sufficient planning to show how service problems would be mitigated in the short term and improved over the long term. A merger proposal could take 15 months for regulatory review, based on previous mergers reviewed by the STB. And there is no guarantee the STB would approve the idea. The STB is really focused on trying to find ways to improve service. The STB is reluctant to approve a merger that contributes to delays on an already congested rail system. The U.S. economy is dependent on rail to move freight. The U.S. needs a stronger commitment from public and private sectors to improve infrastructure in the rail community.

Disclosure: The author is long BRK.B, CNI, CP, UNP, NSC.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.