Shippers challenging high rail rates will likely learn the only thing more enduring than railroads’ pricing power is federal agencies’ embrace of precedent.
The Surface Transportation Board is expected to side with BNSF Railway in its argument that the $8.1 billion premium Berkshire Hathaway paid to acquire the railroad should be used to determine the cost base for captive shippers, primarily coal and grain companies that ship by bulk. The Warren Buffett-led company acquired the railroad for $43 billion in 2010, and as reconfirmation of the Oracle of Omaha’s wisdom, the railroad paid a $1 billion distribution to its parent company in February.
Although BNSF and bulk shipper groups made strong cases to the board at a March 22 hearing, the three-member STB “will likely fall back on precedent,” wrote John G. Larkin, managing director at Stifel Nicolaus. When the board makes its decision, it will probably be the latest blow to shipper attempts to dent railroad pricing power, particularly in relation to customers who only have access to one rail service.
Congressional attempts to curb the railroads’ power have weakened, with shipper champion Sen. Jay Rockefeller, D-W.Va., not expecting rail reform in the near future and fellow advocate Sen. Herb Kohl, D-Wis., leaving office in November. The STB kicked down the road shippers’ last major push against railroad power: a request for tougher switching rules. The board said it would defer consideration of the National Industrial Transportation League’s request because the issue is part of a broader set of rail competition and shipper rules it’s already considering.
The Western Coal Traffic League’s petition to the STB over the $8.1 billion premium the Warren Buffett-led company paid for BNSF is on track for a similar fate. Commissioners’ questioning whether shippers would support a phased-in capitalization of the premium suggests the board is considering a compromise, and not a shakeup of the current rules.
Shippers responded that such a phase-in still would be unfair, because service wouldn’t be improved through the adjustment to cost of capital. The invested capital base is used to determine how much railroads can raise rates for captive shippers, and shippers expect the capitalization of the BNSF premium to boost rates 2 to 3 percent for roughly 2 percent of the railroad’s customers. The premium will increase a captive grain shipper’s cost by 40 cents per ton for a 1,200-mile haul, and a coal shipper’s cost will rise 50 cents a ton for a 1,000-mile move, said Thomas Crowley, president of L.E. Peabody & Associates, which provides economic consulting to the Western Coal Traffic League.
The issue “has major ramifications for railroad pricing going forward, given that railroads are generally approaching the day when they can consistently earn their cost of capital on a regulatory basis,” Larkin wrote.
Shippers also are concerned that if the STB doesn’t change the accounting rule, investment firms will be increasingly encouraged to buy railroads at a higher market price and pass the additional costs to captive shippers.
Thomas Hund, BNSF’s executive vice president and chief financial officer, rejected shipper criticism that the premium would translate into higher rates. “A significant portion of BNSF’s rates are not regulated by the board. BNSF competes vigorously for this business, and as a result, these rates are based on market forces,” he said.
The railroad uses the same practices when determining rates the STB does oversee, Hund added.
Rob Jenkins, an attorney assisting BNSF, said shippers haven’t provided a reason why the STB should do away with generally accepted accounting principles that have been used for the last 25 years. Rebutting shippers’ claims that premiums were burgeoning, he said the percentage of premiums in relation to total asset costs have been shrinking in recent years.
That’s minor relief to shippers who have seen Class I railroad profits soar and rates rise in recent quarters despite moderate volume growth. With several railroads predicting strong first quarter earnings despite U.S. carload traffic being down and intermodal volume up only slightly, railroads’ pricing power shows no sign of weakening. Meanwhile, the avenues for shippers to push back are shrinking.