Coal''s Costly Switch

Coal''s Costly Switch

Copyright 2004, Traffic World, Inc.

Higher fuel costs are pushing railroads carrying western coal toward pricing strategies that coal shippers and electric utilities fear could sharply raise costs.

Union Pacific Railroad introduces a new Powder River Basin coal pricing strategy March 31 that goes against the flow of transportation pricing since deregulation by replacing individually negotiated contract rates with tariff-style one-price-for-all pricing. That has shippers in sticker shock.

"Indeed we''re concerned," said Tom Cantor, executive director of the National Coal Transportation Association, an educational association that represents coal companies and electric utilities. "We''re not sure exactly what it means yet. Is this the end to bilateral negotiating? We hope not."

Instead of negotiating transportation rates privately with individual customers, UP says it will post a list of rates on its Web site based on what the railroad believes will generate the revenue needed to support the business.

UP says the new strategy will simplify the way customers do business with the railroad but shippers say the initiative takes away leverage crucial to negoting a fair rate.

UP would not comment on the policy beyond what it posted on its Web site. According to its "Circular 111," the pricing authority for the new policy falls, the program initially will cover rates for coal moving from mines in the southern PRB in Wyoming to 35 utility destinations - about 25 percent of its coal business, according to one estimate - and where contracts are set to expire during the next three years. The program, which will apply to short-term business and longer term moves of up to three years, eventually will be expanded to include all of the railroad''s PRB coal business.

UP said it will share actual rates only with customers who are eligible to ship under Circular 111.

"The rate items communicate to current and potential customers in a more straightforward way the revenue needs that Union Pacific has concluded it must achieve from the coal business to those destinations in order to support ongoing capital investments to handle existing and growing coal volumes," the company stated. "The rate items provide Union Pacific''s customers with sufficient information so they can evaluate their position relative to other rail users covered by the program. This mechanism also allows Union Pacific to better respond to large price swings in the price of fuel used to transport coal."

Such a switch away from privately negotiated coal contracts and towards public tariffs has been a long time coming, according to some.

"The railroads figure that they''ve gotten burned, especially on increased fuel costs, when they''re locked-in to contracts for long periods with escalator clauses that didn''t account fully for the cost increases," said Washington, D.C. rail attorney Fritz Kahn. "UP and BNSF have very foolishly cut their contract rates in order to pick up additional tonnage over the last few years and by going to common carrier rates they''ll be able to administer pricing."

That is, with rates now made public, UP rival Burlington Northern Santa Fe Railway will know what rate it needs to match or just undercut UP, thereby allowing both railroads to raise the floor on transportation rates.

Growth in the coal industry, particularly the market for western coal, represents one of the best opportunities for the railroads to capture rate increases, particularly given the slim margins in intermodal, the railroads'' fastest growing business.

Although U.S. coal production has hovered around just over a billion short tons since 1996, low-sulfur coal from the West - particularly Wyoming - has increased steadily. In 2002, Wyoming continued to be the biggest coal-producing state in the country, a position it has held for 15 years, according to the Energy Information Association.

EIA statistics show that in 2002 Wyoming produced a record 373 million short tons of coal, an increase of 1.2 percent from 2001 and 31 million tons more than the combined total of the next three largest coal producing states of West Virginia, Kentucky, and Pennsylvania.

Wall Street suggests UP''s new strategy represents a major opportunity for both carriers. "We view (UP''s) new coal pricing initiative as a bold step because it is a sharp move from the historical long-term contract method and because UP appears to be fully moving over to this pricing model for its PRB coal," said Bear Stearns analyst Edward M. Wolfe. Wolfe said the potential for both railroads is "very significant" given that coal represents roughly 21-22 percent of revenue for both and because there has been downward pressure on coal transport rates for many years.

He said that so far in 2004, roughly $225 million in coal business has moved between UP and BNSF at lower rates.

But coal shippers were unhappy with the prospect of a reversal in the downward trend in coal transportation rates since the rail industry was deregulated in 1980. Many in the industry view UP''s new policy as a continuation of the railroad''s ability to increase its market power.

Three coal rate case decisions by the Surface Transportation Board over the last five months, while not all in favor of the railroads, effectively raised the bar on coal transportation rates in the Eastern United States so that Norfolk Southern and CSX feel they can charge their customers without fear of those rates being significantly turned back by the STB.

Several fuel purchasing managers contacted at UP- and BNSF-served power plants did not want to be identified but all were concerned about the effect of the new policy on rates. "The size of those (Eastern) rate increases has emboldened the railroads to be indifferent to the possibility of being sued," said one fuel buyer. He said the new rates published for coal moving to his utility already are up to three times higher than the contract rates in place. He fears that once his contract is up for renegotiation, the new, higher rates are going to stick.

The UP''s new pricing trend also could take away shippers'' incentives to invest in access to other competing railroads.

"It''s been understood that the way to create competition at a plant is to construct a rail buildout and the STB has encouraged this," said Tom Wilcox, an attorney with Thompson Hine in Washington, D.C. "So there''s concern what this will mean, as to whether there will be benefits to doing that in the future."