The Rail Intelligence Newsletter March 2015 Volume 24, Number 3 AAR Historical Rail Rate Changes are Misleading The Association of American Railroads (AAR) tells Congress, Regulators and anyone else who will listen that rail rates, when adjusted for inflation, are essentially the same now as they were in 1988. This sounds great, but unfortunately for rail shippers: 1. This statement does not accurately reflect the large rate increases shippers have had to bear over the twenty-five (25) years since 1988; and, 2. The AAR s position is what Congress and regulators frequently hear about the cost of moving rail traffic. This article presents what Paul Harvey used to refer to as The rest of the story as it provides a much better measure of how rail rates have increased since 1988. Figure A shows that over the twenty-five years since 1988 Class I railroad operating profit per car increased by 411%, while rate changes on a revenue ton-mile basis, which is what the AAR uses to measure rate changes, increased by only 49%. The magnitude of this difference is quite revealing and indicates that there are problems with using a cents per revenue ton-mile calculation to measure what has happened to rate changes over the last 25 years. The reason for the problems with the AAR s values are that rate change measures are distorted when significant changes take place in an industry and the rail industry has gone through some pretty dramatic changes over the last 25 years. Therefore, for reasons reviewed in this article, the best measure to use in showing what has happened to rates in a rapidly changing rail industry is the contribution that rail rates have provided to railroads operating profit on each car they move. (Continued on page 2)
AAR Historical Rail Rate Changes are Misleading (Continued from page 1) If inflation adjusted rail rates had not increased since 1988, as the AAR contends, you would not be hearing the ground swell of complaints from shippers about the railroads large rate increases. In addition, if rates were the same now as twenty-five (25) years ago railroad profits would not be soaring upward and that is precisely what is happening as average operating profit per car (operating revenue operating expense carloads) increased by 411% between 1988 and 2013. If rates were substantially the same now as they were in 1988 railroads could not have achieved a 411% increase in operating profit on each car they move. The AAR's numbers just don't reflect reality. Figure A does not represent the AAR's actual rate change calculation as the AAR used inflation adjusted rate changes to make its conclusions. Figure B compares the inflation adjusted per ton-mile rates the AAR uses against the change in the Class I railroads inflation adjusted operating profit per car. Figure B shows that since 1988, on an inflation adjusted basis, operating profit per car increased 197%, while the AAR s cents per revenue ton-mile rate change calculation decreased 14%, representing a difference of 211%. Two big changes in rail operations significantly distort the AAR's per ton-mile rate change calculations. 1. The average distance rail freight moves increased almost 40% from 1980 to 2000 As the distance for moves gets longer, rates calculated on a per ton-mile basis will almost always decrease. One reason this occurs is because the railroads charge for loading and unloading cars does not change with miles, but as average miles traveled increase, these charges are amortized over a larger number of miles when rail rates are calculated on a ton-mile basis. This causes longer distance moves to have lower rates on a per ton-mile basis. Figure C shows that as the distance freight moves increases, rates on a ton-mile basis naturally go down. It s simply mathematics! When you divide revenue by a much larger number of miles, per ton mile rates always tend to decrease. The AAR s calculation increases much less than actual rates because it does not take into consideration that the distance rail freight moved increased dramatically in the 1980 s and 1990 s. Figure B shows that the AAR s calculations simply don t reflect the rate changes in the marketplace that generated the railroads large increase in profit. Inflation adjusted profit per car would not increase by 197% if inflation adjusted rates had actually decreased. The Rail Price Advisor is published by Escalation Consultants, Inc. Jay Roman, Editor Shade May, Associate Editor Cathy Ferguson, Coordinator Copyright 2015. No reproduction in any form is permissible without written authorization nor shall any information herein be put into any type of retrieval system without prior written permission. Escalation Consultants makes every effort to supply accurate data, but it does not assume responsibility for the reliability of information attributed to other sources. Subscription rate $490 U.S. (via email) Escalation Consultants, Inc. (301)977-7459 4 Professional Drive, Suite 129 Fax: (301)977-9248 Gaithersburg, MD 20879 E-Mail: RPA@EscalationConsultants.com 2 No reproduction in any form is permissible without written authorization.
2. Railroad owned cars decreased by 45% in the 1980's and 1990's The cost of car ownership was being transferred from the railroad to the shipper for a very large number of moves over this time frame. When the cost of car ownership is transferred from the railroad to the shipper, rates are reduced because: a. The railroads cost of moving traffic is reduced; b. The shipper must absorb the large cost of car ownership. In the 1980 s and 1990 s rail rates would naturally be lower because of the decrease in the railroads car ownership revenue. When the railroad does not supply the car, it does not get paid for providing the car. The AAR ignores the change in car ownership as its cents per revenue ton-mile calculation only considers the decrease in rates shippers received for owning their own cars and nothing else. The ownership of freight cars changed dramatically in the 80 s and 90 s which makes the AAR s rate change calculation significantly understate the cost of moving traffic by rail. Figure D shows the annual change in railroads car ownership between 1980 and 2000. The increase in the distance that rail traffic moved; and, The decrease in railroads car ownership revenue. Since 1988 railroad operating profit per car increased 197% on an inflation adjusted basis, while the AAR s per ton-mile rate change calculation decreased 14%. When considering the accuracy of the AAR s rate change analysis, which is intended to demonstrate that rail rates have not increased over the last 25 years on an inflation adjusted basis, the following questions should be answered: 1. Would shippers have significant complaints about rates if they stayed flat or declined over the last 25 years? and, 2. Have railroads ever told Wall Street, We haven t increased rail rates for a quarter of a century? The AAR s assertion about rates does not reflect the reality of what shippers have experienced in the marketplace or what railroads are telling Wall Street. Yet, the AAR s position is what Congress and regulators frequently hear. When negotiating with railroads you may find it helpful to compare the change in profit for your company and the market price of your products versus the change in the railroads operating profit. The railroads profits have increased substantially over the last ten years (2005-2014) which means that they have likely increased much more than your profits. Presenting a story for why rates should not increase is always a good idea in negotiations as it counters the railroads position for why rates need to increase. Due to the big changes that were occurring in the rail industry in the 80 s and 90 s the change in railroad operating profit per car is a much better indicator of what was happening with rates during this time period as it considers: Escalation Consultants is a strong believer that rail shippers are much more effective when armed with facts that support their position to railroads, regulators and politicians. We hope you find the information in this article useful in demonstrating the historical impact of rate changes on the increased cost of moving your traffic by rail. The decrease in the railroads car ownership expense; No reproduction in any form is permissible without written authorization. 3
4Q2014 Operating Results - US Rates Decreased 0.3% Canadian Rates Increased 9.1% The railroads SEC filings over the last four quarters show that rates on Canadian railroads continue to increase more than on US railroads. All US and Canadian railroads, other than BNSF, are included in this comparison; as BNSF had not filed its data as we went to press. Table 1 shows the percent change in rates (change in average revenue per car) for the five major US Class I railroads and the two Canadian carriers between the fourth quarters of 2013 and 2014. Table 1 Change in Rates for the US and Canadian Class I Railroads (4Q2013-4Q2014) 4Q2013 Avg. Rev/Car 4Q2014 Avg. Rev/Car Percent Change BNSF $2,158 n/a n/a CSXT $1,824 $1,811-0.8% KCS $1,050 $1,038-1.1% NS $1,547 $1,488-3.8% UP $2,323 $2,390 2.9% CN $1,904 $2,082 9.4% CP $2,289 $2,491 8.9% US Average $1,686 $1,682-0.3% Canadian Average $2,096 $2,287 9.1% Overall Average $1,823 $1,884 3.3% Note: Because BNSF 4Q2014 SEC data was unavailable at the time of publication we did not include BNSF in the averages for 4Q2013. The average rate increase for all of the US and Canadian railroads was 3.3% over the last four quarters. Because rates on Canadian railroads were much higher than on US railroads the average rate change was a negative 0.3% on just US carriers, while rates increased 9.1% on Canadian railroads. Table 1 shows the change in rates between the fourth quarters of 2013 and 2014 ranged between 9.4% on CN and -3.8% on NS. The largest increase on US railroads was 2.9% on UP. Table 2 shows that carloads have increased on all US and Canadian railroads. CN led the way with a 10.5% increase, going from 1,310,000 to 1,448,000 carloads between the fourth quarters of 2013 and 2014. CSXT, KCS and UP all had between a 6.1% to a 6.5% increase in carloads. As shown in Table 2, on average carload volume increased 5.8% over the last four quarters for the major US and Canadian carriers. This increase combined with the 3.3% average increase in rates for all US and Canadian railroads is a sign of improved railroad profitability. Table 2 Change in Carloads and Railroad Margins Between the Fourth Quarters of 2013 and 2014 (4Q2013-4Q2014) Carloads Margins BNSF n/a n/a CSXT 6.1% 4.5% KCS 6.5% 18.1% NS 3.6% -2.3% UP 6.3% 15.5% CP 0.6% 761.2% CN 10.5% 34.9% Overall Average 5.8% 47.0% Note: Because BNSF 4Q2014 SEC data was unavailable at the time of publication we did not include BNSF in the averages for 4Q2013. UP had the largest increase in revenue margin of the large US railroads in 2014. UP combined a 2.9% increase in revenue per car with a 2.8% decrease in expense per car to achieve a 15.5% increase in revenue margin. KCS had the largest increase in margin for all US railroads even though its average revenue per car decreased 1.1% over the last four quarters. This occurred because KCS decreased expenses on a per car basis by 6.6%. Due to a drop in fuel prices, all railroads had a decrease in average expense per car in 2014. Table 3, on page 6, shows that between the fourth quarters of 2013 and 2014 the largest decrease occurred on CP, -29.9%. This large decrease was impacted by the service problems CP had in the fourth quarter of 2013, which substantially inflated CP s costs. The next highest decrease was the 6.6% decrease on KCS, followed by the 4.4% decrease in expenses per car on NS. Table 3 contains the change in carloads and margins for each railroad between the fourth quarters of 2013 and 2014. Table 3 provides the railroads financial operating results each quarter between the fourth quarters of 2013 and 2014 for all Class I railroads, excluding BNSF. It 4 No reproduction in any form is permissible without written authorization.
also shows annual results for the years of 2011 through 2014. Figure E shows the change in expenses per car versus revenue per car for the major US Class I railroads, excluding BNSF, between the fourth quarters of 2013 to 2014. Figure E shows that UP had a $45 decrease in expense per car between the fourth quarters of 2013 and 2014, and a $67 increase in revenue per car. This is the reason for the $112 increase in revenue margin on each car UP moved. Figure E shows that for all railroads, other than NS, expense per car decreased more than revenue. This is the reason for the increase in railroad profits (revenue margins). Railroads frequently tell shippers that they must have rate increases to make the necessary capital investments in their system. Figure E presents the other side of the story as it shows that over the last four quarters railroads increased profit by decreasing their average expense per car more than they decreased their revenue per car. Figures F, G and H track the quarterly percent change in expenses per car, revenue per car including fuel surcharge revenue and revenue per car without surcharge revenue for CSXT, KCS, NS and UP between the fourth quarter of 2013 and 2014. Note: BNSF data will be included in next months RPA. No reproduction in any form is permissible without written authorization. 5
Table 3 Railroad Operating Results on a Per Car Basis Percent Change 2011 2012 2013 2014 Percent Change 4Q,13 1Q,14 2Q,14 3Q,14 4Q,14 Burlington Northern Santa Fe Carloads (in thousands) 2,580 2,445 2,572 2,611 n/a n/a 9,458 9,661 10,093 n/a n/a Operating Exp. Less Fuel 1,008 1,151 1,083 1,052 n/a n/a 1,025 1,042 1,029 n/a n/a Revenue Per Car 2,158 2,155 2,154 2,164 n/a n/a 2,002 2,090 2,107 n/a n/a Expense Per Car 1,458 1,625 1,532 1,482 n/a n/a 1,476 1,503 1,476 n/a n/a Revenue Margin 700 530 621 682 n/a n/a 525 633 632 n/a n/a CSX Transportation Carloads (in thousands) 1,662 1,620 1,781 1,758 1,763 6.1% 6,476 6,409 6,539 6,922 6.9% Operating Exp. Less Fuel 1,090 1,128 1,028 1,053 1,095 0.5% 1,028 1,034 1,055 1,076 4.7% Revenue Per Car 1,824 1,859 1,821 1,832 1,811-0.8% 1,813 1,834 1,844 1,831 1.0% Expense Per Car 1,335 1,403 1,262 1,277 1,299-2.7% 1,286 1,295 1,308 1,310 1.9% Revenue Margin 489 456 560 555 511 4.5% 527 523 536 521-1.3% Canadian National Carloads (in thousands) 1,310 1,239 1,463 1,475 1,448 10.5% 4,873 5,059 5,190 5,625 15.4% Operating Exp. Less Fuel 1,035 1,134 939 940 1,035 0.0% 888 932 981 1,012 13.9% Revenue Per Car 1,904 2,081 2,011 1,980 2,082 9.4% 1,665 1,767 1,847 2,038 22.5% Expense Per Car 1,357 1,512 1,270 1,242 1,345-0.9% 1,178 1,234 1,293 1,342 13.9% Revenue Margin 547 569 741 738 738 34.9% 486 542 554 696 43.1% Kansas City Southern Carloads (in thousands) 291 297 317 326 310 6.5% 1,124 1,140 1,180 1,250 11.2% Operating Exp. Less Fuel 639 670 625 624 629-1.7% 596 623 613 637 6.9% Revenue Per Car 1,050 1,036 1,027 1,057 1,038-1.1% 983 1,011 1,017 1,039 5.8% Expense Per Car 818 852 793 791 764-6.6% 770 794 785 800 3.9% Revenue Margin 232 183 234 266 274 18.1% 212 226 232 239 12.8% Norfolk Southern Carloads (in thousands) 1,862 1,763 1,983 2,001 1,928 3.6% 7,115 7,107 7,341 7,675 7.9% Operating Exp. Less Fuel 858 902 814 819 846-1.3% 896 892 869 845-5.7% Revenue Per Car 1,547 1,526 1,534 1,511 1,488-3.8% 1,570 1,554 1,532 1,515-3.5% Expense Per Car 1,074 1,147 1,020 1,012 1,026-4.4% 1,119 1,114 1,089 1,051-6.1% Revenue Margin 473 378 514 499 462-2.3% 450 404 443 463 2.9% Canadian Pacific Carloads (in thousands) 686 618 689 687 690 0.6% 2,597 2,669 2,688 2,684 3.3% Operating Exp. Less Fuel 1,794 1,319 1,192 1,164 1,155-35.6% 1,251 1,305 1,377 1,207-3.5% Revenue Per Car 2,289 2,385 2,383 2,371 2,491 8.9% 1,943 2,079 2,225 2,408 23.9% Expense Per Car 2,176 1,757 1,588 1,527 1,525-29.9% 1,624 1,680 1,751 1,599-1.5% Revenue Margin 112 628 795 844 967 761.2% 319 458 474 809 153.3% Union Pacific Carloads (in thousands) 2,280 2,274 2,431 2,496 2,424 6.3% 9,072 9,048 9,022 9,625 6.1% Operating Exp. Less Fuel 1,207 1,259 1,191 1,190 1,224 1.4% 1,130 1,169 1,218 1,216 7.6% Revenue Per Car 2,323 2,325 2,329 2,331 2,390 2.9% 2,039 2,176 2,293 2,344 15.0% Expense Per Car 1,604 1,664 1,571 1,543 1,559-2.8% 1,525 1,568 1,610 1,584 3.9% Revenue Margin 719 661 758 788 831 15.5% 514 627 683 759 47.8% NOTE: 1) Data are compiled from railroads' SEC filings. 2) Revenue and Expense per car values are in thousands. 3) BNSF 4Q2014 SEC data was unavailable at the time of publication.. 6 No reproduction in any form is permissible without written authorization.
Fuel Price Decreases Not Reducing All BNSF Rates Many shippers are skeptical of BNSF s recent announcement about the change in its surcharge program since it once again benefits the carrier at the expense of its customers. The BNSF has notified customers that effective February 16, 2015 it is eliminating the fuel surcharge on tariff rates for many commodities and charge one rate that is inclusive of fuel costs. Sources have said that BNSF is rolling the current fuel surcharge amount into the rate. To implement this change the BNSF notice states that prices: Will be adjusted and converted to a single freight rate, inclusive of fuel costs, effective February 16 th. This change means that many tariff rates will be increased by the amount of fuel surcharge the shipper is currently paying and that this amount will be locked into the rate. The BNSF has also stated that it will continue to adjust its new tariff freight rates in accordance with changes in the market conditions. A large number of companies are concerned about railroads getting fuel surcharge revenue from shippers as prices increase while being reluctant to share cost savings as fuel prices drop. A reason for this concern is that the change in the Fuel Surcharge Program has come as fuel prices have fallen. In general there is a two-month lag in the application of the strike price for calculating the value of fuel surcharges so a reduction in fuel costs takes two months to be applied to the fuel surcharge. Over the last two months the onhighway diesel fuel price, which is used to calculate BNSF s fuel surcharges, has fallen 18% (12/08/2014 $3.535/gallon to 02/23/2015 $2.900/gallon). The BNSF action appears to keep fuel surcharge revenues gained as a result of fuel price increases, but give shippers little back from the 18% drop in fuel prices over the last two months. BNSF has not provided specifics on how its tariff rates will change in the future as fuel prices go up, however, based on its current actions there is a lot of apprehension about BNSF's future actions with volatile fuel prices. Many shippers have expressed the concern that when fuel prices increase again BNSF will reinstitute its Fuel Surcharge Program and start the cycle again. Escalation Consultants discussions with a large num- No reproduction in any form is permissible without written authoriza- ber of companies indicates that there is a big concern about railroads getting fuel surcharge revenue from shippers as prices increase while being reluctant to share cost savings as fuel prices drop. The BNSF seems to believe that discontinuing its fuel surcharge is great for shippers as it states: The implementation of a single, market-based rate will eliminate the application of the fuel surcharge and simplify the billing process for our customers. Escalation Consultants has yet to find any rail customers that wanted to express their sincere thanks to the BNSF for simplifying the billing system. Shippers have always had concerns that rail carriers are overcompensated for their fuel cost increases in their fuel surcharge programs because they have paid a great deal of money in surcharges to railroads. The BNSF has collected $18.2 billion in fuel surcharge revenue since the fourth quarter 2007, when the Surface Transportation Board (STB) first required railroads to report their surcharge revenue. If BNSF is allowed to discontinue its surcharge programs when fuel costs are decreasing and include surcharge revenue in the rate, then shippers will not get much of this money back they paid through surcharges, indicating their rates will be higher than they should be. Figure I, on page 8, illustrates that from the fourth quarter 2007 to the fourth quarter 2014 BNSF fuel surcharge revenue increased by 32.1%, while BNSF fuel expense increased only 5.4%. This seven year change represents the total time period the STB has required railroads to report fuel surcharge revenue and fuel expenses and this indicates that the fuel surcharge has been a profit center for the railroad. When a surcharge increases more than fuel expenses when the price of fuel increases, then the surcharge will also tend to decrease more than fuel costs when the price of fuel goes down. By eliminating the surcharge while fuel prices are decreasing, the railroad avoids its profit being reduced by surcharge revenue decreasing more than fuel expenses and it locks in those higher costs to its rates going forward. It will also benefit by being able to use a higher rate as the basis for all future rate increases since 6% of a higher number is more than that same percentage on a lower value. (Continued on page 8) 7
Fuel Price Decreases Not Reducing All BNSF Rates (Continued from page 7) BNSF has positioned itself to be able to keep the fuel surcharge revenue it collected from customers when fuel prices increased, but will not suffer a reduction in revenues as energy prices decrease. The concern is that this change will ultimately be applied to all tariffs, as well as, contracts. This would allow the railroad to permanently keep revenue that was intended to compensate it for fuel cost increases even though the railroad is no longer incurring these high fuel expenses. The BNSF s notification to shippers was polite, but conveys a message that does not have an amicable outcome for rail shippers. The concern is that what goes up does not need to come down in the world of railroad fuel surcharges. Rail Negotiation Seminar March 24-25, 2015 DoubleTree Suites Tampa Bay Tampa, FL This seminar has become the industry standard for improving shippers rail negotiations This is a hands-on program with a focus on: Making your specific problems a higher priority at railroads; Obtaining reasonable rates for your traffic; Effective ways to improve your rail negotiations; Changes in the regulatory process that impact your movements; and, Reducing rates on captive moves Due to the large rate increases many companies are experiencing, there will be a special presentation on when to consider a Rate Case at the STB. The Rail Negotiation Seminar changes how companies negotiate with railroads. Learn new strategies for: Increasing your competitive rail traffic Optimizing your rail spend Reducing rates on captive rail moves Stopping railroads from always Increasing your rates This is a hand-on seminar and you are encouraged to bring your problems to the seminar to get input on your rate issues To receive a brochure or further information call Escalation Consultants at 301-977-7459 or visit EscalationConsultants.com This is the most highly recommended negotiation seminar for rail shippers 8 No reproduction in any form is permissible without written authorization.