Analysis & Commentary
The service deterioration on the nation’s Class 1 railroads is approaching the point of becoming a national security issue, shippers informed the Surface Transportation Board (STB) at hearings held April 26-27, where they described how it already has added to the supply chain crisis, inflation and damaged the nation’s ability to recover economically from COVID-19.
In March, rail shippers also presented similar information at an STB hearing on reciprocal switching, and now the crisis has even seized the attention of the highest levels of the federal government. On April 26 White House press secretary Jen Psaki mentioned the STB hearing at her daily press briefing and on that day Pete Buttigieg became the first secretary of transportation to testify in person before the STB.
Along with remarking on rail staffing shortages, Buttigieg pointed out that the agriculture sector has been “significantly impacted by the railroad’s service delays, especially when it comes to obtaining the necessary amount of fertilizer and chemicals that are critical for the growing season.”
Joining Buttigieg was Carl W. Bentzel, Federal Maritime commissioner, who testified that at one point during the height of the delays caused by West Coast port congestion, railroad service failures served as a contributing factor. At the height of problem, he noted, Union Pacific stopped all intermodal service flowing from California to Chicago for a week.
“Unfortunately, the railroads have not been able to keep pace or take advantage of maritime growth,” Bentzel added. “Case in point, last year railroads saw a reduction of 16.8% of intermodal rail service, this at a time when international container volumes surged to a 21% growth. This is stunning.”
Jewel H. Bronaugh, deputy secretary of agriculture, also said that railroad service currently is so bad that grain elevators are full. So little cattle feed is currently available that farmers are seriously considering depopulating their herds at a time when meat shortages are fueling inflation. “It should not be up to the railroads to determine what their service levels should be,” she declared.
Witnesses from agriculture and the chemical industry amplified these views at the hearing. Michael Seyfert, president of the National Grain and Feed Association, offered, “Feed mills and integrated livestock and poultry operations have experienced instances in which trains have not arrived and scheduled feed deliveries have been unable to be made to producers.”
Seyfert and others confirmed Bronaugh’s observation that rail service has deteriorated to the point that grain elevators are already full and unable to accept any additional deliveries or ship out what they already have stored because even the full grain cars left on their sidings next to the elevators are not moving. As a result, some grain is already being piled on the ground near the tracks, they said.
Other rail traffic that has been delayed substantially by service deterioration includes shipments of chemicals needed for communities to produce clean drinking water and other chemicals needed to produce gasoline and diesel fuel. Some of these chemicals and agricultural shippers have been forced to use trucks, which adds enormously to their transportation costs.
STB to Direct Rail Service
The STB did not wait until after the hearing to act. A few days earlier it published a proposed rulemaking to amend its emergency service rules to provide relief for shippers in situations that require immediate relief. The board proposes to clarify that it may act on its own initiative to direct emergency rail service, and to establish an accelerated process to deal with acute service emergencies.
“The recent acute service issues have made clear the need for the board to provide the opportunity for shippers to receive swift action to ensure that the nation’s freight rail traffic continues to move,” the board said when it issued the proposed rule.
“This proposed rule would make it possible for a shipper to receive relief in a short but reasonable amount of time during an emergency,” commented Martin J. Oberman, STB’s chairman. “Given the persistent and serious problems presently affecting freight rail service, it is important for the board to consider new approaches for providing much needed relief to rail customers, not only for the customers’ benefit, but for the well-being of the nation’s economy and all consumers.”
He also made a point of stressing that this new rule is not intended to be a substitute for reciprocal switching, sought by rail shippers for years and which the board also currently has under active consideration. He said work on that proposal will continue as one of his top priorities for the board’s agenda this year.
Although railroads have strenuously opposed reciprocal switching—which allows railcars from one rail line to be transported on another railroad—it was learned at the March STB hearing that they have been practicing this among themselves without telling anyone or allowing their customers to take advantage of the same practice. (In addition, the same practice has taken place between the two major Canadian railroads for many years without any serious problems.)
Most of the witnesses at the hearing placed the blame for what has gone wrong on adherence to what Wall Street analyst and former railroad executive Rick Paterson termed “the Cult of the Operating Ratio” (OR), embodied in a railroad operations model called Precision Scheduled Railroading (PSR), which was first adopted in the U.S. by CSX Transportation five years ago and subsequently swept through the rest of the rail industry.
The change was the result of some clever operators seeing the opportunities for exploiting rail customers and employees presented by rail deregulation. A 1980 law made it easier for the railroads to operate free from excessive rate regulation by the federal government. However, Congress did not foresee a wave of mergers among the Class 1 freight railroads in the 1990s that culminated early in this century with a handful of regional rail monopolies controlling the nation’s entire rail system.
The PSR concept was developed from the knowledge that weak federal regulation combined with monopoly market power could be used to squeeze every last penny out of rail costs, while charging whatever you want for indifferent (at best) rail service.
It has since been deployed by hedge fund managers seeking to take control of major railroads by asserting to shareholders that they could earn more on their investments if they were allowed to impose PSR on railroad management. The whole idea was to increase investors’ return by lowering the railroad’s OR, which is a crude measurement of direct operating expenses against revenue.
For example, if a company spends 85 cents on costs out of every dollar coming in from sales, its OR is 85. The lower the OR, the more revenue it keeps and can pass on to shareholders. The measurement is simplistic and fails to take into account a number of other factors commonly used to measure a company’s financial success. It was an outgrowth of the era of economic regulation when carriers, including truckers, basically charged the same rates to their customers.
How PSR Works
The PSR model honed to a sharp edge by CSX is built on radically slashing all operating costs to squeeze down the OR. As a result, CSX and the railroads that followed its example immediately engaged in firing thousands of workers, sidelining much of their engines, closing transfer yards, abandoning spur line service to customer facilities and cutting back on other services considered high-cost, including intermodal service.
Last year a major hedge fund manager leading a campaign to remove the top management of Canadian National railroad leveled the charge that they had been spending too much money on developing intermodal services. What this approach ignores is that intermodal is really the only major long-term growth opportunity available to railroads who have lost bulk and boxcar traffic in recent years.
Because many of the personnel laid off under PSR were responsible for ensuring service—ranging from train operating and maintenance crews, to office personnel who provide customer interface and communications—service has continued to erode to the point that shippers at the hearing said it was worse at the end of April than it had been when the board’s hearing on reciprocal switching had been held a month earlier.
Paralleling adoption of the PSR operations model was a campaign mounted by rail management to transform demurrage and accessorial fees in profit centers to add more revenue to their bottom lines. Normally charged to shippers for not returning rail equipment on time, the railroads not only raised the fees, they engaged in practices that made it virtually impossible shippers to return the cars on time.
Shippers at the April STB hearing said the late fees have skyrocketed the more rail service has continued to deteriorate, with shippers informing the board that demurrage fees which had been hundreds of thousands of dollars are now running into millions of dollars.
On the other hand, after the railroads told shippers to acquire their own privately-owned railcars, as the railroads themselves are running late in returning them, the shippers cannot assess similar penalties on the rail lines—something they asked the board to allow them to do.
At the hearing, the railroads claimed that service had gotten worse because of COVID and the difficulty recruiting qualified personnel as demand for rail services rose recently with the accelerating economic recovery. They also detailed recent efforts to attract new workers while noting the difficulty employers throughout the economy were having staffing up.
But blaming recent events for the lack of adequate staff would be more convincing if it hadn’t been for the fact that, as was pointed out at the hearing, railroad traffic in December 2020 already had regained 97% of its pre-COVID level.
Returning to Service
All of the railroad unions testified at the board hearing, and none of them bought the railroads’ excuses. Their testimony depicts a disheartening situation in which rail workers, their ranks already thinned by PSR, are being overworked, a practice that drives more of them to retire early or seek work elsewhere
“Despite the claims made by the Class I carriers, it is simply impossible to provide an equivalent level of service after eliminating a third of the workforce in less than a decade,” said Greg Regan, president of Transportation Trades Department (TTD) of the AFL-CIO. “These cuts have guaranteed that adequate crews will be unavailable, that equipment and infrastructure will not be adequately maintained and that critical inspections will be deferred. TTD categorically rejects the absurd claim that the hard work of those 45,000 employees had no demonstrable impact on the quality of service offered by Class I railroads.”
Jeremy Ferguson, president of the nation’s largest rail union, the 40,000-member SMART Transportation Division, also put the blame for poor service squarely on PSR. “As professionals, it is painful to watch our shippers get bad service or no service at all, much higher rates, destroyed product and equipment, and in some cases having to resort to shipping by truck whenever possible.”
Shippers told the STB that they are seeking various forms of relief. These range from injecting more competition into the industry by allowing reciprocal switching to demanding more accurate and detailed statistical reporting from the railroads, and banning them from charging for demurrage when delays are the result of rail service failures, but allowing shippers to charge railroads for demurrage when their private cars are delivered late.
For its part, the STB is proposing directed service orders, although at this point it is not clear how exactly this would work given the sheer complexity of the nation’s rail system, or what the impact ultimately would be.
A few years ago, I suggested that Congress consider imposing a utilities commission regulatory model on the railroads, who with their regional monopolies resemble electric power and gas companies. Under that model, a utility commission sets the rates and established operational standards for a utility while guaranteeing a reasonable return for investors.
The only comment that suggestion drew was from Rep. Peter DeFazio (D-Ore.), chairman of the House Transportation Committee, who took the opportunity to condemn it in no uncertain terms at a public hearing.
Which leads to another idea that could involve reaching into an already particularly messy can of worms: changing the established fiduciary duty owed to investors by management away from only making as much money for them as can be wrung from rail customers under PSR, to establishing the common carrier obligation and maintaining service adequacy as ESG standards imposed by the Securities and Exchange Commission.
However, I can easily imagine that this idea will generate just as much support as the public utilities commission regulatory model I suggested earlier—which was zero.