Date: Monday, May 9th 2022
Service disruptions at the Class I railroads have come to a head in recent weeks, and shippers and the unions representing rail workers are clamoring for changes to the freight rail industry of a magnitude to match the disruptions.
Some examples of subpar rail service: Excessive dwell times at the origin, resulting in the doubling of transit times between the Midwest and West Coast for grain shippers and tardy arrivals that pressure flour and feed mills and ethanol plants to temporarily cease operations or curtail production.
Meanwhile, the National Grain and Feed Association estimates that the combined cost to the grain industry of revenue losses and additional freight expenses was over $100 million in the first quarter of 2022.
The Surface Transportation Board is considering short-term measures — such as the submission of rail service improvement plans — to address these issues. These measures would potentially provide immediate relief to shippers and could be deployed within a 30-to-60-day time frame.
However, the board, the railroads and rail’s stakeholders are under pressure to tackle tough questions in ways that could more comprehensively affect how the railroads run their operations. These questions also touch on the long-term health and viability of freight rail in a transportation sector bent on an automated future.
“There’s probably no elegant solution to structurally fix rail service, but we are all tired of going down this road and something needs to change,” said Rick Patterson, a railroad analyst with Loop Capital Markets and one of many witnesses testifying at a two-day hearing last week before STB to discuss rail service.
Redefining the common carrier obligation
Service disruptions over the past year occurred at a time when there is significant momentum to alter the way the railroads operate. Global supply chain disruptions as a result of the COVID-19 pandemic have exposed weaknesses in U.S. freight transportation infrastructure. Ports were overwhelmed with container boxes, chassis and other equipment were in short supply, and the railroads and the broader supply chain industry grappled with COVID-19-related staffing shortages.
U.S. Transportation Secretary Pete Buttigieg drove home the complexity of the issues.
“There is no single step available to deliver ideal freight rail service overnight,” Buttigieg told the board, adding that the federal infrastructure law enacted last year is “a historic opportunity to transform both freight and passenger rail for the better.”
But just as the problems are complex, so too are the answers.
For starters, there are shipper remedies that the board is considering. These include:
- Requiring the Class I railroads to submit rail service improvement plans, including anticipated recovery timelines. These plans would also address the headcount needed to expand rail service.
- Gathering rail intermodal metrics as part of STB’s data collection requirements.
- Collecting first-mile and last-mile data to provide visibility on those segments.
- Creating penalties for inefficient use of privately owned railcars.
- Amending the rules surrounding reciprocal switching and final offer rate review.
Some of these remedies, such as the submission of rail service plans, could be required easily; others, such as reciprocal switching, are more contentious.
But what these potential remedies boil down to is the railroads’ ability to meet the common carrier obligation, which STB defines as “the statutory duty of railroads to provide ‘transportation or service on reasonable request.’ … A railroad may not refuse to provide service merely because to do so would be inconvenient or unprofitable.”
Some stakeholders believe that definition should be clarified further to provide transparency on what kinds of requests and levels of service qualify as reasonable.
Said Greg Regan, president of the Transportation Trades Department (TTD) of the AFL-CIO, “The ambiguous nature of the requirement has meant that railroads have operated with the understanding that the STB is unlikely to wield its authority” and regulate more aggressive actions aimed at the rail industry.
Richard S. Edelman, an attorney representing four railroad unions, sees little choice but to go big.
“Given the size of these entities and the physical infrastructure, tinkering with the competition will not be effective, although we do support first-mile, last-mile data,” he said.
“What will really help is the board enforcing service standards in the common carrier obligation. I know the shippers say we want to see commercial solutions and competition-based solutions, but given the size and the market dominance of the railroads, a regulatory regime has to be appropriate before commercial solutions can work effectively.”
PSR cut headcount levels too deep, say shippers and unions
The Staggers Act of 1980 deregulated the freight rail industry, providing the railroads with latitude to set their own pricing and enter into confidential contracts with shippers. The Association of American Railroads describes the Staggers Act as “allowing railroads to take a smart, customer-focused and market-based approach to railroading.”
A fairly recent outcome of that latitude has been the adoption of precision scheduled railroading (PSR) among the Class I railroads. PSR is an approach that seeks to streamline operations.
But shippers and the unions argue PSR has created issues warranting government intervention — among them too-deep workforce cuts at the railroads in an effort to reduce costs.
TTD estimates that in the five years prior to the pandemic, BNSF cut its train and engine workforce by 27%, while Norfolk Southern (NYSE: NSC) reduced its train and engine workforce by up to 32%, and CSX (NASDAQ: CSX) slashed its train and engine headcount by 43%.
When demand for rail service rose again following the initial slowdowns during the onset of the COVID-19 pandemic in the spring of 2020, the railroads didn’t have adequate crews. Those staffing issues still exist, critics contend.
“This is not a COVID-19 pandemic-only type of situation. We’re dealing now with years of railroad service cuts to staff, the elimination of switchyards, the slashing of customer resources that have gutted the rail network and gutted its resilience, and making service crises like the ones that we’re facing now almost inevitable,” said Chris Jahn, president and CEO of the American Chemistry Council. “From our perspective, we’re well past the point where we need to rely on railroad promises to flip the switch and fix the situation.”
Those staffing issues also extend to other divisions, such as maintenance, according to the unions. Workers face pressure to rush inspections and maintenance, and having new, larger territories to manage threatens the ability to conduct routine maintenance, said representatives of the Transportation Communications Union and International Association of Machinists and Aerospace Workers, Division 19. Stored locomotives aren’t being maintained adequately, while the increase in overtime and work has affected employee morale, they said.
The railroads testifying at STB’s two-day hearing acknowledged the staffing issues. They said — at this hearing and during recent first-quarter 2022 earnings calls — that they have been aggressive about hiring more train and engine employees to drive the locomotives, although they stopped short of attributing the cause of earlier headcount reductions to PSR.
“Our service is our responsibility, and we simply have not met our customers’ expectations,” said Matt Garland, vice president of transportation for BNSF. “We know that some railroad jobs can be challenging wIth nontraditional schedules [and] time away from home, particularly for our train crews. Where we have options to mitigate that, we are committed to making those changes.”
There are also operational factors to consider when deploying new hires. For instance, NS’ train and engine workforce is a collection of 95 distinct groups of assignments within certain geographic boundaries, which limits the railroad’s flexibility in deploying employees, according to NS Chief Transformation Officer Annie Adams.
However, the unions contend that the rush to fill the ranks of train and engine employees is also sacrificing the quality and duration of training that trainees receive.
“When you come to the railroad, we have a different language we speak. It’s just like speaking French. I don’t know how to speak French, but I know how to speak railroad,” said Steve Groat, a union representative for SMART-TD.” For a person [to cut] that many weeks out of training, I think you’re setting up a dangerous position.”
The unions say that another consequence of PSR is the railroads’ preference for longer trains. The railroads say longer trains make operations more efficient.
But much of the current U.S. rail infrastructure wasn’t built for longer trains. Although the railroads have been investing in longer sidings on their networks, the rail yards — many of which were built after World War II — don’t have the space to configure the longer trains.
Tracks at rail yards may be only 3,000 feet long, but trains can be 10,000 feet. As a result, building a 10,000-foot train requires three different tracks, union representatives said. However, incoming trains have to wait for that new long train to be built, slowing down the rate that trains can be assembled at that yard. Furthermore, during this time, train crews may also have to stop working if workers reach their hours-of-service limit. If that train crew exceeds the amount of time it can work, a second or third crew is needed for the long train to reach its final destination.
“Crew shortage is just one problem with PSR. Train length may be the biggest issue. These trains seriously congest the network,” said Mark L. Wallace, vice president for the Brotherhood of Locomotive Engineers and Trainmen.
How the ‘cult of the operating ratio’ affected service
In tandem with the Class I railroads’ deployment of PSR has been a focus to lower a company’s operating ratio (OR). OR, which is calculated by dividing a company’s operating expenses by its revenue, can be an attractive guidepost for investors because a lower OR implies that the company’s financial health has improved.
“Why has the U.S. pivot to growth so far failed? I can think of three reasons,” Patterson said. He cited the primacy of OR, which clashes with the idea that capacity buffers cost money; the railroads’ possible reluctance to take on new business that could dilute OR and the “instant gratification” quality of OR, which contrasts with the many years it might take to build a competitive service platform.
While PSR does create rail networks that are “mathematically more fragile” because crew and power resources have been reduced as a result of running longer trains, the counterargument is that the networks are easier to manage and optimize because a railroad is running fewer trains within a simpler framework. The early adopters of PSR, Canadian railways CN (NYSE: CNI) and Canadian Pacific (NYSE: CP), while occasionally facing their own operational challenges, have had superior resiliency comparatively, according to Patterson.
“My view is that when it comes to crew capacity and related resiliency, PSR versus non-PSR is not the primary determinant because crew capacity regardless needs to be tuned district by district to the individual railroads’ unique set of circumstances,” he said.
The railroads are under pressure from investors who tend to look at a return time frame of 12 to 24 months instead of three to four years. Otherwise, a railroad might become the target of activist shareholders unhappy with its financial performance, which happened to CN in 2021 following its failed bid to acquire Kansas City Southern.
But OR doesn’t necessarily reflect only cost-cutting measures: “There’s a different way to inflect the operating ratio, and that’s to put more top-line revenue on the railroad,” said NS Chief Marketing Officer Ed Elkins.
To relieve the pressure from investors, STB could set a limit on how low OR could go. “I think the uncomfortable reality is that if you truly want to change behavior in this industry, you need to confront this issue [of OR] to a certain degree,” Patterson said. That could be achieved by presenting a real or perceived regulatory consequence for falling below a standard operating ratio red line for railroads unable to demonstrate service consistency, he said.
But that could cause additional challenges for the railroads, according to CSX President and CEO Jim Foote.
“We don’t operate to an operating ratio. … We set up a three-year strategic plan based upon what our revenue opportunities are and what the realistic costs are for us to be able to deliver based upon the market demand for rail service,” Foote said. And then CSX must generate cash so it can invest billions into the network and start next year where it began this year, he said.
What should the railroads do?
The freight railroads are at a crossroads because the industry is facing future competition from platoons of autonomous trucks.
“If nothing changes, there will come a day in the not-too-distant future when a railroad with poor service and 49.9% OR walks into a customer’s office and extracts an above-inflation price increase,” Patterson said.
Said NS Chief Operating Officer Cindy Sanborn: “Our competitors in the trucking industry aren’t moving backwards. They’re not even standing still. They wake up every day thinking of new ways to leverage technology to implement operational innovations that will improve the customer experience and improve efficiency. And railroads must also think this way.”
However, doing nothing could result in consequences felt beyond rail. Pilot Travel Centers CEO Shameek Konar said Union Pacific’s (NYSE: UNP) efforts to limit the number of railcars on UP’s network could reduce rail shipments of a diesel additive and cause “shortages that will sideline trucks and reduce trucking capacity” because Pilot will be unable to adequately supply its markets with the additive.
Whatever short-term measures STB mandates, questions about the long-term health of the freight rail industry will still loom in the background.
“I expect the executives at this table to be able to plan for the future. That’s one of the things that you’re hired for, and I don’t see it in the results,” said STB Chairman Marty Oberman.
The hearing was part of the board proceeding Ex Parte 770. Written testimony is available on STB’s website.