First of Two Parts

Understanding how a railroad views your business is a key step in finding opportunities to save money through better processes, timeliness and integration.

By Darell Luther

Creating value in transportation and logistics is often tricky. To truly translate transportation and logistics needs to reality is even more complex. Then to optimize these needs to benefit economics and efficient transportation becomes the challenge.

I remember vividly the first rail transportation and logistics consulting company I started back in the early 1990s. I was visiting with a customer one day in a restaurant in Vancouver, WA and he asked me, “Why did you leave the railroad to start this business?” At the time I was doing operational and rail rate consulting and my background comprised of an almost 10-year stint at two Class I railroads where I spent a varied amount of time in marketing, integrated network management (my boss worked for Hunter Harrison), rail fleet management, rail operations, a special finance group, tariff and contracting, unit train operations, and railcar acquisitions and disposal. (As an aside, since that time I’ve spent the last 25 years on the private shipper and car owner side as well as starting two companies that focus on rail transportation at all levels).

My answer to my customer was something along the lines of the following: “I’ve seen just about every angle of a rail carriers requirements.  I thought there was a business in translating those requirements to shippers and receivers first hand while helping shippers and receivers realize an economic benefit in utilization of this information.” Almost 35 years later the model continues to work across a host of disciplines and my company remains dedicated to this same mission.

So to those who are new to rail shipping or who are looking at better adjusting and understanding the rail network, there are a series of items that rise quickly to the top of the list on understanding railroads requirements and competitive position so that you can economically participate in the railroads distribution network.

Rail Rates

As a shipper, receiver or general freight payer, it is best to understand the negotiating position of the railroad(s) that you require to meet your shipment requirements. First, there are seven Class I Railroads in the U.S. and Canada. In the U.S., there are five Class I Railroads, of which two are in the east, two in the west and one that runs from Canada to Mexico down the center of the country. If you take a moment and picture this (or Google it), you’ll soon realize that with some discipline, railroads have a lot of pricing autonomy for their freight services. Railroads have gone through some difficult financial times and have learned from them.

Post Staggers (deregulation) railroads rushed to sign up shippers under long-term contracts to protect their revenue streams. This was a competitive time with significantly more Class I Railroads hauling freight. Railroads soon learned as commodity and processing value chains rose in profits that they weren’t realizing any of this growth because price indexes wouldn’t keep up with value changes so as soon as possible thereafter, railroads shifted as much pricing as possible to public tariffs.

Public tariffs allow price discovery. To look up prices, simply go to a railroad’s Web site, sign up for a log in, and pull up prices for your particular commodity. It is in the railroad’s best interest to obtain as much business on a competitive playing field as possible while optimally pricing your shipment.

So How Do You Obtain “Decent” Rates?

That depends on what options you have available. If you’re participating in a Greenfield site, you have all sorts of options—the most important of which is to obtain access to at least two Class I carriers. This may be accomplished by setting up your site on a Shortline railroad or industrial site that has dual access or setting up your site near two Class I railroads where it is economically feasible to build out tracks to the interchange.

If you’re stuck with one carrier, you may want to review a build out of track capacity to a nearby location that has dual access to two Class I railroads. Other options may be to shift carloads of business to other plants that have competing railroads for rate adjustments on that railroad. A further consideration is to co-op shipments with locations that have competing origin railroads where there is a similar transportation disadvantage.

Straight up education of your business to the railroads is another option. If they realize that their rate actions are impeding your business and rate adjustments can increase volumes in an advantageous corridor, then they should be considered; however, at this stage, don’t kid yourself. If a rate concession won’t move the needle for the railroad they certainly won’t concede their rates. Additionally, do not expect them to put you at a competitive advantage because they won’t.

A last resort is petitioning the Surface Transportation Board for a rate concession. To obtain a rate concession you will need to prove that the railroad is putting your shipments at a competitive disadvantage, you have no alternative transportation modes and the railroad is charging egregious rail rates.

Regardless of where you are at in your shipment scenario, rail rates are often at the head of the list when it comes to accounting for transportation costs. We have found dual access is worth anywhere between a 5 and 25 percent rail rate savings, so it’s worth looking into.

Operating Requirements

Class I railroads have reduced their railway track footprint over the course of time pulling up most any track not required for immediate use and selling a great deal of track and rail access into the secondary market. There are some 500 plus regional and shortline railroads today all created from Class I secondary line sales. Class I Railroads have all put billions of dollars into rail sidings and yards to support major commodity groups such as coal, grain, crude oil, frac sand, chemicals, intermodal, etc. The whole intent of these investments are to make the railroad networks more efficient for the transportation of commodities from an origin area (Powder River Basin, eastern corn belt, Gulf Coast chemical complex, Long Beach, etc.) to a destination area or specific customer or commodity destination area.

The message is that railroads will move railcars as quickly as possible while maintaining fluidity on their network. They expect the same out of their customers. They’ll give their customers a set amount of time to load, present the railcars for shipment, and unload and present the empties back to them. After the set amount of time, the customer pays for the delay in most cases regardless of who is truly at fault (as a side note, we quickly delve into the world of timing, e.g. when railcar(s) offered for pickup by the shipper as a load or receiver as an empty versus when electronic billing was presented versus what the railroad system has in their system).  The message we are being sent by the railroads is that it is necessary to have sufficient track capacity at each origin and destination to accommodate the potential surge in railcars if the fluid system gets out of balance.

To put this in perspective imagine a scaled down version of the human nervous system. Instead of millions of neurons, receptors and signals to specific areas of the body and brain, each railroad has tens of thousands of miles of track connecting millions of customers with each other across additional railroads with tens of thousands of miles of track and hundreds of shortline and regional railroads supporting the transport of more than a million and a half empty and loaded railcars.  It is complex and someone has to provide the buffer to accommodate these railcars or shipments.

Operating requirements play a key role in a customer’s ability to fit into the railroad template. Take stock of your track capacity, local interchange capacity and ability to take a surge of railcars.

 Rail Equipment

Views on rail equipment have migrated over the past two to three decades from one in which the majority of railcars were controlled (owned, leased, financed) by the railroads and provided to the customer for their use to a more even mix of railcars being controlled by private lessors, shippers and receivers, and railroads.

Why the Transformation?

The three factors that led to the change are financial requirements of the railroads, liability risks and use rates for rail equipment. Every Class I Railroad has gone through a rationalization phase. During these phases, assets are reviewed as to the amount of return they can provide, the risk associated with owning them and what use rates they can support. Phase I goes way back to the pre-Staggers (deregulation) stage where railroads were virtually required to invest in railcars to provide transportation to customer. A large majority of the rail fleet was controlled by railroads at this point. Phase II is what I call the asset-financial balancing stage (immediately after Staggers Act) where railroads were deregulated and had more latitude on what they invested in.  The fundamental change in rail equipment ownership began in this phase.

In the west, opportunities were abound with the increased use of coal out of the Powder River Basin of Wyoming; in the south, Gulf Coast chemical plants needed additional rail options; and in the southwest, ports needed infrastructure development to support intermodal. These all required significant track and infrastructure investments, leaving the railroads with little left over funds to invest in railcars. In the east, similar decisions where being made with the breakup/sale of Conrail to CSX and NS pushing invested capital to infrastructure first, changing the fleet mix between railroad and private ownership significantly over time. Railroads still have a significant amount of railcars under their control even after the shift away from controlling the vast majority of the railcars to customers.

Liability risk is another key area considered by railroads in the railcar world. Railcars that carry commodities such as chemicals, hazardous materials, radioactive materials, etc. will almost always require a private railcar. Additionally, railroads have not invested thus far in tank cars outside of a handful of fuel and water tanks used internally.

Providing Railcars

Use of railcars is very important to railroads. That’s how they generate the majority of their income—moving railcars quickly and consistently. If a railcar has low use rates, railroads generally require the shipper to obtain their own rail equipment. A general definition of low use is less than 10 loaded trips per year. Plastic pellet railcars are a good example of this situation where the railcar itself is often used as a storage vessel. Railroads have no interest in rolling storage.

Private shippers/receivers and lessors of railcars must go through an approval process to run private railcars on railroad lines.  This process is called OT-5. Part of the OT-5 approval is documenting to the railroads that there is sufficient space available (see the Operating Requirements section) to accommodate all of your railcars should you need to park them. This doesn’t necessarily need to be at the facility registering the OT-5, but it should be within a reasonable distance. Without OT-5, the railroad isn’t required to let a private railcar owner run their equipment on its rail lines.

The dilemma in working with the railroads when it comes to providing railcars is that on a micro basis it isn’t static. During recessionary periods or when traffic flows are off, if the railroads have surplus equipment that can be substituted for private equipment, they will become insistent that private shippers forgo the use of their own railcars in lieu of the railroads equipment. One can’t blame them for their efforts. It’s a frustrating dilemma, though, for shippers who have taken the extra step to obtain railcars to support their traffic flow expectations when the railroad didn’t have railcars available. Generally, the business case wins out and railroads back off allowing those railcars properly registered in OT-5 to continue in service. Time and time again we see that planning for and using a privately owned or leased fleet of railcars allows the majority of shippers to control their destiny and ensure that when times are prosperous and the railroad doesn’t have equipment to offer, shippers still have access to the equipment they need to support their businesses product transportation success.

Proactively Manage Your Costs

Companies that are trying to fine-tune their logistics and lower transportation costs find that rail rates, operating requirements and rail equipment are key cost drivers that should be proactively managed. Understanding how a railroad views your business from these perspectives is a key step in finding opportunities to save money through better processes, timeliness and integration. Also of importance to understand are Logistics Management, Railcar Maintenance and Accessorial costs. These items will be addressed in part two of this article.

Darell Luther is CEO of Tealinc, Ltd. (Forsyth, MT) a railcar operating lessor, transportation consulting company and broker of freight railcars and rolling stock.  He can be reached at (406) 347-5237 or via e-mail at [email protected].