Rail Merger Stirs Concern

In March, after a long and acrimonious battle that had been raging since the last quarter of 1996, CSX Transportation Inc., Richmond, Va., and Norfolk Southern Corp., Norfolk, Va., finally announced a deal to split Conrail, Philadelphia, more or less in half between them. Initially, CSX had proposed to buy Conrail itself, with no involvement by NS. Both say the move will increase freight competition in the Northeast. Observers say that shippers in the New York area and ports of New York have the largest potential to benefit from the merger, since Conrail previously controlled all traffic into New York and now there will be competition, which could lower rates.

Under the agreement, CSX and Norfolk Southern will form a jointly owned entity to acquire all outstanding shares of Conrail for $115 in cash per share. Norfolk Southern will contribute $5.9 billion for its 58 percent share of the acquisition and CSX will contribute $4.3 billion for its 42 percent share. Both railroads already owned some portion of Conrail stock.

In June, the two railroad companies will file a joint application with the Surface Transportation Board seeking approval of the Conrail acquisition and division. The joint STB application will address traffic flows, terminal operations and related matters; outline the capital investments each company plans to make in new connections and facilities and to increase capacity on critical routes; and detail operating savings and other public benefits resulting from the transaction.

CSX and NS say the merger will result in two strong competitors that will provide single-line service between the New York metropolitan area and Chicago, between New York and St. Louis and between the New York area and markets to the south and southwest.

Although scrap processors are concerned about the rail merger and think it will affect their shipments of scrap, they are not sure exactly what that effect will be, says Dennis Wilmot, director of transportation for Luria Bros., Shaker Heights, Ohio. Until CSX and Norfolk Southern file with the federal Surface Transportation Board and reveal their operating plan, processors can only guess what the plan will look like.

"In general, there are attractive things they have said, and there are some potential concerns," says Wilmot. "The question is, ultimately, will competition be improved as a result of the merger? In some cases there may be improved competition, and in other cases there will be a step backward in competition. It will depend on exactly what moves you’re doing."

Shipments that used to move directly on Conrail may have to go through both Norfolk Southern and CSX, says Wilmot, and there could be the potential for higher rates and longer service. But nothing is certain until the railroads file with the STB. Once that is done, shippers will be given a period in which to comment on the plan before it is finalized.

"The railroads are going to push for an expedited decision by the Surface Transportation Board," says Wilmot. "But we want to make sure that the shippers have the full 120 days that we get under normal terms to respond and comment. If the STB can cut some fat out of their process, without jeopardizing the integrity of their decision, then we’re all for making it faster, but only if it doesn’t affect the integrity of the decision."

This merger is leading people to imagine the possibility that consolidation will continue and one day there will only be two major transcontinental railroads left. This would be a threat to competition, says Wilmot.

"Under the current railroad structure, if there were only two transcontinental railroads, competition would be virtually eliminated in many cases," he says. "It would put the control of service and price into the hands of two mega-carriers, and it would reduce shippers’ voices to just a bare whisper."

"On the surface, there are a lot of interesting things to the merger, based on what we hear from the carriers," says Mike Mattia, director of risk management for the Institute of Scrap Recycling Industries, Washington. "Historically, at least for the past two mergers, if you had two carriers serving you and because of a merger you went to one carrier, generally what was then the ICC and is now the Surface Transportation Board required you to come in and provide the second carrier to maintain competition. However, if you only had one carrier to start with, the merging carriers weren’t required to add competition."

There has been talk that CSX and Norfolk Southern might go from one to two carriers in some areas, such as Philadelphia and New York, but this probably will not apply across the board, says Mattia.

There’s a heavy dependence on rail traffic by scrap shippers east of the Mississippi, says Mattia, so ISRI is following this issue closely to make sure the interests of its members are protected, and has several concerns.

"We’re concerned about any points that go two to one and aren’t properly resolved," he says, "and we sent a memo out to all our members on how to determine two to one points, because it’s not all clear cut. Another thing that’s a concern is going from direct movements to interline. Suppose I was on Conrail and I could go from my facility to the mill and I could always stay on Conrail. Well, when CSX and Norfolk buy Conrail, suppose they route traffic so that CSX picks me up and has to interline with the Norfolk Southern to take it there. That interline might cost more than staying on one carrier. Or maybe because of the way they are routing material the routes are longer and I pay for that."

Another concern is that the tremendous costs associated with several railroad companies merging might be passed on to the shipper.

Most likely, the merger will result in prices to ship scrap via gondola going up, according to William Walters, vice president of Audubon International, Audubon, N.J., as railroads will not be buying more gondolas and because competition, he says, will decrease. As for efficiency, Walters doesn’t expect more.

"Railroads are not efficient," he says. "If your material is going less than 1,000 miles, most of the time it’s cheaper to go over the highway, and it’s going to get there anywhere from two to five days quicker. With the volatility of the market right now, it makes sense to get it to the customer as quickly as possible. If you have heavy weight, like a million pounds, and you have seven to 15 days to get it to a spot, you’re fine by rail. But if you have something that has to be used right away, then you have to go over the road."

Audubon is a third party company that does highway, rail, ocean, and flatbed movement for specialized hauling, and has more than 150 scrap customers.

Walters admits he does not favor railroad movements of material, in general. "I’m never really optimistic because it’s like the government, a big bureaucracy, and only the people in upper management win out," he says. "The end user and customers are the ones that get hurt, either in price or in service."

The division of Conrail between CSX and NS is better than the original arrangement of having CSX only taking over some Conrail assets, according to Ron Havrilla, who handles transportation and does some trading for Pro-Trade, Hudson, Ohio.

"Especially now, with the rates higher than ever before, at least this will result in some form of competition," he says. "We do a lot of business in the South, so we are hoping it will enable us to go single line from this area all the way to the South. It’s going to help in the long run. But it’s not going to happen overnight."

All three of the railroads concerned in the merger – CSX, Norfolk Southern and Conrail – own significant fleets of gondola cars, says Mattia, which raises concerns.

"If you have three companies with huge gond fleets, and now you have two, what happens to gond availability? The railroads would say it’s better because maybe you only had access to one of the three and now you might have access to two of the three. The bottom line is, there are so many variables and these petitions are so complicated, that what you’re worried about is missing something."

This concern is augmented by the extreme regional variations, which makes it difficult for ISRI to advise its members on what to do to protect their interests in the face of the merger. "It’s not like Superfund, which we can argue nationally," says Mattia. "It’s extremely regional – it’s company by company in many cases. We have to dot every "i" and cross every "t" and make sure our members do the same and nobody gets left out of the loop. We can’t respond for each member – they’ll have to do it individually with our help."

There is a reluctance on the part of railroads to invest in new gondolas, says Mattia, as they by necessity are used hard when transporting scrap. "For tissue paper, you can use several different kinds of railcars and you probably won’t ruin the car," he says. "But when I’m loading metal scrap with magnets and banging, gonds don’t have a long life. CSX was quoted in the early 1980s saying they upped the fleet to 10,000 gonds. Then by the late 1980s, only about a third or a half were still in service. Also, shipping the finished product makes more money and doesn’t hurt the gond as much as scrap does, so given a choice the railroads would rather give the gond directly to the steel mill even if scrap guys are hurting for cars."

The bottom line is that a lot of potential good that could result from the merger, because there are scrap processors who might be able to get access to more gonds than they used to, says Mattia. "It might be shaking out for several years. Rates won’t go up overnight, but they will go up over time, and what that will be is hard to say."

Better equipment supply from a bigger fleet, more flexibility as far as car scheduling; improved single line service between the North and the South; and more efficient triangulated moves between steel producers, scrap recyclers and processors will all be benefits of the merger, according to Vance Richardson, director of corporate communications for CSX.

"Basically there will just be greater efficiencies and more opportunities to compete with truck and improve the efficiency of rail transportation throughout the east," says Richardson. "We’re going to make every effort to resolve two for one points. But the specifics on that will be forthcoming once we develop our operating plan."

The two companies will be putting together a joint transaction, says Richardson. "We think this is a very positive resolution," he says. "It’s a very pro-competitive solution to the situation in the East, and we think it will restore balance and improve overall rail efficiencies."

NS and CSX will still be fierce competitors, even though they are cooperating in this one instance to split up Conrail, says Frank Brown, a spokesman for Norfolk Southern. "The two of us are going to buy Conrail and restructure it," says Brown. "They’ll get part of it and we’ll get part of it, and then we’ll be competing every minute of every day with them. We are not teaming up with CSX. We’re looking to restructure the railroad system in the East, and when that’s completed, you’ll have two very strong carriers of comparable size and scope and there’s going to be a lot of competition all over the East. That’s why we pursued our case so very far."

Had CSX been able to go through with their original proposal to buy Conrail by themselves, competition would have suffered, says Brown. "NS, as the remaining large carrier in the East, would have not been nearly the size and scope of CSX and Conrail together," he says. "We would have been at a very serious disadvantage and that would not have been good for competition. They would have had more track, more geographic coverage, more market shares – just more of everything, and we would have been relegated to a much smaller status."

Although there are theoretically enough gondola cars to meet the needs of U.S. scrap processors, says Wilmot, processors can’t always get cars when they need them. This results in the appearance of a gondola shortage. "In general, there still is a struggle to get cars on a timely basis, especially in certain regions and especially on certain carriers," he says.

It’s hard to say if the merger will have much affect on gondola availability. It won’t put more gondolas into the national gondola fleet, but there is the chance that service could improve, says Wilmot.

"There certainly wouldn’t be any immediate impact, because the mergers that we have seen the last two or three years tend to take a couple of steps backward before they ever start going forward," he says. "It takes time to get the systems to talk, and they lay everybody off before they get things to work, which slows down the process. So I would imagine that the merger initially will make things worse before it gets better."

The crisis in gondola availability in 1994 and 1995 was partly due to the price of scrap being very high, says Wilmot. More recently, although it has sometimes been difficult to get gondola cars, it is no longer a crisis. "The price of scrap is still considerably lower than it was in 1995, so the traffic flows have changed," he says. "I don’t know about rail volume per se, but there have been some initiatives taken by the railroads that have helped speed up car movement."

Actions taken by railroads have affected scrap movements, says Wilmot. "Through pricing initiatives, they encourage longer-haul, high volume movements and discourage the more scatter-shot approach," he says. "What this does is limit the flexibility of the marketplace to flow scrap where it would most naturally go."

The issue of gondola utilization has been a sore subject between scrap shippers, steel mills and railroads for years. During the real gondola crunch, ISRI formed a Gondola Utilization Task Force with representatives from these various sectors to study the use of gonds and recommend better ways to use them.

"ISRI put out a position paper about a year ago where scrap dealers were having a hard time getting gonds, and the problem wasn’t a lack of gonds – we found that on average it takes a gond 30 days to go from origin to destination and be ready to load scrap again," says Mattia. "This caused a shortage in the gond fleet – physically there were enough cars, but they were not moving efficiently enough for scrap processors to get them when they needed them."

After several years of studying the issue, says Mattia, it is time for action. At press time, ISRI was about to hold a meeting of scrap dealers, steel mills and railroads to try and come to some resolution. Ideally, changes could be made without going to the Surface Transportation Board for formal rulings, but that will be the scrap industry’s last resort, he says.

One problem the task force will seek resolution on is the holding of gondola cars by railroads. When scrap comes in by gondola, says Mattia, the railroad may not be immediately ready for it. The mill can either unload the scrap, release the car, and store the scrap until it is needed, then handle it again later, or just store it on site in the gondola car, eliminating double handling. Even though the latter option often incurs a demurrage charge for holding the car longer than allowed, this is actually cheaper than double handling the scrap, says Mattia. As a result, there is no financial incentive for mills to return cars promptly.

"That’s great for the mill, but it takes the car out of service," says Mattia. "And if you do that with enough cars, you cause an artificial shortage. There has to be a disincentive for holding the cars beyond the storage time. Then if a few extra cars get freed up on a timely basis, maybe there will be a few more available for scrap."

Another issue the task force will raise is that of car cleaning. Sometimes gondola cars arrive with several tons of debris in them, and processors must either return them and hope for a clean one or do the cleaning themselves, taking the risk that some of the material could be hazardous.

"So we’re sitting down with all the parties and saying ‘maybe we can resolve these issues without going to the Surface Transportation Board and asking for rulings’," says Mattia. "What will happen after this meeting is not sure. Maybe we’ll go to the STB on points one, two and three, and resolve the others another way. We’re at a point where we want to try and resolve it as much as we can."