Hopper car renewal raises new questions about freight rates

Canada’s two largest railways are planning to spend hundreds of millions of dollars over the next few years buying thousands of new grain hopper cars.

Canadian Pacific Railway plans to acquire 5,900 cars over the next four years at a cost of more than $500 million while rival railway Canadian National Railway plans to buy 1,000 new cars at an undisclosed cost.

That comes as welcome news to grain shippers who have been calling for more capital investment in the Canadian rail network and additional capacity.

But not everyone is celebrating the renewal plans.

Some, including skeptical farmers, argue the cost of fleet renewal will ultimately be downloaded onto producers in the form of higher freight costs.

“Thanks …. but the spider senses are telling me farmers got (burned) on this new bill,” said one Saskatchewan farmer who expressed his concerns last week in an email to the Western Producer.

“It’s a big change from a few months ago, where railways were not interested in investing in their infrastructure. Things never move that quick at a railway….”

CN and CP announced their fleet renewal plans shortly after Bill C-49, The Transportation Modernization Act, became law in Canada.

Both railways indicated that the passage of C-49 created a business climate that is more conducive to capital investment.

CP said its decision to invest in hopper car was “made possible by changes to the Maximum Revenue Entitlement formula through the passage of the Transportation Modernization Act.”

According to the farmer, that raises an obvious question: How has the MRE formula been altered and how will it affect grain freight rates?

According to the legislative summary on Bill C-49, provisions that deal with MRE changes fall into three categories.

First, the bill excludes interswitching revenues from MRE calculations.

Second, it excludes from MRE calculations any revenues earned from the movement of containerized grain that is shipped on flat railcars. In addition, soybeans have been added to the list of regulated grains that are covered under the MRE.

And third, it stipulates that both CP and CN should each be allowed to use their own price inflation index, also known as the Volume Related Composite Price Index (VRCPI), when calculating their maximum revenue entitlements from moving Western Canadian grain.

Historically, both CN and CP have used the same VRCPI, regardless of how much each railway spends on essential railroading inputs, including capital expenditures.

Joan Hardy, CP’s vice-president of sales and marketing in grain and fertilizers, cited the third provision, changes to the VCRPI, as a key factor sparking the hopper cars investments.

“Before Bill C-49 passed, the Maximum Revenue Entitlement cost index (VRCPI) applied to both railways together,” Hardy wrote in a June 8 email.

“As a result, there was a free-rider problem: if one railway invested in cars, the other would also get the benefit of that investment through an increase to the MRE,” she said.

“Bill C-49 solved this problem through the bifurcation of the cost index contained within the MRE into two separate indices for the two railways. This means each railroad gets a return on capital directly from its own investments.”

So how much will the railways be charging farmers to pay for the new cars?

Those are legitimate questions, according to Greg Northey, a grain transportation and logistics expert with Pulse Canada.

In a recent interview, Northey said the financial implications of Bill C-49, to farmers, shippers and rail carriers won’t be known for some time.

What does seem clear, however, is that Ottawa has divested itself of the responsibility to buy, build, commission and manage a federal grain hopper car fleet.

“This is government being very clear that they’re not in the business of buying hopper cars…,” Northey said.

“The cars needed to be replaced at some point and that takes money… so if someone’s going to (make that investment), they’re obviously going to try to make some return on that investment.”

Railways have been pushing for changes to the MRE formula for some time, Northey said.

Through Bill C-49, the railways got some favourable changes.

Going forward, each use their own VRCPI price index to calculate MRE limits.

They will also get full credit for the value of their hopper car investments.

Under the previous MRE provisions, the credit for buying new hopper cars was linked to the value of existing cars, meaning railways would not receive full value for their investments within the MRE calculation.

“Essentially, they’ll now get full value for any car that they purchase,” Northey said.

As a result, the railway’s VRCPI index will increase and the revenue the railway retains from moving grain will be higher.

Provisions in C-49 that deregulate the freight rates for containerized grain are another gray area.

For example, it remains to be seen how much freight rates for containerized grain will increase, or if they will increase at all.

Mark Hemmes, president of Quorum Corp., said it’s hard to gauge how much export grain is moved in containers.

It’s even harder to determine what portion of that grain was reported as MRE grain.

“Trying to distinguish between what was shipped in containers and what was counted as MRE grain as opposed to what wasn’t is a very difficult thing for us to do,” Hemmes said.

“That’s because we don’t have the data.”

In theory, containerized grain that’s no longer regulated under the MRE suggests that railways will have new opportunities to generate and retain additional revenues from the grain sector.

But in practice, a significant proportion of the grain that’s moved in containers each year might already be moving as unregulated freight.

In fact, the financial implications of Bill C-49 may not be fully understood for some time, if ever, Northey suggested.

“This is such a black box, trying to figure out how (the MRE is calculated),” he said.

Even the baseline costs that were used to develop the MRE formula in the 1990s raise important questions about the MRE’s relevance as a price protection mechanism.

“If the railways keep on reducing their (per unit) costs, which they have done over the lifetime of the MRE… it just means more profit for them, even within the MRE formula,” Northey said.

“On balance, I think it (Bill C-49) is a positive development…,” he continued.

“But we definitely need to watch the situation and make sure there’s not some kind of obvious downloading on farmers. That said, I think we can definitely expect some changes in how the railways structure their pricing.”

Overall, MRE changes that encourage railway investment in hopper cars should be viewed as a positive development for the industry, added Hemmes.

The industry has been anticipating the fact that aging government cars will eventually need to be replaced.

Concerns over how and when they will be replaced have now been answered.

“The timing of this is actually really good because it gives the industry a lot of breathing space,” Hemmes said.

“The federal hopper car fleet is still very capable of moving grain and it’s going to be around for a few years yet… but this next step, to new shorter, higher volume cars is definitely a positive,” he added.

There may be some uncertainty surrounding MRE changes but at least now “we have a plan ….”

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