Railroads Step Up Against Lawsuit

Four major U.S. railroads — Union Pacific Corporation ( UNP - Analyst Report ) , Norfolk Southern Corp. ( NSC - Analyst Report ) , CSX Corporation ( CSX - Analyst Report ) and Burlington Northern Santa Fe — have appealed against the class one action after the District of Columbia court granted class action status to a price fixing lawsuit.

The U.S. district judge, Paul Friedman of the DC court, brought forward the case of eight shipping companies that accused these railroads of imposing a series of price increases between 2003 and 2008.

A class action lawsuit would now imply that the railroads have to defend themselves from collective charges brought by the shippers under Federal Rules of Civil Procedure Rule 23 and 28 U.S.C.A. § 1332(d).

The carriers, which dictate more than 90% of the freight revenues in the industry, have stated that the court decision could cost approximately $10 billion or more in claim settlements, causing a significant financial burden. Lawyers supporting the railroads have argued that the case should be dismissed due to the lack of proper evidence.

The pricing practice of the U.S. freight railroads is a major cause of friction with captive shippers that move their products through rail and do not have effective alternatives. Since 1980, railroads have been enjoying significant pricing power, based on The Staggers Rail Act that substituted the long existing Interstate Commerce Act of 1887. The Staggers Rail Act provided greater flexibility with respect to freight pricing with less regulatory constraints, more freedom in collective ratemaking as well as entry and exit of companies from the industry.

The Staggers Rail Act allowed the rail industry to recover from its most unprofitable period since the Great Depression, when these railroads where exposed to stringent pricing regulation by the Interstate Commerce Commission. Additionally, the rise in automobile and truck freight market greatly affected the rail business. Hence, the Staggers Rail Act remains an important milestone in the history of the rail industry for its recovery.

However, over the past several years, shippers are continuously struggling to put railroads under review for indulging in unfair pricing practices. This has not only affected the shippers through increased shipping costs, but has also hurt consumers. Customers have accused railroads of extracting more fuel surcharges from them as well as indirectly charging for other costs that have raised shipping cost by almost 100% since 2004, while shipping cost from other modes have only gone up 20%.

Studies show that rail pricing has dramatically shot up since 2004 and continues to increase, with an average rise of approximately 4 to 6% per year. On the other hand, other modes of transportation like trucking and air freight have only risen by approximately 1–2%. Studies have also revealed that all major freight railroads’ fuel surcharges exceeded by approximately $6.4 billion from the actual cost between 2003 and 2007.

Railroads lashed back arguing that despite the ongoing hikes, prices remain below the 1980 levels considering the economical factors. Further, they protest that fuel surcharges, which are subject to adjustments depending on fuel price changes, have not been successful in tapping rising fuel prices.

We believe that the issues between the railroads and shippers will continue as long as matters regarding price fixing by the railroads are out of the realm of the U.S. antitrust laws.

Per the latest studies by Surface Transportation Board (STB), approximately 35% of the annual freight rail is captive to a single railroad, allowing its monopoly pricing practices. The unfair pricing power exhibited by the U.S. railroads has summoned congressional intervention for exercising stringent federal regulations on the railroads. Congress has discussed railroad price regulation but has not passed any new rule so far.

In February 2012, shippers forwarded a joint letter to Congress appealing to support Amendment 1591 to the Surface Transportation Bill to abolish freight rail industry exemptions from the U.S. antitrust laws. The amendment, proposed by Senator Herb Kohl, would create healthier competition among freight rail shippers and stop unfair pricing polices.

Any change brought forward by Congress or the STB would bring good news for the larger market but could mean a serious threat to railroads, especially when economic uncertainty is generating poor volumes and pricing has become a dominant factor for the recovery of the industry.

We have our long-term Neutral recommendation on Union Pacific, Norfolk Southern and CSX Corporation. For the short-term (1–3 months) Norfolk Southern and CSX Corporation hold a Zacks #3 Rank (Hold). Union Pacific has a short-term #2 Rank (Buy).