US chems concerned as rail carrier Canadian Pacific wins fight for KCS

Author: Stefan Baumgarten

2021/09/24

HOUSTON (ICIS)--The US chemical industry is watching closely as the railroad sector is set to further consolidate with the pending merger between rail carriers Canadian Pacific (CP) and Kansas City Southern (KCS), two directors at the American Chemistry Council (ACC) told ICIS in an interview.

Past consolidation and mergers in the railroad industry led to a dominance of railroad companies over their customers, and the latest M&A activities “certainly have our members concerned”, Scott Jensen and Jeffrey Sloan said.

Jensen is ACC director, issue communications, and Sloan is ACC’s senior director of regulatory and technical affairs.

CP earlier this month prevailed in a fight against rival Canadian National (CN) for KCS. If the deal gets regulatory approval, it may trigger further M&A activity in rail.

The deal would reduce the number of “Class I” railroads in the US from 26 in 1980 to just six - inevitably raising concerns about rising freight rates and the quality of service.

The battle for KCS began in March, when KCS agreed to merge with CP, but in May it switched sides to accept a higher rival bid from CN.

After the US regulator, the Surface Transportation Board (STB), raised objections to the CN-KCS combination, the deal fell apart last month, and KCS went back to CP, agreeing to a merger deal valued $31bn, including $3.8bn in KCS debt.

The merged company, to be called CPKC, would have a staff of 20,000 people and operate a 32,000-kilometre rail network across Canada, the US and Mexico. Still, even after the merger, it would be the smallest of the Class I carriers.

CP claims that the merger would enhance rail competition in North America, in particular to and from US upper midwest markets.

The rail carrier also points to access to the port of Lazaro Cardenas in southwest Mexico, which is served by KCS.

Lazaro Cardenas would offer CP customers an alternative to the congested port of Long Beach in California, CP said. (A list of CP’s other claims is at the bottom of this article).

ACC TO WEIGH IN
While ACC has not yet taken an official position on the CP-KCS deal, it expects to “weigh in” and urge the STB to take a close look at CP’s claims, to ensure that competition will be enhanced, rather than diminished, Sloan and Jensen said.

“We may weigh in with our thoughts on what should be imposed as conditions if [the STB] were to grant approval,” to ensure that the competitive benefits are not just claims, but that they become reality, Sloan said.

In particular, ACC wants to see some metrics or requirements that would ensure that any commitments or remedies CP may offer to address competition concerns are enforceable and that CP keeps its promises, Sloan said.

SWITCHING
Going beyond the CP-KCS deal, ACC wants the STB to look how to enhance competition across the rail network and allow more customers to access competitive services, Sloan said.

One key measure for STB to promote competition and reduce freight rates would be to implement the concept of "competitive switching" or “reciprocal switching”, he said.

Switching, if properly implemented, would open competitive options for “captive shippers”, that is, a shipper who is dependent on a single railroad, railroad A.

With switching, railroad A would take the shipper’s freight to an interchange point where the shipper would have the option of getting competitive bids from railroads B or C for the freight to be shipped from the interchange point to the shipper’s customer, Sloan said.

Sloan and Jensen went on to note a recent executive order by President Joe Biden that gives guidance to a host of federal agencies to enhance competition throughout industry and the economy.

That order specifically urges the STB to look into the concept of switching, they said.

Also, workable switching rules would be a more effective way of ensuring competition - rather than just relying on the commitments to improve competition railroads may make during a merger approval process, Jensen said.

He went on to note some “irony” around the fact that the two railroads that bid for KCS are both from Canada – a jurisdiction where a version of the switching concept has been in place for many years.

In fact, switching was “working very effectively to promote competition” in Canada and was not harmful to the railroads, as demonstrated by CN and CP, who were among the most profitable railroads in North America, he added.

TWO STAGES IN CP-KCS DEAL
Meanwhile, ACC will closely watch as the CP-KCS deal makes its way through the regulatory approval process, the officials said.

The deal will proceed in two phases.

First, CP plans to acquire KCS and place the KCS shares into a voting trust, at which point KCS shareholders will receive 2.884 CP shares and $90 in cash for each KCS common share held.

To close into the voting trust, the transaction requires approval from shareholders of both companies, along with other closing conditions, including Mexican regulatory approvals.

The STB already approved the use of a voting trust for the CP-KCS deal.

In a second stage, STB will conduct a full review of the deal, and CP's ultimate acquisition of control of KCS' US railway system is subject STB's final approval.

The full review process is expected to be completed only in H2 2022.

Only after obtaining control approval will the two companies be integrated fully, in a process expected to take three years, CP has said.

IMPORTANCE OF RAIL FOR CHEMS
Chemical railcar loadings represent about 20% of US chemical transportation by tonnage, with trucks, barges and pipelines carrying the rest.

In Canada, rail is more dominant, with chemical producers relying on rail to ship more than 70% of their products, with some exclusively using rail.

According to the Association of American Railroads (AAR), in 2020 US Class I railroads originated 2.1m railcar loadings and 175m tonnes of chemicals.

The highest-volume chemical carried by US railroads is ethanol.

More than half of all rail chemical carloads consist of various industrial chemicals, including soda ash, caustic soda, urea, sulphuric acid and
anhydrous ammonia.

Plastic materials and synthetic resins account for close to a quarter of rail chemical carloads. Most of the rest is agricultural chemicals.

CP’s CLAIMS ABOUT IMPROVING COMPETITON
According to CP, its combination with KCS would offer shippers:
- New single-line routes linking chemical, energy and merchandise shippers to more quickly and efficiently connect origin and destination facilities and reach new markets and global consumers.
- New single-line competitive options for domestic intermodal shipments between Mexico, the US Midwest and Canada.
- New single-line hauls linking key automotive manufacturing and distribution centers in Mexico, the US Midwest and Canada.
- “Unmatched access” to Atlantic, Gulf and Pacific ports, linking international intermodal shippers with North America’s largest consumer markets.
- New single-line routes allowing the efficient flow of agricultural products.

CLASS I  railroads currently operating in the US
1 BNSF Railway
2 Canadian National
3 Canadian Pacific
4 CSX
5 Kansas City Southern
6 Norfolk Southern
7 Union Pacific

Thumbnail image: Canadian National Railway near Jasper in Canada's Alberta province; source: Shutterstock ID 1536975047

Interview article by Stefan Baumgarten

(adds missing words "in KCS debt", paragraph 7)