How Wall Street holds railroads hostage: Analysis
The U.S. Class I railroads’ recurring crew shortages, related bouts of service problems, and a lack of meaningful volume growth are intertwined. You can lay the blame for all three problems at just one place: Wall Street.
BNSF Railway, CSX Transportation, Norfolk Southern, and Union Pacific are in the midst of the mother of all crew shortages. The lack of crews has caused congestion, which in turn has slowed the network and sent operations into a downward spiral that requires even more crews.
So transit times are up. On-time performance is way down. Angry shippers are diverting loads to trucks. And frustrated regulators are demanding answers.
There’s no doubt that current crew shortages are exacerbated by pandemic-related changes in the labor market. It’s equally certain that the railroads’ operational changes and onerous attendance policies have prompted many longtime engineers and conductors to pull the pin, further thinning the crew ranks.
But we’ve seen this movie before. Over the past decade, service has suffered due to crew shortages three times each at BNSF and CSX, four times at UP, and five times at NS, according to a tally by Loop Capital Markets analyst Rick Paterson. “It cannot be all bad luck,” Paterson told the Surface Transportation Board during its rail service hearings in April.
He’s right. The culprit is a persistent failure to keep a sufficient cushion of crews on hand to ensure that a railroad can recover quickly from unexpected surges in traffic or extreme events like hurricanes, cold snaps, and wildfires. And the reason railroads don’t keep that capacity buffer? The Cult of the Operating Ratio, as analyst Anthony B. Hatch calls Wall Street’s hyperfocus on the key efficiency metric.
This short-term focus means railroads aim to keep costs at a bare minimum and reduce them every year — even if it jeopardizes service over the long term. Paterson notes that since gaining pricing power in 2004, railroads (except BNSF) have used a simple and wildly successful financial formula: Raise rates faster than costs and nevermind volume growth. This pushed Class I operating ratios from the 80s to the 50s and ushered in a Golden Era for railroad investors.
The party is over. Investors still push for lower operating ratios, but there’s not much juice left to squeeze. If your operating ratio is 80, a 1-point improvement will boost your bottom line by 7%. Now with an operating ratio in the 50s, a 1-point improvement nets just a 3% rise in income, Paterson says.
And this focus on reducing costs and raising rates has left railroads with a hangover. Since 2004 U.S. rail traffic has grown just 0.6%, even as industrial production has risen 13%, trucking tonnage is up 40%, and overall economic output has doubled.