(The following article by Gregory Richards was posted on the Virginian-Pilot website on August 8.)
NORFOLK, Va. — In the past few years, the big U.S. railroads have begun passing along to their customers the high cost of the diesel fuel that powers their thirsty 5,000-horsepower locomotives.
These additional fees, known as fuel surcharges, are a “much more perfect solution” than other methods of managing fuel costs because of their efficiency and because they remove the railroads’ responsibility for paying higher fuel bills, said Andrew Meister, an analyst at Thrivent Financial for Lutherans, an Appleton, Wis.-based investment firm that owns shares of the major railroads, including Norfolk Southern Corp.
R ailroad customers, however, say the surcharges are far from perfect.
The fees have ignited a contentious controversy between the railroads and the companies that ship via rail such cargo as automobiles, wheat, chemicals and coal. Shippers say the railroads have the right to charge the cost of fuel but that the surcharges are difficult to understand and that the railroads are collecting more in surcharges than their fuel bills. The fees, generally a percentage of base freight rates, can reach as high as 24 percent.
“The ability to mandate these fuel surcharges has become somewhat of a profit center for these railroads,” George Telfer, DaimlerChrysler AG’s senior manager for customs and government affairs, said at a U.S. Surface Transportation Board hearing on railroad surcharges in May, according to a transcript. He was speaking on behalf of the Alliance of Automobile Manufacturers, which consists of nine major vehicle makers.
Thomas Schick, senior distribution director for the American Chemistry Council, told the panel that the railroads’ fuel fees have topped their costs by more than $900 million. The council’s membership manufactures 85 percent of the country’s chemical products.
Officials from the top U.S. railroads said at the hearing that they were not overcharging and that they are losing money on fuel because some older contracts don’t contain fuel surcharges.
“Looking over the last six years since we’ve had a fuel surcharge, I can state that we have not over-recovered over that period of time,” said Donald W. Seale, executive vice president and chief marketing officer for Norfolk Southern, at the hearing.
The Norfolk-based railroad paid $87 million more for fuel than the surcharges generated between 2000, when it implemented the fees, and last year, Seale said. Eighty-five percent of Norfolk Southern’s revenues are covered by surcharges, he said.
In 2005, fuel surcharges represented one-third of the railroad’s $1.2 billion revenue increase, according to a filing with the Securities and Exchange Commission.
Railroads are not the only companies using surcharges to recoup fuel costs. Trucking companies popularized the fees in the late 1990s, and they have now spread to a broad swath of businesses, including airlines and package delivery services, such as United Parcel Service Inc. Even some pizza delivery companies, cruise lines and florists charge such fees.
The popularity of the surcharges comes as the top railroads are phasing out hedging, a centuries-old financial technique of locking in prices to protect a buyer from swings in value.
Norfolk Southern, the country’s fourth largest railroad, began hedging its diesel fuel costs in 2001, mainly to aid in budgeting by fixing fuel prices, spokesman Robin Chapman said.
The program saved the company $59 million in 2003, $140 million in 2004 and $148 million in 2005, according to SEC filings. Norfolk Southern’s 2005 diesel fuel bill was $727 million, including the savings from hedging.
The company placed its last hedge in 2004, and the final contracts expired in May.
“We began hedging when we anticipated prices were going to rise,” Chapman said. “When we thought prices had started to level out, we began phasing out the hedging program.”
However, since it stopped hedging, the price of a barrel of oil has increased to $76.98, the closing price Monday, from $40.28.
Last week, the debate over the surcharges intensified when the transportation board issued four recommendations in response to its May hearing. They included requiring the railroads to disclose more information about their surcharges and also having the railroads calculate fuel surcharges in a way reflecting actual fuel costs for each train movement. That could mean, for example, using each train’s weight and the distance it travels to calculate the surcharge, rather than just using a percentage of the base freight rate, which includes such non fuel costs as labor.
The board is accepting public comments on the proposal until Sept. 25. Norfolk Southern said last week that it will comment directly to the board.
The unhappiness over the surcharges is unlikely to cause railroad customers to change how they send their freight, said Meister, the stock analyst.
Often shippers can’t even choose between railroads. The Chemistry Council’s Schick said 63 percent of the chemical plants owned by its members are served by a single railroad.
In many cases, it’s only practical to move certain types of goods by train, such as coal or chemicals.
“Flying coal is not cost effective,” Meister said.