(The following story by Joe Ruff appeared on the Omaha World-Herald website on June 18.)
OMAHA, Neb. — Everyone winces filling the gas tank these days, but imagine being the nation’s largest railroad and burning more than 3 million gallons of diesel fuel every day.
Diesel costs have hit as much as $4 per gallon for Omaha-based Union Pacific Corp., and fuel expenses could surpass $1 billion in the second quarter ending this month, exceeding what the railroad pays its 50,000 employees in compensation and benefits.
“It will become our single biggest operating expense,” said Wayne Kennedy, the railroad’s general director of fuel conservation.
Second-quarter earnings will be announced July 24.
Costs for fuel have climbed the last couple of years. The railroad spent $3.1 billion last year and $2.96 billion in 2006, while spending $4.5 billion each year on compensation and benefits.
In 2003, fuel made up 13 percent of Union Pacific’s total operating expense. In 2007, it was 24 percent, U.P. officials said.
Union Pacific is among the top three users of diesel fuel in the country, along with the U.S. Navy and chief railroad rival Burlington Northern Santa Fe Corp.
In U.P.’s first quarter ended March 31, diesel fuel prices were up 47 percent for the railroad to an average $2.84 a gallon, compared with $1.93 per gallon in the same period last year. Fuel prices in the second quarter were averaging significantly above $3 a gallon, railroad officials said.
At the same time, the company has dramatically reduced the practice of buying its fuel in advance to lock in a price, which is often referred to as hedging. Instead, it is charging customers as close to its own costs as it can, hoping to neutralize the financial impact of the more than 1 billion gallons of diesel fuel it uses every year.
“Our goal is to get 100 percent of fuel recovery and make it a neutral in our business going forward,” Chairman and Chief Executive Jim Young told analysts in April during a telephone conference call announcing first-quarter earnings.
As fuel prices rose and volatility increased about five years ago, the railroad found hedging had become too speculative. Prices could drop as quickly as they rose. Instead, U.P. began using fuel surcharge programs to recover costs. Last year, surcharges covered about 85 percent of Union Pacific’s freight business.
Some of the surcharges are built into long-term contracts, and the railroad has about 26 percent of that business to renegotiate over the next several years.
Some customers have accused Union Pacific and other railroads of overcharging for fuel, an accusation they deny. Union Pacific also denies charges in an antitrust lawsuit filed last year on behalf of some shippers that railroads coordinated fuel surcharges to fix prices.
Union Pacific has not achieved 100 percent recovery of its costs, in part because fuel surcharges lag behind prices paid by the railroad and in part because one-quarter of its long-term contracts have yet to be renegotiated.
“We are challenged to recover fuel,” Young said in the April conference call. “It will just take time and effort.”
In its first quarter ended in March, Union Pacific spent $1.1 billion on compensation and benefits, while fuel expenses grew to $957 million from $662 million in the same three months last year. Union Pacific said it recovered about $200 million of the fuel cost increase from its customers.
Despite high fuel costs, the company is bullish on the future, in part because of high demand. Union Pacific has been able to charge more for shipping and turn away business that does not meet its price points.
It also believes that high fuel costs hit the trucking industry harder than railroads.
Conservation also is key to fuel savings, Kennedy said. Those efforts, including fuel-saving switch locomotives in rail yards and an awards program for engineers who conserve fuel on their routes, began in earnest in 2004.
Over the last four years, Union Pacific has saved about 90 million gallons of diesel fuel through conservation. The goal in 2008 is saving 24 million gallons, which would be a 2 percent improvement over the consumption rate in 2007.
At $3 a gallon, this year’s goal would save the company about $70 million, Kennedy said. At $4 a gallon Union Pacific would save close to $100 million, he said.
If the railroad can improve conservation efforts by approximately 1 percent to 2 percent each year, that could add up to about 10 percent to 20 percent in savings over 10 years, he said.
“Every gallon counts,” Kennedy said.