Canada Is Strong-Arming These Railroad Companies

Will the Canadian government derail Canadian Railways?

Apr 16, 2014 at 9:19AM

The Canadian government has taken a hard-line stance with Canadian National Railway (NYSE:CNI) and Canadian Pacific Railway (NYSE:CP), issuing an emergency measure ordering them each to move 500,000 tons of wheat per week or face a fine of C$100,000 per day.

Grain companies, at risk of not being able to get their product to customers because of a massive railroad bottleneck, have pressured the Canadian government to issue emergency measures and introduce legislation that would force the two railways to move a minimum volume of grain per week. The railroads have argued that the backlog is due to the record 2013 harvest coupled with the extreme weather during much of the past winter, and that the emergency measures and proposed legislation are a knee-jerk reaction from Ottawa.

Canadian National Railway CEO Claude Mongeau stated, "Canadian National is disturbed that the government has decided to punish railways with reregulation for an outsized crop and winter conditions totally beyond their control." 

Both railways have argued that it is unfair for the Canadian government to single out the railroads when grain-handling companies are ordering railcars and signing delivery contracts at unsustainable rates. Mongeau said grain companies should be penalized if they overbook railcars that they don't have the capacity to unload.

Nasty side effects
More problematic than the fines for non-compliance included in the proposed legislation are measures that would raise the interchange limit from 30 kilometers to 160 kilometers (18.64 miles to 99.42 miles) for all commodities, which would open up the southern portion of both railroad's networks to competition from U.S. carriers including Burlington Northern Santa Fe Railway, which is owned by Berkshire Hathaway. This means that Burlington Northern Santa Fe would be able to deliver grain for shippers in southern Canada who previously only had access to Canadian National Railway or Canadian Pacific Railway in return for receiving a set rate fee. This would effectively result in transferring commodities that would normally be moved by Canadian National Railway and Canadian Pacific Railway to U.S. carriers, which would result in loss of revenue for the Canadian railways.

Another potential negative effect is that the Canadian rail companies may end up moving smaller amounts of more lucrative products because they have to meet their minimum grain volume requirements. Critics have contended that the railroads have increased their crude oil shipments and have purposely ignored less lucrative grain shipments.

Foolish takeaway
Despite their concerns, both railways have announced that they will be able to meet the demand to move the massive amounts of grain called for by the Canadian government. More worrisome for the railroads is the proposed legislation that, if passed, would raise interchange limits and open up both companies to competition from U.S. peers. This would decrease revenue and affect the bottom line, though at this point it is too early to determine the actual impact. It will be interesting to see how these recent developments affect the movement of grain in Canada and what measures Canadian Pacific Railway and Canadian National Railway may take to combat U.S. competition.

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Charles Sherwood has no position in any stocks mentioned. The Motley Fool recommends Canadian National Railway. The Motley Fool owns shares of Canadian National Railway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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