Last July, two of the largest railroad companies in the U.S.—Union Pacific Railroad and Norfolk Southern Railway—announced their intention to merge their networks, giving birth to the nation’s first railroad spanning coast to coast. The companies submitted an application to do so to the Surface Transportation Board, the federal body that regulates railroads, late last month.
But the deal has now run into some trouble with regulators, although it’s not insurmountable trouble. And control of a key St. Louis entity is one of the two major potential problems.
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To understand why, it helps to know a little history.
Ari Rosa, senior equity research analyst at CitiGroup covering transportation and supply chain logistics, says the idea of the merger was a big deal.
“There was a build-up to the announcement where it had been kind of floated and teased as an idea of what if we were to try to look at a transcontinental railroad? And it had come up at a number of industry conferences,” he says.
The potential deal also represented a substantial shift for the industry: It would be only the second proposed merger of Class I railroads in decades, following the successful marriage of Canadian Pacific and Kansas City Southern just a few years earlier.
Just after the turn of the millennium, the Surface Transportation Board adopted new rules for mergers, which effectively placed a moratorium on them, Rosa says.
“Overall, the U.S. economy and the North America economy are very dependent on railroads to … move critical goods across the country. So if there are service failures or integration challenges, that poses a risk to the North American supply chain,” Rosa says. “That’s one of the reasons the [Surface Transportation Board] basically halted rail mergers. And the second was they were concerned about the railroads just getting too big.”
The idea was that any future rail mergers would “have to be pro-competitive and in the public interest,” he explains. Union Pacific and Norfolk Southern in their application to merge essentially argue that merging is in the public interest because the newly formed railroad would improve transit times, with routes that could potentially save “hours to days” when moving goods across the country, Rosa says.
Part of that is because the new combined railroad could more efficiently move through the major rail junctions of Kansas City, Chicago, New Orleans, and St. Louis. These regions can see lots of congestion on the tracks as railroads interchange between different networks, Rosa explains.
“The analogy that Union Pacific has been using is: ‘Imagine if every time you wanted to fly from Los Angeles to New York, you had to stop in Chicago. And not only did you have to stop in Chicago, you also had to book two different plane tickets, one from L.A. to Chicago, and then one from Chicago to New York, and you have to do it with two different airlines,’” he says, adding it’s not a perfect comparison.
On January 16, though, the Surface Transportation Board decided against accepting the merger application for consideration, saying it was incomplete, but left open the door for Union Pacific and Norfolk Southern to resubmit a new one. Union Pacific and Norfolk Southern have until February 17 to indicate to the board if and when they plan to file a new merger application. The board indicated last year’s merger application was incomplete for a few reasons.
One of the problems was a lack of detailed estimates of the expected market share of rail traffic as a result of the merger. The other problem was concerns about how the merger would affect the Terminal Railroad Association of St. Louis, a much smaller regional railroad that operates the two rail bridges crossing the Mississippi River as well as a large rail switching yard in Madison, Illinois.
The Terminal Railroad Association of St. Louis is presently owned by five of the six larger Class I railroads: BNSF, Canadian National, CSX, Norfolk Southern and Union Pacific. The Surface Transportation Board found the proposed merger of Union Pacific and Norfolk Southern would result in a single railroad with an interest over 50 percent and four of the seven board seats. And that, it noted, could have an anticompetitive effect.
Union Pacific had indicated in its merger application that it would commit to reducing its ownership below 50 percent, but other railroads, chiefly CSX, took issue.
“CSX contends that the transaction, if approved, would not only result in common control of those two direct competitors, but also “give [Union Pacific] complete control of the St. Louis gateway on which CSX and all other Class I railroads rely to compete,” including “both Mississippi River bridges, the two rail belts around East St. Louis, multiple joint use yards, and extensive track CSX and other carriers rely on to connect,” according to the Surface Transportation Board’s denial of the merger.
Rosa characterizes the decision from the Surface Transportation Board as wanting more information from Union Pacific and Norfolk Southern before making an ultimate decision.
“That they wanted to review in more scrutiny,” he says. “None of this, I think, should be seen as an insurmountable barrier, but it does pose some incremental risk to the likelihood that the merger gets approved.”
The two railroads have until February 17 to indicate if they will refile an entirely new application if they want to continue with the merger, something Rosa “strongly suspects” will happen. There’s not much precedent for a decision timeline, but based on the Canadian Pacific, Kansas City Southern merger, it could come within 18 to 24 months.
Editor’s Note: A previous version of this story mischaracterized the nature of the Surface Transportation Board’s January 16 decision and timeline for Union Pacific and Norfolk Southern to refile a new application. The article has been updated.
