The Role of the Railwaysin the Western Canadian Grain Transportation and Handling System

D. E. Stirling

Senior Manager, Marketing

CP Rail System

Winnipeg, Manitoba

Agenda

• Grain is Extremely Important to CP Rail
• Western Canadian Grain in World Markets
• CP Rail Long Term Vision
• Government Policy and Regulation
• Getting to an Effective System
• The Case in Grain

Grain is Extremely Important to CP Rail

• 20-25% of railway's revenue and workload in Canada.
• 40% of revenue in western Canada.
• Largest volume moved of any commodity.
• Revenue adequacy of western Canadian grain business is critical to CPRS viability as a railway.

Western Canadian Grain in World Markets

• NAFTA, GATT and changes to European Union's common agricultural policy will benefit Canada, especially wheat.
• Increased market opportunities but also more competition, more risks and more volatility.
• U.S. will be Canada's main competitor.
• Increased focus on "designer" grains - more customized quality blends.
• Increased focus on getting the right product in the right place at the right time.

CP Rail System Long Term Vision

• Same rate regulations for grain as other commodities.
• Rationalized branch line network of high-density feeder lines.
• Gathering system increasingly built around large, high throughput, low cost inland terminals fed by commercial trucking.
• Majority of grain moving from inland points in multi-car blocks.
• Permit shippers and railways to negotiate car allocation system using market tools such as bid system for a potion of fleet.
• Customer driven logistics comprised of:

- just-in-time system of rail car movements.

- decreased grain car cycle times.

- delivering grain based on customers' needs.

Policy and Regulation

Roots of Regulation/Intervention

• Railways were major force for development.
• Economic and railway policy closely linked.
• Initial rail dominance in freight and passenger.
• Protect public from potential for abuse.
• Some things were probably a good idea at the time...fixed grain rate and government ownership of rail.
• 87 years for a fixed rate was unrealistic.

A Failure to Evolve

• Policy evolution constrained by:

- Ease of initial decision to intervene.

- Regulation acquiring life of its own.

• Rail regulation grew from sense of "monopoly".
• Changing economy/transport market not recognized.
• Intent was to protect shippers, but eventually protected rail competitors and weakened the railways.

The Realities of Today

• Limited growth in rail commodities.
• Competitive pressures:

- Shippers: global markets.

- Railways: Deregulated competitors.

• Shipper needs: more demanding and varied.
• But independent studies have warned:

- Rail system is not viable.

- Investment in effective services depends on viability.

• Regulation must link shipper aspirations (low cost) and carrier's ability to meet them (investment).

Getting to an Effective System

Railways and Governments Roles

• Railway responsibility:

1) Services/operations...reliable, responsible, competitive.

• Railways, with supportive public policies:

2) Rail networks/facilities...match utilization to needs.

3) Workplace...productivity, cost relationship.

• Government responsibility:

4) Policy/regulation...align with today's competitive realities.

Getting to an Effective System

1. Services/Operations

- New north-south links.

- New technology.

- New services.

- Re-structured organization.

Needed now: Increased levels of railway investment.

2. Network/Facilities

- Increased density, strengthen core network.

- Challenge of truck dominance.

- CN-CP line-sharing/merger attempts, shortline sales.

Needed now: Cut density gap vs. U.S. benchmark railroads.

3. The Workplace

- Progress in 1995: employment security, work rules.

- But labour productivity growth lags the U.S.

Needed now:

- Accelerated change.

- Improved investment.

4. Policy/Regulation

- Federal goal rail renewal.

- But disharmony remains:

* Canada - U.S.

* Rail - truck

* Federal - Provincial

* Fiscal

Needed now: Innovation, investment encouraged in policy.

Railway Renewal

• Significant changes initiated in 1995:

- Western Grain Transportation Act (WGTA).

- National Transportation Act, 1987.

- Railway Act.

- CN privatization.

• Unresolved issues.

- Slow progress in achieving deregulation.

- Rail still more "policed" than competitors.

- Policies remain "dis-integrated" (highway/rail).

- Slow action on taxes ($200 million disadvantage).

- Grain: lack of incentive for efficiency.

The Case in Grain

• No commodity has been more regulated than grain.

- Crow Rate "ultimate regulation".

- Pre-WGTA losses hurt producers, shippers, governments and railways.

• Distortion from using rails system to subsidize grain production:

- Little incentive for rail investment in grain.

- Negative incentive for agricultural diversification.

- No incentive for grain system to evolve.

- Protection from progress, not from reality.

• Regulation/intervention haven't worked since 1950.

Grain and Railway Renewal: Fundamental Inconsistency

• Now producers will pay the full transport cost:

- Commercial system eventually...or a "new Crow".

- Hybrid system continues distortions.

* Regulated average rate scale preserved.

* No rate distinction between high-cost and low-cost users.

• Hybrid regime the worst of both worlds:

- Maximum cost-based rate dampens market incentives.

- Provisions simulating market forces will push some rates below regulated rate.

- No other commodity has this "protection-plus".

• System efficiencies will remain stalled.

- High-cost use of system is masked.

- Efficient shippers shield less efficient ones.

- Insufficient room for incentive rates.

- Regulatory uncertainty increases investment risk.

- Line rationalization discouraged.

Re-Regulate or Deregulate?

• Intervention/regulation were prompted by:

- Needs of a developing nation.

- Protecting a pioneer economy.

- Rail dominance in transportation.

• Trade offs:

- Protection vs. Achievement of efficiency.

- Future investment need vs. Lack of funds.

• Markets and trade have changed; grain industry needs:

- Efficient, viable producers.

- Efficient, viable handling.

- Efficient, viable transportation.

Railway Grain Competition - Competitive Considerations

• Unlike other commodities, all grain movements start in a truck.
• Approximately 65% of grain originating on CP Rail is within 20 miles of a competing railway and 80% is within 35 miles.
• Grain in a truck will increasingly seek the lowest cost option.
• Grain selling prices place market limits on railway pricing. It is not in our self-interest to price farmers out of world markets.
• Western farmers now have more options to choose from in Canada and U.S.:

* Grain company elevators

* New independents

* Feed lots

* Crushers

* Other processors

* Forage crops

• Prices for other farm inputs such as fertilizers, chemicals, pesticides/insecticides, farm implements are market based and in total, have much greater impact than rail freight rates.

The Case in Grain

Opportunities for Improvement

• The SEO process:

- Involved all system participants.

- Give and take by all participants produced a single consensus package.\

- Includes extended rate regulation to 2005 with open-ended productivity sharing.

• Ownership of government cars:

- Railway should be responsible.

- Dispersal of responsibility means no clear accountability for adequate fleet.

• Car Allocation:

- Recognized need for clear responsibility to be defined by industry, not government.

• Ultimately regulate grain like all other commodities.

Reflecting on Regulation

• Needed when rail served immature economy
• But regulated system inevitably:

- Are less responsive and higher cost.

- Beget further regulatory complexity over time.

- Become increasingly disconnected from the real world.

• Should be removed as soon as circumstances allow.
• Grain transportation has probably the greatest web of regulation in Canada.
• Resolution would be facilitated by:

- Separation of politics and emotions from real issues.

- Visible financial incentives that motivate all participants to seek lower overall cost.