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Biden executive order could hinder Canadian National-Kansas City Southern merger

Highlights

New Biden executive order targets railroad consolidation

CN-KCS deal creates only crude-by-rail network from Canada to Mexico

Merger already was subject to increased regulatory scrutiny

A broad anti-competition executive order US President Joe Biden signed July 9 could hinder the pending merger of Canadian National Railway and Kansas City Southern because of the White House's growing concern over US railroad consolidation.

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The executive order in part targets a railroad industry that has seen the number of major, Class I freight railroads in the US shrink to seven from 33 in 1980, limiting the number of crude-by-rail providers, although there have been no major rail mergers this century.

Canadian National's nearly $30 billion acquisition of Kansas City Southern would create the only Canada-to-Mexico rail network in North America that could move Canadian crude exports to the US Gulf Coast and refined products to Mexico. That combination is expected to prove more beneficial thanks to the revised United States-Mexico-Canada Agreement trade deal. With only CN having rail routes stretching from Alberta to the US Gulf Coast now, adding KCS would allow CN to further dominate the crude-by-rail market.

But the White House is expressing concerns about any more major railroad consolidation, and this executive order comes after the Justice Department already stated its opposition and the regulatory body, the Surface Transportation Board, indicated the deal would face a high degree of regulatory scrutiny.

"Freight railroads that own the tracks can privilege their own freight traffic — making it harder for passenger trains to have on-time service — and can overcharge other companies' freight cars," the White House said in a July 9 statement.

The White House said the executive order "encourages" the STB to require railroad owners to provide rights of way to passenger rail — such as Biden's beloved Amtrak — and to strengthen their obligations to treat other freight companies fairly.

STB Chairman Martin Oberman was quick to praise the executive order after Biden signed it.

"During my time on the board, I have been continually concerned with the significant consolidation in the rail industry that happened as a result of a series of mergers decades ago, which dramatically reduced the number of Class I carriers," Oberman said in a statement. "It is apparent that while consolidation may be beneficial under certain circumstances, it has also created the potential for monopolistic pricing and reductions in service to captive rail customers. Since consolidation, productivity gains often have been retained by carriers in lieu of being passed on to consumers, as would be expected in a truly competitive marketplace."

Canadian National instead has contended its acquisition would result in cheaper customer rates, more selection, new rail construction, and that it would steal market share from the trucking industry. CN also said it would sell a duplicative section of rail in Louisiana between New Orleans and Baton Rouge to alleviate regulatory concerns.

CN and KCS declined to comment on the executive order, deferring to their previous statements in favor of the merger.

The Association of American Railroads did criticize the executive order, however, arguing it could unfairly hurt freight shippers in favor of passenger rail, and resulting in more cargoes being shipped by trucks. Plenty of competition already exists in the sector, the association said.

"With the logistics chain already challenged by the recovery from COVID, this executive order throws an unnecessary wrench into freight rail's critical role in providing the service that American families and businesses rely on every day," AAR CEO Ian Jefferies said in a statement.

KCS recently broke its $25 billion merger with Canadian Pacific Railway in favor of the bigger, but riskier, offer from rival CN that regulators say presents more anti-competition concerns and overlap.

With only seven major freight railroad companies left in North America, Canadian Pacific's argument is that only the two smallest — CP and KCS — should be allowed to merge because their networks do not overlap and meet neatly in Kansas City, Missouri. Approving the CN-KCS deal or any others would set a dangerous precedent inevitably leading to more mergers in an already consolidated industry, CP said.

CN has a lot of north-to-south parallel routes with KCS, but the only direct overlap is in Louisiana. CN's existing rail network moves crude to the refining hub of St. James, Louisiana, but KCS additionally offers more direct access to hubs along the Texas Gulf Coast and into Mexico.

Regulatory questions

The pending CN-KCS deal is currently hinging on the potential approval of a voting trust from the STB. The voting trust is considered critical to the deal to win shareholder approval. Part of CN's argument is KCS shareholders have nothing to lose because they would be paid from the trust even if the deal fails to receive regulatory approval. CN and KCS said the plan is to close the deal within the voting trust in the third quarter, but not combine until 2022 upon full STB approval. If the merger falls through, CN would owe KCS a $1 billion breakup fee.

The STB already approved a voting trust for CP, but rejected it for CN, arguing that CN did not yet have an acquisition agreement in place with KCS, so the second application was jointly filed May 26. If the trust is rejected, then the merger could still fall apart, CN executives have acknowledged.

The public comment period for the voting trust expired on June 28 and CN and KCS jointly submitted their response July 6, leaving the matter up to the STB in the coming days and weeks ahead.

Also in question are STB's updated merger regulations from 2001 that require major deals to show they are in the public interest. Since then, no major rail mergers have come to fruition, not counting Berkshire Hathaway's 2010 acquisition of US leader BNSF.

The STB already waived the 2001 regulations to the now-defunct CP deal with KCS because KCS is the smallest major US railroad and is more regionally focused with less overlap with competitors. But the waiver was rejected for the CN-KCS deal, meaning the more stringent regulatory process applies.

CN noted it would only have the fifth-largest rail network in the US if it acquires KCS. Within all of North America, however, CN would grow large enough to rival the two biggest railroads, BNSF and Union Pacific.

While the deal might offer cheaper shipping rates for Canadian heavy oil sands, analysts said notably greater crude-by-rail volumes would only come if major oil pipelines are shuttered, such as the in-progress Line 3 replacement project and the pending Trans Mountain Pipeline expansion.

Canadian oil production has recovered to its pre-pandemic volumes, while US production is still down by nearly 2 million b/d from its pre-pandemic volumes. Crude-by-rail volumes have not yet recovered, however, and may not rebound for quite some time.