Q&A: AAR President and CEO Ian Jefferies & SVP Policy and Economics John Gray

The freight railroad sector is replete with many moving parts, including hauling various types of freight commodities and intermodal goods, as well as what is viewed as a very active regulatory environment. And there are other things, too, including technology, policy, the sector's role in the over all economy, among other things. To help put everything into perspective Logistics Management Group News Editor Jeff Berman recently caught up with the Washington, D.C.-based Association of American Railroads' (AAR) President and CEO Ian Jefferies and AAR Senior Vice President, Policy and Economics, John Gray. A transcript of the conversation follows below.

Logistics Management (LM): What are your main policy focuses, both short-term and longer-term?

Ian Jefferies: We are always focused on maintaining the sound and balanced economic regulatory structure that has allowed the railroads to earn the revenue necessary to make the investments [needed] to serve our customers. It is key that we maintain that viability, and we are focused very much at the STB (Surface Transportation Board) level to ensure that its activities are grounded in sound economic underpinnings. Obviously, that carries over to the legislative side, but, if you recall, the STB reauthorization bill was very much focused on process at the Board, and we think it is best for that to be the primary focus at the board is implementing the reauthorization. I know that STB Chairwoman Begeman is public about her interest in making the STB a more efficient organization, and nobody can argue with looking for ways to make an agency function more efficiently, so we believe that is where the focus should remain, with an eye on, as I said, sound economic underpinnings in everything it does.

LM: What are some other policies the AAR is closely focused on?

Jefferies: On the operational regulation front, we are very focused on really shifting the thinking to a more future-focused outcomes-based regulatory paradigm. This industry is going through a pretty dramatic transformation when it comes to deploying new types of technology based around different inspections and detections to evaluate the health of our network. And we are still operating under a regulatory structure that is, at times, grounded in the steam locomotive era. Regulators have shown an openness and willingness to allow us to demonstrate new and innovative and equally, if not more effective, ways of meeting regulatory requirements. Whether that comes to track inspection, locomotive inspection, rail inspection…and once we have demonstrated we have a new, more sophisticated, more sensitive way of doing things to allow that to meet the regulatory requirements. That is a near-term and also a long-term goal. Certainly, things never happen as quickly as you want them to, and we feel like we are making good progress.

LM: What about the current state of transportation infrastructure and ways in which the current situation can be improved?

Jefferies: We are all about a user-based structure when it comes to infrastructure. We always say truckers are our biggest partners and our biggest competitors, and we want to see the Highway Trust Fund get fixed, and see it paid for by the users of the highway system. And, to their credit, some of our trucking friends have shown a willingness to increase gas tax payments, for example. A key focus of ours is right-sizing that trust fund so that is supported by its users be it through a near-term gas tax increase or a long-term transition to a more mileage- or weight-based model, which can really account for all infrastructure use.

LM: Looking at U.S.-based volumes, how do you view the state of the rail carload and intermodal on a year-to-date basis?

John Gray: Carload and intermodal serve very different types of markets. Intermodal tends to be what I would call the downstream markets for things like consumer markets or intermediate goods processed by a manufacturer, whereas carload tends to be for much more basic goods. Although the markets are related, they do march to a different drummer at this point in time.

LM: In what ways?

Gray: If you look at intermodal in particular, we have seen records going back to 2013 for every year except for 2016. Intermodal has been very healthy, and the underlying growth has been largely focused over that time on the domestic intermodal business. I can’t relate it to either distribution services or to intermediate manufacturing. International has been much slower. It began to pick up a bit, and I think what we are seeing this year is another correction similar to what we had in late 2015 and early 2016, in which we have really had some really substantial growth. I think we will have substantial growth in intermodal going forward, but it is like everything else in the economy, like the stock market, there are some troubling things, too. That is reflective of the uncertainty in the economy right now. A lot of that is due to trade, and other parts of it are due to people being concerned about how long the growth in the economy has been going on and if we are waiting or a correction there. Nobody really knows at this point. The uncertainty within the economy is kind of creating hesitation for things like goods production. If you look at the total economy…what you will hear is GDP coming in at 3.1% for 2018. That is great for the over all economy, but when you look at the underlying components, things like the goods portion of the economy and the amount of the economy that is really related to the things we can handle, it appears that the growth on that has been more in the 1%-to-1.5% range. The goods portion of things is what we focus on, rather than the total economy. We have looked at the statistical relationship between the total economy and rail traffic and you can get about as good a relationship between the two random numbers as you can. And when you look at the relationship of the goods portion of the economy, you then get a very different picture. It is tightly related.

LM: What about other parts of the economy that directly tie in to rail and intermodal?

Gray: There are some specific portions of what we are doing right now that are very much in flux. You always have that situation. People tend to think of rail movements as always the same thing year after year, but the reality is very different from that…our markets have evolved as our customers markets have evolved. If you look at things like coal, it is still gradually slipping versus where it was a few years ago, and you still see the impact of cheap natural gas on coal volumes. And at the same time there are floods in the Midwest that were unusual for the location and the severity at the time of year they happened in March and April in Nebraska and Iowa. It interrupted the flow of traffic across what were arguably two of the busiest main lines in the world. Both were heavily involved in coal and grain, with one heavily involved in the intermodal business. It is inevitable when you do that, when you basically shut down two extraordinarily busy routes for a week or two. You are going to see a lot of disruption in the flow of goods related to those routes. It is not surprising that we have had some volatility in the routes this year. It would be surprising if we did not, given the situation. The other thing, of course, is the uncertainty with China. That has created two things. One is that when you start doing comparisons to last year because of the early tariffs China and the U.S. placed on each other, you saw more shipping activity earlier in the year and a rush to get things moving earlier in the market to get them imported or exported before the tariffs went into effect. That pull-forward effect creates tough comparisons for the first half of the year, and it also creates a situation in which inventory needs to be worked off. You are going to see some disruption because of that. On the other hand, there are some commodities we are seeing volatility that is going positive for us. One of those things is crude oil. It is very different from what we saw three or four years ago, where it was a reaction to the volumes coming out of North Dakota. It is much more balanced now around the various oil field production areas, and we are seeing a dramatic increase in the amount of Canadian crude moving into the U.S., which is very attractive to some of the Gulf Coast refineries because it is very heavy and they have the resources there to be very productive with crude oil. You are seeing an increase in movements of Canadian crude and at the same time there is also an increase in the U.S. production of crude by rail out of West Texas, and a little bit more now is coming out of North Dakota.

LM: Can you please touch upon some of the key successes the AAR has achieved?

Jefferies: We were able to start from day one of this Congress in leveraging not only our internal resources but also our members’ resources in D.C. to really hit the ground running and really recognizing that we are dealing with a Congress with a lot of very new pieces. I think we have been very effective in getting in early and often with all members of Congress, both those who know us and those who might be new to rail this year. We are really educating them on our key baseline issues about the industry itself. It is privately owned to maintain, along with investing $25 billion a year and hitting on some of the key industry issues in front of them. I think that has resonated well when looking at the Appropriations bill in the House and forthcoming in the Senate…and we feel good about where things stand as far as keeping negative things out and positive things in. I think we have made a lot of headway with the Administration when it comes to regulatory modernization and taking more of an outcomes-based approach. Nothing ever happens as fast as you want it to happen. I think we have done a good job in demonstrating why it makes sense to take a more forward-looking approach on the regulatory front and have a willing audience to work with to find a path forward to deploy some of these new technologies that are out on the railroad.

LM: How do you view the ongoing trade tensions?

Jefferies: Over the past 18 months, we have been very out front on the trade issues, specifically the renegotiation of NAFTA with the USMCA. For us, it is all about creating certainty for our customers and really keeping the freight flow of goods in the North American markets. We feel like it has been good for U.S. agriculture producers, manufacturers, and jobs at large in the North American markets. When our customers do well, the railroads do well, and we want to move goods. It made sense to update and modernize NAFTA, as it was 25 years old, and we wanted to maintain a central North American trade agreement. We are pleased with the outcome and pleased that all three bodies are taking steps to ratifying USMCA and are very outward in our support in getting it across the finish line with the U.S. Congress. I am optimistic it will get done at the end of the day and provide that long-term certainty for U.S. manufacturers and producers, among others.

LM: Looking at railroad service levels, how are current service levels compared to a year ago and how has Precision Scheduled Railroading (PSR) impacted service?

Gray: If you look at what the fundamentals of PSR are supposed to be, it is to reduce the number of handlings of freight cars and containers that makes it possible. Every time you handle equipment, it stops and when it is stopping it is not being productive, and you need facilities to store it when it stops, and it costs everybody money when a freight car is not being moved. That is really the whole orientation of what PSR is designed to do, in reducing the handlings you have, produce a network which can move with more fluidity and one which has some predictability to the end result. That said, all those things sound very simple and straightforward in getting to, but having worked and run a service-based organization within a railroad in the past I know how tough it is to actually come up with a design that is flexible enough to deal with the changes in requirements day-to-day and at the same time come up with something that minimizes the number of times you have to handle and deal with the equipment. That was what CSX had to deal with about 1.5 years ago in getting through that early period where you are learning how to do things. And I think all of the railroads that are adopting that have to try to get through that period in which they have to try things. You are going to get some things right, and you are not going to get some things right along the way. You try to minimize the things that don’t go right, but inevitably you will have to go through some redesigns to get there. The results that have been seen at CN and CP as they have gone forward is that it ultimately gets you a better product that is something that makes sense for your customers. It takes work to get there, and I think the railroads are moving in that direction, which was something that needed to be done in order to meet customer expectations going forward.

LM: In terms of the main ways in which rail is changing, coupled with technologies like PTC (Positive Train Control), among others, where do things stand, in your opinion?

Jefferies: Our folks, collectively and individually, have developed a whole new suite of on-locomotive detectors and sensors that are constantly monitoring the health of our network, constantly aggregating data at a very macro and meta level that allows us to analyze trends, identify risk factors or precursors to risk factors, so that we can identify risks before they become problems. We like to say we are transitioning folks from fixers to finders, using much more sophisticated technologies to find and identify trends and find areas of potential risk on our network so they can be flagged and addressed before they become problems, thereby increasing the level of safety in the network. We are really focused on deploying innovative solutions like that across the board. Other things we are doing include deploying high-resolution cameras on drones and on locomotives to support inspections and emergency response efforts for things like bridge inspections, for example. Instead of having an individual hang over a bridge and do a manual inspection, we can equip a high-resolution camera to a drone and use that, and keep an individual out of a potentially precarious situation, and, at the same time, getting a higher-resolution inspection of a particular piece of equipment.

LM: What about PTC?

Jefferies: When it comes to PTC, railroads remain 100% focused on finishing out the last miles of that. It is encouraging to see the progress that has been made in regards to PTC implementation. The focus moving forward is making sure we have seamless interoperability between our various carriers in making sure that the system as an entire whole functions in a seamless manner,” he said. “We continue to work on that today and will do so for the next several months to a year. We feel really good about where we are.

LM: For a number of years, there has been a push made by the trucking industry to increase truck size and weight (TSW), which has received opposition from the railroad industry. How do you view the current situation?

Jefferies: It remains a central theme and policy point that we continue to push every day on Capitol Hill. But it really goes back to the whole theme of what we call modal equity, where we are almost entirely privately-financed, investing roughly $25 billion annually of our own dollars back into the network to keep it healthy. We think that all users of infrastructure should be the infrastructure they operate over. When you look at the current situation and see that $140 billion in general funds have been transferred into the Highway Trust Fund to keep it afloat, third-party studies have shown that 80,000-pound trucks don’t fully cover the costs of the wear and tear they leave on the infrastructure, which they operate. It is bad policy and undermines the economic competitiveness between the two modes at a time when the Highway Trust Fund is broke. It is wrong-headed policy to even entertain further increasing truck size and weight size with these ongoing challenges with the Highway Trust Fund.