CP Rail eyes link to access U.S. South
Source: Scott Deveau, Financial Post
Published: April 30th 2009

Canadian Pacific Railway Ltd. is discussing a new partnership with Kansas City Southern Railway Co. aimed at granting the railways access to each other's lines. For CP, this would create a more direct route to the Gulf of Mexico in exchange for greater access to Chicago along its own network.

Management teams from both railways are set to discuss the possibility of a deal this week in Calgary, a source briefed on the talks said.

Such an arrangement was made possible by CP's recent acquisition of Dakota, Minnesota & Eastern Railroad Corp., which links the two railways in Kansas City, Mo.

"The CP acquisition of DM&E presents new opportunities for KCS and CP to work together over Kansas City and we are exploring those opportunities," said Doniele Kane, KCS spokeswoman.

In fact, the DM&E lines have the ability to connect to all seven of the top-tier North American railways, and growing its long-haul business through this new "Kansas City Gateway" has become a priority for CP's management, they said on a conference call last week.

Carrying freight over longer distances is typically more profitable, and CP's long-haul business has been hurt by declining potash and coal shipments.

"We looked at ... what point in time can we start the process of extending our hauls to reflect the new franchise that we have, and those discussions are underway with the various connecting carriers," said Brock Winters, CP's vice-president of operations, on the call.

"We've already migrated some and we'll migrate more," he said.

The railway would look to move even more goods through this gateway when DM&E's current contracts expire, Mr. Winters said.

The talks between CP and KCS are centred on reaching some sort of operational routing agreement, and industry observers say a so-called "coproduction agreement" would be a logical outcome.

Such agreements are essentially alliances between the railways allowing each to run freight up each others lines, while preserving the shippers' competitive options. They have become a popular alternative to mergers and acquisitions in the heavily regulated rail sector.

"The agreements are driven by the railroad operations departments [not marketing] and are designed to be 'market neutral' for the customer -- meaning there is no change in pricing or competition," said Walter Spracklin, RBC Capital Markets analyst, in a recent note. "At the end of the day, the agreements make sense and we would expect to see an increasing number of these partnerships. The savings are real and the benefits are significant and immediate."

Typically, these alliances are not defined by rates, Mr. Spracklin noted, but rather involve an equitable split of the savings realized.

Both partners typically benefit through economies of scale, more efficient routing, quicker turnaround and lower fuel burn.

CP's larger domestic rival, Canadian National Railway Co., recently reached a similar deal with Norfolk Southern Corp. to create its so-called "MidAmerica Corridor," in which each railway shares each other's lines between Chicago, St. Louis, Kentucky, and Mississippi.

CN, which has one of the most fluid networks on the continent, currently has more than 100 such agreements across North America.CN's management says it approaches these agreements with the mindset of routing its trains the most efficient way possible across North America. If that requires running its trains across another railway's lines, it moves to strike deals such these, Mr. Spracklin said.