What are per diem leasing and default rates, and how does they affect the rail shipping industry?
In this blog, MRC President Kevin Cook shares his insights on the current per diem leasing system, its importance, the issues it faces and what’s being done to make it fairer.
Q: What is per diem leasing and why is it important?
Kevin Cook: Per diem leasing is a type of lease contract that is utilized for railcars. In particular, a lot of boxcars utilize per diem leasing.
It’s a way for railroad-marked cars to travel on all of the different railroads and have a negotiated rate, so when another railroad is using that car, they pay for the ability to use that car.
So the railroads don’t invest in the cars, private investors invest in the cars. That allows them, with the per diem, to charge as they go on different railroads for the use of the car.
How are per diem leases actually paid?
The per diem rates are basically paid on by an hourly rate as well as a per-mile rate. So, each rail car has a negotiated rate for a certain amount of money per hour and then a certain amount of money per mile.
As the car travels, the mileage adds up, and then as the car’s on a railroad for a given number of hours, the hourly rates are charged accordingly. Those rates are what’s used to then pay the car owner for the car.
Why is per diem leasing important?
It’s really important because in boxcars, in particular, the short line railroads really feed the big Class I railroads. So they are the first and the last mile deliverers and shippers of goods. They have different capital structures than the Class I railroads, so they can’t necessarily afford to invest in rail cars.
This method gives them an opportunity to lease a rail car from MRC and then be able to earn the per diem earnings on that car to pay for it, so that they can provide rail cars and have access to railcars for their customers to be able to ship goods across the country.
How did the per diem system come about?
The per diem system was established back in the early 80s. Basically, when they deprescribed the pricing for railroads, which had been regulated and set by the government, they put in the per diem system.
This was a way for the rail cars to be more closely associated with a market-driven rate for the use of the rail cars to help the railroads out and let the rate fluctuate based on the usage of the rail cars and demand for the rail cars.
What exactly is the per diem default rate?
When there is no negotiated rate between two railroads, the default rate is the rate that’s used on that car. And every car gets assigned a default rate when it’s built new.
There are 280-plus railroads in the U.S., so there’s typically not a negotiated rate between every railroad for every car. So that’s why the default rate is used.
How are the per diem default rates set?
The default rate is actually set up, which is a little crazy, based on the lowest negotiated hourly rate for a rail car in the quarter before that rail car was built.
When that rail car gets built, let’s say that rail car gets built this quarter, the lowest negotiated rate from the previous quarter is what establishes that default rate. And in some cases, that can be as low as $0.05 an hour or $0.17 an hour.
What are the main problems with the per diem default rates?
First of all, the default rates aren’t sufficient to be able to compensate for new car investment. New cars have gone up in price since 1980. They were around $75,000. They’re now around $165,000 for a new boxcar. So the default rate won’t compensate the car owner efficiently. And about 25% of all rates charged are default rates on current railroads.
The other thing is they’re subject to manipulation. So the railroads negotiate these rates with each other, and over time, those rates remain suppressed.
Over the last 30 years, the negotiated rate for 50-foot boxcars has been around $0.05 an hour. The negotiated rate for 60-foot boxcars has been around $0.17 an hour, and they haven’t changed. It’s the only price in the world that hasn’t changed in the last 30 years.
Finally, it really suppresses the ability to negotiate a higher negotiated rate because you’re anchored into this alternative rate. If you don’t negotiate a rate, you’re going to get the default rate. And the only alternative you have is the arbitration process, which is very expensive to go through.
How is the current per diem system unfair?
I think the part that really makes them unfair and kind of reduces competition is that the private car owners are required to use the per diem system in the car hire system, whereas railroad-owned TTX does not have to participate in the car hire system.
So they get to charge their rates by fiat and can charge whatever rates they want to charge for hourly rates and mileage rates. That allows them to get adequate returns on investment when they put boxcars into the market, where private car owners can’t get an adequate return on investment because of the default rate and the lower negotiated rates.
In some cases, TTX rates are almost 40% higher than the average negotiated rate for boxcars. That’s the difference that makes it unfair.
Long term, the real issue is that it’s going to eliminate and reduce competition for boxcars in the market, because private investors will no longer be able to invest. As those cars retire, TTX will take a larger and larger market share within that, and then they will dominate and control the market.
What’s being done to help make the per diem system fairer?
In April, the Railway Supply Institute, RSI, submitted a petition for the equipment lessors that are members of RSI to the STB, the Surface Transportation Board. And they asked them to reopen the car hire rules to be able to address the default rate situation.
STB has really been engaged in the issue. They’ve strongly encouraged both the AAR as well as the Railway Supply Institute to come to a commercial arrangement and an agreement on this issue.
In the meantime, the Railway Supply Institute has been working with members of Congress to send Letters to the STB and have had several letters sent to the STB in support of the petition that we have submitted.
How is the progress on making per diem systems fairer going?
Really good progress. Not a lot of progress early, but recently, AAR has established their Equipment Asset Committee and had that committee open up a docket to review Rule 25, which is where the default rate rules are established.
And they have invited RSI to participate in that task group. That task group will be kicking off here late this spring. And the expectation is that they will have a recommendation to the AAR by the end of October on potential changes to the car hire rule.
So we’re very excited about the opportunity to engage with AAR on the issue and hopefully get some resolutions to the issue within the year.
