Fuel surcharges are deemed necessary by railroad companies to compensate for rising oil prices, but they are unpopular with customers who claim the companies use them to boost revenue.

The parties will weigh in on the issue in coming days when they submit their comments to the Surface Transportation Board regarding its four fuel surcharge proposals. The proposals stem from a public hearing the board held in May that focused on the surcharge practices that railroads employ.

Industry observers say the railroads are unlikely to support the proposals.

“(The railroads) will say that fuel surcharges are rates rather than practices and so they’re not under the jurisdiction of the STB because the STB can’t regulate them,” Morningstar analyst Peter Smith said.

The Class I railroads affected by the measures - Union Pacific Corp. (UNP), Burlington Northern Santa Fe Corp. (BNI), CSX Corp. (CSX) and Norfolk Southern Corp. (NSC) - declined to comment on the four proposals.

Specifically, the board wanted to know about surcharges being computed as a percentage of base shipping rates and the means used to measure increases in rails’ cost of fuel. The STB then proposed the four measures in August.

“The board picked up fairly well on what the (customers’) concerns are,” said Tom Schick, senior director of distribution for the American Chemical Council, who spoke at the May hearing. “Each of the four is going in the right direction.”

Public comments are due on Oct. 2, an extension from the original Sept. 25 deadline. It’s unclear when the board will decide what to do with the proposals after the comments are received.

Fuel surcharges are typically put in place when a customer contract is negotiated or renegotiated. Railroads have employed hedges to protect against volatile fuel prices, but in the past couple of years they’ve turned more to surcharges to cover the additional costs.

Rail customers don’t disagree that the companies should be able to recover increased costs from rising fuel prices. However, they contend the railroads use the fuel surcharges to boost revenue through the way the surcharges are calculated and applied. Also, customers said it’s difficult to understand how surcharges are computed.

“There needs to be some transparency and cost recovery, (it’s) not about generating revenue,” said John Ficker, president of the National Industrial Transportation League, a trade association for shippers. “The crucial thing is what the next step is.”

Fuel surcharges have helped offset the effect of rising fuel prices and have “also provided an (earnings) tailwind,” for rails, Bank of America analyst Scott Flower said in a recent research note. Many of the different surcharges applied “over-recover the cost impact of increases in fuel prices,” he said.

Railroad companies have pointed out several times in recent months that the fuel surcharges don’t cover 100% of their additional fuel costs. Burlington Northern Santa Fe said during its second-quarter earnings conference call in July that the surcharges covered about 80% of its additional fuel costs for that period.

The STB wants railroads to develop a way of computing a surcharge that more closely links it to the actual increase in fuel costs. It wants to end “double dipping,” where railroads charge customers for the same increases in fuel costs for the same shipment both through a fuel surcharge and the use of what’s called a rate escalator. The escalator is based on an index that may include a fuel cost component.

The board would require railroads to use one uniform index for measuring increases in fuel costs. It would also have the railroads submit a monthly report, showing actual total fuel cots, total fuel consumption and total fuel surcharge revenues.

“The worst case scenario is that the railroads will have a modest cost headwind, but it won’t be anything that’s going to move the needle,” Morningstar’s Smith said. (Dow Jones)