Union Pacific's Mystery $149 Million Fuel-Surcharge Profit

(MoneyWatch)  Railroad giant Union Pacific yesterday said reduced diesel costs and better operations will raise its profits this quarter, and investors cheered. But I was trying to figure out what all the fuss was about.

Despite the upbeat tone of the report, third quarter volumes are expected to be about five percent lower than in the previous year -- about twice as worse as the company's previous projections -- due to fewer shipments of cars, automotive parts and intermodal containers. The company blames Hurricane Gustav and Ike for reducing shipments of chemical and industrial products as well as limiting operations, reducing earnings by about 10 cents. That money was regained by the drop in diesel prices, said CEO Jim Young.

Sounds great, but I found a mystery in UP's rosy report. In the company's second quarter report, fuel costs rose $436 million from the year before while fuel surcharges boosted company coffers by $585 million. Yet CFO Rob Knight argued yesterday that "[b]ecause Union Pacific does not yet fully recover higher fuel costs through its various fuel surcharge programs, lower diesel fuel prices help our bottom line."

So I called Union Pacific and asked why the numbers don't pencil out. Shouldn't $585 million in surcharge income more than cancel out $436 million in fuel costs? Spokeswoman Donna Kush said that Knight was referring to the fact that Union Pacific still doesn't charge all their clients a fuel surcharge.

So by that logic, if they don't charge 10 percent of their customers a surcharge, the surcharge fees they do collect still don't cover their extra fuel costs -- even if they exceed actual fuel costs for all customers. Voila!

But that still means they gained more from the surcharge than they lost to rising fuel. So where is that $149 million profit going anyway? And how do UP's customers feel about having the railroad's surcharges turn into a profit center this way?