Can railroads keep the good times rolling? One positive sign: most railroads are beefing up capital spending

Railway Age, Dec, 2006 by William C. Vantuono, Donald M. Itzkoff, Tom Simpson

With a new Congress coming to power that's widely believed to have populist leanings (sidebar, p. 23), railroad lobbyists are looking with special care at a new, 95-page General Accountability Office report that addresses competition and capacity issues in the freight railroad industry. Generally, the report gives a positive picture and describes numerous benefits that have accrued to both carriers and customers in 25 years of deregulation. But it also raises questions.

GAO's analysis finds that while the amount of captive freight business appears to have diminished, "the percentage of industry traffic traveling at rates substantially over the statutory threshold for rate relief has increased." It says "the amount of traffic traveling at rates over 300% of the railroads' variable cost increased from 4% in 1985 to 6% in 2004. Furthermore, some areas with access to one Class I have higher percentages of traffic traveling at rates that exceed the statutory threshold for rate relief.... These findings may reflect reasonable economic practices by the railroads, or they may indicate a possible abuse of railroad power."

As for building the capacity to handle the increasing demands predicted by transportation economists, GAO's investigators were unable to get a clear picture from railroads, which "do not prepare long-term capacity plans because of concern about the potential for significant economic changes."

Noting that "requests for federal assistance to rail infrastructure are likely," GAO said decision makers must determine that "federal involvement is consistent with competition in the freight marketplace, reflects widespread public priorities, and offers benefits that warrant the commitment of federal funds."

These are just some of the issues the railroads will be dealing with even as they continue to invest in plant, equipment, and people. There are others, as well--like revenue adequacy. The Surface Transportation board has determined that the railroad cost of capital in 2005 was 12.2%. Only one railroad achieved revenue adequacy by earning a return that big--Norfolk Southern, with an ROI of 13.21%. BNSF Railway was next, with a return of 10.32%, followed by Soo Line Railroad Co. (including all Canadian Pacific U.S. affiliates), 8.89%; Grand Trunk Corp. Consolidated (including all CN U.S. affiliates), 8.07%; Union Pacific, 6.34%; CSX Transportation, 6.23%; and Kansas City Southern, 5.89%.

As 2007 with its changed political landscape looms, business has been slowing, though revenues and earnings through third-quarter 2006 were still growing. Going forward, what investments do the railroads plan to make to improve capacity? What are capital expenditure plans for 2007? Where do they see particular strengths, or weaknesses, in the North American and global economies that could affect traffic? In what commodities do they expect to see change, positive or negative? Railway Age posed these questions to key executives at North America's "Big Seven." Here's what they had to say:

Wick Moorman, Norfolk Southern: NS will continue to invest aggressively in three key drivers of higher performance--technology, capacity, and people. Development of technology such as Optimized Train Control and the Unified Traffic Control System will give us more sophisticated ways to measure and manage service delivery. Capacity enhancements will flow from our investments in infrastructure, locomotives, and rolling stock. We also will step up our ongoing efforts to hire, train, and retain the best people. Programs such as operations supervisory training will complement increased agreement hiring, and we will launch a new training initiative called Thoroughbred School.

NS has averaged close to $1 billion in capital spending over the last four years, including some $1.2 billion in 2006. In 2007, our capital spending will increase by about 10% as we continue to make investments for growth and improved efficiencies and service. For the coming year, the pace of growth will slow from the levels of the past three. We will build our business by improving service offerings and continuing to seek new and expanded industries on our transportation network.

Jim Young, Union Pacific: UP's 2007 capital plan could be about 15% above our 2006 spending, or approximately $3.2 billion. The additional spending would be used to potentially accelerate our Sunset Corridor double-track project as well as increase coal capacity. The higher spending also would enable us to further increase throughput.

In addition to capital investments, we are focused on achieving greater productivity through new processes and the use of technology over the long term. We continue to believe that we have areas with significant productivity potential and that we can always improve. Also in 2007, we will continue to hire at unprecedented levels to offset attrition and accommodate volume growth. This year we are looking at graduating 2,650 conductors and 1,060 engineers.

The potential budget of $3.2 billion for 2007 capital compares to $2.8 billion in 2006. We are still in the process of developing our 2007 plan, and each year presents new opportunities that we are constantly balancing against our ability to earn our cost of capital. If our evaluation of the Sunset Corridor project results in a determination to accelerate the double-tracking in this corridor, there would be some higher level spending for the life of the project (four to five years). Other opportunities, such as increasing coal capacity, may continue as well.