Shippers Face Capacity Crunch

THIRTY YEARS AFTER FACING financial ruin, business is booming again for freight railroads in the U.S. Once plagued by shrinking demand for service, excess capacity, and a crumbling infrastructure, the industry is now hauling more cargo than ever before.

"There is no question that there is significantly less room to spare on the U.S. rail network today than there was even a couple of years ago," says Edward R. Hamberger, president of the Association of American Railroads (AAR), the industry's chief trade organization. But railroads are hardly unique in this respect, he points out. "All freight modes in the U.S. are facing capacity challenges today."

The volume of freight moved on the U.S. transportation system has increased dramatically in recent years and is expected to grow another 67% above current levels by 2020, according to the Department of Transportation. To trim costs and improve productivity, railroads have gradually reduced track mileage from a peak of 380,000 miles in the 1920s to about 175,000 miles today.

After decades of downsizing, the industry now faces a serious capacity shortage, because the growth in rail freight demand has exceeded what the network of tracks can handle. That's a significant problem for the chemical industry, which ships approximately 170 million tons of products by rail each year. This traffic accounts for more than $5 billion in annual railroad industry revenues.

Thomas E. Schick, American Chemistry Council senior director of distribution, says member companies report that rail service has generally not been good on their inbound raw material movements or their finished product shipments. "There's a lot of capacity crunch right now, and that certainly doesn't help service," Schick remarks. "It takes longer for shipments to get to customers, and it takes longer for empty cars to come back to the chemical companies for reloading. That slows the cycle down and further congests the rail system."

Freight railroads, which haul an estimated 40% of the country's cargo, invested a record $8.6 billion in 2006 to maintain and expand the existing network, and they expect to top that mark with a $9.4 billion investment this year, according to AAR. "The massive investments railroads must make in their systems are a reflection of the extreme capital intensity of railroads," Hamberger says. Capital spending has risen almost 60% during just the past four years, he notes.

But that's not nearly enough to build the new capacity that will be required to carry the additional traffic the economy will generate. The American Association of State Highway & Transportation Officers estimates that railroads will need $175 billion to $195 billion of infrastructure investment to accommodate the anticipated growth in freight volume by 2020. But the group, which is made up of transportation officials from all 50 states, concludes that the industry will be able to fund only $142 billion of that on its own.

Railroads simply do not have access to sufficient capital to maintain their extensive existing infrastructure and equipment and to substantially expand the U.S. rail system, Hamberger says. Unlike highways, for which construction is financed largely by public funds drawn from fuel taxes, railroads must provide their own capital through earnings and borrowing.

To encourage more investment in the nation's freight rail infrastructure, AAR and business groups such as the U.S. Chamber of Commerce and the National Mining Association (NMA) are aggressively pushing legislation that would provide a 25% tax credit to businesses that lay new track, expand tunnels, construct rail yards, purchase locomotives, or otherwise expand capacity. Railroads, ports, shippers, and other transportation businesses would be eligible for the credit.

Senate Republican Whip Trent Lott of Mississippi, a member of the Senate Surface Transportation subcommittee, introduced the Freight Rail Infrastructure Act of 2007 (S. 1125) in April, along with Sen. Kent Conrad (D-N.D.). Reps. Kendrick B. Meek (D-Fla.) and Eric Cantor (R-Va.) are sponsoring a companion measure in the House (H.R. 2116).

"With highways and airways becoming increasingly congested, pressure is on the railroads to accommodate the rising tide of freight," Lott said in a statement announcing the legislation. "The nation faces a major challenge. If we do nothing now, we can expect to pay a growing price."

A STIMULUS is needed, Lott said, because many factors dampen freight rail investment. "Major rail infrastructure investments-like tracks, bridges, and tunnels-involve large fixed costs that have only one use and only in a particular place," he remarked. "An investment that does not earn an economic return cannot be converted to other purposes or moved to other locations."

Noting that record-breaking demand for coal is a major reason that freight rail shipments are expected to triple during the next decade, NMA President Kraig R. Naasz says his organization is "very supportive" of the proposed investment tax credit. "Freight rail is an enormously costly system to expand and maintain," he notes. "Federal incentives are urgently needed to drive the investments needed for a growing economy."

Shippers agree that more capacity is needed, but many chemical manufacturers, public utilities, and other rail customers located in areas served by a single railroad say they routinely receive poor service and are forced to pay rates twice as high as shippers on competitive routes. At a time when the railroad industry is earning record profits, these "captive" shippers argue that any effort to address capacity and infrastructure problems should be part of a broad legislative package that also promotes competition, improves service, and addresses rate-setting practices.

"Most railroads will tell you that because of the capacity crunch, there is a need for infrastructure improvements," says Martin J. Durbin, ACC managing director of federal affairs. "Our concern is that before we start spending U.S. taxpayers' money on what we consider to be a broken system, let's make sure we fix all the underlying problems first. Rather than just giving the railroads some more money to enhance lines around the country where they see they can maximize profits, let's fix the Surface Transportation Board (STB) so that it's effective for rail customers when they're having service or rate problems with the railroads."

STB was established after Congress passed the Staggers Rail Act of 1980, which largely deregulated the freight railroad industry, to oversee the railroads and settle service and rate disputes with customers. But captive shippers claim the board has allowed freight carriers to charge excessive rates and provide unreliable service. "We don't have competition on the tracks right now, and we have to pay whatever the railroads demand of us," says ACC President Jack N. Gerard. "The lack of competition in the nation's freight rail system is jeopardizing the economic security of the country."

Nearly two-thirds of U.S. chemical facilities that depend on rail service are served by only one railroad. Consequently, ACC is a member of Consumers United for Rail Equity (CURE), a coalition of captive shippers that is urging Congress to pass legislation that would reform federal rail policy and end the railroads' long-standing exemption from U.S. antitrust law.

One proposal is the Railroad Competition & Service Improvement Act of 2007 (S. 953, H.R. 2125), which would overhaul STB's policies and procedures to ensure that shippers obtain better service at reasonable prices, particularly in areas where a single rail carrier has monopoly control. This bill, for example, would require STB to submit an annual report to Congress detailing rail service complaints and the procedures the board took to resolve them.

"STB is not doing an effective job of ensuring that rail customers have access to competition and protecting them from railroad market abuses," says Sen. David B. Vitter (R-La.), a cosponsor of the Senate bill. "The lack of healthy competition in our national rail system is stifling rail customers such as the Louisiana chemical industry and utility providers. The extreme prices these customers are charged and the service challenges they face have a direct impact on jobs and prices for consumers," Vitter says.

The legislation also calls for a more workable rate challenge process at STB. Currently, rail customers must pay large filing fees and satisfy paperwork requirements that force them to hypothetically prove that they can build and operate a railroad for less than the rates being charged. "When shippers look to STB for help, they quickly realize that they can't afford the $178,000 filing fee or the millions of dollars necessary to fight rate cases," says House Transportation & Infrastructure Committee Chairman James L. Oberstar (D-Minn.). "This is hardly the competitive environment envisioned when Congress voted to deregulate the railroad industry."

Meanwhile, the Railroad Antitrust Enforcement Act of 2007 (S. 772, H.R.1650), sponsored by Sen. Herbert Kohl (D-Wis.), chairman of the Senate Judiciary Antitrust Subcommittee, and Rep. Tammy Baldwin (D-Wis.), would eliminate the industry's exemption from the two key federal antitrust statutes, the Sherman Act of 1890 and the Clayton Act of 1914. Railroad mergers and acquisitions are currently reviewed solely by STB, and a wide range of conduct by freight carriers, including collective rate-making, is outside the purview of antitrust enforcers.

In the 1970s, more than 60 large domestic railroads were operating. After railroads were deregulated, bankruptcies and a series of mergers left 90% of the nation's rail traffic in the hands of four major (Class I) U.S. carriers: Norfolk Southern and CSX in the East and Burlington Northern-Santa Fe and Union Pacific in the West.

"Industries that are served by only one railroad have faced spiking rail rates," Kohl says. "They are the victims of price gouging. It is time to put an end to the abusive practices of the nation's freight railroads and force them to play by the rules of free competition like all other businesses."

The bill would permit the Justice Department and the Federal Trade Commission to review all proposed rail mergers and eliminate antitrust exemptions for collective rate-making and coordination among railroads. It would also allow state attorneys general and private parties to file lawsuits to halt alleged anticompetitive business practices by the industry and to seek treble damages, neither of which is currently allowed under federal law.

Under the existing system, railroads have no incentive to provide reasonable rates or reliable service, says former Oklahoma Democratic Rep. Glenn L. English Jr., who now heads the National Rural Electric Cooperative Association.

"A 19th-century monopoly will not work in our 21st-century economy," English says. "By providing customers with access to rail service options and a venue to challenge market power abuses, as this legislation does, we will be well on our way to establishing a healthy, competitive system for the future."

Pro-shipper bills have been introduced in Congress for nearly a decade, but the legislation has made little headway in the face of stiff opposition from the railroad industry, which has been one of Capitol Hill's most potent political forces. According to the Center for Responsive Politics, since the early 1990s, the industry has contributed heavily to Republican campaigns, donating more than $5 million to federal candidates and party committees during the 2006 election cycle. Roughly three-quarters of that amount went to the GOP.

With Democrats now in charge of both chambers of Congress, the outlook for passing rail competition and antitrust legislation has improved, says ACC's Durbin. "It's a bipartisan effort. But there's no question that with the turnover in Congress to a Democratic majority, we certainly benefit from having members like Mr. Oberstar and Mr. Kohl now in leadership positions."

As a sign of progress, Durbin notes that lawmakers have added more than a half-dozen rail-related amendments to various bills this year. Rep. Baldwin, for example, inserted language in the recently passed House energy bill that directs the Department of Energy to study whether railroads will be able to transport increasing volumes of ethanol and other biofuels at competitive rates.

"What this shows," Durbin says, "is that a lot more members of Congress have been exposed to the concerns and problems that are out there for rail shippers. We are clearly getting more attention from members of Congress and seeing more interest in the issue. So from that standpoint, absolutely the outlook is much better."

RAILROADS ARE fighting the proposed measures, arguing that "reregulation" would lead to lower rates, which would deprive the industry of several billion dollars in revenue each year and make it impossible to fund improvements in rail capacity. "Under reregulation, rail managers could not commit, and rail stockholders would not supply, investment capital needed to improve service and expand capacity," AAR's Hamberger says. "Disaster might not occur overnight, but there would be little or no capacity expansion."

He also points to a report issued last year by the Government Accountability Office, which analyzed rail transportation rates from 1985 to 2004 and found that "all rate changes were below the rate of inflation and thus all rates declined in real terms." Hamberger says freight railroads "do a remarkable job of meeting the needs of an extremely diverse group of shippers. Railroads move tens of thousands of railcars to and from thousands of origins every day at rates that shippers elsewhere in the world would love to have."

ACC's Durbin says shippers do not want to turn the clock back to the days before deregulation, when one-fifth of the nation's freight lines were operating in bankruptcy. "We rely on a healthy and effective rail system. It's not in our interest to do things that are going to hurt the railroads," he remarks. "We think what we are doing is going to help the entire system."

In addition, if Congress agrees to provide a tax credit to boost investment in rail capacity, Durbin says, the funding should be used to benefit U.S. industries rather than focusing on routes from the West Coast ports, where the vast majority of goods imported from Asia enter the country. Due largely to soaring U.S. imports from countries such as China, intermodal freight has become one of the railroads' most important lines of business. Intermodal services use containers that can be shipped by rail or truck and usually hold consumer products such as computers, cars, clothing, and appliances.

"Right now, the biggest growth area for the railroads is the intermodal traffic coming from imports," Durbin notes. "We have a real concern that if we give them this investment tax credit, those funds are going to go toward improvements at the ports to handle this intermodal traffic. The traffic that essentially moves inside the country, that keeps our own economy moving, is going to be shunted to the side. So if we're going to give railroads U.S. tax dollars to help build their infrastructure, we want to make sure that those funds are used to support U.S. industry and the U.S. economy."