Something I don't understand about capacity

[gabe]

As stated in our many recent discussions about the viability of certain routes as compared to others, one of the key coponents of one line's survival as compared to another is capacity. Mark has championed the ideal that the superior line (most cost effective) will win out every time against the inferior because it will continue to siphon traffic from the inferior line, inevitiably causing the inferior line's demise. Closely related to this contention is the ideal that railroads are not profitable until they are running at or near capacity. (If I have mis-stated this position please correct me).

I am trying to locate/buy the railroad operational books Mark recommended in order to further explore this theory. Until I do, though, could you guys (and girls) help me grapple with some of the issues I see in this theory.

(1) If this is true, how on earth do regional and shortline railways survive--much less receive investment? Regionals seldom--if ever--have the most efficient route between two points and are even more seldomly near capacity. Is it government subsidies that keep these lines afloat, and if so, why on earth do people invest in them?

It seems to me that, if a regional can be profitable, an inferior line could effectively operate like a regional, occassionaly steal traffic under the price umberela of the more efficient line, and be slightly more profitable than a regional.

Also, given the tremendous cost of adding capacity, once the more efficient line reaches capacity, wouldn't it be easier for the less efficient line to add traffic than the more efficient line spending the billions to increase capacity? If the additional traffic over capacity was 15 trains a day, I could see how the more efficient line would be willing to spend the billions to get the traffic; but, if it were 3 trains a day, would that be worth the investment? It seems to me that there is a capacity window favoring the less efficient line.

(2) I assume the DME is the less efficient line, given its partial demise and spin off. Why are people willing to invest billions on its extension on a less efficient line in the hope of stealing traffic from more efficient lines?

Thanks,

Gabe

[tree68]

OK - this is based on what I've seen and read. I'm no expert on the matter....

Regionals and shortlines don't survive - once the reason for their existence is gone. Many a shortline exists based on one industry. If that industry closes, so does the shortline. Happens all the time. The same is certainly true of regionals. That doesn't mean the track comes up. Sometimes there is hope for a re-opening, or the attraction of new industry.

I'd opine that many shortlines aren't making money. Many have been set up by municipalities for the specific purpose of keeping an industry around that would close if the rails went away. The RR wants to divest itself of the spur, so the municipality picks it up, thus preserving jobs and the local economy. By their very nature, governments lose money, so what's a few bucks more? Hopefully the taxes generated by the employees whose jobs are saved will cover the costs.

In the case of an industry that runs a shortline, it's a necessary business expense, and you're paying for the railroad when you buy their product.

In any case, if there is a primary industry that is the reason for the railroad, other customers are mostly incidental, lucky that the RR exists at all.

[gabe]

Thanks Mark and Larry,

Your analysis adds a lot to my thought process.

As far as DME is concerned, I remember reading (in a newspaper, I think the Wall Street Journal) that the DME claimed to have the necessary investors to implement the project. However, I think that was at least over two years ago, and I haven't heard anything similar to that recently.

I have always questioned the feasibility of the DME investment, but I just assumed someone knew something I didn't.

This may be an unanswerable question (I realize most knowledgeable people on here aren't in the business of predicting the future), but what do you think will happen to all of those short lines that eventually will have to pay the piper? The thought of them all going the way of the dinosar is somewhat distressing to me. I am sure the state will bail some out, but I wonder how many? Is there any regulation that could be passed to help short lines help themselves? Is this regulation advisable or are we better off letting them go the way of the dinosar?

Thanks again,

Gabe

[MP57313]

QUOTE: Originally posted by gabe
how on earth do regional and shortline railways survive--much less receive investment? Regionals seldom--if ever--have the most efficient route between two points and are even more seldomly near capacity. Is it government subsidies that keep these lines afloat, and if so, why on earth do people invest in them?

The Santa Fe Southern operates the former AT&SF branch from Lamy to Santa Fe, NM. I don't know if they own or lease the tracks. There have been some upgrades along the line, including new grade crossing signals. SFS runs tourist-type passenger and also local freight trains, but only a handful of cars (boxcars for a beer distribution warehouse, etc.)
My guess is they have received some type of government funding, as I really could not see them earning all the hundreds of thousands/millions of $ necessary for the upgrades along the line.

[Junctionfan]

I don't really understand too much about it either. For example say my railroad goes between Chicago and Detroit. I have 2 lines but l is more effiecient than the other. I would not abandon one for another. I route all traffic on the best route and use the second as an overflow and secondary line (accidents or natural disasters) but for regular use, lease it to 1 or more shortlines. Have an agreement that I get to use it again if my best line is over capacity, that way I don't have to build more sidings and extra rail on real estate that may no longer be available with out spending serious money on market value. I can route all the non priority stuff on the secondary line while keeping the priority stuff on the main and maintaining slight under capacity for future trains.

CN kind of does this with the GEXR line between Georgetown and London Ontario. Even though CN doesn't use it particularly for anything (leases it to Rail America), if there is a derailment on the Halton Subdivision, Dundas Subdivision or near Bayview; they run the trains on that line as a back-up route.

This is my opinion of course.

[jeaton]

Gabe,

I don't think I can add anything of substance to what Mark and Larry have provided, but it may help to think about the capacity issue in terms of short vs. long term consequencies.

For example, I suspect that it is easier for railroads to invest in added capacity if it results in an immediate reduction in operating costs as opposed to covering actual or anticipated traffic growth. Obviously when it comes to investing, the sure thing is better than something that has higher risk. I would call the result that Mark describes as coming at or near the end of the game which can be or is played for decades. In the interim an outsider may see many investment decisions that don't seem to make any sense.

Jay

[bobwilcox]

As a public utility, I would find the prospect of the DME building into the Powder River Basin a useful issue if I were negotiating a five to twenty year contract with the UP of BNSF to move my coal. I would be willing to invest a litte money to help the DME due studies, hire lawyers etc. on a contract worth $50-150 million.

[Overmod]

Gabe, seems to me that the 'logical' thing that will keep short lines from 'going the way of the dinosaur' will be state assistance, or outright participation, with the State of Washington's program being one of the best examples.

One way this might work is the State acquiring the ROW, using some form of public money, directed taxation, or specialty trust-fund income to improve it when necessary, and also if necessary to arrange for suitable cars (e.g., lower axle loading or better suspension when appropriate for lighter or lower-maintenance trackage). If I understand the recent posts on grain services, Washington currently does some of this.

The question of who operates movements over this trackage is a bit more involved, but a very common answer appears to be "whoever best assures the state authorities that they can do the work reliably and at lowest cost" -- in that order, I think.

Some discussion about the logical 'rationale' for state money being used to support rail is available, and makes interesting reading. I'm sure Mark has some input on how this has been implemented historically...

[Anonymous]

Regarding Mark's point on Class I's prefering to handle rail traffic off a regional or shortline vs having traffic delivered by truck, based on what I have observed it seems that the Class I's would prefer to have trucks deliver traffic to a consolidated terminal rather than having the bother of switching out a handful of cars off a Class II or Class III railroad. This observation is probably commodity specific. For delivery of grain, lumber, consumer goods, and containers the Class I's prefer delivery by truck over delivery by shortlines. For chemicals and aggregates, by necessity those commodities must be delivered by rail.

The moral: If you are or are planning on taking over a shortline, make sure your main traffic base is rail dependent e.g. not practical for transport by truck. If your main traffic base is grain, you are not long for this world.

[Anonymous]

QUOTE: Originally posted by Overmod

Gabe, seems to me that the 'logical' thing that will keep short lines from 'going the way of the dinosaur' will be state assistance, or outright participation, with the State of Washington's program being one of the best examples.

One way this might work is the State acquiring the ROW, using some form of public money, directed taxation, or specialty trust-fund income to improve it when necessary, and also if necessary to arrange for suitable cars (e.g., lower axle loading or better suspension when appropriate for lighter or lower-maintenance trackage). If I understand the recent posts on grain services, Washington currently does some of this.

The question of who operates movements over this trackage is a bit more involved, but a very common answer appears to be "whoever best assures the state authorities that they can do the work reliably and at lowest cost" -- in that order, I think.

Some discussion about the logical 'rationale' for state money being used to support rail is available, and makes interesting reading. I'm sure Mark has some input on how this has been implemented historically...

Overmod, I can offer some enlightenment on the State of Washington issue since I reside in this portion of the nation.

At one time, the NP (and later BN) had a viable line running from Spokane south to Lewiston ID through the Palouse country (the P and L branch). When the arrival of slackwater in 1975 made Lewiston a legitimate barge port, the logical thought was that BN would start running grain shuttles down to the barge port to take advantage of the cost savings. Instead, BN chose to shut down the line from Moscow ID to Lewiston, and in doing so cut off the previously viable pre-slackwater eastbound traffic flow as well. The excuse of the time was that BN could now run that traffic 130 miles west to Pasco and then run it east. (That of course begs the question why they didn't just do that back in the early 1900's when the Camas Prairie's Snake River line was opened.) Of course the real reason BN did this was to spite expectations of the improved supply chain economics available in the form of intermodal transload of rail to barge at Lewiston. The result was that 80% of the grain off the Palouse was trucked down to the barge ports rather than moving by rail, either by long haul to the coast OR shorthaul to the barge ports. Thus, if BN's intent was to capture this traffic to rails, they failed miserably, and the region suffered as a result of BN's actions.

BN kept the embargoed rails in place until 1998, when they made sure the rails were torn up prior to selling the Palouse lines to WATCO. This action gauranteed that the new shortline operator could not access the logical routing. The result was that WATCO could not make enough to cover the maintenance costs of the trackage, so they turned to the State of Washington to bail them out.

Studies commissioned by Washington's DOT showed that if the Moscow to Lewiston line were kept in place, the shortline operator could have OWNED the shorthaul to the barge ports, and made more than enough to cover operating and maintenance costs, thus saving the taxpayers of Washington the expense of taking over the lines (a process by the way that is still not finalized). Studies also showed that even with a State takeover of the Palouse lines, shippers will still perfer trucking their grain down to Lewiston due to the uncertainity of getting long term dependable service from the Class I's. WATCO does run some mid-shorthaul grain trains to a barge port at Wallula, but his involves running rights over UP's "Washy" line, as well as getting State-owned hoppers. It is doubtful that the State can afford to upgrade the lines to a point that will allow for speedier service, and even that wouldn't change the grain shipping dynamics.

It is possible that the State of Washington would be better to leave the Palouse lines to WATCO, and instead build a new line from the Palouse down to the barge ports. With the shorter turn around, and the fact that this rail move would bypass the Class I's (thus allowing at will running by WATCO), it is likely that the line could be paid for simply via taxing the difference between rail rates and truck rates, and the accruing savings to roads and highways in the area. Unfortunately, the WSDOT's Rail Office is manned by some ex-Class I folks, and to take on this project would be an admission of failure (and subsequently incompetence or fraud) on the part of BN and the STB in allowing the Moscow to Lewiston abandonment in the first place.

So what will happen is the taxpayers of Washington will end up supporting both the maintenance of the Palouse lines AND continued road and highway maintenance costs, since a majority of the grain will still move by truck down to Lewiston. WATCO ends up with a pretty sweet deal!

[Overmod]

Thanks, Mark & Dave.

[Anonymous]

One other thing that strikes me as profound: The average time cycle for a grain barge from Lewiston to Portland and back is about one week. The average time cycle for a grain hopper from Lewiston to Portland and back is two weeks. This means that even if the railroads match the ton/mile price for shipping grain, the barge lines are still getting twice the annual revenues. This is significant when it comes to bean counting time!

[kevarc]

I work for a utility that burns PRB coal.

1. Right now you CANNOT get a coal contract for more than 1 or 2 years. We just got done with ours and that was what they told us. The reason is the spot market is strong and they want to play in that market more and use short termed contract for covering their base costs.

2. Threatening the RR with using their competitor to haul your coal will only work if you have ACCESS to the 2nd RR. Our plant does not and the RR serving our plant refuses to quote a rate from a mutual point 10 miles away. This costs us close to 8$/ton. The 2nd RR will not build into the plant, they told us "If you build a spur, we will quote you a price." We have looked at it and the payback is less than 5 years, but to get from the 2nd RR to our plant involves a major river bridge. The laugh at you when you threaten without having the second RR already there.

[bobwilcox]

Kevin-No doubt it is a different world when you only have access to one carrier. Did the access study include the bridge?
Based on another group of commidities I would not be surprised to see a local shipper pay 10-20% more for rail service. Many of those shipper changed their situation and got access with build outs or buying manufacturing facilites served by more than one railroad.

I have not keep pace with electirc utility regulation. Do your customer's have a choice when the buy power and/or use your distribution system? Can you put the cost of a spur line into your rate base and have the regulators add the cost the rates you are allowed to charge?

Bob Wilcox

[kevarc]

Yes, the study included the bridge. We would not have to raise rates, the savings would pay for the build out.

One reason RR's are shy about building the build outs, is that after the contract is up, and they average 5 years, the original RR will come back with a competitive price and then the 2nd is out the investment.

We are public power, each of our cities buys their power from us under 5 year contracts. We would like longer, but you get what you get. After the contracts expire, each city puts out an RFP for a new contract and we must bid against brokers and IOU's.

[Overmod]

Yes, you're right about the railroads' building capital investment on short contracts. Note that in the present case you might not care about *your* doing the build-out, as there is a very real 'pay-back' to the ROW investment whether or not the "original RR" submits a lowball bid -- in fact it might be a tad faster payback since there might be fewer operating or maintenance costs involved with lower utilization of the new trackage.

Is there any possibility of assisted funding or cost sharing (e.g. state, regional, other industry) or alternative tax or depreciation methodology?

[kevarc]

We have to be very carefull in this process. There are three owners of the plant, an IOU, us (we are considered a state agency), and another city. This leads to all kinds of weird stuff as far as taxes, taxable status of bonds and other financial considerations due to two owners being public entities (not for profit, etc) and the private IOU. (IOU = Investor Owned Utility)

It has not got to the stage where we are putting the money together. It hasn't got that far due to one of the parties (not us) dragging their feet.

[bobwilcox]

Mark - I agree that the low cost carrier almost always wins because railroading is predominantly a commodity business. However, based on my experience there are important exceptions.

There are several shortlines in the East, such as the P&W, that have operated sucesful plastic rail/truck distribution centers even though the Class I will have a lower rate into their nearby distirbution center. The shortline does a better job or performing the warehousing functions the shipper needs.

Also, CSXT does a very good job with their Transflo facilities. Petrochemical customers will pay a little extra in return for contamination free transfers, warehousing services, real time tracking and a single monthly bill for service from several terminsals.

These types of business have much higher margins than just hauling tankcars from orign to destination but the railroads have lagged in developing these business. The Transflo model has been around since the NYC! However, carriers such as UPS have made great stride in doing all of the phycical distribution service for shippers. As an example one of the domestic car producers out sourced all of their setup car distribution to UPS several years ago.

If you are in a commodity business you must have the lowest costs but if you can break out the margins get a lot higher.

[bobwilcox]

I agree. When I was at the CRIP from 1966-1969 I used costing that would curl your hair. It took such a short term view of incremental costs with trains that "were running half full". Later I saw the same thing occur on the SP as they had to maintain revenue at all costs. In both cases we were looking at .4-.6 rev/lrvc ratio with going business varible costs. Of course the CRIP was not a going business after the dividends and then the merger stopped the train.

Bob Wilcox

Bob Wilcox

[jeaton]

Bob's comments relate to cost accounting-the accounting field that works to calculate the product unit costs of a manufacturing or service entity. I am not even close to being an expert, but let me give this a try.

First some terms relating to business costs. Fixed cost relates to that portion of total cost that does not vary with business volume. Variable cost is that portion that varies with business volume.

Perhaps simple enough, but a big issue in this field is the span of time. There may be better definitions elsewhere, but if the subject is the ratio of cost to volume over the long run, then the "long run" period may be considered the life or expected life of the business entity. "Short run" may be any lesser period, perhaps a day, week, month, year or years.

As a regulatory body, the Interstate Commerce Commission had to have a handle on unit costs in order to attempt to judge the legality of any given freight rate. They had performed studies that said in the "long run" 80% of total railroad cost would vary directly with traffic volume. That may not have been accurate then and may be at a different level now, but serves to illustrate the next point.

For railroads, the short run variable cost may be substantially lower. In the extreme, putting one more car on a 99 car freight train may add almost no cost to running the train. Perhaps a few more gallons of fuel for the run, but everything else is fixed. If the railroad has a substantial excess capacity with idle cars and locomotives, trains that are "short", switch crews that around the system with early quits because of lack of volume, and no track capacity problems, a large increase in volume may be added with a very small increase in cost.

For a railroad, such as the Rock and SP, heading into a desperate financial situation, staying in business for any period may have left no option but to establish rates that only covered short run costs, but were well below long run cost. When he was on the IC, Dave Gunn, as our manager of cost analysis, would call rates at those levels "going out of business rates". With the passage of time, those who may have disagreed have met the truth.

Jay

[daveklepper]

Don't forget the matter of wage rates and job definitions that sometimes permit regionals and most short lines to lower labor costs. There are interchange short lines, not just tourist lines, where the Copmpany President and CEO runs the trains (rather, "the train") and spikes new ties.

[richardy]

Kevin - We have a power plant in NE Oklahoma that is located on the UP (formerly MP) and received the coal via UP for years. A few years ago the utility built a connection to the BNSF main. The spur is around ten miles, includes a large river bridge and a highway bridge; they installed crossing protection on every crossing at grade (most are lights only). A CTC control point with an approach signal was installed in the BNSF main. I am not privy to the inside information but the cost must have made sense to the powers that be in the utility company and the stockholders.

Richard

[daveklepper]

Mark, I appreciate your response and insight. Note that I wrote "sometimes." And there does still exist the matter of job definition. I think you yourself have written articles about short line operations where the company president does the paper work, the way bills, the etc., gets into the cab, runs the train, and on off days installs spikes in ties. I don't mean this to be general case.