A few years ago, the nation’s major rail carriers were enjoying record earnings and freight volumes. Their customers were generally pleased with the service and rates, shareholders were also mostly content, and billions of dollars were being pumped into capital improvements. Most would agree it was a pinnacle of achievement and a stark contrast to the 1970s, which were marked by bankruptcies, deteriorating equipment and infrastructure, declining safety, and rising rates.

The Staggers Rail Act of 1980 passed by Congress to partially deregulate the industry provided the impetus for the dramatic turn-around that has finally seemed to hit a plateau, however. 

Railroads, like other transportation companies, are feeling the effects of a slowing economy. But, that’s not the whole story. The re-negotiation of long-standing rail contracts have driven an increasing number of customers to other transport modes, while Maersk Line’s decision to slash its offering of inland points served by intermodal rail has also been significant. In 2007, on-dock rail lifts at Maersk’s terminal in Los Angeles dropped 40 percent over the previous year largely due to the discontinuation of four weekly double-stacked trains carry roughly 1,000 containers each to inland points.

Consider that a Bank of America survey of 1,400 rail shippers conducted in the fourth quarter of last year showed 67 percent were “actively” seeking to divert traffic to other transport modes compared with the 44 percent who said they looking for alternatives in during the second quarter of 2007. According to the Bank of America survey summary, “We believe pulling too hard on the pricing lever runs the risk of gradually eroding primary demand over the intermediate to longer run.”

Railroads contend that their price increases have been justified. And, to be fair, they don’t get the funding that other transport modes (such as trucks and barges, which travel on heavily-subsidized highways and waterways) get from the federal government. Nearly all of their infrastructure and equipment investments are paid for by earnings or by borrowing from outside investors.

The current uncertainty has been compounded by calls on Capitol Hill to re-regulate the industry, notes Robert vom Eigen, Partner and head of the Surface Transportation practice at Foley & Lardner LLP. “While they need to keep Wall Street happy, they also need to justify their expenditures,” he says, which is causing some concern.

CSX’s CEO Michael Ward wrote recently that some activist investors are worried only about quarterly profits, regardless of the impact on safety, service, and shareholder value. “One hedge fund,” he stated, “actually demanded that CSX freeze investment in its rail system.” Ultimately, “this is no time for railroad companies to succumb to investor demands that will limit their ability to serve the nation. Such investors seem to lack a complete understanding of why railroads are vibrant again and providing more benefits than ever before,” he countered.

In March, over 300 representatives from the rail industry gathered in Washington, D.C. for Railroad Day on Capitol Hill. Those in attendance urged Congress to help expand rail capacity and spoke out against further government regulation.

“This is a critical time as we look for ways to improve our nation’s infrastructure,” said Edward Hamberger, president and CEO of the Association of American Railroads (AAR).

The AAR argues that re-regulation would take railroads away from the financial sustainability they need to pay for their needed investments. “Artificially lower rates brought about by re-regulation would translate directly into lower rail earnings. This, in turn, would inevitably lead to lower spending on rail infrastructure and equipment; a deteriorating physical plant; and slower, less responsive, and less reliable rail service—outcomes that are incompatible with a growing, healthy economy,” states the group.

Figures put forth by the U.S. Department of Transportation estimate that freight railroad demand will rise by 88 percent by 2035. At the same time, a study by consultancy Cambridge Systematics designed to forecast the cost of the capacity expansion necessary for railroads to handle that traffic increase found that if capacity isn’t properly addressed by 2035, some 16,000 miles of primary rail corridors—nearly one-third of the 52,000 miles covered in the study—would be so congested that a comprehensive service breakdown would occur. Currently, less than 1 percent of rail miles are congested.

“Even without re-regulation, railroads will be unable to pay for socially optimal rail capacity entirely on their own,” says the AAR. “With re-regulation, they would be able to fund far less. As the Congressional Budget Office recently noted, ‘As demand increases, the railroads’ ability to generate profits from which to finance new investments will be critical. Profits are key to increasing capacity because they provide both the incentives and the means to make new investments.’”

The light at the end of the (rail) tunnel

Despite the present day doom and gloom, one man remains bullish on the future of rail transportation—Gil Carmichael. During a presentation entitled the “Carmichael Conference on the Future of American Transportation” earlier this year, Carmichael, who spent four years as Administrator of the Federal Railroad Administration earlier in his career and now holds the title of founding chairman of the Intermodal Transportation Institute at the University of Denver, spoke about his vision for the rail industry.

“We should build upon what the freight railroads already are doing. During the past quarter-century a global intermodal freight network evolved. It has given freight customers worldwide a system that is faster, safer, more reliable, more energy efficient, and more economically efficient. It makes partners of container ships, railroads, and trucks. It requires highly efficient terminals for seamless interchange of freight. It is a fantastic system that continues to grow. North America’s railroads have spent huge sums of money to build and operate their segments of this global network.”

“Eventually, I believe that we must build or upgrade about 20,000 miles of freight corridors capable of train speeds in excess of 90 miles per hour—double-tracked, equipped with GPS, and grade-separated. That network will be augmented by as much as another 10,000 miles of conventional routings. I call this ‘Interstate II,’ a high-efficiency network of steel stretching from coast to coast and from Mexico City to Montreal. The freight railroads have begun this process. Their capital contributions should be augmented by public investment. This can take several forms: cost-sharing specific projects, which are already occurring; tax credits; and tax-exempt financing secured by public agencies.”

Looking back, Carmichael points to missteps by the federal government that have contributed to the overall transportation problems in the U.S. “During the 20th century, our government promoted highways, inland waterways, airports, and urban transit. With hindsight, most of us would agree that government over-promoted these modes. Meanwhile, that same government over-regulated railroads and airline companies. We ended up with today’s very unbalanced transportation system. And, because these modes were developed at different times, their infrastructure was built in isolation. Connection between modes were poor or non-existent. After World War II, government also adopted a policy of ‘cheap energy.’ Initially, that policy was sensible, but the politicians refused to abandon it in the face of strong evidence that we were headed for supply trouble—and the policy of cheap energy would only make things worse.”

“We built the interstate highways—another grand achievement, and a necessary one. The great tragedy of federal policy was that in 1956 when Congress authorized the interstates it did not also deregulate freight railroads…nor deregulate airline service…nor repeal the disastrous price controls on natural gas. If all of those actions had been taken in 1956, we might not need a ‘Carmichael Conference’ in 2008.” wt