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Rail News Home Short Lines & Regionals

December 2011



Rail News: Short Lines & Regionals

Rail Outlook 2012: Freight rail



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by Jeff Stagl, managing editor

Summing up Class I chief executives' take on growth prospects in 2012 brings to mind Yogi Berra's famous quote: "It's like déjà vu all over again."

A year ago, the CEOs anticipated extremely gradual traffic growth in 2011 amid a painfully slow-to-recover economy. According to emailed responses to questions submitted by Progressive Railroading — and in one case, replies to questions posed during a mid-October phone interview — the chief execs expect similarly measured volume growth in 2012 in the face of tortoise-like economic strengthening.

"We have seen a continued, gradual economic recovery in 2011 and we expect it to continue in 2012, albeit at a very slow pace," said CN President and CEO Claude Mongeau.

Norfolk Southern Railway's book of business and volume levels are "nowhere near" 2006's pre-recession levels, but are at least stable and figure to remain so, said Chairman, President and CEO Wick Moorman during an Oct. 18 phone interview.

"All of our customers that we talk to would tell you what we're saying, that they don't see extraordinarily robust growth in the immediate future or in 2012, but neither do they see anything which would portend a downturn," he said. "And that's our attitude going into 2012. We are anticipating a stable economy that continues to grow ... [at] a somewhat reduced pace."

Needless to say, the economy and traffic growth remain top-of-mind among the Class I CEO set as 2012 dawns. Although the same slow-go economy is on tap for next year, there at least will be some carload growth, they say.

Traffic levels might even be a smidge stronger next year, if late 2011 volumes are any indication, some CEOs believe.

"In spite of ongoing warnings signs, our consolidated carloadings continue to be strong. In fact, three of the top five weekly volume totals in [our] history have been in the fourth quarter," said Kansas City Southern President and CEO David Starling.

Lately, Canadian Pacific has been registering intermodal traffic gains because of an ongoing effort to improve and sustain service reliability.

"Our intermodal franchise is characterized by a strong network of facilities combined with deep long-term relationships. Given this foundation, [we] are confident our improvement in service quality will allow us to repatriate volume," said CP President and CEO Fred Green. "In fact, we are beginning to win market share in both our domestic and international business."

But carload gains are hardly a given. The factors that likely will impact traffic growth next year are the same ones that affected volume this year, CEOs say. For Union Pacific Corp. Chairman, President and CEO Jim Young, consumer confidence and employment levels are the two most critical ones.

"Consumer confidence is what will drive an improved economy and the single-largest factor is jobs," he said. "I don't see a double-dip recession based on what our customers are telling us, but the economy does seem to be in a holding pattern and could remain that way until we see improvement in the unemployment rate," he said.

BNSF Railway Co. Chairman and CEO Matt Rose concurs.

"The consumer that now fuels around 70 percent of the economy is still unsure," he said, adding that traffic likely won't return to pre-recession levels until 2013. "Until they more confidently participate, we are not going to generate enough growth to get the economy growing at the healthy levels we all know we need."

Other factors cited by chief execs as potentially impactful in 2012 — just as they were this year — include the potential growth-inhibiting outcome of federal regulatory reforms and cost-control-busting effect of the positive train control (PTC) implementation mandate.

"The implementation deadline of 2015 poses significant industry-wide challenges, [which] include the development and testing of software and supplier capacity to meet industry needs," said CSX Corp. Chairman, President and CEO Michael Ward, adding that the Class I's current development and installation costs exceed $1 billion.

Adds Moorman: "PTC is a gargantuan expenditure for a very, very modest benefit, and the further we get, the more concerns we have about the timelines that have been imposed by Congress, and at least in the shorter term, the viability of the technology."

However, the CEOs believe Congress might be too distracted by an election year and economic-strengthening causes in 2012 to take on rail "re-regulation," which they long have claimed could hamper capital investments and restrict growth.

"With ongoing concern in D.C. about unemployment and the economy, there appears to be little appetite for doing anything that could potentially slow capital investment or job creation," said Starling. "It seems unlikely that Congress would pass any legislation making it harder for the railroads to invest and create jobs."

Eye On Economic Indictors

No matter the lingering possibility of regulatory change or promise of volume increases, the CEOs plan to continue keeping close tabs both on Capitol Hill and the economy as the new year unfolds to determine if their late 2011 projections hold.

For example, they plan to keep monitoring the ebbs and flows of several economic indicators.

"We track 22 sub-business groups that include everything from coal, grain and industrial products, to finished automobiles and consumer goods moving in trailers and containers," said BNSF's Rose. "We also pay close attention to real GDP and manufacturing less technology."

For CN's Mongeau, industrial production is a key indicator, too, as are a series of export drivers.

"Housing starts and vehicle sales are also very important given the nature of our business," he said. "More importantly, we listen to our customers. Our supply chain approach has enabled us to engage more deeply with our customers, giving us better insight into what is happening in their businesses, [and] in turn, providing us with a better view of future volume demand across a wide range of markets."

CSX's Ward closely monitors industrial production, as well, via the Institute for Supply Management's Purchasing Managers Index and Manufacturing Customer Inventories Index.

"Through September, these indices indicated continued expansion of U.S. manufacturing and low inventories," he said. "This outlook provides opportunity for growing rail shipments of raw materials for manufacturing and the replenishment of finished goods inventories."

Markets To Bear

Yet, the opportunities for traffic growth extend well beyond the industrial sector. A number of CEOs identified several other markets that hold promise.

"I look at our business in three primary categories — energy, agriculture and all things related to the consumer — and there is potential upside in all three of those areas," said UP's Young.

Energy traffic will be driven by moving more crude oil via rail, especially as new shale reserves are developed or expanded; more materials used in natural gas drilling, such as frac sand and steel pipe; more ethanol; and more coal, which remains the primary source for about half the nation's electricity generation, he said. In third-quarter 2011, UP's coal volumes increased in the Southern Powder River Basin and Colorado/Utah Region, he added.

Because the world's population continues to grow, food demand will keep increasing, helping to drive UP's export grain volume, which was propelled this year in part by a drought in Russia, said Young.

In the consumer arena, the housing market, which is hovering at barely replacement levels, eventually will escalate, while the auto sector already is displaying growth.

"The auto industry expects to sell between 13 million to 13.5 million finished vehicles in 2012; that's up from 12.5 million to 12.8 million in 2011, but still far below pre-recession annual sales of nearly 17 million from 2000 to 2007," said Young.

Ward also is encouraged by recent auto production, as well as record export coal volume in 2011, despite a stagnant housing market. The intermodal sector should show strong growth in 2012 because of modal conversions and the recruitment of new customers, he said.

Ditto for KCS' Starling, who anticipates "especially strong" coal and intermodal volumes next year.

Crescent Corridor To Crest

Intermodal also will be a key traffic driver for NS. The Crescent Corridor planned between New Jersey and Louisiana will take a large step forward next year, said Moorman.

By 2012's end, the Class I expects to complete three intermodal terminals that are considered an essential part of the corridor: Memphis, Tenn., and Birmingham, Ala., facilities that will anchor the corridor's southern end, and a Greencastle, Pa., facility that will serve as a primary distribution center in that area, he said.

In addition, NS plans to make "significant improvements" to a Harrisburg, Pa., terminal, as well as some other facilities, said Moorman.

"So, 2012 is going to be a big year for us in really taking a significant step ahead in terms of our corridors and intermodal strategy," he said.

NS also is banking on more traffic generated by natural gas drilling in the Marcellus Shale.

"There is an abundance of inexpensive natural gas and that's great for the chemical industry, which relies on natural gas as the feedstock for a lot of their processes," said Moorman.

Opportunities in the Marcellus Shale — as well as horizontal drilling material demand and crude oil production in the Bakken Shale — are vital to CP, too. So is a low-cost ethanol customer base that's well positioned to compete in U.S. markets, says CP's Green.

In addition, the Class I's bulk business continues to grow since it's based on "strong fundamentals," he said.

"There is strong pricing in the global grain markets, the Chinese economy continues to grow in the high single digits and existing producers of potash are investing in mine expansions," said Green. "We haven't yet seen weakness in Asian commodity demand, but together with our customers, we are monitoring those markets."

Regulation Trepidation

However, just as certain markets could propel traffic, certain regulatory developments could place a hold on Class Is' growth potential both in Canada and the United States next year, CEOs say. The Surface Transportation Board (STB) continues to analyze rail competition issues and consider a National Industrial Transportation League (NITL) petition requesting a new rule governing reciprocal switching, while the Canadian government remains in the midst of a facilitation process as part of an ongoing federal freight-rail service review. In addition, the push for "re-regulation" might resume on Capitol Hill.

Last month, the STB deferred consideration of NITL's request to change switching rules — which would "vastly complicate rail operations and interfere with rail investment" — to instead examine the whole issue of rail competition, said KCS' Starling.

"We do not see either Congress of the STB enacting harmful change in rail regulation in 2012, but we will need to keep an eye on the STB's ongoing consideration of the [rail competition proceeding] record," he said.

CSX continues to advocate for a "fair and balanced" regulatory environment, said Ward. Since railroads were partially deregulated in 1980, rail rates have dropped 55 percent on an inflation-adjusted basis, volume has doubled and railroads' capital investment reached historic levels, he said.

"CSX is doing its part to promote economic recovery and growth by investing in network capacity, adding more than 4,000 new jobs and contributing to public benefits that include fuel efficiency, reduced traffic congestion, and less wear and tear on highways," said Ward. "Any regulatory action that limits long-haul freight-rail movements or forces the opening of private rail networks would diminish those benefits."

'Nation Needs Sensible Approach'

Regulatory reform is a competitive issue, and burdensome regulatory requirements have become a tax on businesses and their employees, said BNSF's Rose. So, the nation needs a "sensible approach" to additional regulation that better reflects actual risks and economic reality, he believes.

"There is no magic solution [and] no one thing will solve this," said Rose. "The basic question our nation faces is whether we are going to maintain and build upon the infrastructure advantage that helped the U.S. become the world's most successful economy with proactive, pro-growth policies, or allow it to become just another reason why the economy isn't performing better."

For UP's Young, the most important question elected officials need to ask themselves is: What are they doing to make America more competitive?

"I don't think there is an industry that is more regulated than freight rail is today, and yet we provide the lowest-cost freight-rail service in the world. In fact, the industry invested approximately $12 billion of private money in America's infrastructure in 2011," said Young. "Transportation policies that restrict our ability to compete and reduce our ability to earn a fair return will force us to re-evaluate how we deploy capital and likely will drive investment dollars out of the rail industry."

NS' Moorman believes railroads exist in an environment with a lot of "regulatory creep."

"Every month, there is some regulatory issue that makes it more difficult and more expensive for us to do business, and that has very little benefit for anyone," he said.

A dismantling of heavy rail regulation in both the United States and Canada during the 1980s and 1990s helped revive a once-struggling industry and enabled it to provide better service to customers on a sustainable basis, said CN's Mongeau. Commercial principles and a stable regulatory environment are vital to an effective rail transportation marketplace throughout North America, he believes.

"The bottom line is that improved rail service and better customer relationships are, first and foremost, a matter of proper focus, solid execution and mutual trust. These important factors cannot be imposed by legislation or regulatory fiat," said Mongeau. "And that is why we strongly encourage governments in both countries to stay the course with a commercial policy framework for rail regulation."

In Canada, a government-appointed rail service panel missed an opportunity to provide valuable supply-chain input when "it singled out rail service in isolation," said CP's Green.

"We want to be part of the process and we also want to make sure it is focused on the supply chain as a whole, and that outcomes support commercial arrangements," he said.

Transparent And Apparent

Supply-chain transparency is critical if railroads are going to make "smart and thoughtful decisions," and continue to move away from traditional approaches, said Green.

"Like the rest of the industry, we face a rapidly evolving marketplace with a number of emerging trends. Collectively, we must be transparent to our partners in the supply chain and open the change," he said.

CN strives to become a true supply-chain enabler — an effort that will remain a key focus in 2012, said Mongeau. The success of North American and international supply chains will be based on innovation by, and collaboration among, all logistics chain participants, he believes.

Class Is' success with growth initiatives next year also hinges on another issue: their workforce. The large roads need to continue recruiting and retaining "next generation" workers as employees approach retirement in growing numbers, said Starling.

Class Is also will need more workers to handle a projected increase in traffic demand the next several years, said Rose.

"Jobs will continue to be a key issue, not just for the transportation industry, but for the U.S. as a whole," he said. "This is an opportunity for the railroads to be a positive contributor to the U.S. economy."

Class I CEOs certainly hope there are many other contributors to the economy in 2012. A healthier-than-expected economy would mean more traffic — and more revenue and capital — to carry out their ongoing goals of more reliable service, more infrastructure investments and more value for shareholders.

"The overriding issue for CSX and the rail industry is economic recovery and growth, with improved returns generating the capital needed to expand capacity of the nation's freight-rail network for increased demands," said Ward.

Assistant Editor Julie Sneider contributed to this article. Email questions to jeff.stagl@tradepress.com.

No shortage of growth opportunities for the short-line set

Echoing Class I CEOs' take on 2012, executives at several regionals, short lines and short-line holding companies believe business will grow at least a smidge next year.

"It will be marginally better," says Bob Parker, president and CEO of Regional Rail L.L.C., which owns the East Penn, Middletown & New Jersey and Tyburn railroads. "Our same-railroad traffic is up 4 to 5 percent — not where it was for 2010 over 2009. We're not seeing a big boom in the economy. But we will post growth with our existing railroads."

Since August, Regional Rail has assumed operation of four Norfolk Southern Railway lines in Pennsylvania and acquired the Tyburn Railroad in Morrisville, Pa. Acquisitions will be key to growth in 2012, as well, says Parker.

"There are one or two acquisitions that we're looking at," he says. "If there are no deals in 2012, that would be very disappointing."

Ditto for RailAmerica Inc. The company — which owns 43 regionals and short lines in the United States and Canada — anticipates swinging a few deals next year, says President and CEO John Giles.

"We only acquired three small railroads this year," he says, referring to the Three Notch, Wiregrass Central and Conecuh Valley railroads acquired in May. "I think there will be more transactions next year and it will be a good year for acquisitions."

RailAmerica also expects to register growth next year by generating more non-freight revenue, such as via track construction and maintenance services provided by subsidiary Atlas Railroad Construction Co., as well as rail-car repair, industrial switching and leasing services, he says.

"I think 2012 will be better than 2011. I'm thinking the same customers, more traffic and a bit more market share," says Giles. "It's been rough sledding the past three or four years and we've already had a near-death experience in the financial meltdown, and we'll get farther from it."

Of Optimism And Intermodalism

Florida East Coast Railway L.L.C. (FEC) Executive Vice President and Chief Financial Officer John Brenholt also is a smidge more optimistic about 2012.

"The economy will recover — it always does," he says. "We're seeing a little uptick now."

Although FEC's carload business likely will be flat because it's heavily tied to the weak home and road construction industries — meaning no growth in aggregates and lumber traffic — the 351-mile regional's intermodal business should increase, says Brenholt. The railroad is branching out to areas north of Jacksonville, Fla., such as Savannah and Valdosta, Ga., to dray intermodal traffic in from 130 to 150 miles out and rail the cargo to points south, he says.

Longer term, the railroad is working with the Port of Miami to restore rail service and with Port Everglades to build an intermodal container transfer facility. The projects will ensure FEC is ready to take on more business when the economy recovers, as well as after the Panama Canal is expanded in 2014, says Brenholt.

"We will continue to invest in intermodal," he says.

For the Kankakee, Beaverville & Southern Railroad (KBS), banking on agricultural products traffic is the no-brainer. Ag accounts for 90 percent of overall business for the 155-mile short line, which operates lines between Kankakee and Danville, Ill., and Lafayette, Ind.

"As long as there's corn, we will move it," says KBS Vice President Tyler Stroo.

Corn traffic is projected to remain at least stable, maintaining KBS' ag traffic at about 500 to 800 loads per month, he says.

The only drag on KBS' growth ledger of late is rail-car storage business, says Stroo. The short line can store about 1,000 cars, but recently has been averaging about 400 cars.

"We hear that not as many cars are being built and there's more leasing of older cars," says Stroo, adding that he's hopeful the business will turn around soon.

A Taxing Situation

Meanwhile, an issue affecting the entire short-line industry likely will reach a conclusion soon. The Section 45G short-line tax credit, which is set to expire again on Dec. 31, might get extended for six more years if Congress enacts the Short Line Railroad Rehabilitation and Investment Act of 2011 (H.R. 721/S. 672) by year's end or in early 2012.

Originally enacted in January 2005 and extended several times, the Section 45G provision enables regionals and short lines to claim a tax credit of 50 cents for every dollar spent on infrastructure improvements, up to a cap of $3,500 per mile of owned or leased track.

As of Nov. 23, H.R. 721 had landed 194 co-sponsors and S. 672 had lined up 39 co-sponsors; the House bill needs 218 and the Senate bill, 51 to ensure majorities in both chambers, according to the American Short Line and Regional Railroad Association (ASLRRA).

The tax credits pose enormous job creation opportunities for the nation, said ASLRRA President Richard Timmons during an address at Progressive Railroading's RailTrends® conference in New York City Nov. 1.

"The small railroads are contracting out nearly all of [their] work as very few of them have their own maintenance departments," he said. "What they are doing is getting large numbers of railroad contractors, railroad material manufactures and transporters work."

Jeff Stagl



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