New Public Management in the Transport Sector Nordic Transport Research Conference Oslo, Norway, 4th-5th September 2006

1. New Public Management in the Transport Sector Nordic Transport Research Conference Oslo, Norway, 4th-5th September 2006 Rail Infrastructure – The Scene in the USA John C. Spychalski Professor of Supply Chain Management Smeal College of Business The Pennsylvania State University University Park, Pennsylvania 16802-3603 USA jcs2@psu.edu

2. Outline 1. Introduction 2. Industry and Market Structures 3. Infrastructure – Ownership and Access 4. Paying for Infrastructure – Rail Service Providers and Users 5. Paying for Infrastructure – External Sources 6. Current and Emerging Challenges for Infrastructure Funding 7. Summary and Conclusions

3. Industry Structure – Freight Class I Sector (≈ 98,000 miles of line in 2004) Regional and Local (Short Line) Sector (Miles of line, 2004: Regional: 15,641; Local: 27,109) The US Surface Transportation Board (STB) defines Class I railroads on the basis of an annual operating revenue threshold. For 2004, the threshold was $289.4 million or more. The Association of American Railroads (AAR) identifies non-Class I railroads on the basis of their revenue and mileage characteristics. Regional railroads are carriers operating at least 350 miles of line and/or earning operating revenue between $40 million and the Class I revenue threshold. Local (short line) railroads are either line-haul carriers below the Regional criteria or switching and terminal railroads (Railroad Facts, p. 3).

4. Industry Structure – Class I Sector • Seven Class I Carriers – down from fifty-two in 1976 • Four Dominant Class I Companies: - BNSF Railway and Union Pacific Railroad in the • West - Norfolk Southern Railway and CSX Transportation • in the East • Canadian National Railway and Canadian Pacific Railway Subsidiaries in the US Midwest • Kansas City Southern Railway – mid-US to Mexico

5. Industry Structure – (Regional and Local (Short Line) Sector • 31 Regional Railroads in 2004 • 518 Local (Short Line) Railroads in 2004 • Total: 549* – up from approximately 340 in 1976 * Some railroads within this total are subsidiaries of either regional/short line holding companies which own several railroads, or of Class I carriers.

6. Industry Structure – Freight – Summary • Class I – Duopoly in the East and West, Small Oligopoly in the Midwest - Result of post-1976 trend: 86% decrease in sector population, massive consolidation/concentration - Despite consolidation, ≈ 50% of rail shipments are handled by two or more railroads • Regional and Local (Short Line) – Atomistic - Post-1976 trend: 61% increase in sector population, great rise in sector atomization (most short lines are primarily feeders to large railroads)

7. Market Structure/Access – Freight – I For carload (wagonload) and trainload (unit train or block train) service, with origination and termination on rail service users’ private sidings: Monopoly – except in the relatively small number of instances where (a) location of a user’s facility makes possible private siding access to lines of more than one carrier, (b) the user is served by a ‘neutral’ short line that interchanges traffic with two or more line-haul railroads on the same terms, or (c) STB-ordered access as a condition of merger approval.

8. Market Structure/Access –Freight – II For intermodal service (TOFC, COFC, Double Stack, RoadRailer®,etc.: Competitive inhigh-volume corridors served by two or more line-haul railway companies which possess intermodal terminal facilities of comparable internal efficiency and access by complementary (feeder) truck and water carriers

9. Industry and Market Structure – Passenger* • Intercity – Amtrak (National Railroad Passenger Corporation) – only significant long- and intermediate-distance rail passenger carrier since 1 May 1971 • Suburban/Commuter – 17 Carriers Serving 17+ Metropolitan Areas – Intramodal Competition Nil * Excludes metro, light rail, and tram (streetcar) systems

10. Infrastructure Ownership – Freight Ownership – Almost entirely private, with few exceptions, i.e.: • Some shortlines operate on a contract or concession basis on track owned by quasi-independent public authorities • In some areas, freight railroads operate on track owned by Amtrak and commuter passenger carrier • Infrastructure subject to value-based property taxation

11. Infrastructure Ownership – Passenger • Amtrak: - ‘Landlord’ in part of Northeast Corridor (NEC), Washington-New York, Harrisburg-Philadelphia; and short segments in Michigan, northern Indiana, New York State, and California - ‘Tenant’ on suburban/commuter and freight railways elsewhere • Suburban/Commuter: A mixture of ‘Landlord’ and ‘Tenant’ depending upon location

12. Paying for Infrastructure – Freight • Almost entirely internal to private market place • Revenue from freight service must fund capital and maintenance expenditures on infrastructure, operational expenses, and payments to providers of financial capital (investors and lenders) • Exceptions: Limited initiatives by some states and the federal government to assist with funding of renewal/improvement and expansion projects

13. Annual Capital Expenditures – Class I Freight Railroads – Selected Years* • *Notadjusted for changes in purchasing power of money. Amounts rounded.Source: Railroad Facts, p. 44.

14. Infrastructure CAPEX, Operating Revenue and Net Operating Income – Class I Freight Railroads * Gross revenue from charges for line-haul freight transport service, switching (shunting), demurrage and incidental rail operating services. Source: Railroad Facts, p. 12.** Rail operating revenues minus rail operating expenses, taxes, and rent for joint facilities. Fixed (interest) charges are excluded. Railroad Facts, p. 17.

15. Rate of Return on Net Investment in Infrastructure and Equipment vs. Cost of Capital – Class I Freight Railroads * Average net investment in assets used to provide transport service.** As computed by STB, calculated on basis of cost of debt and post-tax cost of equity (shareholders’ investment). Source: Railroad Facts, pp. 18-19.

16. Freight Service Pricing in Practice - I • Coverage of infrastructure costs without external subsidy necessitates demand-based differential pricing • Most elements of rail infrastructure costs are indivisible – i.e., cannot be traced or allocated to specific movements of traffic on the basis of unambiguous cause-and-effect data (except in instances where capacity is fully utilized)

17. Freight Service Pricing in Practice - II • Rail freight marketing and sales officers strive to set price at levels that maximize ‘net contribution margin’ (revenue in excess of causally identifiable marginal cost) within each segment of the traffic base – with the hope that, at year’s end, total revenues ≥ total costs • To do so “ … knowledge of the market, rail pricing history, and competitive alternatives are critical” (Blanchard, p. 33).

18. Freight Service Pricing in Practice – IIIChallenges for Achieving Profitable Rail Freight Operation • Large rail service users exercise monopsony power, particularly in “bundling” of traffic in contracts • Competitive advantage of an individual railroad between a specific origin and destination disappears when the rail user’s traffic between all origins and destinations is bundled together in contracts • Propensity for ‘ruinous’ intramodal rate (price) competition exists when capacity is underutilized

19. Freight Service Pricing in Practice – IV Bases for differential pricing: • Type of commodity transported – value, cost of movement, weight density, etc. • Size (carload, trainload, etc.) and distance of individual shipment • Volume of traffic tendered over time by rail user • Direction of movement • Time of movement • Speed of service (transit time) • Quality of service guarantees, e.g., delivery time • Provider of freight car – railway vs. shipper

20. Instruments for Rail Freight Pricing • Public (tariff) rates - Class - Commodity - Spot (rate in effect only for limited period of time) • Negotiated contract rates (confidential between railway and shipper) • Bidding/auctions

21. Paying for Infrastructure – Passenger • Income from passenger fares and miscellaneous sources ≤ total operating costs for both intercity and suburban/commuter carriers • External subsidy required for covering shortfalls between operating revenue and operating costs, and for funding major portions of capital expenditures for both infrastructure and equipment

22. Rail Infrastructure Supply – Fundamental Challenges and Issues • Basic challenge – Devising policies and programs to provide infrastructure capacity at levels that will yield greatest net social benefit from freight and passenger services • Roles of the private and public sectors – should they remain largely or wholly ‘as is’ or be altered?

23. Consequences of Market-Driven Infrastructure Sizing and Funding • Minimal draw on government treasuries • Great rationalization of light-density and duplicative trackage – e.g., 36% reduction in miles of line, from 218,399 in 1958 to 140,750 in 2004 (ICC, 1959, p.173, and Railroad Facts, p. 3). • Greater economies of line density from concentration of traffic on fewer lines

24. Users’ demands for increased reliability and consistency in service quality are driving adoption of scheduled freight train operating plans, thus increasing productivity of infrastructure, equipment, and operating personnel (Vantuono, 2005) • Market-oriented pricing incentives help to smooth out demand for infrastructure capacity • Aggressive cost reduction efforts have yielded more efficient labor contract terms with railway unions

25. Market-Driven Consequences Under Post-2003 “Sellers Market” Conditions • Post-2003 rail freight traffic boom – “By year end (2006), it is likely that the railroads will have hauled more freight than ever in their 175-plus-year history (measured in ton-miles)” (Vantuono, 2006) • Great rise in containerized import shipments • Growth in domestic-originated shipments

26. Trucking industry difficulties – rising road congestion, soaring fuel prices, driver shortages • Rail freight traffic has grown beyond congestion-free levels on many segments of main line and in yards and at interchange points between different railway companies • Congestion from traffic growth plus operating difficulties from 1990s mergers has caused serious declines in service quality (Miller)

27. CAPEX on increases in capacity have lagged behind growth in traffic, due to: - Doubt about durability of traffic/revenue increases - Magnitude of expenditures required - Specialized, long-lived, site-fixed infrastructure - Skepticism by ‘Wall Street’ – large CAPEX programs often drive down rail share prices - Rates of return on capacity additions seen as ≤ railway companies’ cost of capital

28. Seller’s market conditions have induced large increases in charges on captive shippers’ traffic • Increases in freight charges, plus declines in service quality, have raised pressure from shipper groups for legislation to increase intramodal rail price and service competition (Vantuono, 2006) • Quest for economies of scale at train operating unit level, and reductions in car and locomotive cycle time, has resulted in ‘demarketing’ of less-than-full trainload shipments of some commodities, e.g., grain (Gormick)

29. Restriction of grain shipments to trainload lots loaded at main line stations has shifted grain gathering transport from rail branch lines to rural roads (Gormick) – result: - Reduced infrastructure and operating costs for rail - Increased trucking costs for initial shipper of grain - Increased capital and maintenance costs for rural road infrastructure provider • Tendency to ‘crowd out’ passenger trains on freight-carrier-owned infrastructure when capacity becomes tight, unless passenger train operator pays for additional capacity

30. Passenger/freight train track slot priority conflicts • Accident liability conditions – passenger carrier on freight carrier-owned infrastructure • Maximum permissible speed for passenger trains on freight carrier-owned track reduced by freight carrier actions (e.g., from 100 or 90 mph to 79 mph): - Removal of automatic train stop/automatic train control safety equipment from signal system to lower capital and maintenance costs - Reductions in super elevation of track on curves

31. Private-Public Sector Policy and Planning • Rail transport is an interstate network business – but initiatives to alleviate capacity constraints have been largely reactive, sporadic, ‘spot’ investments rather than systemic-focused • Private capital market unwilling/unable to finance systemic, comprehensive capacity additions at levels consistent with existing let alone projected future demand for rail freight service

32. Public sector participation in rail freight infrastructure improvement has occurred largely at the state rather than federal level • Federal funding of intercity rail passenger infrastructure confined largely to Northeast Corridor. Expenditures lag behind need • Federal and state expenditures on passenger infrastructure have been largely ‘renewal at same functional level’ – no purpose-built high speed track

33. No comprehensive consistent national plan or funding mechanism for intercity rail passenger infrastructure improvement or expansion exists • State-level public-private sector partnerships have yielded successes – e.g., $2.43 billion Alameda Corridor to Ports of Long Beach/Los Angeles, double-stack clearance program in Pennsylvania • Significant state-funded intercity passenger service initiatives exist in a few states – e.g., California, North Carolina, New Mexico, Illinois, Maine, Vermont, Virginia

34. Summary and Conclusions • No open access – Vertical integration and exclusivity in line use ‘reign supreme’ • Freight infrastructure funding largely private – rail carriers and their customers pay • Private market alone may not suffice to supply rail freight infrastructure at greater socially beneficial level

35. Passenger infrastructure funding borne largely by public sector • Private-public sector policy and planning – fragmented and inconsistent • Net result – continuum of ‘muddling through’ – with a lower level of social benefit than rail transport has the potential to provide

36. References Blanchard, Roy “What makes a successful small road?” Railway Age, April 2006, pp. 31-33. “Freight Rail Transportation: Long-Term Issues,” A CBO Paper, Washington, D.C., Congressional Budget Office, January 2006. Gormick, Greg, “The great grain strain,” Railway Age, May 2006, pp. 25-33. Interstate Commerce Commission (ICC), Annual Report-1959. Johnston, Bob, “The Emperor’s new railroad – Less cash, more efficiency required of Amtrak in 2006,” Trains, March 2006, pp.24-25. Miller, Luther S., “Can intermodal ease the squeeze?” Railway Age, August 2006, pp. 19-23. Roth, Daniel L., and Aggarwala, Rohit T., “Whose Railroad Is This, Anyway?: Opportunities and Challenges in Regionalizing the Northeast Corridor,” Paper 02-2636, Transportation Research Board, Annual Meeting, January 2002, Washington, D.C.Railroad Facts – 2005 Edition. Washington, D.C.: Policy and Planning Department, Association of American Railroads, November 2005. Vantuono, William C., “Keep them moving,” Railway Age, September 2005, pp. 45-60.

37. Vantuono, William C., “Rolling to new records,” Railway Age, July 2006, pp. 26-29. Vantuono, William C., Twenty-five years after Staggers – New challenges, huge opportunities,” Railway Age, July 2005, pp. 22-26.