The Railroad Week in Review:
Week Ending May 16, 1998

Three weeks ago we noted that the STB had issued "Ex Parte 575," a ruling which charges the class 1s, shippers, and shortlines to come together and report on progress resolving the issues by specific dates. Well, the STB asked for comment, and it got it - in spades - from Kodak. In a tersely worded statement, the folks from Rochester mention all the benefits wrought by the Staggers act, particularly the "benefits effects of the legalization of rail transportation contracts and the exemption of intermodal from regulation." Kodak wants no turning back on this one.

There is also an eloquent argument of the effects of competition in rate making. Writing on the subject of coal freight rates (Kodak is Conrail's largest non-utility user of steam coal), the company notes that "market competition has been greatly enhanced and has worked to the benefit of users of rail service, as well as the industry." Developing this thread, Kodak continues, " Does the availability of two-carrier competition make a difference? In Kodak's experience, most emphatically, it does. In 1984, Kodak switched from a policy of single-sourcing coal shipment transportation to a dual-source policy. As a result of the implementation of this dual-source policy, Kodak coal rates dropped over 15%.

"By 1990, after dual source transportation procurement had been in effect for six years, rates had risen only four percent over the 1984 rate level, in spite of the fact this was a generally inflationary period. In 1991, Kodak shifted to a single-source coal transportation policy. Seven years later, rates have risen almost 12% over 1991 levels, and this in a period where inflation has slowed down. Kodak is convinced."

Kodak also makes the point that throughout railroad history carriers have sought to gain the competitive advantage by buying up the competition rather than having to beat it fair and square for the customer's business. And now that we're down to two in the west and soon-to-be two in the east, Kodak suggests "The ultimate objective for the 21st century ought to be a rail system that is fluid and provides easy access to rail competition for any potential user."

Canadian National said on Monday that it will trim about 1,600 miles of track from its system this year, 1,200 miles of which will be shortlined. (For a full list of lines, go to the CN website, Says CEO Paul Tellier, "CN's objective is to create a low-cost, growth-oriented feeder network of short line railways allowing CN to focus on becoming a high-density, long-haul railway.'' Note that since 1992 has sold or scrapped 6,500 miles of railroad. But it's not a fire sale. They've still got 15,300 miles left.

The may also be change afoot at BNSF. Doug Babb, recently appointed SVP Merchandise, told the investment analysts aboard last week's special train that shortlines are a major part of his business plan. To put things in perspective, his unit generated 1997 sales $2.6 billion, nearly a third of the railroad's total $8.4 billion in revenue. The shortlines did 13% of the total merchandise revenue.

Babb clearly wants more. The plan calls for merchandise growth of 5-7% this year. The shortline growth falls short at half that rate, so there's work to do. The 103 shortlines connecting with BNSF will be segmented by growth potential and critical issues identified. BNSF will be looking into four areas in particular: creating joint 3-year plans, equipment management, the interchange process, and electronic interface.

The good news is that paper barriers are going to get close scrutiny, and where they can be eliminated or limited without detriment to BNSF they will be (sounds much like the NS approach). The bad news is the growing demand for 286,000 lb. gross weight cars. Relatively few of BNSF's shortlines are equipped to take them, and so may well fall behind in an environment where the supply of traditional 263,000 lb. cars is dwindling.

As every student of investing knows, the Buffetts and Lynches of this world advise selecting companies whose tires you can kick and which you really understand. It follows, then, that if you're interested in a railroad, it'd be prudent to get out on the line, see how it works, and kick the ties. So, when one gets an invitation to do just that from the comfort of a business car with the CEO and his senior staff aboard, one goes. Burlington Northern Santa Fe hosted just such a trip last week, and it was an eye-opener in many ways.

For most of the trip we were treated to CEO Rob Krebs and his staff giving stand-up presentations of every aspect of the company from operations to commercial to engineering and mechanical. The high point -- literally as well as figuratively -- was the ride of the newly opened Stampede Pass route. Recall this former NP line had been operated by the Washington Central from Pasco west to Cle Elum, 150 miles, for about 14 years. BN operated local service on the west end between Auburn and Ravensdale, 14 miles, leaving the remaining 65 miles over the Pass dormant.

When it became evident in 1996 there could be serious capacity restraints over the two Washington lines then in operation, the decision was made to buy out the shortline and reopen the Pass. The job was completed in six months and the numbers are truly impressive. The project involved some 47 miles of new main line rail, nine new remote-control sidings (some 4 miles long), 303,000 ties (about evenly split between concrete and wood), 5,000 cars of ballast, rehabbing tunnels and snowsheds, and renovation or construction of 16 bridges. So, if you want to get a look at what $100 mm more or less can do, arrange to take this trip. And thanks, Rob Krebs, for letting our group go out and kick the ties, figuratively speaking.

Following this bit of excitement, I paid a visit to GNWR's "Oregon Division" headquarters in Albany, about 70 miles south of Portland. The operating principles writ large on the BNSF trip were all there, albeit writ small. Two things in particular struck me: the track program and the class 1 relationships. The former is best shown on a series of three track maps of their 400-mile system. First is track as received when the properties were bought from UP/SP and BNSF showing nearly half FRA excepted or out of service, and half class 2 and 3. The second map is the 1998 goal, removing all the out of service, and most of the excepted track on the core line.

The third map, "Optimum," shows 60% class 2 and the balance class 3. Note also that more than a third of the $3 million track program went into rebuilding a bridge needed to link the northern-most "Astoria Line" with the rest of the system. All of the funds came from GNWR's capital program. Said General manager Robert Melbo, "We can do more work with less resources on good track than we can on bad, and that helps profitability." For what it's worth, the traffic base has grown to 55,000 carloads a year from a start of 35,000 in just three years.

As for the class 1s, Melbo prepared five-year plans to share with both UP and BNSF. Interestingly, BNSF, with less than 20% of the cars, showed the most interest, even offering suggestions to improve and sharpen to document for the benefit of both (which fits with Doug Babb's remarks, above). UP has been somewhat less aggressive on follow-through, though Melbo hopes that as Houston's congestion eases the dialog will be rekindled.

Apropos of paper barriers, Melbo thinks what was inherited as UP and BNSF local traffic will remain that way. However, he sees growth in new traffic lanes as current UP local customers find new markets on BNSF and vice versa. That could add 10% or more to his revenue base, before even considering what the new options would do for prospective customers. Then there's intraline business on his lines plus potential interline with the RailTex-owned Central Oregon & Pacific at Eugene, OR. it's not a question of when, just how much. A nice dilemma to have.

All in all, an interesting and educational week of seeing how things really work in the field.

--Roy Blanchard

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