[Senate Hearing 107-1052]
[From the U.S. Government Publishing Office]



                                                       S. Hrg. 107-1052

                       OVERSIGHT HEARING ON THE 
                     STATE OF THE RAILROAD INDUSTRY

=======================================================================

                                HEARING

                               BEFORE THE

                SUBCOMMITTEE ON SURFACE TRANSPORTATION 
                          AND MERCHANT MARINE

                                 OF THE

                         COMMITTEE ON COMMERCE,
                      SCIENCE, AND TRANSPORTATION
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION

                               __________

                              MAY 9, 2001

                               __________

    Printed for the use of the Committee on Commerce, Science, and 
                             Transportation



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           COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION

                     JOHN McCAIN, Arizona, Chairman
TED STEVENS, Alaska                  ERNEST F. HOLLINGS, South Carolina
CONRAD BURNS, Montana                DANIEL K. INOUYE, Hawaii
TRENT LOTT, Mississippi              JOHN D. ROCKEFELLER IV, West 
KAY BAILEY HUTCHISON, Texas              Virginia
OLYMPIA J. SNOWE, Maine              JOHN F. KERRY, Massachusetts
SAM BROWNBACK, Kansas                JOHN B. BREAUX, Louisiana
GORDON SMITH, Oregon                 BYRON L. DORGAN, North Dakota
PETER G. FITZGERALD, Illinois        RON WYDEN, Oregon
JOHN ENSIGN, Nevada                  MAX CLELAND, Georgia
GEORGE ALLEN, Virginia               BARBARA BOXER, California
                                     JOHN EDWARDS, North Carolina
                                     JEAN CARNAHAN, Missouri


                  MARK BUSE, Republican Staff Director
               ANN CHOINIERE, Republican General Counsel
               KEVIN D. KAYES, Democratic Staff Director
                  MOSES BOYD, Democratic Chief Counsel
                              ----------                              

       Subcommittee on Surface Transportation and Merchant Marine

                     GORDON SMITH, Oregon, Chairman

TED STEVENS, Alaska                  DANIEL K. INOUYE, Hawaii
CONRAD BURNS, Montana                JOHN D. ROCKEFELLER IV, West 
TRENT LOTT, Mississippi                  Virginia
KAY BAILEY HUTCHISON, Texas          JOHN F. KERRY, Massachusetts
OLYMPIA J. SNOWE, Maine              JOHN B. BREAUX, Louisiana
SAM BROWNBACK, Kansas                BYRON L. DORGAN, North Dakota
PETER G. FITZGERALD, Illinois        RON WYDEN, Oregon
JOHN ENSIGN, Nevada                  MAX CLELAND, Georgia
                                     BARBARA BOXER, California
                                     JEAN CARNAHAN, Missouri


                            C O N T E N T S

                              ----------                              

                                                                   Page

Hearing held on Wednesday, May 9, 2001...........................     1
Statement of Senator Smith.......................................     1
Statement of Senator Rockefeller.................................    56
    Prepared statement...........................................    47

                               Witnesses

Brickwedel, Walter J., President, Oregon Short Line Railroad 
  Association and Assistant to the General Manager, Central 
  Oregon and Pacific 
  Railroad.......................................................    47
    Prepared statement...........................................    50
Davidson, Richard K., Chairman and CEO, Union Pacific Corporation     2
    Prepared statement...........................................     4
Kaufman, Kevin D., Senior Vice President, Louis Dreyfus 
  Corporation....................................................    92
    Prepared statement...........................................    94
Levine, Harvey A., Ph.D., Independent Transportation Economist...    97
    Prepared statement...........................................    98
Rennicke, William J., Vice President, Mercer Management 
  Consulting, Inc................................................    79
    Prepared statement...........................................    81
Rose, Matthew K., President and CEO, Burlington Northern Santa Fe 

  Corporation....................................................    31
    Prepared statement...........................................    33
Valentine, James J., Managing Director, Morgan Stanley...........    68
    Prepared statement...........................................    71
Zarembski, Allan M., Ph.D., President, Zeta-Tech Associates, Inc.    83
    Prepared statement...........................................    84

                                Appendix

American Public Transportation Association, prepared statement...   107
Gamble, Patrick K., President and Chief Executive Officer, Alaska 
  Railroad, prepared statement...................................   109
Responses to written questions submitted by Hon. Gordon Smith to:
    Burlington Northern Santa Fe Corporation.....................   116
    Richard K. Davidson..........................................   112
    Kevin D. Kaufman.............................................   125
    Dr. Harvey A. Levine.........................................   127
    William J. Rennicke..........................................   120
    Allan M. Zarembski...........................................   123

 
                       OVERSIGHT HEARING ON THE 
                     STATE OF THE RAILROAD INDUSTRY

                              ----------                              


                         WEDNESDAY, MAY 9, 2001

                               U.S. Senate,
            Subcommittee on Surface Transportation 
                               and Merchant Marine,
        Committee on Commerce, Science, and Transportation,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 10:05 a.m. in 
room SR-253, Russell Senate Office Building, Hon. Gordon Smith, 

Chairman of the Subcommittee, presiding.

            OPENING STATEMENT OF HON. GORDON SMITH, 
                    U.S. SENATOR FROM OREGON

    Senator Smith. Good morning, ladies and gentlemen. I 
apologize that our schedule in the Senate has got us running 
all over and voting and I felt it best to start this when we 
did not have to be interrupted. So the votes are taken and now 
it is time to have this hearing.
    I am pleased to call to order the second Surface 
Transportation and Merchant Marine Subcommittee hearing of the 
107th Congress. In March, Chairman McCain and I announced the 
Subcommittee's intention to hold a series of hearings on rail 
transportation. Our first hearing, in March, focused on the 
Surface Transportation Board and its ongoing efforts to carry 
out its statutory responsibilities. Today's hearing will 
address the state of the rail industry, including its current 
financial condition, capacity constraints, and long-term 
capital investment needs.
    Additionally, we plan to schedule a hearing to consider 
rail shipper concerns, including service reliability, rates, 
and competition.
    As I said during the March hearing, rail transportation 
issues are complicated, whether considering rail service or 
capacity or competition. Therefore I am pleased a number of 
prominent rail industry officials and financial experts were 
available to clear their schedules and appear before us today.
    I look forward to hearing their insights into some of these 
complex issues.
    For the benefit of my Subcommittee colleagues--I am sure 
they are listening--I should point out that each of today's 
rail industry witnesses provides rail service to my home State 
of Oregon. While I may be a new Member of this Committee and 
these issues, I do know there is a prevailing view among some 
that more is better. While I agree that we are fortunate to be 
served by two Class I carriers and 19 short line railroads, 
Oregon's shippers have expressed many of the same concerns that 
shippers have in other States. But that is a topic for the next 
hearing.
    Today the Subcommittee will address the industry's 
financial condition and its projected infrastructure investment 
needs. I expect we will hear views about the impact of 
regulation on the industry and I understand we will be hearing 
some differing viewpoints among the witnesses concerning the 
revenue adequacy of the railroads.
    I am particularly interested in hearing more about concerns 
of smaller railroads and hope we can focus on how best small 
carriers can fund the high costs of track improvement projects. 
Short line carriers are the lifeline for some rural communities 
and I want to ensure that Congress does not forget about this 
important sector of our national transportation system.
    I would like to extend a special welcome to one of my 
constituents who is testifying today, Mr. Walter Brickwedel, 
President of the Oregon Short Line Railroad Association. I look 
forward to hearing your views regarding the State of Oregon's 
short line railroad infrastructure.
    I will now turn--well, there are no others here yet, but I 
believe some will be here soon. We will turn to our first 
panel. Our first panel will consist of: Mr. Richard K. 
Davidson, Chairman and CEO of Union Pacific Corporation; Mr. 
Matthew K. Rose, President and CEO of the Burlington Northern 
Santa Fe Corporation; and Mr. Walter Brickwedel, President of 
the Oregon Short Line Railroad Association. We invite you all 
to the table, and we will start with you, Mr. Davidson.
    We thank you each for being here.

      STATEMENT OF RICHARD K. DAVIDSON, CHAIRMAN AND CEO, 
                   UNION PACIFIC CORPORATION

    Mr. Davidson. Good morning, Senator.
    Senator Smith. Good morning. Good to have you here.
    Mr. Davidson. I am Dick Davidson and it is commonly known 
that I am the oldest rat in the barn as far as the railroad 
industry goes. I have been at this 41 years.
    Senator Smith. I have heard you described in better terms 
than that.
    Mr. Davidson. I would like to say a few things about the 
state of the railroad economy. We, like many other industries 
today, are facing a pretty soft economy. We went from a record 
level of carloadings in October last year to a record low level 
of carloadings in the month of December. We just literally fell 
off the face of a cliff.
    As you can see on the chart here in front of you, it has 
been sort of like a roller-coaster since the end of December: 
down somewhat in December, up strongly in January, down 
strongly in February, and then flat ever since. That is the way 
it looks to us it is going to be throughout the second quarter.
    However, we know that will not last forever. The business 
will strengthen and the railroad industry will be faced with 
good growth again.
    I have submitted a lot of testimony in my written 
submission that I will not bother you with now, but we talk a 
lot about the new services we have introduced, and a lot of it 
is your part of the country, along the I-5 corridor running 
from the Canadian border to Southern California. But in order 
to continue that new service and to grow our business, we have 
to be able to invest in our infrastructure. That is the key to 
providing good service into the future.
    You may not be aware of the fact, but the railroad industry 
is the most capital-intensive business in America by far. We 
invest over 20 percent of our revenues back into the 
infrastructure of the property. The next most capital-intensive 
industry is the paper industry, at about one-quarter of that 
level.
    Over the last 5 years, the Union Pacific has invested over 
$10.5 billion in capital. This year, even in a soft economy, we 
are going to invest somewhere between $1.6 and $1.9 billion. 
Last year, in the year 2000, we acquired over 450 new 
locomotives. They are almost $2 million apiece, so you can see 
what kind of an expense that is. We installed about 1,200 miles 
of new rail and over 3 million cross-ties. This year, even in a 
soft economy, we are going to acquire over 500 new locomotives 
and have a similar track program. So it is quite capital-
intensive and we clearly need to earn an adequate return to be 
able to continue to fund that.
    As to the issue of rail competition, contrary to a number 
of misconceptions, it is very much alive and healthy. It was a 
popular misconception that our merger with the Southern Pacific 
reduced competition, but indeed it did just the contrary. 
Southern Pacific had been losing over half-a-billion dollars a 
day--half-a-million dollars a day, excuse me, and it had had 
negative earnings for 15 of its last 17 years.
    So if we had not acquired SP, it truly would have died. 
Anyplace that competition was eliminated as a result of 
acquiring the Southern Pacific, another railroad was placed in 
its stand so it could provide competition. Burlington Northern 
Santa Fe became the recipient of over 4,000 miles of either 
trackage rights or line acquisitions from us, and of course, 
BNSF is a big, strong, powerful company with enormous reach 
that provides far more competition than the Southern Pacific 
ever could have.
    New competition was fostered by the STB, too. When it 
approved our merger, the STB mandated that companies have the 
right to build transfer facilities or retain the right to build 
in or build out to other railroads to get new competition. A 
wonderful example of that is the BNSF has just announced a 
build-in in south Texas to--well, not so wonderful from my 
standpoint, but I guess from Mr. Rose's and the customers' 
standpoint--to a large chemical facility at North Seadrift, 
Texas, which is now Dow. It was Union Carbide.
    Additionally, that was done in the mid-1980s when Union 
Pacific spent over $500 million to get access to the Powder 
River Basin. The important thing about all of these is it was 
done through arm's length negotiations with an economic 
incentive to do so. None of those had government intervention 
forcing it to happen. It was where the free marketplace was at 
work.
    You hear people talk about the monopoly pricing of the 
railroad. Well, if we do that we do not do a very good job of 
it, because we are still not capital adequate. As you can see 
on the chart in front of you, our return on investment is still 
below the cost of capital. While it is far better than it was 
when the Staggers Act became law in 1980, it is still not 
adequate. We earn less return than what we spend. It is 
something that we still have a long ways to go on.
    But in spite of that, there are a number of customers and 
shippers out there that would like to force us to give access 
to our facilities to our competitors, something if you 
suggested to our customers that they should do, that they 
should give access to their competitors to use their 
facilities, they would fight to the death over. So obviously, 
we feel the same way about that.
    Not only that, if forced access were mandated they want to 
impose price controls, maximum prices that the railroads could 
charge for a specific segment of a movement, which would not 
return an adequate rate of return to keep the infrastructure up 
to speed like it should be. So clearly, it is a bad idea.
    Notwithstanding the disastrous consequences of that, people 
that favor re-regulation claim that open access is required to 
protect captive shippers. I want to talk a little bit about 
captive shippers. We did an intense survey of people that had 
located on our line in recent years and over the past 3 years 
we have had 554 new plants that have located on our railroad. 
Of those 554 new plants, 465--or over 80 percent--chose 
voluntarily to locate on a site served just by Union Pacific.
    They could have chosen a site served someplace by two 
railroads if they had desired, but they obviously did not want 
to. This choice of a location was a free market decision made 
by those customers. Their choice, and similar choices by other 
shippers, shows there is no justification for the far-reaching 
proposals that we now hear.
    We would strongly urge you to reject all re-regulation and 
instead allow the free market to continue to work. It is 
working and has worked since Staggers became the law. 
Otherwise, we will return to the bad old days of pre-Staggers, 
when 20 percent of the railroad industry was bankrupt and we 
had about a $20 billion capital shortfall.
    Thank you very much for permitting me to speak this 
morning.
    [The prepared statement of Mr. Davidson follows:]

     Prepared Statement of Richard K. Davidson, Chairman and CEO, 
                       Union Pacific Corporation

    Good morning. My name is Dick Davidson, and I am the Chairman and 
CEO of the Union Pacific Corporation. I am pleased to be here today, 
and I thank you for the opportunity to testify about the state of the 
rail industry.
    However, before I begin my testimony, I should probably tell you a 
little about my background. I started as a brakeman on the Missouri 
Pacific Railroad in 1960. I worked my way through the operating ranks 
at Missouri Pacific to become the Vice President of Operations. Union 
Pacific Railroad then acquired the Missouri Pacific, and I have held 
various positions with the UP including Executive Vice President of 
Operations, Chairman and CEO of the Railroad, and Chairman and CEO of 
the Corporation. I have been part of the rail industry my entire 
working career. I tell you this because our industry's history is 
critical to our future success. I was part of this industry when the 
government heavily regulated it, and I have seen first-hand the lack of 
investment and stagnation that occurs when the government, rather than 
the marketplace, determines what constitutes competition. Since 1980, 
most of the shackles of government regulation have been lifted. This 
has meant increased investment, increased productivity and increased 
safety. At the same time, rates have fallen over 50%. There are some 
who want to return to regulation. As one who lived through those dark 
times, I can safely say that would be a terrible mistake.
    As you know, our industry has gone through a series of mergers, and 
service disruptions followed for many rail customers. In our case, we 
came out of those problems in 1998, and I am happy to tell you that UP 
is once again strong and healthy. In 2000 our traffic grew by 4% on top 
of a 7% growth in 1999. Although we are in the midst of a slowing 
economy, as you can see from Attachment 1, we are optimistic about 
continued growth in the future.
    To aid that growth, we have recently introduced a broad range of 
new service products. These include:
     I-5 service that provides express service from the Pacific 
Northwest to Oakland, Los Angeles, and Phoenix;
     Intermodal outreach;
     Auto parts transload; and
     Speed Link.
    The I-5 service is a product we would not have been able to offer 
without the UP/SP merger. Prior to our merger with the SP, no railroad 
had single line service up and down the West Coast. Now, as a result of 
the merger, both the UP and BNSF have this capability. As you can see 
from Attachment 2, this service allows us to take traffic from the 
Pacific Northwest to various cities in the Southwest in a 5, 7, or 9-
day time frame, depending on the customer's needs.
    The other three services expand our market reach by providing high 
quality transportation designed to meet our customers' requirements. 
Some of these products combine premium train service with truck and 
transload service. Our goal is to offer products where we can partner 
with trucks to offer our customers services based on what each of us 
does best--rail for the long haul and trucks for the short haul.
    The Intermodal outreach program is truly unique. Partnering with 
trucks based on what each of us does best, we have been able to expand 
our market reach. With this program, we go to customers who have not 
been able to use rail service because they are beyond our terminus. A 
truck picks up or drops off the merchandise, brings it to us or takes 
it from us, and we handle the long haul. As you can see from Attachment 
3, this has allowed us to reach into places like Detroit and Columbus.
    The auto parts transload is another example of partnering with 
trucks (Attachment 4). With this product, three truckloads of auto 
parts are shipped to St. Louis and put into one boxcar. We then take 
the auto parts by train to Mexico City. Shipping these parts by truck 
alone takes eight days. By partnering with trucks, we can now deliver 
the parts in six days and provide substantial savings to the customer.
    Our newest product offering is Speed Link (Attachment 5), and it 
started in mid-April. As with the other services, this product also has 
us partnering with trucks. Speed Link is focused in the I-5 corridor 
along the West Coast. It again is geared to customers who have not 
traditionally used rail. A truck will go to the customer, pick up or 
drop off the merchandise, bring it to us or take it from us at a 
transload center, and we will handle the long haul. This service is 
aimed at business that would normally go by truck from the Portland 
area to Los Angeles, and we are able to get our customers' goods to 
destination in 45 hours.
    We have also created new alliances with our connecting railroads to 
provide new services and improve existing ones. These include:
     Express lane service with CSX for food and food products;
     UPS coast-to-coast with Norfolk Southern;
     Pacific Northwest Canadian-American service with the 
Canadian Pacific;
     Joint dispatching with the BNSF; and
     Joint purchasing with the six largest railroads.
    While Speed Link and the other services I talked about have us 
partnering with trucks, these products have us forming alliances with 
other railroads to offer new services.
    One of our most exciting new products is express lane service with 
CSX (Attachment 6). With this service, we offer seamless 
transcontinental service to bring perishable food and food products 
from California and the Pacific Northwest to the East Coast. This 
started out with 40 cars on one train going from the Pacific Northwest 
to New York and Boston. It has been so successful that we are now 
expanding the service to Georgia, Florida, and Philadelphia. We 
guarantee this service, but because our service has been so consistent, 
only two of our many customers have purchased the guarantee. These are 
customers like Sunkist and Grimmway Farms who haven't used rail for 
years because the commodities they ship are perishable. In addition, 
40% of this business originates on shortline railroads that interchange 
the business to us. Using alliances with shortline and Class I 
railroads, we are able to bring these customers back to rail.
    Another great example is our alliance with the Norfolk Southern to 
bring new, improved seamless service to UPS, one of our major customers 
(Attachment 7). UPS came to us requesting five-day, coast-to-coast 
service. By working with the Norfolk Southern as if we were 
operationally one railroad rather than two, we were able to meet that 
customer's needs. I am proud to say that we have a near perfect record, 
with only 2 out of 12,121 units missing their sort since the inception 
of the program 10 months ago. (A sort is our deadline that requires us 
to arrive at our destination within a prescribed two-hour window.)
    The Pacific Northwest Canadian-American Service with the Canadian 
Pacific Railroad is another example of how alliances work (Attachment 
8). The Canadian Pacific sweeps the Pacific Northwest for products such 
as potash, lumber and paper. Then we partner with them to provide 
seamless service to central California. We can do this two-to-three 
days faster than before, and it is so successful that we have been able 
to increase the volume of this traffic by about 30% over the last 
couple of years.
    The final example is not a new service line, but it is an example 
of how the rail industry is working together to provide better, faster 
service to our customers. There are many places the BNSF and the UP 
operate together, both in the same vicinity and over each other via 
trackage rights. To facilitate the movement of our trains in busy 
corridors and terminals, we have opened joint dispatching centers 
(Attachment 9). Instead of each railroad controlling operations from 
their own control center, we have combined dispatching into a single 
office, enabling both of us to move more trains and better service our 
customers.
    As anyone in a service industry will tell you, service is always an 
issue, but as these products illustrate, we are constantly striving to 
improve. We are also introducing new improved services for other 
segments of our customers. For instance, we have created what we call 
the Freeport Pipeline for Dow and Occidental Chemical.
    Working in a true partnership with Dow and Occidental, the Freeport 
Pipeline creates trainload movements out of what were previously 
carload movements. Working with our customers to change their shipment 
patterns, we are able to bypass terminals, dramatically reduce cycle 
times, and meet our customer's 95% on-time delivery objective. In 
return, they are able to reduce costly inventory carrying charges, as 
well as the number of cars in their fleets.
    In all these cases, it is important to note that rather than just 
offering these products, we started by designing reliability into the 
product itself, thereby increasing our service dependability. By doing 
so, we can expand our revenue base, increase our productivity by 
getting better and more use out of the equipment we have, take more 
trucks off the road, and provide first-class service to our customers.
    Having said that, the real key to service is investment. Capital 
investment in the rail industry is like food to the human body. Without 
it we will wither and die. As a percentage of total revenues, the rail 
industry is the most capital intensive in the U.S. As you can see from 
Attachment 10, we invest over 20% of our revenues back into the system. 
The closest industry to us in that regard is the paper industry, and 
they only re-invest 5.5% of their revenue. Unfortunately, this level of 
investment is still not enough. We still do not earn our cost of 
capital, which I will discuss later, and as a result, the financial 
marketplace will not allow us to invest as much as we would like.
    Over the past five years, Union Pacific has invested over $10.5 
billion in our plant and equipment (Attachment 11). This year we expect 
to invest up to $1.9 billion. Last year we acquired 451 new locomotives 
at nearly $2 million a unit. We replaced 1,185 miles of rail and 
installed 3.3 million ties at a cost of $627 million. This is money we 
have to spend to keep the railroad in the shape it needs to be in to 
meet the demands of our customers.
    A good example of the power of investment is our addition of a 
third main line from North Platte, Nebraska to Gibbon, Nebraska 
(Attachment 12). This is the busiest stretch of freight railroad in the 
world, and triple tracking this segment of line cost $327 million. Was 
it worth it? Absolutely. As the chart indicates, prior to the triple-
track project, we were able to get 107 trains a day over this segment 
of line, and our average speed was 23.8 mph. Today we are running over 
140 trains a day over that line at an average speed of 36.4 mph. That 
is a 30% increase in trains and a 53% increase in speed. This also has 
allowed us to cut our recrew rate by 80%. (The recrew rate is how many 
times we have to change the crew on the locomotive.) This makes us more 
efficient, with our customers being the ultimate beneficiaries.
    Without the ability to generate capital, we would not be able to 
take on this kind of project or offer the kinds of improved services I 
outlined earlier. Capital also allows us to make sure we run a safe 
railroad for our employees and the public. As a service company, our 
main goal is to serve our customers, but our number one priority is the 
safety of our employees. As you can see from Attachment 13, since 
deregulation we have made huge strides in this area as well. Accidents, 
injuries, and loss or damage to our customers' merchandise are all down 
substantially. There is a direct correlation between the ability to 
invest and the safety of our workforce.
    All of this would be put in jeopardy by injecting the government 
back into the rail industry. Some of our customers complain that as a 
result of mergers, there is a lack of competition in our industry. We 
believe these complaints are not really about consolidation in the rail 
industry, but rather they are attacks on our ability to differentially 
price our services. One of the major benefits of the Staggers Act (the 
act that partially deregulated the rail industry) is that it allows us 
to act like any other business in the United States with regard to 
pricing. This is called differential pricing, and it is the ability to 
charge what the market will bear. Every business in the U.S. does this. 
However, with the rail industry, while we can price differentially, the 
Staggers Act provides for high-end rate protection for shippers. This 
formula has worked exceedingly well over the past 20 years.
    So how is competition in the rail industry? We believe it is 
healthy.
    For instance, our merger with the Southern Pacific did not reduce 
competition; it increased it. The SP was a struggling railroad. Prior 
to our merger, the SP had a negative cash flow in 15 of its last 17 
years. At the time of our merger, it was losing a half million dollars 
a day. It could not invest, and with the merger of the Burlington 
Northern and the Sante Fe Railroad, the SP knew it could not survive. 
So how did our merger increase competition? First, no customer that had 
been served by both the SP and the UP went to only having the UP. We 
negotiated an arrangement where the BNSF received roughly 4,000 miles 
of trackage rights or line sales over our lines so it could provide 
competition previously provided by the SP. BNSF is, of course, a much 
stronger and more effective competitor than was the financially weak 
SP.
    Second, with the merger we introduced direct-line competition along 
the I-5 corridor on the West Coast that previously did not exist. Prior 
to our merger, no railroad had direct-line service along the West 
Coast. As part of our merger, both the UP and the BNSF now have this 
service as a result of arms-length negotiations. In fact, some of the 
new product offerings I discussed earlier in my testimony would not be 
possible without this direct-line capability.
    Third, new competition is introduced on a regular basis with the 
construction of new transload facilities and new build-ins and build-
outs to add service by a second railroad. This kind of market-based 
competition is worth taking a few moments to explain. A transload 
facility, as I've discussed before, is a facility where trucks and rail 
interchange traffic. A build-in or build-out is the capability of a 
railroad or customer to build a line to a competing railroad. A current 
example of how this works is the plan of BNSF and Dow (formerly Union 
Carbide) to build a section of rail out to the BNSF from Dow's plant in 
North Sea Drift, Texas. This will give Dow the ability to ship via UP 
and BNSF. The government didn't dictate the decision. BNSF and Dow 
negotiated it, and neither would have made the decision without a 
financial incentive.
    Of course competition from other modes of transportation remains 
fierce. For example, in the area served by the Houston Port Terminal 
Railroad, one of the largest chemical complexes in the country, we 
estimate that rail carries only approximately 30% of the traffic. The 
rest goes by pipeline, barge or truck.
    The important thing to note about all this competition is that it 
is the product of the free marketplace at work. Another example is the 
Powder River Basin coalfields, where we spent over $500 million 
building into the region and a third railroad is now attempting to do 
the same. This is not the result of artificial, governmentally 
regulated competition.
    What challenges lie ahead for the rail industry?
    One is the cost of fuel. As you can see from Attachment 14, the 
cost of fuel has sky rocketed over the past year. Union Pacific uses 
1.3 billion gallons of fuel a year. We manage our fuel prices as best 
we can, but with this kind of consumption, rising fuel prices takes a 
big bite out of our revenue. Last year we spent roughly $450 million 
more on fuel than we did in the previous year.
    Another challenge is to earn our cost of capital. This is basically 
our need to get an adequate rate of return on what we invest in our 
system. As I mentioned earlier, we are the most capital-intensive 
industry in the country. We have to plow a lot of money back into our 
system. However, we do not get back in revenue what we invest. To 
illustrate, it is like buying things on your credit card at a 15% 
interest rate and loaning them out at 8%. Long term, we cannot continue 
to operate like this, but as you can see from Attachment 15, we are 
closing the gap.
    Finally, our biggest challenge is regulation--it is the one thing 
that could take all the progress and gains we have made over the past 
20 years and make them for naught.
    As you can see from Attachment 16, prior to the Staggers Act, our 
industry was in shambles. I know because I saw it firsthand, and it is 
a painful memory. Over 20% of railroad mileage was in bankruptcy. We 
got a 2% rate of return on our investment. Nearly 50,000 miles of track 
were under slow orders. We had $16-20 billion in deferred maintenance. 
Our market share was down to 35%. We had rising rates and declining 
service. In addition safety was a serious issue.
    Congress recognized the problem and passed the Staggers Act, 
partially deregulating the rail industry. You can see the results in 
Attachment 17. From 1965 to 1980, productivity, volume, revenue and 
rates, on a ton-mile basis, were all flat. The Staggers Act passed and, 
as the attachment shows, our industry has regained health and vibrancy. 
Productivity and volume are up. Rates and revenue per ton-mile are 
down. The gap between productivity and volume, and revenue and price 
shows that while the railroads benefited from the Staggers Act, our 
customers gained even more as we shared most of these productivity 
gains with them. The productivity and efficiencies we gained through 
the Staggers Act allowed us to lower rates by over 50% and at the same 
time generate the revenue we need to re-invest in the system.
    Unfortunately, there is a select group of powerful shippers who now 
want to reregulate railroads by forcing us to give our competitors 
access to our facilities and eliminating our ability to differentially 
price. They are trying to do something to us that they would fight to 
the death to prevent if it were proposed for their businesses.
    To make matters worse, along with giving access to our competitors, 
they are advocating price controls limiting what we should be paid for 
this access. They want the government to set prices far below what a 
recent FRA-chartered study found would be fair and proper (see attached 
study). They call this new competition, but it is not. It is new 
regulation.
    This type of forced, price-controlled, government-imposed access 
would trigger a 40% loss in our operating income that would virtually 
wipe out our profits. This is depicted in Attachments 18 and 19. In 
2000 as an industry, we grossed $34.1 billion in revenue. Of this, $29 
billion went toward operating expenses, resulting in $5.1 billion in 
operating income. The proposals advanced by this select group of 
shippers would, on a conservative basis, eliminate $2.4 billion of this 
income. Obviously, this would make it virtually impossible to make the 
investments necessary for our future. This type of needless, 
government-imposed revenue transfer from our industry to others would 
devastate the rail industry with the customers we serve, and this 
nation's economy being the ultimate loser.
    Let me put this in different terms. Try to look at the rail 
industry in this country as a network, similar to the highway, air, and 
waterway networks. Over the past six years, Congress has paid a great 
deal of attention to capacity constraints in these other networks, and 
it has targeted a great deal of funding to them to ensure we, as a 
country, have the infrastructure necessary to support our economy. The 
rail network is really no different. We need a strong, vital rail 
network if our country is to remain competitive. The big difference in 
all of these networks is that the rail network is privately funded, and 
today, by any standard, our rail network is the envy of the world. 
Rates are low, service and safety are constantly improving, and we are 
able to reinvest in the system. All of this came about due to the 
reforms of the Staggers Act and the ability to differentially price our 
services. In short, the system works. If Congress takes this ability 
away, private investors will stop investing in rail infrastructure, and 
the nation will lose those investment dollars. As a result, we will 
have a deteriorating rail network, or Congress will have to find the 
funding to support our rail network.
    In the past this Committee has heard from various shippers and 
shipper groups who want you to change the system. They, in essence, 
want the government to mandate two railroads for every shipper. These 
select groups want you, the government, to give them relief for 
something they often don't choose when they have the opportunity--
access to more than one railroad. You are now probably asking yourself 
how can I say that? We have been having discussions with various state 
economic development officials and private organizations involved in 
industrial plant site selection activities. We have asked them about 
what companies think is important when they site new facilities. As you 
can see from Attachment 20, rail service is number 24 out of a list of 
25 items.
    Given how vocal these groups have been in Congress, we were not 
sure exactly how to interpret this data. We decided to do a survey of 
new plants that have located on the Union Pacific. As you can see from 
Attachment 21, we found this data to be absolutely correct. Between 
1998 and 2000, of the 554 new plants that have located on the UP, only 
89 chose to locate where there was access to more than one railroad; 
465 chose to locate at a site served by only one railroad. We found 
this to be very interesting. With all things being equal, when picking 
a new site, the marketplace choice was to be served by only one 
carrier. Now, many of these same companies want the government to give 
them what they chose not to do in a free-market decision.
    For all these reasons, we strongly urge you to reject their 
attempts at reregulation and allow the railroads to continue on our 
path of progress since the Staggers Act.
    Before closing, I would be remiss if I didn't take a moment to 
discuss commuter rail, which is becoming a growing challenge.
    Urban sprawl and congestion are problems facing city planners, and 
many commuter agencies are looking at passenger rail to solve their 
problems. We can empathize with these planners as we operate in many 
large cities and have employees there who must get around. 
Unfortunately, many of these agencies look at our tracks as a way of 
solving their commuter problems without considering that our rights-of-
way are private, not public easements. We have limited capacity, and we 
need that capacity to move freight. Moreover, if rail freight capacity 
is captured for commuter trains, more freight will be forced into 
trucks, and road congestion will get worse, not better.
    That is not to say we oppose commuter rail. We have partnered with 
many commuter agencies where the commuter agency can replace the 
capacity it takes from our business. These agreements have been 
negotiated on an arms-length, case-by-case basis.
    Today the American Public Transit Association (APTA) is calling for 
legislation that would force commuter rail on our tracks regardless of 
our position or the impact it would have on our ability to move 
freight. Not only do we believe this to be fundamentally unfair, but we 
also believe it to be a taking of private property. The government 
should not force railroads to carry commuter trains unless it funds all 
the capacity necessary to carry those trains.
    Preserving rail freight capacity is essential for the public 
interest. In evaluating their proposal, we cannot lose sight of a 
fundamental reality. We have limited capacity, all of which we need to 
handle current freight levels. If the capacity is turned over to 
commuter rail--without adding new capacity--our current ability to move 
freight is reduced. That means congestion. As our Houston crisis of 
1997-1998 demonstrated, none of us can afford to move in that 
direction.
    This Committee has heard from some shipper groups that want to 
reregulate our industry and curtail our ability to earn the revenue 
necessary to invest in our system. Congress will also be hearing from 
commuter authorities that want to use our tracks without fully 
compensating us for their use or without fully replacing the capacity 
that commuter rail consumes. Both proposals have the same objective, 
and that is to have the government take revenue from the rail industry 
and redistribute it to others, thereby reducing the ability of our 
industry to move the freight that makes up the building blocks of our 
economy. At the same time, you are hearing from others who talk about 
how important it is to provide the infrastructure investment necessary 
to remain a competitive nation and to sustain economic growth. The 
dichotomy of these two schools of thought is striking and very 
frightening to us because we know we cannot have it both ways. We tried 
it once, and it did not work.
    Again, I want to thank the Subcommittee for giving me the 
opportunity to testify today. I would be pleased to answer any 
questions.

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    Senator Smith. Thank you very much, Mr. Davidson, for your 
testimony. It is very insightful.
    Mr. Rose, nice to see you again. Welcome to Washington, and 
we invite your testimony.

       STATEMENT OF MATTHEW K. ROSE, PRESIDENT AND CEO, 
            BURLINGTON NORTHERN SANTA FE CORPORATION

    Mr. Rose. Good morning, Mr. Chairman. My name is Matt Rose 
and I am President and CEO of Burlington Northern. I have not 
been in the industry quite as long as Mr. Davidson.
    I have been in the rail and trucking industry for 20 years. 
I do welcome the opportunity to speak at today's hearing. I 
plan to cover three different subjects:
    First, progress made by the railroads since enactment in 
1980 of the Staggers Act; second, some of the financial 
challenges that currently face our industry today; and third, 
some public policy changes needed to put railroads on a level 
playing field with other modes to ensure we will be in good 
financial shape to handle our nation's growing demand for rail 
freight service.
    As I make my comments, I will refer to four charts that 
hopefully you now have in front of you. I am going to start 
first with the first chart, labeled ``Performance of the Major 
Railroads.'' If a picture is worth a thousand words, this graph 
is worth a million. It captures 35 years of railroad history at 
a glance. It shows the incredible progress we have made since 
the Staggers Act.
    Prior to deregulation, our industry was stagnant and nearly 
bankrupt. After deregulation, our industry caught fire, and 
since then rail productivity has literally tripled. Rail 
volumes have increased 60 percent. The prices we charge have 
declined an average of 62 percent. Finally, since our prices 
have declined more rapidly than our volume increased, total 
rail industry revenues have literally declined. You can imagine 
there are very few industries for which, if you look at on a 
total revenue basis over a 30-year period, revenues have 
literally declined.
    Looking at prices and revenue is another way, if you look 
at the next chart, titled ``Rail Revenue Per Thousand RTM's.'' 
It shows that decline in real revenues. It has been steady and 
dramatic. Two areas where I have seen this firsthand at BNSF 
are coal and agricultural commodities. Prices have dropped 
nearly a third since 1994 alone. These price declines have been 
due to competition from other modes and other railroads, our 
customers' ability to use alternative suppliers and raw 
materials, and our eagerness to get more business.
    Now, you may hear later today that these numbers are not 
accurate, even though they have been supported by the Surface 
Transportation Board's studies. Maybe the rate of decline could 
be debated, but the fact is, even after we factor in shipper 
ownership of cars and shipper costs to construct tracks so 
railroads can access their facilities, average rail rates have 
declined and our industry's revenue is inadequate to support 
the capital investments we need.
    Since Staggers, the rail industry has gradually shored up 
its finances. That is because we have improved productivity 
faster than we have reduced prices. Unfortunately, it has been 
21 years since deregulation and we are still not over the hump 
on profitability, as you can see from the third slide, titled 
``Railroad Cost of Capital versus Return on Investment.''
    The problem is rail industry returns have been persistently 
below our cost of capital, as Mr. Davidson also showed you. 
Rail investors say that makes railroading a capital extraction 
business, not a capital investment business. That is obviously 
dangerous, because capital is literally the lifeblood of 
railroading. We are the nation's most capital-intensive 
business so far, and you can see that on my fourth chart, 
titled ``Railroading is America's Most Capital-Intensive 
industry.''
    The reason we are so capital-intensive is our rights-of-
way. That is where about 75 percent of every dollar of capital 
invested by America's rail industry is spent every year, and 
that is an investment category our competitors, the trucking 
companies and the barges, do not have.
    At BNSF we try to get our returns above our cost of capital 
by improving service to attract new business. We have invested 
$11 billion from 1996 to the year 2000. That has enabled us to 
increase our on-time service to 91 percent for the last 2 
years. We also had a 96-day hot streak where we delivered 
103,502 trailers for United Parcel Service on time, perfect 
service.
    Unfortunately, our returns on invested capital have 
declined for 3 consecutive years after those massive 
investments. The declining returns have forced us to reduce 
capital from $2.5 billion in 1998 to $1.5 billion this year. We 
are still doing some selective expansion for future growth. If 
capital continues to be limited because of the poor returns, I 
anticipate we will have a smaller rail network in just a few 
years.
    To keep that from happening, I have several 
recommendations. First, we need to repeal the 4.3-cent-per-
gallon deficit reduction fuel tax on railroads. This tax is 
discriminatory. It costs BNSF $50 million last year.
    Second, we need to reform railroad retirement. Last year 
Congress considered a bill that would both reduce our taxes and 
increase benefits for railroad retirees. This year, Congress 
again is considering such a bill. Our industry appreciated the 
overwhelming support we got from both houses of Congress last 
year and of course we will be hoping that support will be 
strong enough to pass the bill this year.
    Another area we need help from is in infrastructure 
investments. As I pointed out, our history is proving that 
railroading does not have enough economic advantage to support 
privately owned rights-of-way while most of our competitors 
benefit from government-provided infrastructure. Recently, 
however, we have seen a few examples of public-private 
financing partnerships that benefit both communities and 
railroads, such as the Alameda and the FAST corridors. Many 
rail infrastructure projects have associated public benefits, 
like better public safety, reduced traffic congestion, and 
improved air quality. More public funding needs to be available 
for such projects and the level of support should be in line 
with the public benefits of each project.
    Last, I urge you not to turn back the clock on the Staggers 
Act. You have heard all the pleas for open access or for more 
government-mandated rail-to-rail competition or to further 
restrict railroad pricing freedoms. If these occur, it could 
start a sequence of further cutbacks in capital investments and 
a shrinkage of America's rail network. Ultimately, the future 
of the rail industry, with privately owned and maintained 
infrastructure, would be jeopardized.
    I am not asking the government to take over our rights-of-
way. But I am asking the government to consider projects that 
will have clear public benefits.
    Mr. Chairman, none of the challenges that the railroads 
face today are insurmountable if we get a level playing field 
with our competitors. I am confident that this Committee 
understands the potential public benefits to our nation from a 
healthy rail system, something I think that this nation takes 
for granted. The challenge is to put correct public policies in 
place to achieve these benefits.
    I look forward to assisting you in any way I can to help 
answer questions for your other Members of the Subcommittee.
    [The prepared statement of Mr. Rose follows:]

       Prepared Statement of Matthew K. Rose, President and CEO, 
                Burlington Northern Santa Fe Corporation

    My name is Matthew K. Rose. I am President and Chief Executive 
Officer of Burlington Northern Santa Fe Corporation and The Burlington 
Northern and Santa Fe Railway Company (``BNSF''). BNSF is one of 
America's largest railroads, with about 39,000 employees and 33,500 
miles of routes serving 28 states. BNSF handled over 8 million freight 
shipments last year and had revenues of $9.2 billion. I have 20 years 
of experience in the freight transportation industry, including 
positions in operations and marketing with major railroads and trucking 
companies in both the eastern and western United States.
    As requested by this Subcommittee, the purpose of this testimony is 
to provide information about the financial condition of the railroad 
industry and changes since enactment of the Staggers Act in 1980. My 
testimony will explain why railroads are so crucial to our nation, and 
why railroads require massive amounts of capital. It will also 
demonstrate that although railroads have made great progress in the 
last 20 years, returns are still below the industry's cost of capital, 
forcing significant constraints on future capital investments. This 
puts at risk our ability to meet future demand for rail transportation. 
I will conclude by addressing public policies that have the affect of 
``tilting'' the competitive playing field against the railroads--and in 
favor of other modes--thereby preventing our nation from achieving the 
maximum benefits from its freight rail network.
   freight railroads are critically important to our nation's future

[GRAPHIC] [TIFF OMITTED] T8786.022


    Railroads are the ``workhorses'' of America's transportation 
industry. Year after year, railroads handle more freight volume, by 
far, than any other mode. Railroads handle 40% of our nation's freight 
measured in ton-miles, including 70% of the motor vehicles purchased in 
our nation, 67% of the coal used for generating electricity, and 40% of 
our grain.

[GRAPHIC] [TIFF OMITTED] T8786.023


    Over the last 20 years, rail ton-miles have increased 60%. During 
that time, however, competitive pressures forced rail prices steadily 
downward. The result was that rail industry revenues last year, 
adjusted for inflation, were 42% lower than 1980. Another important 
trend has been the shrinking geographic scope of our nation's rail 
freight network. Route-miles declined from 175,000 in 1980 to 132,000 
in 2000 as competition from other modes intensified.\1\
---------------------------------------------------------------------------
    \1\ Includes Class I, regional and short lines.

    [GRAPHIC] [TIFF OMITTED] T8786.024
    

    Over the next 20 years, our nation will be facing new freight 
transportation challenges. A recent study by the Federal Highway 
Administration Office of Freight Management and Operations forecasts 
that demand for freight transportation will double over the next 20 
years. Rail carload and truck volumes are projected to grow by just 
over 3% per year, while rail intermodal is projected to have the 
highest growth rate among surface modes, at 4.7% per year.
    Such projections beg key questions: Where is the capacity going to 
come from, and how are we going to pay for it? Only a few new highway, 
waterway and rail routes may be built. Clearly, our challenge is to 
develop public policies and business strategies to squeeze every bit of 
productivity from the infrastructure now in place, so that America's 
transportation system facilitates--rather than constrains--economic 
growth. At the same time, the policies and strategies we adopt must 
protect our citizens and our environment, while providing competitive 
shipping rates and high service reliability.
    Any way you look at it, railways will play a major role in 
addressing this challenge, because:
     Railroads are safer than alternative modes: Railroads have 
the lowest employee injury rate among all the modes. Our safety 
improvements of the past 20 years include a 65% decline in train 
accident rates and a 71% decline in employee injury rates.\2\
---------------------------------------------------------------------------
    \2\ The fatality rate for railroads is .86 per billion ton-miles, 
compared with 3.81 per billion ton-miles for tractor-trailer trucks. 
Based on analysis of data from the Bureau of transportation Statistics 
and the National Highway traffic Safety Administration.
---------------------------------------------------------------------------
     Railroads are environmentally friendly. Freight trains are 
nearly five times more fuel efficient than trucks, and trucks emit 
anywhere from three to twelve times more pollutants per ton-mile, 
including nitrogen oxides and particulates.\3\
---------------------------------------------------------------------------
    \3\ Railroads moved 383 revenue ton-miles per gallon of diesel fuel 
in in 1990, compared with 80 revenue ton-miles per gallon for tractor-
trailer trucks. Based on analysis of data from the Bureau of 
Transportation.
---------------------------------------------------------------------------
     Declining rail shipping rates are benefiting consumers. A 
study released last December by the Surface Transportation Board 
(``Rail Rates Continue Multi-Year Decline'') found that the ultimate 
beneficiaries of increases in rail productivity--and decreases in rail 
prices--have been consumers. A key finding of the study was that rail 
rates have fallen 45.3%, adjusted for inflation, since 1984. According 
to the STB, shippers would have paid an additional $31.7 billion for 
rail service in 1999 if revenue per ton-mile had remained equal to the 
1984 level. Another key finding was that ``. . . all types of rail 
customers, and not just those with competitive transportation 
alternatives, have received some portions of the rate reductions.''
    This industry study reflects what has happened at BNSF as well. 
There are numerous examples that confirm this decline. Two that stand 
out are coal and agricultural commodities. BNSF's average revenue per 
ton mile for coal shipped from the Powder River Basin in Wyoming 
declined 32%, adjusted for inflation, from 1994 through the first 
quarter of 2001, due to aggressive rail-to-rail and barge competition, 
our desire to keep generating plants from choosing alternative fuels, 
and competition between utilities.
    In the agricultural commodities area, BNSF's average revenue per 
ton-mile declined by 32%, adjusted for inflation, over the same period, 
due to competition with other railroads and other modes, and because we 
have passed efficiency gains through to customers in the form of lower 
rates in order to increase our business.
     Railroad service is improving: Last year, for the second 
consecutive year, BNSF provided its customers with 91% on-time service, 
up from 82% in 1998 and 79% in 1997. Excellent on-time performance for 
our largest customer, United Parcel Service, was one of our proudest 
achievements: We handled 388,190 UPS intermodal trailerloads during 
2000, and delivered 99.6% of them on time. BNSF is continually 
sharpening its customer focus, including development of a number of e-
business initiatives to make BNSF easier to do business with.
    Even with these improvements, however, we understand that BNSF 
service is not as good as it needs to be across all commodities and 
across our entire network. But, it is getting better, year after year. 
The biggest key to further service improvements is undertaking the 
capital investments to increase the capacity of our infrastructure.

              RAILROADS REQUIRE MASSIVE AMOUNTS OF CAPITAL

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    America's railroads, like all elements of our national 
transportation infrastructure, require massive investments for 
maintenance and capacity expansion. In fact, calling railroading 
capital intensive is an understatement. The U.S. Census Bureau 
calculated that railroad capital expenditures in 1999 consumed a 
whopping 21.7% of revenues, compared with an average of just 3.9% for 
all manufacturers. Railroads require invested capital of about $2.50 to 
generate a dollar of revenue, compared with just 50 cents of invested 
capital per revenue dollar for truckers.
    At BNSF, wrestling with the capital investment dilemma is one of 
our biggest challenges. In the years immediately following the merger 
that created our company in 1995, we adopted an aggressive ``build it 
and they will come'' strategy. In our first five full years, we 
invested over $11 billion--an average of $2.2 billion per year--to 
expand capacity and improve service. We acquired over 1,600 new 
locomotives, 6,000 covered hopper cars, added 1.6 million units of 
additional intermodal capacity and 496 miles of double and triple 
track, betting that we would attract additional business and increase 
our profitability.

[GRAPHIC] [TIFF OMITTED] T8786.026


    This was a credible strategy, but it has not played-out rapidly 
enough. As a result, we have been essentially forced by our investors 
to significantly reduce our investment levels over the past three 
years. BNSF capital investments will drop to about $1.5 billion this 
year. While these are substantial sums, and they are adequate to keep 
our railroad in quality running order, expenditures at this level will 
not get our company--or our nation--additional capacity for handling 
the projected increased demand for rail freight transportation in the 
years ahead.
    Declining capital investment levels have become the norm at the 
three other major Class I railroads in the last two years. Industry 
investment levels peaked at $7.4 billion in 1998, and they are expected 
to decline to about $5 billion this year. While it is natural for 
railroad investment levels to fluctuate from year to year, this trend 
bears watching closely.
    The current excellent condition of most main line tracks, signal 
systems and locomotives on the Class I rail network gives us a bit of a 
cushion, but the weak earnings recently reported by the railroads, 
combined with the soft economic outlook for the quarters ahead, make it 
unlikely that investment levels will increase in the short term, and 
the current investment levels are close to the maintenance level.
    It is important to keep in mind that the difference between capital 
investment intensity of railroad companies, compared with our 
competitors in other transportation modes, is not due to the high cost 
of railroad infrastructure. It is simply because railroad companies pay 
to maintain their own infrastructure, while our competitors do not.

[GRAPHIC] [TIFF OMITTED] T8786.027


    Railroads may be the workhorses of our transportation system, 
especially when it comes to transporting bulk commodities over long 
distances, but despite great strides in efficiency, railroads are 
losing ground rapidly to truckers in revenue market share and tons 
originated. Unfortunately, history is proving that rail technology 
typically does not have enough economic advantage to support privately 
owned rights-of-way in the face of government-provided infrastructure 
for most of our competitors.
despite great progress, railroads are not profitable enough to attract 

       ADEQUATE CAPITAL TO FULFILL THEIR POTENTIAL FOR THE NATION

    Most Americans probably would not put railroads near the top of 
their list of the most dynamic U.S. industries of the last 20 years, 
but they should. After two decades of stagnation in the 1960s and 
1970s, when returns on invested capital in the rail industry averaged 
only about 2%, economic deregulation breathed new life into the 
railroads.

[GRAPHIC] [TIFF OMITTED] T8786.028


    Our industry responded with a vengeance, increasing returns to an 
average of 6.6% since deregulation. Since 1980, railroad productivity 
(expressed as ton-miles divided by operating expenses) has increased 
203% (inflation adjusted), rail shipping rates have declined on average 
62% (inflation adjusted), and industry revenues have declined 42% 
(inflation adjusted).
    The railroad success formula of the last 20 years was relatively 
simple:
     Reduce expenses through a myriad of efficiency 
improvements;
     Trim operations back to the most profitable routes and 
commodities;
     Merge to extend single-line hauls, reduce overhead and 
achieve even greater efficiencies;
     Abandon or spin-off superfluous lines;
     Focus on customers.
    One result of these initiatives was a considerable change in the 
mix of traffic transported by the railroads. Shipments of individual 
carloads of consumer and industrial goods, especially shorter haul 
shipments, failed to keep pace with economic growth as these shippers 
shifted to trucks.\4\ Numerous valiant marketing efforts to retain this 
business have been, at best, only modestly successful.
---------------------------------------------------------------------------
    \4\ Average length of haul for railroads increased from 615 miles 
in 1980 to 834 miles in 1999.
---------------------------------------------------------------------------
    Today, we depend increasingly on bulk commodities and long-haul 
intermodal shipments in high density lanes. Intermodal is increasingly 
the ``growth driver'' for the industry. Western railroads have 
benefited relatively more than eastern carriers from these changes, 
because of their longer hauls and because the Clean Air Act resulted in 
surging demand for low-sulfur coal from Wyoming and Montana.
    Most efficiencies achieved by the railroads have been passed-
through to shippers in the form of lower prices, as STB studies have 
confirmed, due to competition and our need to increase volumes. 
Fortunately, because railroad expenses were reduced even more deeply 
than rates, railroads managed to keep some of the difference, which 
allowed the industry to gradually shore-up its finances.
    Railroads did this through ``differential pricing,'' which is the 
way virtually all industries set prices: costs, competitive factors, 
and the purchaser's demand elasticity all get factored into the price 
equation. Some rail customers have argued to change this approach to 
pricing, but the changes they suggest would severely and immediately 
constrain our ability to make capital investments. Railroads should not 
be denied the same pricing mechanism as other service companies, 
especially since our industry is already subject to STB regulatory 
oversight concerning potential railroad market power abuse.
    Unfortunately, the financial picture for railroads has not improved 
enough, and now we are seeing signs that it is slipping. Our industry's 
``Achilles heel'' is its inability to boost returns on invested capital 
above the cost of capital. This has troubled railroads for years, and 
it may well have more affect on our industry's long-term future than 
any other financial measure. If railroads are unable to achieve returns 
exceeding their cost of capital, capital will flow out of the industry, 
railroads will constrict, and the economic, safety and environmental 
contributions of our industry to the nation will decline--at the very 
time they are most needed.

[GRAPHIC] [TIFF OMITTED] T8786.029


    Progress has stalled since the mid-1990s, after making significant 
headway reducing the cost of capital ``gap'' during the 1980s. Although 
Western railroads seem to be faring better than Eastern roads in 
closing the gap between return on investment and cost of capital, 
BNSF's slippage in this measure over the last three years is troubling.

[GRAPHIC] [TIFF OMITTED] T8786.030


[GRAPHIC] [TIFF OMITTED] T8786.031


    The key to managing our company to achieve returns greater than our 
cost of capital is to generate increased operating income from our 
assets. Because we own our infrastructure, our asset base is 
disproportionately large compared with competing transportation 
companies in other modes, and with other industries in general.
    There are two levers available to manage our returns on invested 
capital. One is operating income, which is a factor of revenues, 
traffic volumes and expenses. The other lever is assets--our right-of-
way, locomotives and facilities. It is my responsibility to achieve 
returns on capital in excess of capital costs by adjusting these two 
levers.
    If BNSF does not make enough on the operating earnings side, we 
must pullback on assets associated with our lowest profit traffic, 
which has the effect of shrinking the company. Eventually, we will be 
``right sized'' as the profitability of remaining traffic yields 
returns that exceed our cost of capital. That is simply the way free 
enterprise must work.

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    The equity markets assess our progress toward improving returns on 
invested capital constantly, and their evaluations are reflected in the 
day-to-day performance of our stock. Over the past several years, the 
market's judgments have been harsh. Railroads in general, including 
BNSF, have lagged severely behind overall returns. The message from 
investors has been loud and clear: reduce capital investments, and 
generate increased cash flow.
    At BNSF, we have been essentially forced by the markets to use much 
of the cash we generate to repurchase our stock. We have repurchased 
93.9 million shares since our stock buy-back program began in July 
1997, using $2.4 billion in cash, and the program is continuing. 
Instead of plowing this capital back into the railroad, we have 
transferred it out of the company, to our shareholders. The 
disappointing thing is that despite this aggressive program, our stock 
performance remains substandard.

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[GRAPHIC] [TIFF OMITTED] T8786.034


    The Class I railroads are not in immediate financial danger. 
Current levels of net operating income are disappointing, but debt 
levels are manageable by generally accepted business standards. In 
fact, baring a serious public policy mis-step such as re-regulation, it 
is highly unlikely we will ever see a repeat of rail industry crisis of 
the 1970s, with widespread bankruptcies, deferred maintenance, and 
declining safety. The Staggers Act gives management flexibility to 
avoid such outcomes.
    The Class I railroads, however, could be on the threshold of a 
subtle, but nonetheless substantial erosion of rail freight capacity. 
Many short lines and regional carriers are struggling to attract 
maintenance capital, or simply to keep the doors open. Class I 
railroads must consider reducing the scope of their networks, if 
returns do not improve. We need to keep in mind that as the rail 
industry shrinks, potential public benefits from the railroads shrink 
correspondingly and our ability to facilitate the nation's economic 
growth is reduced.

                            RECOMMENDATIONS

    I am confident this Subcommittee understands the potential benefits 
to our nation from a healthy freight rail system. The challenge ahead 
is to put the correct public policies in place to achieve these 
benefits.
    In the midst of the debate, the Subcommittee will hear dramatically 
different--even contradictory--recommendations for policy changes from 
various stakeholders. Too often, railroads, certain rail shippers, and 
some shipper associations will appear to be headed in opposite 
directions. There will be demands for Draconian policy changes that are 
not focused on improving services, but only on still lower prices for a 
select group of shippers. As I have pointed out, the railroads--because 
of financial pressures--are already being forced to cut operating 
expenses, employees, and capital investments. Cutting our revenues 
further will only make the challenges faced by the railroads more 
formidable.
    I do not pretend to have all the answers to the railroad policy 
issues you will be addressing during this Congress, but I have several 
recommendations. They fall into three categories--short-term changes, 
public financing issues, and resisting pressures to turn back the 
clock.

Short-Term Policy Recommendations
    Two policy issues stand out for the short-term: Elimination of the 
4.3 cent per gallon ``deficit reduction'' diesel fuel tax paid by 
railroads, and reform of the Railroad Retirement system.
    The deficit reduction fuel tax is a remnant of a past era, and it 
is discriminatory because proceeds from a similar tax paid by motor 
carriers are diverted to maintain their infrastructure. This tax costs 
BNSF about $50 million annually, and railroad industry in total about 
$170 million per year. Eliminating this tax would be an essential step 
forward.
    Reform of Railroad Retirement is an even more important step toward 
modal equity. Last year, BNSF paid about $350 million more into the 
Railroad Retirement system than we would have paid into social 
security, which is the pension system that covers our competitors in 
other modes. Our employees at BNSF contributed another $100 million 
above and beyond what they would have paid into social security. Most 
of that amount, of course, was made-up indirectly by BNSF because we 
must stay competitive in labor markets to retain employees.
    The deficit reduction fuel tax and the Railroad Retirement system 
combined cost BNSF about $61 per freight shipment handled last year. 
That is a substantial burden, given that our net income per shipment 
was just $120. Eliminating the fuel tax and reforming Railroad 
Retirement would be significant steps toward achieving competitive 
equity between modes and providing additional funds for expanding rail 
infrastructure.

Public Financing Recommendations
    Access to capital for infrastructure investments is emerging as one 
of the biggest challenges for the railroad industry. The problem is 
that approximately 75% of the $101 billion invested in America's rail 
industry is in rights-of-way, an investment category competitive modes 
simply do not have.\5\ While I am 100% committed to private sector 
ownership of rail infrastructure, I would like to see more aggressive 
public financing support for railroad projects that have clear, 
demonstrable public benefits, such as public safety enhancements, 
traffic congestion mitigation, or air quality improvements.
---------------------------------------------------------------------------
    \5\ Based on an analysis of rail industry ``R-1'' reports.
---------------------------------------------------------------------------
    Across the nation, we are starting to see excellent examples of 
public/private financing partnerships that benefit both communities and 
railroads. Examples include the Alameda and FAST Corridors, capacity 
expansion projects to accommodate growing commuter and freight rail 
demands, and initiatives to relocate tracks away from congested 
downtown locations. While these examples are encouraging, we need to 
see many more such projects, with more community, state and federal 
funding support, and we need to see them completed faster.
    Many major railroad infrastructure projects have associated public 
benefits. Whether it is constructing a new side track to move passenger 
or freight trains more efficiently through an urban area, expanding or 
building intermodal hubs, implementing a Positive Train Control system, 
or building more grade-crossing separations, all of these projects have 
real public benefits. Unfortunately, not enough projects like these 
will be undertaken without more funding.
    The amount of public money that is spent on such projects is 
miniscule. Especially concerning to me is the small amount of funding 
available for grade-crossing projects, including crossing closures, 
constructing separations, and installing or upgrading signals. Last 
year, BNSF worked with communities to arrange closure of over 600 grade 
crossings across our system, and we have an equally ambitious plan this 
year. Inadequate financing is the biggest barrier to closing even more 
crossings, to improve public safety and community livability.
    I have been encouraged by the emerging dialog concerning increased 
public financing assistance for rail freight projects. I urge you to 
find ways to increase the amount of funding available for rail projects 
that have associated public benefits, including funding for short-line 
railroad infrastructure improvements (H.R. 1020), and to ensure that 
rail freight considerations are a high priority in the upcoming 
transportation reauthorization legislation.

Resist Pressures to ``Turn Back the Clock'' on the Staggers Act
    My final recommendation is akin to the Hippocratic Oath: First, do 
no harm. It is impossible for me to overstate the harm to our industry 
that would result from reversing the differential pricing provisions of 
the Staggers Act, or imposing open access. Rail stocks would plummet, 
railroads would be forced to respond by sharply reducing capital 
investment levels, and the future of a rail industry with privately 
owned and maintained infrastructure would be jeopardized.
    The railroad industry has come a long way in the last 20 years. 
Although there are challenges ahead, none are insurmountable. As was 
pointed out in this testimony, our industry needs your help to 
establish a level playing field with competitive modes. I look forward 
to assisting you any way I can.

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[GRAPHIC] [TIFF OMITTED] T8786.037

[GRAPHIC] [TIFF OMITTED] T8786.038


    Senator Smith. Thank you very much, Mr. Rose. We appreciate 
your testimony.
    We are also very glad to be joined by Senator Jay 
Rockefeller, who is a long-time Member of this Subcommittee and 
has a great interest in these issues, I know, in fact, has a 
bill that you might be referencing. I may want to ask a 
question about that if he does not.
    Senator, do you have an opening statement or anything you 
would like to----
    Senator Rockefeller. Just put it in the record.
    [The prepared statement of Senator Rockefeller follows:]

          Prepared Statement of Hon. John D. Rockefeller IV, 
                    U.S. Senator from West Virginia

    Thank you, Mr. Chairman. Those of us who have been watching the 
freight rail market for some time appreciate the active interest you 
have shown in the state of the railroad industry since assuming the 
chairmanship of this Subcommittee. I look forward to working with you 
on these issues in the months to come.
    I want to welcome the witnesses. For many years, I have been 
engaged in an effort to see the rail industry work in a competitive 
manner. For some reason, through this effort I have acquired a 
reputation as someone who is hard on the railroads. I truly hope to 
dispel that notion a little today, but my overall message will not 
change: Protectionism does not work. It is in the long-term best 
interests of both shippers and railroads alike to operate in a 
competitive market.
    It is true that my interest in rail competition may have originated 
in trying to work with companies in West Virginia dissatisfied with 
their rail service. However, as I learned more about the industry, I 
became certain that a truly competitive rail market would benefit not 
only the shippers, but the railroads as well. Perhaps the benefits 
would not show up in immediate ways that would encourage the financial 
markets, but I am more convinced than ever before that competition will 
improve the health of the industry, and help to prevent the job losses 
and service consolidation that too often result from the current 
unworkable system.
    Once again, thank you, Mr. Chairman, for making the effort to hold 
these hearings. I hope the dialog we engage in here today can result in 
a stronger, more competitive railroad industry.

    Senator Smith. All right, without objection.
    Mr. Brickwedel, welcome. It is nice to have a constituent 
here so knowledgeable about this important industry.

STATEMENT OF WALTER J. BRICKWEDEL, PRESIDENT, OREGON SHORT LINE 
  RAILROAD ASSOCIATION, AND ASSISTANT TO THE GENERAL MANAGER, 
              CENTRAL OREGON AND PACIFIC RAILROAD

    Mr. Brickwedel. Thank you, Chairman Smith, Senator. I am 
Walt Brickwedel, President of the Oregon Short Line Railroad 
Association. I am also Assistant to the General Manager for 
Central Oregon and Pacific Railroad, the largest of Oregon's 19 
short lines.
    Mr. Chairman, let me first say that I am honored by your 
invitation to appear before this Subcommittee today. It is my 
privilege to speak to you about the short line railroad 
industry in Oregon and its infrastructure needs, topics very 
different than what Mr. Davidson and Mr. Rose just addressed. 
But first let me say that nationwide since the 1980s, over 500 
short line railroads are in operation, having saved tens of 
thousands of miles of light density rail lines from 
abandonment.
    Today short line railroads employ approximately 25,000 
people. They serve thousands of local shippers and are often 
the only connection that these shippers have to the national 
rail network. Short line and regional railroads own, maintain, 
and operate almost 50,000 miles of track, or 29 percent of the 
national rail network.
    To survive, Mr. Chairman, these lines need to be upgraded 
and the freight revenues to small railroads are simply not 
sufficient to get the job done. In Oregon, as it is in any 
other State, there is no question that short line railroads are 
a vital link to the State's transportation network. Nineteen 
short lines move 135,000 rail cars annually, for more than 60 
percent of the State's rail-served customers in 200 
communities, most of them rural. They offer the only rail 
transportation to three of Oregon's ports, two of them on the 
Columbia River and one on the coast, the International Port of 
Coos Bay.
    In a separate folder before you, I hope before you, is a 
short story about Oregon's short line railroads, along with a 
map showing each railroad's service area in that State. As part 
of the short line story, you will find a number of testimonials 
that attest to the importance of these railroads to Oregon's 
economy, both for themselves and for a wide range of 
industries. Short lines act as capillaries for economic 
development, especially in rural areas, by providing existing 
and potential businesses with a cost-effective mode of 
transportation to a widespread number of markets, locally and 
nationally, through the vast network of our Class I railroad 
partners.
    Many of Oregon's short lines are unique in that their 
dependency is on the forest products industry and it on us. Our 
principal commodities are lumber, wood products, pulp, and 
paper, all of which make up more than half of the short lines' 
annual traffic and revenue base. The importance of these 
commodities to consumers and to the nation's housing industry 
obviously cannot be denied.
    The short line railroad system in Oregon covers over 1,100 
miles, nearly 50 percent of the total track in the State. 
Preserving rail service to rural communities and maintaining 
these 1,100 miles, however, does not come without a hefty price 
tag. Oregon's short lines were created when the State's large 
railroads chose to lease or sell off unprofitable branch lines 
and concentrate mainly on their line haul business. These 
unprofitable lines understandably had received only the barest 
of maintenance and were in deplorable condition when spun off. 
Now it costs an average of $4,000 to $5,000 per mile to 
maintain this track.
    Altogether, Oregon's short lines spend about $8 million 
annually on the upkeep of their lines, and this does not 
include any capital improvements. The Oregon Department of 
Transportation recently estimated that the State's short lines 
have rehabilitation needs of about $66.3 million. These 
infrastructure needs are necessary to bring track standards up 
to 25 miles per hour and to handle the heavier rail cars with a 
gross weight of 286,000 pounds, cars promoted by the Class I 
roads, but which some of our short line carriers cannot handle 
on these former branch lines.
    These infrastructure needs are summarized on the attached 
statement prepared by ODOT for inclusion in the State's 2001 
Rail Plan. You will see that these capital expenditure projects 
are weighted more towards new ties, new rail and bridge 
repairs. One railroad, for example, has 21 of its total 32 
miles that cannot handle 286,000-pound cars. Another 15-mile 
short line needs $250,000 just to bring its track up to 10 
miles per hour. A third short line, one of our largest, has 
four individual branch lines that cannot handle the 286,000-
pound cars, and each line serves a lumber shipper who is 
feeling the pinch of competition by not being able to load 
heavier cars. These are just a few examples, Mr. Chairman.
    From time to time, the Federal Government has sponsored 
rail assistance programs that benefit the nation's small 
railroads. In the past, funds were made available for railroad 
projects on an 80/20 match under the Local Rail Freight 
Assistance Program. A few years ago, the Central Oregon and 
Pacific Railroad was fortunate to obtain a grant of $5.5 
million under TEA-21 to rehabilitate the 87-year-old swing 
bridge across Coos Bay. Without this rehabilitation, the 
communities south of this bridge are in jeopardy of being cut 
off from their only rail connection to the rest of the country.
    A Federal program currently in effect is a loan program 
which you are familiar with, the Railroad Rehabilitation and 
Improvement Financing Program, or RRIF, as it is known. But 
instead of a required match, the railroads must first come up 
with a hefty credit risk premium just to secure the loan. Only 
one Oregon short line has applied for a RRIF loan to date, but 
because of the high premium it has not yet accepted that loan. 
As a whole, many Oregon short lines cannot afford to pay a loan 
premium, not to mention taking on a long-term debt. A targeted 
grant program is essential.
    One bright sign for short lines this year is H.R. 1020, the 
Railroad Track Modernization Act. Introduced in March, it 
authorizes general fund appropriations of $350 million for each 
of the fiscal years 2002 through 2004 in capital grants to 
rehabilitate, preserve, and improve track on small railroads. 
The driving factor behind this proposed legislation is to 
ensure that the nation's small railroads continue to operate 
efficiently, particularly when handling the heavier 286,000-
pound cars common in the rail industry today.
    H.R. 1020 has broad bipartisan support in the House and was 
endorsed by the American Short Line Railroad Association, the 
Association of American Railroads, rail labor groups, and all 
of the Class I roads. I would like to personally thank Mr. 
Davidson and Mr. Rose for their support of this important 
legislation and for their ongoing support of the short line 
industry in general.
    Mr. Chairman, I am asking you today if you also will 
consider supporting our industry by sponsoring a similar bill 
in the Senate.
    Senator Smith. The answer is yes. We will introduce it 
right away.
    Mr. Brickwedel. Thank you, sir.
    I would like to speak personally about the needs of the 
railroad where I am employed, if I may, the Central Oregon and 
Pacific Railroad. We operate 387 miles of main line track in 
Southwestern Oregon and another 63 miles in Northern 
California. The maximum speed on our railroad is 25 miles per 
hour, but our average systemwide speed is a mere 14 miles per 
hour. Our entire Coos Bay line of 135 miles to and beyond the 
Coos Bay rail bridge must be brought up to FRA Class II 
standards of operation at 25 miles per hour. Currently 60 
percent of that track does not meet those standards.
    We estimate the project to cost $6 million and will involve 
replacing well over 100,000 ties and the resurfacing of that 
entire line. An engineering study also estimated that we will 
need upward of $20 million to enlarge three tunnels over the 
summit connecting Oregon with California in order to handle 
high-capacity rail cars and intermodal and stack-pack 
equipment.
    As Southern Oregon's cities close to California continue 
the grow, it is critical that our rail system be able to handle 
the increasing demand for rail services, especially intermodal 
rail.
    As you can see, Mr. Chairman, the need to preserve and 
improve light density rail lines is great, especially those in 
rural areas that often have taken an economic back seat to 
other areas of the country for years, resulting in their 
neglect. Infrastructure improvements not only benefit small 
railroads and their shippers, but help promote economic 
development and enhance public safety and the environment.
    I hope I have shown through Oregon's experience that a 
strong national short line railroad industry is paramount to a 
healthy economy and a well-balanced transportation system. Your 
sponsorship and support of legislation towards this goal is 
most welcome. Thank you again for the privilege to testify 
before you today.
    [The prepared statement of Mr. Brickwedel follows:]

     Prepared Statement of Walter J. Brickwedel, President, Oregon 
Short Line Railroad Association, and Assistant to the General Manager, 
                  Central Oregon and Pacific Railroad

                          INFRASTRUCTURE NEEDS

    Chairman Smith, Members of the Committee, I am Walt Brickwedel, 
President of the Oregon Short Line Railroad Association. I am also 
Assistant to the General Manager for Central Oregon & Pacific Railroad, 
the largest of Oregon's 19 short line railroads. Mr. Chairman, I am 
honored by your invitation to appear before this Committee today. It is 
my privilege to speak to you about the Short Line Railroad industry in 
Oregon, and its infrastructure needs.
    But first, let me say, that nationwide, since the 1980s over 500 
short line railroads are in operation, having saved tens of thousands 
of miles of light density rail lines from abandonment. Today, short 
line railroads employ approximately 25,000 people, serve thousands of 
local shippers, and are often the only connection these shippers have 
to the national rail network. Short line and regional railroads today 
own, maintain and operate almost 50,000 miles of track, which is 29% of 
the national rail network. To survive, these lines need to be upgraded, 
and the freight revenues to small railroads are simply not sufficient 
to get the job done.
    In Oregon, as it is in any other state, there is no question that 
its short line railroads are a vital link in the state's transportation 
network. Nineteen short line railroads move 135,000 rail carloads 
annually for more than 60% of the state's rail-served customers in 
approximately 200 communities, most of them rural. The short lines also 
offer the only rail transportation to three of Oregon's ports--two on 
the Columbia River, and one on the coast, the International Port of 
Coos Bay. In a separate folder before you is a short story about 
Oregon's short line railroads, along with a map showing each railroad's 
service area in the state.
    As part of the short line story you will find a number of 
testimonials that attest to the importance of these railroads to 
Oregon's economy both for themselves and for a wide range of 
industries. Short lines act as capillaries for economic development, 
especially in rural areas, by providing existing and potential 
businesses with a cost-effective mode of transportation to a widespread 
number of markets, locally, and nationally through the vast network of 
our Class I railroad partners.
    Many of Oregon's short lines are unique in that their dependency is 
on the forest products industry, and it on us. Our principal 
commodities are lumber, wood products, pulp and paper, all of which 
make up more than half of the short liness annual traffic and revenue 
base. And the importance of these commodities to consumers and to the 
nation's housing industry cannot be denied.
    The short line rail system in Oregon covers over 1,100 miles, 
nearly 50% of the total track in the state. Preserving rail service to 
rural communities, and maintaining these 1,100 miles of track, however, 
does not come without a hefty price tag. Oregon's short lines were 
created when the state's large railroads chose to lease or sell off 
unprofitable branch lines and concentrate mainly on their line haul 
business. These unprofitable branch lines understandably had received 
only the barest of maintenance, and were in deplorable condition when 
spun off. Now it costs an average of $4-$5,000 per mile for the state's 
short lines to maintain their track. All together, Oregon's short lines 
spend about $8 million each year on safety and upkeep of their lines. 
And this does not include any capital improvements.
    The Oregon Department of Transportation (ODOT) recently estimated 
that the state's short lines have immediate rehabilitation needs of 
about $66.3 million. These infrastructure needs are necessary to bring 
track standards up to 25 mph. They also take into account the increased 
use of heavier rail cars with a gross weight of 286,000 lbs., cars 
promoted by the Class I railroads, but which some of our short lines 
cannot handle on these former branch lines. These infrastructure needs 
are summarized on the attached statement prepared by ODOT for inclusion 
in the state's 2001 Rail Plan. As you will see, these capital 
expenditure projects are weighted more toward new ties, new rail and 
bridge repairs.
    One railroad, the Willamette Valley RY, has 21 of its total 32 
miles that cannot handle 286,000 lb. cars.In fact it still has some 62# 
rail that it operates over that was rolled in 1891. The minimum weight 
of rail that can safely handle these heavy cars is generally 90#. 
Another 15 mile short line needs $250,000 just to bring its track up to 
10 mph. And a third short line, one of our largest, has 4 individual 
branch lines that cannot handle 286,000 cars, and each line serves a 
lumber shipper who is feeling the pinch of competition by not being 
able to load heavier cars. These are just a few examples.
    From time to time the federal government has sponsored rail 
assistance programs that benefit the nation's small railroads. In the 
past, funds were made available for railroad projects on an 80:20 match 
under the Local Rail Freight Assistance Program, and some are available 
under TEA-21. A few years ago, the Central Oregon & Pacific Railroad 
was fortunate to obtain a grant of $5.5 million to rehabilitate the 87 
year old swing bridge across Coos Bay. The funding, however, is still 
in an account waiting for the required $1.3 million match, which the 
owner of the bridge, the Port of Coos Bay, is still attempting to 
obtain. Meanwhile, the communities south of this bridge are in jeopardy 
of being cut off from their only rail connection to the rest of the 
country.
    A federal program currently in effect is a loan program, the 
Railroad Rehabilitation and Improvement Financing Program (RRIF) but, 
instead of a required match, the railroads must come up with a hefty 
Credit Risk Premium prior to the issuance of the loan. Only one Oregon 
Short Line has applied for a RRIF loan to date, with half of the amount 
to pay down debt and the other half to make track improvements. But 
because of the high premium, it has not yet accepted the loan. As a 
whole, Oregon's short lines cannot afford to pay a loan premium, not to 
mention taking on a long term debt. A targeted grant program is 
essential.
    One bright sign for short lines in Congress this year is H.R. 
1020--The Railroad Track Modernization Act of 2001. Introduced in 
March, the bill authorizes General Fund appropriations of $350 million 
for each of the fiscal years 2002 through 2004 in capital grants to 
rehabilitate, preserve, or improve the track on small railroads. The 
driving factor behind this proposed legislation is to ensure that the 
nation's small railroads continue to operate safely and efficiently, 
particularly when handling the heavier, 286,000 lb. rail cars now 
common in the railroad industry.
    H.R. 1020 has broad bipartisan support in the House, and was 
endorsed by the American Short Line and Regional Railroad Association, 
the Association of American Railroads, rail labor groups and all of the 
Class I railroads. I'd like to personally thank Mr. Davidson and Mr. 
Rose for their support of this important piece of legislation, and for 
their unwavering, ongoing support of the short line railroad industry 
in general. Mr. Chairman, I am asking you today, if you also will 
consider supporting our industry's efforts to upgrade its 
infrastructure by sponsoring a similar bill in the Senate.
    I can speak personally about the needs of the railroad where I am 
employed--The Central Oregon & Pacific Railroad. We operate 387 miles 
in Southwestern Oregon, and another 63 miles in Northern California. 
The maximum speed on our railroad is 25 mph, but our average, system-
wide, is a mere 14 mph. Our entire Coos Bay Line of 135 miles to and 
beyond the Coos Bay rail bridge must be brought up to FRA Class II 
safety standards of operation at 25 mph. Currently 60% of that track 
does not meet those standards. We estimate the project cost to be $6 
million, which will involve replacing well over 100,000 ties and the 
resurfacing of the entire line.
    An engineering study also estimated that we will need upward of $20 
million to enlarge three tunnels over the summit connecting Oregon with 
California in order to handle high capacity rail cars, and intermodal 
and stack pack equipment. As Southern Oregon cities close to California 
continue to grow, it is critical that our rail system be able to handle 
the increasing demand for rail services, especially intermodal rail.
    As you can see, the need to preserve and improve light density rail 
lines is great, especially those in rural areas that often have taken 
an economic back seat to other areas of the country for years, 
resulting in their neglect. Infrastructure improvements not only 
benefit small railroads and their shippers, but help promote economic 
development and enhance public safety and the environment. I hope I 
have shown, through the Oregon experience, that a strong, healthy, 
national short line railroad industry is paramount to a well balanced 
transportation system in this country. Your sponsorship and support of 
legislation toward this goal would be most welcomed.
    Thank you for the privilege to testify before you today. I will be 
happy to entertain any questions you may have.

[GRAPHIC] [TIFF OMITTED] T8786.039

[GRAPHIC] [TIFF OMITTED] T8786.040

    Senator Smith. Thank you very much.
    Mr. Brickwedel, I wonder if other States have an 
association of short line railroads similar to what our State 
is fortunate enough to have?
    Mr. Brickwedel. I cannot answer that, Mr. Chairman. But I 
would be happy to find out and get you that answer.
    Senator Smith. Well, clearly you are keeping rural Oregon 
connected to the big commerce picture of our country, and I 
thank you for that and congratulate you on that.
    You testified that Oregon's short lines are spending $8 
million annually on safety and upkeep, but that figure does not 
include any capital improvements. Can you tell us how much is 
being spent on capital improvements?
    Mr. Brickwedel. I cannot speak for the other roads, Mr. 
Chairman but I know that Central Oregon and Pacific Railroad, 
one of the two largest, averages $2 million a year on capital 
improvements alone. This is aside from routine maintenance, and 
that represents generally 10 percent of our annual gross 
revenue.
    Senator Smith. Are you keeping up with the need for capital 
improvements?
    Mr. Brickwedel. We are making improvements on one line and 
that we call the Siskiu Line between Eugene and the California 
border. But we have not met the needs of the Coos Bay line to 
which I referred, that 135 miles. That is why we really need 
the infusion of $6 million.
    Senator Smith. If these lines did not exist, what would be 
the truck availability to move the wood chips and agricultural 
products I assume you are moving?
    Mr. Brickwedel. Mr. Chairman, I am sure we would not have 
enough trucks available to handle it. On the Central Oregon and 
Pacific Railroad, for example, we handle 45,500 carloads a 
year. If you multiply that by 3 to 3.6 truckloads, that is an 
immense strain on our State highway system and our bridges.
    Incidentally, that is up. Our traffic is up 46 percent from 
when we started 6 years ago. So we continue to grow.
    Senator Smith. Can you talk about the paper barriers that 
you referenced? Tell us about that?
    Mr. Brickwedel. The paper barrier or the agreement, the 
railroad industry agreement that deals with the paper barrier, 
is a very, very significant step towards relations with Class I 
railroads and the short lines. On the Central Oregon and 
Pacific Railroad, I am not aware of any paper barriers that we 
have or breakdowns in the paper barriers that we have. I know 
there are some examples throughout the country, but I believe 
that none exist in the State of Oregon.
    Senator Smith. Mr. Rose and Mr. Davidson, I am not sure I 
know of an industry where the capital requirements are so great 
and the return on capital is so small, frankly. I think if 
America knew the state of our railroads there would be some 
alarm about how we are falling behind the demand. Now, if 
commerce keeps falling off the way it has the last few months, 
there is not a problem. But we do not want that. We want it to 
pick up.
    I guess as I have listened to both of your testimonies, you 
are saying three things: Do not re-regulate, repeal the 4.3 
budget deficit tax that is still in place, and help with the 
railroad retirement. I suspect a lot of the Members of Congress 
would want to know, frankly, if we did all of those things 
would the savings go into these capital improvements that are 
apparently so intensive and so necessary?
    Mr. Davidson. Well, I will just speak for the Union Pacific 
here. Clearly a portion of it would, Senator. As I have 
mentioned today, we have cut back from what has been roughly a 
$2 billion capital level to where this year we are going to be 
somewhere in the $1.6 billion to $1.9 billion range depending 
on what happens with the economy. If it gets worse, it will be 
less than that.
    But that would be a big help. I think Mr. Rose said just 
the fuel tax alone would save his company $50 million. It would 
save us well north of that, because we burn 1.3 billion gallons 
of diesel fuel a year. So it is just a huge number for us. 
Likewise, the Railroad Retirement Reform Act, basically what 
that does is gives us a chance to invest in the equity market 
and hopefully enhance our return so we could reduce the amount 
of capital that we fund the program with. I think between 
employee funding and employer funding it is something like 36 
percent of our payroll goes into railroad retirement. So it is 
just a huge number, and the potential savings there are 
substantial as well.
    Clearly, today we do have the opportunity to invest more 
money in infrastructure and some of that money could certainly 
be directed there.
    Mr. Rose. I would just add that when we get together 
several times a year and plan out the capital requirements for 
our railroad and add it all up, the list is long, about $4 
billion if we funded every project that we thought was a good 
project. This year we are going to spend $1.5 billion. So the 
list is just enormous of where we could spend money to enhance 
the quality of our railroad, as well as provide more 
opportunities to partner with the trucking companies to take 
trucks off the highway.
    I agree with Dick's point that at the end of the day we 
have an industry that is falling well short of the return on 
invested capital and any moneys that can come back into the 
operating income line will only benefit that and get this 
business to where long-term it will have a normal investment 
over the size of the franchise that we have right now, instead 
of this continuum of what I would call a creep of fewer rail 
miles every year in this nation.
    It is really going to come down to a very thoughtful public 
policy debate of whether or not the United States believes that 
money should be spent in terms of making sure that rail 
infrastructure is kept up or continue to invest in the highway 
infrastructure.
    I would just add a fourth point to your three points, and 
that is that I do believe that there needs to be a very 
specific item around public policy, around private-public 
partnerships, to invest in rail infrastructure.
    Senator Smith. My time is up.
    Senator Rockefeller.

           STATEMENT OF HON. JOHN D. ROCKEFELLER IV, 
                U.S. SENATOR FROM WEST VIRGINIA

    Senator Rockefeller. Thank you, Mr. Chairman.
    The capital requirements of railroads are minuscule in 
comparison to the needs of our nation's airlines, minuscule. 
Your statement is pretty good here, 13.9 percent, 9.54 percent. 
I will have some more questions about that.
    You know my general orientation. Neither of you are from 
the East. None of you are from the East. I have a feeling that 
the railroads are contributing to the decline of West Virginia. 
I know that. I have felt that for 17 years.
    But I would like to ask you a question, Mr. Rose. Let us go 
with the railroads for a moment--I mean, airlines. They are 
deregulated, right?
    Mr. Rose. Correct.
    Senator Rockefeller. Now, let us suppose I wanted to take a 
trip from Washington, DC., to Eugene, Oregon. How do you get to 
Oregon from Washington, DC.?
    Senator Smith. It is United to Portland and then commuter 
down to Eugene.
    Senator Rockefeller. Okay. Well, let me add another step in 
the middle to make my case better. Let us say you had to stop 
in Chicago.
    Senator Smith. You often do.
    Senator Rockefeller. You often do.
    Senator Smith. And you often are delayed there, too.
    Senator Rockefeller. Now, let us supposing that the airline 
told me what it would cost to get to Chicago, but they declined 
to tell me what it would cost me to get to Portland, but they 
would tell me what it would cost to get to Eugene from 
Portland. Would you consider that acceptable behavior?
    Mr. Rose. I understand your point. You are going to 
correlate this to the classical bottleneck. But again, I do not 
think that the scenario fits the same story.
    Senator Rockefeller. Well, if you could answer my question.
    Mr. Rose. Well, I would probably choose a different route.
    Senator Rockefeller. You fly, right? You fly?
    Mr. Rose. Right. So I would probably look at both networks 
and decide which network I wanted to travel on.
    Senator Rockefeller. Well, that was not really my question, 
though. My question was, let us suppose in the case--and I do 
not know Oregon except through its fine Senators. But you are 
taking a trip and the airline declines to tell you how much it 
would cost to get you from this point to that point in a three-
point trip. You would find that unacceptable as a traveler?
    Mr. Rose. Well, actually we see that all the time. I will 
use my great home State of Texas, where it is cheaper to fly 
from Texas to Kansas City than it is from Texas to Oklahoma 
City when you fly right over Oklahoma City. That is because 
somebody has decided to make the investments in Kansas City and 
they have found that their economics work to build----
    Senator Rockefeller. Mr. Rose, I appreciate these 
diversions, but you are not answering my question. I have a 
right to have my question answered. You have a right to give 
testimony and I have a right to ask questions. You can say, I 
refuse to answer your question, but do not talk to me about 
other routes.
    Would you consider it acceptable if, let us say, Delta or 
American or United say, well, we will tell you what it costs to 
get from here to here, but we will not tell you what it costs 
to get from here to here, which in effect means that you really 
would not know what the lowest price would be?
    But forget the competition factor. Just take the one 
instant. Let's say only United flies to Eugene, Oregon. I am 
going to make that up. They said they would not tell you the 
price from Chicago to Portland. You would find that 
unacceptable?
    Mr. Rose. Again, it depends on the level of service.
    Senator Rockefeller. If there is a level of service, what 
does that have to do with it if they will not tell you what it 
costs?
    Mr. Rose. Well, again it depends on what service I am 
buying.
    Senator Rockefeller. No, it does not, Mr. Rose. Your answer 
is yes, I would find it unacceptable. Your answer is yes and 
you know that. You know that. You are doing your----
    Mr. Rose. No, I do believe that the traveling public would 
find that unacceptable, but I do understand how an airline 
would make a better investment and make sense out of a network 
to be able to run that all the way to Portland without being 
able to give a division over Chicago. I do understand that.
    Senator Rockefeller. Well, I am glad you do, but I prefer 
to go with your earlier statement that the public would find 
that unacceptable. You might not, but the public would.
    Mr. Rose. Fair enough.
    Senator Rockefeller. Okay.
    Mr. Davidson, how do you define ``competition''? What does 
``competition'' mean to Union Pacific? What does the word mean?
    Mr. Davidson. Well, competition means that there are people 
out there willing to haul business, more than one person.
    Senator Rockefeller. Where there is not more than one 
person, there is no competition?
    Mr. Davidson. Well, there is source competition, but I 
cannot think of an occasion where there is not some form of 
competition.
    Senator Rockefeller. I see. Would I be correct that UP does 
not voluntarily quote a rate to its rail customers for moving 
freight from a point on the UP system to an interchange point 
where that traffic can be transferred to a competing railroad?
    Mr. Davidson. Do you mean a point where only we serve the 
point of origin, the only railroad that would serve the point 
of origin? Is that your question?
    Senator Rockefeller. Your answer should be no.
    Mr. Davidson. Well, I am not sure I understand your 
question. That is what I am trying to clarify.
    Senator Rockefeller. Okay. Would I be correct that UP does 
not voluntarily quote a rate to its rail customers for moving 
freight from a point on the UP system to an interchange point 
where that traffic can be transferred to a competing railroad? 
This is the same conversation as with Mr. Rose.
    Mr. Davidson. Well, there are cases where we do and cases 
where we do not.
    Senator Rockefeller. Well, that is not really very helpful.
    Mr. Davidson. I am trying to answer your question fully. If 
you are getting at the bottleneck question--that is the popular 
term that people use today, ``bottleneck''--there are 
situations certainly where we serve either the point of origin 
or destination and the competitor does not, but at some point 
along the route the competitor could either receive or deliver 
that traffic.
    In many of those cases, we do not offer a rate to that 
point, the reason being that if we invest in infrastructure to 
move that traffic all the way from point A to Z and we were 
forced to give up that traffic after a short movement and then 
the government imposed a maximum rate level above that, 
obviously the rest of the route would wither and die. It is 
just not the way that you do business, and it has not been for 
decades.
    Senator Rockefeller. Would wither and die.
    Mr. Davidson. Would wither and die.
    Senator Rockefeller. But your answer is no and that is what 
I expected. If I am correct also that the effect of this is to 
make the shipper captive to the UP for the entire distance the 
product needs to travel and not just over the bottleneck 
section, how does that square with an objective definition of 
competition?
    Mr. Davidson. Well, you missed the early part of the 
testimony, but one of the examples concerned my competitor 
here, Mr. Rose, as an example. Where the free market provides 
the inducement, there will be competition. As an example, in 
south Texas at a place called North Seadrift, Burlington just 
worked out a deal with a company called Union Carbide, which is 
now part of Dow, to build an eight-mile extension of railroad 
to access that facility to provide competition for us. It was a 
situation worked out at arm's length between the carrier and 
the customer.
    Probably the biggest example in the last quarter of a 
century is our building a piece of track into the Powder River 
Basin, where Burlington Northern had that piece of traffic, it 
looked like a good market to us, and we spent a half-a-billion 
dollars to access that coal field. Now we are so competitive 
that we are hauling coal over 2,000 miles.
    So the free marketplace does work. If the government 
mandates that we give up our private assets, it will not work. 
That is what we had prior to 1980, was government-mandated 
price levels, and our railroad network was $20 billion in 
arrears on capital investment. That is what we do not want to 
go through again.
    Senator Rockefeller. It is interesting because I have been 
here for 17 years on this Subcommittee listening to railroads 
plead poverty, and it has never been what I would call an 
overwhelmingly compelling case, the revenue inadequacy aspect 
and all the rest of it. The infrastructure requirements that 
you have are so much less than what the airlines have, so much 
less.
    Oh, yes, they are. If you take Newark--do you know, there 
are more planes that fly into Teterboro than fly into LaGuardia 
Airport? There are reasons for all of this.
    Mr. Davidson. I must tell you, I know little about the 
airline industry.
    Senator Rockefeller. I know, but I know quite a lot about 
it and I am trying to make a point here. That is that they have 
enormous capital needs, much greater than the $4 or $5--or 
whatever it was--billion that you quoted. They are talking tens 
and tens of billions of dollars and that does not include air 
traffic control and all the rest of it.
    Now, they do not quote. They tell you what it costs at 
every step, and they are in brutal competition. They fight over 
every nickel. They hate each other. They do.
    Mr. Davidson. Mr. Rose and I are being nice to each other 
because we are here testifying, but we do not normally pal 
around together.
    [Laughter.]
    Senator Rockefeller. But you are in a common philosophical 
league, which is called the American Railroad Association, 
which has a way of being together when it counts, and I admire 
you for that.
    But it strikes me as interesting that their capital needs 
are much greater, their poverty is absolute in that they are in 
and out of Chapter 11. You all started out with 50 when I was 
here Class A. Now you are down to four or five, whatever it is. 
Your bound statements are pretty good. But you withhold the 
right to quote where there is a captive shipper.
    Now, the Staggers Act--you always use the word ``re-
regulation'' because you think it scares us or it scares the 
American public. It probably does scare the American public, 
but it does not us, because it does say that where captive 
shippers are involved that the STB, formerly ICC--of course, 
nobody knows what the STB is--that they have a voice in this 
and that if you do not do the right thing there can be a right 
to petition.
    We all know that is a farce, because the right to petition, 
it takes so long that nobody can afford to petition, so it is 
kind of an empty thing. That is our fault. We made a mistake, 
and we need to change the legislation to correct that mistake, 
and one of these days we will. Like my great-grandfather, I am 
going to live to be 98 and that will be my legacy, when this 
thing is changed and put right.
    Mr. Rose. Senator Rockefeller, if I could make one comment 
about your illustration of the airline industry.
    Senator Rockefeller. Yes. Is that getting to you a little 
bit?
    Mr. Rose. Not at all.
    Senator Rockefeller. Okay.
    Mr. Rose. Because there is a huge difference between the 
two industries. The rail industry pays for almost all of the 
infrastructure that we run over and the airline industry does 
not. If you think about what pays for the air traffic control 
system, who pays for the airports, it is the American taxpayer. 
If we want to shift this debate to where the Federal Government 
wants to own all the railroads, all the infrastructure, this 
debate can change totally.
    Senator Rockefeller. Did I not just year you talking about 
pension relief and all kinds of--in other words, you want some 
money from the government, right?
    Mr. Rose. No, we do not want money from the government.
    Mr. Davidson. We are asking for our money back. The 
railroad retirement system is funded by the railroad and by its 
employees.
    Mr. Rose. One-hundred percent.
    Senator Rockefeller. Okay. Mr. Rose, let me go back to you. 
Do you know any other deregulated industries in America that 
are granted the right by Congress to deny their customers 
access to competition? Whether or not you feel you do or do 
not, do you know of any others?
    Mr. Rose. No, I do not.
    Senator Rockefeller. In your BNSF earnings, it is true that 
they were lower than expected.
    Mr. Rose. That is true.
    Senator Rockefeller. That has been happening some these 
days. In part, is that not because you paid about $230 million 
in unusually high fuel prices?
    Mr. Rose. Yes, that is correct.
    Senator Rockefeller. I am going to assume, because BNSF is 
a sophisticated corporation, that your railroad tried to 
mitigate these unforeseen expenses by trying to find the lowest 
priced fuel available. Am I right?
    Mr. Rose. Correct. We hedge a portion of our fuel.
    Senator Rockefeller. Would I be correct to assume that BNSF 
would object to a government-supported monopoly that would 
limit your diesel purchases to one supplier?
    Mr. Rose. As long as our competition had that same thing, 
rail and truck, I would not care.
    Senator Rockefeller. No, I am not talking about rail and 
truck. I am talking about railroads.
    Mr. Rose. Well, just BNSF and everybody else could buy on 
the market?
    Senator Rockefeller. No, railroads.
    Mr. Rose. Yes, I would be opposed to that, because of our 
competitors in the trucking industry.
    Senator Rockefeller. Now, let me say with my fuel monopoly 
hypothet for a moment. In your opinion, if railroad sought to 
allow BNSF to seek the best possible price for fuel would that 
be regulatory?
    Mr. Rose. No. I guess I do not understand your question.
    Senator Rockefeller. Pretty clear. In other words, if we 
specifically gave you the right to find the best possible price 
for fuel. You do your shopping anyway, so you can argue that it 
is a moot question. But if we specifically in law gave you that 
right, would that be regulatory in your mind?
    Mr. Rose. I guess it could be. I mean, if you took it away 
from us and then gave it back to us would it be regulatory? 
Yes, I guess it would be. I am not following your question and 
I apologize for that.
    Senator Rockefeller. Okay. Mr. Brickwedel--well, actually I 
am over my time, Mr. Chairman. I apologize.
    Senator Smith. We will do a second round.
    Neither of you really talked about what Senator Rockefeller 
referenced about the fact that rail rates are challengeable via 
the STB, but air rates are not challengeable by any such 
committee. Is this a sham, as the Senator seems to be 
suggesting? Are they challenged?
    Mr. Rose. They are indeed.
    Senator Smith. Is the STB working?
    Mr. Davidson. Senator, we just went through a challenge 
with a large chemical customer that we do business with and 
there were some adjustments made as a result of that. In fact, 
today we have four rate cases pending before the STB. So it 
does indeed happen, and it works. I wish I could tell you that 
we had more rates that were challengeable, but we have very few 
because our average returns are quite modest.
    Senator Smith. I am interested in it because passenger rail 
seems to be coming back and particularly as it relates to 
commuter rail. In my State in particular, Dick, we are trying 
to get a connection to our light rail system in Portland, which 
is I think a great success. There is the issue of how we 
utilize trackage in common for, obviously, purposes of commerce 
and commuting.
    I wonder if you can speak to the whole commuter rail 
question, if that works at all, or is this a nonstarter?
    Mr. Davidson. I can indeed, sir. We have many commuter 
operations on our railroad, places like Chicago, Los Angeles, 
the Sacramento to Oakland area. Many times the public looks at 
a railroad track and thinks you have unlimited capacity and we 
would like to use that capacity to move commuters, which is a 
totally logical way to look at things.
    However, if commuter rail forces themselves on a freight 
railroad track and you do not have adequate capacity and you 
displace freight, you end up with more people, more trucks on 
the highway, than you had previously with automobiles. So the 
way we have tried to address this issue is by working 
cooperatively with the commuter authorities and understand what 
the track limitations are, the capacity limitations of a 
particular piece of railroad, and work with them to provide 
enough additional capacity so that you can accommodate both 
freight and commuter.
    We have many, many successes there that we can point to, in 
Chicago and Southern California and even in the State of 
Oregon. We recently have worked with Amtrak coming south out of 
Portland to add additional capacity so that we could 
accommodate more Amtrak trains.
    Sometimes the negotiations are not quite as simple as one 
would like, and people are always shocked when they find out 
how much it costs to add infrastructure to a railroad. But 
having said that, I think it is far cheaper than building 
additional highways, and we normally are able to find common 
ground.
    Senator Smith. I know it is not easy, but it is important 
that somehow we make these connections because, frankly, some 
of the utilization of these rails, if we had to duplicate all 
of them for passenger or commuter rail, it just would be 
prohibitive, just as building more highways is prohibitive, if 
not impossible, in some places.
    Mr. Davidson. We will do our best wherever those situations 
exist to try to work them out in a fair and equitable manner.
    Senator Smith. I am intrigued by Senator Rockefeller's 
questions and I want to understand better the relationship 
between you and the STB. We had them in our hearing last time. 
Is this an agency that is working to help foster competition, 
to keep rail rates understandable and fair? Is this a step 
between the re-regulation you fear, or is this an agency that 
in your view is an irritation, but it is just not working? What 
is your characterization?
    Mr. Davidson. Well, I might address that first if you do 
not mind, since we went through a merger in 1996 that we had a 
little bit of difficulty with in 1997 and 1998. I got to be a 
frequent customer of the STB. First off, addressing the issue 
of competition, I would tell you that the first thing they did 
was make absolutely certain that no customer that had been 
previously served by two different railroads lost two-railroad 
service. They did that resoundingly and went beyond that even 
and said that any new customer that developed along the route 
that the BN was given trackage rights on could have access to 
that railroad. So they did more than just ensure that existing 
competition was preserved.
    They also permitted another competitor to use our rail 
lines to gain access to Mexico. So not only was competition 
preserved, it was enhanced in that case.
    As far as maximum rate regulation, as I just testified, we 
just went through a hearing on that with one of our major 
chemical customers where there were some adjustments made and 
there are now four cases pending concerning us. So they clearly 
do manage that responsibility carefully.
    Senator Smith. Is the rate challenge that is imposed on 
you, not on the airlines, but are those--how regular an event 
is that?
    Mr. Davidson. When a customer feels that his rates are 
unreasonable, the customer has the right to challenge them 
before the STB.
    Senator Smith. Just on their own basis? This is 
unreasonable.
    Mr. Davidson. It has to pass certain screens, that the 
revenue-cost variable has to exceed a certain level to be heard 
by the STB. But if it does--well, if it does not, obviously it 
is not an unreasonable rate. But if it does, they will accept 
that and make a decision on it.
    Senator Smith. The hypothetical that Senator Rockefeller 
gives, that they want to get from Chicago to Eugene and you do 
not quote them what it costs to go through Portland, is that 
per se unreasonable?
    Mr. Davidson. Well, let me say this, Senator. The analogy 
is not a good analogy of comparing airlines and railroads, 
because airlines do not maintain their own infrastructure, 
their own track structure, like we do. So I think it fails the 
test of being a reasonable comparison.
    But if what the Senator was trying to get at, that you had 
to quote a rate between point A and B even though you could 
haul the traffic all the way from A to Z, and then you had a 
maximum rate imposed on you from A to B, the railroad industry 
would clearly fail. Now, in my submission, which I did not bore 
you with in my verbal testimony, in my submission there is a 
very detailed study that was funded by the Federal Railroad 
Administration last year that points out that if the railroad 
company is to survive they would have to be able to charge 
their profit for that entire move from A to Z on the bottleneck 
portion, A to B, where we would be required to quote that rate.
    So I know you probably will not have time to read that 
study, but if one of your staff would look through it I am 
certain that they would see the compelling reason why it is set 
up like it is.
    Senator Smith. If I have trouble getting to sleep tonight, 
I will begin reading it.
    Mr. Davidson. It works for me.
    Senator Smith. But thank you, I am glad to know that that 
is there, because this is a question I would like to have some 
answers on.
    Mr. Davidson. In fact, there is an executive summary, if I 
remember right, in the front--it is about three pages--that 
tells the story pretty well.
    Senator Smith. Very good.
    Mr. Rose. I would just like to add, Mr. Chairman, that the 
number of rates that get challenged is minuscule compared to 
the number of shippers we have. That is because, again, the 
vast majority of the rates do not get anywhere close to the 
revenue-cost ratio that is set forth in the STB.
    Senator Smith. Very good.
    Senator Rockefeller.
    Senator Rockefeller. Thank you, Mr. Chairman.
    I want just to clarify one point on the so-called right to 
challenge. One of the things I think that has been pretty 
indisputably established here over the years is that, yes, 
there is a right to challenge, but nothing ever comes out. I 
mean, we have had 17-year challenges. That is a famous case 
which you are all familiar with. But people do not have the 
money to challenge, you know, the granary, the coal mine, the 
whatever. They do not have the money. These folks have the 
money to delay and stall.
    So the right to challenge is there, but in effect it is not 
there. I do not say that ideologically. It really does work out 
that way.
    Senator Smith. Cost of entry is high.
    Senator Rockefeller. It is just, there are so many 
barriers, it is so expensive, things are extended for so long, 
that there is not a right to challenge. That is really a basic 
point in all of this.
    Mr. Davidson, I just wanted to clarify one thing. When you 
were talking about Powder River Basin, you said you thought it 
would be good for the company to build out there. Was it not 
the STB that told you to do that?
    Mr. Davidson. Absolutely not. We did that on our own 
volition. The STB did not exist then.
    Senator Rockefeller. Well, the ICC, whatever.
    Mr. Davidson. No, they did not instruct us to do that. We 
had to get their permission to do it, but it was a free market 
effort.
    Senator Rockefeller. Well, I am questioning that and we 
will be in further touch about it.
    Mr. Davidson. I would be glad to provide you with evidence 
supporting what I just said.
    Senator Rockefeller. Okay. Mr. Davidson, this is a little 
bit what I was saying to the good Senator. A March, 1999, GAO 
report--and we pay a lot of attention to those things around 
here--says that the rate reasonableness process, which is what 
we are talking about, is too expensive, too complex, too 
consuming to work. In fact, the report also says that shippers 
do not want to complain to the STB because they fear 
retribution from the railroads. I have seen that in my own 
State.
    Mr. Davidson. I doubt you have seen it West of the 
Mississippi.
    Senator Rockefeller. I am sure I never could find it West 
of the Mississippi. But I do find it East of the Mississippi 
and I have seen it at work in my own State directly.
    And that railroads have a very good system. If the 
complaint level, Mr. Chairman, gets too high, they will go and 
work out an arrangement with a high profile complainer and they 
will settle the problem and they will reduce rates. But all of 
this--and then of course, that particular granary or steel 
company, whatever it is, coal company, is happy, they stop 
complaining. But the problem persists elsewhere.
    I think about 20 percent of the nation's users of railroads 
are captive shippers. That may have gone up or down in the last 
few years, but it is about 20 percent. That is a lot of people, 
and they are all over the country and they are in all different 
forms.
    In fact, the report also said that the shippers do not want 
to complain because of the retribution. In addition, coal 
shippers at least have to pay a $57,000 filing fee just to 
enter the process. Well, that is a lot of money if you have got 
a little granary somewhere.
    The situation is bad enough that last year 250 CEOs and 
other top officers of companies, trade associations, the 
chemical manufacturers, made it their top issue last year. They 
are all over the country. Captive shipping was their top issue 
last year, the number one thing they wanted to get changed, and 
they are all over the place asking us to address this problem.
    On top of that, the chairperson of the STB testified 
earlier this year to this Subcommittee that there is nothing 
that the STB can do to address the situation. So what are we in 
Congress to do about the situation, Mr. Davidson?
    Mr. Davidson. My suggestion is let the free market work. I 
just gave an example of Mr. Rose and Union Carbide working 
together to provide a second rail line into North Seadrift, 
Texas. I do not believe you were here, Senator, when I was 
testifying, but if you look at that chart in front of you, 
there were 554 new industries that located on the Union Pacific 
system in the last 3 years. Of those 554 industries, 465 chose 
sites that only had one railroad serving them, over 80 percent. 
And some of those were billion dollar chemical companies. I 
could take you down and show a brand new location where they 
have built along our railroad track, where they had other 
choices.
    In fact, we did a survey of State industrial development 
departments and our own industrial development group about what 
the top 25 choices are when a customer locates his industry, 
and two-railroad competition came out 24th on the list of 25 
criteria they used.
    Senator Rockefeller. That is great. I would be anxious to 
look at those figures and try and find what I can underneath 
them.
    Mr. Davidson. It is all outlined in my written testimony.
    Senator Rockefeller. I say that respectfully, but 17 years 
of experience here has taught me that when you get figures from 
the railroad folks that you have got to look underneath the 
figures to find out.
    Mr. Davidson. I would be delighted to go through it with 
you ad infinitum, sir.
    Senator Rockefeller. I am sure you would, sir. I am sure 
you would.
    Mr. Rose, did you not say that you would welcome 
infrastructure help from the government?
    Mr. Rose. Yes, I think that there are a lot of areas where 
public-private development can be made, specifically, the bill 
that is before you, before the House right now, on Amtrak 
funding, we have been actively supporting.
    We also are active in a number of different communities 
around commuter type service: the Alameda Corridor out in 
Southern California, Project North Star up in Minneapolis-St. 
Paul is currently being worked, locations in Denver, the RTA 
project in Seattle going down to Tacoma. I think that there are 
a lot of opportunities to work commuter and Class I railroads 
together for public-private funding.
    Senator Rockefeller. So when you indicated--and Mr. 
Chairman I know my time is up. When you indicated that the 
airlines are different because they get Federal subsidies, but 
you would welcome infrastructure help, would you not?
    Mr. Rose. Well again, at the risk of repeating myself, 
where there is public-private partnership--
    Senator Rockefeller. I understood what you said. I was just 
sort of capping it off.
    Mr. Rose. Yes.
    Senator Rockefeller. All right.
    Mr. Chairman, just in closing I would say that I think that 
only in the railroad context does the victim, so to speak, of 
what I would call monopoly power have to prove the 
reasonableness of a monopoly rate. That is the point I wanted 
to make to you, that when the right to challenge is there, but 
it is unprecedented anywhere else, it is hard to do.
    I thank you.
    Senator Smith. Thank you, Senator.
    I would like to probe just a little bit more on where 
Senator Rockefeller is going because I think we are really at 
the nub of the problem in where we are trying to find some 
answers. If the ability to challenge a rail rate were repealed, 
would the rail carriers be more inclined to quote a rate?
    Mr. Davidson. If there was not maximum rate regulation?
    Senator Smith. Yes, if the STB was not--if there was no 
right of appeal here, would you be more inclined the be quoting 
a rate?
    Mr. Davidson. We would certainly take a strong look at 
that. You cannot have it both ways, though.
    Senator Smith. Currently, when asked to quote a rate is it 
along a segment where interchange is easily accommodated or 
would additional dollars be needed to establish interchange 
points?
    Mr. Rose. That is a good point. A lot of quotes that we are 
asked to make are on interchange points that are low volume and 
literally there is no throughout through that interchange, and 
additional capital would have to be invested.
    Senator Smith. A question comes to my mind as to--and I 
think you and I talked about this, Mr. Rose--what Europe is 
doing. Is there anything to be learned from what Europe is 
doing on rail, or is their example something we learn--and I am 
asking this because I want to get it on the record--is what we 
learn what not to do, or are there some things that they are 
doing that we should do?
    Mr. Rose. I think it is a great lesson, and you are going 
to hear some testimony a little bit later in the day about the 
calamity that Europe is in because what they have done, they 
have separated the infrastructure out from the operations, and 
then within that infrastructure they have subcontracted out the 
maintenance of that infrastructure. At the end of the day, when 
you hear people talking about open access and running trains 
over people's railroad, at the root of it comes where somebody 
has to pay for that capital investment. Somebody has to be 
incented to make that capital investment. Somebody has to be 
incented to make that railroad safe and strong.
    When you separate out the two parts, I think you are going 
to find exactly what happened in Europe is happening in other 
locations as well.
    Senator Smith. Are European countries trying to change 
those things now?
    Mr. Rose. I think right now they are in the middle of 
trying to understand what has happened. In fact, with the 
number of critical accidents that they have had, they have 
literally hired a team of experts from the United States. That 
is the thing that people continue to forget. We are the envy of 
the world in rail freight transportation, not high-speed 
passenger, but rail freight transportation. Everybody looks to 
our model to be the only model that has worked.
    So there is literally a group of experts that Europe has 
contracted with from the United States to go over and show them 
the mistakes that were made.
    Senator Smith. Because you keep the incentive to improve 
and maintain with the railroad.
    Mr. Rose. The underlying owner.
    Mr. Davidson. Mr. Rose is exactly right. In fact, the 
people that operate the infrastructure over there are making 
inquiries today about seeing if there is an American railroad 
executive they could find to go over there and help them 
straighten out the mess.
    Sort of the model I think of railroad privatization in 
recent years would be the country of Mexico. They started their 
privatization process in 1996 and they have used the American 
model to set it up, and it appears to be working quite well, 
where England has done just the opposite. In fact, they have 
announced they are going to have to put huge subsidies into the 
English system to bring it back to life.
    Senator Smith. Mr. Brickwedel, as a constituent I do not 
mean to leave you out of this fight. Do you have any 
observations or closing comments you want to make on any of the 
questions Senator Rockefeller and I have been asking?
    Mr. Brickwedel. I do want to say, Chairman Smith, that our 
relationship as the Oregon short lines, we have a strong 
relationship with both BNSF and the Union Pacific. We work, I 
would say, fairly well with them. I would not say that they 
satisfy every one of our needs, but to date we see no barriers. 
We are able to receive the cars on a timely basis that our 
customers need and provide the service to the Class I 
railroads, to satisfy our customers in getting their product to 
market.
    In fact, the Central Oregon and Pacific Railroad has a 
service agreement with Union Pacific that allows us to swap 
crews. That is part of the railroad industrial agreement that 
was referred to earlier. We entered that agreement probably a 
little over a year ago and that is working very, very well and 
has reduced transit time for our customers.
    Senator Smith. Mr. Davidson, Mr. Rose, any closing thoughts 
or comments?
    Mr. Rose. I just want to end with, capital is the heartbeat 
of this industry. You are going to hear testimony later about 
what we think as an industry, what outside people think it 
needs, using scientific management tools, what really is the 
ongoing capital requirement of this industry.
    You will also see that right now, that the industry is 
being underinvested. Whatever comes from all of these 
discussions, whether we call it re-regulation, rail reform--
everybody has a little bit different name for it--there had 
better be a lot of thoughtful consideration given to how you 
solve the return on investment capital issue. If it is not, we 
will set this industry back in the poor condition that existed 
before Staggers.
    Mr. Davidson. I would certainly second that. I would just 
say once again, while the American railroad industry is far 
from perfect--we strive for perfection, but seldom attain it--
it is still the envy of the world as far as a privately owned, 
privately operated rail system. If you looked at Europe and the 
other countries where it is operated by the government, you 
would see just how inefficient something can be.
    Prior to Staggers, you saw what happened when we were 
overregulated. Companies were going bankrupt. The government 
took over the predecessor companies of Conrail, as one example, 
and put more money in it. So you can imagine. I can assure you, 
if you try to wind the clock back and take away our private 
property and force others into using our facilities at 
regulated rates, that is the inevitable outcome that we will 
have again.
    Senator Smith. Gentlemen, thank you very much. Your 
testimony has been very helpful in understanding this issue, 
and I think we have had a good exchange. So we again thank you, 
and invite now our second panel.
    Mr. Davidson. Thank you, sir.
    Senator Smith. Mr. James Valentine, Managing Director, 
Morgan Stanley; Mr. William J. Rennicke, Vice President, Mercer 
Management Consulting; Dr. Allan M. Zarembski, President of 
Zeta-Tech Associates; Mr. Kevin D. Kaufman, Senior Vice 
President, Louis Dreyfus Corporation; and Dr. Harvey A. Levine, 
independent transportation economist.
    We welcome you all and we will begin with Mr. Valentine 
when everyone takes their seat.
    [Pause.]
    Senator Smith. Mr. Valentine, the microphone is yours.

      STATEMENT OF JAMES J. VALENTINE, MANAGING DIRECTOR, 
                         MORGAN STANLEY

    Mr. Valentine. Great. Thank you. In the brief time I have 
here before you today, I would like to paint a picture of the 
freight railroad industry from the institutional equity 
investor perspective. These are large institutions managing 
money in this country. I think it is going to be somewhat 
unique among all these presentations you are going to hear 
today because my clients do not rely on the freight railroad 
industry's success to run their businesses. That is, they can 
invest in other industries, avoiding railroads altogether, and 
in fact many of them do just that.
    I think the point here is that my testimony is from a 
somewhat impartial group of individuals who are not reliant on 
the industry. Obviously, if we had a collapse of the railroads 
immediately, the shareholders and the bondholders would be 
upset. But I guess what I am trying to get at is that a slow 
deterioration, as we have seen over the years, is not going to 
warrant Wall Street coming down here and lobbying for reforms. 
They will in effect, vote with their shares and get into other 
industries.
    In fact, the value of the U.S. freight railroads right now 
as a percentage of the 500 largest companies traded on the U.S. 
stock market is right now one-fifth the size it was in 1980. I 
think that demonstrating that capital has exited the freight 
railroads at a time when it has flowed into other sectors of 
corporate America.
    Despite all the improvements that we have had since the 
1980 Staggers Act, Wall Street still remains less than 
impressed because the railroads have given too much of the 
savings back to customers instead of the shareholders. That is 
evidenced by the fact--two key points here: that the industry 
still does not earn its cost of capital. I do not care how 
anybody wants to compute it. I have been told that there are 
different ways to compute it. You can do it five different ways 
if you want. You are going to come up that the industry does 
not earn its cost of capital, at a time when the customer rates 
continue to decline.
    In fact, if we look at the period since 1980, during 
Staggers, we see that railroads have lost market share to 
trucks every year. Furthermore, on an inflation-adjusted basis, 
railroad freight revenues last year were 28 percent below where 
they were in 1980.
    Investors bought the railroad stocks throughout the 1980s 
with the idea that once the benefits of Staggers were realized 
the companies would start to earn their cost of capital. Then 
about 10 years later, by the early 1990s, investors were 
becoming frustrated by the lack of progress, although they 
became pacified for a few years because we had PEB-219 that 
took us from five-man crews to two-man crews. There were some 
savings there.
    But a few years later, after it was clear that, even with 
two-man crews, the industry would still not earn its cost of 
capital, investors began again to lose faith in the industry, 
at which time the leaders started to initiate the most recent 
round of mergers, with the prospects of reducing costs and 
their capital needs through industry consolidation.
    But now here we sit, 6 years after this merger round began, 
and we still have an industry with inadequate returns. I guess 
making matters worse--and I think this is a really key point--
is that we are witnessing a long-term trend in freight patterns 
towards faster, smaller, lighter, and more frequent movements 
of freight, which puts railroads at an inherent disadvantage to 
trucks and air freight. I am also a trucking analyst and air 
freight analyst, and I can just see the market shifting just 
because of the way we are moving freight in this country.
    Investors again became aggravated, or I should say are 
still aggravated, for that matter, by poor returns and they are 
now pressuring railroad management to cut back on capital 
expenditures. You heard Dick and Matt up here talking about 
this. I sit through these meetings. I watch when they mention--
when Dick says, we are going to spend $1.6 to $1.9 billion this 
year, you can hear the people in the audience gasp, the 
shareholders, these large institutional shareholders, thinking, 
why are we spending so much capital with such bad returns?
    The railroads spent in excess of $50 billion on capital 
expenditures over the past 10 years and they have generated 
less than $30 billion of net operating income. For now, these 
spending cuts in capex we have seen starting to come down more 
recently due to pressure from shareholders are mostly in areas 
of growth. I think you heard that from the short line speaker 
today, that we are seeing that there is definitely cutbacks in 
growth, in capital for growth.
    I am quite concerned that without some structural change we 
are going to see Wall Street continue to lose interest in the 
industry and run the risk of a government bailout of the 
freight railroads, similar to what we saw with Amtrak for 
passenger service back in the early 1970s. Keep in mind, what 
brought about Amtrak did not happen overnight. It was a slow, 
steady problem with passenger service over multiple years.
    I should also mention, do not let the recent rally in 
railroad stocks suggest that railroad investors have a new-
found hope for the industry, because most of them are up so far 
year-to-date, because I think most of this rally can be 
explained simply by short-term momentum investors returning to 
industrial stocks in advance of what they expect will be a 
recovery in the economy later this year.
    I should also mention that it is probably worth noting that 
even after the recent rally in these stocks three of the four 
major railroad stocks right now are below where they were four 
years ago.
    So here are some of the issues from my perspective, being 
an analyst here for about 10 years watching the industry I 
think Congress might want to consider to help the railroads 
achieve their cost of capital and grow revenue at a rate at or 
equal to the rate of inflation, better than the rate of 
inflation:
    First, put the railroads on an even playing field with the 
long haul trucks and barges in terms of Federal subsidies. By 
any account, long haul trucking--and I'm just talking about 
long haul now, that competes with the rails--and the barge 
industries receive substantial Federal dollars to help maintain 
their right-of-way, whereas the freight railroads get none.
    Second, remove rate caps and other onerous restrictions 
that prevent the industry from pricing its product in a manner 
to obtain proper returns. As is discussed in my written 
testimony, the biggest misconception about freight railroads is 
that they abuse their market power with excessive rates. We saw 
that today, this discussion. If this were truly the case, we 
would see hundreds of upstart railroads attempting to extract 
monopoly rents similar to those upstarts in the 
telecommunications industry that have flourished by extracting 
ATT monopoly rents prior to the 1984 or after the 1984 splitup. 
I challenge anyone to demonstrate where large sums of 
entrepreneurial capital are entering the railroad industry on 
the prospects of extracting these alleged monopoly rents from 
the incumbent carriers.
    Third, remove the disincentives for conducting mergers. We 
need to get the savings from further consolidation.
    Fourth, create incentives for the railroads to conduct 
expansion in places where highways have too much congestion. 
You heard the Alameda Corridor is a perfect example. We need 
more examples like that.
    Fifth, reform FELA. FELA creates too much of a cost for the 
railroads, too much of a gamble for employees who become 
injured.
    Sixth, reform railroad retirement. You have heard that 
already today. Obviously, we could save some money for the 
industry.
    Finally, eliminate the 4.3 cent gallon deficit reduction 
fuel tax.
    I guess some of my suggested reforms may seem 
controversial, but if we keep conducting business the way we 
have in the past we are destined to get the same poor financial 
results and eventually put the entire industry into jeopardy of 
collapse. On Wall Street we have a saying that investors vote 
with their shares and that when they get frustrated with a 
company they usually just sell the stock, as opposed to 
becoming involved in a lengthy battle with management or 
external forces such as regulators or unions. Do not wait for a 
coalition of investors to come marching down here to Washington 
for reform. The investors have been voting with their shares, 
which explains why the industry stock value is one-fifth the 
size it was back in 1980 relative to the overall market.
    Unfortunately, the railroad industry and its shareholders 
have not had enough influence in getting these aforementioned 
reforms accomplished, and unless someone steps in to help we 
may eventually need to turn to the government, as we did with 
the Penn Central when it filed for bankruptcy, which we all 
know was a very costly and painful process for the customers, 
employees, management, and the communities involved.
    Thank you.
    [The prepared statement of Mr. Valentine follows:]

               Prepared Statement of James J. Valentine, 
                   Managing Director, Morgan Stanley

    My name is James J. Valentine and I am a Managing Director at 
Morgan Stanley, a New York-based investment banking firm, responsible 
for the firm's equity research effort pertaining to railroads, trucking 
and air freight. I have been researching the freight transportation 
sector on Wall Street for approximately 10 years. We take freight 
transportation very seriously at Morgan Stanley which may explain why 
our firm has been ranked by third-party constituents as number one or 
two each year for its equity research and investment banking in this 
area. My time is evenly split between interviewing industry sources, 
including company management, and discussing my conclusions with 
institutional investors. The work conducted by my team on freight 
transportation is regularly quoted by the major business news sources 
such as the Dow Jones' and Bloomberg's news wires, The Wall Street 
Journal as well as freight transportation periodicals such as Traffic 
World and Transport Topics. I received a masters degree in finance from 
the University of Iowa and hold the Chartered Financial Analyst (CFA) 
designation.

                               TESTIMONY

    The stock market value of U.S. railroads as a percentage of the 500 
largest companies traded in U.S. equity markets (S&P 500 index) is one 
fifth the size it was in 1980,\1\ demonstrating that capital has exited 
the railroads at a time when it has flowed into other sectors of 
corporate America (see Exhibit 1). In my testimony, I will attempt to 
explain why there has been such a decline in interest for railroad 
stocks by the public equity markets. We believe that any student of the 
railroad industry understands that passage of the Staggers Rail Act of 
1980 was a watershed event, as it removed archaic regulations that had 
burdened the railroads for decades. Since passage of the Act, the 
industry has witnessed improvements to profitability brought about in 
part by the industry's newfound ability to exit unprofitable markets. 
Furthermore, major labor reform in the early 1990s allowed railroads to 
reduce 5-man crews to 2-man crews, thus accelerating the trend of an 
already declining workforce (see Exhibit 2) and resulting in 
substantial improvements to overall railroad productivity. The problem 
from the perspective of Wall Street investors with all of this success 
is that the railroads have given much of the savings back to customers 
instead of the shareholders, as evidenced by the fact that the industry 
still does not earn its cost of capital (see Exhibit 3) at a time when 
customer rates continue to decline (see Exhibit 4).\2\ In my opinion, 
the equity markets are slowly losing patience with railroads as an 
investment as they continue to wait for the promised land of adequate 
returns, and may eventually turn their backs on the industry, leaving 
the government to bail it out similar to what we saw with the creation 
of Amtrak for passenger service in 1970.
---------------------------------------------------------------------------
    \1\ In 1980 the S&P Railroad index was 2.2% of the S&P 500 index 
and has dropped to 0.29% at the end of 2000.
    \2\ Railroad Ten Year Trends Rate of Return on Net Investment and 
Cost of Capital, Association of American Railroads.
---------------------------------------------------------------------------
    I do not mean to imply that the industry is on its last leg because 
it clearly is not, but I believe if we do not make structural changes 
to the business model, the slow downward trend is unlikely to reverse 
itself. Since this is an industry that has taken over a century to 
build, any analysis about its well-being or future prospects should be 
done over an extended period of time. If we look at the period since 
1980, we see that railroads have lost market share to the trucks in 
every year (see Exhibit 5).\3\ Furthermore, on an inflation-adjusted 
basis, railroad industry freight revenues in 2000 were 28% below those 
of 1980 (see Exhibit 6). For any industry, declining revenues is not a 
sign of health and in fact, usually leads to bleak consequences. 
Investors bought railroad stocks throughout the 1980s on the idea that 
once the benefits of Staggers could be realized, these companies would 
earn their cost of capital. By the early 1990s, investors were becoming 
frustrated by the lack of progress although they became pacified when 
PEB 219 reduced crew sizes from 5-man to 2-man, resulting in better 
margins and thus better returns for the industry, but still not enough 
to earn the cost of capital. A few years later, after it was clear that 
even with 2-man crews the industry would not earn its cost of capital, 
investors began to lose faith at which point the industry leaders 
initiated a major round of mergers, with the prospects of reducing 
costs and capital needs through consolidation. But now, six years after 
this round of mergers began, we still have an industry with inadequate 
returns. Furthermore, it appears that the industry's largest area of 
savings in the past, namely labor productivity, is slowing as headcount 
reductions have decelerated (see Exhibit 2) and unlikely to result in 
additional savings unless there is a major change in work rules by the 
unions. Making matters worse, we are witnessing a long-term trend in 
freight patterns towards faster, smaller, lighter and more frequent 
movements of freight which puts railroads at an inherent disadvantage 
to trucks and air freight.\4\
---------------------------------------------------------------------------
    \3\ Transportation in America, Eno Foundation.
    \4\ Internet Strategies: Surveying the Freight Carriers, Morgan 
Stanley Dean Witter, August 15, 2000.
---------------------------------------------------------------------------
    Investors, again becoming aggravated by poor returns, are now 
pressuring railroad management to cut back on capital expenditures. And 
for good reason, we think, when we see that the railroads have spent in 
excess of $50 billion on capital expenditures over the past 10 years 
and generated only $30 billion of net operating income (see Exhibit 
7).\5\ For now, these cutbacks are in areas marked for growth, but if 
this trend continues we could see deeper cuts by the railroads which 
would very likely hurt service levels. Unfortunately, here we sit in 
2001 with the railroads having no more cards to play to win back the 
shareholders. I'm quite concerned that without some structural change 
we are going to see Wall Street continue to lose interest in the 
industry, and thus run the risk of a government bail-out of the freight 
railroads sometime in our lifetime. And don't let the recent rally in 
railroad stocks suggest that the long-term investors have a newfound 
hope for the industry, as we believe much of the rally can be explained 
as simply short-term momentum investors returning to industrial stocks 
in advance of an expected upturn in the economy. If history repeats 
itself, after this economic recovery is underway, the railroads will 
once again be valued by the long-term investors, who traditionally look 
for adequate returns as a prerequisite before investing.
---------------------------------------------------------------------------
    \5\ Railroad Ten Year Trends Rate of Return on Net Investment and 
Cost of Capital, Association of American Railroads
---------------------------------------------------------------------------
    I'd like to dispel the misperception that railroads are taking 
advantage of their market position by charging excessive rates. Let's 
start with the fact that the U.S. has not witnessed a major new rail 
line built in at least 20 years. And yet, during the past 20 years, 
we've seen billions of dollars poured into new industries (including 
the dot-coms) because the prospects of good returns have been there, 
even if the actual returns haven't materialized. If the railroads were 
``gouging'' their customers to the benefit of the shareholders it would 
seem that some of this entrepreneurial capital would have been deployed 
into the railroad sector similar to the manner in which AT&T has been 
under attack by new competition since its 1984 split-up. To illustrate 
this point, in 1999 there were over 700 long-distance companies in the 
U.S. up from just a handful prior to 1984, driven by the prospects of 
extracting the former AT&T monopoly rents and generating returns that 
exceed each of their respective costs of capital. With investors having 
deployed enough capital to add 120,000 route miles of telecommunication 
fiber to non-AT&T networks over the past 10 years, why can't we get 
enough capital to build just one new 100-mile rail line in the U.S.? 
The answer, in our view, is that railroads don't have the prospects of 
earning a good return on their investments and so they can't attract 
new capital. When customers complain that they are being unduly charged 
by the carriers I think it's completely missed that there is no law in 
the U.S. that says a new rail line can't be built. If the railroads 
were charging rates that were truly excessive, we would see 
entrepreneurs pouring capital into new build-outs to get these 
customers competitive access to another carrier, similar to what we see 
in the long-distance telephone market--and yet, we can find less than 
20 such rail build-outs in the past decade. Customers need to be 
careful about what they wish for, as their efforts to drive rates lower 
will likely only cause more capital to leave the industry and service 
to deteriorate, continuing this downward cycle that has occurred for 
the past 50 years.
    Here are some of the issues that we think Washington might consider 
addressing to help the railroads achieve the basic principles of any 
healthy industry, namely revenue growth equal to or better than the 
rate of inflation and a return on capital better than the cost of 
capital.
     Put the railroads on an even playing field with long-haul 
trucks and barges in terms of Federal subsidies.\6\ By any account, the 
long-haul trucking and barge industries receive substantial Federal 
dollars to help maintain their rights-of-way, whereas the railroad 
industry gets none.
---------------------------------------------------------------------------
    \6\ 1997 Federal Highway Cost Allocation Study, U.S. Department of 
Transportation, Federal Highway Administration. ``. . . combinations 
(trucks) registered over 80,000 pounds will pay on average only about 
60 percent of their highway cost responsibility.''
---------------------------------------------------------------------------
     Remove rate caps and other onerous restrictions that 
prevent the industry from pricing its product in a manner to obtain a 
proper return. As we discussed earlier, in this day and age of free-
flowing capital for good investments, customers can force competition 
onto the incumbent rail carrier in almost every instance where they 
would claim excessive pricing.
     Remove disincentives for conducting mergers. The existing 
and pending railroad merger rules require too much of the economic 
benefits of a merger be returned to customers and labor. This is 
evident in the fact that despite all of the industry consolidation over 
the past six years, the industry's returns are no better (see Exhibit 
3).
     Create incentives for railroads to conduct expansion in 
places where the highways have too much congestion. The $2.4 billion 
Alameda Corridor in Southern California would never have been built 
without public funding. When completed in 2002, it will allow for more 
trade to move through Southern California while taking trucks off of 
the local roads, thus allowing for economic growth in an 
environmentally-friendly manner. We need more creative solutions such 
as this in order to help the railroads and the nation's transportation 
system support economic growth in congested places.
     Reform FELA, as it creates too much of a cost for the 
railroads and too much of a gamble for employees who become injured. 
The other modes of freight transportation are not burdened by FELA, 
which puts the railroads at a competitive disadvantage.
     Reform Railroad Retirement by allowing the unions or 
railroads to manage their retirement programs and presumably lower the 
associated costs. Similar to FELA, the other modes of freight 
transportation are not burdened with this regulation, and thus the 
railroads are at a competitive disadvantage.
     Eliminate the 4.3-cent per gallon deficit reduction tax as 
it is no longer needed.
    Some of my suggested reforms may seem controversial, but if we keep 
conducting business the way we have in the past, we believe we are 
destined to get the same poor financial results and eventually put the 
entire industry into jeopardy of collapse. I've been researching the 
railroad industry for ten years and have come to the conclusion that I 
will not be researching this industry ten years hence, unless there is 
major change, because it is unlikely to be an industry that investors 
will want to own. If we assume that the trends that have taken place 
over the past 50 years continue into the future, we see that this 
industry is headed for trouble. Unfortunately, the railroad industry 
has not had enough influence in getting the aforementioned reforms 
accomplished and unless someone steps in to help save the hand that 
feeds many of us, we expect that all of us in the rail industry will 
have to find new industries in which to work.

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    Senator Smith. Thank you very much; very helpful.
    Mr. Rennicke.

       STATEMENT OF WILLIAM J. RENNICKE, VICE PRESIDENT, 
               MERCER MANAGEMENT CONSULTING, INC.

    Mr. Rennicke. Thank you. My name is Bill Rennicke and I am 
a Vice President of Mercer Management Consulting. For the last 
20 years I have been working in the consulting industry and had 
10 years of transportation experience prior to that.
    One of the interesting perspectives I would like to just 
quickly go over today is that we have worked on probably 80 to 
85 percent of all of the railroad restructurings and 
privatizations around the world. It has been kind of a line of 
business as Mr. Davidson and Mr. Rose alluded to, and we have 
exported some of the U.S. railroad freight know-how. We very 
seldom get asked to help with passenger issues around the 
world.
    In doing that, we spend a great deal of time benchmarking 
and looking at the U.S. railroads. Quite frankly, they are 
really the standard, not only the standard for productivity but 
for rate per ton-mile efficiency and overall contribution to 
the economy as well.
    Some of the material that I prepared for you has been 
covered by some of the earlier witnesses, so I will skip over 
it. But I think there are a couple of very important issues. 
Since Staggers, the input cost that the railroads must pay for 
fuel and labor, et cetera, has virtually doubled. They are 
paying twice as much today. Whether you argue that the rate 
decrease has been 20 percent, 40 percent, or zero percent, 
there is still about a 100 percentage point gap between where 
inflation went had there been no productivity or efficiency 
changes and where the freight rates have gone.
    So a great part of that has been a transfer back to the 
shippers. In fact, we went back and looked at the rates since 
1987 and about 80 percent of all of the productivity 
improvements that were generated by the railroads during the 
period went either to shippers or to car leasing companies and 
other suppliers who basically provided some resources.
    The comments today about the capital requirements are very 
important. Some of the biggest failures in railroads around the 
world are due to the lack of capitalization. We are, along with 
Canada and Mexico, the only economy in the world where the 
predominant investment in railroads comes from the private 
sector. We are the envy of the world. Others have tried it and 
in a few moments I will cover where I think some of the issues 
have been, for example, in some of the European railroads, to 
get at one of the questions that you brought up.
    We believe that the railroads need to spend about $6 to $8 
billion a year every year on capital investments. This year, at 
$5 billion, they are about 20 percent short of the mark. We 
think the short lines, including your constituents, probably 
need to spend something in the range of $500 million to a 
billion dollars to get their infrastructure and right-of-way up 
to a condition that is useful.
    I would like to spend a few moments going over the 
experience in the U.K. Unfortunately, on the day I submitted 
all the documents to you I received a news article and some 
information on some recent events there, but I think it is very 
telling and something that we should perhaps think about.
    In 1992, I was fortunate to participate in a session 
arranged by an entity called the Ditchley Group, that talked 
about how privatization of the freight rail system in the U.K. 
should work. I met at the time with Malcolm Rifkin, the 
Secretary of Transportation there. Their vision and the vision 
to this day is that they wanted no bottlenecks, they wanted 
perfect competition, they wanted every customer to have the 
ability to have the right to either use the railroad that was 
the incumbent or any other.
    So their initial view was to have 100 or 200 individual 
origin-destination pairs with big traffic concentrations go to 
the private sector. One of the things we pointed out to them, 
that while that level of competition was probably good in some 
industries and might work in some areas, that once you 
interjected that level of competition and you have asset lives 
in the 15 to 25 to 30 year range, we felt very few parties 
would bid for the concessions or the privatizations to start 
with; or, two, once the bids came in, it was unlikely that a 
lot of private companies would invest.
    In 1993, we were able, I would say as a minority, to 
convince them to create only three freight companies, although 
those three freight companies would face unlimited competition 
from every shipper, at every point in the system. In 1994 they 
hired one of the largest investment bankers in the world, not 
Mr. Valentine's firm, to sell the freight franchises. In an 
entire year scouring the world, they got no takers, zero, 
because when a private sector party or investor would look at 
that situation they could see great opportunities to come in 
and make maybe short-term profits, but the amount of money you 
would have to pay to take those lines was excessive.
    A year later, a new investment banker who replaced the 
first one came to us and said: We have still yet to find one 
party who would invest or even bid on these; would you help us? 
We were able to find two U.S. companies, Wisconsin Central and 
Omnitrax, to bid on the British freight franchises. In the end, 
Wisconsin Central won. It formed a company called EWS. But the 
only way that it would take those freight railroads was if it 
could buy all three. So it bought all three for a very low 
price. To show you, it paid 44 cents for every revenue dollar 
for those concessions or those freight businesses in that 
privatization. Mercer managed the privatization of the Mexican 
railroads. We received between $3.50 and $4.50 for every dollar 
of revenue in a much less stable and more difficult economy. 
But the difference was that in Mexico there was a certain 
degree of exclusivity, but still competition, like the North 
American system, so the market valued it more.
    I think time went on and, just to close here, one of the 
most telling things was that the vision of having a basically 
unsubsidized business, competition everywhere, really seems to 
have failed. Last, on the 3rd of this month the British 
government, through the Strategic Rail Authority, announced 
that is is going to put about 4.5 billion U.S. dollars--and 
this we believe is the first installment--to build freight 
infrastructure and, oddly enough, to provide direct subsidies 
to shippers, who should be advantaged by having 2, 3, 4, 5, 10 
or 20 carrier opportunities knocking at the door in every case, 
to try to shift some of the freight back to rail. They have 
lost several points of market share and the system is in 
relatively poor condition.
    This is riding on an infrastructure that, while it is a 
private corporation, is indirectly subsidized through the 
subsidies that get paid to the 22 passenger operations, and 
thus ultimately trickles back to rail traffic.
    So I would say just in closing that the whole issue of 
attracting capital, holding capital, having the private sector 
provide the capital and the know-how and the infrastructure to 
run these businesses is a very delicate issue and the 
regulatory structure dictates very strongly how you do it and 
how successful you are. We happen to think--and in 20-some 
instances around the world have suggested--that the North 
American, not just the United States but the Canadian, model is 
the preferable way to do that.
    Thank you.
    [The prepared statement of Mr. Rennicke follows:]

      Prepared Statement of William J. Rennicke, Vice President, 
                   Mercer Management Consulting, Inc.

    I have 30 years of experience consulting to the transportation 
industry on a wide range of regulatory, economic, litigation, and asset 
management issues. I specialize in transportation strategic planning, 
management, marketing, economics, and operations, and have particular 
expertise in restructuring, organizational redesign, and transactions 
to improve financial and operating performance of transport operators 
around the world. I have previously provided expert testimony on the 
state of the North American rail industry on several occasions before 
the U.S. and Canadian legislatures. I have also directed the analysis 
of the competitive effects of transactions before the FTC and DOJ. My 
individual qualifications and experience in the railroad industry are 
set forth in Section III. Selected qualifications and experience of 
Mercer are set forth in Annex B.
    My purpose in preparing this statement is to provide the Committee 
with Mercer's perspective on the state of the railroad industry, 
including its current financial conditions and transformation since 
enactment of the Staggers Rail Act of 1980, infrastructure capacity and 
its impact on rail service, and long-term capital funding needs. My 
testimony is based on experience working with many of the largest North 
American railroads as well as their suppliers and customers.
    I would like to make four points before the Committee today. 
Several of these points are updates of testimony Mercer provided the 
Senate and the House in 1999. In making these points, I will refer to 
the supporting visual materials in Section II of the document before 
you.
    1. Deregulation has created an efficient and competitive rail 
industry and has benefited shippers, consumers, and the economy as a 
whole.
     Since the implementation of the Staggers Act in 1980, U.S. 
railways have become more competitive, innovative, and efficient.
     Operating ratios for the ``Big Four'' Class I railroads 
remain positive; volume has been growing strongly; and rail 
productivity has improved substantially in the two decades following 
deregulation.
     However, average revenues per ton-mile for major 
commodities in which railroads have a high market share were 
essentially flat or declining in the 1990s.
     Most of the cost savings from deregulation have been 
shared with customers, suppliers, and other transport companies in the 
form of rate reductions.
     By increasing the efficiency and reliability of railroads, 
deregulation has driven down the cost to the economy of moving and 
managing goods.
    2. Despite significant productivity and service improvements made 
over the past two decades, the industry faces many challenges to 
continued success.
     Rate declines coupled with unit cost inflation have 
continued to expand a large ``rate-cost'' gap for the railroads. 
Productivity improvements have been key to continued rail viability.
     Rates of productivity improvement now appear to be 
slowing. Railroads are running out of traditional sources of 
productivity improvement.
     While facing rate pressure on major bulk commodities, 
railroads are also being challenged by customers to improve on-time 
performance for merchandise traffic. Continued service improvements 
will require higher levels of capital investment.
     For example, most of the Class I railroads are investing 
in assets and facilities to meet the growing demand for intermodal 
service, particularly stacktrain (doublestacked rail) service.
     Total Class I rail capital expenditures have risen from 
$4.5 billion in 1990 to $6.6 billion in 1999--an increase of 49 percent 
in real (inflation-adjusted) terms. Even larger capital expenditures 
will be required, however, for capacity expansion and new efficiencies 
that will enable railroads to cope with the continuing fall in revenue 
per ton-mile.
     The current economic environment is increasing investor 
scrutiny of railroad investment. Wall Street suggests that railroads 
may start looking to the government to assist with infrastructure 
funding as they get more pressure from shareholders to increase free 
cash flow.
     Traditional productivity improvement is not rising fast 
enough to maintain railroad values in financial markets.
    3. A stable regulatory environment is required to ensure the health 
of the industry and the continued flow of private capital.
     The regulatory environment is examining issues surrounding 
merger policy and access regulation which could have both negative and 
positive impacts on railroads.
     Wall Street and rail executives emphasize the paramount 
importance of predictable and growing cash flows. The introduction of 
regulatory uncertainty can disrupt the stability and growth of rail 
industry cash flows and correlate directly to stock prices.
     Experience in other countries has shown that so-called 
``competitive access'' regimes can often leave the rail infrastructure 
owner inequitably at risk for the layers of cost involved in providing 
competitor access to its network, with consequent impacts on the 
owner's ability to recover value from its assets.
     The U.S. and Canada are the only countries in which the 
private sector is primarily responsible for providing infrastructure 
and equipment. Elsewhere, experiments in regulatory change that move to 
greater levels of competition have disrupted normal investment cycles 
and led to increased government intervention and subsidy.
     In the United Kingdom, the government just announced that 
it would provide an additional 3.4 billion pounds in funding for the 
rail freight network and would cut access charges in half over the next 
decade to try to reverse a loss of freight from rail to road (rail's 
share of the freight transport market has dropped to a new low of 6-7 
percent).
     The tragic mistakes made in utility deregulation in 
California have led to increased financial involvement by the public 
and investor uncertainty in the sector.
     Uncertainty surrounding the possibility of open access and 
the impact of new STB merger rules will make it even more difficult for 
Wall Street to reward additional investment through higher stock 
prices.
    4. Commercial alliances between railroads and third parties will be 
needed to fuel additional substantive productivity gains for the 
railroads.
     With historical drivers of productivity improvement 
becoming tapped out, railroads are likely to turn to extended business 
partnerships and strategic alliances (short of merger) in order to 
create new value.
     By ``unbundling'' the rail value chain, railroads can 
identify partner companies that may be more efficient providers of 
distinct services or more appropriate owners of distinct assets.
     Alliances can be formed between a railroad and another 
railroad; directly between a railroad and a third party (such as a 
supplier); or between a railroad and an intermediary (such as a 
financial investor).
     Because direct railroad-to-railroad collaboration can be 
difficult to execute, indirect collaboration through intermediaries 
(either traditional or new Internet-based intermediaries) is often 
easier.
     The largest potential to create value for railroads will 
likely come from alliances with third parties, including equipment, 
infrastructure, and facility providers; financial institutions; and 
technology and e-commerce providers. Other asset intensive industries 
(e.g., airlines) have already demonstrated the potential for alliances 
between buyers and suppliers.
     Railroads are now looking to suppliers for innovative ways 
to ease capital investment levels and increase productivity. To capture 
these opportunities, suppliers will have to take larger stakes in the 
rail value chain and develop closer working relationships with 
railroads.
     Value-creating business alliances will become more 
critical for railroads and suppliers if the economic slowdown 
continues.
     Railroads will likely follow the example of successful 
multi-party alliances in other industries such as aviation, ocean 
shipping, and technology where traditional functions of the vertically 
integrated companies are now shared with vendors.
     After their successful turnaround in the 1980s, railroads 
are once again at a crossroads between a ``railway renaissance'' and 
renewed decline.

    Senator Smith. Thank you.
    Dr. Zarembski.

      STATEMENT OF ALLAN M. ZAREMBSKI, Ph.D., PRESIDENT, 
                   ZETA-TECH ASSOCIATES, INC.

    Dr. Zarembski. Thank you, Mr. Chairman. I am pleased to 
have the opportunity to speak with you today on the subject of 
infrastructure investment needs for the U.S. railroads. My name 
is Dr. Allan M. Zarembski and I am President of Zeta-Tech 
Associates, Inc., a technical consulting and applied technology 
company specializing in the railway industry. I have over 25 
years of professional experience in the area of railroad track 
engineering.
    One of my specific areas of expertise is the degradation 
and failure of the railroad track structure and its key 
components. I have been an industry leader in the analysis of 
track component life and in the development of infrastructure 
maintenance management tools. I am also one of the team of 
experts being brought over to the U.K. and elsewhere to solve 
some of the current problems. Since 1984, Zeta-Tech has 
developed and implemented maintenance planning models for 
numerous railroads in the United States, Canada, and overseas.
    My purpose today is to discuss two separate studies which 
we performed which examined the investment needs of the U.S. 
railroad industry for maintenance of its track infrastructure. 
Last year, Zeta-Tech undertook a study for the American Short 
Line and Regional Railroad Association to determine the capital 
requirements of the approximately 550 short line and regional 
railroads. These are the railroads represented by the Oregon 
group which testified earlier.
    This study was partially funded by the Federal Railroad 
Administration. Its focus was to determine the level of capital 
investment needed by short lines and regional railroads to 
safely handle the new generation of heavier freight cars. While 
their current track structure is generally adequate for 
traditional 263,000-pound railroad cars, it is often inadequate 
and potentially unsafe of the new generation 286,000-pound 
cars.
    Zeta-Tech performed an analysis that determined where major 
component renewals might be required on the 50,000 track miles 
operated by short lines and regional railroads. Our conclusion, 
which was recently presented in testimony before the House 
Ground Transportation Subcommittee, was that an investment of 
$6.9 billion would be required in track and bridges for all 
short lines to be able to safely handle this new generation 
286,000-pound cars.
    In a separate study currently being conducted for the 
Association of American Railroads, Zeta-Tech is determining the 
infrastructure investment needs for the Class I railroads. This 
analysis looks at capital investments in track, bridges, and 
signals, as well as ongoing infrastructure maintenance 
requirements. Its purpose is to identify the steady state level 
of spending. This is defined as the constant level of 
investment required to maintain the existing fixed plant in its 
present condition.
    For Class I railroads, this represents a track condition 
that has already been upgraded to handle the new generation 
286,000-pound cars on most main and secondary lines. 
Furthermore, this upgraded level of track condition is 
significantly better than it had been in the 1970s and the 
1980s.
    Zeta-Tech utilized its engineering-based analysis models to 
calculate the Class I railroads' required annual level of 
capital investment. It also calculated the level of 
infrastructure maintenance required. Preliminary results 
indicate that the annual level of spending required by Class I 
railroads exclusive of short lines and regional railroads is of 
the order of $8 billion a year for track, bridges, and 
structures.
    Of this, Zeta-Tech calculates the required steady state 
capital investment portion to be $3.2 billion a year. In 
addition, the non-capital maintenance expenses was determined 
to be $4.5 billion, for a total approaching $8 billion a year. 
Zeta-Tech believes this level of investment is necessary over 
the long term to maintain the Class I network at its current 
condition for safe and efficient operations. Any reduction in 
this level of investment over time will result in a 
corresponding reduction in the quality of the infrastructure. 
In the case, both safety and service would suffer.
    Furthermore, any investment for expansion of capacity to 
accommodate additional inter-urban or commuter rail service or 
more and heavier freight trains are above and beyond this level 
of spending.
    To summarize, the results of recent Zeta-Tech studies 
showed that the major U.S. Class I railroads must spend on the 
order of $8 billion annually to maintain their track, bridges, 
and signals in their current condition. This is independent of 
any expansion of capacity or introduction of new service. In 
addition, the short lines and regional railroads need 
approximately $6.9 billion as a one-time capital upgrade cost 
to upgrade their physical plant to allow for safe, efficient, 
and long-term operations with this new generation of railroad 
equipment now in use on the Class I railroads.
    Thank you for the opportunity to testify before the Subcom-
mittee.
    [The prepared statement of Dr. Zarembski follows:]

       Prepared Statement of Dr. Allan M. Zarembski, President, 
                       Zeta-Tech Associates, Inc.

    Mr. Chairman and Members of the Committee: I am pleased to have the 
opportunity to speak to you today on the subject of infrastructure 
investment need for U.S. railroads.
    My name is Dr. Allan M. Zarembski and I am president of Zeta-Tech 
Associates, Inc., a technical consulting and applied technology company 
specializing in the railway industry. I have over 25 years of 
professional experience in the railway industry and have expertise in 
the areas of track and track component behavior and failure, 
degradation analysis, railway operations, maintenance, and the dynamic 
interaction between railway vehicles and the track structure. I am the 
former Manager of Track Research of the Association of American 
Railroads where I directed the railroad industry's research program in 
the area of track and structures, as well as former Director Research & 
Development for several major railroad industry suppliers. I have been 
president of Zeta-Tech Associates, Inc. since 1984 when I founded the 
company. I have a Ph.D. and MS in Civil Engineering from Princeton 
University and a Masters and Bachelor degree in engineering from New 
York University. I am registered as a Professional Engineer in five 
states. I am the author of over 90 technical publications and an 
additional 130 published articles, all in the area of railroad 
engineering. I am author of the book Tracking R&D Research & 
Development and was the recipient of the 1992 Rail Transportation Award 
of the American Society of Mechanical Engineers. I am a Fellow of the 
American Society of Mechanical Engineers. My complete CV and list of 
publications is attached to this testimony.
    One of my specific areas of expertise is the degradation and 
failure of the railroad track structure and its key components. I have 
been a leader in the analysis of the life of the key railroad track 
components and in the development of maintenance management and 
planning tools for the prediction of railroad capital and maintenance 
needs. Zeta-Tech has developed and implemented maintenance planning 
models for railroads since the late 1980s and our models have been 
applied on virtually all of the major U.S. and Canadian railways as 
well as numerous railways overseas. Our methodology for assigning the 
costs of maintaining a shared right-of-way to the various users 
(accepted by the Interstate Commerce Commission in 1995) has been 
applied extensively in North America and Europe.
    My purpose today is to discuss two separate studies which examine 
the investment needs of the U.S. railroad industry for maintenance of 
their infrastructure.

                          I. EXECUTIVE SUMMARY

    Last year, Zeta-Tech undertook a study for the American Short Line 
and Regional Railroad Association (ASLRRA) to determine what was the 
capital requirements needed by the approximately 550 short line and 
regional railroads to allow them to operate the new generation heavy 
axle load railways cars safely and cost-effectively on an ongoing, long 
term basis. This study was partially funded by the Federal Railroad 
Administration through a cooperative agreement with the American Short 
Line and Regional Railroad Association. While the current level of 
track and structures is generally adequate for traditional railroad 
cars that weigh up to 263,000 pounds (and have 33 ton axle loads), is 
it often inadequate and potentially even unsafe for the new generation 
286,000 pound cars with 36 ton axle loads. This 9% increase in load can 
translate into damage to the track structure that is as much as 20% 
higher than that caused by the ``standard'' 263,000 pound car. This has 
led to concerns by the short line and regional railroads about the 
ability of their current infrastructure to effectively handle this new 
traffic. These railroads are also concerned about the potential cost of 
upgrading their fixed plant (track and bridges) to handle cars of this 
weight on a long term business basis.
    Zeta-Tech developed a model that took account of traffic volume and 
operating speed in determining where major component renewals might be 
required on the 50,000 track miles operated by short line and regional 
railroads. Our conclusion, which I presented in testimony before the 
House Ground Transportation Subcommittee of the Transportation 
Committee earlier this year, was that an investment of $6.86 billion 
would be required in track and bridges if all short lines were to be 
able to safely handle 286,000 lb. cars.
    In a separate study that we are currently conducting for the 
Association of American Railroads, Zeta-Tech is determining the capital 
investment needs of Class I railroads in the United States.\1\ This 
analysis looks at capital investment in track, bridges, and signals, 
and also quantifies maintenance of way expenses (the non-capitalized 
portion of track maintenance). The purpose of the analysis is to 
identify a ``steady state'' level of spending. This is defined as the 
constant level of investment required to maintain the existing fixed 
plant in its present condition.
---------------------------------------------------------------------------
    \1\ This is a regulatory classification, for railroads having more 
than $258.5 million in revenues in 1999.
---------------------------------------------------------------------------
    For Class I railroads, this represents a track condition that has 
already been upgraded to handle the new generation 286,000 lb. heavy 
cars on most main and secondary lines. Furthermore, this upgraded level 
of track condition is significantly better than it had been in the 
1970s and 1980s.
    Looking at the distribution of traffic, track condition, and 
topography, Zeta-Tech utilized its engineering based analysis models to 
calculate the Class I railroads' required annual level of capital 
investment. It also calculated the corresponding level of 
infrastructure maintenance required. Preliminary results indicate that 
the steady state level of spending required by Class I railroads, 
exclusive of short lines and regional railroads, is of the order of $8 
billion per year for track, bridges and signals. This includes both 
capital and maintenance expenditures.

    II. DETERMINING INVESTMENT NEEDS USING ENGINEERING BASED MODELS

    The U.S. Class I railroads operate and maintain more than 168,000 
miles of track (this figure includes main and branch lines as well as 
yard and industry trackage). Short line and regional railroads 
(regulatory Class II and Class III companies) own and maintain about 
50,000 track miles. Total network size is thus about 218,000 miles. All 
of this track must be maintained in safe operating condition.
    The major components of the railroad's infrastructure consist of 
the track structure itself, which includes the rails, ties, ballast, 
and special trackwork. Also included are the bridges, signals, and 
structures. Many of these major components of the infrastructure are 
subject to wear and tear under railroad operations, specifically the 
passage of the railway cars over the track. This includes all of the 
major track components.
    On the higher density main and secondary lines, these track 
components will ``wear out'' after the passage of millions of tons of 
train traffic and require replacement. This replacement is performed 
independently for these track components at the end of each component's 
useful life.
    The lives of the major track components are determined primarily by 
the volume of traffic, secondarily by factors such as axle loads, 
operating speed, curvature and grade, and environment. To remain in 
business, railroads must replace these components at least as fast as 
they wear out. There is a good indication that railroads are doing this 
in the safety statistics published by the Federal Railroad 
Administration. Track related railroad accident rates have been 
declining for more than ten years. This is due in part to the generally 
good condition of the fixed plant on the Class I railroads. The fixed 
plant today is certainly in better condition than it was in the 1970s 
and 1980s.
    The relationship between traffic volume and the mechanisms that 
determine the life of track components (wear and fatigue for rail, 
mechanical deterioration and environmental decay for ties, and the same 
for ballast/surfacing) can be quantified. It is possible to construct 
models that will calculate the life of track components if information 
can be provided on traffic volume and other track and traffic 
characteristics such as speed and axle load, curvature, and the type, 
age, and condition of track components.
    Zeta-Tech has constructed such models, and has successfully applied 
them for railroads both in the United States and abroad. Since these 
models calculate the life of track components, they can also be used to 
determine the quantities of components that must be replaced each year. 
By application of appropriate unit costs, the size of the annual 
investment required to maintain a railroad in its present condition may 
be calculated.

           III. CLASS I ``STEADY STATE'' INFRASTRUCTURE NEEDS

    Railroad investments in track components (especially rail and ties) 
are long-term investments. Surfacing may be required every one to ten 
years (depending on such factors as climate, volume of traffic, and 
ballast and subgrade conditions), ties last 10 to 40 years (or more, in 
dry climates on tracks with low traffic), and rail can last as long as 
a century on light-density lines.
    The long lives of track components make determination of steady 
state requirements difficult. External factors in the past, such as 
periods of boom traffic, have produced periods of heavy investment in 
track assets. Amounts spent in any given year will depend upon: Past 
investments; Current traffic volumes; Business conditions; Traffic 
expectation.
    Fortunately, when the entire Class I industry is considered as a 
single network, these cycles tend to even out. Selection of a long 
enough time series of data enables an analyst to at least approach an 
estimate of steady state spending. In addition, engineering based 
component life models allow for a more accurate assessment of specific 
component lives and corresponding maintenance cycles. Applying these 
component life models to a large network allows for an accurate 
analysis of long term capital needs.
    As an example of the use of engineering models for determining 
capital needs, Zeta-Tech developed a Capital Allocation Model. As its 
name indicates, it is intended to tell a railroad what quantities of 
components must be replaced each year, on a steady state basis, and the 
associated capital budget required by the railroad to maintain its 
infrastructure investment. Such a model makes use of known component 
life relationships between such key factors as traffic density, track 
structure, and topography (e.g. curvature). These component life 
relationships were developed using Zeta-Tech engineering equations and 
railroad performance data, and they address the key track components of 
rails, ties, ballast, and special trackwork (turnouts, switches, 
crossings).
    The Capital Allocation Model was originally developed to provide a 
railroad with a neutral and scientific method of programming track 
capital renewals for rail, ties, and ballast/surfacing. To do this, the 
model had to properly account for the physical and environmental 
characteristics that determined track component degradation. For each 
of the major component categories (rail, ties, ballast, special 
trackwork) the model incorporates a relationship between traffic 
density and environment, that allows the model to predict component 
life in years and the required date of replacement. In addition to the 
density/environment relationship, the model also addresses other key 
track and geographic parameters such as curvature, a very important 
determinant of rail life.
    The model's mechanism for prediction is to take the component lives 
(in MGT), developed within the model, to obtain an expected life on 
each segment for each combination of traffic density and curvature. The 
relationship between rail life and tonnage is linear, since general 
practice in the rail industry is to express rail life interchangeably 
in either cumulative tonnage or years. However, annual tonnage on many 
segments is low enough to produce improbably long lives for rail. At 
some point, rail must be replaced due to technological obsolescence or 
environmental decay (rust and corrosion) even if no traffic uses a rail 
line. The Capital Allocation Model uses an 80-year maximum life for 
rail, based on Zeta-Tech and industry experience.
    For turnouts, a similar relationship is used. However, maximum life 
of turnouts in main track is set at only 10 years, due to the rapid 
accumulation of damage from the passage of heavy axle load traffic. For 
ties and ballast, relationships can be nonlinear, particularly at lower 
traffic densities. This is due to the substitution of traffic damage 
for environmental decay as traffic increases. Again, however, a maximum 
life in years is established, due to the effects of environment on low-
tonnage lines.
    The model then uses the above component life relationships and 
costs to predict, for each segment in the database, a life for each of 
the component categories (rail, ties, ballast/surfacing, and turnouts). 
Using these lives, and standard unit costs the model produces the 
following:
     Steady state renewal requirements for each component (in 
units);
     Steady state capital budget requirements (in $), by 
component, category; and
     A total capital cost for steady state track component 
renewal.
    For the Association of American Railroads, Zeta-Tech applied its 
Capital Allocation Model to a database of all Class I railroad track in 
the United States to determine the capital investment required to 
maintain the fixed plant in its present condition. The network database 
used was that of the U.S. Class I railroad industry prepared by the 
Volpe National Transportation Center at Cambridge, MA. This model 
consists of more than 8,000 line segments.
    Zeta-Tech used engineering model based track component lives for 
new rail, secondhand or ``relay'' rail, ties, and ballast/surfacing in 
modeling required capital investment. Engineering models such as Zeta-
Tech's capital expenditure model predict component renewals that should 
be needed, taking into account annual tonnage and track geometry. 
Actual trackwork performed will vary from year to year, due to factors 
previously mentioned: traffic volume, the financial health of the 
industry, and the age distribution of rail and turnouts already in 
track.
    Therefore, statistics on historical renewal rates have been used to 
calibrate the Zeta-Tech model's predictions.
    The product of Zeta-Tech's model application to the database of 
track segments making up the Class I railroad industry is an estimate 
of the component replacement requirements necessary to maintain the 
network in its present condition.
    In addition, supplemental analyses were performed to determine the 
maintenance of way expenses, i.e. the non-capitalized portion of track 
maintenance, as well as the capital costs associated with bridges, 
signal systems, and other related infrastructure components. In the 
case of the maintenance of way operating expenses, these analyses 
examined the relationship between these expenses and such key 
parameters as miles of track and ton-miles of traffic carried. As with 
the capital investment analysis, the focus was on defining the level of 
outlays necessary to maintain the railroad's infrastructure in the 
condition it is in today.
    This analysis, which is not yet complete, will provide an estimate 
of the ``steady state'' infrastructure investment requirements of the 
Class I railroad network. Preliminary results indicate the following:
     Replacements of rail, ties, ballast, and turnouts, and 
performance of miscellaneous related activities such as rail grinding 
and welding, were estimated to require $2.7 billion annually.
     Estimated expenditures on bridges and signals add another 
$500 million.
     Maintenance of way operating expenses represent an annual 
cost of approximately $4.5 billion.
     Zeta-Tech estimates that a total approaching $8 billion 
annually, or about $46,000 per track mile, must be spent annually to 
maintain Class I railroads in their current condition.
    The total does not include funds spent on additional passing 
sidings, double track, or other measures to increase capacity.

      IV. UPGRADING SHORT LINE INFRASTRUCTURE FOR HEAVY AXLE LOADS

    In order to take advantage of the economic benefits offered by a 
new generation of heavy axle load freight cars, the Class I railroads 
began to upgrade their track structure to handle these cars in the late 
1980s and early 1990s. As such, their current track structure, 
particularly their main lines and major secondary and branch lines 
which are constructed with heavy rail sections and adequate ties and 
ballast, are capable of handling these heavy cars.
    Unfortunately, the track on Class II and Class III railroads is not 
in the same condition as Class I track. Many small railroads were 
organized to operate branch lines no longer needed or wanted by Class I 
railroads. Often, these lines were in relatively poor condition when 
the short line began operations.
    With about 50,000 miles out of the total US railroad network's 
218,000 miles, these short line and regional railroads represent just 
under one quarter of the US network. Yet their revenues represent less 
than 10% of the railroad industries gross revenues. As such, they have 
significantly less revenue per mile to maintain their track, resulting 
in a track structure that is often well below the standards of the main 
lines of the major freight railroads. Nevertheless, their physical 
plant must be capable of handling the heaviest freight cars allowed in 
interchange on North American railroads.
    While the current level of track and structures is generally 
adequate for traditional railroad cars with 33 ton axle loads, is it 
often inadequate and potentially even unsafe for the new generation 
286,000 pound cars with 36 ton axle loads. The result is a significant 
potential cost to short lines for upgrading their fixed plant (track 
and bridges) to handle cars of this weight.
    Last year, Zeta-Tech Associates performed an assessment of the 
capital needs of the short line and regional railways to operate the 
new generation heavy axle load railways cars. This analysis was 
sponsored by the American Short Line and Regional Railroad Association 
and partially funded by the Federal Railroad Administration. The 
analysis quantified the total investment required of short line and 
regional railroad industry to ensure the safe, long-term operation of 
heavier freight cars. Many short lines now operate over marginal track, 
and while it is possible to maintain operations under such conditions, 
it is neither safe nor economical to operate in this manner over the 
long term. Therefore, the objective of this analysis was to make an 
engineering-based estimation of how much trackage meets a defined set 
of minimum criteria for operation of 286K cars and how much does not. 
Based on that analysis, the amount of component replacements required 
to bring the whole short line and regional railroad industry to an 
level of track condition adequate for safe, long term operations of the 
heavier cars was determined. This, in turn, was then used as the basis 
for the determination of the capital needs of the short line and 
regional railroad industry.

Analysis Methodology
    The analysis approach used in this study was structured so as to 
allow for the evaluation of the capabilities of the track and bridge 
structures to handle the increased car weights for a large data set of 
short line and regional railroad information. The approach therefore 
combined engineering analysis and heavy axle load experience to create 
a series of evaluation steps to determine the adequacy of the track and 
bridges based on key component size and condition information.
    In order to avoid the need to collect data from all 550 railroads, 
a sampling approach was used to collect in depth information from a 
representative group of short lines. This data, and the analysis 
results, was then generalized to the entire short line and regional 
rail industry. The target sample size for this analysis was 55 
railroads and 5,000 route miles, or about 10% of the railroads and 10% 
of the track mileage in the industry.
    In all, complete data was received from a total of 46 railroads, 
with 4,742 track miles. The 46 railroads in the sample ranged from 
small switching roads to medium-sized regional railroads distributed 
throughout the United States. The data collected was representative of 
the short line industry.
    Following assembly of the database of track characteristics and 
condition, Zeta-Tech engineering models were used to determine the 
minimum track standards required to handle 286K cars. Using its 
proprietary engineering models, Zeta-Tech constructed a series of logic 
matrices in which each category of track component (rail, ties, 
ballast, turnouts) was evaluated as to its suitability to carry 286K 
loads in service. Using these individual component analyses, and their 
interactions, the combinations of components that were adequate, 
marginal, or required replacement in order to safely handle the heavier 
cars was determined as a function of speed and traffic density.
    Logic matrices were developed for rails, ties, ballast, and 
turnouts, at different speed and density ranges. These were then 
applied to the data base of short line and regional railroad 
conditions.
    Output of the Zeta-Tech analysis was a total amount of component 
replacement required, in terms of:
     Rail (track miles of rail required)
     Ties (number of required to achieve adequate condition and 
total mileage of track requiring tie renewals)
     Ballast (total track miles of ballasting required)
     Surfacing (performed whenever ballast is required)
     Turnouts (installed with rail), total number replaced
    The quantities of rail, ties, ballast/surfacing, and turnouts 
required to handle 286K cars were then translated into dollars by use 
of standard costs for component replacements and other maintenance 
activities.
    A separate analysis was also performed for bridges. Bridges had 
been identified as a potential problem in several previous heavy axle 
load studies by Zeta-Tech for Class I railroads. Therefore, they 
represented an area of potential concern that needed to be addressed. 
Since bridges are individual and unique, there is really no substitute 
for a detailed inspection of each. Nevertheless, an attempt was made to 
estimate the cost of needed bridge upgrading and replacement.
    Based on information received from the sampling of short lines and 
regional railroads, a percentage distribution of bridge condition was 
developed. Multi-year budgets for bridge maintenance and rehabilitation 
prepared by a number of short lines were used in developing a cost of 
bridge repair for bridges in marginal condition. These represent 
expenditures needed to render bridges capable of handling 286K loads. 
Bridges in ``poor'' condition were assumed to require complete 
replacement, and standard industry costs were used in developing 
replacement costs. Calculations were made on the basis of the track 
feet of each type of bridge (wood, steel) on each railroad.

Results
    Applying this analysis approach resulted in a summary of the amount 
of rail, ties, ballast, and turnouts, that have to be replaced to 
accommodate 286,000 lb. cars. In percentage terms, components needing 
replacement in the Zeta-Tech sample (and, by extension, the entire 
short line and regional industry) break down as follows:
     Rail: 22% of track miles must be replaced
     Ties: 43% of track miles require at least some ties
     Ballast/surfacing: 23% of track miles require ballasting/
surfacing
     Bridges: 22% require replacement; 27% require upgrading
    Using the unit costs for track and bridge upgrades/replacements, a 
total replacement cost for each category of expenditure was calculated. 
Table 1 shows the calculated total cost for the sample and its 
extension to the entire short line and regional rail industry.

      Table 1.--Calculated Cost of Upgrading Short Line and Regional Railroads  to Handle 286,000-Lb. Cars
----------------------------------------------------------------------------------------------------------------
                                                                 Required
                          Component                           Investment per    Total Cost        Total Cost
                                                                   Mile          (Sample)         (Industry)
----------------------------------------------------------------------------------------------------------------
Rail........................................................         $75,106    $356,150,175      $3,754,182,002
Ties........................................................         $16,372     $77,636,048        $818,362,236
Ballast/Surfacing...........................................          $2,657     $12,597,440        $132,789,720
Turnouts....................................................          $7,882     $37,377,454        $393,996,056
Bridges.....................................................         $35,236    $167,085,889      $1,761,253,773
Total.......................................................        $137,253    $650,847,006      $6,860,583,787
Track Mileage...............................................                           4,742              49,985
----------------------------------------------------------------------------------------------------------------

    A comparison of the per mile costs develop in the Zeta-Tech 
analysis with two recent studies performed by the Kansas and Iowa 
Departments of Transportation provided additional support for the Zeta-
Tech estimates. The Zeta-Tech estimate for track upgrading lies between 
the Kansas and Iowa estimates.
    The Zeta-Tech analysis uses new material costs, since there are 
simply not enough secondhand track materials to support a track upgrade 
program of this size (involving railroads with almost 50,000 track 
miles, and a total expenditure of close to $7 billion).
    Thus, Zeta-Tech found a need for $6.8 billion in capital investment 
to upgrade short line track for the heavier cars now in operation on 
Class I railroads.

                              IV. SUMMARY

    Analysis of the infrastructure condition of the U.S. railroad 
industry shows that while the Class I railroads track and structures 
are adequate for current operations, the smaller short line and 
regional railroads require significant capital outlays to enable them 
to operate the new generation of heavy axle load freight cars. 
Furthermore, the Class I railroads still require major capital outlays 
simply to maintain their infrastructure in its present condition.
    Using its engineering based analysis models, Zeta-Tech calculated 
the Class I railroads' required annual level of capital investment 
needed to maintain its infrastructure. It also calculated the 
corresponding level of infrastructure maintenance (non-capitalized) 
required.
    Preliminary results indicate that the steady state level of 
spending required by Class I railroads, exclusive of short lines and 
regional railroads, is of the order of $8 billion per year for track 
and structures. This is based on a level of track condition that has 
already been upgraded to handle the new generation heavy cars. and 
which is significantly better than it had been in the 1970s and 1980s.
    Zeta-Tech believes this level of investment is necessary over the 
long term to maintain the Class I network in its current condition. 
However, any reduction in this level of investment over time will 
result in a corresponding reduction in the quality of the 
infrastructure. In that case both safety and service would suffer.
    Furthermore, any investments for expansion of capacity, to 
accommodate additional interurban or commuter rail service, or just 
more and heavier freight trains are above and beyond this level of 
spending. Thus, introduction of even heavier freight cars, such as the 
315,000 lb. cars currently used on the mining railroads of Western 
Australia, will likewise increase the required level of capital outlays 
for track and structure.
    In the case of the short lines and regional railroads, the current 
level of capital spending is not adequate to maintain their fixed 
plant. The Zeta-Tech study that established the capital needs for 
operation of 286,000 lb. cars also revealed that much of the rail on 
these railroads was old, many of the bridges were of marginal capacity 
or in poor condition. In general it determined that significant 
investment would be required even to return the network to a state of 
good repair capable of handling the current generation of heavy freight 
equipment now being operated by the Class I railroads.
    The results of the Zeta-Tech study showed that short line and 
regional railroads need a one time investment of approximately $6.86 
billion to upgrade their physical plant to allow for safe, effective, 
and long term operations under the new generation of railroad equipment 
that has been introduced into the industry.
    Of this, more than 50% is for the replacement of rail. This is in 
line with Class I experience, where rail is always the largest track 
maintenance cost area. Smaller railroads, with lighter tonnage and more 
limited resources, have continued to use rail that would be removed 
from track by larger railroads. Thus, 22% of the rail on these smaller 
railroads need to be upgraded. Likewise, tie condition on these short 
lines and regionals is only fair, and the heavier 286,000 lb. cars 
demand better tie condition, in order to spread the 36 ton axle loads 
from rail to subgrade. Thus 43% of short line track miles need at least 
some ties. Likewise 23% of track miles require addition of ballast and 
surfacing to improve them for heavy axle loads.
    There are also many miles of timber trestles on these rail lines. A 
large percentage will require increased maintenance, and many in poor 
condition will require replacement, in order to handle heavier cars. 
Steel bridges will also require significant investment to allow them to 
carry 286,000 lb. cars on an ongoing basis.
    Finally, as freight car weights increase toward 315,000 lbs., as 
governments implement additional passenger train service, and as short 
lines are forced to handle heavier cars, railroad infrastructure 
requirements may be expected to increase even more in the future.

    Senator Smith. Did you say it requires $8 billion a year of 
investment?
    Dr. Zarembski. That is correct, that is $8 billion a year 
investment.
    Senator Smith. That is nationwide?
    Dr. Zarembski. That is nationwide for Class I railroads.
    Senator Smith. What is the investment?
    Dr. Zarembski. What does that consist of?
    Senator Smith. No, I would be interested in that also, but 
what are they currently investing?
    Dr. Zarembski. They are currently investing--last year, the 
last several years, which have been good years financially from 
a revenue point of view for the railroads, actually have been 
investing in that level.
    Senator Smith. At that level.
    Dr. Zarembski. At that level. However, they are starting to 
look at reducing that level of expenditure now, given the 
downturn in the economy.
    Senator Smith. The reason for the reduction is to attract 
the investors that Mr. Valentine says they are losing?
    Dr. Zarembski. Yes. There is a natural tendency to cut 
infrastructure investment if the marketplace, particularly the 
capital marketplace, demands a better return and the returns 
are limited.
    Senator Smith. For the record, the $8 billion, what is it 
spent on?
    Dr. Zarembski. That $8 billion is spent on the railroad 
track itself, rails, ties, ballast, turnouts, also the bridges, 
all of the bridges, the large overhead bridges as well as 
bridges crossing highways, and also the signal system necessary 
to operate the trains on a high capacity line.
    Senator Smith. What are the most likely problems to develop 
on a railroad line if that money is not invested in that 
infrastructure?
    Dr. Zarembski. The major track components simply wear out 
or fatigue out. Take rail would be a good example. Rail is one 
of the really big dollar items on a railroad. It costs 
approximately $350,000 to $400,000 per mile to put in new rail. 
Remember, we are talking about 216,000-218,000 miles of 
railroad track in the United States.
    Senator Smith. Just for the steel?
    Dr. Zarembski. Just for the steel. We are not even talking 
about the ties or the ballast or anything else.
    Senator Smith. Four-hundred-thousand dollars per mile?
    Dr. Zarembski. Per mile, to replace that one mile of rail. 
Now, that rail on a high density main line, if it is placed in 
a sharp curve, may need to be replaced in anywhere from 5 to 10 
years. On a straight piece of track, it may last 20 years. On a 
very light density line, it may last 40, 50, 60 years. But 
certainly in the high usage locations it can last as few as 3 
to 5 years.
    Senator Smith. Is the steel used of a particular grade or 
quality or it will deteriorate or be inadequate to carry the 
load?
    Dr. Zarembski. The railroad steel is actually a very high 
quality steel from a steel practices point of view. In fact, 
there are two different grades of steel that are used right now 
by the railroads. There is a very high grade of steel that is 
used in the very high density lines. Those lines that I 
indicated that wear out very quickly are actually a very hard 
steel that are manufactured specifically for the railroads.
    Then there is a slightly lower grade, which is still 
considered from a metallurgical point of view to be a very good 
quality steel, but it is a little bit less expensive, it is a 
little bit lower quality, where you put into those lines where 
it was going to last 40, 50 years.
    Senator Smith. What makes some steel better than others?
    Dr. Zarembski. Usually the manufacturing process. Usually 
there is a hardening process that goes along with it. There is 
an alloy processing. So in addition to the normal manufacturing 
process, there is usually a second step where you would 
induction harden the head of the rail, for example, is one 
process, where you actually physically take the second step and 
harden the top of the rail.
    Senator Smith. You do that through heat? How do you do the 
hardening?
    Dr. Zarembski. You will do it by electric induction, 
introducing heat of some form into the top of the railhead, is 
one technique.
    Senator Smith. So having a lot of hydroelectric dams is 
sort of important, too?
    Dr. Zarembski. Yes, it is power intensive.
    Senator Smith. We are going from rails to steel to 
hydroelectric power.
    Dr. Zarembski. That is correct.
    Senator Smith. I thought I would take you there as an 
Oregonian.
    Thank you very much. Obviously, you know the subject in 
every detail. Thank you.
    Mr. Kaufman.

             STATEMENT OF KEVIN D. KAUFMAN, SENIOR 
           VICE PRESIDENT, LOUIS DREYFUS CORPORATION

    Mr. Kaufman. Thank you, Senator. My name is Kevin Kaufman. 
I am a Senior Vice President for Louis Dreyfus Corporation, 
which is a diversified privately held multinational company 
that is engaged in bulk commodity handling, including grain, 
oilseeds, frozen concentrated orange juice, OSB, rice, sugar 
processing, shipping, and petroleum refining and natural gas 
exploration.
    The purpose of me being here I suppose is that the nature 
of our business makes us totally transportation-dependent and 
we consider transportation to be a tradeable commodity. 
Transportation information is a value driver for our business. 
Rail transportation is extremely important to the goods that we 
handle. Obviously, the movement of grains, oilseeds, cotton, 
sugar, and rice, depend on a very healthy railroad industry.
    Also, I am a member of the Rail Shipper Transportation 
Advisory Council, which has the responsibility to advise 
Congress on the needs of small railroads and small shippers. So 
there is a natural interest from that responsibility.
    I also think we have a responsibility as citizens to 
support a strong and viable railroad industry simply because it 
is the backbone of future growth of our economy.
    I think, as Professor Higgins said, there is ``trouble 
right here in River City,'' and the evidence abounds. Jim 
Valentine, I think very well described the problem in specific 
economic terms. The industry has problems. Contrary to what the 
other Senator said, I think if you read railroad financials and 
consider what has happened to them in the last 10 years you 
would as an investor, not be attracted, and their stock price 
reflects that.
    Nearly all parties in this debate agree that if nothing is 
done under the current circumstances there probably will be a 
continual erosion of railroad economic health, which will be to 
the detriment of our economy and probably our future quality of 
life. Now, at the same time, as a student of management and 
involved with management, I would also argue that there is some 
evidence that there are some mistakes made by the railroads in 
certain decisions and choices that they made. However, I do not 
believe that the railroad management wakes up every morning and 
asks itself, what can I do in order to lose 50 percent of my 
company's value today, or also I do not think they wake up and 
say, what can I do today to make my customer miserable?
    I would argue always that our economic behavior is rational 
and based upon the environment in which it operates. So I point 
that the problem here is not the ``P'' of ``pool'' like in 
River City, but it is actually government's inconsistent 
policies with regard to transportation, especially the failure 
by government to focus on having a holistic intermodal 
transportation policy.
    I think there has been too much focus on changing 
regulation and attacking the STB. I consider it to be 
counterproductive because it is missing the point. You know, 
the STB is the administrator of policy and frequently the 
message deliverer. They tend to be excoriated for delivering 
the message and the fact that they have to administer policy 
that has been directed to them by Congress.
    I think Chairman Morgan and the STB have been very 
effective and tireless in trying to be focused public servants 
and trying to make a silk purse out of a underfunded and 
underappreciated sow's ear, because they are basically charged 
with administering a kind of a kachi-bachi transportation 
policy. Frankly, the policy they administer frequently is 
inconsistent legislatively and is inconsistent with politics.
    You know, if we look at this, the system right now is 
organized to treat each mode separately. Appropriations are 
separate. Everything is focused separately on each mode of 
transportation. Because there is no intermodal national 
transportation policy, there are frequently economic signals 
that are sent through that are not really what the public 
probably wants to have accomplished.
    The example of this is modal subsidies that create economic 
distortions. You know, at least 21 percent of current railroad 
returns are derived directly from intermodal moves that compete 
directly with trucks. Trucks do not pay the full cost of their 
use of government-funded infrastructure. That is clear. 
Railroads, on the other hand, must cover all their capital 
costs.
    When a truck is parked, it pays zero infrastructure costs. 
To compete, railroads must by definition compete on a price 
basis with those subsidized trucks. Therefore, trucks have a 
cost per unit advantage. The result may be congestion, 
increasing congestion on the highways by ever-larger trucks, 
especially around our major metropolitan centers, which then 
leads of course to a natural call for more funding to solve the 
problem of why we have highway congestion around our cities.
    But the fact is that rail transportation is more efficient 
and environmentally friendly. So why do we make public policy 
that incentivizes congestion and pollution at the expense of 
efficiency? Why is there a fuel surcharge that goes into the 
highway trust fund that the railroads pay?
    The result is that railroads are denied the ability to 
access a large piece of the economic pie. So how do they find 
economic viability? They find it through consolidation and also 
through cutting back service and capitalization. I frankly 
think mergers are a bad idea, but it is a natural effect of 
what they need to do in order to survive economically.
    Prescription? I think we should have an intermodal 
transportation policy that includes focused, across-the-board 
infrastructure investment. I think we need to increase truck 
user fees. I think we need to rescind the fuel surcharge.
    Railroads should also--and this is something that may not 
be within the jurisdiction of your Subcommittee--do themselves 
a favor if they would diversify their boards, which would lead 
to more accountability of their management. Many times I ask 
myself why railroad boards do not have shipper representatives 
on the boards that might perhaps help them to hear another 
message that is being delivered to them.
    I would like to thank you for the opportunity to testify.
    [The prepared statement of Mr. Kaufman follows:]

    Prepared Statement of Kevin D. Kaufman, Senior Vice President, 
                       Louis Dreyfus Corporation

    Chairman Smith and distinguished Members of the Committee: My name 
is Kevin Kaufman. I am a Senior Vice President of Louis Dreyfus 
Corporation (``LDC''), a domestic and international marketer of grain, 
grain products, and other commodities that move by rail, barge, truck 
and ocean carriers. Since 1996, I have served as a member of the 
Railroad-Shipper Transportation Advisory Council (``RSTAC''), which was 
created by the ICC Termination Act (``ICCTA'') to focus on concerns of 
small railroads and small shippers.
    I very much appreciate the opportunity to appear and testify today 
and to present my views on the importance of a financially secure rail 
industry, capable of future growth to meet the needs of an expanding 
U.S. economy.
    LDC is totally transportation-dependent. We treat transportation as 
a valuable commodity whose understanding is one of the key value-
drivers for our company. Not only do we incorporate transportation into 
all of our major trading decisions, but the value of our physical 
assets are also transportation-dependent. We presently operate major 
export grain terminals at Portland, OR, Seattle, WA, the Texas Gulf, 
Port Cartier, Quebec, and throughout Western Canada, as well as a large 
rice milling operation in Southeastern Missouri. In addition, to 
enhance our shipping flexibility, our company operates a substantial 
fleet of our own rail cars.
    As you know, the merger-related rail service breakdowns that began 
in 1997 induced a critical review of railroad performance from a number 
of interested parties, including Congress, the Surface Transportation 
Board (``STB''), and Wall Street. Few have been more critical than I of 
the failure of railroad management to properly value their acquisitions 
and to anticipate the real costs of operationally consolidating the 
merging properties.
    However, having said that, I think that current dialogue must focus 
on the more important strategic question of whether the industry is 
capable of providing the transportation capacity and management 
required to sustain a growing economy. My purpose here today is to 
argue that in spite of the general search for regulatory scapegoats, 
the real issue is a failure to enact consistent, intermodal public 
policy that provides an economic environment in which the rail industry 
can compete.
    Recession is a mask for service performance. And, therefore, it 
would be a mistake to view the apparent lessening of current service 
problems or even the attainment of some service improvements as 
evidence of fundamental, improved structural changes within the 
railroad industry. While management continues to squeeze improvements 
out of their organizations, I do not see any of the major changes to 
their economic operating environment as sufficient to sustain long-term 
industry financial health. Yet the U.S. economy will again begin to 
grow and the demand for commercial transportation of goods and services 
will outstrip railroad industry infrastructure carrying capacity. In 
fact, in my discussions with the various interested parties in the 
issue at hand, while their prescriptions vary widely, most agree that 
failure to address policy issues will result in a deterioration of the 
financial health of the rail industry and have a destructive impact 
upon the U.S. economy. In my opinion, the more important point is that, 
to a large extent, past railroad management behavior was at least in 
part a reaction to the economic signals that government policy was 
communicating.
    The Staggers Act relieved the railroads of much of the down-side of 
regulatory burden that made it difficult for them to maximize the 
opportunities inherent in their franchises. The ability to price 
differentially and to dispose of under-performing infrastructure 
allowed them to significantly reduce their costs per unit. At the same 
time, double-stacking technology and the ability to increase corridor 
density made it possible for railroads to convert under-utilized 
capacity to become effective intermodal competitors. The expectation 
was that not only would intermodal provide the volume necessary to 
consume under-utilized capacity, but it would actually increase the 
railroad market ``pie,'' thereby increasing earnings. Unfortunately, 
while intermodal did provide the additional volume allowing overall 
railroad cost per unit to decline (cross-subsidization), their need to 
price their services competitively with trucks arguably has resulted in 
earnings that failed to fully cover the costs of operation plus the 
significant required investment.
    The railroad industry regards itself as hampered in attempting to 
achieve its goals by the remaining vestiges of regulation and by long-
standing public concepts of the role of common carriers. This debate 
has partially manifested itself through the introduction of several 
pieces of legislation over the past few years. Clearly, it is 
economically inefficient and counter-productive if, on the one hand, an 
industry sometimes behaves as if it has the obligation to supply equal 
service for all consumers, no matter their relative economic cost, and, 
on the other, is required to fully pay for the investment and 
incremental operational cost. There is a significant cost when the 
politics of public policy fail to take into account the economic impact 
of those policies. The point is that the political environment often 
influences uneconomic behavior.
    Therefore, I am here to try to persuade you to consider solutions 
that address the inequities of current public policy. I believe that it 
is long-term counterproductive for public policy to appropriate 
subsidies that essentially disincent the investment in the railroad 
industry. Railroads cannot price their services at levels that provide 
a sufficient return to attract the necessary capital to sustain their 
business where government subsidizes a competing mode.
    Although rail service has inherent advantages that have been 
developed partially and await yet greater development, the rail 
industry, as you know, labors under one big disadvantage; its principal 
competitor, the trucking industry, is the beneficiary of various types 
of government subsidies. In 2000, federal highway spending alone came 
to $27.7 billion, even though the interstate highway system ostensibly 
is complete. To that, add billions more spent by states. The inland 
waterways also are maintained at taxpayer expense. Railroads, on the 
other hand, currently must meet their capital requirements from 
privately-generated funds, notwithstanding the one recent 
infrastructure loan program that still awaits implementation. In 
addition, railroads must continue to pay a ``budget reduction'' fuel 
surcharge that is paid into the highway trust fund, thus further 
benefiting their competition.
    The fact is that modal subsidies provide a significant pricing 
advantage. The simple illustration is that ``a parked truck costs 
nothing'' while the cost of rail infrastructure maintenance and 
depreciation never sleeps. And if 21% of railroad revenues are derived 
from intermodal traffic which directly competes with trucks, then how 
does one argue that modal subsidies do not impact pricing? (And, at the 
same time, how can you argue that there is no competition?) Modal 
subsidies do affect railroad revenues thereby affecting their 
competitive ability to attract capital. Just ask Wall Street what would 
happen to railroad stock prices if trucker user fees were increased.
    In addition, what are the resulting externalities of these 
subsidies? Is not rail a relatively economically and environmentally 
more efficient mover of goods and services over long distances? What 
would happen if these subsidies were changed allowing railroads to be 
more competitive? Would not there be less trucks on the roads around 
our major metropolitan centers? Would there not be additional private 
capital to spend on the antiquated infrastructures surrounding our 
cities, thus providing the means to get goods more effectively from and 
too these major consuming and delivery points?
    The fact is that we cannot have it both ways. We cannot expect to 
have a viable rail transportation system if public policy hampers its 
ability to increase its revenue base while, simultaneously, requiring 
it to be solely responsible for the investment in its infrastructure. 
Therefore, I view our country and our government as approaching a 
transportation policy cross-roads: we need to choose between continuing 
the present policy of private generation of funds for necessary 
railroad infrastructure improvements with myopic modal subsidization, 
and inconsistent, semi-regulatory transportation policy, or develop a 
broad approach that changes the current regulatory and modal-specific 
environment to a broad, inter-modal policy that may include greater 
public participation in focused, infrastructure funding. The choice is 
significant because the consequences are enormous.
    For example, increasingly, in order to compete, the railroads 
continue to consolidate their respective operations so they only 
operate a route structure that fits into their highest-yield operating 
model. Railroads are best at operating single-commodity ``super-
highway'' corridors at high capacity with minimum origins and 
destinations. As soon as multiple origins, multiple commodities and 
multiple routes are added, there is an exponential increase in the 
operating complexity and iterations necessary to provide such service. 
Infinitely worse is the addition of low volume services that increase 
the costs of operation. Therefore, by necessity, they are becoming 
selective, taking steps--big steps--in the direction of abandoning the 
old common carrier concept that the franchise holder must take the good 
with the bad, serve the profitable and unprofitable, and respond to a 
superior public interest.
    The fact is that the railroad industry is simply reacting to the 
economic reality of the status quo. In order for them to generate 
privately the funds that they need to enhance their infrastructure and 
satisfy their investors, they will have to continue taking steps that 
may be unpleasant for many of their customers and, perhaps, for the 
political representatives of those customers.
    In the area of bulk grain transportation, we are in the midst of a 
trend toward large, high volume shuttle trains that operate with 
continuous power between contractually designated destinations and 
origins where the loaders and unloaders have agreed to expedite origin 
and destination handling of the train in return for rate concessions. 
These shuttle trains enable the railroads to offer lower rates where 
the loaders and unloaders are able to make these high speed loading and 
unloading commitments, commitments that require substantial equipment 
and track investments that not all rail customers are willing or able 
to make.
    In this type of a structure, the railroad achieves its goal of 
handling what it perceives to be its market needs over a minimal route 
network making the most efficient use of locomotives, cars, and crews. 
Another benefit realized by the railroad is the concentration on 
infrastructure funding where traffic densities are likely to be 
highest. The result is increasing investment into those lines 
consistently carrying the volume and a reduction in the investment in 
those peripheral tracks that no longer sustain a sufficient return to 
justify the investment. The obvious result is consolidation. And this 
consolidation occurs not only in the track infrastructure but also for 
the customers.
    The company that formerly loaded the grain on the lighter density 
lines may, and probably will, lose business to the high-speed elevator 
that participates in the shuttle program. That high speed elevator, in 
order to attract the large volumes of grain necessary to meet the 
shuttle train volumes, must offer a better price to farmers to induce 
them to sell there, rather than someplace else. In return for that 
better price, the farmers are buying or hiring trucks, bypassing 
smaller country elevators and short line railroads and going directly 
to the new, high-speed terminals.
    This is but one example of the rational decisions that are made 
because of current public policy. There are, as I see it, enough 
segments of society that are impacted by these events in the rail 
industry to suggest that there is a legitimate reason for across-the-
board transportation policy to be considered, rather than just a rail 
industry focus. There is no question that there are serious 
infrastructure issues facing all transportation modes. We read almost 
everyday about infrastructure inadequacies in our airports, air traffic 
control, river systems, highways, ports, and railroads. In the past, 
these issues have been addressed separately and competitively without 
regard to having a national, intermodal transportation policy. The 
situation today is but one example of the unintended consequences of 
addressing the issue en micro.
    To me, the exercise of focusing on one without including all of the 
others results in the huge risk of ``fixing'' one while making the 
whole system worse. In spite of arguments to the contrary, there is 
modal competition and there is huge intermodal impact in the use and 
investment in transportation infrastructure. And the inarguable fact is 
that transportation infrastructure is so costly as to be almost outside 
the reach of the private sector to fully properly maintain and sustain 
adequate investment. Therefore, as part of your look at transportation 
policy, the role of government's long-term investment should also be 
considered.

    Senator Smith. Thank you very much.
    Dr. Levine.

             STATEMENT OF HARVEY A. LEVINE, Ph.D., 
              INDEPENDENT TRANSPORTATION ECONOMIST

    Dr. Levine. Good morning, Mr. Chairman. In that my views 
are somewhat contrary to some of the other members of the 
panel, I appreciate the opportunity to have the last word.
    Over the past 4 years, I have been an independent 
transportation economist and consultant. Today my observations 
are strictly my own, based on what I believe to be in the 
public interest. These observations are detailed in the written 
report I provided to the Subcommittee.
    In a nutshell, I find the current state of freight 
railroading to be troublesome and full of unfulfilled promises. 
This is not to say that there are not positive aspects to the 
system. The U.S. railroad infrastructure is a mature national 
resource which has been rationalized since the early 1900s, has 
achieved commendable levels of productivity in recent years, 
and has passed some of this productivity on to its customers in 
its competitive markets in the form of constrained pricing.
    But this is only part of the story. The industry continues 
to lose market share to motor carriers, has consolidated into 
four dominant carriers, has used an ineffective regulatory 
system to exercise its market power, and has created an ever-
widening chasm between itself and its rail-dependent customers.
    Over the past 6 years, four financially viable railroads--
and I am talking about four railroads that were financially 
viable in the mid-1990s--spent over $18 billion to purchase 
other Class I railroads on the theory that projected added 
revenues and earnings of about $2 billion annually would make 
them more than revenue adequate. Obviously, something is amiss. 
It seems to me that the concerns raised by railroads and some 
Wall Street analysts would be mitigated if railroads performed 
more to the satisfaction of customers. They have not done an 
adequate job of this, to some extent because existing public 
policy prevents them having to do so.
    I offer three suggestions for change. First, eliminate the 
annual STB determination of revenue adequacy. Stripped of its 
trappings, revenue need is synonymous with capital 
attractiveness. Railroads compete for capital in open markets 
where financial reports to shareholders are the basis for 
investor decisions. The record abounds with examples of 
railroads informing their shareholders that they have made 
record profits while earning their cost of capital and expect 
even rosier futures--and you have to go back to the mid-1990s 
for this--when at the same time the regulatory agency has 
declared them to be revenue inadequate.
    The STB's calculation is extremely limited, often 
misunderstood, and serves no useful purpose. When regulatory 
and national transportation policy decisions are based on 
improper assessments of railroads' capital needs, the public in 
general and railroad-dependent customers in particular are not 
well served.
    Second, strong consideration should be given to adopting a 
final offer arbitration process as employed in Canada. The 
Staggers Rail Act requires fair and expeditious regulatory 
decisions, but implementation of a fair standard is doubtful 
and there is nothing expeditious about regulatory decisions. 
Some proceedings have taken more than 10 years to resolve, are 
extremely costly, and are intimidating to shippers. Adopting a 
final offer arbitration process would allow for a quick 
resolution of disputes at a reasonable cost for the parties, 
ensure that arbitrated decisions occur within a practical zone 
of analysis, and encourage a negotiated railroad-customer 
agreement.
    Third, public policy should not preclude the enactment of 
provisions which provide for increased competition to the 
railroad infrastructure. While prudent railroad cost control is 
admirable, public policy can best be served if railroads 
increase their traffic volume. Such growth benefits society in 
regard to the environment, fuel conservation, highway 
congestion, and low-cost transportation. Adequate railroad 
competition could provide the needed responsiveness to rail-
dependent shippers and help to grow the traffic.
    The very same public that provided railroads with exclusive 
rights-of-way and limited competition has the right to adjust 
the level of competition when conditions demand it. In fact, 
the encouragement of railroad competition is consistent with 
the goals of the Staggers Rail Act of 1980: to ensure effective 
competition among rail carriers, to reduce regulatory barriers 
to entry into and exit from the industry, and to avoid undue 
concentrations of market power.
    In conclusion, staying the present course will not promote 
a financially viable railroad industry that meets the needs of 
its customers. Open capital markets and competition are the 
engines that drive our free enterprise system. Change is in 
order for our nation's railroads, and I hope I have given you 
some ideas for that change.
    Thank you for your time and I will answer any questions 
gladly.
    [The prepared statement of Dr. Levine follows:]

          Prepared Statement of Dr. Harvey A. Levine, Ph.D., 
                  Independent Transportation Economist

    Mr. Chairman and Members of the Subcommittee, I appreciate this 
opportunity to present my perspective on issues concerning the freight 
railroad industry relative to the industry's financial performance, 
current posture, and future needs. My experience spans over 35 years in 
the field of transportation in general and railroad economics in 
particular, including employment with: railroad customers (shippers), 
the New York Central Railroad, the U.S. Department of Transportation 
(DOT), several transportation consulting companies, the Interstate 
Commerce Commission (ICC), and the railroad industry's major trade 
association, where for 18 years, I was the Vice President of the 
Economics & Finance Department. I also have taught transportation 
economics and other business subjects at several universities, written 
a book on national transportation policy, and co-authored a book on 
local and regional railroads. Over the past four years, I have provided 
consultation to a multitude of railroad, shipper, and other 
organizations involved in, or affected by, freight railroads. As an 
independent transportation economist and consultant, the views that I 
present in this testimony are strictly my own, based on what I believe 
to be the public interest.
    No matter what my past professional position, I have always 
believed that a financially viable, freight-railroad industry is in the 
public interest. After all, railroads are conduits that serve the 
function of providing time and place (location) utility to our nation's 
consumers. Adequately staffed and capitalized railroads are needed for 
such an important role, but at the same time, it is through the 
satisfaction of customer needs that railroads have the opportunity to 
become financially viable. Thus, the achievement of railroad financial 
adequacy and the satisfaction of rail customer needs are two sides of 
the same coin. And it is with this concept in mind, that I offer this 
testimony.
    The current state of affairs in freight railroading is 
controversial, highly contentious, and somewhat beyond the 
comprehension of many people, but it retains the one constant that has 
characterized freight railroads since before World War II--a perceived 
financial need, commonly referenced as a capital shortfall. Railroads, 
in their presentations to the ICC, Surface Transportation Board (STB), 
and public policy makers, describe themselves as being burdened with 
``woefully inadequate earnings,'' even if individual carriers were 
financially stable, and no matter what the railroads earned. The 
industry gained support for this view from the ICC beginning in 1978, 
when the first annual revenue-adequacy determination was made. This 
determination has been continued by the STB since 1996. During more 
recent years, the railroads' mantra of ``woefully inadequate earnings'' 
has been replaced by ``revenue inadequacy.'' In fact, of the four 
dominant railroads that currently control the overwhelming portion of 
railroad traffic, only the Norfolk Southern (NS) has been declared by 
the regulatory agency to be revenue adequate in more than a single 
year. The Burlington Northern (BN) was deemed to be revenue adequate in 
1989 and the Union Pacific (UP) in 1995. CSX Transportation has never 
been found to be revenue adequate. However, what CSX's president, as 
well as other railroad executives, has stated in his company's annual 
report to shareholders is another matter.
    Incredibly, the alleged state of railroad revenue inadequacy 
prevailed during the early and mid-1990s, even when railroads enjoyed 
record earnings and the president of the industry's major trade 
association--the Association of American Railroads (AAR)--touted the 
``Second Golden Age of Railroading.'' Magazine articles abounded with 
such positive headlines as ``Back on the Right Track,'' and ``Back at 
Full Throttle.'' Consider the financial strength at the time of the 
current four dominant railroads. In 1994, the BN earned an impressive 
16.9% rate of return on equity (ROE)--that is, net profit after fixed 
charges and incomes taxes are paid as a percent of the value of the 
owners' investment. Furthermore, the BN had the financial capacity to 
outbid the UP and acquire the Atchison Topeka & Santa Railroad (ATSF) 
in 1995 for $4.1 billion. Similarly, in 1995, the UP earned a 16.7% ROE 
and completed its purchase of the Southern Pacific Railroad (SP) in the 
following year for about $4.0 billion. In 1997, the CSX and NS 
railroads realized ROEs of 12.4% and 12.6% respectively, and 
consummated their joint purchase of Conrail for over $10 billion in 
1999. And yet, with the exception of the NS in 1997, these railroads 
were declared by the STB to be revenue inadequate during those years. 
At the same time, the four railroads expended billions of dollars in 
employee buyouts, distributed expected dividends to their shareholders, 
and paid sizeable bonuses to their executives.
    What is especially troublesome about the current state of alleged 
railroad revenue inadequacy is that it comes when the industry has been 
merged into four dominant carriers based largely on the theory that 
such consolidation was necessary to achieve revenue adequacy. As shown 
below, the number of Class I railroads has shrunk from 109 in 1960, to 
36 in 1980 and to seven in 1999--with two of these carriers being owned 
by the Canadian National and Canadian Pacific railroads. Furthermore, 
the concentration of power has greatly increased among the four largest 
railroads, rising from 25% of Class I railroad traffic in 1960, to 43% 
in 1980, and an astonishingly 95% in 1999.\1\ These four dominant 
railroads--two each in the East and West--control more than the traffic 
they handle. They also have significant control over traffic on both 
local (short line) and regional railroads and either control or heavily 
influence: industry-wide procedures in regard to operating--including, 
interline--rules; accounting practices; car-repair billing; 
technological research and development; and, policy development and 
strategy.
---------------------------------------------------------------------------
    \1\ Association of American Railroads, Analysis of Class I 
Railroads (annual). Interstate Commerce Commission, Statistics of 
Railways in the United States For the Year 1960.


------------------------------------------------------------------------
                                           No. of     Percent of Traffic
                 Year                     Class I      Carried By Four
                                         Railroads    Largest Railroads
------------------------------------------------------------------------
1960..................................          109                   25
1980..................................           36                   43
1999..................................            7                   95
------------------------------------------------------------------------


    What is additionally astonishing about the four ``mega-railroads'' 
is that they were created based on projections of huge financial 
benefits. For example, the BN's purchase of the ATSF came when the 
former was already making record profits, and when the BN projected 
that the purchase would save the railroad $450 million annually in 
operating expenses and add another $110 million in operating income. 
Similarly, the UP was earning record profits in 1996 when it purchased 
the SP based on an operating income benefit of $820 million by the year 
2001. And the CSX and NS purchase of Conrail in 1999 came at a time 
when those railroads were earning moderate profits, and when they 
projected significant benefits mainly in the form of cost reduction and 
traffic diversion from motor carriage.
    No matter what it is called--that is, ``woefully inadequate 
earnings,'' ``revenue inadequacy,'' or even ``sub-par financial 
performance,'' where railroads can demonstrate a capital need, they 
have support, if not an outright propensity, for acceptance of their 
industry-wide, policy positions. The answer to the question of ``How 
can we help the poor railroads?'' may come in the form of: tax relief; 
low-interest loans; outright grants; approval of mergers and 
acquisitions; rate increases to rail-dependent customers; changes in 
demurrage provisions; and, the warding off of otherwise desirable 
market competition. Consequently, with railroads still being cast as 
revenue inadequate by the STB, the environment exists for more of the 
same--that is, for more railroad behavior based on alleged capital 
need; more explanations for inadequate service and increased freight 
rates; and an even greater concentration of power. This is not to say 
that in some years, railroads don't have a capital need, and it is not 
to say that the two railroads in the East are not currently earning 
sub-par profits. However, the permanent state of alleged railroad 
financial depravity is a frightening prospect for rail-dependent 
shippers and should be to the public at large.
    The latest rationale of the railroads' alleged revenue inadequacy 
is that competition forced them to pass on their massive productivity 
gains to their customers, proving that railroad competition is more 
than adequate. The productivity gains have been attributed to 
deregulation as enacted by the Staggers Rail Act of 1980, as is 
seemingly all good things that have happened to railroads since that 
time. In turn, the combination of continued capital need and 
competitive markets means that the railroads cannot afford any more 
competition. After all, proffer the railroads, new competitors would 
``skim the cream'' off the top and leave the incumbents with little 
more than the lower-margin, more competitive traffic. This is a picture 
which on the surface appears to be plausible, for to refute it requires 
an unusually deep understanding of railroad financial data, statistical 
methodologies, cause-and-effect relationships, rail-customer service 
levels, and railroad behavior in general. In essence, railroad issues 
relating to national transportation policy are often embodied in a mass 
of statistical information and economic theory.
    My perspective of the state of the freight railroad industry is 
different from that being portrayed by the industry itself. As a 
reflection of my views, I present three observations below, including 
summary statements of support and recommendations, followed by a more 
detailed discussion leading to each of the three observations.
    1. Railroad data presented in annual reports to shareholders, and 
supplemental data to the Securities & Exchange Commission (SEC), is 
often in conflict with industry-wide data distributed to and by the STB 
and especially that agency's annual determination of railroad revenue 
adequacy.
     Railroad revenue need is synonymous with capital 
attractiveness.
     Railroads compete for capital in open capital markets 
against companies who provide annual financial reports to their 
shareholders and supplemental financial information to the SEC.
     Potential investors rely upon the financial documents 
prepared and provided by the owners of businesses in consideration of 
where and when to invest their funds.
     Consequently, where railroad capital attractiveness is at 
issue, annual reports to shareholders and supplemental data to the SEC 
should be used as the basis for analysis.
     At the same time, the link between the STB's annual 
determination of railroad revenue adequacy and capital attractiveness 
is at best elusive and in all probability, non-existent.
     The annual STB revenue-adequacy determination should be 
terminated and railroad financial data submitted to the Board should be 
consistent with the information presented to shareholders and the SEC.
     Finally, railroad revenue need should be thought of in 
terms of: (1) individual railroads as opposed to an industry-wide 
average, (2) as a fluid, and thus temporal state of being, and (3) as a 
prospective concept.
    Railroads are no different than other for-profit companies in that 
they must pay their operating expenses, meet the interest obligation on 
their funded debt, and have the ability to attract needed equity 
capital if they are to provide adequate service to their customers. By 
earning any level of net profit, operating expenses and interest 
charges are paid because such profit is calculated after those payments 
and income taxes are subtracted from revenue. Thus, stripped of its 
trappings, the issue in regard to railroad financial viability is that 
of capital attractiveness to providers of equity. This attractiveness 
is enhanced by a variety of factors including the most recent returns 
to the providers of equity capital--measured by the ROE--a strong 
balance sheet, significant cash flow relative to capital expenditures, 
and sound management policies and procedures. Many of these 
considerations are discussed in the railroad's annual reports to their 
shareholders and other information provided to the SEC. In fact, the 
``President's Message'' sets the tone for the annual report to 
shareholders. But the overall message, analysis of financial 
performance, and even thoughts about the future, are not revealed in 
the annual reports to the STB. They are also not reflected in the STB's 
annual revenue-adequacy determination. This disparity can lead to 
contradictory views by the railroad itself, and between the railroad 
and the STB. Consider an especially egregious case involving the UP in 
1996.
    By any reasonable standard, 1996 was a great year for the UP and 
its parent company, Union Pacific Corporation (UPC). As stated by the 
Chairman and Chief Executive Officer of UPC: The Union Pacific merger, 
the spin-off of the Resources company and the full integration of the 
Chicago and North Western acquisition, made 1996 a banner year that 
created significant value for shareholders and positioned this company 
for the future as a highly competitive, premier transportation 
provider. Through all of these strategic achievements, we kept our eye 
on the numbers, reporting record financial results. Our income from 
continuing operations was $733 million compared to $619 million in 
1995, a gain of 18 percent.\2\
---------------------------------------------------------------------------
    \2\ Union Pacific Corporation, 1996 Annual Report, ``Letter to Our 
Shareholders,'' p. 1.
---------------------------------------------------------------------------
    UPC earned an ROE of 12.4% in 1996, largely sparked by the 
railroad's ROE of 16.6%. To UPC and the UP, these profits were more 
than adequate. They not only exceeded the corporate ROE threshold that 
triggered executive bonuses and the long-term compensation package 
(stock grants and options), they also exceeded the maximum-payout level 
to those executives. Consequently, aside from significant amounts of 
stock distributions, the average bonus given to 138 UPC executives in 
1996 amounted to a record $112,000.\3\ Furthermore, when in 1997 UPC 
earnings were below the executive-bonus threshold, the corporation 
still awarded $7.1 million to 154 executives because ``a balance was 
available in the reserve fund from prior years.'' \4\ In essence, 
surplus profits from 1996 were used to further reward executives in 
1997. At the same time, the STB found the railroad to be revenue 
inadequate in 1996. Rhetorically speaking, who would potential equity 
investors be most likely to believe?--the company itself or the STB, 
which based its conclusion on a single, statistical and highly 
controversial calculation? The unfortunate result of the STB's 
declaration of revenue inadequacy is not only that it could be applied 
in regulatory proceedings involving maximum rates, but that the UP 
could adopt it as support for its positions of public policy.
---------------------------------------------------------------------------
    \3\ Union Pacific Corporation, Proxy Statement to the Securities & 
Exchange Commission, 1996, from DGAR database on SEC's Web Site.
    \4\ Ibid, 1997, p. 21.
---------------------------------------------------------------------------
    In general, the financial health of individual railroads is far 
better than that projected by the revenue-adequacy determination. 
Consider the case of the four dominant railroads in 1999. While they 
were all declared to be revenue inadequate, the BNSF earned a healthy 
13.9% ROE and the UP a moderate 9.5% ROE. While these figures may have 
been below the STB's cost-of-capital calculation, did they really deter 
either railroad from attracting needed capital? Where is the evidence 
of such capital shortfalls? With interest rates around seven percent, 
the equity investors in these two railroads were rewarded for their 
risk taking, and both railroads spoke of even more promising returns in 
the future--that is, in their annual reports to shareholders and in 
their presentations to Wall Street security analysts. Furthermore, in 
his oral presentation to the STB regarding the BNSF's proposed merger 
with the Canadian National system, the president of the BNSF boasted of 
his railroad being into its strongest financial position in history. 
The reality is, that the record abounds with examples of railroad 
executives calling attention to their strong financial results in the 
annual reports to shareholders, while citing their STB-determined 
revenue inadequacy in matters of public policy.
    In essence, the STB's annual determination of railroad revenue 
adequacy serves no useful purpose and can be highly misleading. A 
railroad cost of capital can be estimated without an annual revenue-
adequacy determination. At the same time, potential equity investors 
can employ the more credible railroad annual reports to shareholders, 
and if desired, supplemental financial reports to the SEC, to help them 
in their determinations as to where they funds should be invested. 
Annual reports to shareholders represent the ``real world;'' the same 
cannot be said for the STB determination.
    2. Railroad deregulation as enacted by the Staggers Rail Act of 
1980 has been given far too much credit for both the significant gains 
in railroad productivity and the ensuing constraints on freight rates, 
thereby inappropriately inferring that railroad market competition is 
ubiquitous.
     With the exception of liberalized procedures for 
eliminating light-density branch lines, there is no direct link between 
the Staggers Rail Act and increases in railroad productivity.
     Aside from a host of other factors, railroad productivity 
gains have emanated largely from favorable union contracts (supported 
by Presidential Emergency Boards) resulting in the elimination of many 
employees.
     The measure of freight-revenue-per-ton-mile is a limited 
surrogate for actual freight rates, and its use by the railroad 
industry and the STB results in improper conclusions regarding both 
freight rates and the impact of deregulation.
     Railroad productivity gains have been shared directly by 
shippers in competitive markets and the railroads themselves, but no 
matter how the benefits have been distributed, rail-dependent customers 
exist and are still faced with the lack of carrier choice.
     The existence of rail-dependent customers is a reality 
that should not be ignored by the STB--whose purpose is, in fact, to 
address the needs of such shippers--or by national transportation 
policy.
     In addition to providing adequate carrier choices for 
rail-dependent customers, an appropriate remedy for their complaints 
appears to be the ``Final Offer Arbitration'' (FOA) process available 
to railroad customers in Canada.
     Professional arbitrators can replace the lengthy and 
costly STB maximum-rate procedures and as in Canada, complete the 
process within 60 days.
    There is no disputing that since the Staggers Act was passed in 
1980, the railroad industry has become more productive, and has passed 
on a portion of this productivity to some of its customers in the form 
of constrained pricing. But with the exception of the more liberal 
provisions to eliminate light-density branch lines, there is no 
evidence that links the Staggers Act with increased railroad 
productivity. The major contribution of deregulation was to free the 
railroads from the unnecessary cost of regulatory proceedings involving 
competitive traffic. Money was certainly saved in these instances, but 
this regulatory efficiency had nothing to do with reducing the bloated 
labor force, eliminating duplicate facilities, and implementing cost-
saving procedures. Those achievements were due to a combination of 
factors including: a heightened sense of need on the part of 
management; the introduction of new technology, economies of scale and 
density associated with mergers and acquisitions, and especially, 
favorably-negotiated labor contracts (including billions of dollars 
worth of buyouts). In fact, as shown below, the number of employees 
working for Class I railroads has been in a long-term decline since its 
peak of 2.1 million in 1916.


------------------------------------------------------------------------
                                                         No. of Class I
                         Year                             Employees \5\
                                                           [Thousand]
------------------------------------------------------------------------
1916..................................................             2,148
1929..................................................             1,661
1955..................................................             1,015
1970..................................................               566
1980..................................................               458
1999..................................................               178
------------------------------------------------------------------------
\5\ Association of American Railroads, Railroad Facts and Railroad Ten-
  Year Trends. Interstate Commerce Commission, Railroad Transportation,
  A Statistical Record, 1911-1951, and Statistics of Railways in the
  United States For The Year Ended 1929, 1955, 1970.


    Mis-casting the Staggers Act as the cause of increased railroad 
productivity and constrained pricing inappropriately supports a 
continuation of present market conditions; and yet, this is exactly 
what the railroad industry and the STB do. They use an industry-wide, 
unaudited, inflation-adjusted, and deficient surrogate for railroad 
freight rates--more specifically, freight revenue-per-ton-mile--to 
proffer that railroad rates have declined since 1980, and then 
automatically tie those alleged decreases to the enactment of the 
Staggers Act in that year. What is not mentioned is that the rate 
surrogate had been declining before 1980, and its relationship to 
actual freight rates is at best, dubious. Furthermore, actual rate 
surveys undertaken by the AAR in 1980 provide evidence as to the 
inappropriateness of the surrogate measure.
    The reliance on the average freight-revenue-per-ton-mile measure is 
an example of how the manipulation of large and varied databases can 
act to confuse issues. The issue before the STB should not be overall, 
average railroad freight rates. In the first place, freight rates 
should be related to individual railroads, individual commodities, 
individual markets, levels of cost, and levels of service. But even 
more importantly, in regard to railroad matters, the STB exists only 
because there are rail-dependent customers. These customers, as well as 
the STB, should not be concerned with averages, surrogates, and 
inappropriate cause-and-affect relationships.
    The reality is that deregulation did little, if anything, to 
address the needs of rail-dependent customers. These shippers have 
become increasingly vocal in regard to their captivity and the 
railroads' insensitivity to their needs. Similarly, they find virtually 
no relief in the regulatory process. While the Staggers Rail Act 
requires fair and expeditious regulatory decisions, the ``fairness'' of 
current standards is at best, questionable, and there has been nothing 
expeditious about regulatory decisions. Some maximum rate proceedings 
have taken more than 10 years to resolve, while regulatory proceedings 
in general are extremely costly, time consuming, and intimidating to 
shippers. At the same time, because of fewer and similar operations, 
railroads have strengthened their common resolve and have the financial 
resources to employ a delay-and-wear-them-down strategy. This has added 
to the lengthy and costly regulatory proceedings favoring the staying 
power of railroads.
    An alternative to the ineffective regulatory proceedings 
administered by the STB, would be the concept of Final Offer 
Arbitration (FOA), similar to the practice in Canada. In a nutshell, 
FOA is a process employing either a single arbitrator, or a panel of 
three arbitrators, to resolve rate and/or service disputes between 
railroads and their dependent customers. Unless otherwise agreed to by 
the parties, decisions are binding and last for a stated period of 
time. Benefits of FOA as applied in Canada, compared with current 
railroad regulatory practices are as follows:
     The arbitrator's decision is made within 60 days compared 
with proceedings taking years--in some historic cases, over 10 years.
     Railroad customers would identify their rail dependency by 
committing to file FOA submissions. They are unlikely to be frivolous 
submissions because of the accompanying costs. This eliminates the need 
for theoretical and controversial determinations of ``captivity'' and 
``market dominance.''
     FOA offers by both parties are likely to be moderate in 
that the arbitrator must pick one or the other (i.e., baseball-style 
arbitration). An unreasonable offer is likely to be readily rejected. 
This brings the dispute into a more practical zone of analysis and 
encourages a negotiated railroad-customer agreement prior to an FOA 
decision.
     There are a host of available arbitrators, and thus the 
process has more credibility than alternative regulatory decisions. 
Unlike members of the regulatory authority, arbitrators are not 
political appointees. They are qualified experts whose records and 
reputations determine whether or not they will be selected for 
arbitration.
     The cost of arbitration is shared equally between the 
railroads and their customers. While the customers' initial experience 
in arbitration may be somewhat costly, it is far less than that of 
current regulatory proceedings. Furthermore, customer expenses decline 
as experience with FOAs is gained.
     The FOA process takes railroad-customer disputes out of 
the political process. Often, the disputes are resolved by the involved 
parties after an arbitration application is filed but before a decision 
is made. In essence, moving from an FOA-type decision-making process 
seems to be a win-win situation for railroads and their dependent 
customers.
    3. While prudent railroad cost control is admirable, public policy 
can best be served if railroads increase their traffic volume, thereby 
helping to relieve highway congestion, having a positive impact on the 
environment, and providing relatively low-cost transportation service; 
adequate competition should help to stimulate traffic growth and 
improve overall profitability.
     The major economic focus of railroads has been to maximize 
profits through cost reduction.
     While intermodal traffic has grown significantly, massive 
railroad cost cutting has not helped railroads to increase their market 
share, especially vis-a-vie the motor carrier industry.
     Traffic growth requires the satisfaction of shipper needs 
and in turn, this requires a sensitivity to those needs, a commitment 
to fulfill those needs, and innovative and flexible thinking.
     The culture of the large freight railroads is one that is 
slow to change and has never been known to have keen market 
sensitivity.
     Adequate railroad competition could add to railroad 
efficiency, but more importantly, could provide the needed sensitivity 
to shipper needs.
     The encouragement of railroad competition is consistent 
with the goals of the Staggers Rail Act of 1980.
     Public policy should not automatically preclude the 
enactment of provisions that provide for increased access--and thus, 
competition--to the railroad infrastructure.
     The very same public that provided railroads with 
exclusive rights-of-way and limited competition has the right to adjust 
the level of competition when conditions demand it.
    The railroads' emphasis on cost cutting over the past 20 years is 
well documented. In fact, projected efficiencies were the major factor 
supporting the many mergers and acquisitions during these years. For 
example, in 1980 the railroads' operating expense per ton-mile was 2.75 
cents compared with 1.95 cents in 1999.\6\ This decline was realized in 
the face of virtually a 100 percent rate of inflation during those 19 
years. And as previously shown, the reduction in railroad costs was led 
by draconian cuts in the level of railroad employment. Rational cost 
cutting is admirable and in the interest of shareholders, but what is 
also important--especially to the public at large--is that railroads 
recapture some of their lost market share, and here, the story is not 
good.
---------------------------------------------------------------------------
    \6\ Analysis of Class I Railroads, Ibid.
---------------------------------------------------------------------------
    The railroads' share of intercity tonnage has steadily declined--
from 46.7 percent in 1950, to 28.7 percent in 1980 and 25.1 percent in 
1998.\7\ During the late 1980s and early 1990s there was a leveling off 
of this downward trend, but it again has started to recede. In 1996 the 
railroad percent of market share was 25.8 percent, falling to 25.1 
percent in 1997 and remaining there in 1998. With the motor carrier 
industry currently carrying about double the tonnage hauled by 
railroads, there is a substantial traffic base available for railroad 
penetration--or in reality, for market recapturing. This potential 
traffic base is expected to expand significantly in the future, as DOT 
has projected annual average increases in the U.S. domestic freight 
market of 3.4 percent annual between now and the year 2010.\8\ 
Furthermore, DOT projections call for an annual 4.0 percent increase in 
U.S. international traffic over the next decade. Clearly, there is a 
sizeable market for potential railroad penetration. But such 
penetration requires more than continued railroad cost cutting. It 
requires the ability to meet customer service standards at reasonable 
prices. It requires competition. It requires compliance with the 
Staggers Rail Act, which recognized the need for competition among 
railroads.
---------------------------------------------------------------------------
    \7\ Eno Transportation Foundation, Transportation in America 1999, 
p. 46.
    \8\ Federal Highway Administration, U.S. Department of 
Transportation, Freight Forecast Growth Rates, 2001.
---------------------------------------------------------------------------
    The Staggers Rail Act supports and encourages the existence of rail 
competition in the marketplace. One of its policies is, To ensure the 
development and continuation of a sound rail transportation system with 
effective competition among rail carriers and with other modes, to meet 
the needs of the public and the national defense. This policy is 
supported by two other policy statements: (1) to reduce regulatory 
barriers to entry into and exist from the industry, and (2) . . . to 
avoid undue concentrations of market power . . . These policies are 
consistent with one of the findings of the Staggers Act, which is that: 
Greater reliance on the marketplace is essential in order to achieve 
maximum utilization of railroads to save energy and combat inflation.
    There are many ways to induce adequate railroad competition in the 
marketplace. Railroads themselves can generate competition through 
commercial agreements and voluntary sharing of infrastructure. The 
selling of branch lines to local and regional railroads--without so-
called ``paper barriers'' is a form of increased competition. So are 
expanded reciprocal-switching zones. The STB can induce added 
competition by disallowing bottlenecks in its decisions on maximum 
rates. And Congress can mandate adequate competition through a change 
in legislation that provides for increased access, somewhat on the 
order of the ``running rights'' provision available to shippers in 
Canada. In the case of running rights, a railroad would have to 
petition the STB for the use of another railroad's facilities, but with 
over 400 local and regional railroads in existence, such a provision 
may be useful. The success of such a policy is already well documented 
right here in the U.S. and by the railroads themselves. Both BN and UP 
have testified that the application of 4000 miles of trackage rights--
which were imposed by the STB as a condition of the UP-SP merger--are 
working very well for both customers and railroads. And despite claims 
to the contrary, when railroads oppose policies that would increase 
access in this way, trackage rights have resulted in no safety or 
operational problems, at least none reported by the railroads at this 
time. The point is, that adequate competition is not evil. In fact, 
competition is the only route for ensuring long-term financial 
viability for the rail industry. Deregulation and competition are 
inseparable. With adequate competition, the partial deregulation that 
now prevails can be completed and full deregulation can be implemented. 
Partial deregulation with ineffective regulation is not a formula for 
traffic growth. Without meeting shipper needs, the future of a 
privately-owned-and-operated, financially viable, freight railroad 
structure in this country is dubious. Meeting customer needs is the 
number one priority of virtually all for-profit companies in 
competitive markets, and it must be at the core of national 
transportation policy affecting railroads. Adequate competition is what 
drives customer satisfaction, and this basic concept of the free-
enterprise system is what drives the country's standard of living.
    In conclusion, it is my belief that staying the present course--
that is, preventing adequate competition while relying on ineffective 
regulation--will do little, if anything, to ease the burden on rail-
dependent customers, to make railroads more customer-driven, and to 
grow the traffic. At worse, it will lead to further consolidation and 
possibly, to government subsidization of the freight-railroad 
infrastructure.
    I thank you for the opportunity to prevent my views, and I would be 
pleased to answer any questions.

    Senator Smith. Thank you, Dr. Levine.
    All of you have contributed wonderfully to this research. I 
am in the regrettable situation where I am supposed to replace 
Senator Bunning on the chair presiding over the Senate a minute 
ago. He is a really big man and he gets really upset when you 
are late. So I may have some questions for you that I will 
submit in writing, and we appreciate any response you can 
provide to that. You have contributed immensely to the quality 
of this hearing and I thank you for your time.
    We are adjourned.
    [Whereupon, at 12:00 o'clock noon, the hearing was 
adjourned.]

                            A P P E N D I X

               Prepared Statement of The American Public 
                       Transportation Association

    APTA is a nonprofit international association of over 1,400 public 
and private member organizations including transit systems and commuter 
rail operators; planning, design, construction and finance firms; 
product and service providers; academic institutions; transit 
associations and State departments of transportation. APTA members 
serve the public interest by providing safe, efficient and economical 
transit services and products. Over ninety percent of persons using 
public transportation in the United States and Canada are served by 
APTA members.

                              INTRODUCTION

    The American Public Transportation Association (APTA) appreciates 
the opportunity to submit testimony to the Senate Surface 
Transportation and Merchant Marine Subcommittee on railroad 
infrastructure capacity and long term capital funding needs.
About APTA
    APTA's 1,402 public and private member organizations serve the 
public and public interest by providing safe, efficient, and economical 
public transportation service, and by working to ensure that those 
services and products support national energy, environmental, 
community, and economic goals. APTA member organizations include 
transit systems and commuter railroads; design, construction and 
finance firms; product and service providers; academic institutions; 
and State associations and departments of transportation. More than 
ninety percent of the people who use public transportation in the U.S. 
are served by APTA member systems.

          COMMUTER RAIL: A GROWING PART OF THE RAILROAD FAMILY

    The past 20 years has been a period of significant change for the 
American railroad industry. While the Staggers Act of 1980 is 
rightfully credited with helping the once threatened railroad industry 
become profitable again, it has also led to significant consolidation 
and downsizing of America's railroad network. Meanwhile, commuter 
railroads have blossomed in this period, and are a major success story 
in the railroad industry.
    Let's start with ridership. Mr. Chairman, the latest numbers are 
in, and they prove that more and more people are choosing public 
transportation. Last year was a banner year for transit, with a greater 
number of transit trips taken (9.4 billion) than in any year since 
1959. Thanks to Congress' investment in the Federal transit program 
through legislation such as the Transportation Equity Act for the 21'' 
Century (TEA 21), thanks to improved customer service by public 
transportation providers, and thanks to a healthy economy, ridership on 
the nation's public transportation systems has grown 21 percent over 
the past 5 years. This is four times faster than the U.S. population 
(4.8 percent), double the growth rate of highway usage (11 percent), 
and faster than the growth rate in domestic air travel (19 percent).
    Last year, passengers took 411 million trips on our commuter 
railroads, and ridership was up 5.2 percent in the year 2000--a year in 
which new operations were inaugurated in Seattle, Washington and 
Burlington, Vermont, and a major extension of the Dallas-Fort Worth 
Trinity Railway Express. Following are examples of commuter rail 
ridership increases for the year 2000: Philadelphia's SEPTA regional 
commuter rail ridership was up 8.5 percent; Southern Florida's Tri-
Rail: 10 percent; San Jose's Altamont Commuter Express: 66 percent; the 
Virginia Railway Express: nearly 20 percent; Trinity Railway Express: 
39 percent; New York's Metro North Commuter Railroad: nearly 5 percent; 
the Metrolink system in Los Angeles: 11 percent; and the Bay Area 
Caltrain: 14 percent. Clearly, when people are given a choice, many 
will choose to ride quality rail transportation.
    Significant growth is projected for the future. Currently there are 
almost 3,825 route miles of commuter rail service in operation in the 
U.S. An additional 134 miles are under construction and 300 miles are 
in design; with over 2,300 miles in planning and 1,100 additional miles 
under consideration for commuter rail projects. New commuter rail 
systems are in various stages of development in Nashville, Anchorage, 
Minneapolis, Salt Lake City, Kansas City, Houston, Charlotte, and 
Portland. Major expansions of current operations are underway in 
Chicago, Dallas--Ft. Worth, Seattle, and Miami and others are planned 
by almost every other system.

                    PARTNERSHIPS ARE KEY TO SUCCESS

    How will commuter railroads be able to achieve the expected rate of 
growth? Certainly, it will require a partnership among communities, 
freight railroads, and, I believe, Federal and State governments as 
well. APTA is interested in supporting a broader agenda to foster the 
growth of railroads.
    Historically, America's rail corridors have been used for both 
freight and passenger purposes. At one time, both passenger and freight 
services were operated by the private sector under laws governing 
public utilities. As passenger operations were abandoned by private 
railroads, services were often taken over and/or supported financially 
by public entities.
    Currently, a number of publicly owned rail passenger agencies 
(among them NJ Transit, Long Island Railroad, Metro North, Trinity 
Railway Express, and the Utah Transit Authority) own the rights-of-way 
used for rail passenger service, and have negotiated agreements with 
freight carriers allowing the use of their track for freight movements. 
In many more instances, however, public transit agencies use rights-of-
way owned by private railroads for the operation of their passenger 
services.
    Therein lies the challenge--and the opportunity. We must come up 
with a better process for using freight corridors for passenger 
operations. Without access to these corridors, the cost of many new 
passenger rail projects will become prohibitive. Indeed, the 2,300 
miles of commuter railroads in planning and the 1,100 miles under 
consideration may not be built unless we find an easier way for the 
freight railroads and passenger railroads to work together on rail 
access. While many access agreements have successfully been negotiated, 
freight railroads can, and do, unilaterally deny access to passenger 
rail agencies or hold out for financial conditions that are beyond any 
fair or reasonable standard of the passenger authority to pay. In such 
situations, there is no process for the public interest to be taken 
into consideration, and local officials have no recourse or ability to 
appeal the unilateral decision of a freight railroad. We are supportive 
of legislation directed at this problem, and I look forward to 
continuing discussions with the Subcommittee and with freight 
railroads.

               THERE IS A NEED TO GROW THE NATION'S RAILS

A Looming Crisis in Transportation System Capacity
    America's transportation system is showing signs of severe stress. 
Demand for transportation services is increasing, and it is critical 
that we develop a strategy for new investments in the nation's physical 
infrastructure. In many places, severe congestion in our roadways and 
railways, severe overcrowding of public transportation vehicles, and 
gridlock in our airports are beginning to take on crisis proportions. 
The capacity of the nation's transportation system is an issue 
affecting all modes. Adding to the capacity of our railroads, airports, 
roadways, port facilities and public transportation infrastructure will 
be critical to our ability to sustain strong economic growth in future 
years.
    Testifying before the House Transportation and Infrastructure 
Committee on April 4, 2001, Transportation Secretary Norman Mineta 
spoke of the congestion in the various components of America's 
transportation system, and made specific mention of the growing role of 
commuter railroads. The hearing called attention to U.S. DOT's 
Condition and Performance Report, and its $17 billion capital funding 
needs figure for public transportation (a formidable figure, but one 
that underestimates the scope of transit's future growth). Federal 
support for public transportation is provided largely through the Mass 
Transit Account of the Highway Trust Fund. A key to the continued 
growth and success of commuter railroads and other public 
transportation modes is the Highway Trust Fund and keeping it true to 
the need for greater investment in highway and transit infrastructure.
Railroad Legislation and the 107th Congress
    In today's hearing, the Subcommittee has focused attention on the 
policy issues that confront railroads as they seek to position 
themselves for an expanded role in our transportation future. A number 
of specific programs already have been put before the Subcommittee.
    APTA is supportive of efforts such as the High Speed Rail 
Investment Act of 2001 (S. 250) because rail infrastructure needs 
improvement. In supporting such efforts, APTA affirms its longstanding 
policy that the Mass Transit Account of the Highway Trust Fund be used 
exclusively for public transportation needs and not be expanded to 
cover other uses, including intercity rail.
    Mr. Chairman, there has been discussion in both the House and the 
Senate about ways to provide funding for shortline railroads to improve 
track and related structures to a level that can accommodate the safe 
and efficient movement of the new, heavier 286,000-pound rail cars 
being adopted as an industry standard by the large railroads. While 
this bill probably will have limited direct benefit to APTA's 
membership, APTA commends the consideration of innovative ways to help 
railroads grow.
    I also note that the $3.5 billion Railroad Rehabilitation and 
Improvement Financing program (RRIF) is a potential source of important 
capital funding for both freight and passenger rail projects. No loans 
have been released under this program since it was reconstituted in TEA 
21, and APTA urges that any remaining administrative obstacles be 
cleared in order to put this innovative program to use.
    I also want to highlight the importance of research and technology 
to the future of railroads. For example, the continued development of 
positive train control can facilitate the integration of commuter rail, 
freight rail, and high-speed intercity rail on common trackage by 
lowering cost and improving performance. This can help maximize the 
productivity of existing infrastructure.
    Finally, at some point the Subcommittee will review the rail safety 
programs administered by the Federal Railroad Administration and take 
up the reauthorization of the Railroad Safety Act. APTA's position 
calls for reauthorization of the Rail Safety Act without additional 
statutory requirements. Additional statutory and regulatory 
requirements for railroad safety could divert focus and limited 
resources away from pro-active safety activities and infrastructure 
investments. To enhance safety, we also urge additional funding for 
elimination of grade crossings and installation of protective devices. 
Finally, nothing should be done to weaken the important new 
partnerships among FRA, rail management and rail labor that have 
developed over the past years. Through the FRA's Rail Safety Advisory 
Committee and our own Passenger Rail Equipment Safety Standards 
program, rail labor and management are partnering with FRA to enhance 
rail safety--to make permanent our record of the seven safest years in 
railroad history.

                RAILROADS AND OUR TRANSPORTATION FUTURE

    In the railroad family, as well as the transportation community at 
large, all modes benefit as each mode is improved. Whenever this 
happens, the public is the beneficiary. APTA will be supportive of an 
agenda that benefits all segments of the transportation industry.
    For commuter rail, we want to build on the success of TEA 21. There 
are clear indications that the public wants rail passenger 
transportation, and will choose to use public transportation when 
provided the availability of quality service. All around the country, 
people are voting with their feet and flocking to rail.
    We also want a process that can assure better cooperation in the 
use of shared corridors. In the end, this will also be of benefit to 
freight railroads as well as passenger agencies by bringing in 
additional resources and public support. On a more practical level, the 
200 new passenger rail projects authorized by Congress in TEA 21 will 
not happen without a workable process.
    APTA appreciates the opportunity to testify, and looks forward to 
working with the Subcommittee to assure that our nation continues to be 
served with an efficient and effective freight and passenger rail 
network.

                               __________
               Prepared Statement of Patrick K. Gamble, 
         President and Chief Executive Officer, Alaska Railroad

    My name is Pat Gamble and I am the President and Chief Executive 
Officer of the Alaska Railroad. Thank you for the opportunity to submit 
this testimony for the record.
    In many ways, the story of the capital infrastructure needs of the 
Alaska Railroad are unique. But in other ways, the bottom line of our 
story is identical to that of other smaller freight and public 
passenger railroads: There is a proper Federal role and genuine need 
for Federal capital assistance for our nation's rail network, both 
passenger and freight, in order to continue to safely connect all areas 
of our entire nation together.

                     BACKGROUND ON ALASKA RAILROAD

    The Alaska Railroad is not your typical Lower 48 Class II railroad:
     The Alaska Railroad has been in existence 87 years as a 
result of the Congressional Enabling Act of 1914. Congress recognized 
the need to open the Alaskan territory for economic development and 
therefore empowered the President to construct and operate a rail line 
to connect one or more of the open Pacific Ocean harbors on the 
southern coast of Alaska with the navigable waters in the interior of 
Alaska.
    Throughout the period of Federal ownership, the railroad has come 
under the Department of Interior, and later the Department of 
Transportation. During the period of Federal ownership the Alaska 
Railroad was mandated through its enabling legislation to be a self-
sustaining enterprise. Capital funding, therefore, was limited and 
sporadic.
    Since its first beginnings, it has been a full service Railroad, 
providing both freight and passenger service to Alaskans. Beginning, in 
its early years of the 1920s and continuing up through the 1950s, the 
Railroad inaugurated passenger, mail and freight service, and connected 
via river barge out of the railbelt community of Nenana up the Tanana 
river to the village of Holy Cross some 642 miles up river, as well as 
other villages along its route.
     In 1985, the Alaska Railroad belonged to the U.S. 
Department of Transportation. Congress passed the Alaska Railroad 
Transfer Act of 1983 and sold the Railroad to the State in 1985. Today, 
the Alaska Railroad is a state-owned corporation, similar to Amtrak 
being a federally owned corporation. The Railroad has a 7-member Board 
of Directors appointed by the Governor. Under Alaska law, our board 
includes the State Commissioner of Transportation, Commissioner of 
Economic Development and also one employee from a bargaining unit. our 
railroad has long been fully unionized under both State and Federal 
ownership and we value our partnership with our union employees. The 
remainder of the Board Members must have business experience and one 
member must have management experience on a United States Railroad.
    The Alaska Railroad is really two railroads in one:
     We are a Class II freight railroad subject to the 
jurisdiction of the Surface Transportation Board, just like any other 
freight railroad. While our track does not physically connect with 
track in the Lower 48 or Canada, we are part of the North American 
freight rail system via rail barge connections in Seattle with 
Burlington Northern Santa Fe and Union Pacific, and in Prince Rupert, 
British Columbia, with Canadian National.
     We are a full-service year-round passenger railroad, both 
short-haul and long haul. our passenger service meets Federal Transit 
Act definitions of ``mass transportation'' and ``transit'' just like 
the 17 other State passenger railroads do. Our unique combination of 
both short-haul and long-haul passenger service places us with one foot 
in the ``Amtrak'' business, and the other in the metropolitan transit 
business.
     The Alaska Railroad's passenger service significantly 
influences our corporate vision. We carry more passengers each year 
than the entire population of our state. To put that in a Lower 48 
equivalent, Amtrak would have to increase ridership over 13fold for the 
same proportion of riders to population. 70 percent of Alaska's 
population lives along what we call our ``rail belt.'' The rail belt is 
our version of the Northeast Corridor for rail passenger service, 
except that in Alaska it contains proportionately more people.
     The major portion of land mass within Alaska, however, is 
without any transportation corridor, whether it be rail or highway. We 
want to advance the vision of the 1914 Congress by continuing to 
utilize the Alaska Railroad as the primary tool for further development 
of a transportation corridor, as well as continued expansion of 
economic development through the State of Alaska. Railroads provide the 
most cost and energy efficient method for opening undeveloped areas for 
resource development.
    We also want to continue the vision of our early Alaska pioneers by 
creating a transportation corridor into some of the mineral rich 
resource areas. Ultimately we want to link our rail transportation 
system with the rest of the nation.
    To summarize our history, we have been providing complete 
transportation service for Alaskans since 1923. Alaska's growth and 
development makes us what we are--a successful enterprise.

                    CAPITAL NEEDS OF ALASKA RAILROAD

    As I said at the outset, since we are full service the Alaska 
Railroad is not a typical Lower 48 railroad. But in other ways, our 
funding situation is typical of Lower 48 public passenger and Class II 
and III freight railroads where essential Federal capital assistance is 
concerned.
    When the Federal Government sold the Alaska Railroad to the State 
in 1985, it came with a huge backlog of deferred capital investment and 
maintenance. We have been trying to catch up ever since. Under Federal 
ownership, we had been a low U.S. DOT budget priority. We were the 
Alaska equivalent of Washington Reagan National Airport in the mid-
1980s, which likewise had a massive capital backlog from direct Federal 
ownership days, and was transferred about the same time as us. (In fact 
the language used in the transfer legislation for the Alaska Railroad 
was used by Congress as model language for the transfer of National 
Airport).
    For 10 years after the Federal Government transferred the railroad 
to the state, we received no regular Federal capital funds, despite 
being a public passenger railroad, within FTA ``transit'' definitions, 
and providing Amtrak-like service. There was understandable desire in 
Washington to show a budget savings from the transfer, so we often fell 
short in the Federal railroad support programs. For 10 years, we were 
the only public passenger railroad in the nation who did not receive 
Federal capital funds.
    At the time of Federal transfer, our railroad should have been 
putting about $15-$20 million annually into its capital program, 
according to an independent analysis at the time. But after Federal 
transfer, our only resources for capital improvements were whatever 
earnings we had left over at the end of a year, if any--typically a 
third or less of what was required just to maintain the status quo. Our 
passenger rail operations received no regular State financial support, 
but we are allowed to retain our corporate earnings. So our freight 
earnings had to subsidize our passenger services. As you know, this was 
the way passenger systems in the Lower 48 used to be supported.
    A benchmark we use at Alaska Railroad for railroad capital 
investment is about 20 percent of revenue. After Federal transfer, we 
could only afford to invest an average of 6 percent. So not 
surprisingly, we were in a downward infrastructure spiral, similar to 
that which many small railroads in the Lower 48 are now facing.
    If the 10 years without any Federal capital assistance had gone on 
much longer, we honestly don't know where the Alaska Railroad would be 
today. Largely inoperable, I suspect.
    Fortunately, the Alaska Congressional delegation recognized the 
problem and stepped in. Beginning in fiscal year 1996 due to Sen. Ted 
Stevens, we received our first installment of badly needed capital 
appropriations for our passenger system. Administered through FRA, it 
helped us begin to address our massive deferred maintenance and 
modernization needs. For example, until just recently, our whole system 
was entirely ``dark territory''--completely out of contact with any 
rail dispatcher. Keep in mind ours is a system transporting passenger, 
freight, and hazardous materials all together along a single track 
system.
    Then beginning with TEA-21, the FTA law was clarified and we began 
to receive some FTA formula funds as other State passenger railroads 
and rail transit systems do.
    Congress has continued to be most understanding and we are truly 
thankful for your support. Today, thanks to Federal capital assistance, 
we have been able to improve our track safety, and undertake important 
modernization initiatives.
    I would like to point out, however, that all of our continuing 
Federal capital funds are legislatively tied to passenger operations. 
We receive no Federal funds to sustain or upgrade our freight 
operations. But there is a compelling need in this area, in Alaska, as 
well as, for other small freight railroads in the Lower 48.
    Mr. Chairman, on the one hand, we have been fortunate because we 
began receiving long overdue Federal funds. But on the other hand we 
still have a lot of catching up to do in order to achieve and sustain 
the safety and productivity standards expected by our customers and by 
the State of Alaska. That is made all the more difficult when one 
considers the particularly rugged and harsh environment we work and 
operate in year around.
    In terms of our passenger operations: We request further equity 
within the FTA capital funding programs. For example, other State 
passenger railroads and rail transit systems count 100 percent of their 
passenger factors for FTA funding formulas. We are allowed to only 
count 20 percent, despite 100 percent of our passenger system meeting 
the FTA ``transit'' definition. That is because we are the only State 
passenger railroad where our service is not wholly for an ``urbanized 
area'' as defined by FTA. Being able to count 20 percent is a big 
improvement from the days of zero, and we are certainly grateful for 
those funds. But we hope to solicit support to refine that percentage 
upward even further out of consideration for our status. We understand 
this issue is within the jurisdiction of the Senate Banking Committee. 
I petition that Committee to ensure we are treated comparably to other 
State passenger railroads under FTA capital programs.
    In terms of our freight operations: We ask this Subcommittee to 
approve legislation for capital assistance for freight projects of 
Class II and III railroads. Like other Class II and III freight 
railroads, we have pressing needs to maintain and modernize our freight 
system for which we do not have sufficient resources. As I stated 
earlier, in Alaska our freight system is part of the interstate rail 
network, via rail barges. Therefore, it is not just an Alaska issue, 
but an issue of keeping our national rail system tied together.
    The House has before it H.R. 1020, introduced by the leadership of 
the Railroads Subcommittee and cosponsored by Chairman Don Young and 
other Members. H.R. 1020 would authorize capital funds for track 
projects of Class II and III freight railroads. A Senate version is 
expected to be introduced soon.
    The Alaska Railroad supports H.R. 1020 and Senate companion 
legislation as a step in the right direction. We hope the bill will 
clearly State that our track and other infrastructure needs will be 
eligible. We understand the bill was prompted primarily to upgrade 
Class II and III track to handle the new heavier 286,000 pound rail 
cars used by Class I railroads. The Alaska Railroad does not have a 
286,000 pound car problem as such. However, our geographic and 
climactic situation being, what it is, we too have compelling track and 
freight infrastructure needs. We ask that when this Committee considers 
this legislation, it will keep our situation in mind.
    Finally, Mr. Chairman, I note H.R. 1140, the Railroad Retirement 
and Survivors' Improvement Act. Again, Senate companion legislation is 
expected to be introduced soon. Our railroad is not under the Railroad 
Retirement system, since we have always been governmental. But we still 
support the Railroad Retirement bill for several good reasons: First, 
we have many great workers who transfer from Lower 48 railroads who 
would rightfully benefit. What is good for railroad workers is good for 
our railroads. Second, the bill will help us in Alaska by making it 
easier to recruit skilled workers from Lower 48 railroads to move to 
Alaska, because the bill reduces the vesting period from 10 years to 5 
years. Accordingly, I want to add our support to the coalition of AAR, 
ASLRRA, and the rail unions supporting H.R. 1140.
    Thank you, Mr. Chairman, for this opportunity to submit this 
testimony for the record.

                               __________
     Responses to Written Questions Submitted by Hon. Gordon Smith 
                         to Richard K. Davidson

    Question 1. Mr. Davidson testified that in many instances, UP and 
BNSF are working together to provide better service and in some cases 
have actually created competition for shippers as a result of trackage 
rights over each other's lines. I am informed that about 18 percent of 
U.S. rail mileage consists of trackage rights under which one or more 
railroads have authority to operate over the track owned by another 
railroad.
    (a) To what extent does the industry ``voluntarily'' share its 
track or equipment? Is such ``sharing'' only because the industry has 
been required to do so as a condition of a merger?
    (b) To what extent has such ``sharing'' negatively impacted either 
BNSF's or UP's bottom line?
    (c) If trackage rights work for nearly 20 percent of the rail 
system, why shouldn't we presume it would be successful over a larger 
percentage of the system?
    Answer. Existing trackage rights are of two types. The first are 
those that are required by the Surface Transportation Board (or its 
predecessor, the Interstate Commerce Commission) as a condition of its 
granting approval for two railroads to proceed with a proposed merger. 
In reviewing a proposed merger, the Board identifies those places 
where, as a result of the merger, a shipper would lose the competition 
he previously had with two railroads. In those cases, the Board, as a 
condition for approving the merger, may require the merged railroad to 
grant trackage rights over its lines to another railroad to ensure that 
no shipper would lose service by two railroads as a result of the 
merger. There is no forced market extension and no injection of new 
competition--only the preservation of preexisting competition.
    Moreover, the proposed merged railroad has a choice. It can agree 
to the trackage rights condition and proceed with the merger, or it can 
forego the merger. This decision is a voluntary one, based upon the 
merging railroads' analysis of the underlying economics, i.e., do the 
expected benefits of the merger exceed the projected costs of the 
trackage rights? If they do, the merging railroads consummate their 
merger. If not, they walk away.
    The second type of trackage rights agreement is significantly 
different. It does not grant the tenant railroad access to any of the 
owning railroad's customers. Instead, it provides operational benefits 
to both railroads. This type of trackage rights is generally found 
where two railroads have duplicate facilities. For cost saving reasons, 
they can agree to abandon one track and to operate over the other, 
sharing maintenance and operating expenses. Alternatively, they could 
agree to keep both tracks, giving each other reciprocal rights so that 
both railroads could operate the tracks directionally--e.g., one track 
carrying only southbound traffic with the other carrying only 
northbound--an arrangement that allows both railroads to operate more 
efficiently. The significant feature of this type of trackage rights is 
that it is only operational in its impact. It is not a market 
extension, it does not grant either railroad new access to customers 
previously served only by the other, and it does not change the balance 
of supply and demand that previously existed in the free marketplace.
    The trackage rights proposed by shipper groups such as CURE and ARC 
are something entirely different. Indeed, they are totally 
unprecedented and, as such, the impact of such trackage rights cannot 
be measured by experience with the two types of trackage rights 
mentioned above.
    The unlimited trackage rights referenced in your question are 
unprecedented. First of all, they are totally involuntary in that they 
would be unilaterally imposed by the government upon the railroads 
against their will. This, in substance, would be a taking of private 
property.
    Second, the new type of trackage rights being proposed, unlike 
those now in existence, would have a major net negative economic impact 
on the railroads.
    The imposition of such trackage rights is intentionally designed to 
destroy the ability of the railroads to differentially price their 
services on the basis of the needs of the shippers, which is essential 
to the railroads' economic survival. This stands in marked contrast to 
the two types of currently existing trackage rights. The ``operational 
trackage rights,'' since they do not grant access to customers served 
by only one railroad, have no effect on the railroads' ability to price 
differentially. Thus, they produce operational savings and efficiencies 
without any loss of revenue. Similarly, since merger trackage rights 
simply replace competition that existed before the merger, they do not 
reduce the railroads' ability to price differentially. Moreover, any 
loss of revenue that might be attributed to those trackage rights is 
offset by merger savings.
    Thus, both types of existing trackage rights produce positive net 
economic benefits to railroads. In contrast, the trackage rights now 
suggested are specifically designed for the sole purpose of driving 
down existing rail rates (and thus rail revenues) by artificially 
forcing competition where the free market will not support it, without 
any offsetting cost savings or efficiencies.
    The rail industry recently completed a study showing that the loss 
of differential pricing that would result from the current open access 
proposals would cost the rail industry up to $4 billion annually in net 
revenues (which even at current levels do not cover the railroads' cost 
of capital). This would eliminate the railroads' ability to reinvest in 
and maintain the nation's rail system, eventually creating the need for 
a Federal subsidy to replace that lost revenue and preserve our rail 
system.
    Question 2. Senators Dorgan and Rockefeller have introduced 
legislation (S. 526) that would, among other things, subject rail 
agreements and transactions under the STB's jurisdiction to antitrust 
laws. How would enactment of this proposal affect the rail industry and 
the manner in which it currently operates?
    Answer. The enactment of legislation subjecting rail agreements and 
transactions now under STB jurisdiction to the antitrust laws under 
Department of Justice jurisdiction could have several surprising 
consequences. For example, a DOJ review of proposed mergers would be 
confined to a traditional antitrust analysis, which is considerably 
narrower than an STB review, particularly if the Board adopts the 
currently proposed changes in its merger rules. Under traditional 
antitrust analysis, a merger of any two of the six largest American 
railroads would very likely be approved by the DOJ since it would 
basically be an end-to-end merger with little competitive overlap. STB 
review, particularly under the proposed new merger rules, would be a 
much broader analysis into whether the proposed merger would be in the 
public interest, taking into account its potential downstream effect 
(would it trigger other mergers?), as well as its impact on labor and 
the environment. Under its proposed new rules, the STB would also 
insist that, as a condition to approval, the merger must not merely 
preserve competition, but enhance it. Traditional antitrust review 
addresses none of these issues. Accordingly, it is likely the STB would 
take a harder and more critical look at another rail merger than would 
the Department of Justice.
    This STB broader review is made possible not simply by the breadth 
of its statutory mandate, as implemented by the proposed new merger 
rules, but also by the fact that the STB staff over the years has 
acquired a special knowledge of, and expertise in, the railroad 
industry that goes beyond that possessed by the staffs of the 
Department of Transportation and the Department of Justice. This makes 
it possible for the STB and its staff to look behind and critically 
examine merger applicants' claims more intensely than the Department of 
Justice would be able to do.
    The difference in approach between the Department of Justice, 
applying traditional antitrust analysis, and the Surface Transportation 
Board (including its predecessor, the Interstate Commerce Commission), 
applying the broader public interest standard, also extends to review 
of other railroad agreements, such as the inter-railroad agreement that 
created Trailer-Train, a major supplier of rail cars to the entire 
industry. The Department of Justice looks with disfavor upon such 
``pooling'' agreements even where it could be shown, as it was in the 
Trailer-Train case, that such pooling creates major efficiencies that 
improve rail competition. The Trailer-Train pool was approved by the 
STB's predecessor and has clearly served the public interest. It would 
not have existed had it been reviewed by the Department of Justice 
under the much narrower scope of the antitrust laws.
    Question 3. To what extent do capacity constraints impede the rail 
industry?
    Answer. Capacity in the rail industry includes track, terminal, 
repair shop and workforce capacity, as well as the size and condition 
of locomotive and car fleets. Lack of capacity in any of these areas 
directly reduces a railroad's ability to provide reliable service. 
Without consistent and reliable service, a railroad cannot attract the 
traffic volume and revenues needed to support the large capital 
investment a railroad requires. Without increased capacity, a railroad 
would obviously be unable to accommodate growth in the general economy, 
such as in the demand for the transportation of coal needed for 
generation of more electricity. Without increased capacity, a railroad 
would certainly be unable to expand its transportation of premium 
products, such as intermodal business.
    The importance of capacity to a railroad is illustrated by looking 
at track capacity as an example. Track capacity is a function, among 
other things, of the number of tracks (single, double or even triple), 
the number of sidings (to accommodate overtakes, meets and passes), 
track condition (which determines allowable speed) and the existence or 
nonexistence of advanced traffic control systems on a particular route. 
Lack of capacity over any route reduces train velocity over that route, 
which, in turn, increases operating costs and reduces the utilization 
or productivity of all assets (locomotives, cars and crews) used over 
that route. Thus, inadequate capacity could trigger a downward spiral. 
The best (or worst) recent example of this was the 1997-98 service 
crisis following Union Pacific's acquisition of Southern Pacific, which 
was principally caused by a lack of capacity and track maintenance on 
the Southern Pacific. SP lacked the capital needed to make the 
investments required for adequate capacity.
    On a more positive note, a good example of how capacity 
enhancements can improve the overall performance of a railroad is our 
recent investment of over $300 million in upgrading and adding a third 
main line to our 110-mile route between North Platte and Gibbon, NE 
(which is the busiest section of railroad in the country). The attached 
chart illustrates the very substantial productivity gain that resulted 
from that capacity addition.
    Notwithstanding investments such as this and a total investment of 
over $10 billion in plant and equipment over the last 5 years, there 
are still areas where Union Pacific is capacity restrained. For 
example, we need to continue adding capacity in the form of additional 
doubletrack and sidings over the former SP Sunset route between Los 
Angeles and Kansas City to accommodate intermodal traffic between West 
Coast ports and Chicago. We also need to expand intermodal facilities 
throughout our system. These are only two examples of capacity 
additions that are required to serve our customers. In addition, we 
need to continually maintain our roadbed, terminals and fleet to avoid 
what happened to the Southern Pacific prior to our merger.
    All of this requires a continuing high level of capital investment 
and reinvestment that is dependent upon maintaining and growing our 
revenue base. This is a major challenge since railroads are still not 
earning their cost of capital. Reregulation, such as the current forced 
access proposals which are designed to reduce our revenue base 
substantially, would make our task impossible.
    In short, capacity, continuing capital investment, and the strong 
revenue base to support them are the keys to building and maintaining a 
sustainable and reinvestable railroad. Conversely, restraints on 
capacity, investment and revenues would be serious threats to a 
railroad's sustainability.
    Question 4. Railroads, like other businesses including utilities, 
chemical manufacturers, and agriculture, need incentives in their 
operations in order to improve their services and products. Yet there 
is concern that in the effort to provide rate relief to captive 
shippers and mandate rail-to-rail competition where none has existed, 
we run the risk of reducing incentives for railroads to reinvest in 
improving their service and expanding capacity. What are your views on 
these possible risks?
    Answer. ???
    Question 5. The concept of ``open access'' is sometimes recommended 
by rail shipper groups--although not all shippers--as a means to 
generate competition.
    (a) How would open access affect the rail industry's incentive to 
invest in infrastructure?
    (b) How could differential pricing be carried out in an open access 
environment?
    Answer. There are two themes in these three questions. They are how 
would rail-to-rail competition and open access impact our ability to 
invest, and how could differential pricing be carried out in open 
access? The short answer is universal rail-to-rail competition and open 
access would have a devastating impact on our ability to invest, and I 
know of no way to have differential pricing in an open access regime. 
This is particularly so in the open access regime proposed by certain 
shippers, where government, rather than the marketplace, would set 
prices.
    Open access proposals take various forms, including universal 
trackage rights, mandatory reciprocal switching, and mandatory 
``bottleneck'' rates. All these proposals (which by clear implication 
would include government price controls on what a railroad could charge 
for access or a ``short haul'' to a bottleneck point) would undercut 
rail revenue and cripple our ability to invest. By trying to force more 
competition where the marketplace will not support it, these proposals 
would lead to a shrinkage of rail services and the ultimate non-
viability of the railroads. This has happened twice before when 
regulators went too far--before World War I and after World War II. 
Both times the government had to bail out railroads that lacked the 
funds to invest.
    Indeed, in a number of places on our system, particularly in and 
around major metropolitan areas, our capacity, though not presently 
constrained, is at or near its limits. If additional traffic demands 
were imposed on our system in those places, additional capacity would 
have to be added to avoid constraints that otherwise would impair our 
ability to provide adequate service.
    Railroading is highly competitive with many shippers being served 
by trucks, water carriers, and other railroads. Moreover, product and 
geographic competition also helps to constrain rail rates. However, 
every rail-served facility does not have two railroad service. This 
does not reflect any inadequacy in existing competition. The current 
level of rail competition reflects private marketplace decisions as to 
which rail markets will sustain multiple carriers and which will not. 
Having the government artificially engineer more competition than the 
private markets can support can only reduce the ability of railroads to 
earn an adequate rate of return. There simply can be no other outcome.
    To put this in a better perspective, let me provide some real 
dollar amounts to show the devastation these kinds of proposals would 
create. In 2000, as an industry, railroads grossed $34.1 billion in 
revenue. Of this, $29 billion went toward operating expenses, resulting 
in $5.1 billion in operating income. With this $5.1 billion, we have to 
pay taxes, make capital investments, and pay for other expenses. As I 
indicated in my written testimony, these types of open access proposals 
would, on a conservative basis, eliminate $2.4 billion of this $5.1 
billion. As stated above, our latest studies indicate that the real 
cost will be much higher ($4 billion). Obviously, this would cripple 
our industry.
    Some argue it is unfair that railroads are allowed to charge some 
customers higher rates than others. Such differential pricing, however, 
is common in one form or another in every industry. This is the only 
system that allows railroads to be self-sufficient. Differential 
pricing, charging rates that reflect customer demand for rail service--
coupled with maximum rate limits, that are enforced by the STB, allows 
every shipper to pay the lowest possible rate consistent with a self-
sustaining rail system. Changing this system will either shrink the 
rail network or require large amounts of public subsidies.
    Can differential pricing work in a forced access regime? Simply 
put, it cannot. Differential pricing is based on marketplace needs. 
Forced access, which is based upon artificial competition imposed by 
the government, would radically restructure that marketplace. Open 
access will require invasive regulation. An essential part of open 
access is that the government must determine access fees, and these 
fees will be heavily litigated. Bottleneck schemes would re-balkanize 
rail routings and create more inefficiency. Moreover, forced, below-
cost fees would give rise to contentious disputes about operations and 
investment. Railroads will not spend money on infrastructure that is 
being used by a competitor at below-market rates.
    If Congress should choose to go down the path of open access, it 
should do so with its eyes open. The current regulatory scheme has 
created a rail network that is the envy of the world. If Congress 
should choose open access as the new scheme, it should be prepared for 
one of two outcomes. We will either have a much smaller, less efficient 
rail network, or the government will have to be prepared to invest 
billions of dollars into an industry that today is largely self-
sustaining.
    Question 6. At least two of the witnesses on the next panel will 
comment about the Federal subsidy discrepancy between the rail industry 
and its competitor modes. What are each of your views on this? Is the 
rail industry seeking a Federal funding program similar to the highway 
trust fund?
    Answer. The Federal subsidy difference between other transportation 
modes and the rail industry is well documented. While the trucking and 
waterway industries pay taxes to support their infrastructure, it is 
not sufficient to cover their use of these systems. Moreover, these 
modes have different, more favorable tax treatment for their equipment, 
and are not burdened with other governmentally imposed costs such as 
the Federal Employers Liability Act (FELA) or an antiquated retirement 
system that is maintained by a 36 percent payroll tax. Having said 
that, I am not advocating an increase in our competitors' taxes. 
Rather, I would urge Congress to repeal the 4.3-cent gas tax we pay for 
deficit reduction, pass railroad retirement reform, and make no changes 
in our economic regulatory structure. This would be an excellent first 
step toward parity between the modes.
    The second part of your question asks if the rail industry is 
seeking a Federal funding program similar to the highway trust fund. 
The answer is absolutely no. As you know, we build and maintain our own 
systems. Having a program similar to the highway trust fund would 
divert our resources to such a fund. Rather than each railroad making a 
business decision on where to invest, the government would be placed in 
that role. Not only would that create a needless and inefficient 
middleman for rail investment, but it could also unfairly skew the 
competitive landscape. For instance, suppose we invest private dollars 
to build an intermodal yard. Would it be fair for the government to 
fund a similar yard for our competitors?
    However, are there places where government investment is acceptable 
and worthwhile? Yes, there are. One such area is commuter rail. Urban 
sprawl and congestion are problems facing city planners, and many 
commuter agencies are looking at passenger rail to solve their 
problems. Many of these agencies look at our tracks as a way of solving 
their commuter problems. However, they often do so without considering 
that we have limited capacity, and we need that capacity to move 
freight. If rail freight capacity is captured for commuter trains, more 
freight will be forced into trucks, and road congestion will get worse, 
not better.
    That is not to say that we are opposed to commuter rail. In fact, 
we have participated in many commuter rail projects where the commuter 
authority replaces the capacity used by its passenger trains, usually 
with public money.
    Additionally, there are other public/private projects that make 
sense. The FAST Corridor project in the Pacific Northwest and the 
Alameda Corridor project are two examples. These two projects allow us 
to move freight in a more efficient manner, while at the same time 
allowing for a more livable community by eliminating grade crossings.
    Another type of project that makes sense is rail relocation 
efforts. Often communities have a transportation plan that requires the 
relocation of a rail line. Since our industry usually derives no 
benefit from such a relocation, it is often up to the community to find 
the funds to move the line.
    Yet another example is intermodal access routes. These are highway 
projects that develop transportation infrastructure for intermodal 
terminals which, among other benefits, improve air quality by reducing 
highway truck traffic.
    The general theme in all of these types of projects is that there 
is some overarching public benefit. The rail industry is proud that it 
funds its own network and is not seeking a change in this area. 
However, State and local planners should have the flexibility to use 
their transportation dollars in a manner that best addresses the needs 
of the communities where they will be spent.

                               __________
     Responses to Written Questions Submitted by Hon. Gordon Smith 
              to Burlington Northern Santa Fe Corporation

    Question 1. Mr. Davidson testified that in many instances, UP and 
BNSF are working together to provide better service and in some cases 
have actually created competition for shippers as a result of trackage 
rights over each other's lines. I am informed that about 18 percent of 
U.S. rail mileage consists of trackage rights under which one or more 
railroads have authority to operate over the track owned by another 
railroad.
    (a) To what extent does the industry ``voluntarily'' share its 
track or equipment? Is such ``sharing'' only because the industry has 
been required to do so as a condition of a merger?
    (b) To what extent has such ``sharing'' negatively impacted either 
BNSF's or UP's bottom line?
    (c) If trackage rights works for nearly 20 percent of the rail 
system, why shouldn't we presume it would be successful over a larger 
percentage of the system?
    Answer. Track and equipment sharing arrangements are common in the 
railroad industry. Such arrangements are a key element of our 
operational efficiency and they underlie our networking capability, 
which enables railroads to transport shipments between customers served 
by different carriers. The nature of railroading requires companies 
that compete with one another to also cooperate and coordinate with one 
another, to ensure an efficient, free flowing and national system.
    As far as track sharing, BNSF has rights on more than 8,300 miles 
of trackage owned by other railroads, and other railroads have rights 
over 4,900 miles of BNSF trackage. Some of these are longstanding 
arrangements, going back a century or more, such as Union Pacific's 
rights on BNSF over Cajon Pass in Southern California, BNSF's rights on 
Union Pacific across the Tehachapi Mountains, and Union Pacific's 
rights on BNSF between Tacoma and Vancouver in Washington. Other 
agreements are more recent, resulting from the need to maintain rail-
to-rail competition for shippers served by merging carriers, or from 
traffic declines so severe that separate operations need to be 
consolidated on a single route as the only economically feasible way to 
maintain service. It should be noted that trackage use agreements do 
not necessarily allow the tenant railroad to serve on-line customers--
some agreements do, while others do not.
    Equipment sharing is ubiquitous in railroading. Many rail cars are 
in ``free running'' service, allowing them to be loaded and sent to any 
rail destination in the nation, then immediately reloaded. Certain 
other cars, such as those used for intermodal and automobile-carrying 
service, are predominately owned and managed by TTX Corporation, a 
company jointly owned by the railroads for purposes of ensuring 
equitable access to cars for member railroads, adequate car supplies 
for customers, and efficient utilization of the equipment. Locomotives, 
too, are frequently ``run-through'' on trains that are interchanged 
between railroads, in order to ensure good service and the best 
possible asset utilization.
    A critical point to recognize is that all these track and equipment 
sharing agreements are voluntary. Access rights and fees are negotiated 
at ``arms length'' between the parties to ensure the best possible 
customer service and asset utilization, and, if additional track 
capacity is required to accommodate additional trains on a route, the 
parties work out a voluntary arrangement for sharing the costs. While 
trackage rights agreements made to facilitate a merger are typically 
memorialized as a condition of the merger, the ultimate basis for such 
agreements is voluntary.
    It is possible that voluntary trackage rights agreements could be 
successful over certain additional routes of our nation's rail network. 
In fact, adjustments to trackage rights agreements between railroads 
occur regularly, and it is not uncommon for such adjustments to result 
in expanded rights over additional routes, or for entirely new 
agreements to be negotiated between rail companies.
    Our concern, quite frankly, is over proposals made by certain 
shipper groups that could result in involuntary access, mandated by 
government, with prices and other terms set by a government agency that 
could be considered tantamount to government running the railroads.
    Question 2. Senators Dorgan and Rockefeller have introduced 
legislation (S. 526) that would, among other things, subject rail 
agreements and transactions under the STB's jurisdiction to antitrust 
laws.
    (a) How would enactment of this proposal affect the rail industry 
and the manner in which it currently operates?
    Answer. This legislation would effectively give both the Surface 
Transportation Board (STB) and the Department of Justice (DOJ) 
jurisdiction over rail mergers and certain equipment related 
agreements.
    With respect to rail mergers, DOJ can and has actively participated 
in the STB rail merger review proceedings. The STB is statutorily 
charged to address both rail competitive issues and make a broader 
determination of whether a transaction is in the public interest. The 
STB includes consideration of operating, service and environmental 
effects of proposed rail industry consolidation transactions in an 
extensive review and approval process. There is no reason to add to 
this already extensive review process another layer of regulatory and 
legal review. There is no reason for such multiple, duplicative review 
of rail merger transactions, although we do not object to DOJ review 
itself if it were the sole reviewing agency.
    Question 3. To what extent do capacity constraints impede the rail 
industry?
    Answer. Railroad capacity is a function of a myriad of inputs, 
including tracks, rolling stock, yards, repair facilities, customer 
support capabilities, dispatching and signal technology, equipment and 
infrastructure maintenance levels, and workforce productivity. All 
these factors, together, determine the amount of freight railroads can 
handle and the service levels that can be provided.
    Many of the elements that determine rail capacity have long service 
lives and. are not mobile. As a result, as demand for rail service 
declines in certain markets and increases in others, most elements of 
capacity can't be relocated from the area of declining demand to the 
emerging growth area. As a result, the network doesn't have as much 
capacity as is needed in high growth markets like the Midwest-
California intermodal lane, but there is excess capacity in certain 
declining markets.
    In the broadest sense, market-based pricing mechanisms are utilized 
by carriers and shippers to balance rail capacity and shipment volumes. 
Rail rates decline when excess capacity is available, and they increase 
as the network fills up. In the short term, factors like floods, 
derailments or other disruptions sometimes cause congestion problems, 
ranging from a few days to a few months. But over the longer term, 
since both rail prices and the number of miles of track in the nation's 
rail network have been declining, most rail industry observers and Wall 
Street analysts would agree that the industry's problem is too little 
business, not too much.
    Today, primarily because of the high level of capital spending by 
railroads over the last several years, the mainlines of the Class I 
railroads and their cars and locomotives are in excellent operating 
condition. The result has been steady improvements in both safety and 
customer service levels. The question for the future, however, is 
whether railroads will be profitable enough to justify making 
investments to handle projected future growth. If rail industry 
profitability is inadequate to justify such investments, more freight 
will be carried on the.highways. and waterways, and the amount of 
government subsidy for these modes will increase correspondingly.
    Question 4. Railroads, like other businesses including utilities, 
chemical manufacturers, and agriculture, need incentives to invest in 
their operations in order to improve their services and products. Yet 
there is concern that in the effort to provide rate relief to captive 
shippers and mandate rail-to-rail competition where none has existed, 
we run the risk of reducing incentives for railroads to reinvest in 
improving their service and expanding capacity. What are your views on 
these possible risks?
    Answer. Railroads are a very capital intensive business, and 
already face pervasive competition, not only from other modes of 
transportation, but in the case of the shipper served by one railroad, 
product, geographic and source competition. Programs to mandate lower 
rates or mandate additional rail-to-rail competition run a tremendous 
risk of destroying incentives for investment in rail industry.
    Congress and the ICC/STB historically recognized that the shift to 
a demand-based pricing system required the adoption of measures 
designed to protect shippers when competition is found to be inadequate 
or there is a risk that market power will be abused. For instance, the 
STB's competitive access regulations enable a shipper to secure access 
to a second carrier if it is shown that the existing carrier has abused 
its market power through its rates or service. Further, the STB rules 
provide a mechanism for determining maximum reasonable rates where a 
rail carrier is ``market dominant''.
    Continued improvements in the industry infrastructure and service 
can only be achieved through continued capital investment, and 
investment can be attracted only by maintaining the current demand-
based pricing structure. If railroads are not given the opportunity to 
recover, and achieve a fair return on, their investment costs, they 
will not attract the capital necessary to invest in track construction 
and maintenance, to upgrade yards, and to undertake other 
infrastructure and service improvements required to keep them 
competitive. The service and safety improvements which have been 
achieved also cannot be maintained and expanded without continued 
massive capital investments.
    While rail continues to be the cheapest and safest form of 
transportation for most goods, it has achieved that because of our 
ability to invest. Anything that interferes with the ability to attract 
capital would lessen our ability to be the lowest cost and safest 
provider of land transportation services.
    Question 5. The concept of ``open access'' is sometimes recommended 
by rail shipper groups--although not all shippers--as a means to 
generate competition. (a) How would open access affect the rail 
industry's incentive to invest in infrastructure? (b) How could 
differential pricing be carried out in an open access environment?
    Answer. We believe forced rail access would undermine investor 
confidence and reverse the post-Staggers trend of relatively improved 
earnings, enhanced financial stability and increased investment. Forced 
rail access would also increase regulatory uncertainty and market risk 
and would undercut growth expectations and very likely reduce expected 
rail earnings. Each of these would in turn chill the enthusiasm of 
investors and drive their capital to other uses, adversely affecting 
the rail industry's incentive and ability to invest in infrastructure.
    Moreover, forced rail access would reverse many of the network and 
system efficiencies brought about by the Staggers Act. The pre-Staggers 
regulatory scheme effectively compelled the railroads to operate 
numerous inefficient routes. They were unable to concentrate traffic on 
the most efficient routes and gateways, and their ability to compete 
was diminished. Staggers reversed that system and allowed the railroads 
to invest in a streamlined and much more efficient and competitive 
network. Forced rail access would result in the breaking up of a 
nationwide network of single-line and run-through train service and 
efficient blocking in favor of a splintered, slower and less 
competitive service with inefficient car utilization and supply. This 
would not generate sound and healthy long-term competition.
    An open access environment brought about by government mandated 
programs would be fundamentally contrary to differential pricing. 
Differential pricing is pricing of services based upon the demand for 
those services, so that different customers pay rates which yield 
different contributions to fixed costs based upon the different demand 
characteristics of those market sectors and movements for that rail 
service.
    Under a system of forced rail access, the Surface Transportation 
Board, or some government entity, would have to reinject itself into 
the ratemaking process, establish the priorities for and the terms and 
conditions for allocating rights to use tracks, and, in short, reverse 
the deregulatory direction of the Staggers Act and the progress it 
fostered.
    Question 6. At least two of the witnesses on the next panel will 
comment about the Federal subsidy discrepancy between the rail industry 
and its competitor modes. What are each of your views on this? Is the 
rail industry seeking a Federal funding program similar to the highway 
trust fund?
    Answer. Longstanding inequities between government tax and user fee 
policies have distorted markets for freight transportation and played a 
significant role in the relative decline the rail industry has 
experienced over the last several decades. While railroads pay 
essentially 100 percent of the costs associated with building and 
maintain their networks, the most recent USDOT study of highway user 
costs confirmed that motor carriers pay only about 66 percent of their 
costs for using highways, and our own analysis has determined that 
barge operators pay only about 12 percent of the capital and operating 
costs of the inland waterway system.
    The efficiencies of railroading are not great enough for our 
industry to overcome these inequities, except in limited circumstances 
such as with especially heavy commodities like coal or grain, or in 
very long haul, high density intermodal lanes.
    There are essentially two alternatives for correcting this 
situation and level the playing field between modes. One is to increase 
the user fees paid by truckers and barge operators so they are in line 
with the costs of building and maintaining their infrastructure. The 
other alternative is to provide railroads with a level of support that 
is, at least in theory, comparable to the subsidy received by the modes 
we compete against.
    A trust fund for railroads, funded by rail industry contributions, 
would not resolve this inequity, nor would it have the implied effect 
of increasing the amount of capital available for investment in 
railroad infrastructure. Basically, such a fund would merely 
redistribute rail industry investment capital in a politically 
influenced environment, compared with the market-based methods now used 
to determine railroad investment levels.
    The first step in the process of achieving modal equity should be 
relieving the railroads of the inequitable 4.3 cent deficit reduction 
diesel fuel tax. The second step is to provide railroads relief from 
the onerous burden of the Railroad Retirement system. Next, over the 
longer term, railroads will need pubic financing assistance that 
offsets the public benefits associated with investments in rail and 
rail related infrastructure. Many, if not most, rail freight projects 
provide demonstrable public safety, congestion, environmental, and 
economic benefits, so such assistance is justified.
    Resolving the modal equity dilemma in the freight transportation 
industry is going to be a difficult process. The modes that currently 
benefit from inequities are certain to stridently resist any increase 
in the user fees they pay, and even simple ``first steps'' like fuel 
tax and retirement relief are proving difficult for our industry to 
achieve. The longer we wait to take action, however, the weaker the 
railroads will become, as the level of infrastructure investments 
declines, and as capacity shrinks, one branch line at a time. 
Eventually, America could be left with a sub-optimally sized rail 
network, and more and more traffic will be forever transported on 
heavily subsidized modes.

     Response to Written Questions Submitted by Hon. Gordon Smith 
                         to William J. Rennicke

    Question 1. Policy changes: What would be the most beneficial 
policy change Congress could adopt to improve rail transportation?
    Answer. The most critical action Congress could take at this 
juncture is to ``cause no harm.'' Anything that jeopardizes the rail 
industry's ability to generate an adequate return on investment will 
put the efficiency, safety, and sustainability of the U.S. freight rail 
industry at risk. This applies not only to potential regulatory change, 
but equally to any extension of the privileges accorded commuter rail 
interests, if these were to exceed the current arrangement of arms-
length, private sector negotiations between interested parties. No 
legislation should be enacted which will adversely impact the freight 
rail industry's ability to handle not only existing traffic, but the 
huge increases in freight demand anticipated in the coming decades.
    More specific areas for Congressional action would include reform 
of the Railroad Retirement System ($400 million cost reduction per year 
with greater benefits for retirees) and repeal of the 4.3 cents per 
gallon ``deficit reduction'' fuel tax ($170 million per year). Even 
more important is the establishment of parity among freight 
transportation modes under the law. Trucks (and, to a lesser extent, 
barges) should be encouraged to pay the costs of construction, 
maintenance, and damage caused on their behalf. Incorporation of an 
even-handed philosophy into transportation policy would serve to ensure 
that decisions are made on the basis of economic realities and overall 
social good.
    Question 2. Subsidy options: What is being recommended to remedy 
the Federal subsidy discrepancy between the rail industry and its 
competitors? Do you want to create a rail transportation trust fund 
supported by the users--in this case the rail shippers--similar to 
those for highways and aviation?
    Answer. What I am recommending is that the playing field be 
leveled: Either stop subsidizing motor carriers or provide similar 
subsidies for rail. I would not want to see new taxes or government-
administered trust funds imposed to provide such subsidies, however, as 
overhead and administration of such funds typically consume much of the 
tax revenue. Such taxes can also cause misallocation of economic 
resources in the inevitable political battling for funding. The 
railroads have shown themselves to be efficient administrators of the 
limited Federal funding that has thus far been injected into projects 
with clear public benefits, such as highway grade crossing elimination, 
investment in the Alameda Corridor to relieve port and highway 
congestion, and institution of commuter operations (where capacity 
exists and arrangements are mutually agreeable between the parties).
    Question 3a. Future operational/productivity gains: Are there 
future operational improvements to be gained from additional 
consolidation in the rail industry?
    Answer. Additional consolidation in the rail industry would still 
yield future operational and productivity improvements, although on a 
percentage basis these would not be as large as in the past. More 
extensive alliances with non-railroad partners such as vendors and 
financial institutions would also enhance productivity. As large as the 
current Class I railroads are, many of the functions they carry out are 
subscale and could be made more efficient through integration with the 
subscale functions of other railroads. For example, each railroad has a 
car movement and train control system that is large enough to serve the 
entire industry. Consolidation of these activities could marshal scarce 
funds into fewer, more comprehensive 
systems. The efforts of the six largest North American railroads to 
introduce 
greater efficiency into the railroad supply chain through their 
creation of RailMarketplace.com is one example of consolidation efforts 
that benefit both buyers and sellers of rail products and services.
    Question 3b. If railroads fail to make further operational 
improvements, what will be the impact on customers?
    Answer. The railroads must continue to make significant operational 
and productivity improvements to offset declining revenue per ton-mile. 
If productivity stagnates, railroads will be forced to increase their 
prices or to consume capital funds that would normally be invested in 
the network. If railroads cannot fund investment in the network, the 
condition of the industry will likely deteriorate to that of the 
difficult pre-Staggers Act period. However, because cost efficiencies 
and further productivity will be incrementally more difficult to 
achieve, growth in railroad traffic will be an even more critical 
element in the future health and sustainability of the freight railroad 
industry.
    Question 3c. Is there capacity in other modes to make up for a lack 
of quality service by railroads?
    Answer. In the long term, other modes have and will continue to 
provide service to customers where railroad quality stumbles. The 
overall capacity of the motor carriers and the highway system, however, 
is not sufficient to serve as a substitute means of transport for any 
significant portion of the huge volumes of bulk commodities carried 
efficiently by rail. Furthermore, it should be noted that rail users 
represent a wide spectrum of customers--from those who prefer to pay 
very low transportation rates for service that may be less than 
optimal, to numerous groups of rail shippers who demand--and get--fast 
and highly reliable rail service. While there are multiple 
transportation modes that may at times provide better service, none are 
able to do so at the very low prices offered by rail--it is a well-
known fact that North American freight railroads provide some of the 
lowest cost transportation in the developed world. Many rail users, 
such as coal, ore, and other extraction-oriented businesses, have 
become accustomed to and dependent on highly reliable and efficient 
rail ``shuttle'' services--these have become the norm.
    Question 3d. Under current conditions can railroads continue to 
attract the investment needed to . . . grow the system to meet the 
predicted increase in demand over the next 25 years?
    Answer. Railroads' current ability to attract new investment is 
already quite tenuous, as investors require a stable, predictable 
regulatory environment in which investment risks can be clearly 
understood. If greater uncertainty creeps into the business and 
regulatory environment, funds will either flee to lower risk 
opportunities or the cost of the funds will increase. If, however, 
railroads are allowed to continue to use differential pricing to manage 
revenue yields, and the government is open to the development of new 
industry structures and alliances with third parties, then sufficient 
funds are likely to continue to flow into the rail sector.
    Question 3e. When productivity gains have been made, who has 
benefited--the investor or the customer?
    Answer. As a net effect of productivity gains, railroads have been 
able to substantially reduce their costs, with nearly all of the 
benefits going to customers. Over 80 percent of productivity gains/cost 
reductions since 1989, as shown in Exhibit 1, have been shared with or 
returned to customers, suppliers, and other transport companies (e.g., 
ocean carriers) in the form of rate decreases.

[GRAPHIC] [TIFF OMITTED] T8786.045


    Question 4. Competition: In conducting your research on the rail 
industry, have you seen evidence of decreased competition (as a result 
of recent rail mergers), and if so, to what extent?
    Answer. In the work Mercer does for shippers and carriers in all 
modes, we have observed very little reduction in rail-to-rail 
competition. If anything, the mergers have accelerated sustainable 
competition. For example, the Southern Pacific (SP) was a very weak 
competitor to UP and BNSF. It is unlikely in the long run that it could 
have continued to be a viable competitor. As a result of the merger of 
SP with UP, however, service at SP competitive points has been 
significantly strengthened and on balance the competitiveness of rail 
has increased. As presented by Mr. Davidson of UP at the hearing, 
competition is not simply a matter of having two (or more) rail 
carriers at common points. Locating at single service points on a 
strong railroad is far more preferable for shippers than locating at 
points served by two or more carriers where the carriers are weak or 
single line networks do not function efficiently.
    Question 5a. Traditional sources of productivity improvement/
mergers: Can you explain what you mean by ``traditional sources'' and 
how the railroad industry has used them?
    Answer. ``Traditional sources'' of productivity improvement are 
those that have been available to the railroads since passage of the 
Staggers Act, including reducing the workforce (and increasing output 
per employee), shedding excess track and rollingstock, increasing the 
traffic density per mile operated, and improving the fuel efficiency of 
locomotives. We are now, however, beginning to bump up against the 
physical and technical limits of many of the activities railroads have 
used thus far to reduce costs, and future cost takeouts will be 
increasingly more difficult to attain.
    Question 5b. Do ``traditional sources'' include mergers?
    Answer. Consolidations, mergers, and increased coordination among 
railroads have been major sources of productivity improvement in the 
past. Mergers however are now becoming much more difficult to get 
approved and the benefits that can be realized from them are growing 
smaller. The BNSF/CN merger would have introduced new levels of service 
and productivity into the NAFTA environment, but would not have led to 
significant reductions in personnel, track, or rollingstock.
    Question 5c. How have the numerous rail mergers impacted 
productivity in the rail industry?
    Answer. While it is difficult to develop a precise estimate, it is 
likely that mergers since 1980 have created the possibility for 
approximately 25-50 percent of all savings realized by U.S. railroads. 
For example, the Kansas City terminal area involved a complicated set 
of multicarrier networks and operational processes that were very 
expensive to operate, yet often provided very poor service to 
customers. Control of the terminal by just the current two carriers, 
BNSF and UP, has led to efficiency and service improvements that could 
only be dreamed of in the past. The Senator and the Committee may wish 
to look at the private investment and intercarrier coordination that 
have been achieved at Kansas City since the mergers. There are also 
many new productivity and efficiency initiatives being undertaken by 
BNSF and UP in the West and by NS and CSX in the East. In addition to 
the two CEO witnesses at the hearing (BNSF and UP), you may wish to ask 
David Goode (CEO of NS) and John Snow (CEO of CSX) to comment on the 
productivity and network coordination plans they have underway.
    Regulation often stands in the way of productivity--to everyone's 
loss. For example, NS wanted to close a highly inefficient car shop in 
Hollidaysburg, PA, but was stopped by the STB. The problem is that 
business realities have changed: The car fleet is contracting and non-
railroad leasing companies are, in many cases, becoming the most 
efficient providers of rail rollingstock. In the end, the cost of 
keeping a facility open will be determined by market dynamics and 
changing relationships. In this case, it would appear that any 
inefficiencies inherent in the operation of the shop are being borne by 
the shippers, who in essence are cross-subsidizing the employees and 
the community that is trying to keep the shop open. In advising the 
railroads and governments of other countries, Mercer has recommended 
closing many similar unneeded facilities, to the benefit of shippers 
and the economy.
    Question 5d. Is there additional productivity to be gained from 
further mergers and, if so, to what extent?
    Answer. Additional productivity gains could likely be realized from 
a further round of mergers. In any new merger, some of the traditional 
merger-related benefits always will be present; namely, the benefit of 
shorter routes between selected origins and destinations, the 
elimination of costly interchanges between carriers, consolidation of 
carrier organizations, etc. Proportionately, however, the gains that 
could be realized will be less than in prior mergers because the 
carriers are all much bigger and the synergies available to them are 
about the same. The next mergers will be increasingly end-to-end, 
resulting in fewer operating savings than side-by-side combinations. 
But while end-to-end mergers have much less effect on reducing 
workforce, track, or rollingstock, they do have a positive effect on 
the combined entities' ability to offer more streamlined and seamless 
service, thus benefiting customers and the economy as a whole, while 
improving rail's financial returns.
    Over the near term, the ability of railroads to earn their cost of 
capital will become increasingly critical, as the industry faces huge 
capital investment demands for positive train control, intermodal 
facilities and access, upgraded and integrated information technology, 
more efficient ``next generation'' railcars and locomotives, and the 
expansion of capacity to meet the huge increase in freight demand 
commonly projected over the coming 10- and 20-year periods. Whether 
through mergers or some other means, railroads must find a way to 
continue to improve productivity and financial returns--the 
consequences of failing to do so can only adversely effect everyone who 
uses or benefits from rail service.

                               __________
     Responses to Written Questions Submitted by Hon. Gordon Smith 
                       to Dr. Allan M. Zarembski

    Question 1. What would be the most beneficial policy change 
Congress could adopt to improve rail transportation?
    Answer. Given the capital-intensive nature of railroads, 
particularly their need to invest in the maintenance and upkeep of 
their infrastructure, as well as the additional capital required to 
improve service and handle future traffic growth, any programs that 
provide additional resources or reduce financial burdens will be 
helpful. For example, the Association of American Railroads has 
proposed repeal of the 4.3" per gallon ``deficit reduction'' fuel tax. 
In the longer term, increased public funding of railroad improvements 
might be justifiable from a public policy standpoint.
    In the case of the smaller short line and regional railroads, the 
need is for immediate capital assistance for the upgrade of their 
infrastructure.
    Question 2. What exactly is being recommended to remedy this 
discrepancy [in subsidy received by railroads and their competitors]? 
Do you want to create a rail transportation trust fund supported by the 
users--in this case, rail shippers--similar to how the users of the 
highways fund the highway trust fund and air passengers fund the 
aviation trust fund?
    Answer. While there certainly may be merit in creating a ``rail 
transportation trust fund'', it should not be financed by placing an 
additional burden on either the railroads or shippers, Doing so could 
further increase the discrepancy. An additional tax on railroad 
shippers to support the railroad industry could potentially drive 
traffic away from the railroads and thus in the long run have a 
negative impact.
    The nation as a whole, however, may benefit from publicly funded 
improvements to railroad infrastructure that facilitate operation of 
high speed passenger trains, commuter trains, or simply expedite the 
movement of rail freight such as over the short lines which often are 
the primary rail transportation connection for small industries in 
rural territories. This latter case is clearly evident in the short 
line railroads' need for capital to upgrade their infrastructure to 
handle the new generation heavy freight cars being used by the Class 1 
railroads.
    Question 3a. Several of you discussed productivity gains made by 
railroads in recent years through both consolidations and service 
improvements. Are there future operational improvements to be gained 
from additional consolidations of the rail industry?
    Answer. It has been argued that there are ``economies of density'' 
in railroading. As far as track maintenance is concerned, I believe 
these economies may have largely disappeared for the freight railroad 
industry, particularly on the higher density lines. In fact, there may 
be diseconomies as traffic density continues to increase. For example, 
on very high density lines track access is limited thus restricting the 
ability of the railroad to perform maintenance and resulting in 
increased maintenance costs.
    Also, there is evidence of capacity constraints at a number of 
points on the rail network. This suggests that mergers undertaken in 
order to reduce physical plant and further concentrate traffic flows 
may have greater difficulty producing operational improvements and 
maintenance economies. There may, of course, be other justifications 
for mergers, such as increased efficiencies due to shorter routes and 
elimination of interchanges.
    Question 3b. If railroads fail to make further operational 
improvements, what will be the impact on customers?
    Answer. If railroads cannot fund necessary infrastructure 
investments, service and safety will suffer. Poorer service quality 
will result in lost traffic and lower revenue. Ultimately, if railroads 
fail to generate the resources necessary to maintain their fixed plant, 
the industry will require another major transfusion of capital, such as 
occurred when Conrail was formed out of a group of bankrupt 
Northeastern railroads.
    Question 3c. Is there capacity in other modes to make up for a lack 
of quality service by railroads?
    Answer. Zeta-Tech specializes in the railroad industry and has not 
conducted studies of capacity in other modes. But based on observation, 
it appears that other transportation modes, especially highways, lack 
the capacity to absorb traffic lost by railroads, thus the pressure to 
build more highways and to permit larger trucks.
    The Association of American Railroads reports that the average 
train in 1999 had 69 cars\1\ and carried 2,947 tons of cargo.\2\ On 
average a truck carries about 30 tons of freight. Therefore, a 69-car 
train carries the load equivalent to that of about 100 loaded trucks. 
Put another way, a line with one million gross tons (MGT) of traffic (a 
very light tonnage typical of branch lines and short line railroads) 
sees about five average-sized trains a week--the equivalent of 500 
loaded trucks per week or more than 70 loaded trucks per day.
---------------------------------------------------------------------------
    \1\ Loaded and empty cars.
    \2\ ``Yearbook of Railroad Facts 2000'', (Washington: Association 
of American Railroads)
---------------------------------------------------------------------------
    Traffic volume on trackage owned by Class I railroads averages 12 
MGT, the equivalent of approximately 860 loaded trucks per day. 
Clearly, if all rail traffic was to be handled on the highways, a very 
substantial investment in additional capacity would be required.
    Question 3d. Under current conditions, can railroads continue to 
attract the investment needed to not only maintain the current system 
and provide safe and efficient service, but also grow the system to 
meet the predicted increased demand over the next 25 years?
    Answer. The Zeta-Tech analysis established the need for heavy 
railroad investment simply to keep the existing freight rail network in 
a fully operational, safe, and efficient condition. I must defer to the 
railroads and Wall Street to answer whether railroads can earn enough 
or can continue to attract the needed investment.
    As indicated by Mr. Rose of BNSF, at least some railroads are not 
now earning returns sufficient to justify investment in expansion of 
capacity. However, based on their revenues in the last decade, they do 
appear to be able to generate sufficient capital to met their current 
infrastructure needs, provided that this current level of return is not 
reduced.
    Question 3e. When productivity gains have been made, who has 
benefited? The investor or the consumer?
    Answer. While Zeta-Tech's expertise is in the engineering and 
costing arenas, I am aware of studies carried out by a number of 
academics, most notably Carl Martland of the Massachusetts Institute of 
Technology, which indicate that most of the railroad productivity gains 
of the past 20 years have been given to consumers. This is supported by 
the evidence presented to your Subcommittee about the downward trend in 
average rail rates over the past two decades.
    Question 4. In conducting your research and analytical work in the 
rail industry, have any of you seen evidence of decreased competition 
and, if so, to what extent?
    Answer. Zeta-Tech's area of practice is limited to engineering, 
operations, and transportation cost analysis. We do not analyze the 
competitive environment in which railroads operate.
    Question 5. You note in your findings that short lines were in 
relatively poor condition when they began operations. Further you note 
that your findings show that these lines are now in need of a great 
deal of attention in order , to continue to work with the heavier load 
weights now being carried by the Class 1 lines. In your opinion, can 
the short line and regional railroads make the necessary repairs and 
upgrades to meet the heavier load weights on their own?
    Answer. Short line and regional railroads for the most part lack 
the resources to make large investments in their track structure. While 
there are exceptions, most short line and regional railroads will 
require outside funding if they are to be able to perform upgrades 
necessary to safely handle the new generation of 286,000 lb. cars. 
Zeta-Tech has determined that the approximately 550 short line and 
regional railroads. require $6.9 billion to upgrade their track and 
structures to be able to handle these heavier freight cars on a long 
term basis.\3\
---------------------------------------------------------------------------
    \3\ Carl D. Martland, ``Sources of Financial Improvement in the 
U.S. Rail Industry, 1966-1995'', Proceedings of the 39th Annual 
Meeting, Transportation Research Forum (1997).
---------------------------------------------------------------------------
    In terms of money available to maintain track, Class I roads 
receive, on average, approximately $269,000 in revenue from each mile 
of track; the short line and regional industry receives only about 
$60,000 per mile, less than 25 percent of the Class I revenue. Given 
this revenue constraint, and noting that the $6.9 billion upgrade cost 
works out to $138,000 per mile,\4\ this level of investment is beyond 
the current capability of the short line and regional railroad 
industry. There is little likelihood that short lines could finance 
these necessary track upgrades or improvements without foregoing other 
necessary expenditures. Many of the short lines will be altogether 
unable to make the necessary investments in track.
---------------------------------------------------------------------------
    \4\ Based on 50,000 track miles of short lines and regional 
railroads.
---------------------------------------------------------------------------
    Question 6. You found that it is going to cost the short line rail 
industry roughly $6.9 billion to make the repairs and upgrades needed. 
How would such expenditures impact the short lines' current maintenance 
schedule and their ability to finance other capital costs such as 
rolling stock?
    Answer. Many short lines have only limited resources to expend on 
maintenance of track and rolling stock. This is evidenced by their 
average revenue per track mile which is less than \1/4\ of that of the 
Class 1 railroads. With their limited revenue per mile, most short 
lines only have sufficient resources to maintain track in safe 
condition for lower speed operation (typically 25 mph or less). Given 
that short lines are often capital limited, to attempt to undertake 
major trackwork upgrades would deplete their resources and 
significantly limit their ability to finance other capital costs such 
as locomotives and cars.
    Question 7. To what extent would the $350 million as proposed under 
H.R. 1020 actually be able to meet the infrastructure investment needs, 
given the projected overall need?
    Answer. The $6.9 billion figure developed in Zeta-Tech's study for 
the American Short Line and Regional Railroad Association covered the 
upgrade of all short line and regional railroad trackage to standards 
necessary for 286,000 lb. cars. Even if the money were available 
immediately, an upgrade of this magnitude would require many years, 
since track materials simply are not available in quantities sufficient 
to perform this work immediately. Given this, the $1.05 billion ($350 
million per year for 3 years) in H.R. 1020 is certainly a valuable 
start, and will allow short lines to address some of their most serious 
track deficiencies as well as their highest priority routes. However, 
this total of $1.0.5 billion will only be enough to perform perhaps 15 
percent of the necessary work.
    Continuation of this level of spending will be necessary to 
completely rehabilitate short line trackage within the constraints of 
material and workforce availability. Alternatively, the additional 
capital could come from other programs such as the Railroad 
Rehabilitation and Improvement Financing (RRIF) loan program which was 
passed by Congress in 1998 and which provides loans and guarantees for 
railroad infrastructure and equipment projects. When these loads are 
implemented, they will also help meet these railroad infrastructure 
investment needs.

                               __________
     Responses to Written Questions Submitted by Hon. Gordon Smith 
                          to Kevin D. Kaufman

    Question 1. What would be the most beneficial policy change 
Congress could adopt to improve rail transportation?
    Answer. Approach policy decisions for surface transportation on an 
intermodal basis, which is not to say that Federal policy should ignore 
intramodal issues, but is recognition of the fact that financial 
policies for one mode of surface transportation directly impact the 
economics and performance of other modes. As explained in response to 
Question (2) below, the extent of public financial support and 
subsidies for the truck industry directly impacts the ability of 
railroads to compete for a significant part of their potential traffic 
base.
    Question 2. At least two of the panelists, Mr. Valentine and Mr. 
Kaufman, discussed the Federal subsidy discrepancy between the rail 
industry and its competitors. What exactly is being recommended to 
remedy this discrepancy? Do you want to create a rail transportation 
trust fund supported by the users--in this case rail shippers--similar 
to how the users of the highway trust fund and air passengers fund the 
aviation trust fund?
    Answer. A rail transportation trust fund supported by rail users--
shippers--is not appropriate or similar to a highway trust fund 
concept, supported by highway users, because rail rights-of-way are 
privately owned whereas highways are publicly owned and are used by 
non-commercial tax payers.
    Nevertheless, railroads today face funding inequities which should 
be corrected. They are, for example, charged a fuel surcharge that goes 
directly into the Highway Trust Fund. The Federal Government budgets 
and spends billions of dollars per year for the improvement of highways 
and bridges. While commercial motor carriers are by no means the only 
beneficiaries of these public expenditures, it is apparent that truck 
lines are not called upon to pay the full share of their public highway 
and bridge costs, as railroads must pay the full share of their road 
and bridge costs.
    We would propose (1) that the fuel surcharge paid by railroads into 
the highway trust fund be rescinded and that trucking companies be 
charged a per mile user fee (perhaps based on axle odometers installed 
in each truck) calculated to return the full cost of highway 
construction, maintenance, and improvements attributable to commercial 
use.
    Question 3a. Several of you discussed productivity gains made by 
railroads in recent years through both consolidations and service 
improvements. Are there future operational improvements to be gained 
from additional consolidations of the rail industry?
    Answer. There may be some gains for the railroads, but not as many 
as when prior mergers eliminated redundant routes. Today, there are 
fewer redundant routes capable of elimination, except at the potential 
sacrifice of the rail industry's ability to meet future growth 
possibilities. The market's declining valuation of railroads following 
the last two major mergers suggests a belief by investors that there 
are limits on remaining operational benefits from prior mergers.
    Question 3b. If railroads fail to make further operational 
improvements, what will be the impact on customers?
    Answer. The failure of railroads to achieve further operational 
improvements is likely to have adverse impacts on both railroads and 
their customers. Many facets of rail service today are unpredictable, 
thus increasing customer costs in the form of larger inventories or 
excess rail car inventories (railroad customers supply the majority of 
freight cars in use). Improved operations will similarly reduce 
railroad labor and power expenditures and improve the ability of 
railroads to attract additional business. In fact, if railroads do not 
make further operational improvements, which I am convinced they are 
capable of doing, their market valuations are likely to continue to 
reflect that condition.
    Question 3c. Is there capacity in other modes to make up for a lack 
of quality service by railroads?
    Answer. There are extensive limitations on railroad substitutes if 
efficiency and environmental impacts are factored in. For example, a 
truck is technically capable of transporting 25,000 tons of coal from 
the Powder River Basin to an electric generating facility in Illinois, 
but it takes four trucks to replace one rail car, with the attendant 
consequences on cost, highway maintenance, and air pollution. Barges 
are perhaps environmentally and economically preferable to rail, but 
are limited geographically. Air is essentially not a competitor of 
rail.
    Question 3d. Under current conditions, can railroads continue to 
attract the investment needed to not only maintain the current system 
and provide safe and efficient service, but also grow the system to 
meet the predicted increased demand over the next 25 years?
    Answer. Perhaps. The Class I railroad industry clearly is moving 
toward a high density configuration, concentrating operations on a 
limited number of mega-routes. Technological advances may improve their 
ability to utilize those routes more efficiently than at present, but 
not without substantial investments. To fund that investment, railroads 
must be able to provide a competitive return, which in all likelihood 
means attracting additional traffic to fully utilize the route 
structure. If the area of greatest revenue potential for railroads is 
traffic now moving by truck, as many experts regard to be the case, and 
if trucks have a cost advantage because the Federal Government is 
subsidizing their infrastructure, railroads should continue to suffer 
an erosion of their capital base, all things being equal.
    Question 3e. When productivity gains have been made, who has 
benefited? The investor or the customer?
    Answer. Clearly, the railroads themselves have benefited, as 
indicated by market values prior to the service failures of the late 
1990s. Customers also have benefited from either rate reductions or 
slower levels of rate increases, although there is some debate over 
whether at least some customers have seen their total transportation 
costs rise as a result of supplying and increasing proportions of rail-
related investments, such as freight cars and storage tracks.
    Question 4. Some rail industry observers have asserted that instead 
of resulting in productivity gains, recent rail mergers have resulted 
in decreased competition for customers. In conducting your research and 
analytical work on the rail industry, have any of you seen evidence of 
decreased competition and if so, to what extent?
    Answer. I believe that rail productivity gains are as much a result 
of the interstate highway system and transportation deregulation 
generally as they are of rail mergers, although, by eliminating 
redundant rail routes, mergers no doubt have improved rail 
productivity. Railroads had to become more efficient in order to 
compete with motor carriers using the interstate system. Before rail 
deregulation, virtually all rail rates were set collectively within the 
rail industry, and the law instructed the Interstate Commerce 
Commission to pass through all labor increases in the form of high rail 
freight rates, so that there was virtually no incentive for improved 
efficiency within the rail industry. Deregulation and mergers made the 
railroad industry conscious of the need to be competitive with the 
motor carrier industry.
    Consolidation among competitive rail carriers by definition leads 
to less intramodal route competition, so that there should be many 
examples of less competition between rail carriers as a consequence of 
rail mergers.
    Mergers may also impact the level of intermodal competition, 
depending on the nature of the merger. Western rail mergers seemed to 
have strengthened the ability of the surviving carriers to offer 
improved intermodal service, competitive with trucks, whereas the 
eastern mergers seem to have resulted in little shift of traffic from 
trucks to rail.
    Merely to say that there has been a loss of competition following a 
merger is not sufficient to describe the consequences of that loss. 
Rail mergers have the potential to impact rates, service, and market 
reach. Rates sometimes are increased after mergers, but those increases 
in some cases are not borne by the railroads' direct customers and 
instead are passed through to raw material suppliers or end products 
purchasers. Rate increases which cannot be passed through are those 
designed to affect the flow of traffic--those higher rates designed to 
constrain the movement of traffic from or to the lines of the merged 
carrier where that carrier believes that its profits can be maximized 
in that fashion. These steps may well be difficult for some customers 
as their choices of source competition or markets are curtailed.
    Service is the third area of merger consequence, and mergers have 
had a varied impact in that area. For some, mergers improved service by 
expanding access to points of supply or consumption, and enabled a 
carrier to institute innovations such as contract trains which operate 
continuously between various points on the carrier's expanded system. 
However, where the carrier does not have the incentive to provide such 
service or the market it serves is not susceptible to such innovations, 
mergers in fact may produce worse service.
    Question 5. You stated, ``industry sometimes behaves as if it has 
the obligation to supply equal service for all consumers, no matter 
their relative economic cost, and, on the other hand, is required to 
fully pay for the investment and incremental operational cost.'' You 
then go on to argue that government must change its policy toward other 
modes in order to correct his behavior.
    Please explain how you believe a change in government policy toward 
other modes will cause railroads to make sound economic business 
decisions?
    Answer. The competitive disadvantage to rail resulting from 
governmental subsidization of motor carriage requires railroads to 
charge lower prices in order to meet subsidized motor carrier rates 
than railroads would have to charge if motor carriers lost some or all 
of their subsidy and charged higher rates as a consequence. From these 
depressed rail rates, railroads must pay the full measure of the 
infrastructure and operating costs.
    The rail industry has responded to these circumstances with 
decisions that are sound in relation to their premises, but are not 
always welcome by all rail customers. My point is that, if rail rates, 
at least for the 21 percent of rail volume that consists of intermodal 
traffic, can rise as a result of changes in government policy toward 
motor carriers, then there will be a different set of premeses to guide 
railroad decisionmaking, and a different set of sound business 
judgments is likely to emerge, perhaps less objectionable to other 
segments of the railroad' customer base.

                               __________
     Responses to Written Questions Submitted by Hon. Gordon Smith 
                        to Dr. Harvey A. Levine

    Question 1. What would be the most beneficial policy change 
Congress could adopt to improve rail transportation?
    Answer. Congress should recognize that the freight railroad 
industry in the United States has been re-monopolized to the point 
where four railroads control over 95 percent of the industry's traffic. 
At the same time, while deregulation has served the interests of 
competitive markets, rail-dependent customers have been adversely 
affected by the increased concentration of power within the rail 
industry. While the ultimate remedy for this chasm may be a more 
competitive sharing of the railroad infrastructure, Congress can even 
the playing field between railroads and their dependent customers by: 
(1) eliminating the regulatory provisions of the Staggers Rail Act--
specifically the ones addressing maximum-rates, and (2) adopted a Final 
Offer Arbitration provision similar to the one that exists in Canada. 
Railroad rate disputes could then be handled by arbitrators within a 
60-day timeframe and the STB jurisdiction in this area would be 
eliminated. The Final-Offer-Arbitration mechanism is timely, relatively 
inexpensive, and a producer of reasonable offers from both the 
railroads and shippers. Its adoption would help to significantly reduce 
the anguish of rail-dependent customers.
    Question 2. ???
    Answer. I did not discuss Federal subsidies for railroads and I do 
not believe in them. If railroads are to be compared with highways, 
then the industry should open access to competition.
    Question 3a. Are there future operational improvements to be gained 
from additional consolidations of the rail industry?
    Answer. If so, these are probably marginal and would be far 
outweighed by the reduction in transportation competition. The ICC and 
STB have gone too far already in reducing railroad competition through 
mergers of Class I railroads. The ultimate end game of such a policy is 
a one or two-railroad system either heavily regulated or completely 
controlled by the Federal Government.
    Question 3b. If railroads fail to make further operational 
improvements, what will be the impact on customers?
    Answer. Railroads must bring their technology into the 215` 
century. Failure to do so will deprive dependent customers of adequate 
service and reasonable rates. Customers in competitive markets will 
continue to flee to motor carriage and other options. Operational 
improvements can be induced by competition.
    Question 3c. Is there capacity in other modes to make up for a lack 
of quality service by railroads?
    Answer. No. The highways will never be able to handle long-
distance, bulk movements such as coal, without huge negative 
consequences for the nation's standard of living, environment, and 
energy use. Highways are already congested and it should be a national 
transportation policy to fully utilize the large capacity of our 
nation's railroads--without public subsidization.
    Question 3d. Under current conditions, can railroads continue to 
attract the investment needed to not only maintain the current system 
and provide safe and efficient service, but also grow the system to 
meet the predicted increased demand over the next 25 years?
    Answer. If by ``under current conditions'' means that railroads 
will not change their culture and attitude, then their ability to 
attract needed capital is somewhat dubious. Railroads are by nature 
more efficient for long-haul traffic then their motor carrier brethren, 
and can readily attract needed capital by meeting customer needs. This 
requires a devotion to customer interests, the realization that 
dependent customers are legitimate complaints, and the elimination of a 
``win-at-all-cost'' mentality. The potential for railroad growth is 
enormous and such growth is in the public interest. While the public 
can aid this growth by eliminating man-made obstacles (like the archaic 
maximum-rate regulations), the key to the railroads' success is 
railroad management.
    Question 3e. When productivity gains have been made, who has 
benefited? The investor or the customer?
    Answer. This is not an either-or question. When the impact of the 
more recent railroad mergers are removed, it is clear that both 
railroads and their customers have benefited from productivity gains. 
Rail customers in competitive markets have enjoyed constrained prices 
and up through the mid-1990s, railroad investors were richly rewarded. 
Productivity gains will always be shared by producers (service 
providers) and their customers in competitive markets. It is the rail-
dependent customers who should be at issue in regard to this question.
    Question 4. Some rail industry observers have asserted that instead 
of resulting in productivity gains, recent rail mergers have resulted 
in decreased competition for customers. In conducting your research and 
analytical work on the rail industry, have any of you seen evidence of 
decreased competition and if so, to what extent?
    Answer. I have not studied individual railroad markets with the 
purpose of measuring the relative degrees of competition. However, it 
is clear that over the past 5 years, shipper complaints about 
inadequate rail service and railroad arrogance have greatly increased--
witness the letter of more than 250 shipper executives to Congress 
seeking more market competition. Overall, the increased concentration 
of power among just two railroads each in the East and West is evidence 
of reduced railroad competition.
    Question 5a. You point out in your testimony that annual reports to 
the SEC, the STB, and private investors, while all focused on financial 
performance, often project completely different pictures of a 
railroad's annual performance. Can you explain how you came to that 
conclusion and what is the impact on investors and regulators?
    Answer. In my work, I constantly examine the railroads' annual 
reports to investors, the SEC, and the STB. One can't help but notice 
that not infrequently, railroads boast to investors that they are 
revenue adequate and attractive investments, while at the same time, 
the STB declares them to be revenue inadequate. A most striking example 
is the Union Pacific Railroad in the year 1996. The railroad informed 
its investors of record profits that year and informed the SEC that it 
was rewarding its executives with maximum incentive compensation 
(bonuses, stock grants, stock options, etc.) At the same time, the 
railroad's earnings were so substantial in 1996 that it established a 
surplus fund from which to reward executives in 1997, if in that year, 
earnings' thresholds were not met. And yet, the STB found the railroad 
to be revenue inadequate in that year. Obviously, the railroads' 
themselves do not believe in the authenticity of the STB's revenue-
adequacy determination, for it has not produced results consistent with 
management's assessment in a number of instances.
    Question 5b. Can you explain how the differing information provided 
to the SEC and the STB is used?
    Answer. Information to the SEC is used in the same way as other 
corporations in the United States--to measure compliance with national 
requirements. The STB's use of the information is for the most part, 
limited to railroad costing and as part of the revenue-adequacy 
determination. The major difference between the two reporting systems 
is that the STB report includes detailed reporting of railroad expenses 
by a multitude of categories, therefore lending itself to cost 
estimations for the purpose of rate regulation.
    Question 6. In regard to rail transportation, what is the more 
serious problem--inadequate shipping capacity or inadequate 
competition?
    Answer. I believe that inadequate competition is the more serious 
problem. Railroad capacity constraints seem to be caused by problems 
with throughput at certain terminals--a correctable and probably, 
temporal--condition. In other countries, railroad track is much busier 
than in the United States, although the traffic is mainly of passenger 
trains. Still, even the main-line track in this country is 
characterized by relatively infrequent train movements. Furthermore, 
railroads have been reducing their track capacity as a result of 
mergers and acquisitions. This is akin to a self-fulfilled prophecy. On 
the other hand, as discussed above, the lack of railroad competition is 
at the root of shipper complaints, inadequate service, and poor 
responsiveness to shipper needs.
    1. the rail industry since deregulation: financial performance 
                          of class i railroads
    While higher than in 1999, operating ratios for all of the 
remaining ``Big Four'' Class I railroads was positive in 2000, ranging 
from 77 to 94 percent.

                                             1999/2000 Selected Measures for Big Four \1\ Class I Railroads
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                          1999/2000
                                                          Operating   Operating   Operating   Operating     Oper.                 Revenues     Freight
                                                           Revenue     Revenue   Ratio 1999  Ratio 2000     Ratio     Number of      per      [millions
                        Company                          ($million)  ($million)      [In         [In       Change     Employees   Employee     of tons
                                                            1999        2000      percent]    percent]       [In        1999        1999     originated]
                                                                                                          percent]                               1999
--------------------------------------------------------------------------------------------------------------------------------------------------------
UP.....................................................      $9,987     $10,539       82.3%       82.8%        0.6%      53,306    $187,352          453
BNSF...................................................      $9,094      $9,200       75.8        77.1         1.8       42,659    $213,179          440
CSX....................................................      $5,623      $6,075       92.3        94.7         2.6       32,023    $175,593          378
NS.....................................................      $5,195      $6,159       90.4        92.0         1.8       30,897    $168,139          270
CR \1\.................................................      $1,516  ..........       82.3        N.A.        N.A.        8,260    $183,535           56
Big Four...............................................     $31,973     $31,415       N.A.        N.A.        N.A.      167,145    $187,951        1,597
Class I................................................     $33,521        N.A.       83.6        N.A.        N.A.      177,557    $188,790       1,716
 Railroads.............................................
--------------------------------------------------------------------------------------------------------------------------------------------------------
Note: R-1s for 2000 are not available for all railroads.
Source: Company Annual R-1 reports; Association of American Railroads, Railroad Facts 2000 Edition, Mercer analysis.
\1\ Conrail figures are through May 1999. The last 7 months of 1999 are reflected in NS and CSX data.

  
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