Before The

U.S. House of Representatives

Committee on Transportation and Infrastructure

Subcommittee on Railroads, Pipelines, and Hazardous Materials

March 5, 2008 Hearing

Investment in the Rail Industry

11:00 A.M.

2167 Rayburn House Office Building

![](media/image1.png)

Testimony Of

**Vice Chairman Francis P. Mulvey**

Surface Transportation Board

395 E Street, SW, Suite 1290

Washington, DC 20423-0001

\(202\) 245-0210

Good morning Chairwoman Brown, Ranking Member Shuster, and other
Members. Thank you for this opportunity to testify on investment in the
rail industry.

Several months ago, at the September 25, 2007 full Committee hearing on
rail competition and service matters, I expressed concern about
potential "hedge fund" purchases of a significant stake in a railroad,
followed by divestiture of the railroad's assets, deferred maintenance,
and a rolling back of capital improvement programs. I noted that these
actions could result in deterioration of service to shippers and a
return to the "bad old days" of the 1970s when railroads were
hemorrhaging cash and unable to adequately maintain the rail plant.
Ultimately, a strategy of reduced investment could lead to a failing
firm and less railroad capacity.

In a letter dated October 24, 2007, I and my fellow Board Members
responded to several follow-up questions from Committee Members, one of
which was about the limits of our authority over rail acquisitions, and
specifically about investment in rail carriers by certain types of
investors. We noted that, as it currently stands, the Board does not
appear to have any authority under existing law to limit such
investments by hedge funds or other "short term" investors.

Today, I would like to elaborate on my prior testimony on the topic of
investment in the rail industry. First, I would like to review the
investment trends in the industry and then turn to the topic of the
Board's authority in this area.

During the period between the Staggers Rail Act of 1980 and 2006, annual
investment in rail plant and equipment trended upward in nominal
dollars, but has remained relatively static when adjusted for inflation.
In fact, compared to 1980, capital spending in constant dollar terms was
20 percent less in 2006 ([see]{.underline} graph 1 attached).

Of course, it is also true that the rail plant has shrunk over the
years. Miles of Class I railroad track have declined from 340,779 miles
in 1980 to just 162,056 miles today---a reduction of more than 50
percent. Similarly, miles of road served by the Class I's have fallen
from 207,334 miles in 1980 to 94,942 miles in 2006 ([see]{.underline}
graph 2 attached). Net investment per track mile or road mile has
fluctuated since 1980, but is on balance much higher today
([see]{.underline} graphs 3 and 4 attached). Likewise, the locomotive
and freight car fleets are also much smaller today than they were at the
time the Staggers Act was passed. There were 28,094 locomotives operated
by Class I carriers in 1980, compared to 23,732 in 2006. But, today's
locomotives are much more powerful. The average locomotive has 51
percent more horsepower per unit than in 1980.

The railroads' freight car fleets are even more reduced than their
locomotive fleets. While the Class I railroads' freight car fleets
comprised 1,168,114 cars in 1980, there were only 475,415 cars in
service in 2006. Some of this decline was offset by growth in the fleets
operated by Class II and Class III railroads, and the spinning off of
car supply responsibility to shippers and other car suppliers. Class II
and III railroads grew their fleets from 102,161 cars in 1980 to 120,688
cars in 2006. More dramatically, shippers and other car companies
expanded their car fleets from 440,552 cars in 1980 to 750,404 cars in
2006. Despite the overall reduction in the freight car fleet, today's
cars have much greater capacity. The typical car can handle nearly 25
percent more tons than the average rail car in 1980. In addition, the
railroads operate more cars per train and the trains travel longer
distances today. The result is that the nation's freight railroads now
generate roughly twice as many ton-miles of service as they did in 1980.
In fact, the rail share of the intercity freight transportation market
has grown from its low point of 37.5 percent in 1980 to 42.3 percent in
2003---the last year for which data are available.

So, physical infrastructure has shrunk, the rail labor force has been
reduced significantly and traffic has expanded. The result is that the
railroads have gone from a situation of pervasive excess capacity to one
in which they face capacity constraints. The upshot, of course, is that,
as demand has exceeded supply, prices have risen and the railroads today
are more profitable than they have been in decades. One would anticipate
that some of these profits would be plowed back into the infrastructure
so that the railroads could continue to accommodate further growth in
demand.

Indeed, the railroads have begun to invest more into growing the
infrastructure. While railroad-specific data are not available, it is
generally thought that about one-fifth of rail capital spending for
infrastructure is used for expansion. In 2007, the AAR estimates that
the Class I railroads spent \$1.9 billion for expansion of capacity
through the building of new roadway and structures. This represents a
steady increase in recent years in spending for capacity expansion. For
example, Class I railroads spent \$1.1 billion in 2005 and \$1.4 billion
in 2006 to expand the infrastructure. The railroads are reducing their
spending on capacity somewhat in 2008, due to the recent downturn in
rail traffic demand. Over the past several weeks, a number of the Class
I railroads have announced their capital expansion budgets for 2008:

-   BNSF Railway Company announced it plans to spend a total of \$2.45
    billion in 2008 on capital expenditures compared to \$2.59 billion
    in 2007, of which \$950 million will go toward capacity *expansion*.
    It will spend approximately \$350 million *less* on its capital
    expansion program than it spent last year.[^1]

-   Norfolk Southern Corporation plans to spend 29% of its \$1.425
    billion capital expenditures budget \-\-- about \$413 million \-\--
    on growth and productivity projects such as infrastructure and
    terminal expansion investments, strategic opportunities, and
    projects to improve its productivity and efficiency.[^2]

-   Union Pacific Railroad will spend \$840 million to expand its
    network and terminal capacity in 2008. This represents about a
    quarter of its total \$3.1 billion budget for capital expenditures,
    and this total budget is about the same amount it spent last
    year.[^3]

-   Canadian National Railway is targeting C\$1.5 billion in capital
    spending for 2008, approximately C\$500 million of which will go
    toward expansion projects.[^4]

A recent report by Cambridge Systematics[^5] for the AAR estimated that
\$148 billion will be needed for rail infrastructure capacity expansion
to accommodate the projected growth in rail traffic demand through 2035.
Of this amount, the Class I railroad share is \$135 billion. This
projection is for expansion capacity only, and does not include spending
to maintain and support the new lines, acquire additional cars and
locomotives, or operate, maintain and replace existing facilities. The
report projected that the Class I railroads could supply \$70 billion
from earnings growth and an additional \$26 billion from productivity
savings to partly cover the \$135 billion. This would still leave a
shortfall of nearly \$40 billion, or about \$1.4 billion annually. And
this is what is needed to simply sustain the status quo in terms of the
rail market share. If the nation is serious about shifting substantial
volumes of truck traffic off our streets and highways, the amounts
needed and the size of the shortfall will be far greater than the
Cambridge Systematics' projection.

Where will these monies come from? There are a number of potential
sources, all of which have promise and problems. Investment tax credits,
public/private partnerships, and the establishment of a railroad trust
fund as advanced by a former member of this Committee are all potential
ways to close the gap. However, there is another source of investment
capital that has recently gained the attention of many in the industry
and in the Congress---investments by hedge funds---and I want to focus
the remainder of my remarks on that subject.

Hedge funds and other non-traditional rail investors have recently
become significantly involved in railroads. Because these types of firms
are believed to have time horizons of five years or less and strategies
of maximizing short-run returns, there are concerns that their
investment strategies will run counter to the needs of railroads for
long-term capital investment. Thus, investment in the rail industry by
hedge funds could be at odds with the public interest and common carrier
aspects of the rail industry. Railroads have a fundamental common
carrier obligation to provide rail service upon reasonable request, and
there is a public interest component to the Board's regulation of
certain rail transactions. When investors demand a relatively quick
return on their investments, that could result in deferred maintenance
or a deterioration of assets and could conflict with the railroad's
obligation to provide service to shippers and communities.

I want to stress that it is, categorically, not the source or identity
of investors that is of concern, but the timeframes and goals for the
investments. As you know, the rail industry is capital-intensive, with
long-lived assets, and long lead times for the replacement and
improvement of assets. Thus, investors with the goal of reaping
short-term profits may be at odds with the very nature of this industry.
A "long term" investment for a private equity firm may be 5 years. But
in the rail industry, that is a short period of time. Can a short time
frame for rail investment result in a commitment to expansion capital?
Can it even result in preservation of the status quo? The answer may
depend on how actively the investors become involved in the management
and strategic decisions of the railroad.

What is the Board's ability to address these concerns? If rail
investment---or disinvestment---manifests itself in reduced service, the
Board already possesses the power to replace an owner or operator of a
line who is unwilling or incapable of providing adequate service, under
our "feeder line" and directed service provisions.[^6] We have used
these provisions several times in the past few years. For example,
following up on a 2006 authorization of alternative rail service at the
request of a shipper in Lubbock, Texas, the Board extended the temporary
relief until a long-term solution could be developed. In August 2007,
the Board ordered divestiture of the lines involved, at a price set by
the Board to reflect the value of the property, to enable improved rail
service to the affected shippers.[^7]

Concerning our jurisdiction over investments, as we stated in our letter
of October 24, 2007, the Board has authority to regulate some railroad
transactions, but not others. Any authority that the Board might have
over the takeover of a rail carrier by a non-carrier such as an
investment partnership or hedge fund would derive from either the
provision in the law that applies to acquisitions of rail property by
non-carriers[^8] or the provision that applies when transfers of stock
and control of a company are involved.[^9] The latter provision might
apply if a non-carrier were to acquire a single rail carrier that itself
owns another rail carrier (for example, a large railroad that owns a
small railroad), but under agency precedent the authorization
requirement would not apply if the two or more carriers being taken over
operate as a single integrated transportation system. And the former
provision, which generally applies to transfers of physical property,
requires Board authorization if a person other than a rail carrier
acquires a "railroad line."[^10] This provision appears to be focused on
discrete lines, not carriers, and I do not believe that it would
normally be applied if a non-carrier sought to take over a major rail
carrier.

The question of the agency's jurisdiction over leveraged buy-outs arose
in 1989 with respect to a proposed takeover of Chicago and Northwestern
Transportation Company, then a Class I rail system, by Japonica
Partners. In response to a request from the Senate Commerce Committee,
the agency's predecessor, the ICC, prepared a report in which it
analyzed the relevant statutory provisions and concluded that it would
be difficult as a matter of law for the ICC to exercise jurisdiction
over the proposed transaction.[^11] Reacting to the ICC's report,
Congress quickly moved to give the agency responsibility for approving
such transactions.[^12] In particular, the legislation would have
required ICC approval for a non carrier to acquire direct or indirect
control over a Class I rail carrier. President George H.W. Bush,
however, vetoed the legislation because he viewed it as a
counterproductive step backward from prior deregulatory legislation.
Although not dispositive, this legislative history tends to confirm that
the agency would lack approval authority over the acquisition of a large
rail system by a noncarrier.

In closing, I would like to note that while the Board generally does not
have the power to order what investments are made or how much is spent
on the rail plant, it does have the power under the existing statute to
remedy severe service deterioration problems, which is the ultimate
concern of shippers and communities. We as a nation need to find ways of
encouraging, not discouraging, investment in the rail plant to ensure
our continued mobility.

Thank you for the opportunity to testify today. I look forward to
answering any questions you may have.

[^1]: "BNSF Announces \$2.45 Billion Capital Commitment Program,"
    *available at*
    <http://www.bnsf.com/media/news/articles/2008/01/2008-01-29b.html>;
    "Class I capex plans for 2008 are mixed," Argus Rail Business at 5
    (Feb. 11, 2008).

[^2]: Remarks of Debbie H. Butler, Exec. V.P. Planning and Chief
    Information Officer, Norfolk Southern Corp., Financial Analysts'
    Meeting, New York, NY, Jan. 23, 2008, *available at*
    http://www.nscorp.com/nscportal/nscorp/Investors/Executive%20Speeches/2008/dhb012308.html.

[^3]: "Union Pacific Announces 2008 Capital Plan," *available at*
    <http://www.uprr.com/newsinfo/releases/financial/2008/0201_capital.shtml?print>;
    "Class I capex plans for 2008 are mixed," Argus Rail Business at 5
    (Feb. 11, 2008).

[^4]: "Class I capex plans for 2008 are mixed," Argus Rail Business at 6
    (Feb. 11, 2008).

[^5]: *National Rail Freight Infrastructure Capacity and Investment
    Study* (Sept. 2007), (prepared for Association of American Railroads
    by Cambridge Systematics, Inc.), *available at*
    http://www.aar.org/Newsroom/Capacity_Investment_study.asp.

[^6]: 49 U.S.C. 10907 & 11123.

[^7]: [PYCO Indus., Inc. --Alternative Rail Service---South Plains
    Switching, Ltd.]{.underline}, STB Finance Docket No. 34889, et al.
    (STB served Nov. 21, 2006); [PYCO Indus., Inc.---Feeder Line
    Application--- Lines of South Plains Switching, Ltd.]{.underline},
    STB Finance Docket No. 34890, et al. (STB served Aug. 30, 2007).

[^8]: 49 U.S.C. 10901.

[^9]: 49 U.S.C. 11323(a)(4) (providing that Board approval and
    authorization is required for the "\[a\]cquisition of control of at
    least 2 rail carriers by a person that is not a rail carrier.").

[^10]: 49 U.S.C. 10901.

[^11]: [See]{.underline} Letter to the Hon. J. James Exon re: ICC Ex
    Parte No. 480 from ICC Commissioners (May 15, 1989).

[^12]: [See]{.underline} Amtrak Reauthorization and Improvement Act of
    1990, H.R. 2364, 101st Cong. § 8 (1990).