# Presentation: 359449

## Coal Transportation by Rail – Outlook for Rates and Service 

- Presentation to:
- NEMS/AEO Annual Conference
- Energy Information Administration, March 12, 2002
- 	Presented by:
- 	Stan Kaplan
- 	PA Consulting Group
- 	Washington, DC
- 	202-442-2553   stan.kaplan@paconsulting.com

## Agenda

- Background –Rail, Coal and Power
- The Rail Industry – Running into a Dead End?
- Railroad Business Strategy
- Implications for Coal and Power

## Background – Rail, Coal and Power

## The Railroad Implosion

## Rail Network and Coal Fields

***Dominant in the West:***
***UP and BNSF***

***Dominant in the East:***
***CSX and NS***

- Map from RDI *PowerMap*

## Powder River Basin – A Third of the Nation’s Coal

***Powder River Basin – A Third of the Nation’s Coal***
**Est’d 2002 Production: over 380 million tons**
**Est’d 2002 US Production: 1132 million tons**

- Maps from RDI *PowerMap*

## The PRB Supplies Over a Third of Coal for Generation

- Source: EIA, *STEO*

## The Rail Industry – Running into a Dead End?

## State of the Railroads

- Staggers Act of 1980 was intended to save the rail industry through partial deregulation.
- Rail industry today is far healthier than 21 years ago.
- The railroads have pursued several paths to financial success:
- Cost-cutting and productivity improvements
- Merger
- Differential pricing
- Diversification
- New Services
- Investment

## Several of the Key Railroad Business Strategies of the Past 21 Years Have Run Out of Steam 

- Diversification is being abandoned by the carriers.
- Cost cutting may be reaching a point of diminishing returns.
- The mergers have not proved to be the ticket to financial success:
- UP with Chicago North Western: 1995
- BN with Santa Fe: 1996
- UP with Southern Pacific: 1996
- CSX and NS division of Conrail: 1999

## Growth has Been Elusive...

- Source: AAR, *10-Year Trends* and web site

## ... and Unit Revenues Have Been Declining

- Source: AAR, *10-Year Trends* and web site

## Rate Trends for PRB Movements

- Source: PA Consulting Estimates

## Productivity Gains are Beginning to Flatten

- Source: AAR, *10-Year Trends* and web site

## Increased Commitment of Resources

- Source: AAR, *10-Year Trends* and web site

## Railroads: Share Value has Lagged the Market

## Impact of the Conrail Breakup -- NS

- Conrail

## Impact of the Conrail Breakup -- CSX

- Conrail

## UP After Two Acquisitions

- CNW

- SP

## BNSF: Avoided Disaster, But Growth is Elusive

## Railroad Business Strategy

## Now What?

- Cost-cutting and productivity improvements
- Merger
- Differential pricing
- Diversification
- New Services
- Investment

## “Yield Management”

- Another catch phrase is “charging rates that reflect the value of the service.”
- Translation: rate increases.
- This has been pushed by Wall Street, and is a common strategy element for the Big Four.

## Yield Management -- UP

## Yield Management -- NS

## Capturing Value -- BNSF

- From remarks made by BNSF President Matt Rose at Salomon Smith Barney, November 5, 2001:
- Clear that cost-cutting alone will not produce financial success.  A new, more balanced business strategy is needed.
- Elements of balanced strategy: greater efficiency, greater volume, and higher rates (made possible by improved service and elimination of excess capacity).
- Long-term, confidential rail contracts have contributed to low coal pricing by obscuring price signals.  More transparent pricing will help to encourage rate increases – this is one goal of the BNSF’s coal transportation options auctions.
- Decline in rail rates for coal must stop.  Rates should reflect value of service.

## Growing the Top Line – New and Improved Services

- Much of the focus is on improved intermodal and other truck-competitive services.
- Object in part is to win back business lost to trucks due to merger problems, and in part to expand market share.
- Even a small shift in market share from trucks would yield enormous benefits to the railroads:
- For example, in the western US the Union Pacific estimates the total size of the potential market at $90 billion, of which trucks control 78%
- Each percent of market share would boost revenues by almost $1 billion

## UP’s “Blue Streak”

- High-speed intermodal service from LA to Atlanta.
- Seamless service via an alliance between UP and NS.
- Three levels of service and pricing:
- SuperFlyer: on-time or free
- Premium: priority call on train space and other services
- Standard: capacity available to price sensitive customers as available.

## Key Characteristics of Premium Services

- Generally aimed at trucks.
- Essential elements are speed, certainty, and consistency.
- Object is to convert a commodity service into a differentiated product that will attract new business at profitable rates.

## Who Needs Top-Flight Service?

## Who Will Get the Money?

## Implications for Coal and Power

## The Path not Taken? (1)

- Market and Cooperative Solutions to Increasing Capacity at a Low Capital Cost:
- Rationalize the allocation of railroad  capacity to reflect buyer’s willingness to pay
- Give railroads flexibility to allocate private rail fleets to meet system needs.
- Examples Include:
- Seasonal pricing
- Pricing tied to service quality
- Auctions of blocks of railcar capacity
- Railcar pooling

## The Path not Taken? (2)

- Some market-based innovations have been tested, but generator response has been tepid, and the railroads move at a glacial pace.
- The strategic focus of the railroads – concentrate on truck-competitive traffic, cut capital investment even as demand grows, and push to increase rates – is a formula for confrontation, not cooperation.

## Implications (1)

- Coal service will continue to take a lower priority to intermodal and other truck-competitive, time-sensitive services.
- In an effort to increase ROI and placate Wall Street, the railroads will seek to minimize CapEx, and will focus available funds on *truck-competitive* growth opportunities and high-value targets (e.g., chemical business).  This does not bode well for coal shippers.

## Implications (2)

- The railroads have been unable to consistently provide a reasonable level of service.  Tight rationing of investment dollars increases the likelihood of future service disruptions.
- Bad service is more than an inconvenience. In the worst case, generators have had to back-down coal plants and use gas plants or purchased power to meet commitments – this can get very expensive very fast, and can undermine system reliability
- Captive shippers are also likely to face aggressive efforts by the railroads to increase rates.

## Implications (3)

- At a minimum, the current railroad business strategy is unfavorable to coal-burning utilities, and is likely to lead to increased contention over rates and service.
- Contention will be inimical to cooperation and joint innovation, which will inhibit steps that could improve reliability or decrease costs.
- The increases concentration in the rail and power industries may increase the possibility that a misstep by a few key players could play havoc with coal service, generation reliability and costs.