Financial Viability of Conrail: Review and

Analysis

September 1975

NTIS order #PB-250630
UNITED STATES CONGRESS

Office of Technology Assessment

The Financial Viability

of CONRAIL

REVIEW AND ANALYSI S

PREPARED AT THE REQUEST OF

THE SENATE COMMITTEE ON COMMERCE

SURFACE TRANSPORTATION SUBCOMMITTEE

PREPARED UNDER CONTRACT OTA C-19 BY

ENERGY AND ENVIRONMENTAL ANALYSIS, INC,

1701 N ORTH F ORT M YER D RIV E

A RLINGTO N, VIRGINIA 2220 9

SEPTEMBER 1975
T ECHNOLOGY A SSESSMENT BOAR D

U.S. GOVERNMENT PRINTING OFFICE : 1975 0–593-079
DIRECTOR’S OFFICE

Emilio Q. Daddario, Director

Daniel V. De Simone, Deputy Director

CONRAIL REPORT REVIEW PANEL

Robert Calhoun Prof. Thomas Sutherland

Sullivan & Worcester Princeton University

G. Gerald O’Donahoe James Tapley

Harbridge House, Inc. Southern Railway

Lawrence Goldmuntz Prof. Robert Tollison

Economics & Science Planning, Inc. Texas A & M

OTA TRANSPORTATION PROGRAM STAFF

Gretchen S. Kolsrud, Ph.D., Program Manager

Mary E. Ames Larry L. Jenney

V. Rodger Digilio Beverly Johnson

Thomas E. Hirsch, III Teri Miles

Energy and Environmental Analysis, Inc., contractor

● ✎ ✎ %-L%
DSPUTY DIRECTOR

Honorable 01 in E. Teague

Chairman of the Board

Office of Technology Assessment

U. S. Congress

Washington, D. C . 20510

Dear Mr. Chairman:

In response to the requests* of Senator Schweiker of

the OTA Board on February 26, 1975, and Senator Warren G.

Magnuson, Chairman, Senate Commerce Committee on March 20,

1975, I am pleased to submit an initial report: The Financial Viability of CONRAIL - Review and Analysis.

Prepared by the Office of Technology Assessment, with the

assistance of an ad hoc task force of consultants knowledgeable in rail industry operations and problems and a contractor, the report is part of an OTA review of the United

States Railway Association’s Plan for restructuring the

bankrupt Northeast railroads.

It is anticipated that the report will be used as background for hearings planned for mid-September by the Senate

Commerce Committee and for hearings to be held by the House

Committees on Commerce and Appropriations.

* See Appendix
O FFICE OF T ECHNOLOG Y

The Honorable Warren G. Magnuson

Chairman, Committee on Commerce

United States Senate

Washington, D. C. 20510

Dear Mr. Chairman:

On behalf of the Board of the Office of Technology Assessment,

we are pleased to forward a report: Financial Viability of

CONRAIL .

This study is a part of a review of the United States Railway

Association’s Plan for restructuring the bankrupt Northeast

railroads. This report considers the Final

to Congress on July 26, 1975.

This report is being made available to your

dance with Public Law 92-484.

System Plan submitted

Committee in accorSincerely, Sincerely,
Preface

In 1973, the financial disarray of the Northeast and midWest railroads led to the passage of the Rail Reorganization

Act of 1973. The Act established the United States Railroad

Association (USRA) to develop a plan for a Consolidated Rail

Corporation (CONRAIL) to be formed of the financially distressed railroads. On February 26, 1974, USRA issued a Preliminary System Plan for CONRAIL, and on 26 July USRA submitted the Final System Plan to Congress.

This review and others in the series were prepared in

response to requests from the Senate Commerce Committee.

Originally intended to deal with the Preliminary System Plan,

these reviews are based on the Final System Plan to maximize

their utility to the Congress.

This review was accomplished in a two month period by

OTA’S Transportation Assessment Group supported by Energy

and Environmental Analysis, Inc. and a task force of individuals knowledgeable in railroad problems. Contact was

maintained with authorizing, appropriations and budget

committees of both the Senate and the House as well as the

GAO, Library of Congress and the Congressional Budget Office.

The brief period of time precluded a rigorous assessment,

Instead, the major issues have been identified, frameworks

have been developed for their consideration and the data have

been organized to allow for thorough review.

5~3-f17fl o - 75 - 2 ix
TABLE OF CONTENTS

Page

Abbreviations . --- ------------ ------ ---- --------------

Chapter 1 - Summary --- -- ---- -- -----------------------

Purpose and Approach --- --------------------------

The Basic Financial Projection -------------------

Revenues -----------------------------------------

Operating Cost -----------------------------------

Sensitivity Analysis ----------------------------

Coal Revenues Could Be Higher --------------------

Operating Improvements Will Fall Short of

USRA Expectations -----------------------------

ConRail May Be Burdened With a Higher Initial

Cost of Acquiring Bankrupt Assets -------------

S ummary Impact -----------------------------------

The Federal Commitment ---------------------------

Issues and Questions -----------------------------

Chapter 2 - Introduction ------------------------------

“The Problem --------------------------------------

What Has Changed? --------------------------------

The Financial Framework --------------------------

Chapter 3 - Revenue Generation ------------------------

Introduction -------------------------------------

Baseline Traffic Growth --------------------------

Coal Projections - the USRA Approach -------------

An Alternative Estimate --------------------------

Trailer On Flat Car (TOFC) -----------------------

Inflation - Background ---------------------------

Chapter 4 - Operating Expenses ------------------------

Improvement in Yard Operating Expenses -----------

Car Utilization Improvements ---------------------

Track Utilization Improvements -------------------

Improvements in Cost Control ---------------------

Improvements in Labor Productivity ---------------

Management Generated Improvements ----------------

Chapter 5 - Financing: Acquisition, Costs,

Rehabilitation Expenses, and Accounting Methods ----

Income Based Reorganization ----------------------

Valuation ----------------------------------------

Rehabilitation Expenses --------------------------

Choice of Depreciation Method --------------------

Chapter 6 - Sensitivity Analysis ----------------------

Improved Coal Revenues ---------------------------

Failure to Achieve Operating Improvements --------

Deficiency Judgement -----------------------------

Unified ConRail ----------------------------------

Chapter 7 - Financial Assessment and Consequences

for the Federal Government ------------------------

Impact of Sensitivity Analysis -------------------

Consequences for the Federal Government ----------

1

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2

2

4

4

4

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5

5

s

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7

9

12

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Appendix: Congressional Letters of Request ------------ 75

xi
Chessie

ConRail

FSP

ICC

MT

N&W

PSP

RSPO

TOFC

USRA

ABBREVIATIONS

The holding company that controls the Baltimore

and Ohio (B&O) and Chesapeake and Ohio (C&O) systems.

The new railroad entity proposed by USRA to

operate the bulk of the bankrupt lines - the

Consolidated Railroad Corporation.

Final System Plan, published by USRA in July, 1975.

Interstate Commerce Commission. Responsible for

regulating the rates and conditions of competition

for U.S. railroads.

Million tons, used as an abbreviation for coal

shipments, output, etc.

Norfolk and Western Railroad, a system operating in

the Northeast and East Central United States.

Preliminary System Plan, published by USRA in

February, 1975 as its preliminary plan for reorganizing the financial and operating affairs

of the bankrupt railroads.

Rail Services Planning Office. Office within

ICC responsible for critiquing the USRA plans.

Trailer on Flat Car freight, better known as

“piggyback” freight.

United States Railway Association, established by

Congress in 1973 to plan the restricting of the

bankrupt railroads of the Northeast and Midwest.

Xii
-1-

CHAPTER 1

SUMMARY

PURPOSE AND APPROACH

This report examines the financial outlook for ConRail,

the railroad entity proposed by the United States Railway

Association (USRA) to acquire the bulk of the railroad assets

and operating responsibilities of the bankrupt Northeast railroads. On July 26, 1975, USRA dispatched to the Congress its

Final Systems Plan (FSP), or “blueprint”, for reorganizing the

bankrupt railroads now responsible for 22,200 miles of track.

Early in 1975, in accordance with the 1973 Regional Rail Reorganization Act, USRA published a Preliminary Systems Plan (PSP)

to which the public, creditors, shippers, ICC and other interested parties responded.

The approach of this report is to examine the critical assumptions affecting ConRail’s financial viability using background data developed by USRA, the views of the key parties and

independent analysis. Not surprisingly, ConRail’s financial

future depends on (a) how fast its revenues can grow, (b) whether

it can reduce its operating expenses per ton mile of freight

carried by improving efficiency, and (c) how much it must pay

to acquire capital assets from the bankrupts and upgrade such track

and equipment to give better and lower cost service. This report provides an independent assessment of how the decisive factors in each of these areas might be expected to develop between

now and 1985. It concludes with an analysis of what these outcomes may mean in terms of the three critical financial questions

facing the Congress as it weighs the ConRail proposal in reaching its

November 1975 decision:

● What is the size of the Federal government’s subsidy

to start and sustain ConRail?

● Is it realistic to plan on an “income-based” reorganization? That is, can ConRail be expected, in 1979 as

projected by USRA, or ever, to make profits adequate

to shift it from public to private ownership?

● Finally, if the forecast shows that ConRail will encounter financial problems more serious than contemplated by USRA, are there superior alternative approaches?

Can these be implemented now or can acceptance of the USRA

ConRail proposal be viewed as the first step toward such

options?

THE BASIC FINANCIAL PROJECTION

USRA’S report to the Congress projects modest increases in

revenue and dramatic improvements in operating efficiency. These
-2-

outcomes together with the low estimated cost of acquiring the

bankrupt railroads’ assets, and the use of favorable depreciation accounting methods lead to USRA’S conclusion that ConRail

can be launched at a cost of $1.85 billion, plus another $650

million in contingency funds.

During the planning period, USRA projects that ConRail will

collect $43.7 billion in revenues (current dollars) and generate

$1.5 billion in income. This represents a dramatic turnaround

from a $332 million loss in 1976 to a profit of $397 million in

1985. The first profitable year of operation is expected to be

1979.

REVENUES

USRA estimates that the tonnage of freight shipped on ConRail will increase by 15.4 percent from 317.1 million tons in

1973 to 366.3 million tons in 1985. Tonnage shipped by the

Penn-Central has been dropping for the last decade. ConRail

is projected to experience a 1.20 percent per annum tonnage

growth rate. Revenues (in 1973 dollars) are projected to grow

by 15.7 percent, or 1.22 percent per year, to $2.090 billion by

1985. The GNP growth rate through 1985 of at least 3.5 percent

is more than twice the revenue growth rate.

This projection is not optimistic in light of the projected

growth in coal shipments. It assumes increased coal tonnage will

constitute 62.2 percent of the total increase in freight shipped

from 1973 to 1985. Even accounting for the declining share of

Eastern coal in U.S. production, the absolute amount of coal

produced in the U.S. is expected to grow so dramatically that

major new ConRail shipments can be expected.

A pessimistic factor that could lower the USRA revenue projection results from the operation of the ICC-managed regulatory

system for railroads. Railroads seek rate increases based on

cost increases. At projected inflation rates of six percent or

more, if the railroads are not quick to document cost increases

and seek ICC actions, and the ICC does not rule expeditiously and

responsively, then revenues will be eaten up by costs with no margin for profits. The magnitude of revenue losses due to unplanned

lags could be $100 million or more over the 1976-1985 period.

For ConRail, the situation is even worse because the ICC grants

rate increases on an industry-wide average cost basis. ConRail’s

costs will exceed, at least into the early 1980’s if not beyond,

the costs experienced by other railroads. Thus, rate increases

granted are likely to fall short of ConRail’s requirements.

OPERATING COST

Today, the bankrupt Penn-Central loses 9.9¢ on every dollar

of revenue. ConRail is expected to make a profit of 13.5¢ by

1985. This is to be accomplished primarily by reducing operating

expenses. The most dramatic cost saving is to occur in the cost
-3-

of transporting freight. Transport costs will, according to

USRA, drop from about 40¢ on the revenue dollar to about 30¢.

USRA projects that such savings will result from improved

yard efficiencies, car utilization, and better traffic densities

(tons per mile of track) which can reduce costs. Many USRA FSP

critics doubt ConRail will do so well. USRA correctly identifies

yards as the chief delay point in car movements. Only 14.6 percent of car time is spent moving whereas 61.8 percent is spent in

yards. If yards can be bypassed and if yard efficiencies improve,

the average time a car spends on a trip (through 5-6 yards per

trip) will decline. Cost per trip will drop, and because more

time per car and per locomotive will be available, less new equipment will need to be purchased to handle new tonnage. USRA anticipates an investment savings of $1.2 billion due to car utilization improvements.

USRA expects these gains to result from the implementation

of a computerized car management system. “Blocks” of cars will

bypass yards. However, USRA’S projections will not be easily

attained. The primary reason is the structural characteristics

of the Northeast railroads. There is an inverse correlation

between railroad operating ratios (operating costs + revenues) and

the percentage of railroad mileage devoted to mainlines as opposed to yards and light density lines. Thirty-one percent of

Penn-Central line is mainline and its operating ratio is 84.4 percent. This compares with the N&W’s operating ratio of 71.1 percent and mainline proportion of total track of more than 70 percent. Even the divestiture of 5,700 miles of light density lines

from the bankrupts as recommended by USRA will not free ConRail

of this disadvantage.

Other characteristics of the Northeast bankrupts will impede

improvements in efficiency. Generally, greater traffic per mile of

track (called density) allows better recovery of fixed costs. But,

the Penn-Central’s density is near the bottom of the top ten railroads (measured in terms of revenue). ConRail’s average haul

length is shorter than most major railroads, making trip simplifications and yard avoidance more difficult. Finally, the nature

of the Northeast economy leads inevitably to more rail car terminations on ConRail than other railroads which enjoy more through

traffic. Because a railroad pays other lines when their cars are

on its tracks, this characteristic works to ConRail’s disadvantage.

A prudent forecast would not assume that these structural

limits of Northeast railroads can be easily overcome by sophisticated computer-based planning. Most likely, the operating improvements ConRail will experience will fall substantially short

of those assumed by USRA.
-4-

SENSITIVITY ANALYSIS

Adjusting USRA’S estimates for possible outcomes that

are more pessimistic or optimistic than the FSP forecast

serves to illustrate how much worse or how much better

ConRail’s financial outlook might be over the period to 1985.

Coal Revenues Could Be Higher - The FSP assumed that coal tonnage

shipped by ConRail will grow 36 percent by 1985. But, growth

of 58 percent is possible if national coal production doubles

in accordance with current plans. This adjustment would increase

ConRail revenues by $752 million. Profits would rise by $150

million. In addition, a 50¢ per ton rate increase for coal

shipments is possible in 1976. If implemented, ConRail’s coal

revenues would jump $375 million and profits would increase by

the same amount.

Operating Improvements Will Fall Short of USRA Expectations -

If the efficiency gains anticipated by USRA in the FSP occur later

and fall short of USRA projections, the investment required by

ConRail would increase $1 billion and operating costs would grow

by $1.85 billion. Illustrative of the failures that would

produce this result are: only 50 percent of the equipment utilization savings are achieved and not until two years after the USRA

schedule, yard rehabilitation fails to reduce yard operating

expenses, and only 75 percent of blocking improvements are

achieved (see Chapter 6 for complete details).

The Federal Government May be Burdened with a Hiqher Initial

Stoc elders

of the bankrupt railroads are to be offered $422 million according

to the FSP. The U.S. Supreme Court has held that the creditors -

may sue the U.S. Government for damages if they can prove the USRA

offer is less than the “constitutional minimum” they deserve.

Other estimates of the value of the bankrupts’ properties are

$7.4 billion (by Penn-Central creditors assuming continued operation)

and $3.5 billion (by Penn-Central creditors assuming liquidation) .

If any outcome above $422 million is reached, the Federal guarantee

to the creditors and stockholders would increase proportionally.

SUMMARY IMPACT

The impact of alternative assumptions on the projected

revenue and income of the system is summarized below.
-5-

The Impact of Alternative Assumptions on

Revenue and Income (1976-1983)

Alternative Revenue Income

1. Final System Plan $43.7 billion

2.

$1.5 billion

Increased Coal Revenue 44.8 billion 2.0 billion

3. Lags in Operating 43.7 billion - .3 billion

Improvements

4. Deficiency Judgment

(Assume assets valued

at $7.4 billion) 43.7 billion .5 billion

5. Unified ConRail 51.1 billion 2.5 billion

THE FEDERAL COMMITMENT

Under the proposed restructuring, the Federal government

replaces private investors as the primary source of capital.

As a result, a majority of the ConRail board members will be

government appointees until long after the year 2000. The federal investment will vary depending upon ConRail’s success in

achieving the projections set forth in the FSP. In all cases

however, it is in excess of the publicized $1.85 billion investment. Better performance will probably speed up repayment of

the Federal debt but worse performance would substantially increase the Federal liability. The level of required Federal

commitment is summarized below for alternative assumptions: .

Direct Other Deficiency

Alternative Investment Assistance Judgement Payments Total

FSP $ 2.7B $ 2.8B o $ 5.5B

Increased

Coal Revenue 2.7 2.8 0 5.5

Operating Failures >3.4 3.9 0 >7,3

Deficiency Judgement 2.7 3.9 6.8 13.4

Unified ConRail 1.8 2.8 0 4.6

ISSUES AND QUESTIONS

In the short time available to complete this report, many

questions were left unanswered or, to speed the analysis, simplifying assumptions were employed. Nonetheless, conclusions were

reached that merit serious consideration. Other questions need more

investigation.
-6-

#1

#2

#3

#4

#5

#6

On balance, the downside risks for ConRail from the basic

USRA forecast are greater than the upside profit potential.

This means it is likely that the cost to the Federal government of the ConRail package will exceed that anticipated

in the USRA forecast, perhaps by billions of dollars.

The choice between a Unified ConRail and a ConRail/Chessie

solution in the Northeast has very significant financial

consequences. The public is being asked to pay possibly

$650 million or more for the additional rail-to-rail competition resulting from the USRA preferred solution versus

Unified ConRail. It would be helpful to have more insight

into the value of this competition, taking into account the

role of trucks and other presently viable railways in the

Penn-Central area of operations.

It may be appropriate to explore further the financial consequences of some of the findings herein. USRA relies on a

computer model for financial forecasting. The authors of

this report did not have access to that model. Thus, the

report’s ability to incorporate the results of the model is

limited by the requirement that the analysis consists solely

of adjustments to published projections. For example, the

scale of the projected coal tonnage increase may exceed the

amounts assumed in the USRA sensitivity analysis, especially

in the early years, to such a degree that different cost factors, capital requirements, etc. may need to be employed.

The USRA analysis of coal has become dated. This report

finds that the coal tonnage and revenue forecasts in the

FSP are probably too low. Moreover, USRA’S proposal that

Chessie rather than ConRail acquire the only Penn-Central line

into the lucrative West Virginia coal area raises questions

about how thoroughly coal was considered in USRA's plans for

restructuring the bankrupt railroads. Recently available information from government and private sources could be used

to considerably strengthen the coal projections in the FSP.

As the most important commodity in ConRail’s future, it would

appear desirable to understand more fully how more up-to-date

projections will impact on the key issues raised in the FSP.

Both USRA and industry personnel recognized that a deficiency

judgment was likely to be entered against the government. Since

the cost of these claims could exceed all other government

investments, it deserves further consideration.

Once agreement is reached to invest Federal funds in ConRail,

contingency plans should be made to minimize losses. Otherwise, the taxpayer could continue indefinitely to subsidize

the railroad with no hope of ever recovering public capital.
-7-

CHAPTER 2

INTRODUCTION

THE PROBLEM

“How do you turn around a company losing $500 million per

year and have it make $500 million per year?” The foregoing

statement by a United States Railway Association official captures the essence of the ConRail financial issue. The proposed

railroad’s principal component, the Penn-Central, will lose about

one-half billion dollars in 1975. From the merger of the Pennsylvania Railroad and the New York Central in the 1960's, the

railroad has been experiencing a steady financial decline. The

largest railroad in the United States, the Penn-Central, serves

a 16-state territory where half of the U.S. population resides

and a major portion of its industry is located.

In the years since the Penn-Central Transportation Company’s

bankruptcy, other Northeast railroads have experienced a similar

fate. Among these are the Central of New Jersey, the Lehigh

Valley, the Leigh and Hudson River, the Ann Arbor, the Reading,

and the Erie-Lackawanna. Together with the Penn-Central, these

lines cover about 22,200 miles. The Regional Rail Reorganization

Act of 1973 called for the development of a new rail system to

replace the bankrupt carriers operating in the Northeast and

Midwest. The traditional process of reorganizing the debt structure of individual bankrupt railroads was acknowledged as inadequate to deal with these bankruptcies. Instead, innovative ideas

applied regionally were to form the basis for a new viable rail

system. The U.S. Railway Association (USRA) was established to

prepare a “blueprint” for the new system.

This assessment is concerned with the financial viability of

the restructured railroad entity proposed by USRA and named ConRail,

or the Consolidated Railroad Corporation. USRA anticipates that

this new entity can profitably operate the bulk of the lines of

the bankrupts, after a sizable U.S. government investment at the

beginning. The USRA forecast projects profitable operation by 1979.

On February 26, 1975, the USRA published a Preliminary System

Plan (PSP) to describe this new regional rail system. Considerable

criticism was levelled at that plan by the ICC, bankers, solvent

carriers and the public. USRA considered that criticism and on

July 26, 1975 published a revised Final System Plan (FSP). A

difficulty faced by USRA was implicit in the statute that charged

it with the reorganization task. The 1973 law stipulated that the

new system was to fulfill many and in some cases conflicting goals.

The new railroad was to be profitable. Yet, it was to provide

maximum service, which to some implied that unprofitable lines

were not to be shut down. The new plan was to provide for competition, but whether this had to be rail-to-rail competition or

whether inter-modal, for example, truck-to-rail, would

be sufficient was not specified. In short, USRA tried to incorporate
-8-

in its plan the conflicting goals of the Act by creating a

system that was financially viable yet did not destroy competition among the solvent carriers and still provided adequate service to shippers.

The recommended alternative in the PSP was a three-carrier

system with the Chessie and Norfolk & Western Railroads competing with ConRail in the Northeast and Midwest Regions. These

currently profitable railroads were to purchase portions of

the bankrupts which would provide them with competitive access,

along with ConRail, to key market areas such as Newark and

Albany. Comments received from the public by the ICC generally

indicated that USRA had fulfilled the goal of maintaining competition among the carriers. In the FSP, USRA slightly modified

the approach because the Chessie expressed an interest in buying a

major part of the bankrupt railroads whereas the N&W did not.

The proposed solution contemplates the purchase by the

Chessie System, Inc. of 2,500 miles from the bankrupt lines

for $62.5 million. USRA proposes that another 5,700 miles of

light-density lines be pared from the bankrupts and either be

closed down or operated with State and Federal subsidies. According to this solution, USRA believes the Act’s goal of maintaining competition will be met by giving the 11,500 mile Chessie

stronger access to Northeastern markets. The separation of 5,700

miles of light-density lines from ConRail is USRA’S attempt to

balance the Act’s goal of forming a financially viable entity

with its goal of maintaining adequate service to the Northeast.

This paper focuses solely on whether or not the ConRail

plan fulfills the goal of developing a financially viable system. The significance of this issue for the Congress can be

summarized in the following questions:

1.

2.

What are the total financial burdens that will be

placed on the general taxpayer if the ConRail proposal

is implemented? The proposal seeks $1.85 billion in

Federally provided capital with delayed payback provisions on interest and principal. $650 million in contingency funds are sought in addition to subsidies,

guarantees and loans totalling billions of dollars more.

But, the total financial burden may be more than twice

this amount.

Will ConRail succeed financially? This question is not

independent from the first, for if enough unprofitable

burdens are lifted from ConRail and enough subsidies are

provided, presumably financial viability could be assured. But such a solution would be a pyrrhic victory,

because it would be little more than an accounting accomplishment. The basic question is:How long will Federal

subsidies be needed after initial transfer? The ConRail

proposal expects the restructured railroad will earn a
—

-9-

profit before taxes and extraordinary items of $36

million by 1979. Is this a reasonable projection?

3. Did the Congress in charging USRA through the 1973

Rail Reorganization Act, or did the USRA in interpreting its Congressional mandate, bias the proposed

rail solution to the point that superior options to

that favored were not seriously put forward? This

question involves the choice of the favored “system.”

For example, the USRA interpreted the Congress’ mandate that competition be provided by the solution as

requiring rail-rail competition in the major ConRail

market areas. However, trucks and barges or other

water borne traffic compete with railroads for freight

shipments. This inter-modal competition is extensive.

For example, more than half of all commodities shipped

by rail are also shipped by truck. Even where intermodal competition is weak, for example, on some routes

for basic commodities such as coal and grain, the Interstate Commerce Commission regulates rates and to some

degree service conditions. The price implicit in adoption of the FSP’S preferred ConRail solution, with its

rail-to-rail competition, is substantial. If intermodal competition were instead deemed adequate, a onesystem or unified ConRail solution could reduce the initial cost to the Federal government to establish ConRail.

The amount of the reduction is, according to the FSP,

from $1.85 to $1.2 billion, a thirty-five percent

savings. A unified ConRail might divert revenues from

other Northeast railroads, in part because of a greater

long-haul service capability, but the size of such diversions as judged by USRA would not substantially alter

the financial outlook of other railroads.

4. What other Congressional actions are possible that might

help ConRail to financial viability without incurring

additional Federal financial burdens? Since the late

1950’s, Federal funding of the Interstate Highway System

has greatly enhanced truck competition with railroads

for freight traffic. President Ford’s Administration

has urged regulatory reform of the ICC. In 1974, the

Congress enacted legislation allowing truck weights to

be increased, thus improving truck competitiveness

with railroads.

This study focuses principally on the first three of the above

listed four questions. But, indirectly, the financial viability

of ConRail relates to the powers exercised by Congress and listed

in item 4.

WHAT HAS CHANGED?

Throughout this report, a variety of non-financial considerations will be cited as potentially decisive influences on the financial projections. These are best labelled as structural or
-10-

secular forces, beyond the control of railroads. The PSP cited

many of these factors in explaining the demise of the Penn-Central.

Expectations about a reversal in the financial performance of the

Northeast railroads must realistically reflect how these factors

will impinge on rail operations in the future. Below, some of

these considerations are noted, along with how they might evolve

in the future in comparison with the past.

TABLE 1 - EXTERNAL FACTORS AFFECTING RAILROAD FINANCIAL

VIABILITY

1960 - 1975

Increasing truck competition

for inter-city freight aided

by cheap petroleum, interstate highway construction

and the flexibility of trucking versus fixed-track limited

rail.

High economic growth rates

favored other areas of the

U.S. compared with the

Northeast.

Manufactured goods more commonly shipped by trucks have

dominated growth since 1960

whereas basic commodities

have suffered a relative

decline.

Spatial growth patterns have

increasingly concentrated the

U.S. population in large urban centers. Greater raw material specialization has increased the average length of

bulk commodity movements.

These developments should

have favored rail freight

movement, but railroads for

regulatory, management and

other reasons did not reshape

their systems to fit new

patterns.

In the Northeast, over forty

million tons of coal-fired

electrical generation capacity was converted to oil

and gas between 1967 and 1972.

Railroads lost a major share

of these shipments. Oil and

gas moved by water or pipeline.

Post-1975

Truck competition may continue

to make inroads but railroads

use less energy per ton mile

(at least one-half) than trucks

and new highway construction is

being curtailed.

Economic growth in the Northeast will continue to lag

nationwide performance, particularly performance in the South

and Southwest.

The energy crisis has boosted

coal as a major rail-shipped

commodity. But, manufactured

goods will continue to pace

economic growth.

Projected population growth

and movements should favor

rail’s ability to compete

if over-developed rail systems covering low-density

routes can be reduced in size

and railroad reliability and

speed of delivery times improve.

Oil and natural

will favor coal

gas shortages

conversions

and the siting of new coalfired facilities.
-11-

The above citations of some of the possible external developments that could make or break ConRail highlight coal as a key

consideration. The ConRail plan expects coal to play a major

role in the Northeast railroad revival. This report, therefore,

gives special attention to coal. Illustrating the decisive role

of this commodity are the two other major rail systems operating

in the Northeast: the Chessie and the N&W. At the end of the

first quarter of 1975, the Chessie led the nation’s railroads with

cash on hand of $185 million. It was followed by the N&W with

$175 million. Yet, it is questionable whether a third railroad

operating in the Northeast can also base its profitability on

coal. These other entities are better positioned vis-a-vis the

West Virginia coal fields and both serve the export port at Norfolk. Moreover,- the ConRail plan, rather than focusing on coalbased viability, contemplates selling to the Chessie its only

coal line into West Virginia (in 1974, this line carried oneeighth of the coal tonnage that the Penn-Central originated) and

strengthening the Chessie’s access to the fastest growing 1974 coal

market, Canadian exports. A key question, therefore, is how coal

fits within the financial plans for ConRail. (See Chapters 3 and

6). In explaining Chessie’s earnings gain in the first six months 1 Chessie's Presi--

of 1975 while the rest of the economy faltered,

dent attributed success to “good management and coal.” 2

The expectation of good management and the projection of

major financial savings because of improved management are central to the profitability of ConRail as foreseen by USRA’S FSP.

The plan anticipates that large financial benefits will result

from improvement in rail yard efficiency, from the use of a computerized car tracking and allocation system, and from a car

blocking system which reduces yard burdens by moving blocks of

cars around points of congestion. Improved management performance

will be essential if ConRail is to capture, as the ConRail plan expects, $50 million in revenues from other rail carriers. Innovative marketing by management is assumed in the forecast of an

additional $41.6 million in revenues from piggy-back freight.

The management challenge in making ConRail financially self-sustaining cannot be understated. The prospects are made even more

sobering by the realization that the nation’s largest and most efficient major railroad has consistently proved to be unmanageable.

In weighing the financial viability of ConRail, the possibility

cannot be totally eliminated that the density of railroads in the

Northeast is greater than that area can sustain. The ConRail

plan meets this possibility by proposing the divestiture of 5,700

miles of light-density track. But, some PSP critics deemed that

inadequate. Little was done to reduce yards and main line trackage.

Even superior management operating a system too large for its markets cannot achieve success. The ICC noted that comments on the

PSP repeatedly emphasized that more attention be given to the

1 Capacity utilization in the industrial Sector was slightly

less than 70 percent.

2 Business Week, August 11, 1975, P. 51
-12 -

“problem of mainline and terminal rationalization and that the

‘spaghetti’ of redundant facilities throughout the Region must

be eliminated.” 3

The solvent railroads criticized the PSP,

saying according to the ICC, ‘... operating efficiencies could

only be achieved by eliminating duplicative terminals, yards,

and mainlines, not by simple elimination of branch lines.. . . "4

Yet, the FSP includes no significant further measures to reduce redundancy.

In judging the merits of the final ConRail plan, the search

for the perfect solution could sacrifice the attainability of

a successful second or third best solution. Most critics of

the PSP, however vehement, urged that above all something be

done quickly to head the bankrupt Northeast railroads in a

new direction. The Congress in weighing the USRA proposal must

decide whether the possible weaknesses in the ConRail plan

justify further delay or whether they can be dealt with in an

evolutionary way as the FSP maintains.5

THE FINANCIAL FRAMEWORK

The financial viability of ConRail will depend on its ability

to generate revenue, control operating expenses and attract financing. The bankrupt carriers were notably unsuccessful in

all three areas. Declining revenues in the Northeast coupled

with skyrocketing interest rates and labor costs made attracting

private capital impossible. These carriers have now turned to

the Federal government as the lender of last resort to obtain

the cash necessary for continued operations.

The Final System Plan recognizes that a simple injection

of new capital will be insufficient to create a profitable railroad. Revenue will have to be generated by competing more effectively for freight with trucks and other carriers. Costs will

have to be reduced by employing more advanced control systems,

rehabilitating the rails and equipment, and obtaining management

of ‘the highest caliber." Finally, capital will have to be provided in large part by the Federal government to accomplish these

aims. In return, the nation is to receive a rail system that will

provide adequate service to shippers and eventually become a profitable privately owned and operated enterprise.

The FSP projects the performance of ConRail during the planning period 1976-1985. The USRA analysis relied extensively upon

field surveys, consultant reports, simulation models, analysis

of historical data and internal staff work. USRA in preparing

the FSP as the final plan for reorganizing the Northeastern railroads synthesized these voluminous studies choosing those assumptions which they felt best reflected future ConRail operating

conditions.

3

ICC Evaluation of U.S. Railroad Association Preliminary Systems

Plan. p. 11

SSee FSP, p.5-6. ‘A task so complex as the restructuring of the

rail system in the Region must be evolutionary. . . In the longer

term, after the ConRail system is established, further sales, mergers

and consolidations of facilities may be desirable.n
-13 -

On closer examination, however, the financial viability

of the plan proves quite sensitive to a few key assumptions.

Varying these assumptions between optimistic, pessimistic

and moderate scenarios demonstrates the impact on the profitability and capital demands of the proposed system. The critical

assumptions examined fall into the following categories:

Revenue Generation

. Baseline growth - The USRA forecast foresees an improved performance by the Northeast economy. Recently, the Northeast economy has grown at a slower

rate than other regions of the U.S.

2. Coal - Because of the energy crisis, USRA foresees

a major increase in coal shipments and revenues.

3 . Trailer on Flat Car (TOFC) - Rapid growth but questionable profitability is USRA’S outlook for this railroad

market area.

4. Inter-modal Competition - USRA forecasts a decrease

in incursion by trucks into ConRail markets.

5. Inflation/Regulatory Action - The USRA anticipates

that in the future the railroads will expedite their

requests for and the ICC will act more rapidly in allowing rate increases to pass through cost increases

borne by railroads.

Operating Expenses

1. - - —

2.

3.

4 *

5.

6 .

Yard Efficiencies - USRA expects significant savings from

improved yard efficiencies.

Car Utilization - Improvements in car management, according to the USRA outlook, will increase car utilization

and reduce the required investment in rail cars and locomotives.

Track Utilization - By increasing rail density - the

number of cars per mile of track - USRA expects ConRail

can reduce operating costs.

Cost Control Systems - Future potential savings are expected because of closer cost control.

Labor Productivity - Few improvements in labor performance are forecast by USRA.

Management - ConRail expects great improvements will result from better management.

between the creditors of the bankrupt railroads and USRA

on the value of railroad assets. If the lower USRA estimate prevails in court tests, the cost of ConRail implementation will be substantially lower.

2 . Depreciation Accounting - Various accounting options can

impact on profits. USRA’S approach departs from conventional railroad practice and improves ConRail’s outlook.

j I t.{); I ( ) - 75 - -1
-14-

3 . Rehabilitation Cost - A major use of capital is in

upgrading rails and equipment. USRA has carefully

weighed the possible impact of inflation on the cost

of such improvements.

4. The Form of Federal Investment - The future flexibility of ConRail is affected by how deeply the

government, as ConRail’s principal creditor, is involved in control of the company.

5. Passenger Subsidies - Large passenger subsidies from

the government to ConRail are viewed by USRA as essential for successful ConRail financial performance.

The approach of this report is to examine the critical

assumptions just reviewed in light of the background data provided by USRA, the views of other key parties such as the ICC,

the creditors of the bankrupts, and independent analysts. The

methodology of the report is summarized in the accompanying simplified schematic (Figure 1). Step 1 is to assess likely railroad revenues, expected costs of operating the railroad and the

required capital investment to acquire and upgrade the bankrupt

rail track and equipment. Chapter 3 examines the revenue outlook,

covering such considerations as baseline economic growth in the

Northeast, coal, TOFC, and inflation and regulatory lag. For example, a key assumption is how quickly the railroads can document

a cost increase, request an appropriate ICC rate increase, and

obtain an ICC decision. Chapter 4 looks at operating expenses

and assesses FSP projections in such areas as yard, track and car

utilization improvements. USRA’s expectations for major gains in

these areas are evaluated against performance by other railroads

and in the context of ConRail’s unique structural characteristics.

The third major determinant of financial viability is the cost to

ConRail of acquiring from the creditors of the bankrupts the assets of the bankrupt companies and the cost of upgrading these

run-down facilities. Chapter 5 addresses these issues.

The second step in the analysis (Figure 1) is to pick from

the many determinants of performance in the areas reviewed in

Chapters 3, 4, and 5 a handful of the most critical ones. For

these, a sensitivity analysis is presented in Chapter 6 to show

how outcomes in these areas could alter ConRail’s financial outlook. Some of the possible developments, for example coal, could

give ConRail a financial boost. Others could worsen the financial outlook. At the end of Chapter 6, a conclusion is drawn on

whether the likelihood is greater that the ConRail forecast is

optimistic or pessimistic.

The third step is to incorporate the sensitivity analysis

into revised financial accounts for ConRail. A new income statement and a sources and uses of funds analysis is provided.

The final step in the analysis (Chapter 7) is an assessment

of the consequences of various ConRail financial outcomes for the

size of the Federal government’s commitment to the railroad reorganization. Abbreviated financial statements provide a financial overview and permit the reader to readily assess the size of

the Federal commitment.
- 15 -

I

,

I
-16-

CHAPTER 3

REVENUE GENERATION

INTRODUCTION

In the ten years from 1976 to 1985, USRA predicts that

ConRail revenue will rise from $2.81 billion to $6.18 billion,

an increase of 111 percent. Figure 2 traces this dramatic

growth back to 1970 and divides it among its five key component parts.

● improved mix and volume of traffic (primarily coal

and TOFC)

● inflation

● maintenance of base level traffic

● rate increases above inflation adjustments

● passenger revenues and operating subsidies

While the most striking aspect of the figure is the tremendous

growth in inflation relative to real traffic growth, the small

increase in traffic volume indicates a reversal begun in the

1970’s of the long-term decline in Northeastern traffic (Figure

3). Most of the reversal is due to an increase in coal which

accounts for 62.2 percent of the growth in total tonnage, though

only a 24.7 percent increase in revenue. A second major area of

growth is in TOFC (trailer on flat car) or piggyback shipments

which account for 14.7 percent of revenue growth.

The following four key assumptions, critical to the revenue

forecast, are investigated:

● baseline traffic growth

● coal traffic growth

● TOFC traffic growth

● inflation and regulatory impacts.

BASELINE TRAFFIC GROWTH

Figure 2 indicated that the increase in revenue due to changes

in the volume and mix of traffic and rate increases between 1973

and 1985 would be $283.8 million. The tonnage increases projected

for the twelve principal commodities are shown in Table 2. Between

1973 and 1985, tonnage will increase 15.4 percent (1.20 percent

annually) . But, revenues in constant dollars will increase more

rapidly, by 15.7 percent (1.22 percent annually). Nonetheless,

this growth rate in revenues is lower than the expected growth in

real GNP during the same period, 51 percent (3.5 percent annually).

This discrepancy is explained, however, by the fact that historically railroad tonnage as a percentage of GNP has been decreasing

by .15 percent annually.
-17-

TABLE 2 - PROJECTED 1973-1985 FREIGHT PERFORMANCE

Million Tons Revenue

Commodity 19/ 3 1985 1973-85 % of Constant % of

% Change Total Dollars Total

Increase % Increase Increase

Farm Products

Metallic Ores

Coal

Non-Metallic

Metals

Food Products

Lumber

Pulp & Paper

Chemicals

Stone, Clay &

Glass

Primary Metals

Transportation

Equipment

Waste

Coke

TOFC

Other

10.7

28.7

84.5

19.4

23.6

8.6

18.8

21.1

14.6

26.0

13.9

15.5

7.0

7.8

16.9

8.8

31.9

115.1

18.1

20.5

8.9

21.4

21.9

14.6

31*7

17.4

18.7

7.8

10.6

18.6

-17.8

+11.1

+36.2

-6. 0

-13.1

+2. 9

+13.8

+3. 8

o

+21.9

+25.2

+20.6

+11.4

+35.9

+10.1

-3. 9

+6. 5

+62.2

-2. 6

-6. 3

+0. 6

+5. 3

+ 1.6

0

+11.6

+7. 1

+6. 5

+1. 6

+5. 7

-3.8

+11.9

+33.4

-1.6

-10.49

+7. 7

+24.9

+5. 7

o

+23.2

+29.4

+33.8

+16.1

+36.8

-1. 0

+3. 2

+24.7

.3

-7. 0

+1. 6

+9. 6

+2. 9

.4

+13.4

+24.8

+8. 7

+1. 6

+14.7

+3. 4 -4.0 +2. 7

TOTAL 317.1 366.0 15.4 +99.3 +15.7 +99.2

~ SOURCE:

i

FSP, p. 171
-18-

I‘1-l
-19-

The ICC assessment of the PSP expressed serious doubts

about the growth forecasts, considering them generally “optimistic.” The constant (1973) dollar revenue outlook in the

FSP can be summarized as follows:

1973-1985 Revenue Growth

1. Growth in coal tonnage + $ 70.1 million

2. Trailer on flat car growth + 41.6 million

3. Baseline growth in other traffic + 161.8 million

4. Selective rate increases + 53.3 million

5. Diversion to long-haul routes + 30.0 million

6. Light density line abandonments 41.8 million

7. Market transfers to solvents 31.2 million

+ $283.8 million

SOURCE: FSP, p. 170 as adjusted by EEA.

In fact, the projections indicate a “hopeful” reversal of

the trends in the Northeast since the mid-1950’s (Figure 3).

Between 1955 and 1974, coal and other freight carried on the

Eastern railroads declined 26 percent. Both USRA and its critics emphasized basic weaknesses which still remain: population outmigration, diminished growth in traffic volumes, out-migration

of manufacturing centers and raw material sources and competition from trucks for short hauls. As seen in Table 2, the

largest contributions to the expected total 1973-1985 gain in

revenue are expected to result from increased shipments of

transportation equipment (24.8 percent), from increased coal

revenues (24.7 percent), and from increased TOFC (14.7 percent).

In absolute terms, the gain in coal revenues (in 1973 dollars)

is expected to be $70 million versus a $41 million TOFC increase.

These ConRail expectations are worth examining in detail because

they are decisive factors in the revenue outlook.

COAL PROJECTIONS - THE USRA APPROACH

Focusing on the year 1980 for which already announced coal

production plans are relatively firm, USRA projects a slight

growth in ConRail coal traffic of 10 million tons or 12 percent.

This projection is questionable both in the face of an increase

in national coal production of from 30 to 50 percent and on

methodological grounds.

Step one in the projection is a forecast of national coal

production. USRA’S consultant used an econometric forecast of

future growth which when coupled with an input/output model (INFORUM) yields estimates of national production by industry and

commodity groups. For coal the 1980 production estimate is

785 million tons. This estimate is extremely conservative in

comparison with projections of 895 million tons prepared by FEA,

and similar projections from other sources.
.

z

H

.

800

700

600

500

400

300

200

100

-20-

FIGURE3

Eastern District Originated Tonnage and

,

ConRail Tonnage

Eastern

District

ConRail

Projection

1920 1930 1940 1950 1960 1970 1980

Source: FSP pp. 171

Railroad Facts - 1975 Pp. 28
-21-

Despite criticism of the Preliminary System Plan by the

ICC and others that focused on whether the forecast was too

optimistic, (coal provided 62 percent of the increase in ConRail tonnage after 1973) , a combination of factors support the

higher estimate. Substantial new coal-fired electric capacity

is scheduled to come on-line, industry users of oil and gas

are converting to coal where possible (e.g. in cement production), and coal exports overseas and to Canada have already

surged.

Step two of the USRA analysis consisted of projecting the

Eastern district share of national production. Here the USRA

forecast is also in error. The methodology used projects two

ratios: the rail fraction of total production (rail loadings/

national production) and the Eastern share of national rail

loadings (Eastern rail/total rail). These two ratios together

give the Eastern rail share of national production. The projection was based on historical trends, with relatively little

change expected from current figures. A third relationship is

implicit in these variables: the Eastern share of total production. This ratio has not changed dramatically in recent

years. However, analysis of potential supply done by FEA

(Coal Supply Task Force Report of the Project Independence

Blue Print) and modelling conducted by Energy and Environmental

Analysis, Inc. for the National Science Foundation project a

sharp shift in shares. Currently, Eastern production is about

75 percent of national production. By 1980, Eastern production

may be from 45 to 62 percent of national production. Using

this corrected estimate, and the USRA baseline of 785 MT annual

production yields an estimate of Eastern production and hence

Eastern rail originations 20 to 40 percent lower than USRA’S.

But, because USRA’S assumption of national coal production of

only 785 MT in 1980 is too low, the mistakes fortuitously cancel

each other.

Step three in the USRA analysis focuses on the rail share

of Eastern production. USRA treated this issue indirectly in

the methodology described above (i.e. by estimating Eastern rail

share of national rail tonnage) . The question should be: What

is the split of Eastern production between rail, water, minemouth use and truck transport? The USRA analysis indicates, albeit indirectly, that the rail share is constant (at roughly 50

percent).

Step four is the allocation of rail traffic between ConRail

and the solvent railroads. USRA does not explicitly state the

method by which this is done, but the projections prepared allot

most of the increased Eastern originations to the non-ConRail

lines.

593-o’7~ (j - 75 . 5
-22-

TABLE 3 - EASTERN RAIL ORIGINATIONS, USRA ESTIMATES

ConRail Non-ConRail

1973 (million tons) 42. 6 1 4 4

1980 (million tons) 44.9 178

% Increase 5% 24%

The explanation given is that sulfur regulations will result in most of the increased coal production occurring in

West Virginia and Virginia where no ConRail lines begin. (The

Penn-Central has a West Virginia line but USRA proposed to sell

it to the Chessie.)

AN ALTERNATIVE ESTIMATE

A recent survey by the National Coal Association of new

coal mining capacity shows high gross additions to capacity

in Illinois, Indiana, Ohio and Pennsylvania, where ConRail

coal shipments originate. These planned expansions must be

adjusted for replacement of retirements (equal to 1/30 per

annum) and for a ConRail share. The acquisition of lines by

solvent railroads will not give them greater access to or better

routes from these producing areas. Hence ConRail’s share of

rail loadings in these states should be constant. With these

assumptions, the forecast of net growth from identified new

coal production capacity in states with current ConRail originations is 34 million tons. Of this total, assuming historical portion of ConRail originations to total production

in these areas holds, 9.2 million tons would be expected to

originate on ConRail. This estimate is almost certainly an

understatement, since smaller operations are not adequately represented in the Coal Association survey, and many probable

expansions are not yet announced. Even taking into account

the loss of 6.3 million tons of West Virginia originations to

the Chessie system, there is likely to be more and possibly

substantially more growth than the 2.3 million tons projected

by USRA.

In addition, a significant amount of ConRail coal traffic

will be coal received from other systems. This accounts for

55 percent of ConRail coal traffic now. 1

USRA projects coal

received to grow to 52.5 MT by 1980, an increase of 24 percent

over 1973. An EEA analysis of demand for coal in 1980 in the

IAccording to TBS, LJsRA’s consultant, in 1973 ConRail originated 42.6 million tons and received 52.9 million tons.
-23-

United States served by ConRail (New England, New York, New

Jersey, Pennsylvania, Ohio, Indiana and Illinois) indicates

a growth of 107 MT or 46 percent by 1980.2

If ConRail keeps its share of total terminations, and

its originations do not increase dramatically (as described

above), its coal received must grow by 46 percent from 43 MT

to 62 MT (VS. 52 forecast by USRA). Assuming the sale of the

Erie-Lackawanna and other properties to Chessie and N&W does

not materially increase their access to major coal using markets, this seems a reasonable assumption.

The net coal traffic could, adding new originations and

terminations together, be in the range of 110 million tons

versus the 95 million tons in 1980 projected by USRA. If all

mining plans were known, the coal originated could be higher.

In the FSP, USRA discusses the possibility that its coal projections may be too low (p. 78). The USRA financial sensitivity analysis assumes in a calculation that by 1985 there is

a 33 million ton increase in the ConRail coal tonnage transported. The estimated financial effect of such an increase is

to increase total coal revenues by $371 million and cash by

$150 million over the 1976-1985 period. Since the analysis

reviewed above finds a coal traffic increase of at least 15

million tons by 1980, the 1985 impact of this adjustment is

even more profound.

In short, the upside financial possibility is that by 1985

ConRail’s cash position could be as much as $300 million stronger

than is assumed in the base case USRA forecast.

Two other positive factors in the coal revenue outlook for

ConRail are the possibility that rate changes approved by the

ICC will increase the per ton profit on coal and that improved

unit train operations will reduce per ton mile coal transportation costs to ConRail. The FSP noted the first possibility (p.

180-181). The USRA estimates that a 50¢ per ton increase in

coal rates would yield a $34 million increase in annual ConRail

revenue. Of course, this benefit could be higher if USRA’S coal

forecast proves too low. As far as the feasibility of unit train

operations, the following table shows that for the key coal producing states served by ConRail a significant portion of 1973

coal traffic did not move on unit trains. If rate reforms by the

ICC are coupled with greater reliance on low cost unit trains,

ConRail’s financial situation would be enhanced.

zBased on individual plant data on existing and new utilities, estimates of metallurgical exports, and industrial use.

Total estimated demand in 1980 is 897 million tons.
-24-

TABLE 4 - 1973 COAL SHIPMENTS VERSUS UNIT

SHIPMENTS FOR SELECTED STATES

Tons by Total

Unit Train Tons

TRAIN

% by

Unit Train

Illinois 22,155 41,138 54

Indiana 5,493 15,172 36

Pennsylvania 22,262 30,628 73

Ohio 18,266 20,607 89

The foregoing discussion of coal and ConRail’s financial

prospects suggests that USRA’S revenue forecasts for this commodity are too low. However, the subject deserves more thorough

treatment than this report is able to give. A more complete analysis of coal and ConRail is needed. It should identify the

new and converted power plants in ConRail’s markets that will

burn coal, the share of European and Canadian exports ConRail

can ship, industrial conversions to coal in ConRail’s area, and

growth in base period coal consumption by ConRail served coal

consumers. Such an analysis must reflect possible EPA actions

limiting the burning of high sulfur coal, probable ICC coal rate

actions, and the cost savings possible from increased ConRail

reliance on unit trains. This analysis should also examine the

implications for ConRail profitability of giving up to Chessie

the Penn-Central line into Charleston and the contemplated cooperative agreements giving the Louisville and Nashville (L&N)

access to southern Illinois and Indiana Penn-Central coal

markets. 3

TRAILER ON FLAT CAR (TOFC)

Another major growth area in the USRA forecast is TOFC (Trailer

on Flat Car) traffic, commonly known as piggyback. TOFC commodities

tend to be higher rated goods which often are shipped by truck.

Penn-Central significantly expanded traffic in this area although

profitability of this traffic is disputed. Between 1973 and 1985,

TOFC tonnage and revenue (in constant dollars) are projected to

increase 36 percent (2.65 annually). In the PSP, growth was

31n the Fsp (VO1. II P“ 6) , USRA recommended that a “fossilfuel rail bank” be established by the Department of Interior or

other Federal agency to administer rail trackage serving potential

coal reserves which are not presently developed to a point that

justifies ConRail service. Another possible entity for administering

such rail assets could be the Appalachian Regional Commission which

has jurisdiction over and knowledge of much of the Appalachian coal

reserves and economic development potential in 12 Eastern states from

Georgia to New York and Maryland to Ohio.
-25-

projected at 5.16 percent annually. The reduced growth is

due to the fact that:

● TOFC oriented commodities are most affected by

recessions

● USRA is recommending rate increases which will improve TOFC profitability but lower demand

● recently increased truck size and weight limitations will divert potential TOFC traffic from the

railroads.

TOFC growth accounts for 14.7 percent of the $284 million

in real freight revenue growth projected by USRA. The FSP predicts that this growth will occur as ConRail continues to penetrate the market for small shipments. The mechanisms for penetration include expanding rail operated motor carrier operations

to provide control over pick-up and delivery, modification of

the rate structures to make TOFC more competitive with trucking

for smaller shipments, and improved reliability through rehabilitation and operating improvement since shippers of high tariff

goods seem more sensitive to service and reliability than price.

Additional inter-modal traffic will probably be generated as

light density lines are eliminated and shippers are forced to

use truck and rail combinations for delivering goods.

The two principal arguments against TOFC expansion are

that it is unprofitable and that railroads have historically

failed to compete successfully with trucks for small shipments.

According to the ICC, Penn-Central in 1973 lost $30 million

handling $170 million of TOFC traffic, or about 18¢ for each

dollar of traffic handled. TOFC has been traditionally unprofitable traffic due to extensive competition for small traffic

volumes, too many small terminals which do not cover fixed costs,

the high capital cost of tying up flat cars and trailers, and

rate structures which allow empty trailers to travel at below

cost rates.

Because 85 percent of highway freight shipments are less

than truck load size, ConRail will have to assemble shipments

into profitable truckload quantities. Freight forwarders historically have served the function of assembling small shipments

into carload lots, yet between 1950 and 1970, the tonnage assembled by freight forwarders has not increased. During the same

period, the less than carload tonnage shipped by railroads declined 95 percent.

In summary, shippers have concluded through the market system

that trucks haul small shipments over all distances better than

railroads. Making TOFC a worthwhile market for ConRail will require

a change in the rate structure so that railroads can make a profit

on TOFC traffic, and better service on the part of railroads including control over the pick-up and delivery (through trucking subsidiaries) of shipments. ConRail may have considerable difficulty

succeeding in this highly competitive market while solving more

pressing startup problems.
-26-

INFLATION - BACKGROUND

Between 1976 and 1985, USRA predicts that inflation will

account for 84 percent of the growth in revenue. Since rate

increases must be approved by the ICC, regulatory response will

be a critical element in system profitability. If COStS go u p

because of escalation of labor or material prices and rate increases lag behind, revenues and profitability suffer. The ability of ConRail to recover inflationary cost increases will depend on the speed with which ConRail documents cost increases

and requests rate changes, the adequacy of the rate increases

granted by the ICC to cover increased costs, and the speed with

which the-ICC responds.

In the Final System Plan (FSP), USRA assumed that rate increases necessary to accommodate inflation hikes would lag cost

increases by 6 to 8 months. Normally, the ICC approves rate

increases in 2 to 3 months after a request. The industry, however, takes 5 to 6 months to define the needs. The speed with

which increases are granted is especially critical to ConRail

profitability because inflation rates are expected to average

over 6 percent annually between 1976 and 1985. First National

City Bank of New York (Citibank) tested the sensitivity of income projections using data from the PSP which assumed no lag.

Assuming a 3-month and a 6-month delay in rate increases, the

impact on profitability is shown in Table 5.

TABLE 5 - IMPACT OF RATE DELAY ON NET INCOME

Net Income

1976 1985

PSP (no delay) -$ 96 million $ 171 million

3-month delay - 180 million 6 million

6-month delay - 265 million - 157 million

SOURCE: A Financial Analysis of the Preliminary System

Plan as proposed by the USRA, First National

City Bank, May 15, 1975.

The FSP assumes that by 1981 the lag in pass-through will

drop to 6 months. This implies a faster response time on the

part of industry than has been demonstrated in the past. Table

6 indicates historical rate increases and increases in the major

component costs. Obviously, in the Eastern district, increases

in revenue per ton mile have historically lagged increasing costs.

As the inflation rate accelerates from historically low levels

to the projected 1975-1980 average of 6.3 percent, the impact of

a lag will be more severe. For identical expenditures, profits

are increased by the amount of the rate increase with losses occurring only if traffic is diverted to another mode. Consequently,

the impact of rate increases on profitability is tremendous.
-27-

TABLE 6 - EASTERN DISTRICT COMPONENTS

(Normalized: 1967 value = 100.0)

Revenue

Average of Per Ton

Fuela

Waqesaall factorsaMileb

1967 100.0 100.0 100.0 100.0

1968 103.3 105.9 106.4 105.2

1969 106.0 113.2 113.3 108.6

1970 109.2 122.9 123.6 116.3

1971 115*3 136.6 134.3 137.0

197 2 117. 7 150. 0 147. 4 138. 8

1973 137.3 165.5 165.7 140.7

1974 271.4 175.2 188.6 159.8

a AAR Series Q-MPW-88, July 22, 1975

b

Railroad Facts, p. 33

The extent to which ConRail as an individual carrier can

recover cost increases through rate increases is questionable.

The ICC historically grants rate increases on an average cost

basis. Thus, those carriers which are more efficient than the

average will benefit more than less efficient carriers. Consider the operating ratio (operating expense as a percentage

of operating revenue) as a measure of efficiency. The N&W,

Chessie and Penn-Central are the three largest carriers in the

Eastern district (76 percent of all revenue).

TABLE 7 - RAILROAD OPERATING RATIO (1973)

Norfolk & Western 72.5%

Chessie 74.8%

Penn-Central 82.7%

Average of all Class I 79.4%

Carriers

SOURCE: PSP, p. 24.

Assume that inflation averages 6.3 percent annually and that

rate increases are granted which will allow the average Class I

carrier to recover additional costs in higher revenues. Table

8 illustrates the impact on the least efficient, most efficient

and average carriers.
-28-

TABLE8 - RATE INCREASE IMPACT ON RAILROADS

OF VARYING Efficiency

(Normalized: 1973 operating revenue = 100.0)

N&W Class I Ave. Penn-Cen. ConRail

1973 1980 1973 1980 1973 1980

Operating

Revenue 100.0 142.3 100.0 142.3 100.0 142.3

Operating

Expenses 72.5 111.2 79.4 121.7 82.7 126.8

Contribution

to Profit 27.5 31.1 20.6 20.6 17.3 15.5

a

Carrier costs increase 6.3 percent annually but revenues increase only enough to maintain average industry ‘profits

The impact is striking. While in 1973 Penn-Central’s contribution to profit would have been 84 percent of the industry average,

by 1980 it was only 75 percent. Until ConRail achieves parity

with average industry operating efficiency which is not projected

until 1981 under the FSP, rate increases will be insufficient

to cover added costs. In addition, very efficient carriers may

“hold down” or prevent tariff increases for all railroads in a

district if the efficient carriers do not need them.

The final impact of inflation concerns the relative shift

it may cause in rail-truck-barge rates. If inflation hits railroads harder, there would be a diversion of traffic away from ConRail. An analysis for USRA by Chase Econometric Associates showed

that the future impact of inflation on truck and rail would be

comparable so that no net diversion of traffic should occur.

“Diversion would occur if:

1. the increase in prices for input factors (labor,

material, fuel) were more expensive for one mode

than for another;

2. interest costs were higher for one mode; or

3. rate increases were not passed along with equal speed.

On balance, therefore, the assumed regulatory lag for ConRail

is slightly optimistic when judged by historical performance.

Quick documentation by ConRail and improved reaction times at the

ICC could reduce the lag to be consistent with USRA’S assumption.

More serious is ConRail's disadvantage in obtaining rate increases

due to its comparative inefficiency. Most probably, until ConRail

efficiency approaches industry average performance (in 1981 at the

earliest) , inflation will not be passed through completely and

ConRail’s profitability will suffer.
-29-

CHAPTER 4

OPERATING EXPENSES

Between 1976 and 1985, the Final System Plan (FSP) projects

that ConRail operations will improve markedly turning a 1976 loss

of 9.9¢ on every dollar of revenue to a 13.5¢ profit. Table 9

illustrates the percentage reduction in expenses through which

this profit turnaround is accomplished. The most significant

improvement occurs in the transportation expense category, (i.e.,

the cost of transporting the freight) which drops from 39.8% of

revenue to 29.0%.

Percentage reductions are achieved in nearly every expense

category. Maintenance of Way (M of W) expenditures per mile of

track increase due to better track rehabilitation, but the

elimination of light density lines allows M of W expenditures

to decrease as a percentage of revenue. Similarly, maintenance

of equipment (M of E) expenditures rise, decreasing the number

of freight cars currently out of service from 10.7% to 5%.

However, a reduction in fleet size due to improved car utilization lowers M of E expenditures as a percentage of revenue.

General administrative and passenger expenses remain relatively

constant on a dollar basis reflecting ConRail’s ability to

generate more freight revenue without increasing management overhead. Net car hire decreases as a percentage of revenue reflecting better car utilization and the assumption that cars will be

purchased rather than leased. The “other” category decreases as

a Percentage of revenue due to the stable work force size (lower

payroll taxes as a percentage of revenue) and increased income

gained from investment of excess ConRail stock in short term

securities.

To improve transportation expenses, from 39.8% to 29.0% of

revenue, ConRail will rely primarily upon increased yard efficiencies providing faster throughput of freight, improved car

utilization through a computer-based car management system,

economies of density obtained by running more traffic over less

track and better management of costs and operations. The USRA

analysis relies heavily upon computer-based simulations of projected ConRail performance. These results are integrated with a

financial model projecting system profitability and cash needs.

Considerable doubts, however, have been expressed by railway

operating personnel and the ICC about the ability of ConRail to

obtain these dramatic improvements.

Most of the critiques concern ConRail management’s ability

to improve equipment utilization as much as expected. A number

of critical assumptions were identified that affect achievement

of the operating improvements.

5n3.07u r) - 75 . fj
-30 -

Table 9

NET INCOME (1973 dollars)

(normalized revenue = 100.0)

1976

Total Operating Revenue 100.0

Operating Expenses:

Maintenance of Way (11.5)

Maintenance of Equipment (14.8)

Transportation (39.8)

General, Administrative,

Passenger, and Other

Expenses (23.9)

Net Operating Revenue 10.0

Other Expenses:

Net Car Hire

Other Income, Expenses,

and Taxes

Earnings Before Interest

Interest

Income

( 9.9)

( 9.2)

( 9.1)

( .8)

( 9.9)

198 5

100. 0

(11.1)

(12.1)

(29.0)

(18.9)

28.9

( 8.3 )

( 5*7)

14.9

( 1.4)

1305

SOURCE: USRA Final System Plan, pp. 71.

IMPROVEMENT IN YARD OPERATING EXPENSES

ConRail projects that yard operating expenses will be

reduced by system modifications. No improvements in labor

productivity are expected other than those resulting indirectly

from system changes. A principal system modification is blocking changes, which reduce yard expenses by 8%. This involves

assembling blocks of cars into trains in an efficient manner

which minimizes transportation costs, for example, by forming

longer trains. It also maximizes delivery speed, for example,

by bypassing intermediate yards. A second major system modification is rehabilitation of yards and related facilities. This

reduces yard expenses by 6%.
-31-

The importance of yard improvements to the efficiency of

the system is illustrated in Figure 4. Cars spend 61.8% of the

time in yards and only 14.6% of the time moving with the remaining

23.6% of the time spent under customer control. More importantly,

on an average haul, a car will pass through 5 or 6 yards. Rehabilitating tracks to increase train speeds, for example, from 10

mph to 40 mph, may have little effect on system efficiency if

the car spends 60% of the time waiting in yards for reclassification or loading.

Comparing ConRail yard expenses with other railroads indicates that even after the expected improvements, ConRail will

incur higher yard expenses per freight movement than other

railroads. For example (see Table 10), in 1976 ConRail will spend

$3.15 per 1,000 ton-miles for yard-related expenses while Southern

spends only $1.47. By 1985 ConRail’s costs will still be higher

at $2.41 per 1,000 ton-miles. This is due primarily to the yard

intensive nature of the Northeast rail operations. For the same

reason, yard expenses will continue to account for a higher percentage of transportation expenses than other railroads. Although

USRA projected a 22% drop in yard-related expenses from $3.07 to

$2.41 per 1,000 ton-miles, yard expenses will remain a high percentage (29%) of all transportation costs.

Another indication of the “spaghetti” nature of the old Penn

Central system is given in Table 11 showing the relationship

between operating ratios (i.e., operating expenses ÷ operating

revenue) and the percentage of track which is mainline. The data

suggest a strong correlation between more branch lines and higher

(i.e., less efficient) operating ratios. In a branch line

intensive operation, like ConRail, yard requirements may be

increased substantially. In 1969, for example, only 31.1 percent

of Penn Central track was mainline resulting in an extremely high

operating ratio of 84.4 percent.

Yard improvements predicted by USRA rely heavily on a systems

analysis approach which optimizes traffic movement over the ConRail

system based on computer simulations. This sophisticated model

was not previously available to Penn Central management. It will

ensure some improvements, but whether these will be as dramatic

as the FSP predicts is questionable. The PSP indicates that Penn

Central already had "a relatively efficient blocking plan” for

intermediate yards.1

Therefore, USRA projected gains must occur

primarily at origin and destination yards.

Deciding which yards to expand or contract and where to

focus yard rehabilitation efforts requires an accurate prediction

of future traffic flows. Predicting market growth is an inherently

risky business and failure to accurately predict traffic flows may

reduce some of the projected yard efficiency improvements.

1

PSP p. 60.
-32-

Figure 4

AVERAGE EQUIPMENT TRIP CYCLE

\

In

61

15

NOTES:

Average Cycle Time 25.6 Days

SOURCE:

Moving

14.6%

3.7 Days

,,/

Federal Railway Administration

Report: FRA-OE-73-1
MEASURES

Railroad

ConRail (1973)

ConRail (1976)

ConRail (1985)

Seaboard Coast Line (1973)

Burlington Northern (1973)

-33-

Table 10

OF YARD EFFICIENCY

Yard Related

Transportation

Expenses

$ per

(1000 ton-miles)

3.0 7

3.1 5

2.4 1

1.8 5

1.6 3

Illinois Central Gulf (1973) 1.56

Southern (1973) 1.47

Atchison, Topeka & Santa Fe

(1973) 1.17

Union Pacific (1973) 1.11

Yard

Expenses as a

Percentage of all

Transportation

Expenses

29%

30%2

29%2

28%

26%

27%

26%

19%

21%

SOURCE: Evaluation of the USRA’S Preliminary System Plan

Rail Services Planning Office pp. 42-43.

2 Preliminary System Plan, P. 63.
-34 -

Table 11

RELATIONSHIP BETWEEN PROPORTION OF MAIN

LINE TRACK

Percentage of Total Road

Mileage Devoted to Main Line

20% - 50%

50% - 60%

60% - 70%

70% - 80%

80% - 90%

90% - 100%

AND OPERATING RATIO

Mean Operating Ratio

85.9%

80.5%

76.1%

76.8%

77.5%

75.1%

Example Railroad

Operating Ratios

PC 84.4%

BN 82.1%

c&o 76.2%

N&W 71.1%

B&O 73.1%

RFP 57.9%

NOTE: In 1969, 31.1 percent of Penn Central Track was main line and

the operating ratio was 84.4 percent.

SOURCE: Competition in the Railroad Industry; Simat, Hellieson &

Eichner, February 1975, pp. II-28, II-29.

The existence of an optimal blocking plan does not ensure that

it will be rapidly implemented or followed. Blocking changes may

require the transfer of sorting operations from one yard to another,

in addition to shifting work loads, train schedules and car routing

patterns. Yard expansions and schedule changes will require time

for implementation. Blocking plans may be overridden by a desire

to expedite certain types of traffic. Because railroads compete

primarily on service, blocking decisions may be adjusted to provide priority service to important customers. These blocking

adjustments may reduce the efficiency of the entire system, sacrificing the efficient movement of less time-sensitive freight. If

ConRail is to compete more effectively with trucks in the TOFC

market, these service differentials may conflict with optimal

blocking patterns.

Despite all these projected improvements, ConRail will remain

a more yard intensive railroad than most due to the congested

nature of Northeast traffic.
-35 -

CAR UTILIZATION IMPROVEMENTS

The savings from yard and track rehabilitation appears

largely in the form of better car utilization. USRA projects

a 28% improvement in car utilization over present levels.

Improvements are primarily due to four factors: improved

travel speeds due to track rehabilitation, faster throughput

in yards, better maintenance of equipment and better freight

car distribution techniques.

ConRail will begin with approximately 175,000 freight

cars.

3

During the planning period approximately 24,000 cars

will be purchased4

and 49,000 will be retireds decreasing

the fleet to 150,000 which is 40,000 less than would be needed

without the anticipated efficiency improvements. The anticipated savings is approximately $1.2 billion.6

In addition, the

number of locomotives will be reduced by 223 from current levels.

ConRail’s fleet consists potentially of 4,500 locomotives.7 The

total anticipated expenditure for new equipment is $1.78 billion.8

Consequently the improvements in car utilization will save approximately 40% of the total capital expenditure that would otherwise

be required for new equipment.

Improved car utilization affects the railroad financially

by reducing capital requirements, interest costs, transportation

expenses and net car hire expenses. The net car hire account includes net per diem and mileage payments in addition to car leases.

The net per diem and mileage charges are the difference between the

amount which ConRail must pay for borrowing other railroad’s cars

and the amount it receives from other railroads using ConRail

cars. The Northeastern railroads are at a disadvantage because

more goods are shipped to the Northeast than originate there.

Consequently ConRail is more likely to have a negative net car

hire balance because it will be holding cars belonging to shippers

in the South and West. A comparison of six Southern and Western

railroads indicates that they had net car hire balances equal to

only 55% of ConRail’s.

ConRail has the choice of leasing or purchasing new cars.

If the railroad chooses to purchase new cars, the financial statement will reflect higher depreciation and interest costs. For

presentation purposes, USRA assumed that all cars were purchased

and therefore all debts would appear explicitly on the balance

sheet. The assumption that ConRail would purchase rather than

lease cars accounted for 41% of the savings in net car hire paid.

However, ConRail is likely to lease cars because it will be unable

to use the tax advantages resulting from accelerated depreciation.

By allowing outside investors to purchase the cars, use the depreciation to protect other income, and then lease the cars to ConRail,

the railroad will conserve its cash. Lease payments would then

increase the negative balance in the net car hire account and

reduce reported income.

3PSP p.

4

FSP p.

5PSP p.

‘Strong

TFSP p.

PSP p.

8FSP p.

92

99

92

Wishart, p. 2-1

7 9

78

61
-36 -

Several other factors are likely to reduce net car hire

savings. Net car hire has a tendency to increase because the

price of cars hired increases. Between 1963 and 1973, net car

hire increased 10 percent annually despite a 6.6 percent drop

in car loadings. Increases were due to newer cars and higher

interest rates which produce higher costs. There has also been

a tendency to rely more heavily over time on shippers’ cars.

This practice increases net car hire expenses.

The achievability of projected car utilization improvements

will significantly affect ConRail’s profitability and capital

requirements. Improvements will certainly result from raising

mainline travel speeds by 21 percent, reducing classifications

by 10 percent, and reducing the bad order ratio (i.e., the percentage of cars not in operating condition) from 10.7 percent to

approximately 5 percent. However, the major improvements rely

on an improved computer based information system to control car

movements.

Because a car spends only 14 percent of the time moving, a

21 percent increase in track speed would only improve car utilization by 3 percent. Reducing the number of classifications by

10 percent improves car throughput but does not solve the critical

problem of having cars available at the locations demanding cars.

Again, USRA relies on the computer-based information system to

fill the gap.

The car management system will probably be a hybrid of the

Penn Central’s TABS system and the Southern Pacific’s TOPS system.

Output of the system will be used to predict areas of future demand

and to move cars to those areas. While implementation of the

anticipated system would dramatically improve car utilization, the

difficulties in developing and implementing the system are considerable. If a combination of TOPS and TABS is chosen, the problems

of integrating two large computer systems will be encountered. In

addition, demand forecasting involves a new application of these

systems and will require time to debug. The most critical aspect

of a sophisticated car management system, however, involves data

input and quality.

Improvements in car distribution will require input of car

information daily including: car type, ownership, grade cleanliness, and previous commodity. When a car is under shipper’s

control this information is difficult to obtain. The data input

operation must also be extremely accurate. Because ConRail will

be controlling so many cars, the opportunity for “losing” cars

through failure to input data or input of bad information is

higher than for most railroads. Persons responsible for data input

and integrity must exhibit a high level of discipline. Cooperation

among railroads in the exchange of information necessary to

track car movements across -boundaries has historically been a

problem.

Improvements in car utilization may result from several

regulatory reforms suggested by USRA.

● Reducing the amount of free time which a shipper

has to unload a car from 48 hours to 24 hours.
-37 -

● Eliminations of special exceptions to normal demurrage

charges (charges for a shipper keeping a car beyond the

agreed upon free time) .

● Additional charges for cars which shippers release to

the railroad without disposition instructions.

In addition, future coordination projects to prevent empty

back hauls could considerably improve car utilization. Potential

savings from these programs have not been included in the FSP.

Their implementation depends on ICC action, which is not

imminent.

USRA has projected dramatic improvements in car utilization

relying primarily on implementation of a sophisticated computer

based car management system. Many problems exist in the development, implementation and operation of the system. These are

likely to reduce the savings below those projected by USRA.

Similarly, savings in the net car hire account will be

reduced assuming that ConRail chooses to lease rather than purchase a portion of the new equipment. The natural dependence of

the Northeast on shipments from the South and West will limit

improvements in this expense category.

Proposals requiring regulatory action could provide incentives

to shippers to handle cars more efficiently. However, no concrete

proposals have been made. These potential savings rely on actions

which are beyond the control of ConRail management.

TRACK UTILIZATION IMPROVEMENTS

Yard improvements and car utilization improvements reflect

better utilization of the track. USRA projects that ConRail

will improve profitability by passing more traffic over a

shorter track system and using fewer cars and less locomotive

power than its predecessor railroads. ConRail will be reaping

the economies of density which are the railroad’s version of

economies of scale. Table 12 illustrates the high correlation

between density and operating ratio. Ranking the 24 Eastern

railroads by density and computing the average operating ratio

shows that operating ratios get much worse (i.e. higher) as

density decreases. There are exceptions to the rule, for example,

a railroad which hauls high tariff items, but the relationship

is generally true. ConRail’s density is currently near the

national average of 4.2 revenue tons per mile, but will show a

marked improvement by 1985 to 8.2, making it the third densest

railroad in the East and the fourth in the nation.9

Table 13

indicates that by 1985 ConRail will exceed the average densities

of seven other major railroads and all the area averages.

gCompetition in the Railroad Industry; Simat, Hellieson and

Eichner, February 1975, pp. 37-39.
-38 -

TABLE 12 - RANK OF EASTERN RAILROADS BY DENSITY

Number of Railroads Average Density Average Operating

in Each Group of Group Ratio of the Group

5

5

5

5

4

SOURCE:

8.5 77.7

5.0 80.4

3.7 85.0

2.5 88.2

.75 109.4

Competition in the Railroad Industry; Simat,

Hellieson & Eichner, February 1975.-

The improvement in track utilization is an indication of

the improved operating efficiency of the entire system. The

elimination of 5,700 miles of light density lines, improved

blocking procedures, yard operations and car control systems

allow the passage of more traffic over less track in a given

time period. The only constraint concerns the scheduling of train

movements and the ability to accurately monitor the movement of

equipment. Neither of these factors are expected to hinder

expected improvements.

Average density, however, may be misleading because averages include numerous light density lines and very dense but

shorter main routes. Penn-Central mainline traffic is already

quite dense. Elimination of 5,700 miles of light density lines

may increase ConRail density without significantly affecting main

line densities. Very high densities are not thought to impede

traffic flow, however, scheduling of additional traffic requires

good centralized traffic control and keeping accurate track of

all equipment.

Another factor considered relative to traffic density was

the average length of haul. In a longer haul, there is less

interfacing with other railroads, less time in switch yards

and supposedly more profit from the traffic. As trucks absorbed

most of the railroads’ short-haul traffic, the average length of

haul for rail freight nationwide increased. Between

1960 and 1974, the average haul per ton increased 20 percent from

442 miles to 531 miles. However, a haul is normally split up among a number of railroads. Table 14 compares the average length

of haul of ConRail and six other railroads.
-39-

TABLE 13 - AVERAGE DENSITIES

Railroad

ConRail (1973)

ConRail (1976)

ConRail (1985)

Union Pacific

Southern

Santa Fe

Seaboard CL

Illinois Central-Gulf

Burlington Northern

Chessie

Density (ton miles\mile)

4 . 2

4 . 6

8 . 2

6 . 2

4 . 7

4 . 7

3 * 9

3 . 5

3 . 2

6 . 2

National Average 4 . 2

Eastern Average 4.9

Southern Average 4.4

Western Average 3.9

SOURCE: RSPO, p. 43
-40 -

TABLE 14 - AVERAGE HAUL LENGTH

Railroad Average Haul (miles) Index

ConRail (1973) 268 41

ConRail (1976) 293 45

ConRail (1985) 295 45

----------------------------------------------------

Union Pacific 656 100

Atchison-Topeka

& Santa Fe 640 98

Burlington Northern 495 75

Illinois Central-Gulf 333 51

Southern 249 38

Seaboard 220 34

SOURCE: RSPO, p. 43.

Both Southern and Seaboard Coast Line are profitable yet

handle shorter average hauls than ConRail. The Western and

Midwestern railroads tend to have longer hauls. The ConRail

merger only increased haul length by 10 percent and will presumably have little impact on operating efficiency. ConRail

may suffer relative to shorter haul carriers such as Southern

and Seaboard Coast Line because while all three have similar average

haul lengths, the Penn-Central maintains twice the amount of track as

the other two. Presumably one of the advantages of a larger system

would be the ability to fully control shipping over a longer portion

of each freight movement; yet ConRail has not noticeably improved.

The elimination of 5,700 miles of light density lines obviously

improves ConRail’s track utilization rate and should improve profitability. More traffic should be attracted as ConRail service improves

due to track rehabilitation. Slow orders now restrict speeds on

9,000 miles of ConRail track.10 In addition incursions by trucks

into the remaining rail freight commodities will decrease since the

most divertable traffic is already gone.

10 First National City Bank, a Financial Analysis Of the primary

System Plan as proposed by the USRA, pp. 6-7.
-41-

.

The major questions concerning ConRailrs ability to dramatically improve traffic density stem from comparisons with other

systems. While physically the system can handle increased density, it seems peculiar that none of the nation’s ten largest

rail systems have densities approaching the ConRail projections.

The factors which could prevent achievement of these densities

include requirements that ConRail continue to operate light density lines, a continuing decline in Northeast rail traffic and

an inability to implement projected operating improvements (i.e.

car management system, yard rehabilitation) .

IMPROVEMENTS IN COST CONTROL

The ability to achieve potential cost savings arises from

consolidation of track, rehabilitation of yards and identification

of unprofitable traffic. Identifying unprofitable freight movements so that selective rate increases can be requested depends

on management’s ability to assign costs to individual rail movements. A yard or a piece of track supports many trains consisting

of individual cars of different commodities with different origins

and destinations. Thus, tying costs to particular freight movements

is difficult. Traditionally management optimized on an individual

yard or other sub-system basis to maximize throughput.

ConRail management will attempt to optimize on the whole system

and accurately identify costs.

In periods of rapid inflation where the costs of fuel, labor

and materials may change drastically, the problem of identifying

cost components with traffic movements is critical. Figure 5

illustrates the exponential rise recently experienced in fuel and

other costs. As cost components vary in growth rates (i.e.,

labor, fuel, materials), ConRail management must be able to distinguish between profitable and unprofitable investment opportunities. Between 1945 and 1965 the fuel index only doubled

while during the 20 years from 1965 to 1985 it is expected to

increase more than five fold. The index of combined material

costs has also begun to exhibit an exponential growth pattern.

Traffic which may have been marginally profitably when diesel

fuel was 20 cents a gallon may be unprofitable at 30 cents a

gallon. As costs change rapidly unprofitable commodities must

be identified quickly.
100

90

80

70

60

50

II

5(

4(

3(

2(

10

-42-

Figure 5

CHANGES IN THE FUEL INDEX AND THE WEIGHTED INDEX

OF COMBINED MATERIAL PRICES AND WAGE RATES

1935 1940 1945 1.950 1955 1960 1965 1970 1975 1980 1985

YEAR
-43 -

A standard cost system is one method of tracking management

performance and costs. A variance from the predetermined standard cost (for example, if rehabilitation costs for mainline

track are projected at $100,000 per mile and actual expenses are

$250,000 per mile for a particular stretch) is a warning to

management that operations may be losing money. While rehabilitation at $100,000 per mile may have allowed a sufficient return

on investment, $250,000 per mile may not. Implementation of a

standard cost system is an intricate and time consuming venture.

USRA has already begun to identify noncompensatory freight

traffic for which $54 million in rate increases will be requested.

This represents an improvement in tying costs to freight movements. Previously railroads used the standard ICC form both to

request rate increases and as the basis for cost control, though

it is recognized as inadequate for the latter function.

Implementation of an ongoing cost management system, however,

will be much more difficult than a one time identification of

unprofitable traffic. Standard cost systems take years to design

and implement before savings are fully realized. The bankrupts

currently have inadequate performance standards for men and

equipment. In addition, management information systems have

not been integrated which is a prerequisite to improved cost control.

Overcoming these problems will require more attention from management

that is likely to be available during the start up period. Short

term problems of greater immediate impact are likely to take

precedence over a cost control system.

While the need for a better cost control system is recognized as essential to achieving the operating improvements

projected in the FSP, it may be delayed in implementation.

Management will probably focus on projects such as car management

or good rehabilitation which will have a more immediate impact on

system profitability. Consequently, the information necessary to

make decisions, for example on the desirability of retaining a

given traffic movement,will probably not be available and some

possible operating improvements will not be recognized.

IMPROVEMENTS IN LABOR PRODUCTIVITY

USRA assumed that 90,000 employees would be transferred

to ConRail under the reorganization, and that by 1985 the work

force would have grown to over 93,000. The mix of labor classes,

however, does not match the projected system needs so some

workers would be terminated and new ones hired. The FSP projects

that by 1985 60% of the present work force will have been replaced

due to attrition.

Although work rules, pay structures, and craft distinctions

were considered obstacles to better productivity, the FSP assumed

no changes in these areas. Thus, no improvements in labor

productivity are expected other than those occurring incidentally

through system modifications.
-44-

The importance of the labor component nationally in rail

expenditures is illustrated in Table 15 Over half of every

revenue dollar is spent on labor. In the bankrupts which are

considerably more unprofitable than the national average, this

ratio is probably considerably higher. Table 16 compares some

of the labor productivity measures for the bankrupts with

industry averages. Compared to the national averages, the

bankrupts: produce only 78% as many gross ton miles per crew

hour, generate only 92% as much revenue per crew hour, and

spend 12% more crew time switching than other Class I railroads.

Table 15

DISTRIBUTION OF OPERATING REVENUES

FOR THE RAILROAD INDUSTRY 1974

(normalized so that all figures are

per dollar of revenue)

Total operating revenues $1.00

Labor Cost

Fuel Materials

Other Expenses

Depreciation

Other Taxes

$ .51 (Doesn’t include those

capitalized)

and Supplies $ .24

$ . 1 0

$ .0 5

$ .0 4

Net Railway Operating Income $ .06

SOURCE: arbook of Railroad Facts 1975 edition

AAR p. 11
-45 -

Table 16

DIRECT LABOR PRODUCTIVITY

1000 gross ton-mile

per crew hour (1973)

Dollar revenues per

crew hour (1973)

Percent of crew hours

yard switching (1973)

(Stated as averages)

Southern Western

Bankrupts Class I District District

22. 8 29. 2 25. 3 35. 5

200. 0 217. 0 184. 0 241. 0

58. 6 52. 3 47. 6 49. 5

SOURCE: Preliminary System Plan p. 57

These reduced productivity figures reflect in part the congested,

yard-intensive nature of the Northeastern railroads and the poor

condition of the track and equipment.

Labor productivity improvements have been dramatic. Since

1960, 33 percent fewer employees have been needed to produce 49 percent

more revenue ton miles. Industry employment has dropped while

traffic (revenue ton miles) has increased steadily. These

improvements will probably continue. Wage increases however,

have offset the absolute drop in employment, rising by 52 percent

since 1960. Thus, despite improved productivity, compensation

as a percentage of operating revenue decreased only 7 percent

from 1960 to 1974.

ConRail could trade labor protection for labor productivity

improvements through work rule changes but this is unlikely. The

problems of labor productivity, work rules, etc. are long

standing industry problems. ConRail management with its

numerous other responsibilities can hardly be expected to lead

in the difficult and controversial area of labor reform.

MANAGEMENT GENERATED IMPROVEMENTS

Improvements in ConRail operating performance will depend

heavily on implementation of the numerous studies conducted by

the USRA in developing the FSP. While management will not be

obligated to follow the FSP, it represents a $30 million investment to study ConRail’s problems . After conveyance the time

ll Yearbook of Railroad Facts 1975 Edition, AAR, p. 12, 29, 58.
-46-

and resources to repeat the process will not be available. The

viability of the plan will depend on management’s ability to

adapt it to changing conditions.

While considerable criticism has been levelled at the PennCentral management, USRA staff members, consultants and railroad

industry people have quite divergent views on the exsiting

management’s capabilities. Several people indicated that Penn

Central management was out of date and incapable of implementing

the reforms suggested by USRA. A more prevalent attitude, however,

described Penn-Central management as capable and well intentioned

but constrained by the deterioration in the Northeast and the

lack of funds in the company to implement reforms.

The major unknown when control of the bankrupts passes to

ConRail will be the ability of new management to make a difference in the operating efficiency of the bankrupt railroads.

Optomists point out that new management will:

● have the benefit of the USRA studies which have

evaluated the operations of these railroads more

thoroughly than any railroads in the nation.

● have flexibility to implement necessary changes

because of the available federal financing. Previous

managements have not had adequate funding.

● include a new group of non-railroad men who can apply

the systems analysis techniques developed at USRA and

innovate without being constrained by the traditional

railroad mentality.

Some felt that the techniques developed by USRA were sufficient to guide almost any management to successfully operate

the restructured system. Consequently, management was not a

particularly crucial factor.

A more prevalent view however, held that the impact of

new management would be minimal. This pessimistic view concludes that:

● ConRail must integrate the managements and operating

systems of six firms into one. Historically, mergers

of this type have not been very successful or have

taken a long time to complete. (i.e., Pennsylvania RR -

New York Central merger and C&O, B&O merger) .

● The new president succeeds two presidents who were

successful managers with railroads outside the Northeast

indicating that the problem may be systemic.

● Existing staffs cannot be rapidly “shaken up” without

disrupting the ongoing operation of the companies. These

staffs have been decimated by the loss of young staff due

to the stagnancy of the company, demoralization and the

stringent controls of the bankruptcy court.
-47-

CHAPTER 5

FINANCING: ACQUISITION COSTS, REHABILITATION

EXPENSES, AND ACCOUNTING METHODS

The principal role of the Federal government in the reorganization of the bankrupt railroads will be to inject massive

amounts of Federal funds. Because the return on investment

(ROI) in the railroad industry is so low, it cannot attract

private capital. In fact, the collapse of the Penn Central

was precipitated by the inability of the railroad to “roll

over” its existing debt and obtain new debt to finance future

operations. Given the low return on investment in the industry and the dismal profit performance of the bankrupts, creditors prefer to invest money elsewhere. Table 17 compares

the average ROI for Class I Railroads and alternative investments. The railroads’ lack of attractiveness is striking.

The magnitude of Federal funding will be contingent on two

variables besides railroad operating performance: the

cost of the properties to be acquired from the bankrupts,

and the cost of rehabilitating those properties for ConRail’s

use. USRA has estimated that $1.85 billion of Federal funds

will be required for rehabilitation and operating expenses.

Another $1.05 billion will guarantee that the former owners

of the bankrupt railroads are adequately compensated for the

properties conveyed to ConRail. Other guarantees, subsidies,

loans, etc. are included under the plan to insure the financial viability of the system.

The form of Federal funding is a key to creating a

profitable railroad. The proposed mechanism allows ConRail to

initially use Federal funds without paying interest in cash.

Much later (the process is not completed until the year 2016

when the railroad will presumably be strong enough to support

the Federal debt), interest is paid in cash and the outstanding

debt and stock are redeemed.

INCOME BASED REORGANIZATION

The greatest potential liability for taxpayers may be

hidden in the form of deficiency judgments against the government for failing to adequately compensate creditors for the

properties conveyed to ConRail. Two key questions are: Can

ConRail produce a profit to support an income based reorganization? Is $422 million adequate compensation for the creditors?

Because of the laws of bankruptcy, answering the second question

may be contingent on a positive answer to the first.
[69. CLASS 1 RAILROADS — . , 3 0/ -

70. Investment funds

Source:
-49-

USRA argues that $422M is a reasonable value for the

assets converged given the risks being taken by the government to salvage the bankrupt railroads. USRA assumes that

the reorganization will be successful and that ConRail will

operate as a profitable entity. If the creditors can prove

that ConRail is not financially viable, then the mandatory

conveyance requirements in the Act make the acquisition a

“taking” of private property under the governments right of

eminent domain. Under these circumstances a much higher

valuation may be awarded by the courts.

An "income based reorganization" requires proof that the

bankrupt railroads can be restructured so as to produce a profit.

The return to creditors then includes not only the $422 million

offered initially for the property but also the stream of earnings

which follows. USRA claims to have proven that the reorganization

is income based through the FSP projections that ConRail will

generate enough profit to raise the value of ConRail Common and

Series B Preferred Stock to $1.575 billion by 1985. This value

is in excess of the Certificate of Value based on the $422 million

valuation plus 8 percent annual interest. Critics of this approach argue that the machinations required to make the system

appear profitable (including use of depreciation accounting, Federal debt that pays interest by distributing stock rather than

cash, and remarkable projected operating efficiencies) make profitability an “accounting fiction.” These critics argue that

normal Section 77 bankruptcy can represent an income based reorganization because the same entity continues in operation with a

revamped capital structure. ConRail is a new entity with less

assurance of producing any income, and to offer a minimum valuation

in the hope that this untried new rail system will produce a profit

is inconsistent with the Section 77 principles of reorganization.

Precedents do exist, however, for operating railroads at a marginal rate of return even where creditors might prefer liquidation and investment in higher yielding ventures. This stems

from the concept that railroads are “public service enterprises”

which have received special considerations such as land grants

in return for a necessary public service. Under this definition, ConRail can produce a marginal profit and still be considered a successful income based reorganization.

If ConRail fails to produce a profit and the assets of the

creditors erode (i.e., rails and ties deteriorate as cash generated by the railroad is used to pay off operating expenses

instead of for rehabilitation), then it may still be argued that

the reorganization was not income based. Under this scenario,

the government has appropriated the creditors’ properties at

a low value based on expected future income. However, since they

did not produce an income the Court could consider that conveyance

constituted “taking” private property under the right of eminent

domain. The valuation would then be the cost of reassembling

these properties at market value or perhaps their value on the open

market if sold for purposes other than railroading. In any event,
-50 -

ConRailcs profit producing potential remains the critical issue.

VALUATION

The creditors and stockholders of the bankrupt railroads

are being offered $422 million for their properties. Table

18 indicates the manner in which value has been assigned to

the various properties and the liabilities that will be assumed by ConRail. The valuation was determined by examining the

assets of the various line (some by actual site visits) and assuming that the railroad was to be dismantled and sold piecemeal. Costs were assigned for managing the system’s liquidation.

In addition, some economic factors were included to determine how

the sharp increase in supply coupled with the limited demand for

many of the assets being sold might depress prices. The returns

to creditors were discounted at a 15% rate back from the presumed

date of sale to the date of conveyance.

TABLE 18

ASSETS AND LIABILITIES CONVEYED TO CONRAIL

Assets Acquired: $M

Road & Facilities 290

Transportation equipment 340

Land 44

Net Passenger Assets 22

Other Assets 71

TOTAL ASSETS 767

Liabilities Acquired:

Equipment Obligations

Unfunded Pension Benefits

Section 215 Government Loans

TOTAL LIABILITIES

TOTAL NET ASSETS

2 5 0

3 1

64

3 4 5

4 2 2

SOURCE: FSP, p. 57
-51-

The Supreme Court, in upholding the constitutionality of the

Act, held that creditors have a right to sue the U.S. government

for damages under the Tucker Act if they can prove that $422

million is less than the “constitutional minimum” to which they

are entitled. The argument turns on the resolution of three

issues: 1) the valuation method used to determine the value of

the assets conveyed (i.e., liquidation value if the assets are

sold piecemeal; assemblage value, meaning the price of repurchasing

the bankrupt’s properties on the open market minus depreciation;

or book value meaning the depreciated value which the bankrupts

used in their accounts for the assets); 2) the basis of the reorganization (i.e., will the new ConRail be profitable and provide

the creditors with a stream of earnings implying an "income

based reorganization"or will the new Conrail lose money continuing to dissolve the assets of the old creditors); 3) value

of the securities conveyed depends on the type of securities

issued (i.e., USRA has suggested using stock with a minimum value

guaranteed by the U.S. government) . The Act allows ConRail to

take control of the bankrupts’ assets before a final conveyance

price has been determined. If the final price is significantly

different than $422 million, two principal effects occur. First,

if the value is more than $422 million the assets conveyed to

ConRail may be increased in value which would increase the depreciation charges. For example, if the value of transportation equipment conveyed is assessed to be $700 million instead of $340 million, and the depreciation rate is 5 percent annually, the depreciation deductions from income would increase from $17 million to

$35 million annually. Second, the U.S. Government investment in

Conrail could increase indirectly under the proposed financing

scheme through Federal “Certificates of Value” guaranteeing the

value of stock issued to the creditors. Presently the Government

would guarantee $1.05 billion worth of securities issued to the

creditors (this is the $422 million plus 8 percent annual interest

because the certificates are redeemable on or before November 1,

1987).1

Many industry members and USRA staff members believe that a

court case to settle the value of the properties conveyed is

inevitable. Table 19 indicates the results of some alternative

evaluation methods. The USRA valuation is the lowest, with

alternative methods producing values 3 to 30 times higher.

Further payments by the Federal government, however, would be

contingent on resolution of the court case which USRA staff

members indicated would take years to reach a judgment. USRA

argues that $422 million is more than adequate because creditors

are continuing to lose money on these assets, giving them no real

earning power, only a liquidation value. The increased government investment will be responsible for the turnaround in the

bankrupts’ earnings, yet the taxpayers will not share in the

appreciation of the assets since their investment will carry

fixed returns. Additional federal grants and subsidies above

the $422 million will protect creditors’ assets for example by

I

Final system plan p. 9 5 .
-52 -

TABLE19

ALTERNATIVE VALUATION TECHNIQUES

Total Value

($B)

USRA net liquidation value

Book value 12/31/75

Cost of Reconstruction New

(less depreciation)

Gross proceeds from Liquidation

Net Proceeds from Liquidation

Penn-Central Creditors assuming

continued rail use

Penn-Central Creditors minimum

value assuming liquidation

.6

4.4

17.9

3.6

1.8

7.4

3.5

(excludes LH, AA, CNJ)

(includes only PC)

(excludes L&H)

(Penn-Central only)

(Penn-Central only)

RANGE

SOURCE: FSP, p. 142-43, 155.

$ .6 - 17.9B

z~ashington Post 7~17/75~ p. ’14

subsidizing passenger service. The taxpayer is exposed to

substantial losses and potential deficiency judgments while even

the most successful outcome would be a return of the initial

capital over a very long period of time at an interest rate

that scarcely justifies the risk. Allowing the government to

participate directly in the proceeds from ConRail, for example

by reviewing dividends, would use up cash that will now be used

to pay the creditors and increase the value of their stock. It

is the government’s willingness to postpone cash interest payments

during the startup period that makes the venture viable. In sum,

the taxpayers are taking substantial and unrewarded risks in

addition to the initial $422 million that more than compensates

the creditors.

The creditors argue that they would receive more than

$422 million for their properties if they could liquidate now.

USRA’S valuation technique reduces the asset valuation unreasonably. For example, the 15 percent after tax discount rate is too
-53-

high, reducing the net present value of the assets below the

proper rate. Without discounting, net proceeds from liquidation equal $1.8 billion and gross proceeds (i.e., before the

administrative costs of liquidation) are $3.6 billion.3 Common

sense would dictate a higher value for the land owned by the

Penn Central than $422 million.

Resolution of the valuation question will probably require

court action and USRA staff members expressed considerable

doubt about the probable outcome. Any increase in the $422 M

figure, however, will come directly from the taxpayers and could

materially increase the cost of the ConRail venture.

REHABILITATION EXPENSES

As shown in Table 20 ConRail will spend $4.2 billion for

rehabilitation of road property and $1.78 billion for additional

freight equipment during the planning period. To calculate

roadway rehabilitation costs, USRA determined which tracks were

to be upgraded and to what level. Contractors developed engineering

estimates of anticipated rehabilitation expenses.

The rate of rehabilitation increases markedly to accomodate for previously deferred expenditures. Between 1976 and 1985

ConRail will more than double the number of ties and triple the

miles of rail replaced by the bankrupts in the previous ten year

period (1965-1974) .4 The increase results from the infusion of

Federal cash which may be used for rehabilitation of roadway and

structures. Railroads nationally have had problems financing

capital expenditures. In the ten year period, 1965-1974, the

railroads spent $14.4 billion for equipment, roadway and structure

additions and betterments. Cash generated in the railroads during

that period covered only 63 percent of the cost with the remainder

borrowed against equipment because loans for roadway improvements

are generally not available. At the same time, the AAR estimated

that as of November 1974, $7.2 billion in maintenance and capital

improvements had been delayed.5

Because rehabilitation expenditures are a significant use

of Federal funds and because there are no alternative external

sources for those funds, the accuracy of the estimates are a

critical factor in determining the sufficiency of the $1.85

billion request.

3FSP p. 155

4A Final System Plan p. 87

5A Financial Analysis Of the Preliminary System Plan as

proposed by the USRA, First National City Bank, 5/15/75

P* 59-60 .
-54 -

TABLE 20

REHABILITATION

Road Property Expenditures

Additions & Improvements $1.lB

Deferred Work 1.4B

Current Maintenance 1.7B

$4.2B

Locomotives

Freight Cars

Misc. Equipment

Freight Equipment Additions

.74

1.00

. 0 4

1.7 8

SOURCE: FSP, p. 61

The USRA estimate was based on information from four

independent sources. USRA integrated the results and eliminated gross errors. Rehabilitation costs for track vary

widely depending on the traffic which the rail must bear and

the funds available for rehabilitation. For example, funds may

be allowed for upgrading a stretch of track from 10 mph to only

30 mph because the savings from increased train speeds would not

justify the cost of upgrading it further. Rehabilitation estimates were revised downward from the PSP to the FSP because USRA

carefully specified the level to which each line would be upgraded.

All track must be upgraded to a level which ensures safety, prevents derailments and reduces equipment operating and repair costs.

USRA and outside commenters generally felt that the $4.2 billion

for road property rehabilitation allowed management sufficient

flexibility to perform necessary repairs and cover potential cost

overruns.

The major criticism on the subject of rehabilitation is the

fear that ConRail management cannot resist pressures to “gold

plate the rail.” Once the precedent is set of providing

rehabilitation funds from the Federal Treasury, political

pressure may be applied to ensure that one community’s branch
-55 -

line is upgraded to as high a level as another’s. Rehabilitation costs could spiral if ConRail attempts to

achieve equity among jurisdictions. Minimizing road rehabilitation costs is essential because costs are hiqh and

returns in terms of increased system efficiency may be very

low. Under normal private enterprise incentives the profit

motive will force management to reuse old materials and

replace only the necessary rail. Whether these incentives will function for ConRail remains to be seen.

In summary, the rehabilitation estimates seem reasonable,

but managements ability to stay within those estimates by

resisting political pressures and rehabilitating only where

necessary remains unproven.

CHOICE OF DEPRECIATION METHOD

USRA tried to choose a method of depreciation which

accurately reflected the real cost incurred by ConRail.

Depreciation should reflect the decrease in the value of

ConRail’s assets resulting from use, decay and obsolescence.

Three depreciation methods were considered:

● Betterment accounting is used by almost all railroads

for depreciating track structures. Under betterment

accounting all track structure replacement expenditures (i.e., replacement of rails, ties, etc.) are

subtracted directly from income. Consequently, the

value of track structures on the balance sheet is

low because some items may be 100 years old. Another

consequence of betterment accounting is that higher

rehabilitation expenditures result in lower reported

income. Thus, railroads hoping to report higher profits over the short term simply reduce rehabilitation

expenditures. The ICC accepts betterment accounting

as standard practice partly because record keeping is

easier. Under normal depreciation procedures, it would

be necessary to record the date of installation of all

ties, ballast and track and to depreciate them at

various rates depending upon the degree of wear. Betterment accounting eliminates the need for such calculations.

• Modified betterment accounting was developed by USRA

and used in the PSP to depreciate track structures.

USRA argued that expenditures for replacement of track

structures resulting from the previous managements’

failure to perform timely maintenance should not be

subtracted from income (as under betterment accounting),

Instead those expenditures related to such deferred maintenance would simply be added to the balance sheet.

This method was ultimately rejected by USRA for the

FSP because it was impossible to separate expenditures
-56 -

related to deferred maintenance existing prior to ConRail from other maintenance expenditures, and more importantly because the accounting profession would probably have refused to certify it as a valid means of

public reporting.

● Depreciation accounting was chosen as the basis for reporting the FSP results. Under depreciation accounting,

only 3.33 to 6.66 percent of the rehabilitation expenditure is subtracted from income in a single year.6 Thus,

rather than subtracting all rehabilitation expenses from

income in a single year as in normal betterment accounting,

the expenses are spread over 15 to 30 years, ConRail’s

reported income is much higher than would be reported

by other railroads using betterment accounting. While

depreciation accounting requires record keeping similar

to that required under modified betterment accounting,

it eliminates the necessity of making arbitrary decisions

about which expenditures stem from pre-ConRail deferred

maintenance.

Using depreciation accounting, ConRail profits are considerably higher than would be reported by railroads using normal ICC

accounting procedures. Table 21 illustrates the impact of depreciation accounting on reported income. Using betterment accounting, income would be reduced by $2.4 billion. Rather than

producing a $2.0 billion profit in the planning period, ConRail

would have reported a $400 million loss. This loss will be reported for tax purposes because the IRS uses the betterment approach.

The choice of depreciation method only affects ConRail’s

profits on paper. Cash flow would remain the same regardless of

the accounting method chosen, however, the attitude of investors

towards the railroad may be improved by the choice of an accounting method which reports a $2 billion profit rather than a $400

million loss. Unfortunately, ConRail’s operating results will

no longer be comparable to other railroads.

GFW, p. 58 .
-57 -

TABLE 21- PROFIT IMPACT OF DEPRECIATION ACCOUNTING

INCOME (inflated $M)

ConRail

Depreciation

Accounting

($M)

1976 (332)

1977 (220)

1978 ( 79)

1979 36

1980 259

1981 354

1982 413

1983 475

1984 544

1985 597

TOTAL Profit $2,000M

(Loss)

SOURCE: Final System Plan, p.66.

ICC

Betterment

Accounting

($M)

(464)

(375)

(271)

(192)

( 2)

81

129

180

237

275

($400M)
-58-

CHAPTER 6

SENSITIVITY ANALYSIS

Chapters 3, 4 and 5 discuss critical areas in USRA’S Final

System Plan and raise questions about the reliability of some

of the assumptions. To test the sensitivity of the FSP to

changes in critical assumptions is difficult without using the

models available to USRA. However, based on data in the FSP

the impact of some alternative assumptions on revenues, profitability and required federal investment may be deduced. Four

alternative assumptions were identified, one each from the

revenue, operating and financing categories and finally a

systems option.

● Revenue: assume that USRA coal revenue projections

are increased beyond the FSP predictions.

● Operating Expenses: assume that ConRail fails to

achieve projected operating improvements.

● Financing: assume that a deficiency judgement is

entered against ConRail.

● Systems option: assume that Unified ConRail is

selected as the systems alternative.

While other assumptions could be tested, these indicate that

the financial viability of ConRail is very sensitive to changes

in the underlying assumptions of the FSP.

IMPROVED COAL REVENUES

The variable promising the most upside potential is coal.

First, it is a commodity that cannot be easily diverted to

trucking, and barge competition is limited to areas accessible

by water. Second, rapid growth in coal usage is resulting from

the increasing scarcity of alternative fuels and the rise in oil

and gas prices. Third, because much of the traffic is not

divertable and coal prices have risen rapidly, rate increases

could significantly improve profits.

Two assumptions were changed to consider the impact of

improved coal revenues. USRA predicted that between 1976 and

1980, coal tonnage shipped on ConRail would rise from 85 million

tons (MT) to 94 (MT) (10.5 percent). EEA projections indicate

that coal shipments may increase to 110 MT (29 percent) by that

date.

Over the planning period using EEA estimates, an additional

165 MT of coal could be shipped on ConRail.1 In 1973, Conrail

received $2.48 per ton, so uninflated revenue would increase by

IAs~umes a ratio ‘ 110/ f

94 and total USRA predicted coal

shipments of 975 tons over the planning period.
-59-

about $409 million. Considering inflation, the increase

could be $752 million.

In addition, a 50¢ per ton rate increase on coal was

considered. ConRail divides revenue with other railroads

because shipments are often split between two lines and

therefore ConRail is likely to receive only 33¢ of the 50¢

increases This increase would generate revenues of $321

million on the 975 MT which USRA projects that ConRail will

carry during the planning period; and it will add to that

another $54 million if EEA projections are correct. Table

22 summarizes the results.

.

TABLE 22

INCREASED COAL REVENUE

Coal tonnage

shipped 1976-

1985

Uninflated

Revenue from

coal shipments

Inflated

revenue from

coal shipments

Added revenue

from a 50¢/

ton rate

increase

Revised

FSP FSP

Assumption Assumption Increases

975 MT 1140 MT 165 MT

$ 2377 M $ 2786 $ 409 M

$ 4373 M $ 5125 M $ 752 M

$ 321M $ 375 M $ 54 M

2 Ratio of inflated to uninflated revenue over the planning

peri~d in 1.84

In 1973 when the average rail for coal was $3.71 per ton,

ConRail received only $2.48 per ton.
-60-

Adding the increases from both higher rates and greater

tonnage could provide ConRail with an additional $1127

million (752 million from increased tonnage and $375 million

from increased rates) in revenue during the planning period.

The $375 million rate increase would go directly to income.

The $752 million from increased tonnage however, net of expenses,

should generate $304 million in cash using the USRA methodology

(FSP p. 78). Since the primary sources of cash from operations

divide almost equally between income and depreciation, income

could increase by an additional $150 million. Income could

therefore be increased by $525 million based on more optimistic

coal projections.

FAILURE TO ACHIEVE OPERATING IMPROVEMENTS

USRA tested the sensitivity of the ConRail financial

projections to a failure to achieve many of the operating

improvements projected. For each

savings were reduced as follows: 4

Cateqory

Equipment

Utilization

Yard

Rehabilitation

Blocking

Improvements

Cost System

Implementation

FSP

Assumptions

28 % car

utilization

improvement;

223 fewer

locomotives

Reduction of

6% in yard

operating

expenses

Reduction of

8% in yard

operating

expenses

Allows identification of noncompensatory

traffic and a

$53 million rat e

increase

of four categories,

Revised FSP

Assumptions

Achieve only

50% savings,

2 year delay

in achievement

(assume net car

hire drops from

8.7% of operating revenue to

an average of

7.5% rather than

6%).

No savings from

yard rehabilitation

Implement only

75% of blocking

improvements

with less reduction in yard

operating

expenses

Operating expenses

increase 3% due to

delay in cost system implementation.

expected

Increased

Expenses

Net Car Hire

+ 453 M

Transportation

Expenses

+ 264 M

Transportation

Expenses

+ 88’M

Operating

Expenses

+ 1040 M

TOTAL INCREASE + 1845 M

4 FSP p. 79.
-61 -

USRA concluded that required funds would increase by

$1 billion primarily to pay for the extra equipment which

would be needed to handle growth. If existing equipment

cannot be utilized more efficiently through better car

management, yard and track rehabilitation, and other operating improvements then more freight cars and locomotives

must be purchased. A portion of this equipment could probably be financed by external equipment obligations but

during the startup period ConRail cannot assume a larger

interest burden. Consequently, much of the capital needs

must be met with Federal funds.

Using data provided by USRA an attempt was made to

calculate the increase in expenses that would occur due to

these operating failures. The total reduction in income is

estimated at $1.8 billion which exceeds the estimated $1.5

billion in income generated during the planning period.

Serious consequences would result from an operating

failure. The concept of an ‘Income based reorganization”

could be placed in jeopardy if ConRail fails to produce

profits. The creditors’ argument that their property had been

taken would be strengthened and a sizable deficiency judgement could be entered against the government. The Certificates

of Value issued by the government would be exercised by the

creditors because ConRail stock would be virtually worthless

thus further draining federal funds. The rehabilitation program could be delayed as management attempted to use rehabilitation funds to cover operating deficits. Rather than redeeming

Series A Preferred Stock for cash, ConRail would continue to

pile up interest-bearing securities virtually eliminating the

prospect of ever becoming a private corporation. Penn-Central

calculated an alternative estimate of savings achievable through

cost reduction. If ConRail handled 1985 tons at the 1976 expense

level, costs in 1985 would increase by $463M (1973 dollars) ●

Penn-central predicts, based on an "exhaustive study" of savings

achievable through plant rehabilitation and elimination of deferred

maintenance that only about $200M (1973 dollars) could be saved

once the rehabilitation is complete. A loss of $263M (1973 dollars )

in operating savings in 1985 would translate into approximately a

$657M (inflated dollar) decline in profits in that year. This

far exceeds the $397M projected in profits for 1985 and implies

that ConRail would not generate a profit during the planning

period. ConRail would improve somewhat on these savings by reducing

Penn-Central costs through consolidation of the bankrupts’ facilities

and by increasing volume which reduces per unit costs. However,

for ConRail to make a profit, operating improvements would have to

substantially exceed Penn-central cost savings estimates.

In summary, if ConRail fails to achieve the planned operating improvements and produce a profit during the planning

period, it will remain a public entity that will cost the

government significantly more than the proposed $1.85 billion.

lpenn-central: Memorandum on FSP 9/5/75.
-62 -

DEFICIENCY JUDGEMENT

If USRA and creditors of the bankrupt railroads cannot

agree on a valuation for the properties to be conveyed, then

the issue will be resolved in court. If the Court rules

that the $422 million offered to the creditors is insufficient

then the Federal government will be liable for the difference.

For illustrative purposes, assume that the court accepts

Penn Central’s asset valuation of $7.4 billions The $422

million value offered to the creditors represented the difference between USRA’S $767 million estimate of assets and

$345 million estimate of liabilities. If the assets are

increased to $7.4 billion from $767 million then the depreciation charges must be increased to reflect the higher value of

the assets being used by ConRail.

Thus, a deficiency judgement would have two effects: the

Federal treasury would have to pay the creditors the difference

between the assumed value of the assets ($767M) and the court

determined figure; and ConRail’s income would be reduced

by the increased depreciation charges.

Assuming the $7.4 billion asset valuation, the treasury

would have to pay approximately $6.7 billion to the creditors

($7.4 B - $.7 B = $6.7 B). The Certificate of Value scheme

would not work because ConRail could not earn enouqh income to

raise the value of its stock to $7 billion. In fact, through

increased depreciation charges, which would lower income, the

value of the originally distributed stock would decrease.

Table 23 illustrates the impact of a deficiency judgement

on depreciation charges. Over the planning period (1976 - 1985)

depreciation of the assets conveyed to ConRail assuming the

original $767 million asset value would have been $366 million.

With assets revalued to $7.4 billion, depreciation expenses

would total $1363 million. Consequently, net income would be

reduced by $977 million.

5 Letter from Paul R. Duke StatiIICJ Penn-central claims

6/17/75.
-

$7.4B valuation

Land

Track

Cars and Locomotives (net)

Grading

Bridges

Buildings and

Equipment

TOTAL

-63 -

TABLE 23

IMPACT OF ASSET REVALUATION

Value6 Depreciation

($M) Rate (%)

4000 0

1100 5.0 %

7 0 0 6.5 %

5 0 0 5.0 %

2 0 0 3.75 %

8 0 0 3.75 %

730 0

- - -

Depreciation

($M) Expense

(1976-1985)

Using a $767M asset value, depreciation is $366M.

- Net depreciation addition = $1363M - $366M = $997M

o

5 5 0

4 5 5

2 5 0

7 5

3 3

136 3

6 Washington Post article 7\17/75 - letter from Paul R. Duke

6/17/75

7 FSP p. 58.
-64 -

UNIFIED CONRAIL

The Unified ConRail option (i.e., not selling any of the

acquired properties to competing carriers) promises a more

profitable railroad requiring less Federal investment. The

option was rejected as a first choice primarily due to political and competitive ramifications. USRA felt that this

option did not adequately fulfill the non-financial goals of

the Act. Specifically, Unified ConRail did not provide for

rail-rail competition in markets exclusively served by the

bankrupt carriers. Shippers argued strongly for maintenance

of competition and Congress declared it one of the

goals of the Act. USRA also felt that Unified ConRail could

damage the profitability of competing railroads by diverting

traffic to the larger system.

In balancing the goals of the Act, USRA determined that

a smaller ConRail would be politically more palatable than

the Unified ConRail option. However, a decision that the

proposed FSP does not adequately protect taxpayers interests

might warrant a closer examination of Unified Conrail. Unfortunately, USRA has not yet released a full analysis of the

Unified ConRail option so all the required data were not

available.

Existing information however, demonstrates that Unified

ConRail is financially a stronger system. Data from “Pro

Forma Financial Forecasts” MAY 29, 1975, were used for the

analysis. The data indicated that over the planning period,

Unified ConRail would generate 18% more revenue and 66% more

profit than the proposed structure. In addition, USRA

personnel estimated that the required Federal investment

would be only $1.2 billion or two thirds of the planned $1.85

billion investment. Table 24 illustrates the results.

TABLE 24

UNIFIED CONRAIL

Item

FSP FSP

Assumption Assumption Revised

Revenue $43.7 B $51.1 B

Income 1.5 B 2,5 B

Federal Investment 1.85 B 1.2 B

SOURCE: Pro Forma Financial Forecasts May 29, 1975, p. I-9,

II-4, II-22.
-65-

In addition to general arguments about the virtues of

selling portions of the bankrupt carriers to competing railroads some specific issues deserve attention. USRA has proposed to sell to the Chessie a major coal producing line in

West Virginia. This may increase competition at the expense

of ConRail profitably and future growth. Another example

involves offering the Pittsburgh and Lake Erie Railroad trackage rights between Ashtabula and Pittsburgh, an important coal

and iron ore shipping connection. Again, future growth markets

and profits may be sacrificed to produce competition.
-66 -

CHAPTER 7

FINANCIAL ASSESSMENT AND CONSEQUENCES FOR

THE FEDERAL GOVERNMENT

Based on the sensitivity analysis in Chapter 6, it is

possible to project the impact of changes in some basic

assumptions on the financial viability of ConRail and the

required Federal commitment.

To factor the results of the sensitivity analysis into

the FSP financial projections a pro forma income statement

and sources and uses of funds statement were prepared. The

income statement (Table 25) aggregates all of ConRail’s

revenues and expenses for the planning period (1976-1985)

and computes an aggregate income. Figures are expressed in

current dollars. USRA projects that ConRail will generage

$43.7 billion in operating revenues and $1.5 billion in

income during the planning period. Over 34% of the expenses

are attributable to transportation costs. Income represents

only 3% of revenue indicating how quickly an increase in

operating costs or a revenue decline could eliminate profits.

Ninety-seven cents of every revenue dollars is devoted to

expenses, many of which are not variable with volume. Trucks,

for example or barges can ease operations during slack periods.

This decreases their tolls or taxes because the government owns the

right of way. Railroads however, must continue to pay property

taxes and maintain their own right of way. Assuming that onethird of ConRail’s costs are variable, a 45 percent drop in

revenue would eliminate all profits during the planning period.

Similarly, a 4.5 percent increase in revenue would more than

double profits.

The sources and uses of funds statement (Table 26) indicates

that during the planning period, ConRail will take in and disburse $8.96 billion in funds. The largest sources of funds will

be Federally financed debentures and Series A Preferred Stock

(27%). Income will generate only 13 percent of the funds requirements. Seventy-five percent of the funds will be used for

addition to road, facilities and transportation equipment. The

Table obviates the need for ConRail to draw on funds other than

those generated internally (i.e., depreciation and income) to

replace its physical plant.

The $1.85 billion figure used to represent the Federal

commitment includes the $1,000 million of 7.5 percent debentures

and $850 million of the $1392 million of Series A Preferred Stock

shown in Table 26. The remaining $542 million in Series A

Preferred Stock represents additional stock accepted by the taxpayers in lieu of cash interest payments. The Federally guaranteed Certificates of Value worth $1.05 billion in 1987 do not

represent a source of funds for ConRail but only a guarantee

to the creditors.

These two tables provide the baseline data from the FSP

necessary to apply the results of the sensitivity analysis.
.

-67 -

TABLE 25

INCOME STATEMENT (1976-1985)

(Current dollars)

REVENUES :

Freight & Other Revenue

Passenger Revenue

Passenger Subsidy

Total Railway Operating Revenues

OPERATING EXPENSES:

Maintenance of Way

Maintenance of Equipment

Transportation

Gen. & Admin. & Other Expenses

Passenger Operating Expenses

Total Railway Operating Expenses

OTHER INCOME (EXPENSES):

Net Car Hire

Payroll Taxes

Other Taxes

Other Income and Expenses

Total Other Expenses

Interest Expenses

Net Tax (After Extraordinary Item)

INCOME

36,32 6

5,69 4

1,65 0

43,67 0

4,71 0

5,34 6

15,22 2

2,11 9

7,34 4

(34,741 )

2,73 5

2,56 0

7 0 4

9 9

(6,098 )

(784 )

(520 )

1,52 7

83%

13%

4%

100%

10%

12%

35%

5%

17%

79%

6%

6%

2%

> 1%

14%

2%

1%

3%

Source: Final System Plan pp. 51
-68 -

TABLE 26

SOURCES AND USES OF FUNDS (1976-1985)

SOURCES OF FUNDS (Inflated $M) Percentage of Total

Income

Depreciation

Deferred Taxes & Tax Credits

Series A Preferred Stock

Series B Preferred Stock

Common Stock

7.5% Debentures

Equipment Obligations

Passenger Assets & Reimbursements

Salvage Value for Retired Assets

Increase in Noncurrent Liabilities

1,15 6

1,35 7

8 9 1

1,39 2

4 0 0

2 1

1,00 0

1,50 2

6 7 7

1 6 2

4 0 2

13%

15%

10%

16%

4%

> 1 %

11%

17%

8%

2%

4%

TOTAL 8,960 100%

USES OF FUNDS (Inflated $M) Percentage of Total

Dividends

Accretion of Series A Preferred

Additions to Road & Facilities

Addition to Transportation Equip.

Increase in Net Passenger Assets

Repayment of Equipment Obligations

Increase in Other Assets

Increase in Working Capital

5 6 9

8 6

4,58 2

2,12 1

4 8 8

4 1 4

121

5 7 9

6%

1%

51%

24%

5%

5%

1%

7%

TOTAL 8,96 0 100%

Source: Final System Plan pp. 54-55
-69 -

IMPACT OF SENSITIVITY ANALYSIS

The analysis in Chapter 6 calculated the impact of

alternative assumptions on revenues, expenses and the

required Federal investment. Table 27 summarizes the

results.

TABLE 27

THE IMPACT OF ALTERNATIVE ASSUMPTIONS ON REVENUE,

INCOME AND INVESTMENT REQUIREMENTS (1976-1983)

Alternative Revenue

Final System Plan $43.7B

1 Increased Coal $44.8B

Revenue

2 Lags in Operating $43.7B

Improvements

3 Deficiency judgement $43.7B

(assume assets valued

at $7.4B)

4 Unified ComRail $51.lB

Income Investment

$1.5B $1.85 B Federal

investment

$2.OB More rapid repayment

of Federal debt

$-.3B Require increased

Federal investment

Of $lB

$ .5B Increased Federal

payments directly to

creditors of $6.7B

deficiency

$2.5B $1.2 B Federal

The results in Table 27 illustrate that the financial viability

of ConRail may be jeopardized by failure to achieve the operating improvements projected in the FSP. The Federal commitment

could be increased substantially by an adverse deficiency judgement

or failure to meet operating goals. The latter case could eliminate the possibility of ConRail ever returning to private ownership. Coal provides the most optimistic possibility but an

increase in coal rates would require a decision by the entire

railroad industry, not only ConRail. Unified ConRail requires

further analysis to examine the adverse impacts which could

result from a monopolistic rail system. In addition to the indepth sensitivity analyses, several other aspects of ConRail’s

financial projections deserve consideration.

The $1.5B profit is in part an accounting fiction= If

ConRail were to depreciate rehabilitation expenditures using

normal ICC betterment accounting, a $900 million loss would have

been reported rather than a $1.5 billion profit.
-70 -

Failure of ConRail to achieve the average industry

operating ratio will mean that rate increases will not

cover cost increases and profits would decline. The losses

predicted under the “operating failure” assumption would be

magnified.

USRA assumed that ConRail would receive $1.65 billion in

subsidies primarily from the Federal government. Failure to

receive this subsidy would convert the $1.5 billion profit

to a $100 million loss ($50 million of the subsidy is for

capital replacement) .

If ConRail is required to continue operating light

density lines without a subsidy after the initial two year

"reexmination" period losses could increase substantially.

Numerous additional variables could be cited reconfirming

Conrail’s susceptibility to changes in the operating environment. On balance, however, the FSP seems to be optimistic

with a considerable downside risk for the taxpayers should

ConRail fail to meet operating expectations.

CONSEQUENCES FOR THE FEDERAL GOVERNMENT

The Final System Plan requests $1.85 billion in Federal

funds to be invested in ConRail during the first 5 years. $1.0

billion will be injected as debt in the form of debentures

earning 7.5% interest annually. In case ConRail fails they are

the first securities to be repaid except for secured debt (i.e.,

equipment mortgages) .85 billion will be invested as

equity in the form of Series A Preferred Stock, which earns

dividends at 7.5% annually. If there is not sufficient “cash

available” (as defined by USRA) to pay dividends in cash then

ConRail will issue more Series A Preferred Stock.

In fact, the Federal investment exceeds $7 billion rather

than $1.85 billion because guarantees and subsidies are also

expected to be provided during the planning period. By 1985,

the U.S. will have invested about $7.3 billion in the reorganization, including loans, grants and guarantees. Potential

deficiency judgments against the government could more than

double that amount. Table 28 details other Federal costs

implied by the Plan. These calculations assume that the FSP

profitability projections are achieved. A poorer performance

could increase the need for Federal assistance.

There are five basic types of financial commitments which

the Federal government will incur in support of ConRail.

(Table 28).

Direct Investment: The Federal government could potentially invest $3.4 billion in ConRail by 1985. $2.7 billion

will definitely be invested in the form of cash $1.85 billion

and postponed interest ($880 M). The remainder are discretionary funds which could be used if ConRail fails to meet FSP

projections. The government may forgive interest payments

if ConRail requests it and the Government Investment Committee

approves.
-71 -

TABLE 28

Type of

Commitment

Direct

Investment

Subsidies

Grants and

Loans

Form of Funds

7.50 % debentures

Series A Preferred Stock

accrued interest (1985

Secretary of Transportation

Discretionary Funds

Government Investment

Committee Discretionary

Funds

Passenger Subsidies

Light Density Lines

Reimbursement for

Northeast Corridor

conversion

Section 215 interim

assistance

Section 213 emergency

assistance

Value

($M)

100 0

8 5 0

8 8 0

4 0 0

2 5 0

165 0

1 8 0

2 1 1

3 0 0

2 8 2

Total

($M)

338 0

204 1

Guarantees Certificates of Value

(1987)

Labor Protection Costs

5 8 2

105 0

2 5 0

130 0

TOTAL

POTENTIAL DEFICIENCY JUDGEMENT

POTENTIAL TOTAL

730 3

0-680 0

7303-1410 3
-’72 -

Subsidies: The government will provide over $2 billion

in subsidies primarily to support passenger operations. Table

29 outlines the uses of the $1.65 billion requested for subsidies. USRA concluded that freight traffic should not subsidize

passenger service and that local or federal authorities would

have to provide the necessary subsidies.

TABLE 29

PASSENGER OPERATIONS

Operating Revenue

Operating Expenses

1976 - 198 5

($ billion inflated)

$6.07

($7.34)

Operating Loss ($1.27)

Government Subsidies:

Operating Loss Reimbursement $1.27

Additional Depreciation

(betterment accounting) $ .33

Additional Working Capital

Needs $ . 0 5

$1.6 5

In the FSP, USRA estimated that passenger subsidies and

revenue would increase from a 1973 level of $322M to a 1976

level of $377M (1973 dollars). This 14 percent increase will

result from a renegotiation of contracts with passenger authorities.

After 1976, USRA predicts that subsidies and revenues will

rise to cover the inflated cost of passenger operations.

Reimbursements would cover the allocated cost of passenger

service which includes all those costs attributable to passenger

operations.
-73 -

Penn-Central, in reviewing the FSP, noted that historically

railroads have not succeeded in recovering inflationary cost

increases. In 1976 ConRail may be able to negotiate contracts

with passenger authorities such that all passenger costs are

covered. However, beyond 1976 if passenger authorities fail to

raise rates sufficiently to cover inflationary cost increases,

ConRail will be forced to cover the shortfall. Historically,

this has been the experience of the railroads.

Once ConRail agrees to provide passenger service, an ICC

ruling will be required before service can be terminated. In the

past, the ICC has not even allowed abandonment when a passenger

authority failed to pay a bankrupt railroad for inflationary

cost increases beyond avoidable costs (less than fully allocated

costs) . It is even less likely that the ICC would allow abandonment

if passenger authorities do not raise rates to pay ConRail for

inflationary cost increases. Penn-Central estimated that the

$1.5B in profits projected for ConRail would be reduced by $1.3B

or 87% if relationships with passenger authorities follow existing

patterns.

Grants and Loans: The government has already provided

the bankrupt railroads with $582 million in loans to meet

current operating and maintenance deficits. USRA expects that

$236 million of this will be converted to a grant.

Guarantees: $1050 million will be authorized to guarantee

creditors the value of their assets ($422 million plus 8 Percent

annual interest to 1987) . The FSP projects that if operating

projections are achieved, these funds will not have to be

expended. An additional $250 million of labor protection guarantees are provided but ConRail expects to use only $200 million.

Deficiency Judgement: The Federal government will be

liable for any deficiency judgement entered against ConRail.

Because ConRail will not be able to issue more stock to

pay off these claims, they will probably be paid directly

from the Federal treasury. Payments could range from zero

to nearly $7 billion.

Table 30 summarizes the potential Federal costs under

each of the alternatives discussed in the sensitivity analysis. Improving profitability through higher coal revenues

will not decrease the Federal investment although the payback

period would be shortened. On the other hand, operating failures

could increase the Federal commitment by more than 30%. A large

deficiency judgement could do the most to increase the Federal

contribution. Unified ConRail could decrease the Federal investment by more than 17 percent.
-74 -

TABLE 30

Alternative Direct Subsidies Grants Guarantees Defi- Total

Invest- and ciency

ment Loans Judgment

Payments

FSP $2.7 B $2.O B $ .6 B $ .2B O $5.5 B

Increased

Coal Revenue 2 . 7 2 . O ● 6 . 2 0 5 . 5

Operating

Failures >3.4 2.0 .6 103 0 )7.3

Deficiency

Judgment 2.7 2.0 ● 6 1.3 6.8 13.4

Unified

ConRail 1.8 2.0 .6 .2 0 4.6

In every case, the taxpayers investment far exceeds the

publicized $1.85B figure. The government could further protect

their investment by adding indenture agreements and restricting

ConRail activity. For example, if FSP projections are not

achieved further loans could be restricted. The opposite “

reaction, however, is more likely. Once taxpayer’s funds are

invested, the government may feel committed to infuse

more capital to salvage the existing investments. In addition,

because ROI in the railroad industry is so low, few railroads

will be able to obtain long term financing. ConRail sets a

precedent for substituting Federal funds for conventional

sources of long term debt and over the next ten years as $1.3

billion in debt comes due, the US may have to supply funds to

other railroads.1 The Federal investment in ConRail may signify

the beginning of a new Pattern in relationships between the

Federal government and the railroad industry.

A Financial Analysis of the Preliminary System Plan as

proposed by the USRA, First National City Bank 5/15/75.
APPENDIX

Congressional

Letters of Request
March 20, 1975

—
.

.

Dear Dick:
Sincerely,

CPC:td

.— — —— . ———
i
8United States Senator

U. S. GOVERNMENT PRINTING OFFICE : 19750-598-079