Short on Miles But Long on Service

The short line sector of the railroad industry is not new. In fact, the current Class 1 railroads (those with revenue in excess of $ 319.3 million annually), are, in effect, made up of many smaller lines acquired over the years. The short lines have undergone a rebirth dating from 1980 when changes in the law made it much easier for railroads to shed unprofitable track. That is proving beneficial to shippers.

The short line sector is made up of two separate categories “Regional Railroads” and “Short Lines”. The regionals are defined as line-haul railroads operating at least 350 miles of road and/ or earning revenue between $40 million and the $319.3 million Class I revenue threshold. Short lines are those roads that earn less than $40 million and/or have less than 350 miles and are either switching or terminal railroads.

Together, they are not insubstantial in railroading. In fact, these railroads operate about 29% of the track mileage, accounting for 9% of all rail freight revenue and 11% of the employees, according to the American Short Line and Regional Railroad Association (ASLRRA).

The Association, which dates from 1917, has 418 members (but not all short lines are members).

These short line and regional railroads are gaining new customers while preserving transportation alternatives for many existing shippers. Proving it is only an ill wind that blows no good, these lines are benefiting from one of the solutions to the nation’s current fuel problems. But the track ahead is not “all clear” signals as railcar weights are increasing, requiring track and bridge upgrades at the same time other challenges, such as tax credit legislation which expires December 31, 2007, or a slow economy must be dealt with.

“Until recently, business has been very good for our sector but this year our carloadings are off by 6%,” says Steve Sullivan, vice president and executive director for the ASLRRA. But, he adds, while this year is down, the industry experienced a 9% growth in 2004 and 11% in 2005. (A net gain of 15%.)

“We are dealing with a weak economy and Maine is one of two states with negative growth,” says Edward A. Burkhardt, chairman of the Maine, Montreal and Atlantic Railway.

Even though the general trend is down, many short lines and regionals are bucking that trend. “We have seen our car count go from 19,000 to 46,000 and are securing more business such as a reload operation handling drywall which will add another 200 to 300 cars a year,” says Mark Bonnell, vice president of marketing for the Arkansas & Missouri Railroad.

“A new shuttle train from Butterfield, MO to on-line customers will add more volume, and we are handling refrigerated traffic to the West Coast in connection with either BNSF or the Union Pacific and our freezer traffic is growing,” says Bonnell.

RailAmerica, Inc. operates 41 short line and regional railroads, with approximately 7,800 miles in the United States and Canada. “We are excited about serving a number of new customers and facilities including a Honda assembly plant that is coming on line late next year and we are in discussions with a number of other industries about expansions or new facilities as well,” says Charlie Patterson, vice president, RailAmerica, Inc. He adds that shortlines are a great place for industries to locate.

The Finger Lakes Railway operates about 160 miles of former Conrail, Pennsylvania and Lehigh Valley track in the Syracuse-Geneva area of New York, building carloads from 5,600 in 1995 to about 18,000 this year.

“We worked hard to grow our business. As an example, Nucor Steel, was built without direct rail access, but we have been able to handle about 1,300 to 1,400 outbound carloads [for them] annually by developing a reload operation,” say Mike Smith, president of the railway. He adds that part of the growth has come from attracting new industries such as a glass plant which may have been the area’s largest new manufacturer in the last 20 years.

As with some other short lines and regionals, the Finger Lakes Railway operates passenger excursions which Smith says has integrated his railroad into the communities on the line.

“Many of our local communities are concentrating on tourism to replace lost income from now closed industries and, combined with the great scenery of the Finger Lakes area, offers a real opportunity,” says Smith. He feels that this type of operation can make money and produces political good will as well.

The recent developments in connection with ethanol have produced significant amounts of new business for short lines. “In partnership with Kiewiet Group Companies and KAG Ethanol Logistics, we have formed Manly Terminal LLC, located in Manly, IA, which will provide for collection by truck, 20 million gallons of liquid storage with distribution for ethanol and other chemicals by rail,” says Dan Sabin, President of the Iowa Northern Railroad. He points out that this facility is located within 300 miles of more than half of all ethanol production in the United States which could generate 200,000 carloads a year by 2013.

But Smith did not wait for ethanol to provide business. When he purchased the line; he cut rates by 20%, tripled the level of service, and doubled the number of covered hopper cars available to his customers. The road’s car count went from 2,800 in the first year to 50,000 this year.

From his background, Craig Damstrom, president and CEO, director of Montevideo, MN-based North Star Rail Intermodal, LLC, knew a market existed for Distiller’s Dried Grains with Solubles or “DDGS” as well as Identity Preserved food-grade soybeans and wheat products. The problem was how to get them to the Asian markets where there were waiting buyers. Damstrom could see that while the bulk grain transport system worked well for products that could be commingled, this would not be acceptable for those grain exports which require identity preserved products or those buyers who wished to purchase in smaller lots seeking to minimize inventory. Motor carrier service was ruled out, as was intermodal service, either for cost or service requirements. While the cost of trucking was too high, the distance from a major railhead such as Minneapolis made intermodal container service uneconomical as well and there were no closer intermodal terminals. Rail service was available in Montevideo, but there was no “piggyback” ramp; however a new type of intermodal equipment was coming on line. Railrunner uses specially designed chassis and railroad bogies or wheelsets to transport standard ISO shipping containers in intermodal service. The equipment does not require a ramp, cranes, or specialized equipement other than a spotting tractor. “This was the equipment we needed to transport containers to Minneapolis for onward movement via the CP,” says Damstrom. He adds that this would also allow the marine carriers to return loaded containers to Asia rather than have them move empty. “CP was very interested and supportive as were Hapag-Lloyd, OOCL, and COSCO which was critical to our ability to move forward,” says Damstrom. The other partner in the mix was the Twin Cities & Western Railroad (TC&W), a 240-mile short line that was very interested in enhancing its traffic mix. “We have been interested in intermodal but until now, could not really see how we could participate in North Star’s business,” said Mark Wenger, TC&W’s president. The TC&W started using Railrunner on August 1 and is moving between three and four trains a week with each train containing about 70 containers. The equipment is leased to the TC&W by an affiliated leasing company. “We deliver the Railrunner to the CP at Shoreham yard in Minneapolis and use the same set to bring empty containers back to Montivedio for the next trip,” says Wenger. He adds that they are looking at other areas for this equipment as well. The CP has a dedicated track where they handle the transfer of the containers from the Railrunner equipment to their stack trains. The CP also reloads the Railrunner train for its return by the TC&W. “We are going to expand our reach by using Railrunner equipment to transport soybeans and sugar beets,” said Damstrom, which will increase business.

One area that is not likely to expand is the growth of new small or regional railroads. “I think the big period of growth is over as the Class 1 [railroads] are done spinning off lines and they now have become more efficient and cost effective,” says MM&A’s Burkhardt. But Burkhardt feels there are opportunities for growth for many roads as well as “going head to head” with trucks—providing pricing is kept in line.

There is no single profile of ownership or business model in this part of the railroad business, and even if there was, it would not be the same as before. In the early days, many of the lines were started by entrepreneurs or local industries faced with the loss of rail service. This model evolved into holding companies such as RailAmerica and Genesee & Wyoming Inc. The G&W owns 47 separate railroads in the US, Canada, Australia, and Bolivia with more than 5,700 miles of owned and leased track and approximately 3,500 miles of trackage rights.

While the short lines and some regionals were created by track spun off by a Class 1 railroad, some are now being purchased by another Class 1. One such example is the purchase of the regional Dakota, Minnesota & Eastern Railroad (DM&E) by the Canadian Pacific Railway. The DM&E is made up of track from the old Chicago & Northwestern, the Milwaukee Road, and Union Pacific. The short line has being trying to put together a financing package which would allow it to build into the coal rich Power River Basin (PRB) of Wyoming. Even though the DM&E received regulatory approval to build, however, financing remained illusive.

In a press conference announcing the agreement, CP officials stressed their great interest in the PRB and the ethanol plants being built in the DM&E territory. According to Fred Green, president and chief executive officer of CP, his company will invest $300 million to upgrade the DM&E track. Financing has been put in place for construction to the PRB in phased increments.

Another business model is a joint venture between a Class 1 and a short line holding company. “We had been working with the Norfolk Southern (NS) for the past four years and developed this joint venture to operate the NS lines in southern Michigan, roughly along I-94,” says Ed McKechnie, WATCO’s executive vice president and chief commercial officer. The joint venture, one third NS and two thirds WATCO, is the first time this has been done in the railroad sector; keeping both companies involved in the operation, helping to ensure its success.

“Traffic has been declining on this route. As an example while there were five auto plants before, there are none now, but we feel confident we can grow the business,” says McKechnie.

Other purchasers include hedge funds and private equity firms, and each may have a different agenda for the railroads. Hedge funds have been acquiring Class 1 stock, but the private equity firms have sought smaller roads. An example is Fortress Investment Group L.L.C. who purchased RailAmerica Inc. for $1.1 billion and more recently, in May 2007, bought Florida East Coast Industries (FECI), parent company of Florida East Coast Railroad, for $3.5 billion.

There are some troubling aspects to this trend of ownership and investment which could be detrimental in the long run. “While private equity funds look at the asset base and return without worrying about quarter-to-quarter results for Wall Street, the hedge funds could be looking for a return on equity which could lead to decisions not in the best interest of the railroad or its customers,” says Sullivan.

While the government, through the Federal Railroad Administration, has been making grants such as $420,527 to the Sumpter Valley Railroad for track and equipment upgrades and $369,386 to the Portland & Western Railroad for track and bridge work, tax credit legislation will expire at end of 2007.

“We are working very hard on re-authorization of the tax credit legislation and have significant support in the House and Senate, but we need to get this accomplished before the current Congressional session ends this year,” says Sullivan.

“We have some major bridge projects in the future and this tax credit is critical to us to help finance these improvements,” says Iowa Northern’s Sabin.

As for the future, most operators are bullish. But at least one railroader feels the industry is missing a critical market. “I think there is real opportunity in the under-500-mile market and we need to look at that for new business,” says Finger Lake’s Smith. He adds that the shortlines and their Class 1 connections need to look at car supply, rates, and service, but he has made it happen on his road.

It is interesting to note that Canada has experienced a similar growth in short lines for many of the same reasons. The 1996 Canada Transportation Act replaced the National Transportation Act of 1987 and contained provisions which streamlined the rail abandonment process as well as made it much easier to transfer ownership of a line segment.

Since the passage of the 1996 Act, about 40 new railroad companies have started operation on lines that otherwise might have been abandoned.