There is no doubt in anyone's mind that long-haul trucking can no longer keep pace with the skyrocketing demand for commercial transportation in the U.S. As last year's report from the U.S. Department of Transportation (“National Freight System Capacity and Importance”), declared over the last 20 years, vehicle miles of travel on U.S. roads have nearly doubled, while lane miles have increased only about four percent. Nor are prospects hopeful. “It is unlikely that highway capacity will expand rapidly in the coming decades,” the report concluded. “Current annual revenues will suffice only to maintain the highway system, not provide significant new capacity.”

The bottom line: highway congestion will worsen, the speed and reliability of truck freight transportation will deteriorate, and costs to shippers and receivers may rise. Here's a dispiriting metric: freight truck flows experienced 29% peak hour congestion in 1998; by 2020, that is expected to be 46% peak hour congestion.

The logical alternative, of course, is rail. “Rail is fuel efficient, environmentally friendly, and is also the safest mode of transportation for moving hazardous material,” points out Bob vom Eigen, a partner with the law firm of Foley & Lardner (Washington, D.C.), who specializes in the rail industry.

Rail is nearly half as expensive. While trucking costs are 5.0 cents per ton/mile, rail costs are 2.7 cents. It is also more energy-efficient, providing 455 ton/miles of transport for each gallon of fuel (increasingly important as the cost of fuel goes up). The industry also enjoys a significantly lower accident rates. So it's little surprise that over the past few years, the rail industry has seen a noticeable up-tick in business as a result of the shortfalls occurring in the trucking industry. “We are certainly in a period of growth,” reports Tom White, spokesperson for the Association of American Railroads (AAR) (Washington, D.C.). “We don't see any reason to believe it won't continue. We are moving record volumes.”

The big question, though, is are the six Class I railroads in the U.S. and Canada (Burlington Northern, Canadian National, Canadian Pacific, CSX, Norfolk Southern, and Union Pacific) as well as the regional Class Is and short line Class IIIs ready to shoulder the immense challenges and unprecedented opportunities that await them?

Major challenges

The recent upsurge in domestic business is not something railroads anticipated. It caught many of them off-guard. In the wake of federal deregulation of freight trains in 1980, the railroads have been on a long-term trend of reorganizing and downsizing to match what had been shrinking demand for freight-rail services. Economic growth over the last decade has absorbed much of the underutilized capacity of that downsized system. Consequently, congestion on the rails has grown.

“Our biggest challenge is increasing our capacity to handle that growth,” admits the AAR's White. “Since 1990, our traffic density, which is the amount of traffic we are moving over each route mile, has more than doubled.”

There are three specific challenges the industry needs to address: labor shortage, capital shortage, and equipment shortage.


Labor

Many railroads got into the habit of laying off workers over the years as a way to cut labor costs. In 1980, according to AAR's White, the industry had almost 500,000 employees; today just over 200,000. In part the layoffs were the result of technology. “For example, a lot of freight trains had five crew members; now they have two,” says White.”

Another reason is that, in 2001, the railroad retirement program changed such that employees with 30 years of experience could retire at age 60 with full benefits, instead of age 62. “We saw a greater than expected number of retirements,” says White.

And since customers didn't anticipate the increased demand for rail services, “they weren't able to let us know in advance so we based our hiring decisions on lower than actual demand,” adds White. “As a result of all of this, in 2004, we began to face definite crew shortages.”

In the last two or three years, the industry has had to scramble to rehire and train new workers to meet increasing demands. “Railroads have had a hiring program underway for the last couple of years,” notes White. “We think there are enough employees to meet the current demand, but the railroads will need to hire even more in future to keep up with retirements and increasing demand.”

One thing working in the industry's favor is its wage rates. Since Class Is pay better than most industries, it may be easier for them to attract the necessary number and quality of employees. However, this is not necessarily the case for short lines, many of which operate on a shoestring.


Capital

The most significant reason the railroads have not expanded more rapidly is the challenge in acquiring growth capital. While highway construction is financed primarily by public funds from fuel taxes, railroads generally must build their own railways.

Again, to cite the U.S.D.T.: “New freight-rail capacity is needed to keep pace with the expected growth in the economy and relieve congestion, but creating this capacity will be a challenge for the railroads.” While the industry is stable, productive, and competitive, with sufficient business and profit to operate, it doesn't have the resources to quickly replenish its infrastructure. Why? Even though productivity and volume have increased since 1980, competitive pricing has forced rail revenues down.

How capital-intensive is the railroad industry? According to the AAR, the average capital expenditures as a percent of operating revenue made by manufacturing companies is about 3%, while Class I railroads spend almost 18%. “This creates challenges for the railroads in terms of gaining interest from Wall Street,” says attorney Robert vom Eigen.

The American Association of State Highway and Transportation Officials (AASHTO) estimates that the railroads must invest $175 to $195 billion over the next 20 years to address the worst bottlenecks and keep pace with the growth of the economy. The railroads themselves are a bit more modest; their number is a 'mere' $142 billion. Despite limitations, railroads have been investing. In 1990, the AAR reports, Class I railroads spent about $45,000 per mile of road owned. By 2004, it was spending double this amount--$90,000. And in 2004, according to the AAR, Class I railroads spent $5.7 billion on capital improvements (this year they are expected to spend $8.3 billion).

“We are hopeful we can get to the point where we are earning our cost of capital,” states AAR's White. “This will make it possible for us to invest in capacity such as new locomotives and expansion of track from single to double and even triple or quadruple track. It is not cheap, though-it costs about $2 million for a mile of new track on an existing right of way.


Equipment

The industry also faces significant challenges getting the equipment it needs. Locomotive manufacturers are struggling to meet demand, and prices are correspondingly rising. One estimate is that prices for railcars are up an average of 15% to 20% in the last four years (a box car that cost $75,000 in 2002 now costs $90,000).

Beyond cost, delivery is an issue. “All freight car manufacturers and locomotive manufacturers are booked solid well into 2007,” states AAR's White.

Why the backlog? “There was not much purchase of new equipment until a couple of years ago,” replies Carl Martland, senior research associate and lecturer with the Massachusetts Institute of Technology (who specializes in rail industry research. “Then, with the growth in the last couple of years, everyone wants to expand their fleets at the same time.”


Growth strategies

Despite the impediments, the rail industry is gearing up for growth. Where the industry is really focusing attention is in the area of capital by improving efficiencies and looking to the government for new sources of funding.


Efficiencies

With demand increasing, the key is to increase the efficiencies of existing transportation routes. In terms of internal efficiencies, railroads are investigating technologies and other strategies that will allow trains to run closer together and also increase the frequency of one-way running (dedicated eastbound and westbound lines).

The other way, the 'external' way, to increase efficiency is through more intermodal. Intermodal allows railroads to cut into some of the business once handled exclusively by the trucking industry, rather than simply trading a limited amount of business back and forth from each other. In recent years, in fact, intermodal has become a more significant portion of business for the railroads and is now its largest source of revenue (although not most profitable). In 2001, the Intermodal Association of North America (IANA), (BNSF, CSX, Norfolk Southern, and Union Pacific) rail intermodal volume was 10.3 million (7.9 million containers and 2.4 million trailers). By the end of 2005, it had increased to 13.6 million (11 million containers and 2.6 million trailers). However, the U.S.T.A. report concluded, the railroads' capacity to expand intermodal service quickly, while maintaining carload and unit train (bulk) service, is “limited.”

According to Tom Malloy, vice president, member services and business development for the IANA, “Intermodal transportation makes economic sense when the distance is greater than 700 miles.

These days, the railroads are doing just about everything they can in terms of service design, capital reinvestment, and operational refinements to take advantage of intermodal opportunities. In capital reinvestment, for example, railroads are installing additional tracks, sometimes a third and even a fourth right of way.” Even just adding 20 miles of a double track section in a congested area allows multiple trains to pass each other without having to slow down or wait on sidings.


Government programs

“It is clear there is a need for the infusion of more public money into the industry,” observes Foley & Lardner's vom Eigen. There are two major government programs designed to help the rail industry with its capital needs-the Railroad Rehabilitation and Improvement Financing Program (RRIF) and Public-Private Partnerships (PPPs).

RRIF is a loan program managed through the Federal Railroad Administration, which allows freight railroads to access capital on terms they couldn't negotiate in the private markets. The program provides direct loans and loan guarantees up to $35 billion, up to $7 billion of which is reserved for projects (predominately intermodal) benefiting Class II and Class III railroads.

Public-Private Partnerships are an attempt to fund specific projects designed to improve rail efficiency in a certain area. The PPP is funded partly by the railroad involved (since it benefits from the improvement), and partly by different local, state, and federal government entities (whose region benefits from the improvement). PPPs are difficult to organize, though, because they require significant coordination among numerous governmental bodies.

Examples of PPPs include the Alameda Corridor (Los Angeles area), the FAST Corridor (Seattle area), Shellpot Bridge (Delaware), the Heartland Corridor (Virginia to Columbus and Chicago), the Mid-Atlantic Rail Operations Study (New Jersey to Virginia), and CREATE ((Chicago Regional Environmental and Transportation Efficiency).

In the CREATE project, for example, the goal is to unscramble rail lines into five rail corridors, only one of which will be dedicated to passenger service. This will eliminate time losses that occur when trains must wait for other trains to cross tracks in front of them. Observers, however, note that the CREATE project got only $100 million federal funding, less than expected, although a big step forward when compared to federal funding over the previous thirty years. Where do things stand as we move into peak season?

Railroad traffic density is rising, shipping volume having tripled between 1983 and 2004. And railroads are doing well financially. Between 2004 and 2005, according to the AAR, net revenues from operations increased 54% (from $5.4 billion to $8.3 billion), and net income increased 71% (from $2.9 billion to $4.9 billion).

In sum, revenues and profits are up, which bodes well for an industry that needs to continue to invest in its workforce, equipment, and infrastructure.

And, according to at least one shipper, things are starting to pay off. “In the last two years, the situation has been livable, but not optimal, due in part to a record number of imports and a lot of congestion,” points out Diane el-Hakim, logistics manager for Degussa Corp. (Parsippany, New Jersey). “Because of the congestion, we have had to flood the system with cars just to maintain inventories.”

More recently, though, things have been improving. “One reason is that the railroads have been imposing some strict operating plans,” explains el-Hakim. “These hurt for awhile, because I think it's been difficult for them to operate their systems at the same time they've been changing them.” But, she says, “In the last couple of months, we have begun to see some of the benefits of these new plans and expanded infrastructures. Things are getting better.”

Sidebar: Telematics Could Prove a Key Driver in Rail Efficiency By Eric LaBat

While rail is the safest and most efficient way to move the nation's freight on land, it's no secret that capacity constraints are affecting the industry and the term “bottleneck” is becoming an unfortunate part of conversation for many supply chain managers. In the end, the key to keeping freight moving may be not only adding billions of dollars of infrastructure, but also collecting, analyzing and using billions of bytes of data.

The “old way” of acquiring and processing information is just not sufficient anymore. Today, a shipper can track a load of inventory placed into a rail car through Radio Frequency Identification Devices. Shipping logs, global positioning systems and checkpoint data let the shipper know approximately where the assets are as they move across the country. And, when the shipment is delivered they can use customer data, carrier information, accounting details and other information to integrate back into their management systems.

There are volumes of raw data available today-but most must be acquired and analyzed manually. To be useful, this raw data must go through a series of “cleansings,” which is often an imprecise and time-consuming process. If the industry has to spend time and resources sorting through raw data to determine the location and condition of assets, productivity is wasted and we are sacrificing the security and efficiency of our shipments.

The rail industry is now developing “smart data” systems that turn information into knowledge. With knowledge comes the power of improved productivity and reliability, enhanced security and, ultimately, a better bottom line.

New telematics technologies, including GE's VeriWise™ Rail telematics solution, are being implemented today by a number of companies.

Simply pinpointing an asset's location is just the beginning of the process, as technology is rapidly advancing to monitor cargo condition, temperature, engine performance, gas emissions and fuel load. All can now be tracked and evaluated via telematics and implemented into a shipper's increasingly complex information database. Sensitive materials can also be identified, tracked and traced by authorities more efficiently. This can help speed the processing of goods and services at the ports and borders, and increase the overall level of security and accountability within the system. At the same time, telematics can help speed up the supply chain and reduce costs incurred through delays.

Real-time data from telematics systems will allow shippers to better manage the entire supply chain. For example, integrating predictive maintenance will help avoid costly delays from equipment breakdowns. Evolved dynamic ETA systems, which can compute expected arrivals from more than just historical information, will help re-route freight around bottlenecks to maintain delivery schedules. Predictive diagnostics will assure shipping integrity (internal commodity temperature or intact door seals for example). Products are delivered with the expected quality, and losses and delays from leaks or mishaps can be sharply reduced or avoided entirely.

The benefits that come with the investment of technologies that provide “smart” data, far outweigh the costs involved. And, when you consider the cost of inaction-lost or damaged goods, loss of productivity and bottlenecks-the benefits are even greater.

Companies looking to leverage rail services must adopt, demand and specify security-friendly, technology-based advances for their inventory management practices.

After all, transporting goods by rail is still the most efficient and effective means for many goods. By investing in and implementing technologies that provide clean, up-to-date data, we can create “smart” assets to better serve the global supply chain. In essence we are leveraging technology to transform rail cars into information tools where data and knowledge is the precious cargo.

Eric LaBat is chief marketing officer for GE Rail Services in Chicago.

Sidebar: 'Captive' Shippers Call For Renewed Government Regulations

In June 2006, Senators Herb Kohl (D-WI) and Russ Feingold (D-WI) introduced the Railroad Antitrust Enforcement Act of 2006, which proposes to repeal antitrust exemptions afforded to freight railroads. It is based on their concerns that “freight railroads are abusing their dominant market power and raising rates for those who rely on them to ship dozens of critical commodities, including coal and agricultural products.”

The senators note that current antitrust exemptions deny rail customers the protections that are available to consumers in virtually every other industry. These “captive shippers” are served only by one railroad and end up facing constantly rising rail rates. The senators refer to these shippers as “victims of monopolistic practices and pricing gouging.”

“Right now,” says Montana Senator Conrad Burns (R), “our small businesses and energy customers are being taken advantage of by the railroads.” Behind this legislation is the Consumers United for Rail Equity (CURE), formed in 1984 when investor-owned utilities were concerned with how they were being impacted by deregulation. Today, CURE includes members from not only the utility industry but also the chemical industry, and the wood/pulp/paper industry.

“In 1995, the government repealed the ICC and replaced it with the Surface Transportation Board (STB), which turned out to be an even weaker version of the ICC; the main problem today,” states Bob Szabo, executive director of CURE, “is that there is not the amount of competition in the rail industry that was anticipated 25 years ago when the industry was deregulated.”

CURE points the finger at the Class Is, rather than the Class IIs and Class IIIs. The reason: “Most of the track that serves captive shippers is still owned by the Class Is, which they lease to the short-lines,” he explains. “The lease agreements state that the short-lines can't do business with any other Class I except the one that leases the track to them. As such, most of the short-lines are captive to the Class Is.”

According to CURE, rates for captive shippers (including farm products, coal, chemicals, lumber, and pulp/paper) are, in many cases, almost double what they are for shippers in competitive markets. “The current state of rail industry is affecting our economy in a very adverse way,” continues Szabo. “For example, many chemical companies are having problems competing in the global economy because of the railroads. Two-thirds of chemical plants are served by only a single railroad.” As such, up until two years ago, according to Szabo, chemicals were one of the nation's most robust export commodities. “Today, chemicals are a net import.” While CURE doesn't lay the entire blame for the shift from export to import at the door of the Class I's, it does state that Class I pricing and servicing practices are one of the most serious causes.

Not everybody agrees with CURE.

“The people who have been pushing for re-regulation have been doing so for about 20 years, and they haven't gotten anywhere,” notes spokesperson Tom White of the Association of American Railroads. “Since deregulation, rates have decreased, and I don't think there are many businesses that can claim their prices are lower than they were in 1980.”

Carl Martland, Senior Research Associate and Lecturer, Massachusetts Institute of Technology concurs: “Rates only began increasing to any significant degree in the last year or two. The reason a company is considered a captive shipper is because its rail rates are so good that it doesn't really have an option of shipping by truck. The rate increases in the last couple of years don't come anywhere close to wiping out the rate decreases of the previous 20-plus years.”

Sidebar: Short Lines Are Upgrading

According to the American Short Line and Regional Railroad Association (ASLRRA), which represents the nation's Class II and Class III railroads, there are over 500 short lines and regional railroads operating about 50,000 miles of track.

“Estimates are for between 60% to 70% freight increases between now and 2020,” states Association President Richard F. Timmons. “In terms of meeting current and near future demand, short lines are in great shape. They have plenty of capacity. Barring major natural disasters, there should be no problem with their ability to deliver on time.”

The big reason for this optimistic prognosis is that the short lines have been able to upgrade their systems; funding streams have been healthy. “The industry is thoroughly using the federal tax credits of half a billion dollars for infrastructure upgrades that were passed about 18 months ago,” he states. “In addition, the federal RRIF loans [see main story] are seeing a lot of activity among our members.” Meanwhile, carloads and revenues are at very high levels.

The only serious concern is how their relationships with the Class I railroads. In testimony to Congress, Timmons noted that almost 90% of short line and regional railroad traffic originates or terminates on a Class 1 railroad. As such, these railroads are directly impacted-positively and negatively-by Class I business practices.