Ken Silverstein EnergyBiz Insider Editor-in-Chief

At issue are fuel adjustments that are linked to the consumer price index. Utilities and others are not necessarily opposed to such rate increases to keep pace with climbing fuel prices. But, they are against what they say are arbitrary price hikes that are meant to increase profits. The rail companies deny such practices and say that they are unable to move coal fast enough because of limitations in the nation's infrastructure.

What to do? Well, Congress is now considering a proposal to give the railway companies a 25-percent tax credit for investments in rail infrastructure. Fine, say utilities, so long as it is part of a broader legislative package to increase capacity -- or, the number of lines to carry coal to their generators.

"Railroads impose fuel surcharges not simply to recover their unanticipated and uncontrollable increases in the cost of fuel, but rather in excess of their increased fuel costs in such a manner as to enhance their net revenues," says Steve Sharp, principal engineer with the Arkansas Electric Cooperative Corp., at a hearing before the Surface Transportation Board.

Fuel surcharges are a relatively new phenomenon. In 2002, for example, they were small at 2 percent of freight charges. But, now, and specifically from coal supplies delivered from the Powder River Basin in Wyoming that is the nation's largest source of low-sulfur coal, they are 18.5 percent.

The rail industry's return on investment has risen from 2 percent in the 1970s to 7 percent today. With the industry's improved financial condition, the rail companies are investing an average of $6 billion a year in infrastructure and equipment.

Rail operators say that it takes billions to upgrade their systems. And these investments are risky because it takes time to go through the regulatory and construction processes. And by the time any improvements are made, the entire economic scenario could change. That's why they advocate tax credits as a way to lessen their risks.

Re-investment by today's standards is still considered inadequate. And that's why the Surface Transportation Board is given the authority to regulate rates where rail competition is negligible and where shippers might need protection. The Surface Transportation Board estimates that as of the mid-1990s, 16 percent of all such traffic remained regulated.

Captive Generators

Rural cooperatives are particularly affected by constraints in the nation's rail system. While the nation depends on coal for half of its electricity generation, the electric cooperative community relies on coal to supply 80 percent of the power generated by its plants. And because few such facilities are located near the actual coal mines, the commodity must be transported.

To complicate matters, consolidation among rail operators has resulted in many generators being held captive to a single transporter, the National Rural Electric Cooperative Association says. The group openly questions the intent of the rail companies: Certainly, all parties recognize that constraints in the system do exist. But, the co-ops think that the rail companies are not committed to fixing the problem because rail shortages are good for business. The result: Rail stocks are at a premium and some utilities are paying the price.

Take the Laramie River Station in Wyoming: In the spring of 2005, two derailments on the tracks coming from the Powder River Basin occurred. Those accidents reduced rail deliveries of coal by 80-85 percent. And, deliveries have yet to recover. In the case of the Arkansas Electric Cooperative that relies on the system there, it has turned to alternate forms of energy production that have raised its cost by $100 million over 12 months.

"We recognize that rail traffic is growing and there is a need for investment in rail infrastructure," says Glenn English, CEO of the National Rural Electric Cooperative Association. "That need for investment, however, is not an excuse for the unfair practices that are now standard operating procedures for the railroads."

Indeed, the U.S. Energy Information Administration says that the rail industry set a new high for freight traffic transporting more than 1.5 trillion revenue ton-miles, which is a unit of measurement that incorporates both weight and distance. Coal makes up 40 percent of that total, with farm and chemical products totaling 9 percent each.

Deals are taking place today. The Dakota, Minnesota and Eastern Railroad received permission to build from the Surface Transportation Board in February. It will be the largest such deal to be constructed in 100 years -- a 900-mile project involving upgrades and new construction that heads eastward.

"It's been a long time coming," says Kevin Schieffer, CEO of the Dakota, Minnesota and Eastern Railroad project. "This project will have a tremendous positive impact on agriculture, grain prices and economic development in our area. And it will help lower energy costs and expand rail capacity nationally."

While an important development, more needs to be done to ease the capacity crunch and to lessen the cost of transportation. Toward that end, the big utilities have no objection to a fair method of adjusting rail rates for the cost of fuel. The Edison Electric Institute says that if a railroad has agreed with customers by contract to rate adjustments, then a buyer must live with the terms of the deal. Conversely, the institute says that it is patently unfair to add fees for more than the carrier's cost of fuel.

Rail companies may be sincere in their desire to expand their infrastructure and keep prices down. But the methods by which they impose rate surcharges deserve more scrutiny and must become more transparent. If Congress decides tax breaks are needed to build more lines, then development should start where the tightest constraints exist and where certain generators are held captive to single carriers.

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