Rail System Rallies

Rail System Rallies

December 02, 2009

Ken Silverstein
EnergyBiz Insider
Editor-in-Chief

Warren Buffett is banking on the rail system to move America into the next era of prosperity. By extension, he might also be helping to boost the coal industry, which is dependent on rail transportation.

Through his purchase of the nation's second biggest railroad company Burlington Northern Santa Fe, Buffett's Berkshire Hathaway will now be transporting about 300 million tons of coal a year that account for 27 percent of the carrier's revenues. The railroad industry, generally, represents the pulse of America -- a point that Buffett has made in several interviews, saying that its importance will only expand.

"Our country's future prosperity depends on it having an efficient and well-maintained rail system," Buffett said in a statement. "Conversely, America must grow and prosper for railroads to do well. It's an all-in wager on the economic future of the United States. I love these bets."

Berkshire already has a 22 percent stake in Burlington. If he wins all shareholder and regulatory approvals necessary early next year as expected, he will have invested a total of $44 billion. He agreed to pay investors $100 a share, or a 30 percent premium over the value of their stock in early November. After the formal offer was made, it reportedly took Burlington's board just 15 minutes to sign off on it.

It's not Buffett's first foray into rails. He completely liquidated shares he held in Union Pacific Corp. and Norfolk Southern Corp. in preparation for closing of the Burlington deal. His attraction to the industry is based on the simple premise that shipping by rail is not just more productive but also more environmentally friendly than moving goods by truck. Rail cars can carry a lot more product at a faster rate and use 4-times less fuel.

But what does this portend for the coal industry and those utilities that are reliant on the rail system to retrieve their coal shipments? Burlington Northern says that it is reinvesting in its lines so as to increase the number of its routes, all of which benefits those utilities that have been held captive to certain rail carriers.

At the same time, Buffett's move tends to suggest that despite the risk of adverse federal legislation, he thinks coal will be around for a long time. His Berkshire Hathaway already owns MidAmerican Energy Holdings, which has several properties in its portfolio that are major consumers of coal.

"Hopefully, Mr. Buffett will put Burlington Northern on a more pro-competitive and consumer-friendly path," says Robert Szabo, executive director of Consumers United for Rail Equity. "Whether or not he does so, there is a compelling need to restore fairness to railroad pricing for all rail consumers."

Captive Shippers

Here's the beef that organizations such as "Rail Equity" and the National Rural Electric Cooperative Association have with the railroads: They say that the current regulatory structure is outdated, allowing the rail carriers to charge captive shippers prohibitive prices. That, in turn, raises the cost of electricity for consumers.

Moreover, before deregulation of the rail sector in 1980, roughly 40 railroads existed. But now only four Class 1 companies operate, providing 90 percent of all rail service. To the point: Railroad mergers and acquisitions are exempt from antitrust laws and are reviewed solely by the Surface Transportation Board. Railroads that engage in collective ratemaking are also exempt from those same laws.

Rail opponents cite statistics by the Consumer Federation of America, which say that U.S. consumers pay roughly $3 billion per year in higher costs on everything from utilities to groceries because of artificially high charges. The Government Accountability Office, meanwhile, concludes that the rail industry is insufficiently competitive. That has resulted in an increasing number of rail customers that now pay three times more than those that have transportation options.

Nearly everyone agrees that the rail infrastructure must be expanded to accommodate the demand for greater goods and services and particularly for coal. But the question is how to go about it, with the rail carriers arguing that they need to make profits to accomplish this goal. The industry, in fact, says that it is committed to reinvesting, noting that it plows back $6 billion a year and that American commerce is the benefactor.

"American railroads move 40 percent of our nation's freight, but account for just 2.2 percent of all transportation-related greenhouse gas emissions," Burlington Northern says on its web site. The rails collectively say that if they were re-regulated it would prevent the very expansion in the system that the rural utilities require.

Indeed, the Surface Transportation Board recently said that Burlington Northern was not earning enough to grow its own infrastructure. But Szabo's rail equity group disagrees, emphasizing that Buffett's investment in the company at a 30 percent premium is a strong indication that the system is alive and well and in dire need of more oversight.

The captive coal shippers along with the electric cooperatives have their advocates in Congress who have attempted to eliminate some market advantages that rails hold on service in rural areas. But those bills have faltered: Rail service is expected to grow by 70 percent by 2020, requiring billions of dollars. And that growth would include new investment in the coal-rich western states that are in need of additional routes.

Buffett's move provides a window into tomorrow's preferred method of transportation. If the rail system's fortunes are to grow and their networks do expand, the co-ops and the coal shippers could have more options and thereby escape the constraints that now hamper the rail network.