Betting on the rails

A billionaire recently made an offer that a Western railroad giant couldn't refuse -- in fact, it took only 15 minutes for the company to agree. Warren Buffett will pay $34 billion for Burlington Northern Santa Fe, some 30 percent more than the company is worth on paper. He will also take on $10 billion in debt in the acquisition. "This is all happening because my father didn't buy me a train set as a kid," the richest man in the world joked to the New York Times.

And Buffet's "train set" doesn't need extra batteries; it already comes with a huge amount of power.

His company, Berkshire Hathaway, will control about half the freight in the West. BNSF owns 30,000 miles of track, just under a fifth of the country's rail. Despite the worst recession in decades, 2009 hasn't been bad for BNSF and the industry as a whole. Profits remain strong, mostly due to big staffing and fuel-cost cuts.

But the biggest factor in the railroads' success is the unparalleled power they have in the transportation industry. With a host of antitrust exemptions, railroads are able to merge, set rates, control terms of service, carry hazardous loads through major cities with little oversight, and override local authorities on matters of eminent domain. The railroads have had "monopoly power to set whatever rates (they) want," says Bob Szabo, executive director of Consumers United for Rail Equity, which represents farmers, utilities and manufacturers who ship their goods by rail. Excessive costs are passed on to the consumers.

Szabo's group and others have been lobbying Congress for years to make regulation more proactive and consumer-oriented, encourage competition and improve the process for challenging freight rates. But the industry argues that antitrust regulation would hamper expansion, reduce profits, and force more freight onto the highways, increasing traffic and pollution. "We now have a freight system that's the envy of the world," says economist Kevin Neels of the Brattle Group. "It's efficient and well integrated into the supply chain. Will this return the railroads to the sorry state of 20 or 30 years ago?"

In 1980, the industry was in shambles, with rising rates and accidents, multiple bankruptcies, a steady decline in market share and a failing infrastructure. So Congress passed the Staggers Rail Act, which deregulated the railroads, freeing them from the close federal control that had existed for a century. Staggers dramatically improved the industry: Productivity has tripled, accidents are down, profits are up, infrastructure is sound. But Staggers also encouraged monopoly: 42 large railroads have consolidated into seven, and just four of them -- BNSF and Union Pacific in the West, CSX and Norfolk Southern in the East -- move about 40 percent of the nation's freight.

Staggers also mandated protection for "captive shippers" in areas where there was no competition, a common occurrence. But critics say the Surface Transportation Board, which now oversees that protection, is too close to the industry. It also puts the burden of proof on shippers, who pay as much as $100,000 to file a rate case with the board and millions to prosecute.

BNSF has often been accused of overcharging its shippers. The largest container carrier in the world, it moves overseas products to inland markets and ships a lot of corn and wheat. But its biggest single commodity is coal from the Powder River Basin in Montana and Wyoming: 274 million tons in 2008, supplying 10 percent of the country's electricity. In February, a federal judge ordered BNSF to provide $345 million in repayments and rate reductions to two Powder River Basin power cooperatives, after finding that the railroad charged about six times more for coal transportation than the service cost.

In Montana, BNSF controls about 95 percent of all rail freight, making the state's shippers "the most captive in the country," according to a 2007 study. Montana shippers paid the highest rates in the nation: The annual overcharge for wheat alone was up to $50 million. A recent study by the Consumer Federation of America found that overly high railroad rates cost consumers an additional $3 billion each year on purchases from groceries to electricity.

In theory, new legislation will change all this while keeping the rail freight industry robust. A bill introduced by Rep. Tammy Baldwin, D.-Wis., has cleared the House judiciary committee, and in the Senate, a comprehensive bill to reform both the industry and the regulatory panel is in the works, to be introduced by Sen. Jay Rockefeller, D.-W.V. "You have people who are sympathetic to captive shippers, but everyone knows rail capacity has to increase," says Neels. "It's a balancing act." Increased regulation won't weaken the railroads, says Toby Kolstad, president of Rail Theory Forecasts, a rail transport consulting company. "The type of restrictions that used to hamper them (before Staggers) had to do more with what they couldn't do -- like abandon unprofitable lines."

As for Buffett's acquisition, some industry watchers characterize it as a massive bet on coal, since coal-hauling accounts for a quarter of BNSF's revenue. Others caution that lower natural gas prices and climate change legislation make coal's future uncertain. In addition, the Chinese imports that provide a big chunk of BNSF's profits are down 30 percent this year and may never return to prior levels. Still, says Kolstad, "Buffett's making a long-term play for the same reasons that applied in the '30s, '50s, and '80s -- it's an efficient means of transporting goods."

Marty Durlin is an HCN assistant editor.

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