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MANAGING A SOUND RAIL TRANSPORTATION STRATEGY
Presented by:
Kelvin J. Dowd, Esq.
Slover & Loftus
1224 17th Street, N.W.
Washington, D.C. 20036
(202) 347-7170
info@sloverandloftus.com
International Quality & Productivity Center
Inventory Control & Supply Chain
Management Seminar
January 29-30, 1997
Atlanta, Georgia
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- The Existing and Prospective Rail Coal Transportation Networks
- Key Transportation Concerns for the Utility Fuel Manager
- Goals of the Rail Service Marketer
- Coal Transportation Strategy: the Importance of Accurate Cost Data
- Coal Transportation Strategy: Nature and Sources of Leverage
- The Modern Coal Transportation Contract
- Emerging Issues and Closing Observations
The Western Coal Rail Network
Burlington Northern Santa Fe Railway
- 35,400 miles of road
- 58% of western coal originations
Union Pacific System
- 25,000 miles of road
- 38% of western coal originations
Ineffectiveness of Merger Conditions
- Underutilized trackage rights
- Marginalized shipper conditions
Consequences of Rail Duopoly
- Rate stabilization or inflation
- Service quality deficiencies
- Insensitivity to customer needs
- ROI burden
- Legislative initiatives and "open access"
The Eastern Coal Rail Outlook
CSX Transportation, Inc.
- 18,600 miles of road
- 51% of utility coal shipments
Norfolk Southern Railway
- 14,500 miles of road
- 26% of utility coal shipments
- Significant presence in export market
Consolidated Rail Corporation
- 11,000 miles of road
- 23% of utility coal shipments
After the Corporate Wars
- Coal revenues:
- CSX-CR: 75% of low sulfur coal origins
- $10 Billion to be returned to investors
Key Utility Coal Transportation Concerns
Volume Flexibility
- Year to year in response to power market
- Month to month to manage inventory
- Irregular shifts due to outages, etc.
Service Reliability
- Transit times to maximize efficient utilization of railcars
- Adequate car fleet management, repair
- Ancillary service quality
Competitive Base Pricing
- Transportation costs are 30-70% of delivered cost
- Competition for available rents is issue
Predictable Price Adjustments
- Index based adjustments
- Cost based adjustments
- Market true-ups
General Risk Protection
Accommodations for Changing Laws and Regulations
- Environmental legislation
- Utility deregulation
Railroad Marketing Goals
Long-term volume commitments
- Standardized schedules with minimum deviations
- Service commitments that match utility volume commitments
- Maximum operating flexibility
- Maximized differential pricing
- Most rail traffic is unregulated
- Coal demand is relatively inelastic
- Merger investment return and competitive intermodal traffic
Risk assumption by shippers, coal operators, connecting carriers
- No reopeners or "easy outs"
The Importance of Accurate Cost Data
Costs as a Key to Goal-Setting
- Credible foundation from which to negotiate
- Avoidance of over or under-reaching
- Can facilitate a "win-win" solution
Your Costs
- Coal costs and forecasts
- Transportation equipment
- Generation, transmission, O&M, debt
- Environmental compliance; allowances
- Other regulatory costs
- Purchased power costs; market clearing prices
The Railroad's Costs
- Fixed and Capital Costs
- Relationship to mergers
- Recovery of "system improvements"
- Variable Costs
- Costs that vary with the level of output:
- labor
- fuel
- m-o-w
- locomotive maintenance
- variable capital costs
- Threshold for federal rail regulation: 180%
- Threshold for system "revenue adequacy": 135-140%
- Competitive pricing: 150% (8-9 mills)
- Key to ineffectiveness of negotiated trackage rights as merger conditions
- owner: vc (5 mills) + fc/p (3 mills) = 8 mills
- user: fee (5 mills) + vc (5 mills) = 10 mills
- variable costs are an information source, not a negotiating tool
- Stand-Alone Costs
- Least cost, efficient hypothetical competitor
- Contestability theory and the legal standard for maximum rate reasonableness
- SAC can be a negotiating tool
Nature and Sources of Negotiating Leverage
Competition: The Holy Grail
- Intramodal competition
- Rare to find natural origin-to-destination rail competition
- ICC/STB hostility to forced use of rail lines to create or enhance competition
- Terminal trackage rights
- Reciprocal switching
- Merger conditions for vertical foreclosure
- Open access legislation
- Competition through capital investment
- Spur lines and private lines
- Expedited regulatory approval
- "If you build it, we will come."
- Intermodal Competition
- Volume and distance limits on effectiveness of truck competition
- Geography dictates role of water transport (East)
- Geographic Competition
- May be feasible for utilities with multiple stations
- Heavily dependent on fuel supply profile and presence of intramodal competition
- The Bottleneck Problem
- Mergers and the "one lump" theory
- Regulation of bottleneck rail rates
- Product Competition
- Dual fuel capability
- In combination with geographic competition
- Limits on effectiveness of gas as long-term substitute
- Contracts and sunk costs
- Purchased power
- Key to volume flexibility
- Double-edged sword
Maximum Rate Regulation
- No meaningful role where bona fide competition (commercial leverage) exists
- Market dominance threshold
- Commercial and regulatory leverage are mutually exclusive
- Timing considerations
- STB only regulates common carrier rates
- New procedural rules: 480 day schedule
- Long lead time for effective use in negotiations
- Coal Rate Guidelines can lead to favorable rate prescriptions
- West Texas Utilities (1996):
- $19.36 to $13.68/ton
- Omaha Public Power District (1987):
- $11.62 to $9.58/ton
- Arkansas Power & Light (1987):
- $14.50 to $12.33/ton
- Regulated rates still carry a monopoly premium
- STB jurisdiction limited to 180% of variable costs
- West Texas Utilities
- true competition: $9.90
- stand-alone cost: $12.73
- prescribed rate: $13.68
Major Elements of Modern Coal Transportation Contracts
Term
- Shipper trend is toward shorter terms
- Clean Air Act Phase II
- Implications of a concentrated rail market
Volume Commitments
- Fixed minimum
- Percentage of requirements
- Schedules and adjustments
- Volume-rate relationships
Railroad Service Commitments
- Cycle times and aggregate transportation obligations
- Make-up service issues
- Penalty payments-reciprocity of liquidated damages or cover cost for substitute energy?
Rate Structures
- Base rates
- Step rates for incremental volumes
- Incremental rates based on power market clearing prices
Rate Adjustments
- Goals and purposes
- Fixed adjustment
- RCAF-based index adjustments
- Material modifications
- The RCAF-5
- Market basket
- Periodic true-up or adjustment for competitive connecting rates
New Facilities
- Service; volumes
- Rates; mileage prorates
Equipment Supply and Management
- Positioning of spare cars
- Switching for repairs
- Turning trains
- Substitute cars
- AAR Interchange Rules
- Out-of-route movements
Loading and Unloading
- Free time and the shifting of risk
- Mine operator as shipper agent
- A trend toward outsourcing?
Force Majeure
- Definitions and issues
- Administration -- 48 hour rule
- Partial suspension of operations
- Coordination with coal use forecast
- Make-up obligations
- Force majeure and step rates
Changes in Law and Regulation
- Environmental laws, regulations
- State regulatory changes
- Coal use limits vs. market losses
Resolution of Disputes
- Litigation
- Arbitration
- Mediation distinguished
Emerging Issues and Closing Observations
Increased Rail Market Concentrations
- They Talk About "Partnering," But Do They Mean It?
- Stranded vs. Expanded Investment
- Choosing Your Goal: Price vs. Flexibility
- Fighting for Rents In a Deregulated Environment
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