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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

	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: NS-CR 60% CSX-CR 70% 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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