TRANSPORTATION:

Big coal carriers navigate a risky climate track

Dakota, Minnesota & Eastern Railroad this summer started to walk away from its rail expansion project in the Powder River Basin, the largest source of coal in the country, citing the flagging U.S. economy and regulatory uncertainty.

The giant coal deposits in Montana and Wyoming promised decades of low-cost power to fuel the U.S. economic engine when the railroad proposed the ambitious project in 1997. Global warming had barely made a ripple as a national issue. Projects to develop fossil fuel alternatives had gone by the wayside, and the idea that an economic downturn could cut a deep gash into U.S. electricity demand and coal shipments seemed hard to imagine.

For years, a new rail line made sense to industry analysts.

But since 2007, DM&E has struggled to finance the expansion, for an assortment of reasons. The Federal Railroad Administration denied a $2.3 billion loan, concluding the project posed too high a risk to taxpayers. Canadian Pacific Railway, which acquired DM&E two years ago, offered tepid support, and the railroad last month decided to end its efforts to condemn land in Wyoming for part of the project.

Canadian Pacific says no final decision has been made to permanently shelve the expansion into the coal-producing region. But spokesman Mike LoVecchio said the U.S. recession and efforts in Washington to regulate carbon dioxide emissions from coal-fired power plants are financial uncertainties that weigh heavily on company decision-makers and on the entire railroad industry.

"With the cost of proceeding with such a project, we would need some assurance that coal is part of the long term," LoVecchio said.

The Senate has restarted work on energy and climate policy legislation, which it aims to reconcile with a carbon cap-and-trade bill passed by the House in June. The Senate is ground zero for lobbyists dissatisfied with the House version, and the railroads are in that mix.

But for many of them, the outlook is mixed, as well. Long-term investments in new and upgraded rails and depots will depend on how mandatory carbon reductions hit electric utilities, chemical makers, steel makers, car companies and manufacturers. Part of the coal business might get derailed, but the cost of hauling goods could push an increasing number of trucks off of congested highways and shift their cargo onto train cars, which use far less fuel to haul a ton of goods.

Freight haulers with a presence on Capitol Hill, including the powerful Association of American Railroads (AAR), are lobbying for and against major aspects of climate legislation that splits along regional and ideological lines. The nation's dominant railroads, Norfolk Southern, Burlington Northern Santa Fe Railway (BNSF), CSX Corp. and Union Pacific, rely on coal for roughly 15 to 20 percent of their revenue. The industry has an interest in preserving coal's position as the dominant source of electricity, and sources said that means joining utilities and coal companies in their fight for free carbon emissions permits and for long lead times for emissions reductions.

A marked shift in lobbying

Railroads spent about $24 million on lobbying through June, according to the Center for Responsive Politics, tracking with last year's spending, but easily trailing spending by major utility groups. Much of that targets high-priority railroad regulation, but an increasing amount ties into energy and climate legislation.

The biggest railroads have signed on with influential electric energy and environmental lobbyists in the past year: CSX Corp., for example, retains Joe Stanko of Hunton & Williams, a former counsel for the House Energy and Commerce Committee who represents electric utilities and refineries. BNSF has joined BP and utility giants Duke Energy and NRG in signing on with the Alpine Group, which has a bipartisan stable of former top congressional energy policy aides.

John Gray, AAR's senior vice president for policy and economics, said incentives for technology that can capture and sequester coal plant emissions are critical to a final bill, "both for national energy needs and for maintaining our coal franchise. We realize changes will go forward, but it's important to preserve the option of coal."

Still, Gray and other industry sources said rails don't have the luxury of opposing climate change bills on the basis of their treatment of coal alone. For them, the issue isn't that simple.

Railroad officials said their "intermodal" freight business that transports goods in containers and trucks along rail lines is already booming. Railroads hauling a ton of freight travel about four times as far on a gallon of fuel as trucks, boasts the industry.

"There's clearly a role for rails," Gray said, "for providing transport that helps the realization of a national goal of reducing greenhouse gas consumption."

But having climate policy priorities that don't perfectly align has also left the railroads with a split personality as they join other industries and environmental groups to build lobbying coalitions.

The four major railroads remain part of the American Coalition for Clean Coal Electricity, for example, even as some companies have resigned from the group, citing ACCCE's open hostility toward climate legislation and concern about being at cross-purposes with their goals of shaping a climate bill, rather than killing it. Duke Energy and France's Alstom Power left the clean coal group earlier this month, leaving behind an alliance of railroads, utilities and coal producers, including Murray Energy, which has been an outspoken opponent of legislation to address global warming.

"Where we find organizations that have an interest parallel with ours, we're trying to work with them. Frequently, also environmental groups," Gray said, citing work done with the Natural Resources Defense Council on high-speed rail issues.

U.S. coal rolls to fire up China

A mighty haul of 2.3 million tons of coal is expected to snake across the eastern United States this month, en route to ports in Baltimore and Norfolk, Va., and on to final destinations at industrial plants in China.

Booking a shipment of this much U.S. coal for export to China is Norfolk Southern's biggest haul of its kind ever, equaling the amount of export coal it shipped during the entire second quarter. In this economy, the railroad sees the China deal as a triumph, as Norfolk Southern has struggled alongside other freight haulers to keep its footing in the recession.

The industry's relative efficiency has helped it maintain profits as the United States slipped into its economic slump. But this year, the largest railroad companies have watched falling freight volumes take bites out of their business.

Donald Seale, chief marketing officer for Southern Norfolk, presenting at a Dahlman Rose & Co. investor conference in New York last week, said his company's operating revenues dropped 28 percent in the first half of the year. Utilities continue dipping into coal stocks instead of purchasing more coal to power less consumer electricity demand. Norfolk Southern's coal volumes dropped 19 percent in August, Seale said, which is a slight uptick from the 23 percent first-half decline.

Electricity demand is off about 6 percent across Norfolk Southern's territory, which spans nearly the entire eastern half of the United States. "Demand destruction for electricity in a recession is unheard of; usually, it stays about flat," Seale said. He pointed to rock-bottom domestic prices for natural gas. "It's competing with coal. Longer-term, we don't expect that to continue."

Sources in the rail industry say coal is still king. It still fuels nearly half of U.S. electricity demand, and utility and industrial demand is expected to return as the economy creeps back. Energy Department projections also expect coal to remain the dominant source for decades.

Even so, competitors such as natural gas, which is selling at about $2 to $3 per million Btu, and the billions of dollars being poured into renewable energy and high-efficiency technology, could put a dent in coal. The question remains: Will some long-term coal demand be sliced off as utilities adapt to a carbon-constrained environment?

BNSF Railways is the nation's second-largest freight rail line and a partner with Union Pacific on a joint line out of the Powder River Basin. In 2008, it earned $4 billion in revenues from hauling coal, out of $18 billion in total revenue, according to a company spokeswoman.

Waiting and watching the climate bill 'play out'

Steve Bobb, vice president for BNSF's coal operations, said the lagging economy and the drop-off in coal shipments buy the railroad time as the climate policy debate develops. "We're not in a position to have to make capacity expansions," he said. "We have time to watch this play out." The risk to the railroad is still very unclear because of the variety of ways a carbon cap-and-trade bill could affect different regions and power plants.

Energy market volatility and uncertainty in recent years -- and the tough political and business environment for utilities -- led BNSF to resist predicting which coal-fired power plants will actually be built. In 2006, Bobb said, when a bunch of new power plants were under discussion, the company made it policy not to expand its rail network until a plant was under construction. "It was an easy decision to make," he said.

The joint line's capacity out of the Powder River Basin exceeds the current volumes. High coal inventories and declining electricity demand will help maintain a comfortable capacity cushion on that line, Bobb said. Further, he said, the basin responds quickly to supply needs, and there is room for growth.

While a number of coal-fired power plants are expected to begin operating in 2013, many have been shelved for now. To land the multibillion-dollar capital needed to expand, railroads might press their customers for a faster recovery of that expense. "I'm sure with climate change legislation in the mix, they may be thinking [about] how quick the payback period is," he said. "The more uncertainty there is, the greater the calculus before putting the capital in."

Shipping volumes are shaky, and the railroads are trimming their capital budgets, but freight haulers are still spending $9 billion to upgrade and expand their systems this year. "We have to do that to keep our business going," said AAR spokeswoman Patricia Reilly, adding that the railroads can't afford to be caught flat-footed when the economy turns around. "There may not be as many carloads moving on the tracks, but we're beginning to see an uptick in commodities."

Mixed signals ahead in the fog

Railroads operate like other infrastructure-heavy industries. They face big pressure from Wall Street to make conservative spending choices. But because rails are so intertwined with the economy, concerns about long-term planning and reliability attract attention from Congress and regulators.

A 2007 Congressional Research Service report said a tight rail system has helped companies raise rates and increase profits in recent years. "To improve their return on investment, the railroads tailor investments to the expected change in demand over the short term," said the report. "They do not 'build ahead' of short-term demand forecasts."

The CRS found that uncertainty about prospective state and federal carbon emissions controls and renewable energy development has not stopped coal-related investment by the railroads. "Nonetheless, these uncertainties and incomplete information complicate long-term investment planning for railroads."

A report in March prepared for the Surface Transportation Board, a railroad regulator, also got into projecting coal use into the future. For example, the Transportation Department's and the Energy Information Administration's forecasts of coal rail tonnage through 2030 are vastly different. Transportation predicts 78 percent growth in that time, and a 2009 EIA analysis, which begins to factor in lower economic growth and higher greenhouse gas-related costs, predicts 24 percent growth.

Tom Bozzo, vice president of Christensen Associates in Madison, Wis., which prepared the Surface Transportation Board report, said coal mines in both Appalachia and the West are heading into a period of slower growth. There is less cheaper-to-mine coal in the country. "The EIA scenarios are not necessarily problematic for the railroads," he said. "Without the prospect of rapid growth, there are big capacity projects that don't need to come online."

The jury is still out on coal, but Bozzo said rails could replace lost coal shipments a lot more easily than some have thought: For example, trucks in the East could shift to rails, and wind turbines could ship into Wyoming instead of coal shipping out.

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