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August 2006

Rail News: Rail Industry

What will it take for the Powder River Basin's 20 mines to meet the nation's insatiable energy needs? More cooperation among railroads, mines and utilities


By Jeff Stagl, Managing Editor

What's the top power-generating fuel for U.S. utilities? It isn't natural gas or petroleum. It's coal — the fossil fuel that dates back to the cave man as a heat source and the 1880s as an electric-generating fuel for U.S. power plants, but dropped in usage during the 1980s and 1990s because coal prices escalated in the East and production was only beginning to boom in the West.

As prices for natural gas and other fossil fuels have skyrocketed the past few years, coal has become the least expensive option. So, U.S. utilities currently use coal to produce half of the nation's electricity output.

Considered the "Saudi Arabia of coal," the United States has 25 percent of the world's coal reserves.

And a large portion of those reserves lie in the Powder River Basin (PRB), a 20,000-square-mile region in northeastern Wyoming and southeastern Montana. Twenty PRB mines, 16 of which are in Wyoming, produce about 400 million tons or 40 percent of the country's coal.

Between 1990 and 2005, Wyoming coal production rose 121 percent because PRB coal is the lowest-cost fossil fuel per BTU and contains little sulfur, helping reduce the amount of sulfuric acid that is produced in the atmosphere during combustion.

With power plants in the West and utilities in the East clamoring for PRB coal, the basin's mines project annual production increases of between 5 percent and 15 percent. Tonnage should reach 500 million by 2012 and 600 million by 2025.

That's good news for BNSF Railway Co. and Union Pacific Railroad, which move all of the coal out of the region, most of it along a 102-mile, jointly owned line. The region accounts for 90 percent of BNSF's and 72 percent of UP's originated coal volume.

But PRB coal shipments haven't been a "good news" story in recent months for coal shippers. Although the two railroads have been moving record coal volumes out of the basin the past few months and getting better at moving trains in and out of mines more efficiently, they've been struggling to overcome joint line outages that occurred in spring 2005. Cycle times remain inconsistent. Even with the recent increase in coal trainloads, railroads aren't meeting current delivery requirements, utilities say, adding that their stockpiles — and patience — are wearing thin.

Utilities' and energy users' wallets are getting thinner, too. Utilities continue to purchase high-priced natural gas or more expensive coal from other regions, curtail power production to conserve coal or spend millions of dollars to purchase power from brokers on the open market to compensate for fewer PRB deliveries, then pass on higher operating costs to consumers.

Moreover, utilities also are frustrated with recent rate increases — which they say can range from between 50 percent to as high as 100 percent. Given what shippers perceive as mediocre rail performance at best, that's adding insult to injury.

Capacity's coming that'll improve throughput, the railroads say, adding that capacity-building takes time — and money.

"It will probably be late 2007 or early 2008 before we really catch up," says UP Vice President and General Manager of Energy Doug Glass. "We're just trying to get breathing room now."

For utilities trying to meet today's already insatiable energy needs, that's anything but comforting. The long view is even less promising. During the next 20 years, overall energy demand is projected to jump 40 percent. And utilities plan to do their part to meet demand by building dozens of power plants — which would run on PRB coal — to meet energy users' needs.

But they're also counting on a little help from their railroad business partners — BNSF and UP, for sure, as well as the Dakota, Minnesota & Eastern Railroad Corp., which plans to build a second major rail line in the region by 2009.

Other shippers are seeking legislative relief. They're backing the Railroad Antitrust Enforcement Act of 2006 (S. 2921 or S. 919), a bill that proposes to repeal railroads' antitrust exemptions to spur rail competition and ease rate increases, particularly for captive coal shippers.

Crunch Time

But even dozens of new power plants and tens of miles of additional rail lines won't solve the capacity crunch any time soon. So, for the foreseeable future, expect higher energy prices — and more railroad-coal shipper wrangling.

"Forcing utilities to take coal-fired plants off-line or reduce electric generation output to conserve coal stockpiles presents a situation of enormous potential consequence — especially given the amount of time the [rail] service lapses have been continuing," said David Welks, president of Xcel Energy, which operates 15 coal-fired plants in the West and Midwest, in a prepared statement.

Officials at BNSF and UP say they've been working to address the service issues, and that ramping up traffic volumes remains a top priority. To an extent, the two Class Is still are recovering from weather-related track washouts and two coal dust-caused train derailments on the joint line in spring 2005 that reduced last year's rail shipments to about 85 percent of total demand. But officials from both roads believe they've made strides in recent months.

As evidence, they cite the recent coal traffic records they've posted as Exhibit A. UP loaded a record-setting 1,079 coal trains in June and 6,383 trains in the first half. BNSF loaded a record daily average of 50.4 coal trains in June and delivered 115 million tons of coal through May 31 compared with 105 million during 2005's first five months.

As Exhibit B, the Class Is point to infrastructure improvements. BNSF and UP are adding dozens of miles of double, triple and quadruple mainlines on the joint line.

During the next two years, the Class Is will jointly spend about $100 million to build more than 40 miles of third and fourth mainlines.

Next month, BNSF and UP will open a new 19-mile third mainline on the joint line's northern end between West Nacco Junction and Donkey Creek in Wyoming. Next year, they plan to complete a 39-mile third mainline on the northern end and 15-mile fourth mainline near the southern end.

"As additional capacity is completed, the time to and from mines will decrease," says Steve Bobb, BNSF group vice president-coal business unit.

Tracking Progress

The railroads are expanding coal-carrying capacity on their own systems, too. As part of this year's PRB-related projects, BNSF has completed Rozet Yard filler tracks in the Black Hills Subdivision in Wyoming, 6.6 miles of double track in the Valley Subdivision in Colorado and 10 miles of double track in the Sand Hills Subdivision in Nebraska. The railroad also has begun a double-track project in Nebraska's Angora Subdivision.

UP is spending about $115 million this year on coal capacity projects, with a majority of the dollars to be invested in North Platte, Neb., and coal corridors between Kansas City and St. Louis, Mo., to support PRB traffic.

By year's end, UP will complete the Marysville, Kan., bypass on the Gibbon, Neb.-to-Kansas City coal corridor; three additional run-through tracks in North Platte dedicated to fueling and servicing coal trains; signal system improvements in eastern Nebraska and western Iowa; and double track between Morrison and Gasconade Junction, Mo.

But you can't build track in the PRB overnight, says UP's Glass. It typically takes about two years from design through construction.

"We're trying to get ahead of the curve on where to invest for capacity," says Glass. "We want to step up to the plate."

The Class Is also want to step up efforts to change operating practices and keep coal trains moving.

At UP, crews now weatherize power switches — something the Class I hasn't done in the past — to ensure the equipment operates in the harshest conditions, says Glass. In addition, managers at both railroads are stressing the need to identify out-of-round wheels to prevent derailments.


But improving service reliability — which BNSF and UP officials believe had been consistent for decades prior to 2005 — is a three-party effort, the railroads say. Mines, utilities and railroads will need to get better at coordinating the utilization of 130-car train-sets, which mostly are shipper-owned, to reduce loading time.

"We have a team working with mines to change loading processes," says BNSF's Bobb.

Eleven of the largest PRB mines not only accept the Class Is' help, they contract Genesee & Wyoming Inc. subsidiary Rail Link Inc. to load trains after BNSF and UP drop off train-sets.

"Miners aren't railroaders — they rely on our expertise to load trains more efficiently," says Rail Link President Billy Eason.

The company has increased its staff to 10 managers and 115 hourly workers to speed loading operations. Rail Link currently loads an average of 65 PRB trains daily.

"We add to the loading capacity at every mine, which helps improve velocity," says Eason.

To one PRB mining firm, having more trains to load has helped drive up sales. Arch Coal Inc., which operates two PRB mines, registered a "slight increase" in the number of trains serving its Black Thunder Mine in the second quarter, said President and Chief Operating Officer John Eaves during the company's July 21 earnings conference. Improved rail performance helped the company increase quarterly PRB sales volume by 2.1 million tons compared with second-quarter 2005.

"[But] additional throughout by the railroads will be needed to reach the mine's planned production rate," said Eaves.

If the Class Is could guarantee additional throughput is on the way, utilities would eagerly order more coal from mines.

Burning more PRB coal would be a boost to utilities' pocketbooks. Right now, it's costing them billions of dollars to use an alternate fuel source, according to Glenn English, chief executive officer of the National Rural Electric Cooperative Association, which represents 930 power co-ops.

"It is widely acknowledged that there will be at least a 20 million-ton shortfall in PRB coal in 2006," he said during testimony June 21 at the Senate Subcommittee on Surface Transportation and Merchant Marine's hearing on rail industry service and capacity. "Making up this shortfall will require the use of about 340 billion cubic feet of natural gas costing about $2.6 billion more than the coal it replaces."

Since May 2005, the delivery rate for PRB coal hasn't met the Dairyland Power Cooperative's normal burn rate, says Dennis Rackers, director of procurement for the co-op, which operates three power plants in Wisconsin and obtains 75 percent of the 3.2 million tons of coal it burns annually from the PRB. During the past year, the cooperative has had to purchase coal from alternative sources in a high-priced market and use an older, less efficient power plant more than it would prefer to meet energy demands, he says.

"I understand that other utilities are purchasing coal from Indonesia and Columbia or using lignite to supplement coal they can't get from the Powder River Basin," says Rackers.

Xcel Energy has incurred tens of millions of dollars in additional costs to curtail production and reduce PRB coal usage, said Xcel's Wilks.

Utilities have little choice but to pass those additional costs onto consumers. In June, Black Hills Power Inc. filed a request with the South Dakota Public Utilities Commission to raise rates 9.5 percent beginning Jan. 1, 2007, partially because of costs associated with purchasing power. The utility serves 63,500 customers in western South Dakota, northeastern Wyoming and southeastern Montana.

But it can take months or years for a regulatory body to act on a request.

"It's a long process to get approval to raise customers' rates," says Duane Richards, CEO of the Western Fuels Association, which buys and delivers PRB coal for six member co-ops and municipalities.

High Rail Rate Of Late

While consumers' energy prices climb, so are utilities' rail rates. Western Fuels Association's rates have risen more than 50 percent — in some cases, 100 percent — instead of a more tolerable 5 percent or 10 percent, says Richards.

Dairyland Power Cooperative's rates rose 93 percent Jan. 1 after a three-year contract expired. It will cost the utility $75 million to ship $30 million worth of coal, says spokesperson Deb Mirasola.

The current three-year tariffs "don't include a service obligation like the previous contract, only the railroads' obligation as a common carrier," says the co-op's Rackers.

Utilities can file a rate complaint with the Surface Transportation Board. But few cases succeed and the board's filing fee exceeds $140,000 compared with a federal district court's $150 filing fee, utilities say.

Despite recent price hikes, utilities' rates have been decreasing for a long time, BNSF and UP say. A U.S. Government Accounting Office report issued earlier this year shows railroads' coal rates dropped 35 percent between 1985 and 2004.

"In general, rates have been going down, down, down," says BNSF's Bobb.

The railroads used to adjust prices to reward customers for their business.

"Depending on their last rate, maybe a customer had a great deal for a long time," says Bobb.

Now, BNSF and UP are increasing rates to offset capital invested in infrastructure, although they're being careful not to over-invest in track and equipment, the railroads say. During the past decade, UP has spent $6 billion on coal-related capacity projects; since 2003, BNSF's coal capacity investments have increased from $151 million to a projected $626 million in 2006.

"We're looking to add capacity and not fill capacity," says Bobb. "Do customers want more capacity and reliable capacity or do they want lower rates? "

Reaching Critical Mass

Both, of course. So the calls for more regulatory oversight of the rail industry will continue — from the coal crowd as well as other shipper contingencies. But solving the capacity conundrum remains the top priority for shippers and rails alike.

Utility strategists, too, recognize the need to take a more proactive role, whether it means upgrading their own facilities, purchasing equipment or improving processes on their end to boost cycle times.

But even with all the project and process improvement plans, utility managers can't help wondering: Will it be enough to accommodate the demand for PRB — not only in the West, but in the East, where several utilities are conducting test burns?

"In the next three to five years, more PRB coal will be wanted in the East, so what does that mean in the short term to us in the West?" asks Western Fuels Association's Richards. "There will be competition for capacity."

For now, utilities will continue paying more for alternate fuel sources, passing on higher operating costs to consumers and hoping potential long-term PRB coal shipment solutions are put in place sooner rather than later.

And the Class Is will continue telling shippers that better times lie ahead.

"From traffic managers to track engineers to sales and marketing folk, we're all focused on moving more trains," says UP's Glass. "But it's a slow process to satisfy organic growth with existing customers and new demand. It can't all be done in one year."


DM&E: The Quest To Become Third PRB Rail Competitor Continues

Since 1998, the Dakota, Minnesota & Eastern Railroad Corp. (DM&E) has been trying to prove that its proposed rail line into the Powder River Basin (PRB) is critical to meet transportation demand for the region's coal. With demand at an all-time high — and rising — and the Class Is scrambling to meet utilities' delivery needs, the $2.5 billion project has gained the most momentum it's had in eight years, proponents believe.

"From a customer standpoint, the need for the project has never had this level of urgency," says DM&E President and Chief Executive Officer Kevin Schieffer. "There's too much of a need not to build it, especially with the costs associated with service disruptions at other carriers."

The DM&E plans to build a 262.3-mile line through western South Dakota and eastern Wyoming, and upgrade 600 miles of other lines in South Dakota and Minnesota to access the PRB. If the project is completed — in 2009 at the earliest — revenue generated from coal traffic along the lines would transform the railroad into the first new Class I in nearly a century.

The DM&E is focusing its efforts on starting the project in 2007, says Schieffer. But before that happens, the railroad will have to overcome two obstacles.

Long-time opponents the Mayo Clinic and city of Rochester, Minn., might begin another legal proceeding to stall the project (they lost a court fight in 2003) and already have relayed safety concerns about the DM&E in a letter to the Federal Railroad Administration (FRA) — potential problems that Schieffer & Co. will have to sort out.

"We have 55 communities that believe we have a quality project and one NIMBY," says Schieffer.

The DM&E also is awaiting FRA approval on its application for a $2.5 billion Railroad Rehabilitation and Infrastructure Financing (RRIF) loan to help fund the project. As of July 5, the administration hadn't completed necessary environmental work associated with the application and the 90-day clock — the time within which the FRA is required to rule on the RRIF loan — hadn't yet started, said FRA spokesman Steve Kulm.

Filled With Anticipation

For now, the DM&E has begun purchasing land from private landowners in "anticipation of our timeline to get in the ground next year," he says. The railroad also is trying to acquire about $4 billion in financing for track materials, rolling stock and other project components that won't be covered by the RRIF loan, as well as line up contracts with PRB mines.

"Whether we get the FRA loan or other financing, the customers have to be there and be committed," says Schieffer.

If the mines do so and the project is completed, a second major line and third carrier in the region would help speed up coal deliveries and slow down rate increases, utilities say.

"The increase in competition would be a real boon to service and pricing," says Dairyland Power Cooperative Director of Procurement Dennis Rackers.

— Jeff Stagl


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