Why H.R. 2125 Should be Rejected Association of American Railroads July 2007

1. Why H.R. 2125 Should be Rejected Association of American Railroads July 2007

2. North America’s Rail Network: Extensive, Efficient & Integrated

3. Today’s U.S. Freight Railroad Environment  Vast majority privately-owned  Generally owner and operator • Access privately negotiated, voluntary • Historically very low government funding  Freight & passenger are separate

4. Class I Railroad Traffic in 2006 (Gross Freight Revenue) Intermodal* - $11.5 bil Coal - $10.8 bil Chemicals - $6.0 bil Transportation equipment - $4.2 bil Farm products (mainly grain) - $4.2 bil Food - $3.7 bil Lumber & wood - $2.3 bil Primary metal products (e.g., steel) - $2.2 bil Pulp & paper - $2.1 bil Stone, clay & glass products (e.g., cement) - $1.7 bil Nonmetallic minerals (e.g., sand, gravel) - $1.5 bil Source: AAR *Estimated. Some intermodal revenue is also included in individual commodities.

5. 26+ Years After Staggers: Solid Gains and a Promising Outlook • Unprecedented productivity gains passed to customers as lower rates • Dramatic safety gains • Infusion of advanced technology • Growth of non-Class I carriers • Closer to financial sustainability

6. U.S. Railroad Performance: 1964-2006(Index 1981 = 100) Productivity Volume Staggers Act Passed Oct. 1980 Revenue RR Rates Source: AAR

7. A Variety of Forces are Pushing Freight to Railroads

8. One Result: Tight Capacity on Many Parts of the Rail Network Millions of Class I Ton-Miles Per Mile of Road Owned Source: AAR

9. What Are Railroads Doing About It?  Aggressive hiring • Massive equipment and infrastructure investment New operating plans Cooperative alliances Working with customers Technology

10. Freight Railroad Investment Challenge • Rail investment must grow sharply over the next 20 years just to maintain the current rail share of freight traffic. • AASHTO, the Transportation Research Board, and others report that freight railroads are unlikely to be able to make the necessary investments on their own.

11. RRs Are Highly Capital Intensive Capital Expenditures as a % of Revenue: Avg. 1996-2005 Class I RRs Computers Avg. All Mfg. Wood Prod. Chemicals Petrol. & Coal Prod. Nonmet. Minerals Paper Food Motor Vehicles Plastics Sources: U.S. Census Bureau, AAR

12. Fortune 500 Return on Equity: Selected Industries, 2006 Industry ROE % Industry ROE % Fortune 500 Median 15.4% Oil & Gas Equip., Services 31.8% Petroleum Refining 30.7% Food & Drug Stores 15.4% Railroads 15.0% Metals 30.3% Household & Personal Prod. 24.6% Energy 14.9% Pharmaceuticals 24.2% Food & Grocery Wholesalers 14.8% Industrial & Farm Equip. 22.6% Engineering, Construction 13.8% Mining, Crude-Oil Prod. 21.8% Motor Vehicles & Parts 12.6% Aerospace and Defense 21.5% Pipelines 12.6% Chemicals 20.9% Utilities: Gas & Electric 10.6% Food Consumer Products 20.5% Packaging, Containers 9.6% Computers, Office Equip. 18.5% Telecommunications 6.4% Beverages 18.0% Food Production -3.1% Source: Fortune (April 30, 2007) 2006 Was a Good Year, But Even Then RR Profitability Was Below Average

13. Nevertheless, RRs Are Spending More Class I RR Capital Commitments ($ Billions) $9.4 e - AAR estimate Source: AAR

14. If ROI >cost of capital: • Capital spending expands • Stronger physical plant; more and better equipment. • Faster, more reliable service • Sustainability If ROI < cost of capital: • Lower capital spending • Weaker physical plant, equipment • Slower, less reliable service • Disinvestment Return on Investment is Crucial ROI

15. Today, the U.S. Freight Rail Industry is the Best in the World “Because of a market-based approach involving minimal government intervention, today’s U.S. freight railroads add up to a network that, comparing the total cost to shippers and taxpayers, gives the world’s most cost-effective freight service.”Lou Thompson, World Bank

16. Rail Rates Not the Problem Change in Prices for Farmers: 1995-2005 153% 150% 125% 100% 75% 53% 44% 36% 29% 30% 50% 5% 12% 0% All Farm Inputs Feed Seed Fertilizer Fuel Farm Mach. Agric. Chem. RR Grain Rates -20% Source: USDA, STB

17. Same is True for Electricity Costs 150 140 130 120 Electricity rates* 110 100 90 80 RR rates for coal** 70 60 '81 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 *U.S. avg. revenue per kwh, all sectors **Revenue per ton-mile coal Source: EIA, AAR

18. “Bottleneck” Policy  H.R. 2125 would force railroads to “short haul” themselves. • Estimated annual RR revenue loss of up to 10% would prevent RRs from covering their costs and replacing their assets. • Is a non-competitive outcome based on regulation and is not sustainable.

19. Mandated Reciprocal Switching  H.R. 2125 would mandate reciprocal switching where “practicable” and “in the public interest.” • Eliminates need for prior finding of anti-competitive conduct. • Could be interpreted as mandating reciprocal switching whenever it was operationally feasible — thereby essentially creating forced access on demand in terminal areas.

20. Final Offer Arbitration  Could be used in essentially any dispute with a railroad.  Completely outside STB purview. No requirement that arbitrator follow regulatory precedent or sound economic principles.  No other industry faces this type of mandate.  Direct attack on differential pricing and high-margin rail traffic.

21. Areas of Inadequate Competition  Most of the country would qualify. • In these areas, regulators could: Control rail rates Allow “cherry picking” by other railroads  No need to show anti-competitive conduct by owning railroad.

22. New Rate Reasonableness Test • Dismisses all currents tests and precedents. • Mandates new methodology without guidance. • Ensures departure from sound economic theory. • Impact indeterminable.

23. Reregulation Would Mean Reduced Capacity and Service “As demand increases, the railroads’ ability to generate profits from which to finance new investments will be critical. Profits are key to increasing capacity because they provide both the incentives and the means to make new investments.” – Congressional Budget Office (Jan. 2006)  Goal = lower rail rates for certain shippers • Result = lower rail revenue, capital drain, disinvestment. • Reregulation would mean less rail capacity when we need more.

24. H.R. 2116 Tax Incentives to Leverage Capacity Expansion • H.R. 2116 provides a 25% tax credit for projects that expand rail capacity. • H.R. 2116 would permit expensing of other infrastructure capital expenditures • Leverage private investment.

25. Thank You!