His career has ranged far and wide, observing and analyzing business and finance in a nearly 50-year career for such publications as Kiplinger’s Personal Finance, U.S. News & World Report and the Chicago Sun-Times.
He edited the popular Kiplinger’s Mutual Funds series for many years.
But all along, Fred Frailey’s particular interest has been railroads—both from an objective dollars-and-cents business perspective as well as enjoying a subjective aura few other industries hold.
He currently writes a column and a blog for Trains magazine. He may be best known in railroad circles for his best-selling book, “Twilight of the Great Trains,” that covers the 26-year decline and fall of passenger service between its peak as World War II ended and its near extinction before Amtrak’s start in 1971.
His business coverage of the industry spans its nadir in the 1970s when the Rock Island and other lines were going bankrupt and shutting down, to the industry’s spectacular rebirth via deregulation through the Staggers Rail Act of 1980.
Frailey took time to visit with Midstream Business and offer his insights on the industry as it stands today. He emphasized energy industry executives should remember that issues related to crude by rail (CBR) are only one challenge the railroads face now. Railroad executives—like their peers in the energy business—must contend with multiple issues at a time.
Happy investors
As with all businesses, keeping investors happy is a priority for North America’s railroad system, which for the most part is owned by private shareholders.
“One thing that’s happening is that the railroads are focused on pleasing Wall Street and their share-holders—but not necessarily pleasing their customers,” Frailey said. “And some, in the cases of CSX and Norfolk Southern, fear takeovers. To keep shareholders happy while handling less business, they raise prices aggressively while buying back shares with borrowed money. If you have fewer shares with the same earnings, you achieve higher earnings per share. So while traffic is down, they report double-digit earnings growth.”
Canadian Pacific Railway confirmed market rumors in November that it would make a play for Norfolk Southern. Both are major CBR players. Canadian Pacific is a major service provider in Western Canada and the Bakken while Norfolk Southern serves many terminals and refineries along the East Coast.
He cited one example of a big eastern railroad that had scheduled a daily merchandise freight over an important run. To save money, the line began dispatching the freight every 28 hours instead of every 24, “which works out to six trains a week instead of seven. That can blow every connection in the world, but it saves on crews and locomotives,” he said.
Missing talent
Railroads, like the oil and gas business, must contend with the challenge of a graying workforce and a shortage of qualified, younger employees to fill critical jobs.
“A lot of the talent is retired, just quit or has been fired,” Frailey said of railroad staffing. “And these old hands could work wonders; magic. They’re gone, and the new people have their heads stuck in computers instead of going out and seeing what’s really going on. There’s a lot of interest in computer programs but software can’t replace people who know the business.”
CBR traffic may be off but its share of railroad business, even at its peak a couple years ago, is small in relation to coal—and coal traffic has dropped off sharply and probably won’t come back due to government air quality efforts. Could crude help replace it?
“Not at all,” he answered. Coal is too big, and CBR too small, even if it comes back, to take up the slack. The move to cheaper natural gas by power generators could be a permanent loss in railroad freight traffic.
“The railroads will be lucky to keep any significant amount of oil over time—unless, you know, you get a nice, big, fat Brent-West Texas Intermediate spread again. That’s what attracted the East Coast refiners. It’s what actually kept them open, as you know,” Frailey added. “They could get that cheap West Texas oil delivered. I don’t know what prevents the midstream pipeline companies from building to the East Coast. All they have to do is go over a mountain range, right? And they can go down to the Delaware River” where Philadelphia’s refining center lies.
The importance of price
Price drives the marketplace. “I mean, who could have predicted the speed, longevity and severity of the [crude] price decline?” he said. “I can give you my opinion but everything has changed with the collapse in crude prices. A Norfolk Southern vice president told me recently that their crude-by-rail business is off 50% from last year. I suspect CSX is off by more than that.
“BNSF has a lot of business, out of the Bakken, to the West Coast, and they’re doing a good job of handling it,” Frailey added. “The problem is they can’t get into California. Right now, it’s cheaper to take it to Washington and barge it from there.”
Oregon and Washington may have easier regulatory environments than notoriously troublesome California but both also have strong environmental movements. A proposal to expand an existing rail terminal at Vancouver, Wash., across the Columbia River from Portland, Ore., to handle increased CBR traffic has drawn strong environmentalist opposition.
Energy executives may complain about regulation, but no business has contended more with heavy-handed bureaucracy than the railroads. Over-regulation nearly killed the industry before the Staggers Act. One immediate regulatory challenge railroads face is Positive Train Control (PTC), a well-intentioned but poorly thought-out law requiring intricate safety system improvements on nearly all rail lines. The 2008 law man-dated technology that did not yet exist, the Federal Communications Commission delayed approvals of vital radio towers and conflicting interpretations of the law further delayed implementation along rights of way.
U.S. railroads have spent billions of dollars on PTC, money that could have gone to capex, but still will not meet the law’s fixed Dec. 31 deadline.
“The railroads are supposed to have it installed by the end of the year, and if you’ve been reading about what’s been happening in the last month, they can’t make it,” Frailey said, pointing out they have asked for a three-year ex-tension to allow installation of the very complex—and untried—system. BNSF and Amtrak, which owns the passenger-heavy Northeast corridor between Boston and Washington, D.C., are among the rail operators that have said they cannot legally risk operating past that date.
“The railroads have more or less said ‘we’re going to obey the law—and we’re not going to run any trains [after the deadline].’ The acting Federal Railroad Administration [FRA] administrator [Sarah Feinberg] has said that the agency can’t make law, only enforce it—and they are going to enforce it. Her interpretation is you can’t run any trains [without PTC], we’ll fine you up to $25,000 per train start.
“And the railroads have said they have no intention of breaking the law, we will run no trains on these territories. So essentially they say we are going to shut down. Will Congress grant an extension? Who knows?” Frailey asked. In early November, there were reports that Congress had agreed on a three-year extension but the measure still had to pass both houses and gain the president’s signature to become law.
Crude regulations
Regulation also could have a significant impact on CBR going forward with multiple requirements for strengthened cars and altered operating rules following a spate of spectacular derailments that made headlines throughout North America in the last couple of years.
“That’s a huge issue,” Frailey said of CBR-related safety regulations. “Congress, or actually I guess it was the FRA, has almost made crude by rail economically unfeasible.” In addition to the substantial cost of building a new tank cars fleet, or modifying existing cars—costs that must be passed along to customers—there are operating procedures to consider.
“If you don’t have these cars you have to reduce its speed. And that soaks up capacity on a railroad like a sponge. When you throw a 40-mile-per-hour crude train into a network that is running 55- to 70-mile-an-hour trains, it in effect lengthens the distance between sidings, it creates overtakes, which are difficult to execute when there’s a lot of traffic going in both directions. It just makes a mess,” Frailey said.
“On the other hand, it doesn’t help that we have exploding trains. The [CBR] derailments the last couple of years should be an embarrassment to railroads,” he emphasized.
But the railroads have done some things right, Frailey said, and if crude prices cooperate CBR could be a long-term, viable midstream option for getting oil from producers to refiners. Railroads’ relative speed and flexibility—compared to pipelines—are major selling points despite higher costs.
“On the good side, BNSF is the epicenter of crude by rail and they have spent prodigiously improving their net-work, particularly between North Dakota and Chicago,” he added. “Given the volume of oil that they have now, I think they provide pretty damn good service.”
And that example may prove, despite myriad challenges, that railroads work, in Frailey’s opinion.