Alternative Funding and Financing Mechanisms for Passenger and Freight Rail Projects (2015)

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12 2.1 Rail Project/Service Types and Their Financial Dynamics Rail projects and services can differ substantially, and so can their funding needs and associ- ated financing. This chapter discusses different types of freight and passenger rail projects and operations in the United States and basic related financial dynamics. 2.1.1 Freight Rail Generally, there are two types of freight rail operations in the United States: • Class I freight railroads6 are large railroads, with extensive operations and multi-state or trans- continental track networks. Seven Class I freight railroads operate in the United States: BNSF, Union Pacific, CSX Transportation, Norfolk Southern, Kansas City Southern, CN Rail, and CP Rail. • Short-line and regional railroads include the more than 550 regional and short-line rail systems that are mostly privately owned. Regional and short-line freight railroads typically provide ser- vices over short distances and sections of track. In most cases, they connect small communities or remote industries to the larger freight rail network of Class I railroads. In virtually every case, freight rail operations are for-profit businesses, although some short lines require financial support to be viable. 2.1.2 Passenger Rail This research project considered the funding and financing requirements for intercity passenger rail (including high-speed rail) and commuter rail projects and services as discussed below. • Intercity passenger rail. Amtrak is the main intercity passenger rail operator in the United States, although some states and private companies also operate services with intercity char- acteristics. On some routes, especially long-distance routes through scenic areas, passengers are tourists for whom the rail trip is part of the holiday and not just a form of transportation. • High-speed rail (HSR) projects are intended to provide faster intercity passenger rail service, typically at speeds in excess of 125 miles per hour (mph).7 Although HSR is well established C H A P T E R 2 U.S. Rail Industry Structure and Financial Dynamics 6 The Surface Transportation Board (STB) defines a Class I railroad in the United States as “having annual carrier operating revenues of $378.8 million or more” after adjusting for inflation using a Railroad Freight Price Index developed by the Bureau of Labor Statistics (BLS). (49 CFR Part 1201, General Instructions 1-1, GPO, 2007). 7 U.S. Code Title 49. 1 March 2012—Definitions. Retrieved July 9, 2013.

U.S. Rail Industry Structure and Financial Dynamics 13 in Europe and Asia (where speeds in excess of 185 mph [300 km/h] are achieved), for various historical, geographic, and market reasons, only Amtrak’s Acela Express service—between Boston and Washington, DC—comes close to HSR, achieving speeds of up to 150 mph on some short sections of the line. Other HSR projects are in planning, with the most advanced being in California linking the Los Angeles and San Francisco areas. Although there is no single standard definition of high-speed rail worldwide, most definitions associate high-speed trains with speeds of at least 125 mph (200 kilo- meters per hour [km/h]). • Commuter rail projects and services are intended to transport people between suburban or “bedroom” communities and large urban centers and sometimes also serving suburban activ- ity centers. Commuter rail stations are generally closer together and train frequency is typi- cally greater than intercity passenger rail service. The Caltrain service linking San Francisco and San Jose (and Gilroy) in California, and services provided by Metro-North in New York City, are examples of commuter rail services. Passenger rail projects and services in the United States, whether intercity or commuter, gener- ally focus on providing a public service and associated benefits, rather than delivering for-profit financial returns, as is so with most U.S. freight railroads. 2.1.3 Shared Corridors and Corridor Improvement Projects Shared passenger/freight corridors involve the shared use of rail infrastructure. For instance, with the exception of some Amtrak-owned lines in the North-East Corridor (NEC), Amtrak operates passenger services on tracks owned by private freight rail companies, paying fees to use the track. Many commuter services operate over lines shared with freight services; private freight and government-owned commuter rail companies pay Amtrak for use of some Amtrak-owned lines in the Northeast United States. That most intercity and commuter rail passenger services in the United States operate on private freight railroad-owned track is notably different than in most international jurisdictions, where rail infrastructure is typically owned by public or quasi-public entities that then provide access to passenger and freight railroads at a rate typically below commercial terms (and supported by subsidies). Corridor improvement projects, including the Alameda Corridor in California, CREATE in Chicago, and the Heartland Corridor on the United States East Coast, are designed to improve capacity and fluidity on particular rail corridors and/or to reduce road/rail interactions along certain routes. Although corridor improvement projects can offer private benefits as well as public benefits, they are typically not commercially viable on their own and require some form of public fund- ing support.

14 Alternative Funding and Financing Mechanisms for Passenger and Freight Rail Projects 8 There are some exceptions to this ownership and charging structure. Amtrak owns the infrastructure along some parts of the North-East Corridor, where it imposes access charges on private freight and public commuter operators. 9 Airline deregulation (Airline Deregulation Act of 1978) and trucking deregulation (Motor Carrier Act of 1980). 10 There is still tariff oversight by the U.S. Surface Transportation Board, an independent agency administratively housed with- in the Department of Transportation. Shippers can bring excessive tariff charges to the STB where these cases are adjudicated. 11 BNSF: Burlington Northern Santa Fe Railway; UP: Union Pacific Railroad; CSX: CSX Transportation; NS: Norfolk South- ern; KCS: Kansas City Southern Lines; CP-SOO: Canadian Pacific, Soo Line; CN-GT: Canadian National, Grand Trunk. 12 AAR, Railroad Facts, page 3, 2013. 2.2 A Brief History of the U.S. Rail Sector and Financial Implications Until the 1970s, freight and intercity passenger rail services in the United States were provided exclusively by private companies. Up to this time, the rise of affordable passenger transportation by automobile and commercial aircraft had culminated in a significant decline in rail passenger traffic and associated losses for railroads. The private railroads were prevented by regulation from abandoning passenger services, and many were also facing bankruptcy partly as a result. Confronted with the choice of insolvent railroads or providing direct public support for passen- ger losses, in 1970 Congress undertook a major restructuring initiative and formed the National Rail Passenger Corporation (Amtrak), a private “as if for-profit” corporation (all shares owned by government) to take over most intercity passenger rail services. Under the new structure (still in place today), freight railroads have ownership of most rail infrastructure, but are required by law to allow Amtrak passenger trains to operate over their lines upon payment of “variable cost” access charges.8 Even after the establishment of Amtrak, heavy regulations on the freight railroad industry (including limiting the railroads’ ability to abandon lines and lower tariffs in order to attract traffic) led to growing financial challenges for freight railroads and several bankruptcies. In 1980, deregulation of the railroad industry (among other industries9) was carried out through the Staggers Act, which effectively freed railroads to make decisions in their own com- mercial interests, including abandoning under-performing freight services, setting tariffs freely,10 and negotiating contracts on a confidential basis with shippers, with no government interfer- ence. As a result, freight railroads in the United States were able to turn around their operations to become profitable, as they largely are today. 2.2.1 Freight Context in the United States Freight rail systems in the United States are almost exclusively privately owned. The sector is dominated by seven large Class I private railroad companies, including subsidiaries of two private Canadian rail companies.11 Combined, they operate over 95,000 miles of track (exclud- ing trackage rights) and over 120,000 miles of track (including trackage rights), originating 2.3 billion tons and carrying 1.7 trillion ton-miles of freight.12 The Class I railroads account for 94% of all rail freight revenue in the United States. The remaining freight is carried on short-line and regional railroads. In virtually every case, freight rail operations in the United States are for-profit businesses. The larger freight railroad companies are self-financing (infrastructure and operations) and require no public support. All Class I railroads finance investments from their own cash, the sale of stock (equity), shipper finance, and conventional debt instruments available on the commercial market. All Class I railroads have investment grade credit ratings, making them attractive and rela- tively secure long-term investments in the case of both equity and debt. Indeed, some Class I rail- roads have issued general corporate bonds with a 100-year term in recent years—an extremely

U.S. Rail Industry Structure and Financial Dynamics 15 13 In part because they are too small to be able to afford the administrative costs and fees necessary for access to debt markets; some may be marginally profitable and unable to access commercial debt markets or bank financing. 14 Some commuter-style services offering intercity passenger transport (e.g., New Jersey Transit moves between New Jersey and New York City, and Metro-North Railroad services New York and Connecticut. SEPTA provides service from Trenton, NJ, to Newark, DE. CalTrans operates the Capital Corridor between San Jose and Sacramento). 15 Lane, R., D. Schned and P. Todorovich. 2011. High-Speed Rail International Lessons for U.S. Policy Makers. Policy Focus Report, Lincoln Institute of Land Policy. 16 Louis S. Thompson. 2005. Options for Federal Ownership of the Northeast Corridor (NEC) Infrastructure. Available from www.tgaassoc.com long term by any market standard. Most corporate debt instruments rely on the company’s underlying balance sheet. Typical cost of money (interest rate) for the strongest Class I railroads is about 2.5% above the U.S. treasury rate (currently 2% on 10-year bonds). The cost of debt for strong short-line holding companies (e.g., Genesee & Wyoming and Fortress) is not much more expensive than for Class I railroads, but it can be higher for smaller regional and shoreline rail entities—many smaller short lines do not have access to debt mar- kets.13 These smaller private entities often cooperate with larger private freight rail systems to help finance projects important to both. Smaller short lines are also the major beneficiaries of federal, state, and local financing programs in the United States (Appendixes A and B list federal and state rail funding and financing programs). The federal Railroad Rehabilitation & Improve- ment Financing (RRIF) Program, for example, seeks to address the challenges that smaller short- line railroads have accessing commercial financial markets. 2.2.2 Intercity Passenger Rail in the United States: Amtrak Amtrak is the main intercity and long-distance passenger rail operator in the United States,14 moving passengers over 21,200 miles of routes across three types of service: 15 long-haul “national” system train lines, 25 short-haul, mostly single-state train lines, and the North-East Corridor service between Boston and Washington, DC, via New York City.15 Most track along which Amtrak trains run is owned by private freight railroads, which charge Amtrak access charges based on the short-term variable cost of accessing the track (the addi- tional costs incurred by the railroad as a result of Amtrak trains operating on the tracks). The basic costing method (short-term variable costs) was agreed between railroads and Amtrak when Amtrak was formed. The particular charges (but not the method) are negotiated on a case-by- case basis and are subject to confidential agreements between Amtrak and the private railroads in question. The exception is about 365 miles of track along the NEC corridor, which was acquired by Amtrak in 1986, along which tenant commuter and freight operators pay access charges to Amtrak.16 Amtrak purchases or leases equipment, primarily passenger cars and locomotives, and related maintenance infrastructure under capital leasing arrangements. Amtrak is funded through a combination of ticket sales, revenues from third parties, and government support. The sources of Amtrak’s operating revenues in 2012 are presented in Figure 2-1. Since its establishment in 1970, Amtrak’s operating revenues have never covered operating costs, let alone made any contribution toward capital investment; operating losses between 2008

16 Alternative Funding and Financing Mechanisms for Passenger and Freight Rail Projects and 2012 ranged between $1.1 and $1.3 billion annually.17 However, operating financial per- formance for Amtrak’s services vary widely: the Acela service on the Northeast Corridor, for example, earns an operating profit, which has been used to subsidize other services. On state corridors, state DOT contributions have been used to narrow the funding gap where states have determined the public benefits merit public funding. Long-distance services also have a fund- ing gap, but are funded because Congress has seen the need for public investment in Amtrak’s national network to provide more transportation options to communities that are remote and not well served by other modes. Amtrak’s operating losses, as well as its capital costs, are covered largely through appropriations from the federal budget. Amtrak has also made use of federal financing programs. For example, in 2010 it executed a loan agreement with the FRA’s RRIF program for $562.9 million to be used toward the purchase of 70 new electric locomotives, maintenance facility upgrades, and spare parts.18 This RRIF financing was raised against future funding from ticket revenues on the Northeast Corridor. 17 Amtrak Annual Reports, years 2009 through 2012. Available from www.amtrak.com 18 Amtrak News Release “Amtrak receives $569.2 million RRIF loan to fund new generation of electric locomotives,” June 29, 2011. http://www.amtrak.com/ccurl/913/848/ATK-11-098_Amtrak_Statement_on_,0.pdf (accessed July 15, 2013). Source: CPCS Analysis of Amtrak Annual Report, 2012 [Latest available at the time of writing] Ticket Sales, 48% Government Support (Net operating loss), 30% State Supported, 4% Commuter, 4% Other revenues, gains and reimbursables, 7% Food & Beverage, 3% Commercial Development, 2% Freight Access Fee and Other, 1% State Capital Payments, 1% Figure 2-1. Amtrak operating revenue sources, 2012.a a Breakdown of categories: Commuter: Amtrak operates commuter services on contract to local authorities on a cost-based fee structure; State support: Revenues from state govern- ments that pay to receive more shorter-haul services than Amtrak would otherwise provide; State Capital Payments: Revenues from the amortization of state funds used to acquire depre- ciable assets; Other: Transportation revenue from use of Amtrak-owned tracks and other ser- vices; revenue from reimbursable engineering and capital improvement activities; Commercial development: revenue from retail, parking, advertising, real property leases/easements/sales, right-of-way fees; Freight access fee and other: revenue from the use of Amtrak-owned tracks by freight railroad and commuter rail companies and other gains.

U.S. Rail Industry Structure and Financial Dynamics 17 As a private corporation (with most shares owned by the federal government19) Amtrak has the legal ability to borrow from private markets. It has done so extensively in the past but, fol- lowing unmanageable debt burdens in the early 2000s, is now being restricted in its borrowing capacity.20 Specifically, Section 205(g) of the Passenger Rail Investment and Improvement Act (PRIIA) of 2008 provides that Amtrak may not incur more debt after the date of enactment of the Act (October 2008) without the express advance approval of the government. Both the Grow America Act and the PRIIA identify reforms that bring more transparency to managing and reporting Amtrak financial performance (e.g., reinvesting the above-the-rail profits into the NEC, and relying on public funding instead of other ticket revenue to pay for long-distance service). 2.2.3 HSR in the United States The only HSR services in the United States are Amtrak’s Acela Express trains and some NEC regional trains operating in some sections of the NEC at up to 150 mph and 125 mph, respec- tively (although average speeds are much lower). The United States has a long history of attempts to establish high-speed rail, dating as far back as 1965 under the High Speed Ground Transportation Act. There are two main approaches to building high(er) speed rail:21 (1) Improving existing tracks and signaling to allow trains to reach speeds of up to 110 mph, generally on track shared with freight trains;22 and (2) building new tracks dedicated to high-speed service to allow trains to travel at speeds of 200 mph or more.23 The FRA defines three categories of high(er) speed rail corridors: • Core Express services: frequent trains at 125–250+ mph in the nation’s densest and most populous regions; • Regional services: 90–125 mph service between mid-sized and large cities; and • Emerging services: (up to 90 mph) connecting communities to the passenger rail network and providing a foundation for future corridor development. Figure 2-2 shows the proposed priority HSR corridors by type of service. Many of the existing federal and state funding programs (see Appendixes A and B) can be used to fund HSR projects. However, the largest and most recent funding support for HSR was initiated through the PRIIA 2008, which authorized federal funding for Amtrak and state-led efforts to develop HSR corridors between 2009 and 2013. Shortly after PRIIA was signed into law, the Act became the vehicle for appropriating $8 billion for high-speed rail under the Ameri- can Recovery and Reinvestment Act (ARRA). An additional $2.5 billion for high-speed rail was 19 In addition to the federal government (represented by the Department of Transportation) Amtrak has at least four private shareholders—some of whom acquired their shares from the original railroads that participated in Amtrak’s formation. 20 In the late 1990s and early 2000s, Amtrak took on significant commercial debt for capital improvement projects. The debt burden reached approximately $4 billion by 2002/3 and significant resources were required to service debt repayments. The debt burden has now been reduced to approximately $1.3 billion through repayments and refinancing activities. 21 Congressional Research Service. “The Development of High Speed Rail in the United States: Issues and Recent Events,” June 28, 2012. 22 Rehabilitating new track is a lower cost option, but results in limitations: (1) some aspects of the rail infrastructure (e.g., curves and at-grade road crossings) will always limit speed improvements; (2) most existing track is used for freight trains that operate at slower speeds and operational considerations may ultimately constrain the speed of passenger trains; and (3) FRA regulations limit train speeds on routes that handle both freight and passenger traffic. 23 The typical costs per mile are much higher for new tracks—a major deterrent to this option. Other challenges with building new dedicated track include that, in order to attain high speeds, freight trains would be prohibited from the track and would also therefore not contribute to covering construction or maintenance costs.

18 Alternative Funding and Financing Mechanisms for Passenger and Freight Rail Projects 24 Lane, R., D. Schned and P. Todorovich. 2011. High-Speed Rail International Lessons for U.S. Policy Makers. Policy Focus Report, Lincoln Institute of Land Policy. 25 FRA, High Speed Intercity Passenger Rail Program: Federal Investment Highlights. February 2, 2012. appropriated by Congress in the 2010 budget. These appropriations became the centerpiece of the Obama Administration’s High-Speed and Intercity Passenger Rail (HSIPR) program, a com- petitive grant scheme administered by the FRA.24 Nearly 85% of funding awarded by the HSIPR in early 2012 was concentrated in six corridors. Investments in five corridors seek to upgrade existing freight and Amtrak lines: Seattle-Portland; Chicago-St. Louis; Chicago-Detroit; the Amtrak NEC; and Charlotte-Washington, DC. In the sixth corridor, Los Angeles-San Francisco, funding is for construction of a new high-speed line.25 States are also contributing to the development of HSR, and some have established dedicated funding streams for conventional intercity and high-speed passenger rail. 2.2.4 Commuter Rail in the United States At the time of writing, 24 commuter rail systems were owned and operated by state and local transit agencies or authorities across the United States (see Appendix C). The ownership of track infrastructure along which commuter trains run varies across the country. In some instances, transit agencies own the track and use it exclusively or provide Source: Federal Railroad Administration, High-Speed Intercity Passenger Rail Program: Federal Investment Highlights, February 2, 2012 Figure 2-2. Proposed US high-speed rail corridors.

U.S. Rail Industry Structure and Financial Dynamics 19 trackage rights to freight rail companies and/or Amtrak. In other cases, commuter rail operators operate exclusively on track owned by freight rail companies and/or Amtrak. Regardless of the structure, track owners charge rail operators track access fees. Commuter rail agencies typically do not have the statutory right to access freight railroad companies’ track and must negotiate track access fees with freight railroads on a case-by-case basis. Commuter agencies that wish to increase current services must negotiate additional track access rights and fees on a case-by-case basis. In such cases, the agencies generally invest in infra- structure improvements to provide the extra capacity as a condition of access. None of the 24 publicly owned commuter rail systems in the United States cover their oper- ating expenses from passenger revenues. As shown in Figure 2-3, passenger cost recovery from operations varies from 3% to 63%. Most systems achieve less than 50%. The recovery ratio is the percentage of operating expenses covered by passenger revenues. Overall, the funding sources for commuter rail in the United States can be broken down into four high-level categories based on the original source of the funds: • Directly generated revenues acquired by the public transit agency by its own activities, includ- ing fare receipts, taxes levied by the system, sale or leasing of development rights to land and existing facilities, and other revenues (e.g., advertising, concessions, and parking revenues); Source: CPCS analysis of Federal Transit Administration’s 2012 National Transit Database (NTD), 2012 NTD Data Tables, “Fare Per passenger and Recovery Ratio.” Downloaded from: http://www.apta.com/resources/statistics/Pages/NTDDataTables.aspx (accessed August 13, 2014). The recovery ratio is the percentage of operating expenses covered by passenger revenues. Figure 2-3. Commuter rail systems and passenger fare recovery, 2012.

20 Alternative Funding and Financing Mechanisms for Passenger and Freight Rail Projects • Local revenues from taxes or fees generated by a local or regional government (e.g., local sales taxes or income tax, a property tax, or other local taxes); • State revenues from taxes or fees imposed by a state government; and • Federal revenues originating from federal government funding programs. Given that operating revenues do not cover operating costs, all of the funding for capital expenditures (e.g., rolling stock, track construction, and maintenance—where applicable) must be funded from other sources. How the U.S. Rail Market Differs from Most International Rail Markets and Implications for Funding and Financing This research project reviewed international examples of rail funding and financ- ing models to identify potential lessons for the United States. Specifically, the research reviewed passenger and freight rail revenue generation and financing models in the United Kingdom (UK), elsewhere in the European Union (EU), and Australia. A summary of this global review is provided in Appendix D. The structures of the rail sectors in most international markets are significantly different from those in the United States—many of the funding and financing models used in such jurisdictions are not applicable to the United States. The most significant of these differences are as follows: • Ownership of the rail network and control of rights of way. The rail network in the United States (and by extension the rail rights of way) is predominantly owned and controlled by private freight railroads. In most international juris- dictions, the rail network (including track, stations, and yards) is predominantly owned and controlled by government or quasi-government agencies. • Integration and access. Freight railroads in the United States are vertically integrated, controlling both the rail network and freight operations. Access to the freight railroad network, including by passenger operators, is subject to private access agreements. In the international jurisdictions reviewed, freight and passenger companies are becoming more and more vertically separated from the rail network operator and provide train services under regulated open-access regimes. • Competition: Unlike the United States, in the international jurisdictions, freight companies compete “above the rail”a to provide services, as do intercity passenger operators. Private provision of passenger rail service. In international markets, local, regional (and sometimes intercity) passenger rail services are often operated by the private sector under limited-term contracts or franchises, awarded by public tender. Although management contracts exist in the United States, the more extensive franchise model is not used for passenger rail in the United States. Table 2-1 summarizes key differences in rail industry structures in the US vis-a-vis international markets reviewed. a Competition among two or more operators on the same rail infrastructure.

Table 2-1. Comparison of US market structure with international jurisdictions, and related funding and financing implications. Country/ Region Rail Infrastructure Ownership Freight Operators Passenger Rail Operaons Rolling Stock US Majority of cross-country tracks privately owned by freight railroads. Amtrak owns some track in North-East Corridor. Public agencies own some commuter tracks. Private Class I railroads operate 100% commercially without subsidy. Some smaller short line/regional railroads receive support from state and/or federal government. Public-sector companies that receive public support for operang and capital costs not covered by revenues. A few private operators (e.g., niche tourism services). Owned outright, financed through a special rolling stock bond (equipment trust cerficate) or acquired through leasing contracts of various lengths. UK Network Rail (a not-for- dividend private company which has no shareholders and whose borrowing is mainly backed by a government guarantee) owns virtually all rail infrastructure and charges track access fees to both freight and passenger operang companies. Network Rail receives financing from the government for infrastructure costs not covered by track access revenues. Private “freight operang companies” compete on open-access commercial basis on track owned by Network Rail. Mostly private “Train Operang Companies” (TOCs) that operate on a franchise basis, with contracts between 7 and 15 years. TOCs receive a subsidy or pay a premium to the government based on franchised lines and specified services and depending on the extent to which the above rail service generates a loss, or a profit. TOCs run on Network Rail track. Typically leased from privately owned rolling stock ownership companies (ROSCOs). (continued on next page)

Country/ Region Rail Infrastructure Ownership Freight Operators Passenger Rail Operaons Rolling Stock EU Owned and managed by state- owned companies. Under EU rules, infrastructure must be managed by a company that is separate in its decision-making from any operators. Public sector-owned companies in most cases, private companies in others. Must allow compeon. For cross-border services, public or private, as long as there is potenal compeon for operaons “above the rails.” Some countries have not yet opened compeon for domesc services. Owned by operang companies, which for the most part are state enes. Australia Two types of systems: Common carriage network: states own infrastructure and provide open access to private operators. Private freight railroads: private companies own infrastructure. Some are required to provide open access. Other isolated lines are dedicated to commodies mines with no requirement for open access. Private companies Commuter rail operators are public-sector owned, except in Melbourne where services are franchised to a private operator. Intercity services in Queensland and New South Wales are operated by state-owned companies. Some long-distance services are operated by a private company, without subsidy. Mostly owned outright by operators. Some use of leasing structures. Japan HSR lines constructed pre- privazaon are owned by private Japan Railways (JR) Passenger Companies. New HSR lines (constructed post-privazaon) are generally owned by the naonal government. Private company (JR freight) pays to access tracks owned by JR Passenger or other companies Private JR Passenger Companies Owned by private companies. Table 2-1. (Continued).