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experienced the greatest volume increases. In tentatively approving the 22 percent coal rate increase for the L&N, the ICC required that all funds derived from it be used only for the announced projects or others ordered by the ICC to insure adequate service to affected shippers.

L&N rates and earnings

Through the years, L&N steam coal rates to what had been their low volume markets in the Southeast have been low compared to C&O and N&W rates to the same destinations. According to ICC calculations, L&N bituminous coal rates average 111.3 percent of variable costs, while the Commission considers 150 percent and sometimes more as reasonable. Since 1970, four general rate increases applied to Southern District coal traffic were lower than increases in other parts of the country. When the ICC has granted percentage increases, as has been the case in recent years, the absolute rate increases for traffic moving at these historically low rates are small. During the same years, the L&N's new coal traffic to the Southeast has caused costs to increase more than proportionally.

In September, 1978, the Louisville & Nashville proposed a 22 percent increase in its coal rates, to cover the high capital and operating costs of hauling the new traffic. The ICC voted to allow the increase to go into effect last fall, ruling that: "While L&N's inadequate revenues may not be the only factor contributing to this service problem, additional revenues appear necessary in order to improve service and to meet the demand for coal transportation."

If all the 1977 coal traffic moved at 22 percent higher rates, the L&N would have earned $50 million more. The management estimates that some traffic would have been diverted by thr rate hike, leaving the total increase in revenues closer to $40 million. The railroad has projected almost $500,000,000 in capital investments (in 1978 dollars) to serve the predicted coal traffic over the next five years, of which the increased revenues would cover only about half.

The L&N has been and is still thought of as a profitable railroad. However, the rate of return on net investment exceeded 5 percent only once in the last ten years (5.03 percent in 1976). The cash safety factor-the percentage of rail operating revenues brought down to cash2-slipped from 16.74 percent in 1965 to 11.13 in 1973, 6.40 in 1977, and 1.02 in 1978, compared to the 15 percent considered a minimum satisfactory level for railroads. Net railroad operating income is no longer sufficient to cover fixed charges. The L&N has been sharply criticzed for maintaining dividend payments of between $10 and $15 million a year to its parent company, the Seaboard Coast Line, between 1974 and 1977. For a corporation facing the prospect of securing the repaying of large capital investments from internal funds or private borrowing, the most common and reasonable course is to put cash income into operations that can make the best return; from a stockholder's point of view that is the corporation's obligation. At the depressed rate and revenue levels of the L&N in those years, the railroad was not an attractive reinvestment prospect. In 1978 the L&N paid no dividend. The railroad reported a net loss of $31.2 million on operating revenues of $824.4 million. The steepest increases in expenses have occurred in equipment rents and fuel costs, but all rail operating expenses increased much faster than rail revenues. In this situation, the L&N cannot be cited for siphoning rail profits; it would be more accurate to say the railroad has been practicing forced "cash flow" pricing. This can only be a short-term action. In the long run, the company must increase revenue and cut non-compensatory operations, or go out of business. Since the management prefers not to take the last course and has too heavy an investment "sunk" in coal lines and equipment to abandon coal service altogether, it has chosen to try to make adequate revenues on present coal traffic.

It is in the interest of the railroad, coal producers and their employees, the state of Kentucky and all those concerned that the East have an ample supply of coal, to see the L&N's coal operations continue. Many in the coal industry and the general public, however, insist that the delivered price of coal stay at the low levels of past years. This is the source of the conflict between the railroads and suppliers and consumers of coal, and this is a central issue in the debate of rail deregulation. Economics of Deregulation and Coal Transportation

It is not cheap to extract, process and ship energy resources, including coal. The United States is now suffering the consequences of failing to face the true costs of using petroleum products. Prices held below market level have encouraged con

2 Cash income is defined as net income after taxes, plus depreciation, plus or minus retirements, minus other income, plus miscellaneous deductions. It does not include subsidies or income not related to rail operations. Cash income is divided by total rail operating revenues to calculate the cash safety factor.

sumption and discouraged investment in developing new supplies. Today the Administration maintains that prices should be based on the full resource costs of goods and services.

A major objective in deregulating the railroads is to allow rail rates to more closely reflect rail costs, so that shipping decisions can be made on the basis of the true costs of receiving the transportation service. Under deregulation, rate proposals would no longer have to be designed to meet ICC approval, but instead to meet the test of the market.

Shippers would not have to accept a system-wide or region-wide average rate and service level.

Contracts for rail service

The railroads, producers, and consumers need greater certainty in their relationships. Nowhere is this more obivous than in coal transportation. For producers, greater certainty means the assurance of a market and transportation system adequate to move their coal; for the railroads, as assured volume of traffic at compensatory rates; and for coal consumers, the necessary supply of coal at a reasonable price. Contracts, which are explicitly permitted in the Administrtion's proposed deregulation bill, should provide these assurances. Coal suppliers and customers, particularly the large utilities and industrial users, generally negotiate contracts for coal, often twenty to thirty years long. They cannot do the same with railroads. Thus, even prudent businessmen find themselves locked into long-term coal supply contracts, without corresponding assurances about rail service and price. That has contributed to the feeling of "captivity" held by many in the coal market. Under the proposed deregulation bill this disadvantage would be erased. Railroads, for the first time, would be premitted to negotiate long-term contracts for specific movements. These contracts would not be subject to ICC regulations, except those requiring that similar terms be offered to other purchasers ready, willing and able to enter a contract at the same time. To assure that the terms of a contract could be met, contract agreements would take precedence over non-contract orders. This would mean that the ICC would not be able to direct rail cars or locomotives to other shippers, as it now does. As coal producers themselves assert, the change wold be an improvement. ICC orders requiring equitble distribution of equipment among all shippers have actually reduced the overall level of service by removing cars from unit train and volume movements which carry the largest possible tonnage with the greatest efficiency.

Some observers have maintained that for low volume mines and low volume customers, particularly those buying and selling on the spot market, long-term contracts may not be a real option. These firms benefited by the low rate set by the ICC and foresee rate increases and service reductions if the deregulation bill is passed. But the ICC has not protected them from service problems or rate increases. The ICC substitutes its perceptions and judgments for the judgments of private firms in the free marketplace. The regulatory process is cumbersome and timeconsuming and the results often are not satisfactory to either side. Because the ICC cannot have complete information about the parties involved, the ICC has often failed to come to a solution suited to the particular interests of the parties involved. Control of rail equipment and track

In a rail system based on principles of private ownership, railroads must have control of their own equipment. Likewise, the present system functions most efficiently with each railroad managing its own tracks and yard, for scheduling and maintenance. Voluntary trackage rights agreements between railroads are allowed, and have been arranged in some places by mutual consent, at fees negotiated by the parties involved. In only a few cases has the government ordered a railroad to sell or share trackage rights.

Mandatory joint trackage rights have been suggested as a way to encourage the introduction of intramodal competition in areas served by a single railroad. The Administration maintains the position that such an intervention in the management of a private business should be made only where the threat of anticompetitive action is severe and the benefits of government action to promote competition are both certain and substantial. In the coal producing regions of Eastern Kentucky, mandatory trackage rights would not be likely to aid most shippers. Most railroads would hesitate to operate over another carrier's branch lines to gain access to specific shippers, particularly scattered small shippers. Problems of traffic control and the splitting of traffic, in many cases to volumes below an economic level, probably limit the prospects for entry of a second railroad. In the Southern Appalachians, geography is another serious constraint. The coal branches were built to follow the narrow, winding valleys to a main line. The L&N and Chessie lead north

from valleys east of the divide in Virginia, West Virginia, and extreme Eastern Kentucky. The ICG system is concentrated in the Midwest and runs only to a portion of the Western Kentucky coal fields. With the heaviest demand for Eastern Kentucky coal primarily to the South and Southeast, the Southern Railway would be the most logical competitor for the L&N, but the Southern's lines are across the ridge from the L&N, and operating over the mountains might be prohibitively expensive for the Southern, as it has become for the L&N. Although railroads achieve somewhat different levels of productivity and operating efficiency, no railroad could be expected to compete for a market if the rates shippers are willing to pay to the existing carrier fall far short of costs.

The railroads, the government, coal producers and coal consumers are looking for a long-term solution. For the L&N, the increased demand for steam coal has brought unexpectedly large capital and operating expenses. Coal companies and their customers have quite naturally opposed the higher rail rates levied to cover these costs, partly in fear of continuing increases. All of the parties are trying to adjust to the growing, but still uncertain, role of coal in the U.S. energy market. The railroads maintain that if they complete their coal-related projects as planned and receive the predicted volumes of traffic, the new rates will cover the capital and operating expenditures involved. It is not in the railroads' interest to drive away coal traffic earning compensatory rates; they cannot recoup their investment in track and equipment if they lose the coal traffic. On the other hand, many coal mines were built around a rail facility, and have never developed an alternative. Coal customers, particularly electric utilities and other large industrial users of coal, often rely on specific mines and the railroads that serve them. All threerailroads, producers, and consumers-claim they are "captive". In fact it is more accurate to say that they are interdependent. Once they are able to enter into longterm contracts, the relationships will be stabilized, to their mutual advantage. Conclusion

In all of its studies, the Department of Transportation has found substantial competition in the transportation market, among carriers, modes, and sources of supply. For the Eastern Kentucky coal industry, non-rail modes offer less competition than in many areas, but competition between Kentucky railroads and carrierproducer combinations in other regions is strong. Competitive forces combined with pressures from the public and from government agencies enforcing antitrust as well as transportation and energy policies can keep rail rates in line with rail costs. For some shippers, these costs may be higher than the present rates. If a firm is unwilling to pay the true resource costs of shipping by rail, the railroads should not be required to absorb the costs of carrying the traffic at noncompensatory levels. Where the long-run costs of another mode would be lower, the traffic should shift to that mode. If there is no lower cost mode and the government believes there are overriding public benefits in letting the traffic move at less than compensatory rates, then the government should pay the costs of achieving this social goal. The railroads are not financially able to bear this burden any more than the coal producers are, and forcing them to do so distorts their incentives and their investment decisions.

Adjustments to deregulated transportation pricing may cause disruption for some firms. The Administration's deregulation bill is designed to ease the transition. In the long run, coal and energy policies will not be effective without a healthy transportation system. Transportation and energy policies both must serve the economic and social interests of the nation as a whole. U.S. coal resources will not be developed and used if the transportation network is not sound. In particular, the railroads cannot contribute to the domestic energy situation unless they are able to cover the long-run costs of handling coal and other energy resources. Sound rail policy and sound energy policy can and must agree.


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Source: U.S. Department of Energy, Coal-Bituminous and Lignite, 1976, 1977, and 1978; U.S. Department of the Interior, Bureau of Mines, Mineral Industry Surveys, 1973, 1974, and 1975.


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Source: National Coal Association, Coal Traffic Annual 1978 edition, citing U.S. Bureau of Mines figures on class I, II, and private railroads as

reported by mine operators.


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Source: National Coal Association, Coal Traffic Annual, 1978, as reported by mine operators to the U.S. Department of Energy.


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Source: National Coal Association, Coal Traffic Annual 1978 edition, citing Association of American Railroads.


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Source: National Coal Association, Coal Traffic Annual 1978 edition, citing Association of American Railroads.


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