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All Aboard: Why America's Second Rail Boom Has Plenty Of Room To Run

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This story appears in the February 9, 2014 issue of Forbes. Subscribe

The relic of the 19th century will become the most important logistics system of the 21st century--making billions for Warren Buffett and others. By Joann Muller, Zack O'Malley Greenburg and Christopher Helman

On an overcast Tuesday morning in dusty North Platte, Nebr., Tony Orr stands at the center of the world's largest freight rail yard, watching as billions of dollars' worth of commodities and goods roll by. He's the general superintendent of Union Pacific's Bailey Yard--at 2,850 acres, it's three times the size of New York's Central Park and handles 10,000 train cars per day on 315 miles of track.

Orr's view is a soot-caked cross-section of the American economy. To his left a 1.25-mile-long train trundles west toward Wyoming to refill after dropping off 30 million pounds of coal; to his right 140 double-stacked cars clack off to the East Coast with furniture, auto parts and electronics from China and Japan. Beyond, westbound grain trains shriek through the yard while refrigerated cars the color of dirty snow carry fresh produce from California to the Mid-Atlantic, and rusty blue boxcars bear lumber from the Pacific Northwest to points east. "We stay busy," says Orr. "It's like New York--this place doesn't sleep."

Rail is on a roll, and not just in North Platte. Thanks to leaps in technology, the rising price of diesel and improved delivery speeds, more and more freight traffic has moved from roads to rails, where trains can move one ton of goods about 500 miles on a single gallon of fuel. Since 2009 Union Pacific's weekly carloadings have increased from 133,000 to 180,000, helping the company achieve record earnings every quarter since the beginning of 2010. Since 2009 its stock price has surged 350% while competitors like Kansas City Southern and Canadian Pacific have seen shares more than double, all of which makes Warren Buffett's $34 billion purchase of the rival Burlington Northern four years ago look like the great train robbery: FORBES estimates BNSF is worth about $65 billion today.

The industry, so recently an aging also-ran in the age of superhighways, is now a fountain of superlative figures: Industrywide, revenues have surged 19% from $67.7 billion to $80.6 billion since 2009, creating 10,000 new jobs at railroad companies and countless thousands in related industries--and paying out $21 billion in wages last year alone, up nearly $1 billion. As the U.S. population swells, the Federal Railroad Administration projects that the tonnage of freight shipped by the U.S. rail system will increase 22% by 2035.

"This is the best they've been doing in half a century," says rail consultant Carl Martland, a retired MIT lecturer. "It's hard to imagine a scenario where there is not growth. People are going to continue to eat, heat our homes, buy cars. If everything else is outsourced, that means all the products are going to be coming into the United States at a port in containers. How are they going to get where they're going? They're going to Chicago, Memphis, everyplace else by rail."

All of which is driving a multibillion-dollar revival in rail R&D and infrastructure, investment unseen in America since the transcontinental railroad. Thousands of new state-of-the-art locomotives--far more fuel efficient and less polluting than the ones they replace--are now operating on U.S. railroads.

The most impressive fact of all is that the boom has been underwritten by industry, with no cost to taxpayers. That's annual infrastructure spending of $20 billion--including $3 billion so far on a massive, federally mandated safety upgrade known as Positive Train Control. Contrast that to America's highways, which receive $40 billion a year in federal subsidies. "It's paid for by private investors," says Union Pacific Chief Jack Koraleski. "In today's world, where the tax dilemmas are mounting and there are so many issues, the rail industry is one of the true success stories."

It isn't all good news, of course. Carloads were roughly flat last year, due to weakness in the coal industry and other commodities, and are still 16% below peak 2006 levels. And as rail has been rejuvenated, so have concerns about safety and the environment, highlighted by a string of deadly oil-train explosions. But rail's new success is far from a fad. There's plenty of indication that we're just in the early stages of a surprising renaissance.

***

America's second great rail boom started with tragedy. On a sunny southern California day in September 2008, an engineer guiding a crowded commuter train, reportedly distracted by texting with a teenaged train enthusiast, blew through a red light and rammed head-on into a Union Pacific freight train. The driver was killed, along with 24 passengers; an additional 135 were injured. It was the worst accident on the rails in nearly two decades. The following month Congress passed the Rail Safety Improvement Act of 2008, requiring the country's major railroads to fund, build and implement a new, safer "Positive Train Control" system by the end of 2015. The law called for Union Pacific alone to refit an average of 2.5 locomotives and 10 miles of track per day for seven years, placing GPS devices on every locomotive.

Diesel fuel had topped $4 per gallon. At first it seemed the new technology might reduce costs substantially. UP alone consumed 1.2 billion gallons of fuel that year--second only to the U.S. Navy--leading prognosticators to believe the efficiency gains brought on by the new system could cut fuel consumption by as much as 8%, saving UP nearly half a billion dollars a year.

Then the bottom fell out of the economy. Rail revenues plunged 20% in 2009 to their lowest levels in five years. Railroads laid off 14,000 employees and stripped more than $2 billion in wages from their books in a single year. Then there was that pesky train-control system, which looked a lot more expensive after diesel dipped toward $2 per gallon.

"Even the government has said it's a dollar returned for every $22 invested," says Koraleski. "It's a pretty complex law, and it's probably the single most complex piece of technology the railroad industry has ever undertaken."

Nonetheless, with the plodding pace of a coal train snaking through the Rockies, the beefed-up train control system--more likely to be completed, Congress willing, in 2020--has been revolutionizing freight hauling in America, allowing the railroads to pinpoint a locomotive's location within one yard (and remotely stop it if an engineer ignores a signal). Safer, yes, but also more efficient: Instead of sending trains speeding across the country only to stop at each red signal, the new system means conductors will be able to know about planned stops well in advance, allowing them to simply reduce speed (and fuel consumption) to a level that won't force them to stop altogether and burn major amounts of fuel when restarting from a standstill.

These increased efficiencies have dovetailed with a better economy. Diesel is once again edging toward $4 a gallon--so Positive Train Control costs feel a bit less of an albatross--and manufacturers are turning to rail for shorter and shorter shipping jobs. Less than a decade ago diesel prices were so low that manufacturers rarely considered rail for shipments of less than 1,000 miles. Now they're ditching trucks in favor of trains for jobs as short as 500 miles.

Ironically, the biggest growth area for the rail industry is oil itself. The Great American Energy Boom has been a boon for the railroads, especially when the gushers are found in spots uncrossed by pipelines, like the Bakken formation of North Dakota. EOG Resources contracted the first crude oil train out of the Bakken in 2009. Now BNSF, for one, is moving 600,000 barrels of oil per day (enough oil, once refined, to fill up the gas tanks of 1.35 million cars), up from 54,000 barrels in 2010.

Canadian crude is moving by rail as well. With a few more years of growth, railroads might be handling as much Canadian oil as was meant for the sandbagged Keystone XL pipeline--about 300 million barrels per year. BNSF now has 10,000 tanker cars dedicated to moving oil. "We're on the path to 1 million barrels per day on our railroad," says BNSF Chairman Matt Rose. The growth "is like nothing I've seen in my career."

It's not just crude the railroads are shipping. For every new oil or gas well that gets drilled and fracked, the oil companies haul in 40 railcars of materials. There's crushed rock and concrete to build pads for drilling rigs. And fracking each well requires hundreds of tons of sand that gets shot down the wells to prop open tiny cracks to let the oil and gas through. Much of that sand is flowing by rail from mines in Wisconsin.

All this moving oil, of course, poses increased risk. On July 6 an oil train operated by Montreal, Maine & Atlantic Railway crashed in Lac-Mégantic, Que., killing 47, destroying the town's core and spilling hundreds of thousands of gallons. In Alabama last November, 25 cars on a 90-car oil train derailed in another inferno that dumped thousands of barrels into marshland. And in the last week of December a BNSF train carrying grain derailed near Casselton, N.D., causing a collision with a 106-car oil train; 18 oil cars derailed and several burned. Recent data from the Manhattan Institute find trains are four times more likely to have accidents than pipelines, but pipeline spills release significantly more oil than train accidents. Still, "the railroads carry oil right through town, over rivers and pastures," says the Sierra Club's Wayde Schafer. "When routing pipelines at least you can take them around populated areas."

Prompted by these incidents, the National Transportation Safety Board investigated the safety of moving Bakken crude by rail. It determined that many railcars now moving Bakken oil are too old and need to be replaced or retrofitted to meet new safety standards. Both Ottawa and Washington are likely to impose stricter regulations on oil shipments. "Newer railcars are much stronger and don't crack like an egg," says Schafer.

The industry agrees. Edward Hamberger, president of the American Association of Railroads, says it's time for the Department of Transportation to review standards for tank cars that carry hazardous materials. "There's 92,000 cars that need to be assessed," he says. "If they can't be retrofitted, then they should be phased out."

Who will benefit from that replacement cycle? Buffett's Berkshire Hathaway, for one. Even before acquiring BNSF, Berkshire in 2007 bought Union Tank Cars.

***

The next generation of railroading is taking shape inside a massive, sparkling white building in Fort Worth, Tex. A starry-eyed developer once envisioned this building as a sophisticated distribution center for the likes of Amazon and Wal-Mart. Instead, GE Transportation, a subsidiary of General Electric, turned the empty shell into a showcase for advanced manufacturing. For more than a century GE has been building locomotives at a massive complex in Erie, Pa., where it employs 5,000. But the Fort Worth plant, which opened in January 2013 in anticipation of increased demand, is 20% more efficient.

Wal-Mart could fit nearly ten of its discount stores inside this million-square-foot factory, where approximately 12,000 parts come through the loading docks every day and four locomotives lumber out each week (the plan is five per week by the second quarter). It is bright and airy, with ceilings so high a locomotive can be somersaulted to install its wheels. With the help of massive, overhead cranes, a lean staff of 400 newly hired GE workers in matching black polo shirts, some toting iPads, snap locomotives together like kids with a Lego set, popping five preassembled modules onto a 73-foot-long steel platform. The 12-cylinder engines are brought in from GE's plant in Grove City, Pa.; the alternators come from the Erie factory; the traction-motor combos from a GE facility in Mexico.

These 220-ton rolling power plants are majestic. But GE's locomotives--as well as those from rivals like Caterpillar, Siemens and Bombardier--are smart, too, crammed with as many as 250 sensors and 20 or more microprocessors to monitor critical functions and performance. By analyzing the massive reams of data collected, GE helps railroads and their customers increase their productivity, decrease fuel use and minimize downtime. GE's new monitoring and diagnostics software, RailConnect 360, can even predict train breakdowns before they occur.

An example: Trains snaking across undulating terrain are like Slinky toys. On the way up a hill the cars pull apart; on the way down their tendency is to crunch together. GE Transportation's new Trip Optimizer is a smart cruise-control system that knows the slope of the hill, the length and weight of the train, its contents and its braking ability. It then automatically regulates the train's speed to maximize its efficiency and consume the least amount of fuel.

The data come from GPS signals, track-topography maps and sensors embedded in the locomotive. All of which gets fed into complex train-handling algorithms. The train is not fully automated like some passenger rail systems (parts of the Paris Metro, for example); the conductor remains in control. But the system is smart enough to know when a curve is coming or a section of track is occupied, and automatically starts slowing in a controlled manner to smooth out that Slinky effect.

The system is already in use by eight railroads on 2,500 locomotives in North America, Australia and Brazil. Customers have seen fuel savings of 3% to 17%, depending on the type of train service and topography, GE says. The company says locomotives equipped with Trip Optimizer have already logged 100,000,000 real-world miles, saving some 25 million gallons of diesel fuel. Norfolk Southern estimates that an increase in network velocity of just one mile per hour will save the company over $200 million a year.

GE is also piloting new technology that will help rail yard managers get the right railcar on the right train more quickly. Currently railcars sit idle in a rail yard about 40% of the time. That lack of productivity irks customers like Ford Motor, whose chief operating officer, Mark Fields, met with railroad officials last year to plead for faster turnaround times after its vehicles were piling up in parking lots waiting for enough rail carriers to take them to dealerships. That problem has largely been resolved, Ford says.

Today's diesel locomotives are a lot cleaner than those 19th-century coal-fired steam engines, but they're still not clean enough. The rail industry faces tough new diesel-emissions standards starting in 2015, and GE spent five years developing new engine technology that it says will meet the new regs without the need for costly after-treatment.

Now GE is focused on fuel, rolling out a new line of locomotives that can operate on liquefied natural gas and reap up to 50% savings over diesel (of which the freight-rail industry uses 3.5 billion gallons a year). That's critical, since rival over-the-road heavy truck fleets are shifting to cheaper natural gas, too. BNSF and Canadian National are already testing converted natural gas trains around North America.

"I think it's real," says Lorenzo Simonelli, who led GE Transportation until last October, when he became CEO of GE Oil & Gas. "If LNG technology fulfills its promise and is adopted throughout the nation's freight railroad locomotive fleet, natural gas would be the most transformative change in the railway industry since diesel replaced steam."

***

Meanwhile, back in the present, in North Platte, Tony Orr and Union Pacific's chief information officer, Lynden Tennison, are perched atop an observation tower nearly 100 feet above the Bailey Yard, practicing a little innovation of their own, as individual railcars far below are sorted into new trains through a time-honored technique called "humping." Mustard-yellow engines push chains of cars up one of the yard's two hills, or humps. Then, as each car crests the incline, it's remotely detached from its neighbor, rolling down alone on its own momentum. Next, it's routed by a series of switches onto one of a dozen or so trains forming on parallel tracks at the bottom of the hill.

In recent years railroads have been using this process to build longer and longer trains, Tennison says, pushing lengths from 10,000 feet to as much as 15,000 feet in some cases, thereby boosting fuel efficiency and cutting crew costs. In 2010 Union Pacific even tested a double-stacked 18,000-foot train, running it from Texas to California--and drawing some complaints from motorists over five-minute waits at road crossings.

"There's almost no limit," says Tennison, staring out across the yard below. For the trains, or for the industry itself.

Four Ways to Ride

Railroad shares like Carl Icahn's American Railcar Industries have been on a tear, but there is still room to get aboard these four stocks.

American Railcar Industries (ARII)

It's enjoyed a terrific run, and with a P/E of 11 remains cheap compared to peers. No sign of slowing, thanks to oil boom.

Genesee & Wyoming (GWR)

Biggest operator of short-line railroads in U.S. doubled in size after buying RailAmerica. Plenty of other targets remain.

Trinity Industries (TRN)

Another railcar maker, Trinity also benefits from the fracking boom. New safety mandates should keep the rally going.

Westinghouse Air Brake Technologies Corp. (WAB)

Will keep chugging, thanks to train control mandates. "A lot of spending still needs to occur," says Justin Long at Stephens Inc.

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