Prior to the Staggers of Act of 1980, the only way a Class I railroad could shed the cost of marginal or money losing light density rail line was abandonment. It was a costly and lengthy regulatory process, and if successful left shippers on the line high and dry, eliminated railroad jobs associated with the line, and resulted in railroad infrastructure being torn up and sold for scrap. The economic freedoms and regulatory flexibility unleashed by the Staggers Act provided an opportunity for a group of entrepreneurs to purchase or lease these lines creating new short line railroads. These entrepreneurs bet on the notion that the more realistic cost structure of a smaller operation combined with the more flexible service of a local company would bring back these marginal lines. The result was dramatic. In 1980 short lines operated 8,000 miles of track. Today they operate nearly 50,000 miles of track, almost all of which was headed for abandonment.
It was a risky bet because these lines required substantial capital investment to eliminate decades of deferred maintenance by their previous Class I owners. Given that requirement, the lowest possible purchase price was essential and in a large percentage of these transactions the Class I sellers offered a lower purchase price in exchange for certain conditions placed on the buyer. Those conditions most commonly included a prohibition on interchanging traffic with another railroad or financial penalties if volume guarantees are not met. These conditions are known as “Paper Barriers.”
Some will argue that paper barriers were the grease that made line sales or leases possible by reducing the cost to the buyer. Be that as it may, the Class I seller is the huge winner. It offloads all the costs of operating and maintaining the line while still getting all the traffic and associated revenue directed to its long haul network. Further, the ability to direct all the traffic over its own interchange gives it monopoly-like pricing power over any new business generated by the short line. Meanwhile, the short line buyer gets all the risk – paying for the cost of operating and maintaining the line, and hoping it can secure a competitive rate for any new traffic it is handing off to its Class I interchange. It’s a risk-reward combination that makes paper barriers one of the most anti-competitive practices in the railroad industry. Most egregious is the fact that many paper barriers remain in place long after the short line has increased traffic far above the declining level available to the Class I when the line was sold. They got what meat was left on the bone at the time of the sale and now decades later they are still getting all the gravy.
The diagram (see below) illustrates the downside of the most common paper barrier whereby the short line can only interchange traffic with the Class I seller. This paper barrier requires A&A Grain carload traffic to travel 200 miles to B&B Bread Co. versus 75 miles via the alternative Class I connection. The longer circuitous route costs the short line, the shipper, and the customer both time and money – valuable commodities in a competitive marketplace. If, as is generally the case, the short line has increased its carloads since the original Class I sale, the Class I remains the primary beneficiary from the new traffic.
The Union Pacific Railroad (UP) has recently announced its intention to merge with the Norfolk Southern Railway (NS) creating the first transcontinental railroad. The merger must be approved by the Surface Transportation Board (STB), and the STB is required to show that the merger will enhance competition. In preparation for its analysis the STB is requiring the two railroads to provide a detailed list of all the paper barriers that limit or may limit interchange with a third-party connecting carrier. Both UP and NS were active sellers of light density lines following the Staggers Act and are likely to have a significant list of paper barriers. This merger will create the largest railroad in North America and its size alone will give it enormous market power. The STB can take a good first step in insuring that this new mega railroad enhances competition by requiring that all paper barriers be eliminated.
Jim Bowers is a Certified Public Accountant. In 1980 he founded the Syracuse, New York accounting firm Bowers CPAs and Advisors providing a large clientele of short line railroads assistance in financial and tax planning, mergers and acquisitions, and payroll services. Prior to his retirement he was an active member of the American Short Line and Regional Railroad Association (ASLRRA) and in 2024 received the Association’s “Schlosser Distinguished Service Award” for his contributions to the short line industry. He currently resides in Liverpool, N.Y. and continues to do consulting work with his former firm.
