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SMART Just Got Hit by a Freight Train – PART II

Posted by: Mike Arnold Ph.D. - August 27, 2020 - 8:52 PM PDT

This is Part II of a series that investigates the recent purchase of the old NCRA freight railroad service from the Northwestern Pacfic Company.

Freight vs. Trucks: The Factors Considered by Businesses that Need to Ship their Products

Should businesses ship their goods by freight rail or truck? This question has been part of the freight transport business the day trucks became wildly available after the invention of the automobile.

The environmental benefits associated with transporting cargo by rail rather than trucks that are frequently cited in local media are:

Another of the oft-repeated statements by various advocacy groups and politicians is, “freight rail removes trucks from the freeway.” This is a wild simplification because to get goods to be shipped onto freight trains requires delivery by trucks to a freight loading platform and pick-up by trucks from the freight station where the goods are transported. However, this simplification is sometimes used to rationalize public subsidy of freight rail operations.

In reality, there are many economic factors that determine the choice by businesses to ship by truck vs. rail when they have the choice and the net environmental benefits depend on multiple factors.

One of the ways to understand this is by considering the choice of businesses that need to ship their goods from where the goods are produced. What do they consider? There are many websites available to help businesses make this selection and these are summarized in the table below (see table 1).

Table-1-Pros-and-Cons-of-Shipping-Freight.JPG

As indicated in the table, one of the critical issues is how far the goods are going to be shipped.

Trucking services dominate distances that are under 750 miles. For instance, most containers arriving at the Port of Oakland heading to Los Angeles are placed on trucks, rather than freight trains awaiting loading near the port. There are multiple reasons for this, but the foremost reason is time; it takes a long time to load freight trains, while trucks awaiting loading can depart as soon as a container is placed on their truck.

In addition, when freight trains are used to ship goods, they can only be shipped to a freight terminal, requiring unloading and reloading by truck services who then deliver the goods to the ultimate destination. Trucks leaving the Port of Oakland heading for warehouses in Southern California can deliver the goods directly to the destination in about six to seven hours, depending on traffic and the ultimate destination.

So, the choice of how to ship goods is an economic one. These underlying economics facing shippers explains why so little is shipped by freight rail on the SMART-owned track. The freight line owned by SMART is relatively short, serving a relatively small population of businesses that may find shipping by rail advantageous. At the June 29, 2017 CTC hearing reviewing an NCRA business plan, Vice Chair Susan Inman stated,

“The short line freight business is a difficult business. Post [the] Staggers Act we saw a lot of the short lines go out of business. Where they tend to be successful is where there is high volume and when they’re service multiple class ones. As much as we’d love to migrate more freight to rail it just doesn’t economically make sense. It sounds to me here we have exactly that example where it doesn’t economically make sense.”

Astonishingly, the underlying economics of the freight rail business were not even mentioned at the May 20, 2020 SMART Board meeting that approved the takeover of the north coast freight rail service.

SB 1029 (McGuire) Approved by Gov. Brown, September 29, 2018

The passage of this legislation provided the legal basis for two significant changes to the future ownership and operations of the Healdsburg to Humboldt County rail right-of-way.First, SB 1029 dissolved the NCRA’s oversight of freight traffic currently operating in the SMART-owned right-of-way. Second, it provided for the transfer of the oversight of freight operations to SMART (and that responsibility extends to Willits) should freight service be extended further north from Windsor.

From an environmental perspective, it removed any potential for freight operations north of Willits in the Eel River Canyon, and created the process to create the “Great Redwood Trail” through the Canyon.

SB 1029 allocated $4 million for the purpose of providing payment to NWP Co.—the exact amount to be determined—but is owed for the loans from NWP Co. to the NCRA for NCRA’s operations and capital improvements.

The new law also gives the SMART the ability but not the funding to negotiate for the takeover of the complex, long-term freight contract that NCRA signed with NWP Co. As written, SB 1029 could provide SMART with full control of the rail line from Marin to Willits in Mendocino County.

While the bill contains many specifics, here is one of the key statements in the legislation (the “authority” refers to NCRA):

The Legislature finds and declares that it is in the public interest to dissolve the authority, and to transfer its rights-of-way to other entities for the purpose of potentially developing a trail that could include railbanking and continuing freight where it was operational on January 1, 2018.

Other relevant specifics in the bill are as follows:

It provides for the Transportation Agency to perform an assessment of various items—referred to as an “audit” at the SMART Board meeting—to be completed by July 1, 2020 of the following, pertaining to the southern section of the right-of-way:

See my comments below and the representations made at the SMART Board about this report.

Based on emails from the State Dept. of Finance and phone follow-ups with Dept. of Transportation staff, the “audit” report has still not been completed as of August 4, 2020. SB 1029 is the legal basis for the purchase of NWP Co. assets and the transfer of the Operating Agreement that was approved by the SMART Board at the May 20 SMART Board meeting.

The question that Marin and Sonoma County taxpayers should be asking is why the Board did not insist on being provided financial information before making the decision as called for by former SMART Chair Mayor Gary Phillips of San Rafael.

The answer to that can be found in the comments made at the May 20th SMART Board meeting.

Comments from the May 20th SMART Board Meeting

The transcript of the May 20th SMART Board meeting is very long because the discussion occurred over a two and half hour period. (to read the entire transcript, CLICK HERE)

However, based on what transpired at the hearing, some key takeaways are as follows:

1) The SMART Board adopted resolutions authorizing the purchase of NWP Co. assets, becoming the owner of the Operating Agreement, and agreeing to apply to the State Transportation Board (STB) to become a “common carrier,” without requiring any financial information to be brought before the SMART Board.

Consider the following:

“I’ll be happy to share anything I get from the state and all of the NWP Co. financial information, once that is provided to us.”

“SMART does not have copies of the financial statements or reports that are in the state’s possession.”

“When we were going through the negotiations of 1029, we staff determined that we need to go back and do additional and ongoing maintenance on the Highway 37 area Brazos branch, as well as the new area north of Healdsburg. We estimated that we need $10 million to do so.”

“I am against this board not performing due diligence on a very complicated issue, which is the ownership of a private business, which you know nothing about, and have no one in the room representing the taxpayer and the SMART Board with regards to due diligence, and many, many questions that have already been asked and not answered by people who are commenting on the proposal before you. For example, your General Manager mentioned a $10 million study. What $10 million study? He’s got the $10 million study. Have you seen the $10 million study? Do you know whether or not it covers all of the potential pitfalls and risks associated with owning a business?”

[Note:This comment was in reference to a staff estimate that taking over ownership of freight operations would ultimately cost the agency $10 million.]

2) As a consequence, neither the SMART Board nor the public was provided information on whether the proposed acquisition will help or hurt SMART, financially. The Board was provided no information on the downside financial risks associated with the following:

“I don't want to disclose the exact numbers because that’s our proprietary information.”

“As the common carrier, SMART will need to continue to provide freight transportation to all existing local customers and to all parties on the rail line upon reasonable request, including requests for the transportation of hazardous materials. In addition, as the common carrier for freight, SMART must now also comply with the all the requirements and regulations of the Surface Transportation Board.”

[Note: Even though he said there were these exposures, there was no attempt by him or the Board to quantify how large they may be.]

3) Further evidence that not even staff understands the economics and future revenues and expenses associated with owning freight service is found in the SMART CFO’s written memo to the SMART Board on June 17, which asks,

“Does the Budget Include Anticipated Freight Revenues and Expense? There are a number of steps remaining before SMART can assume freight responsibilities, including approval by the North Coase Railroad Authority (NCRA) of a property transfer, State of California approval of $2 million allotment and the $4 million for the purchase of Northwest Pacific Company (NWPCo.), Surface Transportation Board common carrier license approval, and negotiations with NWPCo. For interim freight service. These steps can take several months and are not guaranteed. Any rejection or appeal of any of these decisions can alter the final outcome. Thus, we did not feel it was prudent to include uncertain revenue and expense in the budget at this time. If, following those approvals, we feel that a significant budget change is warranted, we will report to the Board and adjust the approved budget accordingly.”

4) Only one SMART director (former SMART Chair Gary Phillips) objected to this procedure. All the others endorsed this incredibly imprudent and irresponsible process. Phillips stated, (1 hr., 48 min on the video):

“I find it almost incomprehensible that when faced with this kind of decision, with so many unknowns, certainly for the board, at least this one board member, are faced with making this decision between now and June 30.”

5) Representations were made at the Board meeting that the State Dept. of Finance had completed its analysis.

“Auditors from the Department of Finance and the experts at the State Transportation Agency have gone over this deal with a fine-tooth comb and I trust them when they say the deal is worth the investment.”

“Once SMART and NWP Co. had come to the conclusion that this is something that they wanted to do, it was submitted to the State Department of Finance... The current administration went into their analysis of this for the last four or five months. They took a tour of the line, especially from Novato to Schellville, looked at it individually themselves and went through pretty much every aspect that they could have. They talked to Mr. Bosco and his folks extensively, certainly the NCRA, and of course SMART… and have all come away with a conclusion that that is, in fact, well worth the state dollars in this time of COVID.”

“SMART does not have financial information. The State of California is purchasing the acquisition through SMART. The State of California Task Force have reviewed NCRA and NWP Co. financial documents and are satisfied with the results. Once SMART receives any additional financial correspondence he will provide it to the Board.”

“Regarding the report pursuant to legislation, it is in the final stages of review by the Transportation Agency. Unfortunately, due to the COVID emergency, many priorities had to be shifted over the past several months. However, we expect this report to be publicly available shortly.”

In a follow up email with the Dept. of Transportation (Aug. 5, 2020), I was told the report is still not completed.

6) A careful reading of SMART GM’s memo indicates that while staff estimated that there are $10 million in identified costs, only $2 million is potentially available in the near term.Based on follow-up phone calls with Jason Liles, there are no bills currently in the legislature authorizing the additional $8 million to cover these costs, after SMART assumes the liabilities.

7) Representations were made at the May Board meeting that SMART was a “friend of freight.” This view was contradicted by comments from members of the public.

“As environmentalists we want to see the maximal use of freight rail and fewer trucks. SMART has absolutely no history of a friendly relationship to freight rail. In my written comments, I've pointed out how SMART has placed numerous obstacles to a successful freight rail operation. It's on that basis that TRAC finds SMART’s declaration that it wants to operate freight highly suspicious."

“SMART held many industrial spurs and sidings. Frankly, I agree with what David Schonbrunn said. SMART has forced the NWP to make their lives a lot harder: they were forced to run at night, they lost a lot of sidings, a lot of possible business. So, frankly there is a good possibility that this is just another scheme from SMART, let’s force all the freight business out once this deal goes through.”

Representations made at the meeting regarding the state’s interest in continuing to support freight services are contradicted by an email to me (July 2018) from a staff member of the Assembly, in which it states,

“Freight operations are going to cease upon the elimination of NCRA, so the operating costs are not going to be much. Sure, there may be some general oversight, and future maintenance of the ROW is a concern, but my understanding is that there is either going to be a deal made identifying more funding for work like that or the bill won’t get signed into law. So you are correct to worry about this, but I think that it will be resolved before any action is taken. SMART isn’t going to absorb costs without additional revenue, and the state isn’t going to either without identifying a source to pay for it.”

What was really behind the Purchase of NWP Co. Freight Trains?

What follows is what I have been able to piece together based on multiple conversations with various individuals. Much of what was presented and what wasn’t discussed at the May 20 SMART Board meeting occurred behind closed doors at Senator McGuire’s behest, including the provision of state funding to SMART.

Note: Discussions on www.altamontpress.com (a well-known freight rail blog) frequently refer to Farhad interfering with additional freight services.

In my opinion, the entire push for the purchase transaction was to get all of the rail operations—passenger and freight – into public ownership and to get the Board to “rubber stamp” the transaction without considering the many known risks to SMART, passenger service, and Marin and Sonoma taxpayers.

Farhad stated at the meeting that “they” had estimated the ownership of freight rail operations would cost the agency $10 million.As noted, while there was no documentation of the estimate that was provided, only $2 million of this cost was potentially available.Senator McGuire pledged to work with SMART to obtain the additional funds, but there are no guarantees he will be successful.

Whether this transaction is a benefit to local taxpayers in Marin and Sonoma counties remains to be seen.

Caveat Emptor

It is impossible to come away from all this without feeling that the SMART Board failed to do the job it was empowered to do and expected by Marin voters. It did not adequately represent the voters who elected them.

As Gary Philips said, it is “incomprehensible” that the Board would insist that financial information that existed, prior to committing the agency and taxpayer dollars to something voters, not be presented to them or considered.

It’s a safe assumption that the only person who any idea about risks and rewards entailed in running freight operations over SMART’s newly acquired North Coast rail line, was Doug Bosco, part owner of NWP Co, who, by the way, is the only one walking away from the table with no liabilities and millions of dollars of taxpayer funds in his pocket.

Bosco was legal counsel to NWP Co. prior to and following the signing of the Operating Agreement between the NCRA and NWP Co.The SMART Board, its management, and Senator McGuire, on the other hand, have zero experience in doing either.

At a time when SMART should be hyper-focused on its own financial troubles and the constraints it has placed on providing passenger rail service, they have chosen to roll the dice, knowing full well that they know nothing about the freight business or operating freight trains, nor what risks it may be exposed to in the future.

Some might say that they are allowed to do this. The problem is they are playing with taxpayer money.After badly losing a tax extension measure (Measure I) on March 3rd, one would think they would be particularly careful about exposing future rail service to financial risks caused by the freight trains.Instead, they ducked their responsibility to the taxpayers and the voters.

[1] See comment #3 in the prior section.

CLICK HERE TO READ PART I

Arnold is a PhD economist, currently lecturing at the Fromm Institute (USF) and in the Osher Life Long Learning Institute (OLLI) at Dominican University and Sonoma State University.