Order No. 1994-R-515

December 22, 1994

File No. T6130-3

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WHEREAS notice of the agreement was filed with the National Transportation Agency of Canada (hereinafter the Agency) on July 28, 1994 pursuant to subsection 158(2) of the National Transportation Act, 1987, R.S.C., 1985, c. 28 (3rd Supp) (hereinafter the NTA, 1987);

AND WHEREAS submissions both in support and opposition of the proposed agreement were filed with the Agency;

AND WHEREAS on October 14, 1994, the Agency appointed Mr. Keith Penner as an Inquiry Officer to make an inquiry and report on the agreement, pursuant to subsection 32(1) of the NTA, 1987;

AND WHEREAS the Agency has considered all matters and documents on file concerning the agreement and the Report of Mr. Keith Penner which is appended hereto.

THE AGENCY HEREBY ADOPTS THE REPORT AS ITS DECISION AND DETERMINES THAT:

ACRI is a company authorized to operate the line to be conveyed and there was not sufficient evidence to conclude that the proposed conveyance would not be in the public interest.

THE AGENCY HEREBY ORDERS THAT:

The agreement for the conveyance between ACC and ACRI to transfer the termini and lines of railway between Sault Ste. Marie, Ontario and Hearst, Ontario over the Soo and Northern Subdivisions and between Hawk Junction, Ontario and Michipicoten, Ontario over the Michipicoten Subdivision is hereby approved.

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Inquiry Report into the proposed conveyance of the Algoma Central Corporation's Rail Division to Algoma Central Railway Inc.

File No. T6130-3

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December 22, 1994

INTRODUCTION

On July 28, 1994, the National Transportation Agency of Canada (hereinafter the Agency) received notice from the Algoma Central Corporation (hereinafter ACC) that it had entered into an agreement with Algoma Central Railway Inc. (hereinafter ACRI) for the sale of ACC's termini and lines of railway between Sault Ste. Marie, Ontario and Hearst, Ontario over the Soo and Northern Subdivisions and between Hawk Junction, Ontario and Michipicoten, Ontario over the Michipicoten Subdivision. Notification of the proposal was filed pursuant to subsection 158(2) of the National Transportation Act, 1987, R.S.C., 1985, c. 28 (3rd Supp) (hereinafter the NTA, 1987).

Under this proposal, ACC intends to sell its railway land and certain other assets to ACRI, a Canadian railway company which will become a wholly-owned subsidiary of WC Canada Holdings, Inc. ACC will also be selling its rolling stock to WCL Railcars Inc., which will provide ACRI with the necessary rolling stock to operate the railway. In addition, ACC will be selling its interest in ACRI to WC Canada Holdings, Inc. by way of a stock purchase. WCL Railcars Inc. and WC Canada Holdings, Inc. are wholly-owned subsidiaries of the Wisconsin Central Transportation Corporation (hereinafter WCTC).

ACRI has indicated that it is its intention to continue to operate the tour train services, the passenger train service between Sault Ste. Marie and Hearst, Ontario and the freight service of ACC. The Government of Ontario, through its Northern Ontario Heritage Fund Corporation, is participating in the restructuring by supplying financial assistance to ACRI.

On October 14, 1994, I, Keith Penner, Member of the Agency, was appointed as the inquiry officer pursuant to section 32 of the NTA, 1987 to consider this matter. Under the terms of reference, I am required "to inquire into any and all matters which appear relevant pertaining to the Notice of a conveyance dated July 28, 1994, filed by Algoma Central Corporation pursuant to subsection 158(2) of the National Transportation Act, 1987." I have been directed to prepare a report for consideration by the Agency that will enable it to render a decision on the matter.

In fulfilling my mandate, I reviewed and considered all material filed with the Agency. I also conducted a series of meetings with ACC, WCTC, the Government of Ontario, Algoma Steel Incorporated (hereinafter Algoma Steel) and Local 885 of the United Transportation Union (hereinafter the UTU).

AGREEMENTS

Three main agreements were filed by ACC, namely the Rail Line Asset Purchase Agreement, the Rolling Stock Purchase Agreement, and the Stock Purchase Agreement.

Under the terms and conditions of the Rail Line Asset Purchase Agreement, ACRI will be acquiring the line of railway running between Sault Ste. Marie (mileage 0.00) and Hearst (mileage 294.71) on the Soo and Northern Subdivisions and the line of railway running from Hawk Junction (mileage 0.00) to Michipicoten (mileage 24.85) over the Michipicoten Subdivision, a total distance of 319.56 miles, as well as all connecting branch lines, sidings, spurs and wyes, and all rail lines, associated rights-of-way, real property or other interests. Included in the transaction is the rail and track only on the Michipicoten branch line from mileage 24.85 to and including the dock (but not the underlying real property). In addition to all real property required to operate the railway, ACRI will be acquiring all interests in and agreements relating to industry, side tracks and facilities, and all yards. Finally, ACRI will be subject to all orders issued by the Board of Transport Commissioners for Canada, the Agency, the Federal Minister of Transport, the Railway Transport Committee or any predecessor that pertain to the rail operations of ACC.

Under the Rolling Stock Purchase Agreement, all rolling stock presently owned by ACC will be sold to WCL Railcars Inc. This includes 23 locomotives, 21 passenger cars, 176 flat cars, 10 box cars, 503 gondola cars, 5 woodchip cars and 272 hopper cars. All locomotives and freight cars will be pooled into the WCL Railcars Inc. equipment fleet. Locomotives will be provided to ACRI by way of long-term leases while other equipment will be made available on a car-hire basis, similar to the manner in which WCTC leases equipment to its two other rail subsidiaries. To meet the anticipated rail requirements of ACRI, WCL Railcars Inc. will be acquiring an additional 300 cars which will be added to the equipment fleet. ACRI is anticipating leasing some of its passenger equipment from the Ontario Northland Transportation Commission, as is presently done by ACC.

The remaining agreement, the Stock Purchase Agreement, sets forth the conditions under which issued and outstanding shares of ACRI, owned by ACC, are to be sold to WC Canada Holdings, Inc. The Stock Purchase Agreement also provides for the conveyance of railway assets not included in either the Rolling Stock Purchase Agreement or the Rail Line Asset Purchase Agreement.

ISSUES CONSIDERED

Subsection 158(3) of the NTA, 1987 requires the Agency to "... approve the agreement for the conveyance unless the Agency determines that the conveyance would not be in the public interest or that the company to whom the line or segment is to be conveyed is not authorized to operate it".

In the course of this inquiry, I determined that several public interest issues should be examined before a recommendation could be made to the Agency. Of utmost importance was the viability of the new operating structure, that is whether ACRI would likely be viable in the foreseeable future and whether it would be able to function without operating and/or capital subsidies from the Province of Ontario. Also of concern was the future operation of the Hearst passenger-train service and the tour trains on the line. I also examined the importance of ACRI for the regional economy and for future development. In addition, I reviewed information received concerning the safety of future operations and labour concerns raised.

ANALYSIS

Viability of the new operating structure

The analysis of the future viability of ACRI required a thorough review of its proposed business plan.

In assessing the viability of ACRI in the foreseeable future, several issues were examined, namely ACRI's revenue assumptions, the proposed methods of cost reduction, and the financial strength of ACRI.

Revenue Assumptions

ACRI's freight and passenger revenue projections were compared with the actual revenues of ACC to ensure that they were reasonable. These projections were based on a number of assumptions, including the continued operation and growth of Algoma Steel and the continued operation of Algoma Ore Division, Wawa, Ontario.

Historically, the traffic levels generated by Algoma Steel have accounted for approximately 75 percent of the freight tonnage and revenue handled on the line; therefore, it is very important to the survival of the line that it continues to have this traffic base,whoever the operator may be. The traffic is of two types: the shipment of finished steel products from Sault Ste. Marie and rail operations related to the sinter plant at Wawa.

For some time now, the future of the sinter plant at Wawa has been questioned. Sinter is a component used in blast furnaces, including that of Algoma Steel. Generally, the sinter being produced at the Wawa ore mine has been of a lower quality than the iron pellets used at competing North American mills. The sinter plant was previously threatened with closure. In 1992, however, a test program was conducted, mixing mined ore with recycled waste oxides (also known as reverts) from other steel mills. Mixing the reverts with the existing ore has successfully increased the levels of quality. The closure of the Wawa sinter plant would have a direct and immediate impact on ACRI given that it generates approximately 50 percent of the traffic on the line. Algoma Steel has indicated that the continuation of the sinter plant relies on four factors: its ability to continue to source quality acid pellets on an economical basis; Algoma Ore Division continuing to secure its revert requirements; rail rates staying competitive; and a successful resolution of environmental concerns at the sinter plant. Provided that these issues can be satisfactorily dealt with, the sinter traffic on ACRI is likely to continue.

Even without the sinter traffic, WCTC has indicated that it believes that the line could continue to be viable, albeit at a drastically reduced level of operation.

As for finished steel products, it is expected that volumes are to remain constant although there may be changes in shipment patterns, depending on steel demand and improved service from the railway company.

The business plan also projects growth in the transportation of forest products: lumber, logs and pulp. Although the revenue unit forecasts do not include traffic projections of two potential new shippers, namely Georgia Pacific, to be located at Sault Ste. Marie and Jager Strandboard, to be located 160 miles north of Sault Ste. Marie at Limer, it is assumed that the wood and paper businesses will increase. I have reviewed the information filed with the Agency and find that these forecasts are reasonable. Even with the inclusion of the Jager traffic, the forecasts could be considered on the conservative side.

Proposed Method of Cost Reduction

Labour Efficiency

ACRI proposes to reduce its workforce from approximately 496 employees to 217 employees. This will have the immediate effect of reducing all salary requirements for 279 employees and the associated employee benefit costs. According to the collective agreement filed with the Agency, the employees who will not be retained by ACRI will either be entitled to immediate and unreduced pensions or will receive severance payments. These pension and severance payments will be provided by ACC and the ACC pension fund.

New work rules will be established to compensate for the reduction in the number of employees. Instead of one railway worker being responsible for one specific task, workers will be cross-trained to carry out other assignments and duties. Employee salaries will be paid on a monthly basis rather than on a per mileage or hourly wage scale basis which will result in cost savings to ACRI. Cost savings will also be realized with respect to train crews. ACRI indicated that it will be using two-man crews on all of its trains, as compared with ACC's use of four-man crews on some trains, and that it would eliminate cabooses on all ACRI trains. WCTC has experience in the operation of trains with two-man crews and cabooseless operation.

According to ACRI, higher levels of mechanization will result in reducing the number of personnel required in track, roadway and section maintenance gangs. In order to achieve other savings, ACRI has acquired and is licensed to use integrated software which computerizes many clerical functions.

Future Management of ACRI

In looking at how ACRI will be operated from a management perspective, I was informed by WCTC that it was its intention to streamline management operations and to reduce the number of managers and layers of management.

Work Synergies

Apart from the work synergies associated with the labour agreements, WCTC indicated that other synergies would be available to ACRI. This would include such items as equipment utilization and sharing of mechanical shops. It was mentioned by WCTC that both its own existing car fleet and that of ACC require some rehabilitation. Since WCTC's shop facilities in the United States are working at capacity, WCTC intends to use the shop facilities of ACRI in Sault Ste. Marie for its own excess equipment maintenance, as well as ACRI's maintenance.

Financial Strength

Working Capital

With respect to the level of support available to ACRI from WCTC if the conveyance was approved, WCTC submitted that it has been its practice to acquire railway companies with the intention of integrating them, on a long term, with its railway system and not for the purpose of buying and selling assets. Although not accounted for in the business plan, WCTC stated that if substantial capital outlays were required for unforseen events, the parent company would not allow ACRI to fail for the sake of a lack of working capital.

Capital Financing

ACRI is receiving a loan, a grant and proceeds from the sale of preferred shares from the Northern Ontario Heritage Fund Corporation, an agency of the Province of Ontario. Principal repayment of the loan is required under certain circumstances, including default. Interest on the loan is payable only after ten years. The grant is repayable under certain circumstances, including default. In addition, no dividends are paid out with respect to the preferred shares in the first ten years. The financial assistance has diminished ACRI's financial risk associated with the operation of the company.

ACRI's additional loan based on a line of credit in lieu of a mortgage does not encumber any of ACRI's assets and the line of credit will be guaranteed by WCTC.

Elimination of Provincial Freight Subsidies

The remaining item to examine when assessing the viability is the consideration that the Province of Ontario will no longer be subsidizing the operation. The level of assistance being provided to ACC from the Province of Ontario, on an annual basis, was significant. WCTC realizes that subsidization from the Province will no longer be available. WCTC is of the view that the proposed workforce adjustments and labour/work synergies should offset the loss of the subsidies.

Conclusion on the business plan

I found the business plan, on balance, to be credible. The key to realizing this business plan is primarily attributable to ACRI being able to reduce its operating costs and improving efficiency of operations. This will be accomplished through labour rationalization and the introduction of more mechanization. It is evident that operating costs will be significantly reduced after the workforce adjustment program is implemented. Paying employee salaries on a monthly basis will result in cost savings to ACRI. Operating with reduced train crews and employing WCTC computer technology will lower costs and increase efficiency. Other cost savings will result from the favourable terms on which capital financing has been obtained.

Future operation of the Hearst passenger-train service and the tour trains

WCTC did indicate that it would continue to require the federal passenger-train subsidy but that it would make an attempt to cut costs wherever possible. With respect to the operation of the tour trains, WCTC indicated that these operations were marginally profitable, but it was its aim to increase profitability. WCTC stated that it is its intention to create a distinct passenger division to actively promote the passenger services. This passenger division would be separated from the freight operations, having its own vice-president and staff. WCTC would be retaining some ACC employees who have expertise in the area and are familiar with the marketing aspects of the trains. The only assumption made was that ACRI would continue to lease passenger equipment from the Ontario Northland Transportation Commission.

There was concern expressed about the continuation of the federal passenger-train subsidy on the Hearst passenger-train service. The provision of this service is required by section 268 of the Railway Act, R.S.C., 1985, c. R-3. Section 270 of the Railway Act provides that the operator of an uneconomic passenger train service may make a claim based on the amount of its actual loss.

Importance of rail service for the regional economy and future development

Algoma Steel indicated that it requires rail transportation between Michipicoten Harbour and Wawa and between Wawa and Sault Ste. Marie. Algoma Steel submitted that the non-rail alternatives of transporting materials between Wawa and Sault Ste. Marie would increase transportation costs significantly.

Forest products represent the other significant traffic on this line. Comments from other shippers such as Synco Timber Limited, St. Marys Paper Inc., Lecours Lumber Co. Limited, Consolidated Papers, Inc., Dubreuil Forest Products Limited, and Lajambe Forest Products Limited, were also solicited. Shippers who have responded have made it clear that there is a direct relationship between the availability of rail service and their ability to compete. This ability would be threatened if rail service were lost.

With respect to the importance of rail to the regional economy and future development, I am of the view that provision of rail service is essential. There is a significant number of companies which rely on rail. Lack of rail service could result in production declines, decreasing the viability of some shippers. Further, ACRI has indicated that it will continue to operate the tour train services. The continued operation of the tour trains is essential to the well-being of the region as it generates significant tourist traffic.

Safety of future operations and labour issues

On November 30, 1994, I met with officials and members of the UTU in Sault Ste. Marie. The UTU and some of its members had originally filed letters with the Agency objecting to the conveyance on the ground that they did not have a new collective agreement with ACRI. Subsequent to these letters but prior to my meeting, the UTU and members signed and ratified a collective agreement with ACRI. At the meeting, new concerns were raised about safety and the negotiating process.

Safety concerns centered on the possibility that reduced crews and cabooseless operations could reduce the safety of operations.

At the meeting, the question of booking rest was also raised. I have been assured that the UTU has the right to book rest in accordance with the "Letter of Agreement" appended to the collective agreement. The right to book rest is the same for the UTU and the Brotherhood of Locomotive Engineers.

ACRI, as a federal railway company, will be subject to the Railway Safety Act, R.S.C., 1985, c. 32 (4th Supp.) and, in particular, to the safety jurisdiction of Transport Canada.

In addition to ACRI's legal obligations under applicable safety legislation, I fully expect ACRI to operate the line giving the fullest possible regard to all and every aspect of safety.

The UTU also had complaints about the process which led to the ratification of its collective agreement with ACRI. There is considerable bitterness over the negotiation process which took place. Specifically, the UTU asked me to recommend that the collective agreement be renegotiated. The UTU's strong negative feelings about the manner in which the agreement was reached is certainly regrettable, but the Agency has no jurisdiction to interfere in the collective bargaining process. As such, I am in no position to make such a recommendation.

COMMENTS ON THE DRAFT REPORT

Comments were received on the draft report from ACC, WCTC, the UTU, Algoma Steel and the Ministry of Northern Development and Mines (Northern Development Division). ACC and the Ministry of Northern Development and Mines note that letters in support of the proposed transaction were received from the Canadian Auto Workers (Rail Division), the Brotherhood of Locomotive Engineers, the International Association of Machinists and Aerospace Workers, the Transportation Communication Union, the International Brotherhood of Firemen and Oilers and Allied Workers, the International Brotherhood of Boilermakers & Blacksmiths, and the Brotherhood of Maintenance of Way Employees.

WCTC referred to ACC's letter of July 28, 1994, wherein counsel for ACC requested the approval of the proposed transfer and, in addition, an "order that ACRI shall have the same rights under the National Transportation Act, 1987, as amended, or under any other Act of the Parliament of Canada in respect of the operation of the rail lines or any segment thereof as ACC has immediately prior to the conveyance". It is noted that ACRI is a federal railway company which is subject to the National Transportation Act, 1987 and the Railway Act.

FINDINGS AND RECOMMENDATION

ACRI was incorporated by letters patent (dated June 27, 1988) pursuant to the Railway Act. ACRI is authorized to operate the line to be conveyed.

Under the present operating conditions, I am of the view that if the Agency were not to approve the conveyance, it could soon be presented with an abandonment application from ACC. The region could then be faced with complete loss of rail service, which, in my opinion, would not be in the public interest. Looking at the choice of having no rail service to the area, or giving a new operator a chance to demonstrate that it can operate successfully, I would, without hesitation, opt for the latter.

For all of the above reasons, I recommend that the Agency approve the agreement of conveyance between Algoma Central Corporation and Algoma Central Railway Inc. as described in this report. It is my view that there is not sufficient evidence to conclude that the conveyance would not be in the public interest.