The railroad industry continues taking steps to increase the amount of traffic it can handle, but the chief executives of the largest railroads warned that capacity investments must be balanced with the returns they generate.

The executives, who spoke before a Surface Transportation Board public hearing in Washington, DC, about rail capacity and infrastructure requirements, also reiterated that any hint of re-regulation will damp capacity investments. The hearing was broadcast over the Internet.

Over the last several years, railroads have invested in additional employees, more tracks, new equipment and safety measures, executives said. Some customers, however, have said the companies haven’t invested enough to keep up with demand.

Union Pacific Corp. (UNP), the largest railroad by revenue, anticipates 2007 capital expenditures of $3.2 billion, which would be a record, Chairman, Chief Executive and President James Young said. About $2 billion of that amount will be used for maintenance, such as replacing locomotives and freight cars. The remaining $1.2 billion is earmarked for growth, Young said.

“We’re making a bet that we can improve our returns,” Young said.

Norfolk Southern Corp. (NSC) will have capital expenditures of about $1.35 billion this year, roughly the equivalent of the company’s net profit in 2006, Chairman, President and Chief Executive Charles Moorman said. The railroad has invested in areas such as tracks and intermodal terminals, where containers and trailers are loaded and unloaded for movement on rails and trucks.

When making investments, rail companies are also taking into account the demand for coal, particularly out of Wyoming’s Powder River Basin; agricultural products; intermodal and ethanol, executives said.

Whether the investments are enough remains to be seen. US Department of Transportation Under Secretary for Policy Jeffrey Shane noted that congestion in the US, including railroads, trucks, shipping ports and airports, costs America about $200 billion a year in such things as time, traffic and wasted fuel.

Customers of railroad companies have been vocal in saying the industry isn’t spending enough money to handle their higher volumes. The American Chemistry Council, which represents companies in the chemical business, has long said its members are typically subjected to poor service and high prices, given the limited number of railroads in the US Tom Schick, senior director for regulatory and technical affairs for ACC, was scheduled to speak at the hearing later Wednesday.

Customers’ rates will rise as capacity tightens and that is a viable concern, said Burlington Northern Santa Fe Corp. (BNI) Chairman, President and Chief Executive Matthew Rose. But whenever that begins leading to an outcry for legislation or some type of regulation, the litmus test needs to be whether such action will increase capacity, Rose said. Investment tax credits can help accomplish that, he added.

The industry’s profitability has risen as customers’ rates have increased, but it has also been some time since any railroad has been able to sustainably earn its cost of capital, Norfolk Southern CEO Moorman said.

“Customers want more capacity, better service and lower rates, and I don’t know how you do all three of those,” he said.

The absence of new capacity investment and network efficiency initiatives “pose a significant threat” to United Parcel Service Inc.‘s (UPS) ability to serve its customers, Thomas Jensen, a vice president with the Atlanta company, said in prepared remarks. UPS opposes any future mergers of large Class I railroads until the service levels that existed before the flurry of mergers in the 1990s return, he said.

“The promise we all heard from the railroads of improved service, more competitive rates and greater investment has not occurred,” Jensen said. “The opposite has.”

UPS spent more than $1.5 billion last year moving small packages and heavy freight on railroads. The company gives, on average, more than 3,100 trailers or containers to th