The Dakota, Minnesota & Eastern Railroad will merge with a Canadian railroad, but there's still no promise the buyer will fund an effort to extend the railroad into Wyoming's Powder River Basin coal district.

Canadian Pacific Railway Ltd. will pay $1.48 billion cash for the DM&E and its subsidiaries. If Canadian Pacific follows through on DM&E's long-planned expansion project to carry coal from the Powder River Basin, the deal could cost Canadian Pacific an additional $1 billion.

DM&E wants to rebuild 600 miles of track across South Dakota and Minnesota and add 260 miles of track around the southern end of the Black Hills to the Wyoming coal fields.

The rebuilt railroad would haul low-sulfur coal east to power plants, allowing Canadian Pacific to compete with Union Pacific and BNSF Railway, which combined to carry about 450 million tons of coal from the basin last year.

Anthony Hatch, an independent transportation analyst in New York, said there's no immediate change for the Powder River Basin coal market as a result of this week's merger. Whether Canadian Pacific ultimately chooses to exercise the $1 billion Powder River Basin expansion will be a decision based on "shrewd" market analysis, he said.

"The owner of that option is somebody who is financially (capable)," Hatch told the Star-Tribune on Wednesday. "But they have to build the line."

Under a best-case scenario in which construction on the expansion begins next year and lasts about three years, it would still be at least late 2010 before the rail line could begin pulling coal out of the basin, according to DM&E President and CEO Kevin Schieffer.

It doesn't appear that a successful expansion would open a significant Canadian market for Powder River Basin coal producers. The Ontario government, for example, seeks to decommission at least two coal-fired power generation units by 2014 in order to reduce greenhouse gas emissions.

"Politically, (coal is) not the direction the government of Canada is headed," said Dick Price, coal market analyst for Westminster Securities Corp.

Canadian Pacific said the deal will expand its current network by about 2,500 miles and increase its access to Midwest markets for agricultural products and ethanol.

In a research note, Bear Stearns analyst Edward Wolfe said the DM&E has always represented a potential threat to the BNSF and Union Pacific duopoly serving the Powder River Basin.

"Our sense is that today's announcement brings this threat much closer to a reality," although that threat could be three to four years away, Wolfe wrote.

"The issue is whether on top of the large price paid for DM&E, CP can also fund an estimated $3 billion build in to the PRB and still make a profit 4-5 years from now," he wrote.

Although the Powder River Basin's market potential was a key component of the buyout, coal is just one of the deal's two large energy components.

DM&E is forecasting an 18 percent revenue increase for next year, and much of that growth can be attributed to the more than a dozen ethanol plants planned or under construction along its current tracks, Schieffer said. Several of those ethanol plants, which depend on the railroad to move its product, will begin operations this year.

"That's going to increase fairly dramatically next year, and the year after that, and the year after that for the foreseeable future," Schieffer said.

Lisa Richardson, executive director of the South Dakota Corn Utilization Council, said the country is critically short on rail capacity and the deal will help move grains and ethanol to markets that need them. The added rail competition will also reduce transportation costs, she said.

"Once this takes place, we get to go out east, we get to go out west, and that is huge," Richardson said.

Asked when Canadian Pacific will decide whether it takes on the PRB project, President and CEO Fred Green said it won't happen in 12 months but "hopefully it won't take as long as 36."

Canadian Pacific said it intends to spend an additional $300 million on regional railroad upgrades over the next several years.

The railroad has lower cost estimates than DM&E on both the upgrades and the total price tag of the project with the Powder River Basin route included. Engineers from DM&E and CP agreed on the $300 million figure, Green said, adding that the total price tag with the Powder River Basin extension would not reach the $6 billion figure that DM&E has used for several years.

The Canadian Pacific deal is expected to close in the next 30 to 60 days and is subject to review and approval by the U.S. Surface Transportation Board.

The future contingent payments consist of $350 million due if the Powder River Basin expansion construction starts before Dec. 31, 2025, and $700 million if coal begins moving from the basin before that date.