When it comes to the possibility of the Surface Transportation Board (STB) making changes in how it regulates freight rail ratemaking—the job Congress has charged it with doing—the Class 1 railroads in this country have spoken, and their message is blunt: If the board alters the way it regulates rail ratemaking in any substantial way, the industry will seek to block those changes in court
“The STB’s Final Offer Rate Review proposed rule is fatally flawed and exceeds the agency’s authority in determining rate reasonableness,” declared Ian Jefferies, president of the Association of American Railroads (AAR), which represents the Class 1 rail lines.
“There is no rational way to connect overall firm-wide earnings with a determination of whether a single rate for a single customer is reasonable. Railroads are not public utilities and should not be regulated as such,” he added. “Freight railroads support a continuation of existing balanced regulatory policies.”
Jefferies reiterated his position during two days of hearings held by the STB last month in Washington, DC, where it heard from both the railroads and their customers, who have been complaining about the damage done to their businesses by rail practices imposed over the last three years since the trend began towards widespread adoption of the Precision Scheduled Railroad (PSR) business model.
The hearings dealt with two proposed rulemaking proceedings that were opened by the board last September, suggesting changes designed to make the handling of shipper challenges to rail rate proposals easier and quicker.
Shippers have long complained that the cumbersome procedures offer them little or no real recourse to unreasonable rail rates. Among the absurdities they have pointed to for decades have been the annual findings of immensely profitable railroads not to be “revenue adequate” under the board’s current arcane formula.
The proposals were the outgrowth of the STB’s Rate Reform Task Force, an effort by staff involving months of shipper and railroads interviews and resulting in a report in 2019 outlining a variety of recommended changes, including a proposed redefinition of revenue adequacy.
“Many shippers find railroads largely uninterested in their business; many shippers feel that they have little bargaining power with respect to the contracts they are offered,” the report found, noting that some believe they have less recourse available to them today than did shippers in the 19th Century, when the STB’s predecessor agency, the Interstate Commerce Commission, was created by Congress to regulate rate practices of the nation’s railroads.
In its recent rulemaking proposals, the board suggested changing the current standard for revenue adequacy. This is the method by which it figures a railroad’s cost of capital through utilizing a weighted average of the cost of debt and the cost of equity. The board observed that while the cost of debt is easy to assess, the cost of equity—the expected return that equity investors require—can only be estimated.
The STB currently relies on two methods for figuring cost of equity, and is proposing to add a third, which would consist of incorporating the other two into a new model. to come up with a weighted average. The board said in its proposal this would help it deal better with rapid changes in the cost of equity, such as those stemming from the adoption of PSR.
Shippers Seek Changes
The board also proposes simplifying and speeding up its determination of whether a particular railroad enjoys market dominance. It also would reduce the number of steps required for determining the Final Offer Rate Review (FORR), which is used in rate cases involving smaller railroad customers. AAR is equally unhappy with this possible change, characterizing it as “a winner-take-all approach that disregards due process rights and undermines the important principle of regulatory predictability.”
Shippers are generally in favor of the STB’s proposed reforms, although some would like to see a number of changes made to them, ranging from adopting a wholly different methodology to making relatively minor tweaks here and there.
The American Chemistry Council (ACC) told the STB that it should change its Stand Alone Cost (SAC) method, which is used in rate cases involving captive shippers who only have access to a single railroad. It noted that recent cases using the SAC standard have taken an average of five years to complete and cost each shipper well over $5 million—and in some cases can take longer and cost much more.
To fix this problem, ACC and other rail shippers represented by the Rail Customer Coalition are urging the board to adopt a market-based solution called the Competitive Rate Benchmark Method, which involves comparing a company against a number of competitors (or in this case, railroads it does not directly compete against) using a set collection of metrics.
In 2015, a report from the National Research Council’s Transportation Research Board recommended using this form of rate benchmarking to address the problem of dramatically rising freight rail rates, ACC pointed out.
“The Benchmark Method uses real-world data to predict the rate that would be expected in a competitive market,” explained Kevin Caves, an economist testifying on behalf of ACC. “This allows the STB to transparently evaluate how much captive rates should be allowed to exceed competitive rates, taking into account criteria such as railroads’ financial performance.”
Shelley Sahling-Zart. vice president and general counsel of Lincoln Electric System and president of the Freight Rail Customer Alliance (FRCA), told the board, “I can attest from personal experience that even where SAC is utilized, it is slow and expensive. For most shippers, SAC and the existing alternatives do not work at all.”
She argued that once railroads recover their costs and achieve revenue adequacy, allowing further unrestrained rate increases does not guarantee further infrastructure investment but simply punishes captive shippers.
“To the extent the board relies on return on investment and the cost of capital, both must be measured accurately,” Sahling-Zart stressed. “For instance, return is not measured accurately when it ignores railroad tax savings in 2017 of $9 billion. Accuracy is also compromised when the board measures the cost of capital at 12% and BNSF’s own executive chairman says the needed return is only 7%.”
The STB is expected to issue its final rules sometime early in 2020, but it is unclear when—if ever—shippers will see some actual relief. The railroads’ message voiced at the hearings is an ominous one. If the board alters the present form and reduces the time it takes for handling rail disputes, it is inescapable that the rail industry is willing to deploy its substantial wealth to tie up any proposed changes in court from now until forever.