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STB Opens Rail Rulemakings

May not be enough; shippers file antitrust suit against railroads alleging fuel surcharge conspiracy.

After years of deteriorating service quality and imposition of high fees and rates that have been inflicted on shippers by the nation’s largest railroads, the Surface Transportation Board stepped up to the plate by opening several proposed rulemakings aimed at addressing the situation.

In separate development, more than two dozen manufacturers, utility and energy, and chemical companies have sued four of the nation’s major railroads, alleging that they conspired to fix prices and unreasonably profited when setting fuel surcharges.

In recent years, shippers repeatedly called on the STB to help them with widespread disruptions and service failures caused by several railroads’ adoption of an operations model called Precision Scheduled Railroading (PSR), which was created by the late CSX CEO Hunter Harrison. PSR calls for radically slashing costs by shedding rail rolling stock, closing down railyards and laying off thousands of employees.

The goal is to drive down the railroad’s operating ratio (OR), something seen as a marked positive by Wall Street hedge fund managers and other investors, who then drive up the price of the rail company’s stock. Shippers, however, contend that under PSR, the railroads achieve their lower ORs by simply pushing costs onto their customers and, ultimately, consumers.

The turbulent last three years have seen the imposition of PSR damage rail service quality so badly that in some cases manufacturers have had to close down assembly lines because of missed pickups and deliveries. Shippers also have been hurt by steep hikes in demurrage charges and other punitive fees they say were designed for the sole purpose of increasing rail profits.

In addition to seeking enforcement actions against these railroads by the STB, shippers also sought reform of rail ratemaking procedures and the adoption of reciprocal switching, which would allow the cars of one railroad to run on the tracks of another, thereby creating competition in regions where Class 1 railroads currently enjoy monopoly conditions.

On Sept. 12, the board proposed changes to simplify its procedures for handling rail rate disputes that had been developed by an STB staff task force. Among other things, the rules would reduce the cost and complexity of small rate disputes, simplify the Stand-Alone Cost test for assessing revenue adequacy and revise how it determines market dominance.

On Sept. 30, the STB also introduced two new rulemaking proposals. One would change how it determines the railroad industry’s cost of capital, which it uses in approving rates made by the Class 1 railroads and has been controversial since the passage of the Staggers Rail Act in 1980.

This has been a persistent irritant to shippers because the board rarely finds the railroads are “revenue adequate” under the law, making it difficult for shippers to challenge rate increases. For example, this September the STB reported it found that only three railroads were considered revenue adequate in 2018—CSX, Union Pacific Railroad and the Canadian Pacific’s Soo Line.

Shippers Have Little Recourse

On July 25, during a House of Representatives listening session, Randy Gordon, president of the National Grain and Feed Association, informed the members of Congress present, “There has been one rail rate case that has been filed with the STB since Staggers back in 1980. It took 18 years to resolve it—and the shipper lost.”

In figuring what is a railroad’s cost of capital, the board currently utilizes the weighted average of the cost of debt and the cost of equity. In regard to figuring revenue adequacy for 2018, the STB determined that number to be 12.22%, which was exactly the number suggested to it by the Association of American Railroads.

On Sept. 30, the board proposed a new, much more complicated method for costing. “While the cost of debt is observable and readily available, the cost of equity (the expected return that equity investors require) can only be estimated,” the STB explained.

The board currently uses two methods for making this determination, and its proposal would add a third one to the mix. One method it used is called the Capital Asset Pricing Model (CAPM), which describes the relationship between systematic risk and expected return on assets, particularly stocks.

CAPM is widely used by the finance industry for the purpose of pricing risky securities and generating expected returns for assets, given the risk of those assets and cost of capital. This would seem to be an odd method to deploy given the Blue-Chip reputation of Class 1 railroad stocks, especially since CAPM has been criticized for being too simple and flawed for the reason that it assumes future cash flows can be estimated.

The other method STB has relied on is called the Morningstar/Ibbotson Multi-Stage Discounted Cash Flow (MSDCF) model. It measures the cost of equity as the discount rate that equates a firm’s market value to the present value of the expected stream of cash flows capable of attaining revenue levels which should permit the raising of needed equity capital.

The change proposed by the board would combine with both of these tools a new method it calls Step MSDCF, which uses a formula for valuing investments developed by New York University professor Aswath Damodaran in his textbook: Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. A detailed explanation of the formula is contained in the STB proposed rulemaking notice.

Under the board’s proposal, Step MSDCF would be used in combination with both the CAPM and MSDCF methods to come up with a weighted average that the STB would then use in figuring a railroad’s cost of equity for ratemaking purposes. The stated goal is to place the board in a better position for dealing with rapidly changing operating environments.

Making a direct reference to the recent adoption of the PSR operating model by railroads, the STB said the proposed change “could enhance the robustness of the resulting cost-of-equity estimate during periods, like the present one, in which certain railroads are undertaking significant operating changes.”

Chemicals and Fuel Surcharges

Also, on Sept. 30, the board issued a different notice of proposed rulemaking that, if adopted, would change its rules in regard to railroad performance data reporting for chemicals and plastics traffic. The change had been sought by chemical shippers, who earlier petitioned the board to open the rulemaking.

The change would make chemicals and plastics traffic a distinct reporting category in the Class I railroads’ weekly reporting of “cars-held metric,” which tracks the average number of loaded and empty railcars that haven’t moved for 48 hours or longer.

“The board believes that reporting of this data for chemical and plastics traffic would give the agency and stakeholders better visibility into the fluidity of this traffic segment,” the STB said. “With this data, both the board and its stakeholders would be better positioned to detect and mitigate emerging service issues affecting chemicals and plastics shipments.”

Under current STB rules, major freight railroads must file weekly and monthly reports containing service performance metrics, which are made publicly available on the agency’s website. These numbers are then used by the board in overseeing rail operations. Shippers regularly also use the data to update operational information they need for the purposes of supply chain management and planning.

These regular operational reports are now seen as crucial for the board and shippers in the wake of the widespread adoption of PSR and the radical changes it has wrought. Under the law, the STB has the power to compel the railroads to submit this information on a regular basis.

“The board’s proposed reforms are a positive step toward improving how the STB addresses freight rail problems, and we look forward to working with the commissioners and their staff,” commented American Chemistry Council president Cal Dooley. “Chemical manufacturers across the country have been negatively impacted by excessive freight rail charges and lack of competitive rail service for too long.”

On Sept. 27, just three days before the two STB rule proposals were issued, shippers had been vocal in expressing their unhappiness with the board’s decision to drop a proceeding it opened earlier to look into the railroad fuel surcharge issue. The board said it did so because its members had become deadlocked over whether it should remove the safe harbor provision that is currently part of the fuel surcharge rules.

“The board’s statutory responsibility is to regulate and eliminate unreasonable carrier practices, not to arbitrarily brush them aside,” the Freight Rail Customer Alliance and utility and coal shippers told the STB, asking it to vacate its decision and adopt rules designed “to stop (or reduce) carriers’ ongoing fuel surcharge profiteering.”

About 30 major rail shippers also filed an antitrust lawsuit against CSX, BNSF, Union Pacific and Norfolk Southern, alleging that they conspired illegally in setting fuel surcharges between 2003 and 2008. The companies range from automakers Hyundai and Kia, to major chemical firms like Eastman Chemical and Phillips 66, and utilities companies Ameren Missouri, Duke Energy Carolinas and Dominion Energy.

The shippers were forced to press forward with this suit as individual plaintiffs after a federal judge rejected an earlier attempt by attorneys to certify a class action lawsuit that had been filed on behalf of about 16,000 rail shippers.

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