Railroads, shippers grapple over revenue adequacy

A locomotive is hauling container boxes through a field.

Will recommended changes to how the Surface Transportation Board (STB) tracks revenue adequacy end up serving as a revenue cap for Class I railroads? The railroads said yes but the shippers said no on the first day of a two-day hearing sponsored by the board on the topic.

Shippers say offering alternative economic models that calculate revenue adequacy could make rail rate challenges more accessible for captive shippers that don’t have an alternative viable rail option.

The American Chemistry Council’s (ACC) alternative model, called the benchmark method, “will improve access to the rate relief process and substantially reduce burdens on shippers, railroads and the board,” said Jeff Sloan, ACC’s senior director of regulatory and technical affairs. 

But the railroads say changing existing practices with alternatives could be indirectly regulating a railroad’s earnings.

The recommended rate increase constraint (RIC) “would have unintended consequences and might well be transformed over time into utility-style earnings regulation,” said Joseph P. Kalt, Ford Foundation professor emeritus of international political economy at the John F. Kennedy School of Government, in presentation notes to the board. Kalt was representing the Association of American Railroads (AAR).

Discussing revenue adequacy

The point behind the two-day hearing on Dec. 12 and 13 was to get feedback from shippers and the rail industry on the April recommendations from the board’s Rate Reform Task Force (RRTF) on whether to change these economic models and calculations that STB uses to determine revenue adequacy. 

Congress tasked the board with determining annually whether a Class I railroad’s revenue is adequate. Congress wants to ensure that the Class I railroads, which don’t receive federal funding for capital projects, earn sufficient profit to foot the costs of maintaining and investing in their rail networks. 

A railroad reaches revenue adequacy when it “achieves a rate of return on net investment that is equal to at least the current cost of capital for the railroad industry” in the prior year, according to STB. 

Calculating revenue adequacy is important because the determination can inform STB’s decision-making process during certain proceedings, such as those contesting rail rates and particularly in situations in which a captive shipper is involved. 

According to its Sept. 12 decision in the proceeding Ex Parte 722, STB wanted written and oral feedback on the following:

  • Defining long-term revenue adequacy: The task force recommended defining this by looking at the annual determinations over “the shortest period of time, not less than five years, that includes both a year in which a recession began and a year that follows a year when a recession began.”
  • Applying a rate increase constraint: The rate increase constraint would apply to long-term revenue adequate carriers and it would seek to identify a point beyond which further application of differential pricing would be unwarranted.
  • Suspending bottleneck provisions: The task force recommended that STB consider suspending the bottleneck provisions applied to long-term revenue adequate carriers.
  • Modifying the simplified stand-alone cost (SAC) standard: The RRTF suggested reinstating the simplification of the Road Property Investment analysis to help determine whether a long-term revenue adequate carrier’s rate is reasonable. 

Shippers and railroads draw their lines

The board initially scheduled the hearing on revenue adequacy for one day, but it added a day after multiple stakeholders sought to provide oral testimony.

Shippers groups and shippers scheduled to speak the first day included the ACC, the National Coal Transportation Association, the Western Coal Traffic League, Auriga Polymers, Olin Corp. (NYSE: OLN), the Freight Rail Customer Alliance and PBF Energy (NYSE: PBF).

“The Montana Wheat and Barley Committee respectfully requests that the board continue to give due consideration to those shippers, like the Montana farmer [who is] removed from nearly all aspects of the railroad’s operations but [is] entirely dependent upon it for [his or her] livelihood,” said Zachary T. Coccoli, a representative for the Montana Wheat and Barley Committee and deputy legal counsel for the Montana Department of Agriculture. 

He continued, “The ongoing efforts for the STB to learn from history, engage openly with stakeholders with objective and analytical decision-making, informed by accurate information, instills a renewed level of confidence in the outcome of the board’s rate reform efforts.” 

The railroads scheduled to speak included representatives from AAR, BNSF (NYSE: BRK), Norfolk Southern (NYSE: NSC), Canadian National (NYSE: CNI) and Canadian Pacific (NYSE: CP).

“The STB should refrain from adopting regulations that penalize a railroad for being successful in competitive markets without regard for what has driven its return levels,” said Jill K. Mulligan, BNSF’s vice president and general counsel, in her presentation.

Both shippers and the railroads filed extensive written comments on revenue adequacy, and those comments are available online by searching for EP 722.

But the first day of the hearing, as well as the days leading up to the hearing, served as an opportunity for both railroads and shippers to draw their lines.

The ACC offered “the benchmark method,” an alternative economic model to STB’s stand-alone cost standard, which the group said would use “real-world data” to predict a rate that would be expected in a competitive market and could evaluate how much captive rates should be allowed to exceed competitive rates while taking into account criteria such as a railroad’s financial performance.

“Adopting rate benchmarking would be a win-win option for business and taxpayers because it would provide a more streamlined, rational approach for dealing with rate issues that would no longer require shippers, railroads and the federal government to sink millions of dollars into rate cases,” ACC said. 

The Western Coal Traffic League agreed with some recommendations of STB’s rate reform task force, but had “serious concerns” about other recommendations, such as how to determine the time parameters for long-term revenue adequacy.  

“In lieu of the RRTF’s recommendation to use study periods of varying lengths depending on the timing of economic recessions, the board should adopt a rolling five-year period for application of the presumption,” the Western Coal Traffic League said in written testimony.

Meanwhile, the railroads said that following through with the task force’s recommendations could result in unintended consequences, such as curtailing capital investments.

“Artificial caps on rates or other regulatory devices meant to drive rates below market levels, as recommended by the RRTF on long-term revenue-adequate carriers, compromise the ability of rail carriers to make investments to maintain and expand their network and facilities and remain competitive in the dynamic transportation markets we compete in to meet customer growth and secure market share,” BNSF said in written testimony.

The railroads also said STB’s efforts to revise revenue adequacy could result in rolling back some of the deregulation that occurred in the U.S. rail industry following the Staggers Act of 1980.

“Congress gave the agency no authority to impose an earnings constraint, revoke bottleneck protections and long-haul rights or resurrect Nixon-era price freezes simply because a carrier has achieved revenue adequacy, however defined,” said Raymond A. Atkins, a partner at law firm Sidley Austin, in written testimony on behalf of AAR. “Congress plainly did not intend the prize for carrier innovation, improved efficiency and creation of new competitive markets to be a return to overbearing federal regulatory control.”