In recent months, the Surface Transportation Board
( STB or Board ) has issued decisions in three major Eastern rate cases (the
Eastern cases). In each case, the challenged rates were very
high and represented major increases over rate levels in the expiring contracts
that preceded them.
These cases presented certain issues of first
impression to the agency. In addition,
the evidentiary records reflected the continuation of the trend in recent years
to delve into ever-greater levels of detail with regard to virtually every
element of stand-alone costs.
The Boards resolution of the issues in these cases
brings into question the continuing efficacy of the Coal Rate Guidelines
as a meaningful constraint on excessive rates for coal shippers in the
East. The resulting rates substantially
exceed the rates associated with the agencys western rate prescriptions over
the past decade, even after differing cost of service factors are considered.
The purpose of this paper is to address a few of the
major issues in the Eastern cases, and to consider what these cases may mean
for the future of STB rate review. It
should be noted, however, that petitions for reconsideration are pending in
each case and that Commissioners Buttrey and Mulvey have just recently joined
the STB. The decisions are also subject
to appeal. Accordingly, the decisions
may be far from final.
I.
Reversal
of Railroad Strategy on Market Dominance
A significant, but largely overlooked, aspect of the
Eastern cases is the complete reversal in the carriers approach to market
dominance. In past cases, carriers consistently, but unsuccessfully, claimed
that their challenged rates were subject to effective competition stemming from
the rate-constraining impact of interconnected electric grid, generation from
other fuels (chiefly gas), build-out threats, potential motor carrier service,
or other competitive factors. As
recently as 1998-2002, the
AAR
and its member
railroads vigorously resisted the elimination of product and geographic
competition from the Boards market dominance analysis. Throughout that multi-year effort, the
carriers simultaneously insisted that:
(i) their freedom to set rates even for captive plants was constrained
by competitive factors such as competition in the electric utility business;
and (ii) shippers that were not genuinely captive would nevertheless file STB
rate cases.
Ultimately, the railroads effort to preserve the
consideration of product and geographic competition failed, but defendants in
rate cases remained free to contest market dominance on the basis of intramodal
or intermodal competition. However, the
carriers in the Eastern cases not only declined to contest market dominance,
but instead embraced the absence of effective competition as an affirmative
justification for their substantial rate increases. Past assertions that the carriers had
established their rates in the midst of vigorous competition were replaced by
claims that the railroads needed to set rates high on their captive traffic in
order to be able to preserve their networks and serve their other
customers. The carriers further claimed
that the utilities were financially healthy and could easily afford the
increases, particularly since they would spread the burden over their large
numbers of ratepayers.
It is interesting to speculate whether the change in
strategy originated with business or litigation concerns: that is, did the carriers and their counsel
abandon the absence of market dominance defense in order to adopt an
aggressive litigating position (i.e., a corporate decision to go for
broke), or did the carriers prior business decisions to set the rates at 50+
mill levels mandate a shift in litigation strategy, as the carriers could not
credibly claim that their rates reflected any concern for loss of the traffic
due to competitive concerns)?
In any event, the carriers abandoned a line of defense
that had never been well-received. A
further benefit to the carriers of conceding, and even embracing, their market
dominance was to provide some semblance of a rational defense to the shipper
charge of gaming, discussed next.
II.
Gaming
The gaming of common carrier rates is, and, until
the Board devises or accepts a reasonable solution, will remain a particularly
challenging problem for shippers seeking a regulatory cap on unreasonable
carrier rate demands. As the shippers
argued throughout the Eastern cases, the ability of a regulated railroad to act
unilaterally in setting the starting point for an analysis that prescribes
rates on the basis of a percentage reduction has the inherent potential to
defeat the effectiveness of the rate review methodology. Because the carrier sets the starting rate,
the carrier can set the rate high enough so that it will end up with a
substantial rate increase, even after application of the percentage reduction.
Consider a hypothetical where a captive shipper has an
expiring contract with a rate of $10 per ton and the carrier offers a new
contract rate of $15 per ton. The
shipper then considers whether it should seek relief from the STB and concludes
it might reasonably obtain a rate reduction of 15%, corresponding to a rate of
$12.75 per ton. However, based on the
Eastern cases, the shipper would be concerned that the carrier will set a
common carrier rate on the order of $20 per ton if the contract offer is
refused. Even assuming the shipper is
successful, and further even obtains a percentage reduction of 20% in light of
its high rate, the resulting rate of $16 per ton is still higher than the $15
contract rate the carrier offered.
Moreover, the $16 rate is obtained only after the shipper dedicates
approximately three years and several millions of dollars to the litigation,
while paying the $20.00 per ton common carrier rate during the pendency of its
case.
Only in the CP&L decision did the Board even
address the gaming question. Therein, the Board found that the potential
gaming of common carrier rates had been established, but that no reasonable
solution to the problem had been presented. Furthermore, the Board appeared to
equate railroad gaming with so-called shipper gaming in the form of including
high rate non-issue traffic in the stand-alone traffic group. The parties have shown that the percent
reduction methodology is susceptible to manipulation by parties: by a defendant railroad in setting a challenged
rate at an artificially high level to limit the impact of a SARR [stand-alone
railroad] over-recovery, and by a complaining shipper in grouping a challenged
rate with non-issue traffic that is much higher rated to generate a larger rate
reduction. CP&L at 32. The Board went so far as to state that:
Given a traffic group with sufficiently highly rated
non-issue traffic, the percent reduction approach could brand any rate level
established by a defendant railroad as unreasonable (assuming that the R/VC
percentage exceeds the jurisdictional threshold). This potential could encourage a shipper to
challenge an otherwise reasonable rate, or enable a shipper to obtain an
inordinate rate reduction, simply by selecting a traffic group with much
higher-rated traffic.
CP&L at
31.
What
the Board now categorizes as gaming was previously found by the ICC to be an
essential aspect of the stand-alone cost analysis. In particular, in Coal Rate Guidelines,
Nationwide, the Commission observed that:
The parties will have broad flexibility to develop the
least costly, most efficient plant. The
plant should be designed to minimize construction (or acquisition) and
operating costs and/or maximize the carriage of profitable traffic. In selecting the route of a SAC railroad, for
instance, an overriding factor may be the effort to lower costs by taking
advantage of economies of density.Generally, a stand-alone railroad would attempt to fully utilize plant
capacity, adding other profitable traffic in order to reduce the average
cost of operation. . . .
The ability to group traffic of different shippers is
essential to theory of contestability. It allows the captive shipper to identify
areas where production economies define an efficient subsystem or alternative
system whose traffic is divertible to a hypothetical competitor. Without grouping, SAC would not be a very
useful test, since the captive shipper would be deprived of the benefits of any
inherent production economies. The
railroads and shippers agree on the propriety of grouping to develop a SAC
model, but they disagree on what traffic should be included in a stand-alone
system.
We see no need for any restrictions on the traffic
that may potentially be included in a stand-alone group.
Coal Rate Guidelines, Nationwide, 1 I.C.C.2d 520, 543-44 (1985), affd sub
nom. Consolidated Rail Corp. v.
United States, 812 F.2d 1444
(3d Cir. 1987) (emphasis added).
In the space of nineteen years, the agency charged
with the responsibility of protecting captive shippers has gone from (a)
developing a rate review standard premised on allowing shippers to obtain the
benefits associated with economies of density by liberal grouping of traffic,
to (b) condemning the practice of grouping as a manipulative tactic that could
result in the reduction of otherwise reasonable rates.
In any event, the Board essentially punted on the
railroad gaming issue, finding each of CP&Ls proposed alternatives to the
straight percentage reduction methodology to be unacceptable, but declining to
offer any solution of its own. While the
Board welcomed proposals for appropriate alternatives to be used in the
future, the Board found that in the absence of such an alternative, it would
not depart from its precedent.
III.
The Critical
Impact of Operating Cost Determinations
Beyond the gaming issue, the single most important
issue driving the results of the Eastern cases was the Boards selection of an
operating plan (and associated operating costs) for the SARR. In each case, the Board rejected the
shippers efforts to streamline the incumbents existing operations, and
thereupon accepted -- without significant analysis -- the operating plans
proposed by the defendant carriers. The
locomotive, crew, and other costs associated with the operations advocated by
the defendants added largely insurmountable costs to the SARR systems during
each year of the 20-year DCF models.
The critical element in the Boards analysis was its
refusal to accept any modifications in the sources of coal for the SARRs
individual trains or the size of the trains, thereby precluding the SARR from
achieving the efficiencies inherent in trainload service. The obvious teaching of the decisions is that
a shipper faces a high burden in having the operations of its SARR differ from
the actual operations of the incumbent railroad, and that the shipper must
demonstrate that the different operations will be acceptable to the other
shippers in the traffic group and connecting carriers, in addition to showing
that the operations would be feasible and efficient. The decisions, however, leave unclear what
sort of evidence (e.g., direct testimony from shippers whose traffic is
included in the group as to what they would find acceptable in the stand-alone
world) will suffice. Another apparent
teaching is that once the Board decides that the shippers operating plan is
flawed, the railroads plan will be accepted regardless of how flawed it might
be, especially in terms of complying with the least-cost, most-efficient
principle of stand-alone cost analysis.
Some clarification on this issue may be forthcoming
when the Board rules on pending petitions for reconsideration. One of the issues presented is whether the
stand-alone operating plans submitted by the railroads (and accepted by default
by the Board) were less efficient than real-world operations. It remains to be seen how this issue will be
resolved, because Chairman Nober indicated serious concern at oral argument in
the cases that SARR operations should not be less efficient than real-world
operations. The railroads, however, now
have acknowledged in their reconsideration replies that when faced with the
complainants decisions to eliminate the use of so-called gathering or
marshalling yards in the vicinity of the coal mines, they calculated SARR
operating expenses on the basis of assumptions that:
! the
SARR would replace the real-world gathering operations with smaller trains
traveling from a single origin to a destination (or interchange) with as few as
two railcars; or
! the
SARR would replace the real-world gathering operations (under which a single
train makes stops at several origin mines to build a full train) with an
approach whereby trains shuttle cars from a single mine at a time to SARR yards
that are located in areas far more distant from the mines that the real-world gathering
yards.
In either case, the SARR operations posited by the
carriers and accepted by the Board introduce massive inefficiencies and greatly
increased operating costs compared to real-world operations. These overstated operating costs drove the
vast bulk of the difference between the Boards operating cost findings and the
operating cost levels advocated by the complainants.
IV.
Cost
Indexing
Another significant aspect of the decisions involves
the use of the Rail Cost Adjustment Factor Unadjusted for Productivity
(RCAF(U) ) to index operating costs over the 20-year stand-alone cost
discounted cash flow (DCF) model used to evaluate the reasonableness of the
rates.
In the Eastern cases, the Board escalated SARR
revenues and costs using sharply divergent indices, with costs determined
through the use of the Boards RCAF(U) index and revenues escalated at a much
slower rate. The disparity between the
cost index and the rate index caused the SARRs financial performance to
deteriorate over the 20-year DCF model.The shippers in the Eastern cases had argued that SARR expenses should
be escalated using the Rail Cost Adjustment Fact Adjusted for Productivity
(RCAF(A) ), which increases at a more gradual rate than the RCAF(U) because it
reflects improvements in railroad productivity.
In the Eastern cases, the Board acknowledged that the
stand-alone railroads would likely experience some productivity improvements
over their 20-year lives, but not as much as the railroad industry as a
whole. See, e.g., CP&L
at 27 (While it is difficult to imagine that there would not be some areas in
which the [SARR] might realize productivity improvements over the course of the
SAC analysis period, the potential impact of such improvements is far less than
it would be for existing railroads, which make changes incrementally as older
technology assets wear out or become obsolete.). However, the Board did not credit the
stand-alone railroad with any productivity gains on the basis that the
only choice presented was between the RCAF(U) and the RCAF(A).
V.
Phasing
In the two Duke decisions (but not
the CP&L decision), the Board found that phasing, one of the
constraints adopted in the original Coal Rate Guidelines but never
before applied, may be an appropriate means of ameliorating the impact of the
otherwise permissible rate increases imposed upon Duke. It remains to be seen whether this
consideration would be workable in practice.
In particular, the Board commented in Duke/NS
that [i]n proposing ways to apply the phasing constraint, the parties should
be mindful that any approach should tie the phasing constraint to the revenue
needs of the defendant railroad. See
Duke/NS at 40. The Board added,
however, that the application of the phasing constraint nevertheless should
provide some restraint to a railroads pricing even if the railroad falls far
short of the Boards measure of revenue adequacy or has only a small base of
potentially captive shippers to cover its revenue shortfall.
Id.
The phasing issue has been deferred pending
resolution of petitions for reconsideration of the stand-alone cost
analysis. The manner in which the Board
reconciles these competing interests will dictate the value of the phasing
constraint to captive shippers.
VI.
Why
So Much Technical Error?
Pleadings filed after the initial decisions revealed a
large degree of technical error in the Eastern rate case decisions. The origin of the error is unclear, but
invites consideration. Is the Boards
staffing level insufficient? Have the
cases become so complex that the agency no longer has the ability to apply its
SAC standard to them? And if so, who is
to blame? Did the shippers err by
failing to account for sufficient complexity, or did the carriers present too
much factual and analytical complexity for the staff to be able to follow? Or is it the case that both parties are to
blame for inadequately documenting their evidentiary filings?
Whatever the explanation, it is now unquestionably the
case that shippers and railroads must scrutinize the workpapers supporting any
rate case decision in exacting detail.
VII.
East
versus West
Since most decided and pending coal rate cases involve
western unit train coal movements, there is considerable interest in what the
Eastern cases may portend for western coal movements. Some of the Boards major rulings will likely
apply with equal force and effect in western cases. For example, the indexing issues described
above relating to the use of the RCAF(U) to project SARR operating costs and
the use of a productivity-influenced measure to project SARR revenues will
presumably, if not corrected on reconsideration, apply equally in western
cases, although western shippers may also adopt other approaches for
recognizing more limited productivity gains.
Other issues, such as the acceptance of railroad SARR
operating plans that are less efficient and more expensive than the incumbent
railroads operations, seem likely to be limited to the East. Western cases frequently involve traffic groups
that consist entirely of unit train coal
movements and entail less likelihood of the sorts of radically unrealistic and
inefficient railroad-sponsored SARR operations that were accepted in the
Eastern cases. Nonetheless, the Eastern
cases will likely cause any deviation from existing operations, such as
rerouting of crossover traffic, to be analyzed more closely.
Gaming may also be implicated in western cases,
particularly as in TMPA the Board found that the maximum reasonable rate
was governed by the stand-alone cost analysis and not the jurisdictional
threshold.