Thursday, January 28, 2010

Waging a defensive war

Written by  Lawrence H Kaufman, Contributing Editor

The battle between railroads and their price-sensitive customers over legislation that would re-regulate the railroads has become open warfare. Price-sensitive customers like to call themselves captive shippers; perhaps that makes them objects of sympathy, something that gigantic companies have a hard time convincing rational observers.

These rail customers have been unhappy ever since passage of the 1980 Staggers Rail Act, which substantially deregulated railroads. Staggers didn’t give railroads complete freedom, though, and one of its most important provisions is a safety net to protect captive shippers from railroad abuse of unrestrained market power. Shipper lobbies have sought changes in the Staggers Act since the ink was barely dry on President Jimmy Carter’s signature. One difficulty of waging a defensive war in Washington is that you never win. Opponents come back again and again, and eventually they may convince key members of Congress that there is a problem that needs fixing.

That’s what has happened with rail deregulation. The Senate Commerce, Science and Transportation Committee approved the Surface Transportation Board Reauthorization Act (STBRA), and shippers, carriers, and congressional staffs continued working diligently to craft a measure all parties could agree on. They failed. In mid-February, the National Industrial Transportation League (NITL), which calls itself “the voice of the shipper,” endorsed the version of STBRA that awaits Senate floor action, calling also for antitrust law changes that would make it increasingly difficult for railroads to conduct business without exposing themselves to legal challenge from state attorneys general or private shippers.

Railroads negotiated in the hope of reaching an accommodation that would interfere minimally with their operations while giving shippers some additional access to competition. Once it became obvious the two sides could not reach agreement, the gloves came off.

That said, it won’t be at all surprising if the threat of open warfare and eventual failure to pass any law doesn’t bring a last-minute compromise that results in legislation and the end of legislative battling for another decade or more. Railroads are not completely free of rate regulation. They never gained that much freedom, although shipper lobbyists would have you believe otherwise. Shippers whose rates are higher than 180% of variable cost and can prove that the railroad has market dominance over the traffic in question can complain that their rail rate is unreasonably high. If they prevail, the STB can prescribe a rate and order refunds with interest.

In more than half the rate complaint cases filed over the past 30 years, shippers either reached a negotiated settlement or they prevailed in STB litigation. So much for carte blanche rate freedom.

The so-called captives have spent huge amounts lobbying Congress to change the law and force competitive access, which in most cases would drive rates lower. Competition has that effect. While natural competition does keep a lid on prices, artificial competition impelled by government can drive prices below what might be considered a market rate. The result: the railroad fails to achieve revenue adequacy—and it does not earn its cost of capital.

That may not be too serious in the short run, but over the long term it may restrict rail access to expansion capital. Ironically, the very shippers most aggressively trying to force rail rates lower are likely to be the first to have difficulty obtaining adequate rail service in a constrained capacity environment.

There is an element of hypocrisy in this. Utilities and other captives really object to the railroads’ use of differential pricing where shippers that put the greatest burden on the system are charged higher rates. Yet they and just about every other business rely on differential pricing.

Utilities, for example, charge industrial customers one rate per kilowatt, commercial customers another rate, and residential customers yet another rate. A kilowatt is a kilowatt is a kilowatt, though, and utilities shamelessly price their service differentially, sometimes even articulating that they charge higher rates of those who put the greatest burden on their generating and distribution capacity. Their use of a pricing mechanism that they would deny to their coal transportation suppliers is hypocritical.

There is nothing wrong with rail shippers benefitting from competition. But railroading is a high fixed-cost industry where economic survival requires traffic density and that customers cover variable costs and contribute to fixed costs. The Staggers Act has worked for nearly 30 years. Average rail rates are lower than under regulation and both railroads and their customers have prospered.

With a full agenda of vital issues that affect our society, there still is no guarantee that shippers will prevail. They have tried without success for more than a quarter century. With the support of rail labor, acting in its self-interest on behalf of the railroads, there is every likelihood that ship per failure will continue. One can hope.