Rails to Congress, STB: “If in doubt, don’t”

Written by Frank N. Wilner, Capitol Hill Contributing Editor

Successful baseball pitchers learn to throw first-pitch strikes and stay aggressive in the strike zone when their team is in the lead. Life imitates baseball, meaning railroad spokespersons will serve their industry well over the next 10 weeks if they similarly perform—first before a congressional subcommittee examining 35 years of partial economic deregulation under the Staggers Rail Act, and then the Surface Transportation Board (STB) as it considers shipper entreaties that the railroads’ improved financial condition warrants tightening of the strike zone.

The House Transportation & Infrastructure Committee hosts the first upcoming test for railroads May 13 when its Railroad Subcommittee grills railroad, shipper and academic witnesses on “The Past, Present and Future of Deregulation” 35 years following passage of the Staggers Rail Act that, in the subcommittee’s words, “is widely credited with saving the freight rail industry in the face of bankruptcy.”

One would be spot-on to characterize some witnesses invited by Subcommittee Chairman Jeff Denham (R-Calif.) as railroad-favorable.

Georgetown University Economics Professor John W. Mayo is co-author of a recent paper highlighting that “input prices and declining productivity growth—rather than enhanced railroad market power—account for the bulk of the recent rate increases” some shippers cite as rationale for less railroad regulatory freedom. Mayo stressed also that mainstream economists recognize the cost of capital—the STB’s touchstone for determining railroad revenue adequacy—as “a floor for the ability of a firm to attract capital with which to invest.”

American Chemistry Council President Calvin Dooley may find himself having to explain to the Rail Subcommittee how his members—the companies producing and shipping an inventory of the most toxic commodities—expect adequate, safe and efficient rail carriage when their proposals for more aggressive rail regulation would, by the council’s own estimate, slash annual rail revenue by at least $1.2 billion even though some railroads have yet to achieve revenue adequacy and none has done so over the course of even a conservatively defined business cycle.

Also testifying May 13 will be Association of American Railroads President Ed Hamberger, American Short Line and Regional Railroad Association President Linda Darr, and Surface Transportation Board Acting Chairman Deb Miller.

Certainly the Rail Subcommittee has in mind the bi-partisan Senate bill, S. 808, co-sponsored by Senate Commerce Committee Chairman John Thune (R-S.D.), and that committee’s senior Democrat, Bill Nelson of Florida, which would amend the Staggers Rail Act, but less viciously than had been attempted, without success, by Thune’s predecessor, the now retired Jay Rockefeller (D-W.Va.).

S. 808 has yet to reach the Senate floor for a vote, and whether it could receive support in the House is not known.

Congressional watchers should keep in mind the trenchant comment by former House Rail Subcommittee Chairman Al Swift (D-Wash.), who observed, “The other party is only the opposition; the Senate is the enemy.”

Here is a link to S. 808 (co-sponsor Nelson’s name is not shown).

Two STB hearings scheduled

The focus shifts to the STB June 10 when the agency focuses on how to simplify and make less costly and more transparent the agency’s methods for determining the reasonableness of grain rates. Not since 1981—in a case known as McCarty Farms that stretched for 16 years, cost complainants $3.4 million to present and resulted in shipper failure—have grain interests brought a rail freight rate grievance to rail regulators.

That case was brought under the so-called Stand-Alone Cost (SAC) test, intended to insulate a shipper from paying the cost of any facilities or services from which it derives no benefit. The McCarty Farms case exposed the immense cost and complexity of the SAC test’s requirement that the shipper design, on paper, a more efficient hypothetical railroad.

The SAC test is considered by mainstream economists—including a number of Nobel laureate economists who have weighed in, in writing, on the subject—as the most logical, efficient and effective means of determining railroad rate reasonableness. Unlike, for example, the transmission of electrons, the flow of liquid molecules or the transport of natural gas, commodities moving by rail are not homogeneous. They have diverse and distinct physical characteristics and varying modal alternatives—from highly competitive to highly captive, which a SAC test is designed to recognize.

Yet SAC’s cost and complexity caused Congress to order—subsequent to the McCarty Farms case—that the STB develop simplified rate complaint procedures for use by smaller shippers or smaller shipment quantities where the potential recovery isn’t dwarfed by the cost of advancing the complaint, and where a decision can be rendered more quickly.

A “Three Benchmark” test evolved that—while cheaper and speedier than the SAC test—is considered by economists as less capable of producing an accurate result. Rather than requiring design of a hypothetical railroad, the Three Benchmark test considers the relationship between revenues and out-of-pocket costs to move the freight at issue. But the Three Benchmark test has been mostly spurned because of shipper uncertainty as to its usefulness. No grain shippers have sought rate relief via the Three Benchmark approach and only three other shippers – U.S. Magnesium, DuPont and Canexus—have sought it out, with mixed results.

The June 10 hearing will solicit comments from railroads and shippers on alternatives to the SAC and Three Benchmark tests; perceived flaws in the Three Benchmark test; whether the definition of grain should be expanded to include products derived from grain, such as ethanol; if individual agricultural shippers should be permitted to aggregate their rate complaints into one proceeding; whether changes should be made to revenue adequacy determinations, such as including full-system revenue and costs of Canadian carriers rather than just their U.S. subsidiary railroads; and how rail rate setting procedures can be made more transparent for grain shippers.

Grain transportation is among the most competitive, with trucks carrying some 60% of it. Prior to partial economic deregulation under the Staggers Rail Act, grain shippers choosing rail suffered protracted car shortages and endemic service failures owing to the inability of then financially stressed railroads to maintain properly their branch line track servicing rural grain elevators. A challenge in transporting grain is the lumpiness in its shipping pattern owing to the uncertainty of commodity prices that often cause grain to be stored and suddenly released in large quantities when prices rise.

July brings revenue adequacy hearing

Then, for two days beginning July 22, the STB will review how it calculates the industry’s cost of equity capital for use in revenue adequacy proceedings. Coal shippers assert that railroad investments are less risky than reflected by the STB’s cost-of-capital estimate. Incorporated will be a review of revenue adequacy as a “long term concept.”

Among topics to be addressed by shippers and railroads are the appropriate length of a business cycle during which revenue adequacy is measured; the railroads’ requirement for higher revenue—and rates of return on investment—during periods of robust economic activity so as to offset lower revenue and rates of return on investment during recession years; whether factors other than return on investment and cost of capital should be utilized in determining revenue adequacy; what, if any—and how—new rate constraints should be imposed on railroads achieving revenue adequacy; and what impact new pricing constraints on revenue adequate railroads might have on railroads shy of revenue adequacy.

Overshadowing the hearing will be the recurring question of what impact shipper demands for tougher economic regulation would have on the railroads’ ability to attract and retain capital, and the railroads’ incentive for making new investments.

Rather than issue a Notice of Proposed Rule Making (NPRM), which would invite comments prior to the issuance of final revised regulations, the STB is using these two hearings as sounding boards. Whether it moves forward with a NPRM cannot be foretold, but it would not be in the near term.

Several factors likely influenced this lengthier and less predictable approach:

• Senate bill S. 808 has caught the attention of the House Transportation & Infrastructure Committee and certainly caught the attention of the STB, whose budget requests are reviewed by the bill’s co-sponsors.

• There is uncertainty as to whether and when former STB Chairman Dan Elliott will return after departing the agency Dec. 31 at the end of his statutory term. Although renominated by President Obama, his confirmation hearing was only held May 6, and additional hurdles remain before a vote to confirm is held by the entire Senate. In the meantime, the agency has but two members—Democrat Miller and Republican Ann Begeman—who are seen as apart on many issues, which would mean a stalemate were controversial issues to come to a vote.

• S. 808 would increase the size of the STB from its current three members to five members. It could be 2016 before the progress of that legislation, or any of its provisions, becomes certain.

No matter the inclinations of individual STB members, the agency’s general counsel’s office must defend the STB in federal court against challenges to its rulings. The STB has one of the most impressive records of federal agencies in defending its rulings, and a conservative approach to regulatory change has served the agency well over time. Neither Miller nor Begeman is an attorney.

• Many of the regulatory changes sought by shippers run contrary to mainstream economics, causing concern among senior technical staff at the STB and on whom board members and the general counsel’s office rely for guidance.

Congressional historians are hard pressed to point to legislation more effective in achieving its objective than the Staggers Rail Act of 1980. Yet for almost 35 years since its passage, a minority of shippers has been vocal and free-spending on Capitol Hill seeking to roll back some of those rail regulatory freedoms. So far, freight railroads, which literally pulled themselves out of the mud and muck of financial despair owing to Staggers Rail Act freedoms, have prevailed in convincing Congress and regulators to honor a treasured and time-honored caution: “If in doubt, don’t.”

For the next 10 weeks, that is precisely the message railroads must again articulate clearly and persuasively to Congress and regulators—and back it up with the same incontestable evidence they have catalogued since the Staggers Rail Act was passed in 1980.

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