Uncertainty clouds key rail bills in Senate

Written by Frank N. Wilner, Capitol Hill Contributing Editor
John Thune

Two bills of substantial importance to railroads—Staggers Rail Act revisions as part of reauthorization of the Surface Transportation Board (STB), and extension of the deadline to implement Positive Train Control (PTC)—took meaningful steps forward March 25, gaining the imprimatur of the Senate Commerce Committee.

The road ahead for both bills, as they are currently written, could be problematic, with the crucial test being Senate floor action and then consideration in the House, which has made no progress on its own on either of the issues.

PTC Extension

The Railroad Safety and Positive Train Control Extension Act (S. 650) would remedy a problem beyond the railroads’ control by delaying for at least five years the previously imposed congressional deadline of Dec. 31, 2015, for implementation of PTC—a $14 billion safety overlay utilizing computers, transponders, and GPS to stop or slow a train automatically before certain types of accidents occur.

A commuter train accident in Chatsworth, Calif., in 2008, which killed 25, nudged Congress to impose that 2015 deadline on some 60,000 miles of track that carry passenger trains and certain hazardous materials. Failure to meet the deadline would force railroads to halt service on affected track or operate in violation of the law—the latter subjecting railroads to significant federal fines.

A snag developed when the Federal Communications Commission halted testing of thousands of PTC-related poles and towers, and construction of thousands more, pending resolution of siting-compliance requirements of the National Historic Preservation Act and the National Environmental Policy Act.

John ThuneAlthough the FCC has since allowed construction and testing to resume—an agreement including a requirement that railroads pay $10 million into a Tribal Nations Cultural Resource Fund—railroads advised the Federal Railroad Administration (FRA) and Congress that because of the FCC-caused delay, they could not meet the deadline. When the FRA declined to use its own powers to grant an extension, Sen. Roy Blunt (R-Mo.) introduced legislation to extend the deadline for five years until Dec. 31, 2020—with flexibility for yet another two-year extension to 2022. Co-sponsoring the bill are Commerce Committee Chairman John Thune (R-S.D., pictured) and the committee’s senior Democrat, Bill Nelson (D-Fla.).

By voice vote, the Senate Commerce Committee March 25 recommended the bill’s passage, after agreeing to an amendment by Sen. Richard Blumenthal (D-Conn.) to require periodic and public progress reports by the railroads.

“Railroads have made a good-faith effort to install PTC,” Thune said. “Yet, for every major freight railroad, and nearly every small freight or commuter railroad, the PTC deadline is not attainable. PTC needs to be done, and it needs to be done right. Rather than introducing new operational and safety risks from an incomplete system or punishing railroads making a good-faith effort to implement this extremely complex and expensive mandate, Congress should extend the PTC deadline.”

Similar legislation was approved by the Commerce Committee in 2014, but it failed to reach the Senate floor. There is more urgency attached to this bill, as the PTC implementation deadline is but nine months hence.

S. 650 will be ready for a floor vote following completion of a manager’s report to be written by Thune. Senators Blumenthal, Amy Klobuchar (D-Minn.) and Joe Manchin (D-W.Va.) say they are opposed to the bill as now written. Blumenthal, despite having one amendment accepted by the Commerce Committee, has 11 additional amendments he would like added, including a mandate for two-person crews, which is an unrealistic objective in this Republican controlled Senate.

Attempts at such amendments could be made if the bill reaches the Senate floor. Majority Leader Mitch McConnell (R-Ky.) schedules floor time for votes and is unlikely to do so if he cannot obtain unanimous consent to limit the nature and number of amendments and debate. The bill also could be appended to a so-called “must pass” bill, but given the political ill-will within Congress of late, even a “must pass” bill is subject to adverse action, as has been witnessed by government shutdowns and near shutdowns amidst political wrangling.

A key to unanimous consent to limit debate and the nature and number of amendments on S. 650 could be Sen. Diane Feinstein (D-Calif.), who initially led the effort to impose the Dec. 31, 2015, deadline on PTC implementation. Feinstein has yet to express herself on S. 650. A Capitol Hill source suggests that if unanimous consent cannot be obtained under the current circumstances, a compromise might be to change the extension period to one-year increments.

It is expected that if the Senate passes S. 650, the House will vote on the Senate measure without writing its own version. Otherwise, a separate bill must move through the House, with a joint House-Senate conference committee resolving disagreements in the two measures. The clock is ticking.

Here is a link to S. 650 (not all co-sponsors are shown).

STB Reauthorization

S. 808 may be more problematic than the Positive Train Control deadline extension bill, notwithstanding its bi-partisan committee support and stated support by railroads and almost two-dozen shipper trade groups that for years have lobbied for what railroads term “reregulation.”

While shipper groups such as the American Chemistry Council, American Farm Bureau Federation, Consumers United for Rail Equity, and the National Industrial Transportation League urged, in a March 24 letter to Thune, a favorable report on S. 808, they have been heard to grumble over some of its provisions.

Indeed, hours before the Commerce Committee mark-up on S. 808, Sen. Tammy Baldwin (D-Wis.), who has long worked closely with so-called captive shipper groups, introduced legislation containing many of the outcome determinative provisions that previously doomed similar bills, such as advanced by now retired Sen. Jay Rockefeller (D-W.Va.), who chaired the Commerce Committee prior to its Republican control this session.

The Baldwin bill—the Rail Shipper Fairness Act of 2015 (which has yet to receive a bill number)—will be referred to the Commerce Committee, where it will gather dust. The problem is that if the Thune-Nelson bill reaches the Senate floor, the Baldwin bill is likely to be introduced as a substitute for S. 808. For that reason alone, Senate Majority Leader McConnell would be disposed not to schedule a floor vote on S. 808. That is unless Baldwin withdraws her bill or there is unanimous consent to move S. 808 without amendment, such as a Baldwin-bill substitute.

Indeed, S. 808, allegedly supported by so-called captive shippers, could die in waiting just as virtually all captive-shipper inspired bills have over more than three decades since railroads were partially deregulated by the Staggers Rail Act in 1980.

As with the PTC deadline extension bill, there has been no independent action in the House on Staggers Act revisions as part of Surface Transportation Board reauthorization. Again, the House presumably is awaiting Senate action. But unlike the PTC extension bill, there is no looming deadline or other adverse result should S. 808 move no further than it has. If it does move, S. 808 could be married—for legislative convenience sake—to a highway reauthorization bill (not expected to be ready before 2016 at the earliest) or an Amtrak reauthorization bill already passed by the House.

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

So-called captive shippers—those with few or no effective rail transportation alternatives—are privately grumbling, notwithstanding their public support for S. 808. “Materially worse” than anything previously introduced, said one shipper source, asking not to be identified. The problems? Significant ones, say some shippers.

The voluntary arbitration provision of S. 808—unlike one that was advanced by Rockefeller that allowed it to be triggered by shippers alone—requires agreement by all parties. More troublesome to shippers is that before such arbitration can be requested, the STB must make a finding that the railroad is market-dominant based on a ratio of rates to variable costs. This, say shippers, is a lengthy and costly effort.

Then there is the arbitration mechanism, which allows the STB to review the award and overturn or modify it, with the STB instructed to decide if the award complies with “sound principles of railroad regulatory economics,” which shippers say injects a new area for controversy. Moreover, the STB review of the arbitrator’s award can then be appealed to a federal court. “The process becomes more complicated, lengthier, and more costly rather than the opposite,” says a shipper advocate.

Another provision of S. 808 troubling shippers is a requirement that the STB consider the “investment needed to meet the present and future demand for rail services.” This, say shippers, opens the door for revenue adequacy to be measured based on current replacement costs rather than original costs, which could allow higher rates rather than the cap on further rate increases sought by shippers.

(The Watching Washington column in the April issue of Railway Age discusses the economics of using replacement costs rather than historical costs. That column is included at the end of this story—Editor.)

Finally, shippers bemoan that a provision previously advanced by Rockefeller—that it is “the sense of Congress” that the STB “determine the need for a proceeding on mandatory competitive switching; and determine whether a timely rulemaking for competitive switching is needed”—does not exist in S. 808.

“Muddy waters ahead,” said a rail lobbyist, asking not to be identified, in response to shipper concerns.

There are, however, provisions shippers can and do embrace. They include increasing the number of STB Senate-confirmed members from three to five; requiring the STB to develop a separate rate-reasonableness test for grain—a provision grain shippers view as encouraging; a requirement that the STB accelerate and make less expensive its rate reasonableness tests; a study into whether certain contract proposals for multiple origins and destinations limit shippers’ ability to file rate complaints; and authority for the STB to initiate investigations into service problems on its own motion rather than awaiting a shipper complaint.

As for the Baldwin bill, it would assume, even where two railroads compete, that railroads are market-dominant, and shift the burden of proof in most rate cases to railroads. It would amend National Transportation Policy by elevating shipper priorities—presumably for lower rates and improved service—to at least the level of railroad revenue adequacy requirements.

Additionally, the Baldwin bill would encourage the STB to order competitive switching within 100 miles of junction points. And it would eliminate the revenue adequacy test, meaning no longer would there be a requirement that the railroad’s rate of return on invested capital at least equal the cost of obtaining that capital—a provision that would stand mainstream economic theory on its head.

The only logical objective of the Baldwin bill in this Republican controlled Congress is to assure that S. 808 is equally doomed as was all previous shipper-inspired legislation. And that may be just what many captive shippers seek for S. 808, notwithstanding their public comments. Otherwise, the purpose of the Baldwin bill is quite challenging to understand. Now-retired former Rail Subcommittee Chairman Al Swift (D-Wash.) explained such situations by counseling, “Never assume conspiracy when incompetence will do.”

So while S. 650 (deadline extension for PTCl) and S. 808 (Staggers Rail Act revisions as part of STB reauthorization) took meaningful steps forward March 25, there is a long, arduous, and treacherous road ahead for both—with no further action on either expected in the near term owing to Senate recess and a crowded floor calendar.

Dan Elliott

DanElliottSTBFormer STB Chairman Dan Elliott (pictured), who stepped down Dec. 31 after failing to receive a confirmation hearing for a second term, is again awaiting a confirmation hearing this Senate term after being renominated a second time by President Obama. Shipper chatter is that they want him back on the STB and are urging Thune to schedule a confirmation hearing.

Railroads, by contrast, are being heard to whisper their desire that Acting Chairman Deb Miller remain in charge; that the White House perhaps should find another nominee to fill Elliott’s vacancy; or that the STB continue to operate with just two members. From 2003 to 2004, the STB operated with a lone member—former Chairman Roger Nober, who is now BNSF’s executive vice president of law.

As for the STB’s only Republican member, Ann Begeman, her term expires Dec. 31, 2015, although the statute allows her a holdover year if a successor is not nominated and confirmed. S. 808 would amend the statute to permit STB members to remain indefinitely until a successor is nominated and confirmed. Democrat Miller’s term expires Dec. 31, 2017. The vacant seat held by Democrat Elliott expires Dec. 31, 2018—some two years into the next administration, which could explain the Republicans’ desire not to reconfirm him, as the seat would be available for a Republican nominee should the White House go Republican in the 2016 presidential election.


Revenue adequacy is all about expectations

No matter how long the way to Tipperary, the rail industry endures a further trek toward revenue adequacy—the financial nirvana where the rate of return on invested capital (ROI) equals or exceeds the current cost of obtaining that capital.

Only such equilibrium brings forth investors eager to provide sufficient new capital to renew, improve, and expand railroad infrastructure to meet customer demand.

The Surface Transportation Board (STB), which calculates railroad revenue adequacy, has found only a few individual carriers revenue adequate for one or two years.

Economists say revenue adequacy must be calculated over a business cycle—typically five to seven years. If a railroad is prohibited from earning anything more than its cost of capital in good years, the lower earnings in bad years will consign it to never achieving long-term revenue adequacy.

Shippers with limited or no effective rail transportation alternatives assert that improved railroad profitability alone is sufficient for the STB to declare the entire industry revenue adequate, which could trigger tighter caps on the freight rates they pay.

Long-term investors—with multiple alternative investment opportunities, and who must be courted to provide railroads with as much as $300 billion over the next 20 years to meet projected increased demand for quality rail service—calculate revenue adequacy differently than the STB or shippers.

Where the STB uses original (historic) cost as the investment base on which to calculate rate of return, long-term investors focus on replacement cost. The reason is railroad infrastructure is long-lived and cannot be replaced or renewed at anywhere near its original cost.

Indeed, $1 million doesn’t buy what it once did. A 10% return on an asset costing $1 million in 1940 would be equivalent to less than a 1% return today, as the inflation-adjusted cost of replacing that asset would be some $17 million in 2015 dollars.

Rail earnings may have to rise were revenue adequacy measured on replacement rather than original cost. Yet electric utilities, among the most vocal of customers in criticizing railroad rates and service quality, similarly embrace a replacement cost methodology. One of the most glaring examples is Florida Power & Light, which told its own regulators, “If we can’t make an attractive investment for the shareholder, then we are going to have a very difficult time going in the marketplace and competing for [investment] dollars.”

Revenue adequacy and the cost of capital are viewed by investors as expectations, not historical events. In fact, Congress, in the statute, instructed the STB to assist railroads in meeting those expectations and not curb them when revenue adequacy is momentarily achieved.

When shippers cite rail profits to justify tighter caps on rail rates, they step on their own message, which is a priority demand for long-term service quality. The level of profits should not drive revenue adequacy determination. Had railroads never earned more than $100, but last year earned $110, it would be a record. But would it be enough?

The appropriate question for regulators and investors is whether railroads earn their cost of capital over the long term, because expected revenue adequacy is the key to unlocking future investment.

Investors, suspicious the STB won’t permit higher returns, have been demanding their money back.

Over the past five years, investor pressure has forced every major railroad to repurchase its stock—$28 billion worth. Were the STB to view revenue adequacy as Congress intended—as a continuing goal for the railroads—and computed and achieved revenue adequacy on the basis of replacement costs, investors would encourage railroads to make additional investments, such as new main lines connecting the Midwest and Pacific Coast to satisfy shipper demands for increased capacity and improved service quality.

Congress, rather than writing a definition of revenue adequacy, instructed the STB to “maintain and revise as necessary standards and procedures for establishing revenue levels … [that] permit the raising of needed equity capital, and cover the effects of inflation.”

The STB should establish revenue adequacy standards using replacement costs, and not prohibit railroads from earning anything more than their cost of capital in good years, as otherwise there is nothing to offset the lower earnings in bad years.

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