When Congress partially deregulated railroad rates and practices in 1980 (Staggers Rail Act), it instructed regulators to consider revenue adequacy in determining the reasonableness of rail rates charged captive shippers—those lacking effective transportation alternatives to rail. More than four decades later, neither the Interstate Commerce Commission (ICC) nor its Surface Transportation Board (STB) successor have promulgated the intended regulatory rules.
Patience among captive shippers has long worn thin, with the Western Coal Traffic League (WCTL) on Aug. 24 petitioning the STB to stop waffling and complete the task. The WCTL represents utilities shipping coal mined west of the Mississippi River.
Some background, including definitions, are in order before explaining further the WCTL petition:
- Revenue adequacy is an economic concept applied to railroads by Congress in 1976 through the 4R Act (Railroad Revitalization and Regulatory Reform Act). Rail regulators were instructed to assist railroads in achieving “revenue levels adequate under honest, economical and efficient management to cover total operating expenses, including depreciation and obsolescence, plus a fair, reasonable and economic profit or return (or both) on capital employed in the business.”
- In 1981, the ICC, filling in some gaps, ruled that a railroad becomes revenue adequate if it achieves a return on investment (ROI) at least equal to its current cost of capital. The ICC punted, however, on whether revenue adequacy is achieved by meeting the standard in only one year or a longer time period, ruling somewhat obliquely that “in any industry, there are business cycles producing earnings during which [those] earnings exceed projections and years when they fall short of the target. Our concept is simply that a railroad not use [its market power] to consistently earn, over time, a return on investment above the cost of capital.”
- Failure to define a calendar time period left impotent a crucial captive-shipper protection subsequently embedded in the ICC’s 1985 Coal Rate Guidelines (applicable also to other commodities). That protection is a Revenue Adequacy Constraint, providing that upon achieving revenue adequacy, a railroad would be constrained from taking further rate increases unless it could demonstrate, “with particularity,” its need for higher revenue, the harm it would suffer if it could not collect higher revenue, and why a shipper should pay higher rates. Absent greater detail as to its application, captive shippers were left without a procedure to seek the rate protection intended.
- Thus, 42 years following passage of the Staggers Rail Act, and 37 years following ICC promulgation of its Coal Rate Guidelines, rail regulators have yet to establish how the Revenue Adequacy Constraint is to be applied. Among questions unanswered are: For how many years should a railroad be found revenue adequate before applying the constraint (the business cycle)? Will imposing the constraint inhibit or prevent railroads that are not revenue adequate from achieving revenue adequacy? Are there situations—an economic downturn, for example—when the constraint should not be imposed, or, if in-place, be lifted?
- Although the STB, in 2014, opened a proceeding to determine how it should apply the Revenue Adequacy Constraint, it remains in “pre-rulemaking” stage nine years later.
- In 2019, an internal STB Rate Reform Task Force (RRTF) served up new questions to be answered, warning that a railroad could be found revenue adequate in any single year but still not be long-term revenue adequate; or, conversely, be found revenue inadequate in any single year even though it is long-term revenue adequate.
- The RRTF recommended the STB determine the shortest period that constitutes long-term revenue adequacy, but not shorter than five years, and include both a year in which a recession began and a year following; and, identify a point beyond which railroads might use their market power, in the words of the WCTL, “to collect from captive shippers differentially higher rates than other shippers when some or all of that differential is no longer necessary to ensure a financially sound carrier.”
In its Aug. 24 filing (downloadable below), the WCTL urged the STB to “take administrative action now by proposing new rules that implement the revenue adequacy constraint in a manner that will permit shippers to obtain meaningful, cost-effective relief” in rate complaint cases. “Further delays,” it said, “not only hurt captive shippers, they also contravene the Board’s congressional directives to complete proceedings in an expeditious manner.”
The WCTL said the Revenue Adequacy Constraint is “of no practical use” in its current form—absent definition of a business cycle—because captive shippers cannot meet a non-existent threshold.
“As the Board knows, rail shippers are 0 for the [past] 37 years in obtaining any relief under the Revenue Adequacy Constraint,” the WCTL said. “That is most likely to remain the case unless the Board issues rules in this proceeding that implement the Revenue Adequacy Constraint in a way that provides meaningful, and easy-to-apply, relief for captive shippers.”
The WCTL appended to its filing a table showing that, in each of the 11 years between 2010 and 2020 (the latest available data), the STB has found Union Pacific to be revenue adequate; BNSF in 9 of the 11 years (and within one percentage point of revenue adequacy the other two); Norfolk Southern in seven of the 11 years (and within one percentage point of revenue adequacy in the other four); and CSX in three of the 11 years (and within one percentage point of revenue adequacy in six other years).
Although not said by the WCTL, shippers of all stripes have long alleged that, by Wall Street standards, every Class I railroad has long been revenue adequate for purposes of applying the Revenue Adequacy Constraint. Not lost on shippers is:
- The 1994 CSX Annual Report said, “For the past two years, CSX earned in excess of its cost of capital” even though the STB had found CSX not to be revenue adequate. Railroads typically make no mention in their annual reports to shareholders of ever being revenue inadequate.
- Union Pacific, found revenue adequate in each of the 11 most recent years the STB calculated return on investment (ROI), also posted a 41.9% return on shareholder equity for 2021. And in the five years since 2017, UP repurchased $5.8 billion of its stock. Railroads “throw off” significant amounts of cash (free cash flow), which was some $6 billion for UP in 2021. Free cash flow is computed after payment of taxes and meeting network maintenance and growth capital expenditure needs. It is inconceivable that any railroad would find investment opportunities to consume that much cash.
Railway Age Capitol Hill Contributing Editor Frank N. Wilner was formerly Assistant Vice President for Policy at the Association of American Railroads, a White House appointed (Bill Clinton) chief of staff at the Surface Transportation Board, and President of the STB’s bar association. Among his seven books is the soon to be published, “Railroads & Economic Regulation.”