STB Eyes Alternatives to URCS (UPDATED May 25)

Written by Marybeth Luczak, Executive Editor
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The Surface Transportation Board (STB) in October 2022 sought public comment on a new report that identifies and evaluates alternatives to the Uniform Railroad Costing System (URCS) that could be used as a replacement general-purpose costing methodology. The Association of American Railroads (AAR) and the Western Coal Traffic League (WCTL) respond.

STB uses URCS for a variety of regulatory functions. URCS is implemented in rate reasonableness proceedings as part of the initial market dominance determination; at later stages, it is used in parts of the STB’s determination as to whether the challenged rate is reasonable, and, when warranted, the maximum rate prescription. Among URCS’s other uses: to develop variable costs for making cost determinations in abandonment proceedings; to provide the railroad industry and shippers with a standardized costing model; to cost the STB’s Carload Waybill Sample to develop industry cost information; and to provide interested parties with basic cost information regarding railroad industry operations.

“URCS is an accounting allocation method using Class I railroad data as reported annually to the STB,” explains Railway Age Capitol Hill Contributing Editor Frank N. Wilner, a former White House appointed chief-of-staff at the STB, and during two decades at the Association of American Railroads was Assistant Vice President for Policy. “URCS was developed by STB predecessor Interstate Commerce Commission in 1978 and adopted for use in 1989. URCS replaced Rail Form A, an accounting allocation system in use since 1939 that contained elements dating to 1907. URCS, however, was developed using now-antique mainframe computers with low processing speeds, and although it was given updates in 1993, 2009 and 2011, its reliability is questionable.

“A 2015 Transportation Research Board report (Modernizing Freight Rail Regulation) characterized URCS as ‘a cost allocation scheme that has no economic foundation.’ In an Aug. 9, 2019, online article for Railway Age (‘URCS: Love It or Hate It, We’re Stuck with It’), former STB Chief Economist William F. Huneke compared URCS to ‘a classic car lacking modern GPS and satellite radio [with] built-in averages from a time when railroads, rather than shippers, owned most of the freight car fleet and line hauls were shorter as the modern merger movement had not yet run its course.’

“A key gripe of shippers is STB’s prior refusal to allow movement-specific adjustments to system-average URCS costs.”

STB in 2020 commissioned Laurits R. Christensen Associates, Inc. to perform a study and write a report to identify and evaluate alternatives to URCS, the STB reported in an Oct. 26 Federal Register notice. (For more on the commissioning process, read “STB Moves to Rehab Antique URCS.”)

According to Wilner, it is a follow-up on a 2008 Christensen report (A Study of Competition in the U.S. Freight Railroad Industry and Analysis of Proposals that Might Enhance Competition), which said: “[Rail rate increases] do not appear to be excessive from a financial market perspective. The railroad industry is pricing at levels generating earnings that maintain or slightly exceed those necessary to ensure financial viability [which] implies that there is little room to provide significant rate relief to certain groups of shippers without requiring increases in rates for other shippers or threatening the railroads’ financial viability.”

Alternatives to URCS

In its new 203-page report (download below), Christensen evaluated alternatives to URCS “that could better or more efficiently reflect the operating environment of the modern railroad industry. The project focused on costing methodologies that could be used as replacements or major structural updates to URCS to generate movement-specific variable costs for regulatory purposes.”

According to Christensen, the project:

  • “Assessed the economic cost measure(s) that URCS or a successor cost system should represent given the regulatory applications of URCS.
  • “Identified economic assumptions under which URCS or successor cost systems produce economically appropriate measures of costs for railroad movements.
  • “Evaluated whether alternative costing methodologies and structural updates to URCS could generate economically valid railroad variable costs for regulatory purposes.
  • “Implemented URCS alternatives and updates and compared model costs and revenue-to-variable cost (R/VC) ratios to current-methodology URCS.
  • “Quantified the effects of URCS alternatives and updates on the application of the Surface Transportation Board’s jurisdictional threshold for market dominance determinations.
  • “Considered advantages and disadvantages of URCS alternative and updated approaches, including the ability to reflect current railroad operations and adherence to the costing principles in the Railroad Accounting Principles Board (RAPB) Final Report.”

Based on the project’s analysis, Christensen reported reaching the following main conclusions:

  • “Short-run economic costs (marginal and incremental costs) are appropriate for the statutory application of URCS.
  • “URCS and similarly structured models can produce short-run economic costs for railroad movements, but URCS costs depend materially on input values based on ‘stale’ analyses and non-empirical assumptions.
  • “Using Carload Waybill Sample (CWS) data to reveal movement cost information has promise but also practical and theoretical challenges.
  • “URCS variability inputs can and should be updated, but limitations of the R-1 annual report data may merit consideration of changes to cost reporting requirements.
  • “The ‘Hybrid’ model is a feasible alternative for costing Class I movements, and its costs generally are plausible where different from legacy URCS.
  • “Updates to URCS Phases I and III can improve movement costing largely within the existing URCS framework.
  • “Both the Hybrid alternative and URCS update approaches have merit, with the key tradeoffs related to the validity of the Hybrid’s use of NEIO regression models to measure movement-specific costs.
  • “Implementing either the Hybrid model or a significant URCS update will materially affect application of the STB’s statutory jurisdictional threshold.”

The deadline for public comment was Feb. 23, 2023.

STB noted in the October 2022 Federal Register notice that it “has not made any determinations on whether it will propose changes to its general purpose costing system.” Additionally, “[g]iven the preliminary and exploratory nature of this request for comments, the Board will not release supporting materials, such as the Confidential Carload Waybill Sample data or underlying workpapers developed by Christensen Associates, at this time. Should the Board move forward with a proposal to modify its general purpose costing system, a further opportunity for comment will be provided.”

AAR Responds

Following its comments submitted by the Feb. 23, 2023, deadline, AAR on May 24 wrote in an STB filing (download below) that the “Board should reject consideration of the Hybrid model as an alternative to URCS as it is inappropriate for railroad costing.” It outlined the following reasons, which also address comments filed by WCTL and the American Petroleum Institute (API):

  • “The Hybrid Alternative Approach Is a Flawed Model that Is Inappropriate for Railroad Costing.” According to AAR, the Christensen report “did not conduct any updated empirical studies or solicit full input from current stakeholders“ and “acknowledges that, if the Board were to pursue an alternative (e.g., Hybrid) model or otherwise update URCS, there remains substantial study to be undertaken and stakeholder involvement to be secured.“ AAR also pointed out that the report’s “focus on an alternative Hybrid model that combines results from its New Empirical Industry Organization (‘NEIO’) revenue analysis with marginal cost estimates from an econometric cost analysis relies on the incorrect conclusion that short run or marginal costs are the appropriate standard for a regulatory costing model. In addition, the approaches are unable to disentangle costs from the effects of market markup factors on rates, which is significant given that railroads price differentially. In combination, these two flaws prove fatal to the proposed Hybrid model.“ Additionally, the report, AAR said, “incorrectly focuses on the elimination of step functions. While the proper use of step functions may merit additional study, the step function in URCS between through train and unit train costing has a solid logical foundation.“ Finally, AAR noted that the report “offers a flawed analysis of URCS regressions,“ due to a “misunderstanding of the industry.“
  • “WCTL Supports the Results of the Hybrid Model, but Offers Little in Support of the Hybrid Model Beyond Collateral Attacks on the Present System.“ AAR reported that WCTL, in its comments, “urges the Board to explore further the Hybrid model discussed in the Report. While acknowledging that its analysis of the model has been frustrated by ‘the Board’s determination not to make available the underlying workpapers and data,’ WCTL nonetheless offers its support for certain aspects of the Hybrid model. … Specifically, WCTL expresses interest in ‘updating the URCS Phase I variabilities’ in order to ‘reduce the rate level at the statutory rate floor for shipments subject to the Board’s jurisdiction, increasing the share of traffic with rates above the jurisdictional threshold.’“ AAR said that if the STB “is going to proceed with updating URCS, it should not base that update on a desire to increase (or decrease) the amount of traffic subject to Board jurisdiction. Rather, any revision should be undertaken in light of the statutory goal ‘to ensure the availability of accurate cost information in regulatory proceedings’ and based on a thorough understanding of the model—which no party has here, given the Board’s decision not to provide underlying workpapers and data.“
  • “API Acknowledges the Flaws of the Hybrid Model.“ In its comments, API “argues that the URCS model should be replaced,“ according to AAR. “However, even as API shares its support for the Hybrid model advanced by Christensen Associates, it acknowledges that it is flawed. For example, API recognizes that the Report ‘suggests that the Hybrid model is not totally aligned with the Data Integrity principle.’ Further, ‘API recognizes the Hybrid model’s limited ability to cost movements by Class II and Class III railroads,’ as well as its ‘limited ability to distinguish commodity-specific effects on costs.’ Thus, API concludes that, while the Hybrid model is the better of the two options, ‘there may be room for improvement.’“

WCTL Weighs In

Because “there is merit to some of the alternatives proposed for URCS“ in the Christensen report, the STB “should move forward with a proposal to modify its general purpose costing system,“ WCTL wrote in its May 24 filing (download below).

Economists Thomas D. Crowley and Robert D. Mulholland of L.E. Peabody & Associates, Inc., provided testimony on the report on the League’s behalf in comments submitted to the STB in February. They supported many of the findings, conclusions and URCS recommendations that the report put forward. In WCTL’s May 24 filing, the two economists provided reply testimony in response to the comments submitted by the AAR and BNSF in February.

Crowley and Mulholland concluded:

“The freight railroad industry has evolved from an inefficient patchwork of regional rail systems in the 1970s and 1980s to the lean and highly concentrated market that exists today. The once-aspirational goal of revenue adequacy is now a reality for the six (6) remaining Class I railroads. This evolution was made possible in large part due to laws and regulations that enable the railroads to employ differential pricing and extract supra competitive rates on captive shipments.

“The Christensen Report concludes that the decades-old inputs that URCS uses to determine the extent to which costs vary with output in URCS Phase I do not reflect the economics of the modern freight rail industry. The Christensen Report authors further conclude that updating URCS Phase I variabilities applicable to capital costs under their preferred alternative would reduce URCS variable costs across the board (in the absence of any other adjustments). This would reduce the rate level at the statutory rate floor for shipments subject to the Board’s jurisdiction, increasing the share of traffic with rates above the jurisdictional threshold, a result that aligns with the current environment in which the freight railroads have demonstrated an ability to consistently achieve revenue adequacy.

“Despite the good financial health of the industry, the Board has not yet developed a framework for implementing a revenue-adequacy constraint on rates, so captive shippers’ maximum lawful rates remain inextricably linked to the regulatory cost of providing service, as measured by URCS.

“Not surprisingly, the railroads offered several proposed changes to URCS, which would either: (1) increase URCS costs across the board, e.g., increase default variabilities and use replacement cost to calculate a railroad’s variable road property costs; or (2) reallocate regulatory costs from exempt traffic groups (intermodal) to regulated traffic groups (carload and unit train).

“BNSF proposes to do away with cost-based economic regulation altogether, based on a misplaced argument that the railroads need freedom to innovate and cut costs in order to compete with other modes for exempt traffic, without fear of limiting the profit that they can extract from captive shippers.

“Class I railroads now earn adequate revenues by the Board’s standards, and this was made possible over the long term through outsized contributions the railroads are permitted to earn on captive shipments under the regulatory framework. Changes to URCS that are designed to elevate regulatory costs and the commensurate profits railroads can generate on captive shipments would perversely increase the level of permissible contribution on regulated traffic just as the need for differential pricing is waning.“

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