URCS: Love It or Hate it, We’re Stuck With It

Written by Dr. William Huneke, Consulting Economist
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For a sleep inducer, consider working with the Uniform Rail Costing System (URCS), long a general costing system indispensable for determining maximum reasonable rail rates. Worse, its second side-effect is indigestion, as this 30-year-old accounting relic is much like a classic car lacking modern GPS and satellite radio. Practitioners too often become frustrated with its 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.

The basic idea behind partial rail deregulation in 1980 under the Staggers Rail Act was to move away from regulating all railroad rates to regulating just a few. To do that, the regulator required a test to determine if a rate included an excessive profit margin. Hence, the idea of dividing the rate by the movement’s variable cost, to derive an RVC (Revenue to Variable Cost) ratio.

To calculate the RVC required a regulatory costing system, originally an even more antiquated Rail Form A from the pre-computer era, and now the URCS. The Interstate Commerce Commission (ICC), the Surface Transportation Board’s (STB’s) predecessor, developed the URCS following the direction of a Congressionally created Rail Accounting Principles Board (RAPB).

A complexity with current rail regulation is that URCS pervades many of STB’s processes beyond setting the regulatory threshold. To name just a couple: revenue adequacy and qualitative market dominance within rate cases.

With many URCS applications, one would think that STB would be careful to address URCS’s shortcomings. Unfortunately, STB recently terminated a proceeding to improve the way the URCS handles trainload and a multicar shipment costs when it closed the EP 431 Sub 4 rulemaking (Review of the General Purpose Costing System). This rulemaking was the result of a reform process begun 15 years ago, largely at the instigation of former STB commissioner Frank Mulvey.

This reform process had two objectives: update the URCS and have the Transportation Research Board (TRB) of the National Academy of Sciences conduct a review of the regulatory system STB oversees. At that time, Dr. Mulvey observed that the URCS had not been significantly updated since its adoption in 1989, although ICC had promised regular reviews and updates.

Dr. Mulvey succeeded in urging Congress to appropriate money for both endeavors: URCS update and TRB review. STB received the money, which it used to update URCS’s technology, and TRB issued a 2015 Special Report, Modernizing Freight Rail Regulation.

SR-318-Modernizing-Freight-Rail-Regulation-FINAL

The TRB report did castigate the URCS and STB’s use of URCS. The report identified many weaknesses in the URCS linked to its arbitrary allocation of joint and common costs. In its place, TRB offered a creative econometric approach to determine what rates were within STB’s jurisdiction. Problem is, TRB’s approach, while academically elegant, is probably not actionable. Moreover, TRB’s report did not offer any suggestions for improving the URCS in its other applications or offer alternative solutions.

TRB’s URCS observations were not new. In fact, the RAPB considered more theoretically sound, econometric approaches to regulatory costing but dismissed them as too opaque. Congress funded RAPB to set the direction and principles to underlie regulatory costing. That direction and set of principles still guide STB’s use of the URCS.

Although Congress funded the TRB report, Congress ignored the report when it passed STB’s 2015 reauthorization. The URCS approach to setting the jurisdictional threshold and all its other uses remain for the foreseeable future.

The EP 431 Sub 4 proceeding attempted to address a deficiency in the URCS’s estimation of unit train and multiple car shipment costs. In terminating the proceeding, STB said it “continues to believe that URCS can be updated to better reflect economies of scale and improve cost allocations. However, the Board has determined that potential refinements of the URCS would benefit from additional study and analysis, as most commenters argued.” Although STB believes the URCS should be updated, what are the prospects that STB will make the necessary effort at “study and analysis” to make those updates?

One should not judge STB too harshly for walking away from EP 431 rulemaking. Afterall, STB requires input and some consensus from its stakeholders if the agency is to make changes to something as fundamental to rail regulation as the URCS. STB particularly needs input from the railroads that hold the data STB requires for any study and analysis. The railroads should have an incentive to help the agency, particularly if the agency moves forward with one of the Rate Reform Task Force’s proposals.

Rate_Reform_Task_Force_Report

Recall that the Rate Reform Task Force report suggested the agency “identify a point beyond which further application of differential pricing would be unwarranted.” Differential pricing is pricing in accordance to each shipper’s willingness to pay for rail transportation. This proposal looks like a rate cap.

Recall also that the agency’s jurisdictional threshold is set using the URCS as the denominator in an RVC calculation. Why is this problematic? Because URCS underestimates the costs of much chemical traffic, particularly hazardous commodities. The URCS spreads insurance expense evenly across all rail traffic instead adding risk factors to more-hazardous traffic. Rail executives do not lightly say that they are betting the franchise when they move such traffic.

A rate cap, such as the report may be contemplating, would be a disincentive to moving hazardous traffic. It would undercompensate the carriers and could become a safety concern. The carriers would be justified in “de-marketing” such traffic.

What should STB do with the URCS? There are two basic approaches. On the one hand, it could make incremental but necessary improvements to URCS such as fixing the cost allocations for hazardous materials traffic and also the discrepancies in the costing of trainload and multicar shipments.

On the other hand (I am an economist after all), STB could embark on a radical approach. It could develop a costing system based on a more economically sound technique such as what Christensen Associates used in the Competition Study, which STB commissioned several years ago.

January 2010 Competition Study Report

STB concluded that the study “found that the rate increases were driven by fluctuating fuel prices and other costs and did not appear to reflect a greater exercise of railroad market power over captive shippers.”

In any case, as long as the URCS remains a key foundation of the U.S. regulatory regime, STB and its stakeholders should take care that URCS represents a fair representation of rail costs. This becomes more important as STB contemplates any substantial change to its regulations.

Dr. William Huneke is the former Director & Chief Economist at the Surface Transportation Board. He has more than 40 years’ experience in economics, transportation, railroad regulatory policy, management consulting, business analysis and teaching in the commercial and government sectors. He provides economic consulting on regulatory and arbitration matters. At the STB, Dr. Huneke led the Board’s analytical work and oversaw the collection of economic and financial data. Since leaving the STB, he has provided economic and litigation support to Class I railroads and other private-sector clients. He worked with the OECD (Organisation for Economic Co-operation and Development) to advise the Mexican government on its future rail regulatory policy. He represented the United States at an OECD conference on railroad industry structure. His private-sector experience included executive and management positions at UUNET, Freddie Mac and the Association of American Railroads. Dr. Huneke has taught graduate business courses at the University of Maryland, Robert H. Smith School of Business. He holds a doctorate from the University of Virginia and a B.A. from Swarthmore College.

Categories: Class I, Freight, Railway Interchange, Regulatory, Short Lines & Regionals, Switching & Terminal Tags: , , , ,