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     Tom O'Connor Progress Since the Staggers Rail Act of 1980 |
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Table of Contents My name is Tom O’Connor. I am Vice president of Snavely
King Majoros O’Connor & Lee, Inc. (Snavely King or SK) Snavely King is an
economic and management consulting company focusing on transportation and
utilities. Snavely King has been in business for more than 35 years, serving
transportation clients including railroads, shippers and government agencies, in
the United States, Canada and Europe. Since passage of the Staggers Rail act in 1980, rail rate
regulation has receded from its former dominant status and is now a rarity. The
rail rate process has shifted increasingly toward reliance on market forces. In
recent years rail mergers have led to consolidation of the industry and the
widespread disappearance of rail to rail competition. As reliance on market
forces has increased the presence of market competition has diminished. This
creates recurring and persistent imbalances in the rail marketplace and
reinforces the appropriateness of the STB policy goal of ensuring that rates are
reasonable. While we do not advocate increased regulation we do
advocate more rail-to-rail competition as a means of increasing price
competition and improving service. Deregulation has generally performed well, and the
additional freedoms the railroads have enjoyed have been helpful. We do not advocate re-regulation of railroad pricing in
general, but we do see repeated occurrence of very aggressive pricing in
situations where the railroad perceives that the shipper doesn't have a
competitive alternative. This pervasive problem requires access to appropriate
regulatory rate reasonableness review. To help solve this problem, we recommend railroad
management support of STB provision of mediation in rate case disputes, such as
Small Shipment Rate Reasonableness cases. Both Rail and shipper management can
recognize the benefits of using mediation as a flexible and effective form of
rate reasonableness review. Providing and facilitating such mediation is an
important and valid role for the STB. STB mediation can help resolve disputes
that, if left unresolved, could lead to resurgence of prolonged litigation or
result in legislation that railroads and others would find less appealing. As a staff economist at the Interstate Commerce Commission
(ICC), the predecessor agency to the Surface Transportation Board (STB), my
duties included review and analysis of filings in General Rate Increase Cases.
During this period rail rates involved published tariffs, and contracts had
virtually no role. The rail industry sought broadly applicable percentage
increases of existing rates in General Rate Increase Cases. The rate increases
were typically based on cost increases. During this period the ICC had a very
significant role in determining rail rates and rate increases. Status of the Rail Industry During this same time period, the rail industry in the
Northeast was approaching a historic collapse which culminated in the bankruptcy
of the Penn Central and other Northeast Railroads. As Manager of Local Rail Service Planning for the U.S.
Railway Association I was a member of a team tasked with analyzing the rail
bankruptcies and creating a viable entity from the assets of those corporations.
In this project of unprecedented scope and historic impact, at USRA we
developed, computerized, and implemented the light density lines cost analysis
system, which helped define Conrail. We worked closely with the Rail Services
Planning Office, within the ICC. The USRA systems were used to analyze and help
reach line service decisions for over nine thousand miles of railroad, in a 17
state Region of the US including some US railroad lines in Canada. Status of the Rail Industry During this time period, the rail industry in the Northeast
emerged from the ashes of bankruptcy. This process made clear that alternatives
to traditional economic regulation merited more consideration. Conrail, which
had been created out of the bankrupt railroads, was gaining its footing. At the Consolidated Rail Corporation (Conrail) as Assistant
Director, Cost & Economics, along with my staff and managers, we were tasked
with management and regulatory cost analyses in both freight and passenger
areas. To help rebuild profitability we designed, installed and managed a
computerized internal management economic analysis system at Conrail. The
system used specific management accounting data to develop economic costs and
was used to help guide virtually all transportation management decisions,
including service design, equipment acquisition, strategic initiatives, line
abandonments and service discontinuance. We developed and managed profit maximization and plant
rationalization programs. Much of this was based on computerization and
improvement of a wide range of economic and cost analysis systems which were
used to help manage and turn around this multi-billion dollar corporation Status of the Rail Industry During this time period, initially Conrail and gradually
the entire rail industry began to turn away from reliance on rate regulation
seeking a better understanding of, and more reliance on, the marketplace. At the Association of American Railroads as Assistant Vice
President, Economics, initially my duties included preparation, review and
analysis of filings in General Rate Increase Cases. Subsequently, at the AAR we
conducted economic analyses to help formulate industry economic policy positions
which led to the Staggers Rail Act of 1980. After the passage of Staggers,
working with ICC staff, we participated in helping shape the most significant
rail industry Costing System project in 40 years, the Uniform Rail Costing
System (URCS). We also helped direct development and installation of a
commercial computerized economic and market analysis system subsequently used by
virtually all major US railroads. Status of the Rail Industry During this time period, the rail industry, deregulated by
the Staggers Rail Act of 1980, adopted market based management and pricing
policies. Rate regulation was limited and was implemented reflecting other
policy goals including revenue adequacy. In 1982 as Vice President of DNS Associates, we
participated in rail merger analyses, transportation infrastructure analyses,
plant and network rationalization and feasibility studies, which fore-shadowed
the re-shaping of the rail industry, as it moved toward greater consolidation.
As the rail industry and the ICC moved toward the marketplace we advised the
U.S. Rail Accounting Principles Board on the costing aspects of regulatory
reform policies. As part of this process I provided expert testimony in Stand
Alone Cost rate cases before the ICC. Status of the Rail Industry During this time period, the rail industry adopted
Constrained Market Pricing and Stand Alone Costs as the principal rate
regulation method. Reliance on transportation contracts grew and access to rate
regulation became more limited and narrow. In
1988 as Vice President of Snavely King and Associates, now known as Snavely King
Majoros O’Connor & Lee, Inc. the focus on rail continued. Paralleling the
changes in the transportation industry, our transportation practice evolved from
being largely geared toward regulation and litigation to being primarily geared
toward marketplace solutions. We produced a series of guidelines on
transportation negotiations and contracting and facilitated transportation
negotiations and contracting seminars for a wide range of clients. At the same
time, the firm’s officers and staff also provided expert witness testimony in
successful transportation rate litigation. We analyzed dozens of rail merger scenarios including
merger cases which have re-shaped the rail marketplace. Status of the Rail Industry During this time period, the rail industry moved toward
ever increasing consolidation and concentration through mergers and
acquisitions. While more short line and regional railroads came into existence,
the increase in competitive options in the marketplace was limited. Unless the
short line had access to competing Class I railroad connections it tended to
have a limited effect on rail to rail competition. Calls for rate
reasonableness review became more prevalent as rail to rail competition
dwindled. The ICC had established Coal Rate Guidelines in 1985. This
met the needs of a relatively small segment of the rail market. The ICC and STB
responded to the unmet needs by instituting a proceeding to develop non-coal
rate reasonableness guidelines in 1995. The objective, to develop a feasible
and practicable method that can help produce more reasonable railroad rates,
benefits both railroads and shippers. Specifically the Small Shipment Rate Reasonableness cases
address rail rates that generate Revenue Cost Ratios (RCR) which: Ultimately, resolving these situations benefits both
shippers and railroads since Such rates present three sets of issues: The action plan we recommend builds on what has already
been accomplished to design and implement effective strategies to achieve more
reasonable rail rates. The action plan involves coordinated use of both the
Surface Transportation Board (STB) Constrained Market Pricing, Maximum Rate
“Stand Alone Cost” (SAC) concepts and the small shipper rate reasonableness
approach. The STB's "stand-alone cost" ("SAC") test seeks to
determine the lowest cost at which a hypothetical, efficient, "stand-alone
railroad" ("SARR") could provide the transportation service needed by a
complaining shipper. Under the SAC test, the complaining shipper designs a
hypothetical railroad specifically tailored to serve its needs and the needs of
other traffic it designates. The costs of building and operating such an
efficient SARR are then compared to the revenues that such a system could expect
to earn. If the involved shipper demonstrates that the SARR would earn more than
necessary to cover all of its costs (including a reasonable return on
investment), the shipper is entitled to rate relief. The Action Plan consists of the following steps: The rail shipper benefits by achieving rate relief on key
lanes and resolving impasses with the railroads. The rail shipper also benefits
by avoiding the cost and risk of a major rate case. The first use of this
process occurred in the BP-Amoco – Norfolk Southern case which was successfully
concluded through STB mediation in June 2005.[2]
Snavely King served as the witness and Leboeuf Lamb Greene and MacRrae served as
counsel to BP-Amoco The railroads benefit by demonstrating that the small
shipper guidelines mechanism they have been advocating for over a decade can
actually work. This mutes the demand for more stringent rail regulation. The
railroads also benefit by resolving impasses with the involved shippers and
avoiding the cost and risk of major rate cases. As noted above, this process
was successfully applied in the BP-Amoco – Norfolk Southern case. The STB benefits by demonstrating that the small shipper
guidelines they have been working on since the early 1990's can work
effectively. However, the guidelines work only when combined with innovative
mediation techniques such as those advocated by the STB and implemented in the
BP-Amoco – NS case. This was the first small shipment case ever brought before
the STB and was settled in June 2005, facilitated by STB mediation. Our approach uses proven methods
in logistics, systems analysis, negotiation strategy, and regulatory policy.
Each of the steps, as defined by SK, is outlined below. 1. Select specific rail lanes with Revenue Cost Ratios
well above the regulatory threshold on lanes for which rail or other modal
competition is not available or not economically or commercially practical.
Meeting these two conditions satisfies the market dominance prerequisite for
accessing Surface Transportation Board (STB) regulatory rate relief and
indicates that regulatory rate relief may be appropriate. Overall, SK has found numerous instances in which rail
shippers are paying rates, which SK analyses indicate are: 2. Demonstrate that small rail shipments are eligible to pursue Surface Transportation Board Maximum Rate Relief under the STB regulations in Ex Parte 347 Sub No. 1. Having established eligibility for regulatory relief, the strategy is to move first to the STB small shipper guidelines and then to STB-assisted mediation of those guidelines. Under the Interstate Commerce Act, as revised by the ICCTA, the ICC and its successor agency the STB were charged with protecting individual captive shippers from unreasonably high and unfair rate levels.[4] In doing so, the STB was specifically directed to consider three so-called Long-Cannon factors[5], set forth in 49 U.S.C. 10701(d) (2). These factors are:
In determining reasonable rates, the STB is also directed to ensure that carriers have the opportunity to earn revenues that are adequate to cover costs, allow replacement of needed assets, and provide a fair return on investment. The mediation process is particularly appropriate for meeting these combined challenges. Under the Ramsey pricing principles adopted by the ICC and STB, railroads price traffic in inverse proportion to demand elasticity, up to the point at which a reasonable, adequate profit level is attained. In other words, a railroad prices its traffic differentially so as to recover a greater percentage of its unattributable costs from the traffic with greater dependency on its service. If there is a challenge to the reasonableness of a rail rate charged for captive traffic, the regulatory task is to determine whether the degree of differential pricing--i.e., the amount by which the revenues derived from the traffic at issue exceed the long-run marginal cost (LRMC) of handling that traffic--is reasonable. This determination should be carried out in light of the three Long-cannon factors. The STB is guided by Ramsey pricing principles and fundamental fairness in carrying out this regulatory task. But LRMC, attributable costs and elasticities of demand are economic concepts that are typically not directly measurable, and notions of fairness can be subjective. The STB challenge is to reflect these economic and equitable principles, in a practical, readily administered test. The Coal Rate Guidelines, adopted in 1985, provided the regulatory framework, known as Constrained Market Pricing (CMP), now used for analyzing rail rate challenges in major rail rate cases. CMP has been approved by the courts and applied in a number of cases, most often using a stand-alone cost (SAC) analysis. However, the STB recognized that a SAC analysis or other CMP presentation could be quite expensive and thus not feasible where the amount of money at issue does not justify the expense. Accordingly, the ICC initiated a proceeding to determine rate reasonableness guidelines for small shippers. This was intended to determine maximum rail rates where CMP (particularly SAC) is too costly or traffic too infrequent and dispersed for a Stand Alone Cost analysis. The STB recognized that a simpler method would necessarily be cruder than the CMP applied in major rate cases. Accuracy is sacrificed for simplicity. This trade-off is necessary to ensure that shippers are not foreclosed from exercising the statutory right to challenge the reasonableness of rates charged on its captive traffic. Under STB regulations (49 U.S.C. 10707(d) (1)), the reasonableness of a rate cannot be challenged if any of the following conditions hold:
We have identified many lanes that meet all of these tests. 3. Demonstrate that the small shipment rates at issue would be found as excessive in rate reasonableness analyses using the STB small shipper guidelines n Ex Parte 347, Sub No. 2. As noted above, the STB Constrained Market Pricing (CMP) rail rate guidelines were developed in the mid 1980’s for use in coal rate cases in ICC proceeding Ex Parte No. 347 (Sub-No. 1).[6] Subsequently, on December 27, 1996, in Ex Parte No. 347 (Sub-No. 2) Rate Guidelines -- Non-Coal Proceedings, the Board adopted simplified evidentiary guidelines. These were designed to be used in proceedings to determine the reasonableness of challenged rail rates charged on captive traffic where the Constrained Market Pricing guidelines used in major maximum rate cases cannot practicably be applied. As of 1996 these simplified guidelines used three revenue-to-variable cost (R/VC) benchmark figures as starting points for a case-by-case reasonableness analysis.
The RSAM benchmark reflects the defendant carrier's particular
revenue needs (by examining the average markup that the carrier might charge its
potentially captive traffic to meet those needs). Our approach uses each of these STB R/VC to ascertain whether rail shippers on small volume lanes would qualify for and should receive rate relief. · Combined R/VC or RCR BenchmarksTaken together the three RCR benchmarks substantially meet the requirements of the Long-Cannon Factors and Constrained Market Pricing. In combination, these measures provide a solid base on which to determine whether a given rate or set of rates exceeds a reasonable level. The combined benchmarks include all of the factors that must be looked at in a rate reasonableness analysis:
Accordingly, the three r/vc or RCR benchmarks in combination provide a solid base for rate reasonableness analysis. 4. SK recommends a synthesized alternative: a solution based on STB small shipper guidelines and mediated by the STB. In recognition of the ongoing need to improve the Simplified Small Shipper Rate Guidelines to make them effective and available, we recommend continued and broadened use of STB facilitated mediation. The recent successful use of mediation, facilitated by the STB, shows that the STB, railroads and shippers can use this technique effectively. SK has participated successfully in both mediation and arbitration in rail and other industries. The widespread use of mediation and arbitration techniques indicates their effectiveness. Some of the benefits associated with mediation can be summarized as follows:
These are just some of the benefits provided by mediating disputes. Moreover, there is seldom any serious downside to mediation. Mediation works not only because it focuses on the parties’ own interests and agendas, but also because it provides the opportunity for parties to move beyond disputes to chart a better solution. VI. RecommendationSK recommends continued rail rate reasonableness review based on the STB Small Shipper Guidelines combined with STB-facilitated mediation; such as outlined in this Action plan. This approach combines the decades of ICC and STB rail rate reasonableness analyses with the proven strengths of mediation in resolving fact finding and other issues. SK has successfully used all of the techniques recommended in this plan. [1] In the Action Plan we consider all three STB parameters; RCR comp; RCR>180 and Revenue Shortfall Allocation Method (RSAM). [2] See STB Docket NOR 42093 for public filings on this pathbreaking case. [3] The recommended reliance on STB RSAM and similar parameters requires open access to the underlying data and calculations to ensure the credibility and effectiveness of the process. [4] This section draws on excerpts from a series of STB decisions in Ex Parte 347 (Sub No.2) ranging from 1995 through 2004. [5] The Long-Cannon Factors were named for the two Senators who introduced the amendment that added these provisions to the Staggers Rail Act of 1980 (Staggers Act), which deregulated the rail industry. |
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