**FRANCIS P. MULVEY**

**VICE CHAIRMAN**

**SURFACE TRANSPORTATION BOARD**

**395 E STREET, SW**

**WASHINGTON, DC 20423**

**(202) 245-0210**

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**NORTH DAKOTA GRAIN DEALERS ASSOCIATION**

**ANNUAL CONFERENCE**

**FARGO, ND**

**JANUARY 21, 2008**

Good morning and thank you for inviting us to speak to you today. I
appreciate the opportunity to appear here with Senator Dorgan to address
issues of concern to the agricultural community.

The Board has taken a number of steps during the past year to
proactively monitor the railroads and improve our regulatory practices.
But before I elaborate on these efforts, I want to provide a brief
overview of the Board and its responsibilities to set the backdrop
against which we've taken these latest actions.

**Statutory Responsibilities**

The STB is charged by statute with resolving railroad rate and service
disputes and reviewing railroad restructuring transactions (mergers,
line sales, line constructions, and line abandonments). We also have
limited jurisdiction over certain trucking, bus, household goods, ocean
carrier, and pipeline matters.

The Staggers Rail Act of 1980, as supplemented by the ICC Termination
Act of 1995, directs the Board to exempt from economic regulation
traffic where the market is deemed competitive. The Board's governing
statute, like virtually all other modern statutes of economic regulatory
agencies, assumes that aggressive regulation is not necessary where
competition exists, because in such circumstances market forces will
discipline firms and prevent market abuse. The law directs us to rely to
the maximum extent possible on competition to establish reasonable rail
rates. The Board can intervene in railroad rates only if it determines
that a rail carrier has market dominance over the transportation to
which \[the\] rate applies. *I want to note that we recognize that
competition often does not exist in the transportation of many
agricultural commodities and therefore the transportation of grain and
most other agricultural commodities is NOT exempt from active regulation
by the Board.*

A carrier is presumed not to have market dominance where its rates
produce revenues that are less than 180% of variable cost of providing
the service. Also, if there are competitive alternatives for moving the
traffic between the same points -- either from other railroads or from
other modes of transportation -- then the Board does not have authority
to regulate the rate. Finally, the Board has very limited jurisdiction
over traffic that moves under contracts between shippers and carriers.

Back in 1980, the Nation's rail system was in desperate financial
straits. It was burdened with unproductive assets, forced to provide
unprofitable services, and hampered by excessive government regulation.
Congress put in place reforms directing that railroads be treated, in
most respects, more like other businesses. Since that time, the railroad
industry's financial condition has steadily improved. Today, the
industry is considered by most independent analysts to be relatively
healthy.

Unlike most businesses, however, railroads are common carriers. As
common carriers, they have an obligation to provide service to the
general public on reasonable request. In order to ensure that shippers
receive the needed level of service, the railroads' financial resources
must be sufficient to maintain and appropriately expand the rail
infrastructure. At the same time, transportation of commodities vital to
the Nation's economic well-being must be efficient and reasonably
priced.

The Staggers Act made it easier to shed excess capacity and the system
has now been largely rationalized and made more productive. But in
recent years, the U.S. economy has expanded, and the rail network, like
other parts of our transportation system, has become
capacity-constrained. This past April, we held a hearing on rail
capacity, traffic forecasts, and infrastructure requirements. The Class
I railroads testified that -- despite their recent increases in
infrastructure spending and their planned future capacity investments --
they will not be able to keep up with the projected increase in the
demand for rail service. The capacity shortfall that we see in many
markets today will dramatically worsen unless bold new policies and
strategies are adopted.

So, are the railroads earning enough to maintain and expand the network?
Are the railroads revenue adequate?

Each year the STB contrasts the railroads earnings with what they need
to earn to cover their costs and invest in the infrastructure. We
examine the railroads' cost of capital. A railroad's cost of capital
includes both the cost of borrowing and the cost of equity. While the
cost of debt is easy to determine, the cost of equity is far more
difficult. Since 1981, the Board has been using the same basic approach
to estimate the cost of equity, but concerns have been raised that our
approach may be overstate the industry's cost of capital and thus the
revenue needs of the industry.

Last year we launched a rulemaking to examine our methodology and to
ensure the accuracy of this important measure. Last week, we issued a
final rule that changes the way we calculate the cost of capital. This
new estimate will lower somewhat our estimate of the cost of rail equity
capital.

**GAO Report and STB Competition Study**

The Government Accountability Office (GAO) recently issued reports[^1]
on railroad rates, competition, and capacity. GAO noted that between
1985 and 2005, rates rose by less than the rate of inflation for each of
the four major categories of rail traffic \-- coal, grain, motor
vehicles, and miscellaneous mixed shipments. Moreover, GAO found that
despite an uptick in recent years, rail rates overall in 2005 remained
below 1985 levels even in nominal terms. At the same time, the Board's
index of railroad costs increased by 80%.

GAO did focus on the higher rates paid by agriculture shippers. Last
November, the Board held a hearing on market conditions in the grain
industry that may have caused grain rates to diverge from the long-term
trend of reduced rail rates for most other shippers. We also wanted to
hear about the interplay between the American and Canadian wheat
markets, how the Canadian regulatory system differs from the American,
and what impact those differences might have on the US grain market.
Last week, the Board concluded this proceeding by issuing a decision
which recognized the protections afforded grain shippers in the Staggers
Act, and concluded that our recent revisions for bringing small rate
cases should be the avenue for grain shippers to pursue rate relief.

There are of course areas -- states like North Dakota and Montana --
where rail rates tend to be higher than elsewhere. That is largely due
to the economics of the railroad industry. Under the principles of
"differential pricing," railroads, which have a high proportion of fixed
costs and which have fierce competition for most traffic, will charge
more, often substantially more, to their captive shippers than to
shippers who have competitive options. They must do this to earn enough
revenues to cover their direct expenses, invest in necessary facilities,
and still return dividends to shareholders. Although differential
pricing is practiced in many other industries -- such as airlines,
utilities, hotels, and movie theaters -- we understand that the
consequences for captive rail shippers might be much more severe than
for air travelers, movie goers or hotel guests. But if the railroads'
ability to differentially price by is significantly restrained, then
revenues will have to come from elsewhere. If other sources of revenue
cannot be found, then infrastructure investment will suffer, as will
rail service.

To further address the problem of inadequate competition, the Board has
commissioned an extensive study of the issue. The study will also assess
various policy issues, including current and near-future capacity
constraints in the industry. The study is scheduled to be completed this
Fall.

Another recent Board decision involves the paper barriers that are often
part of sale or lease contracts when Class I railroads sell or lease
lighter-density portions of their lines to smaller carriers. Some
parties believe that these arrangements have been vital to the
development of the short-line industry. Others, including myself, are
concerned that they have tend to freeze in place the status quo, rather
than allowing the development of new competitive options not available
before the transaction. In October 2007, the Board ruled that it would
henceforth review these restrictions on a case by case basis to
determine whether they violate our statute. We also proposed disclosure
requirements for new as well as existing paper barrier provisions to
better enable parties who believe they are aggrieved by these
restrictions to challenge them.

**Rate Regulation**

When capacity is tight, railroads, like any other producer, will seek to
raise prices. Those shippers without competitive options will see their
rates rise the most. Thus, with capacity tight today and expected to be
tighter tomorrow, the Board's rate relief processes are particularly
important.

[Rate Disputes]{.underline}. Under the statute, the Board is directed to
ensure that rates are reasonable while at the same time not precluding
railroads from obtaining adequate revenues. Balancing these potentially
conflicting objectives is not an easy task. Many shippers have
complained that it is too expensive and too time-consuming to bring a
case before the STB. In response, we have recently changed our
procedures for handling rate cases, with one set of procedures designed
to streamline large rate cases and two other procedures designed to
reduce the cost and improve access for smaller cases. With the exception
of coal shipments by utilities, most rail movements of captive traffic
will fall under our small case guidelines.

[Small Rate Cases]{.underline}. In 1996, the Congress directed the STB
to develop procedures for addressing smaller cases for which the costs
of bringing a full case to the Board were too costly. The STB adopted
simplified guidelines, but no cases were filed under them until very
recently. On September 5, 2007, the Board issued a decision updating our
process for reviewing rate complaints in cases too small to warrant the
cost of litigating a case to warrant a full fledged review. The Board's
decision, which makes the rate review process available to shippers of
all sizes, allows smaller rate cases to proceed on one of two tracks.
First, freight rail customers may seek up to \$1 million in relief over
a 5-year period, using a process that largely looks at the rates for
moving comparable traffic. A shipper using that approach would have a
Board ruling on its case within 8 months of the filing of its complaint.

Under a second approach, freight rail customers can seek up to \$5
million in relief over a 5-year period, by using a process that focuses
on whether the carrier is abusing its market power by charging more than
it needs to earn a reasonable return on the replacement cost of the
infrastructure used to serve that shipper. This is a simpler form of the
test that is applied in large cases. It relies on standardization of
many of the components in order to reduce the cost and complexity of
litigating the case. A Board decision in a rate case brought under this
approach would be issued within 17 months after the filing of the
complaint. The Board's new procedures -- which have been challenged in
court by numerous rail interests -- are designed to ensure that the rate
review process will be accessible to all captive traffic that moves
under common carrier rates. []{.mark}

[Fuel Surcharges]{.underline}. Another matter that concerned shippers
recently is the way the railroads were assessing fuel surcharges.
Captive shippers voiced concerns that fuel surcharges that were
expressed as a percentage of the rate, virtually guaranteed that they
would bear higher surcharges than shippers in competitive markets.

In January 2007, we issued a decision declaring it an unlawful practice
for carriers to levy a fuel surcharge that was not related to the
increased fuel cost attributable to the particular movement. This action
demonstrates that the Board will use aggressively the authority granted
to it by statute to stop unreasonable practices, thereby protecting
shippers and advancing the public interest.

**Service Quality and Railroad-Shipper Relationships**

The Board actively monitors railroad industry performance. We receive
monthly reports from each Class I railroad, tracking such performance
indicators as average train speed and terminal dwell time. I meet with
Board staff about service metrics at least every other week. Moreover,
in addition to our annual request for each Class I carrier to detail how
it plans to handle end-of-year peak demands, the Board now also requests
the carriers to report their performance goals with respect to
cars-on-line, terminal dwell time, train speed, and employment levels,
as well as their capital spending plans for the next year. The carriers'
responses are available on our website.

The Board has a Rail Consumer Assistance Program which handles about 100
disputes annually. Most of these relate to service including: car
supply; claims for damages; demurrage; fuel surcharges; railroad
employee complaints; and community concerns. Our staff cannot always
resolve the issues informally, but they are often successful at bringing
the parties closer together and getting them to talk to each other
without resorting to litigation or formal Board adjudication.

When parties cannot resolve their differences informally, they can
engage the Board's formal processes by filing a complaint. The Board may
temporarily substitute another carrier for a carrier that is unable or
unwilling to provide adequate service on its lines. For example, we
found that a railroad in Texas was not providing adequate service to a
shipper and we ordered temporary service by another carrier. When it
became clear that the issues were not resolvable, the Board ordered the
lines involved to be sold, at a price set by the Board to reflect the
value of the property. The Board's decisions demonstrate that we will
use every available tool, where necessary, to protect shippers receiving
inadequate service.

The Board acted to preserve shippers' service options in a case in Ohio
last year involving a railroad that would not let another railroad cross
its line. In that case, a Class I rail carrier had unilaterally removed
the crossing diamonds that were needed for a short line to serve several
potential shippers. The Board made clear that a carrier may not undercut
another carrier's ability to fulfill its common carrier obligation by
unilaterally severing track of the other carrier that is part of the
national transportation system. The Board directed the Class I carrier
to promptly reinstall the crossing.

**Conclusion**

The past 12 months have been noteworthy for the number of proactive
steps taken by the Board to reform, streamline, and modernize our
oversight and rail regulatory procedures. Of the more important actions
that will take place between now and the end of this year, the STB will:

-   See that the competition study is completed, and analyze the results
    and recommendations contained therein;

-   Test the new simplified rate guidelines on three newly filed small
    rail rate disputes (and perhaps more cases, if filed);

-   Consult with our new energy advisory committee for guidance on a
    range of significant issues that affect the public interest in a
    reliable delivery network for coal and liquid biofuels;

-   Review the recently announced proposal by the Canadian Pacific
    Railway to acquire the Dakota, Minnesota & Eastern Railroad, as well
    as the Canadian National Railway's proposal to acquire the Elgin,
    Joliet & Eastern Railway;

-   Improve the Board's ability to ensure effective regulation of rail
    operations that handle municipal solid waste and related materials;

-   Address the current ambiguity as to whether certain types of
    arrangements between rail carriers and shippers reflect contracts
    (for which regulatory remedies are unavailable), or whether they
    reflect common carrier service subject to Board regulation; and

-   Prepare the STB to have the capability to address potential
    conflicts between passenger rail and freight rail operations and to
    implement potential legislative proposals in this regard.

    I have also advocated that the Board take a closer look at the
    current status of the "common carrier obligation." I hope that we
    will hold a hearing into this multi-faceted issue in the near
    future.

    I appreciate the opportunity to discuss these issues today, and look
    forward to any questions you might have.

[^1]: The report is entitled *Industry Health Has Improved, but Concerns
    about Competition and Capacity Should Be Addressed*. The supplement
    is entitled *Freight Railroads: Updated Information on Rates and
    Other Industry Trends*.