**Testimony of Roger Nober**

**Chairman of the Surface Transportation Board**

**Senate Committee on Commerce, Science, and Transportation**

**Subcommittee on Surface Transportation and Merchant Marine**

**Hearing on Railroad Shipper Issues and S. 919**

**2:30 p.m. October 23, 2003 253 Russell**

Good morning, Chairman Hutchison, Ranking Member Inouye, and Members of
the Subcommittee.

My name is Roger Nober, and I am Chairman of the Surface Transportation
Board. I appreciate the opportunity to appear before this Subcommittee
today to discuss the rate and service issues faced by railroad shippers
in general and singly-served (otherwise known as "captive") rail
shippers in particular, and the provisions contained in S. 919, the
Railroad Competition Act of 2003.

This is my first appearance before this Subcommittee as Chairman of the
STB. I appreciate the longstanding and deep interest that the Members
have shown in the issues facing the railroad industry, which are vitally
important to the financial health of the freight railroads, to the
railroads' customers and employees and to the nation's freight
transportation system as a whole. I commend the Subcommittee for holding
this hearing and discussing these important issues.

In my written testimony, I would first like to provide the Subcommittee
with an overview of the Board and its responsibilities. Next, I will
discuss steps the Board is taking to address issues faced by
singly-served or captive shippers. Finally, I will discuss S. 919.

**Overview of the STB**

As all of you know, the Surface Transportation Board was created eight
years ago by this Committee in the ICC Termination Act of 1995. The
Board is an economic regulatory agency that Congress charged with the
fundamental missions of resolving railroad rate and service disputes and
reviewing railroad mergers, line sales, abandonments and new
construction. Structurally, the Congress determined that the Board
should be decisionally independent but administratively affiliated with
the Department of Transportation.

When it was created at the beginning of 1996, the Board had to
accomplish its statutory missions with one-third fewer employees than
had been performing those same functions at the ICC. Since 1996, the
Board has met its statutory deadlines while functioning with nearly the
same level of resources during that time. But as I will outline in my
testimony, the Board will face new challenges in the coming year as it
works to address the issues raised today and will need some modest
additional resources to continue its important work.

The Board serves as both an adjudicatory and a regulatory body. The
Board has jurisdiction over railroad rate and service issues and rail
restructuring transactions (mergers, line sales, line construction, and
line abandonments); certain trucking company, moving van, and
non-contiguous ocean shipping company rate matters; certain intercity
passenger bus company structure, financial, and operational matters; and
certain pipeline matters not regulated by the Federal Energy Regulatory
Commission.

In sum, when Congress eliminated the ICC in 1995, it created the Board
to carry out two core functions -- reviewing merger proposals and
resolving disputes over rates and services provided by railroads. One of
the main reasons the Board exists is to provide a regulatory backstop to
assess the reasonableness of rates charged to captive shippers when
those customers and their railroads are unable to successfully negotiate
a contract for the transportation.

The Board has created a number of mechanisms to help railroads and their
customers resolve disputes before availing themselves of the Board's
formal processes. For example, the Office of Compliance and Enforcement
operates the Rail Consumer Assistance Program. That program is intended
to provide assistance to rail consumers in addressing those issues that
have not been resolved through private negotiations. When informal
processes like that one cannot produce a solution, however, the Board
must be the regulatory backstop that Congress intended it to be.

It is no secret that many captive shippers -- the focus of today's
hearing -- believe the Board has inadequately performed this core
mission of ensuring that they have a forum for reaching a formal
resolution of rate or service disputes. They feel that without a
regulatory backstop, the transportation market for freight rail services
does not properly function. Many of the issues they raise are
legitimate, and I will next turn to the fundamental concerns raised by
captive shippers and the steps the Board is taking to address them.

**Issues Faced by Captive Shippers**

1.  [Unreasonable Rates]{.underline}

Under the Interstate Commerce Act, the Board has exclusive jurisdiction
to resolve rate disputes in those instances when railroads have market
dominance -- in other words, the railroad is charging a rate higher than
the regulatory floor and the shipper has no effective transportation
alternative. Under the Interstate Commerce Act, the Board must balance
the often conflicting objectives of assisting railroads in attaining
revenue adequacy, on the one hand, and ensuring that the rates that
individual shippers pay are reasonable and fair, on the other. The
balance, as we all know, is not an easy one. Rates that are too high can
harm rail-dependent businesses, while rates that are held down too low
will deprive railroads of revenues to pay for the infrastructure
investments needed to give shippers the level and quality of service
that they require. The Board is the forum of last resort if a captive
shipper feels his rate is unreasonable, and the agency must do its best
to carry out the law in a way that is fair to all when deciding railroad
rate cases.

The Board has one set of procedures for handling "large" rate cases and
another for "small" cases. In recent years, the Board has experienced a
significant increase in the number of large rail rate complaints filed
with it. Whereas in past years the Board had two or three of these cases
pending at any one time, today it has 13 large rail rate disputes
pending (as well as two pipeline rate disputes and two water carrier
rate disputes pending). The Board still has not had a single small rate
case filed since it adopted its small case guidelines in 1996, but as I
will discuss further, my top priority for the next year is to establish
a meaningful process for quickly and surely deciding small rate cases.

a.  [Large Rate Cases]{.underline}.

Determining the reasonableness of a rate in a large rate case is a
complicated inquiry. The Board's governing statute requires it first to
determine whether the railroad has monopoly power over its customer --
in other words, whether the railroad is market dominant. Only if the
railroad is market dominant does the Board have jurisdiction to review
the rate. This is so because Congress has foreclosed rate regulation
where there is effective competition. Once it has determined that it has
jurisdiction to review the rate, the Board applies a court-approved
methodology for rate review known as "constrained market pricing" (CMP).

i.  [Market Dominance]{.underline}.

The first step in a rate case is a two-part inquiry to determine whether
the railroad has "market dominance" over the transportation to which the
rate applies. The first part is to determine the "variable costs" of
providing the service. The statute establishes a conclusive presumption
that a railroad does not have market dominance over transportation if
the rate that it charges produces revenues below 180% of the variable
costs of providing the service, which means that this 180%
revenue-to-variable cost (r/vc) percentage is the floor for regulatory
scrutiny.

If the rate the railroad charges exceeds the 180% r/vc threshold, the
second part of a market dominance inquiry involves a qualitative
assessment in which the Board must determine whether there are any
feasible transportation alternatives that could be used for the traffic
involved. The Board considers whether there is actual or potential
direct competition -- that is either competition from other railroads
(intramodal competition) or from other modes of transportation such as
trucks, pipelines, or barges (intermodal competition) for transporting
the same traffic moving between the same points. If there are effective
competitive alternatives for the transportation, then the Board does not
have jurisdiction to regulate the rate, even if the rate charged yields
an r/vc ratio greater than 180%.

ii. [Rate Reasonableness Standards]{.underline}.

If the shipper can show that the railroad is market dominant, then the
Board applies its CMP principles to assess whether the rate being
charged that shipper is in fact unreasonable. CMP provides a framework
for the Board to regulate rates while affording railroads the
opportunity to cover their costs. It is premised on differential
pricing, that is, pricing based on the demand for the service provided.
CMP principles recognize that, in order for railroads to earn adequate
revenues, they need the flexibility to charge different customers
different prices based on each customer's demand for rail service. But
CMP principles also impose constraints on a railroad's ability to price.
Despite the complexity of CMP, the courts have held that it is the most
desirable available approach to railroad rate review and that the Board
must use it whenever it is feasible.

Although complaining shippers can choose from three approaches, the most
commonly used CMP constraint is the "stand-alone cost" (SAC) test. Under
SAC, a railroad may not charge a shipper more than what a hypothetical
new, optimally-efficient carrier would need to charge the complaining
shipper if such a carrier were to design, build, and operate -- with no
legal or financial barriers to entry into or exit from the industry -- a
system to serve only that shipper and whatever group of traffic that
shipper selects to be included in the traffic base. The ultimate
objective of the SAC test is to ensure that the complaining shipper is
not charged for carrier inefficiencies or for facilities or services
from which the shipper derives no benefit. As with CMP in general, this
assures the complaining shipper that it is not required to pay for
inefficiencies or to unfairly subsidize other customers of the railroad.

iii. [The Board Is Working to Reform the Large Rate Case
     Process]{.underline}.

     Deciding large rate cases is time consuming and costly for both the
     parties involved and the Board. Although the Board by statute has 9
     months after all evidence is filed to decide a large rate case, it
     can take more than twice that long after the shipper files its
     complaint for the parties to file all their evidence with the
     Board. Preparing that evidence and presenting it to the Board are
     very expensive -- parties have testified that a SAC case can cost
     as much as \$3 million to prosecute, \$5 million to defend, and
     generate more than 700,000 pages of material.

     When I became Chairman, the Board intensified its search for ways
     to simplify and speed up this process, and as a result of this
     effort the Board recently adopted a number of changes to its rules.
     Last February the Board held a hearing in the rulemaking proceeding
     entitled *Procedures to Expedite Resolution of Rail Rate Challenges
     To Be Considered Under the Stand-Alone Cost Methodology*, STB Ex
     Parte No. 638, which was exceptionally productive.

     Based on the extensive testimony received from shippers and
     railroads, in April the Board revised its rules in ways that ought
     to both shorten the decisional process and limit the expense of
     bringing a case. The new rules' most significant provisions
     include: (1) mandatory, non-binding mediation at the beginning of
     the case, under the Board\'s auspices, between the complaining
     shipper and the defendant railroad; (2) expedited procedures to
     resolve disputes, using Board staff, over what information the
     parties can be required to give to each other during
     "discovery"; (3) technical conferences to resolve, before the
     actual evidence is filed, certain factual disputes between the
     parties using the expertise of Board staff; and (4) requiring
     parties to submit versions of all filings with the Board that can
     be read by the opposing party and the public. These new rules have
     already been a success.

     A significant component of the new rules is to increase the
     involvement of Board staff in the process through technical
     conferences and regular meetings with the parties. The Board
     established technical conferences because the parties were spending
     time and attorney and consultant fees fighting about -- and the
     Board was expending resources to resolve -- technical matters over
     which there should be no dispute, such as the number of miles
     between a coal mine and a power plant. In the first technical
     conference (held in the "*Otter Tail v. The Burlington Northern and
     Santa Fe Railway*" case), disputes over 200 pieces of data were
     settled in just over

     an hour. In the past, these disputes would have led to protracted
     litigation that would have cost the parties thousands of dollars in
     fees and could have substantially slowed resolution of the case.

     Another major component of the new rules was the institution of a
     60-day period of mediation at the start of any new case. All
     parties -- railroads and shippers alike -- who testified at our
     February hearing on Ex Parte No. 638 thought mediation would be a
     useful tool to help them to resolve their rate disputes privately.
     The first case since the Board adopted these new rules, "*AEP Texas
     North v. The Burlington Northern and Santa Fe Railway"*, was filed
     in August 2003, and I am pleased to say that I selected former
     Congressman John Thune to conduct the initial mediation. During his
     tenure on Capitol Hill, Congressman Thune served on the Committee
     on Transportation and Infrastructure, where he was actively
     involved in matters concerning railroads and their customers. He
     also served as the State Rail Commissioner in South Dakota. He
     understands the perspective of both railroads and shippers, and the
     involvement of a mediator in this matter will help the parties
     resolve the dispute.

     It is important that the process for resolving major rail rate
     disputes be open and fair, and every party must have an opportunity
     to make its case so that the Board will have a full grasp of the
     implications of any actions it takes**.** In that regard, on
     September 10, 2003, for the first time, the agency held an oral
     argument in an individual large rate case ("*Duke Energy v. CSXT
     Transportation*"). This session was a productive one both for the
     Board and for the parties, and we will continue to hold arguments,
     as appropriate, in future cases.

     One significant outgrowth of this focus on rate cases is that
     recently, as the Board was putting together a decision last week in
     "*Duke Energy v. Norfolk Southern Railway*," we realized that we
     needed to ask the parties to supplement the record, which was
     incomplete in one critical respect. The same issue arises in two
     other similar cases. The Board issued an order addressing this
     situation and is taking additional evidence in all three cases over
     a 3-week period. A decision in the first case, *Duke Energy v. NS*,
     will be issued by November 6, 2003.

     In sum, while major litigation such as large rate cases is
     expensive and slow, the Board has made progress in helping to
     ensure that the rate cases before it proceed faster, cheaper and
     better. I will make it a priority to continue to make more
     improvements in this area, and more progress is possible.

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a.  [Small Rate Case Procedures]{.underline}

Since I became Chairman, my top priority has been to provide shippers
who have smaller rate disputes an effective forum for resolving such
disputes. On April 22, 2003, the Board held an oral hearing on this
matter where it received testimony from representatives of shippers,
railroads, and unions. In sum, shippers raised the following concerns.

First, shippers contend that the ambiguity of who would qualify to use
the small rate case procedures is an insurmountable hurdle that has
chilled them from bringing any cases before the Board. Shippers believe
that the railroads would fight any shipper's claim that it is entitled
to use the expedited procedures, thus tying up the shipper in extensive,
expensive threshold litigation. This uncertainty appears to be a major
reason why no cases have been brought under the small-case process.

The Board can address this concern and bring some level of certainty to
this issue by constructing a test that looks at the size of the shipper
and the value of the case. If a shipper or its shipment met that test,
the shipper automatically would be eligible to use the small case
process.

Second, shippers asked the Board to ensure the expedited consideration
of small rate cases and to constrain the discovery process. These
shippers argued that protracted resolution of small rate case disputes
under our current rules does then no good because the transportation
marketplace for such shipments is so fluid. Many shippers have suggested
arbitration as a way of resolving such disputes because of its speed and
simplicity. Railroads oppose arbitration, since those proceedings are
outside of the strictures of the Interstate Commerce Act -- which
requires a balance between shippers' need for fair rates and railroads'
need to achieve revenue adequacy -- and could produce inconsistent
results. While mandating binding arbitration is beyond the Board's
statutory authority, I believe it is unnecessary because the small rate
case process being developed should be able to accommodate each side's
concerns.

The Board can streamline the discovery and resolution process by
creating an administrative process that combines the speed and
simplicity of arbitration while ensuring that such cases are decided
under the framework of the Interstate Commerce Act. One way for the
Board to accomplish these goals is to hire an Administrative Law Judge
(ALJ) to hear and decide small rate cases in the first instance. The ALJ
would have a prescribed time period for overseeing discovery and for
issuing a decision. The ALJ's decision could then be appealed to the
full Board. This would allow cases to proceed with the speed and low
cost of arbitration, but also ensure that these matters are decided
under the principles of the Interstate Commerce Act. In fact, the Board
is already working toward hiring an ALJ, and recently received approval
to do so from the Office of Personnel Management. The hiring process
will be completed once the Board's revised small case regulations are
final.

The Board could also establish, resources permitting, a Special Counsel
to assist small shippers in evaluating and bringing a small rate case.

The Board could also utilize the discovery and technical conferences now
being used in large rate cases in small cases as well.

Finally, shippers and railroads alike have urged the Board to adopt a
rate standard for small cases that is clear, unambiguous, fair, and of
course, able to withstand legal challenge. The Board promulgated a
standard in 1996, but that standard has been widely criticized and --
despite having never been applied -- was challenged in Court (although
the court declined to hear the challenge before the standard is actually
applied in a case). Identifying an appropriate standard for the
resolution of these cases is our greatest challenge, and while I have
asked the parties to provide suggestions to the Board on revising the
small-case standard, none has yet done so.

After the hearing, I assembled a team from within the agency to meet
with other economic regulatory agencies to gather information on how
they handle smaller disputes. Our team talked with other agencies,
including the Federal Energy Regulatory Commission, the Federal
Communications Commission, the Postal Rate Commission, and the Maryland
Public Utilities Commission, in a "best practices" survey to gather
information that might inform our ideas.

Unfortunately, the Board has not been able to move forward on this
initiative. I have made a judgment that a rulemaking to create a new
process for resolving small rate cases is significant enough that I
should not take such action as a single Board member, even though I have
the power to act alone. Although it is uncertain exactly how the Board's
final proposal will look, I have outlined several key elements of the
process and believe that these will form the core of meaningful reform.

1.  [Bringing Competition to Singly-Served Customers]{.underline}

A common desire of singly-served rail customers is to gain service from
a second, competing railroad. Singly-served rail customers who want to
be served by a second railroad may work with that railroad to finance
and apply for authority to construct a new rail line to the
singly-served facility to gain rail competition. The Board's experience
over the past decade has shown that new line construction can bring
competition while maintaining the private-sector characteristics of our
rail system.

The Board must take two regulatory steps before any such construction
can occur. First, it must approve the addition to the rail network.
Second, it must conduct any necessary environmental review of the
project. The Board has worked hard to expedite consideration of requests
to construct rail lines and to approve them when appropriate.

The Board has recently been able to rule on two such proposals. First,
the Board approved the construction by the Dakota, Minnesota and Eastern
Railroad (DM&E) of a line into the Powder River Basin in Wyoming, which,
if constructed, will provide enhanced rail transportation options for
coal shippers, particularly in the Midwest. Second, the Board recently
approved the construction of a line to provide BNSF access into the
Bayport industrial area near Houston, which would provide competition to
the large concentration of chemical companies located there.

While build-ins can increase competition and provide many benefits, we
have seen recently two examples that demonstrate that at times, the
construction of new rail lines can be

controversial in local areas. Indeed, both DM&E and Bayport Loop have
generated extensive local opposition and spawned court challenges to the
Board's decisions in those cases by various citizen and other groups.

In DM&E, the United States Court of Appeals for the Eighth Circuit
reviewed the Board's decision, and while the Court found the Board had
done "a highly commendable and professional job," it nonetheless
remanded the matter to the agency for limited additional consideration
of a few environmental issues. We are still studying the Court's
decision.

The Bayport Loop case has produced litigation both in Federal court
(where the Board's environmental review process is being challenged) and
in state court (where the City of Houston is resisting the railroad's
attempts to use state condemnation procedures to acquire property needed
for the new line). Just last week, the state court in Texas delayed
construction, but has yet to issue an opinion in the matter.

Despite these two recent court decisions, the Board is confident that it
will prevail in both of these cases. But notwithstanding the litigation
that they can generate, construction projects represent the best way to
balance the need for greater competition with the importance of
preserving the private rail network.

**S. 919**

Finally, I would like to address S. 919, the Railroad Competition Act of
2003.

Taken as a whole, S. 919 would fundamentally change the economic model
of the railroad industry and is unwise. Not a single one of our major
railroads is revenue adequate, and if enacted, S. 919 would call into
question the continued economic viability of our freight railroad
system. While some shippers may realize a short-term gain from lower
rates, in the long run this legislation, if passed, could significantly
degrade our nation's freight rail network, to the

detriment of all of its users. Although the nation's privately funded
railroad system may have some problems, it is the best freight railroad
system in the world, and the United States is the only country with a
national freight rail network that does not need taxpayer subsidy.

Most of the provisions of this legislation reflect unhappiness with the
Board and certain of its regulatory doctrines. I have met with most of
the supporters of this legislation, and they almost all agree that they
would not be calling for this legislation if the Board had interpreted
certain provisions of the Interstate Commerce Act differently. But the
individual provisions in the bill are less significant than the
underlying concerns that gave rise to the introduction of this
legislation. Since I have become Chairman I have worked hard to
understand the core concerns of captive shippers and the railroads that
serve them.

First, many shippers neither understand nor have confidence in the
Board. My most important initiative as Chairman has been to win that
confidence through openness and dialogue. During my nomination and
confirmation process, there was a great deal of concern expressed about
the lack of transparency at the STB. Since I have become Chairman I have
taken several steps to change this perception, including restoring
regular voting conferences on cases; holding hearings on significant
matters such as large rate cases and small rate cases, and on individual
cases pending before the Board such as the "Highline" case in New York
and the "Kansas City Southern/Tex Mex" merger proposal; and most
recently holding the Board's first ever oral argument on a large rate
case.

This summer, the Board also held an open house for practitioners to
introduce our staff to them and explain how our agency processes cases.
I have an open door policy for meetings and

have met with many shippers and railroads. I have traveled extensively
in the past year to better understand rail transportation. While these
may seem like small steps, they have gone a long way to help our
agency's stakeholders understand how and why the Board makes its
decisions.

Second, many disputes between shippers and railroads often take on a
life of their own because of the way shippers feel they are treated by
the railroads. Rail customers often conclude that while rates are high,
the railroads' service and attitude are bigger problems.

Rail customers are primarily wholesale enterprises who are themselves
industrial and manufacturing companies or producers of goods. Like
railroads, these shippers are capital intensive and work on thin profit
margins. They have customers who demand top-notch service and low
prices, and they have suppliers from whom they demand the same. All
operate in a brutally competitive global marketplace. These companies
understand the financial pressures railroads are under, but they feel
that they are not treated by the railroads the way they would treat
their own customers. This has led some shippers to assume that railroads
act this way because they are monopolies and to believe that legislation
like S. 919 would introduce more competition into the rail network and
force railroads to be more responsive to them.

Railroads should work harder to operate in a more customer-friendly
fashion, and I am working with all of our major rail carriers to impress
upon them the importance of doing so. Railroads must be nimble
competitors in the transportation marketplace to increase their business
and grow their revenues. While the leadership of each of the major
railroads understands this, that attitude does not always translate
through their entire organizations. The good news is that in many
circumstances railroads have worked with their customers to improve
efficiency and take costs out of the supply chain to the benefit of both
parties. But these examples are not common enough, and they must become
the norm, not the exception.

Helping railroads improve their operations to provide better service is
one goal that carriers, shippers and policy makers all share. The Board
has been instrumental in bringing the railroads, the city and the state
together to improve operations and devise a capital plan for improving
operations in the Chicago terminal area. Approximately one-third of all
rail shipments go through Chicago at some point in their journey.
Improving Chicago and other rail gateways will allow for faster, more
reliable shipments, to the benefit of all.

Third, a fundamental underpinning of S. 919 is that very few rail
shippers feel the Board provides an effective regulatory forum in those
instances when carriers and shippers cannot privately resolve their
differences and the shipper has no effective recourse.

Although the agency tries to help parties informally resolve their
differences and improve relations between railroads and their customers,
the Board has to be an effective regulatory backstop when a dispute over
rates and services is formally brought before the Board. No cases have
ever been brought under our small rate guidelines. This may be because
there are no smaller rate disputes, or because there is something in the
Board's rules that discourage shippers from bringing such cases. If no
small cases are brought, this means that in practice, only about 75 coal
shippers have a meaningful opportunity to challenge rail rates. This is
unacceptable.

At the same time, we must recognize that the economic relationship
between shippers and carriers is complex. In many cases, shippers have
many facilities -- both captive and competitively served -- and ship to
numerous destinations on several railroads. While the legislation seeks
to simplify the shipper-carrier relationship, in reality the
relationships between shippers and carriers are enormously complicated
and not easily understood. Many shippers do have economic leverage with
railroads when the totality of their relationship is considered, and the
legislation takes no account of this reality.

A more accessible process for bringing small rate cases can be achieved
through procedural reform at the Board, rather than through an overhaul
of the substantive regulation of railroads. Real reform is possible, and
the Board is working to identify the steps in the process that are the
problems and develop reforms to address those problems.

Finally, certain areas of the country are disproportionately dependent
on rail service in general, and on a single rail carrier in particular,
for its economic health. Many who are from the upper Midwest feel that,
because of the importance of producing bulk, commodity-based products to
their states' economies, their region's economies are particularly
dependent upon the business practices of a single railroad.

The Board must pay close attention to the unique set of concerns of rail
shippers in that part of the country. I recently traveled to North
Dakota and met with a number of government officials, shippers and
producers. I have spoken numerous times with the railroad that primarily
serves that area about the issues raised there. The issues faced in that
part of the country are complex, and not easily solved. However,
attention -- and not legislation -- is the best way to resolve the
issues faced there, and while attention may not solve every problem,
significant progress is possible.

**Conclusion**

One of my goals as Chairman of the STB has been to ensure that the
agency's processes work as well as they can. The first step was to open
up the Board. The Board has taken steps to streamline the process for
large rate cases, steps which are already working. The Board will
continue to reevaluate and refine how the parties and our staff work
through the large rate cases. The next step is to improve the agency's
small rate case process.

I believe that the Board can and will do a better job to address the
concerns raised by captive shippers. The reforms outlined today -- and
not substantive changes to the statutory scheme-- are the best way to
address the concerns raised by captive shippers while maintaining a
healthy freight rail network. It is a difficult balance, but one that
can be achieved.

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