Before The

U.S. House of Representatives

Committee on Transportation and Infrastructure

September 20, 2007 Hearing

11:00 A.M.

2167 Rayburn House Office Building

Testimony Of

Commissioner Francis P. Mulvey

Surface Transportation Board

395 E Street, SW, Suite 1290

Washington, DC 20423-0001

\(202\) 245-0210

Good afternoon Chairman Oberstar, Ranking Member Mica, and other
Committee Members. Thank you for this opportunity to testify on rail
competition and service matters.

Following the passage of the Staggers Rail Act of 1980, which greatly
reduced economic regulation of the railroad industry, there were many
who felt that the Interstate Commerce Commission should be abolished
completely and that rail transportation rates and service should be
determined by market forces (subject to the anti-trust laws). However,
it was clear to most in Congress that the railroad industry did differ
in important ways from other industries and that some degree of economic
regulation needed to continue to protect the interests of those shippers
who were "captive" to the railroads. The Surface Transportation Board
was created to balance the needs of shippers for reasonable rates with
the need of the railroads to earn adequate revenues. The overall
questions we confront today are "how well has the Board met its charge
to balance those interests" and "what is the state of competition in the
transportation of bulk commodities that are largely captive to the
railroads?"

To some extent the answers depend on where you sit, but clearly there
are many who believe that the Board could do more to promote
competition, ensure reasonable rates for captive shippers, and improve
the reliability and quality of railroad services.

In the early years of the Surface Transportation Board, the agency
continued to focus on ensuring that the railroads regained their
financial health. In addition to decisions that allowed the carriers to
capitalize, through differential pricing, on routes where shippers were
captive, the Board also approved mergers of large railroads paying less
attention to competitive concerns than to the perceived opportunities
for the merging carriers. Pressure from the Congress eventually resulted
in the Board's declaring a moratorium on major rail mergers and in the
establishment of new merger guidelines that promised to take more
account of the competitive impacts of railroad consolidations.

Over the past 3 years, the Board has held a number of hearings on issues
related to railroad competition. On October 19, 2005, the Board held a
hearing on the state of the railroad industry since the passage of
Staggers. The testimony was near unanimous that the industry has largely
recovered from the financial malaise that plagued it during the 1960s
and 1970s. The Board also has held hearings and has undertaken a number
of initiatives aimed at balancing the scales between shippers and
railroads. Let me briefly outline some of the areas where I believe that
progress has been made.

First, fuel surcharges. The railroads were calculating fuel surcharges
as a percentage of the rates they charged their customers. This meant
that captive shippers, who already paid higher rates, had to also pay
higher fuel surcharges despite the fact that their shipments did not
necessarily require greater fuel usage. The Board found this to be an
unfair practice and directed the railroads to compute the surcharges to
more closely reflect actual fuel consumption.

Second, access to rate relief. Shippers have long complained that the
Board's procedures were too time consuming and too costly. The Board's
procedures for adjudicating rate cases (the stand alone cost test) is
founded on accepted economic principles and has been approved (if indeed
not required) by the courts. The cost of bringing a rate case under the
Board's stand alone cost guidelines can cost a shipper several million
dollars and the case can take several years to be decided. Even those
shippers, who can justify the expense of bringing a rate case before the
Board, generally will either gain no rate relief or a reduction in the
proposed rate much below that which they had desired. Shippers whose
traffic does not justify the expense of bringing a case under the stand
alone cost guidelines believe they have no access to the Board for rate
relief.

The Congress more than 20 years ago directed the Board's predecessor,
the ICC, to develop simplified, less costly procedures for adjudicating
small rate cases. The Board has now acted to address both the cost and
timeliness issues in large rate cases, as well as procedures and
standards for small rate cases. In October 2006, the STB issued new
large rate case guidelines that were designed to take out a significant
amount of the time and cost to bring a case under the SAC process. On
September 5, 2007, the Board issued new procedures for bringing cases
before the Board that do not warrant the expense of a full SAC
proceeding. These new rules give shippers the option of selecting how
they want to proceed to challenge their rates, but set limits on
recovery depending on the process selected. Hopefully, these changes
will provide shippers with better access to the Board. I am committed to
monitoring the results of these initiatives to see that they work as
intended.

In the first test of our new guidelines for large rate cases, the
shippers apparently were disadvantaged by the changes. Because of this
possibility, the Board has taken the nearly unprecedented step of
allowing them to refile their case.

Third, cost of capital. The Board has consistently found that the
nation's railroads are "revenue inadequate" despite the fact that Wall
Street has found the railroads to be profitable. One of the reasons for
this disparity lies in the approach that the Board has taken to
determine revenue adequacy. More than 20 years ago, the Board adopted a
"Discounted Cash Flow" (DCF) methodology to determine the cost of equity
capital. However, over the years, this approach has lost favor with the
finance community and the DCF method has long been abandoned by most
other agencies that need to make such a calculation. On August 14, 2007,
the Board announced a proposed change that could, if adopted, reconcile
the Board's estimation of the revenue adequacy of the railroads with
that which prevails on Wall Street.

At the same time, there are other areas where the Board has not yet made
as definitive a commitment to change. Several areas are of particular
concern to me.

Paper Barriers. The Board has been examining the question of what to do
about so-called "paper barriers," otherwise known as interchange
commitments. These provisions arise when a Class I railroad sells or
leases some of its light density trackage to a small or new short line
railroad. Often the short line pays little or nothing for the right to
haul the traffic, but it must agree to interchange the traffic only with
the Class I that leased or sold it the track. Interchanging with another
railroad would result in severe penalties. I find this practice to be
anti-competitive and I have dissented from the majority in several cases
where paper barriers were contained in the sales or lease
agreements.[^1] What is particularly troublesome to me is that these
restrictions on the short lines' ability to interchange with other
carriers, and thereby offer shippers a competitive option, go on in
perpetuity. Just as new entrants have been the source of competition for
legacy carriers in the airline industry, so too could these new carriers
become the source of competition in the rail industry in the future.

Status of Competition. I am also concerned about the state of
competition overall in the railroad industry. The Government
Accountability Office has recently reported on the status of competition
in the rail industry, and I will not repeat its findings here. I did,
however, believe that the study inaccurately claimed that the extent of
captivity was declining, implying that there were fewer captive shippers
than previously. Even if relative captivity (i.e., the percentage of
traffic that is captive) has declined, there is no evidence that
competitive options have increased for captive shippers. Although the
GAO admits that the approach it took to measuring captivity left much to
be desired, I believe that the implications drawn do not comport with
reality. The GAO also suggested that the STB undertake a study of
competitiveness in the railroad industry. The Board, rightfully I
believe, initially declined to follow the GAO's recommendation because
we lacked the resources. However, the Board has recently contracted to
have a study done in response to GAO's suggestions by a private
consulting firm, Christensen Associates. Although this is a
well-regarded economic consulting firm, I regret that our resources were
not committed to the study authorized in the SAFETEA-LU bill which would
have focused more on how well the Board has handled its mission.[^2] The
study requested in SAFETEA-LU would have been undertaken by the
Transportation Research Board, an arm of the National Academy of
Sciences.

Investment in Railroads. The overall financial condition of the railroad
industry has improved dramatically over the past few years, so much so
that it has led to increased interest on the part of private equity
firms or hedge funds. These types of investors are often into
investments to maximize short term gains for their shareholders. What is
of most concern to me would be an attempt by a hedge fund to purchase a
significant stake in a railroad, followed by divestiture of the
railroads' assets, deferred maintenance, and disinvestment in capital
improvements. These actions could result in deterioration of service to
shippers and then perhaps lead to a failing firm. The Board does not
appear to have any authority under existing law to limit such
investments.

Without projecting the outcome of any particular proceeding that might
come before us, and aside from recent initiatives we have completed or
have pending before us, I have several suggestions for improving rail
competition and service.

One common theme we do hear from all rail stakeholders -- albeit
expressed in different ways -- is that there needs to be more investment
in rail infrastructure. It seems that the railroads alone will not be
capable of making the levels of investment needed, given the capital
intensity of the industry. If we, as a nation, are serious about
shifting traffic from our highways to rails, we need to devote more
public money into our rail infrastructure. While the railroads favor an
investment tax credit, I personally believe the amounts that will be
needed will be far greater than what an ITC would realistically produce.
A railroad trust fund of the type recommended by former Representative
and T&I Committee member Bill Lipinski, could generate the monies that
will be required to upgrade and build our nation's rail transportation
infrastructure.

Further, I believe that the Board must adjust the focus of its
operations to better reflect changing circumstances. For example, the
Board currently exercises regulatory oversight over about a third of all
railroad traffic. Most traffic is exempt from our regulation because it
is presumed to be competitive with other modes of transportation or
because it moves under contract. In the case of the latter,
railroad/shipper agreements have evolved so that the line between
contract and tariff carriage has become blurred. The Board is currently
examining how and whether it needs to clarify the distinction between
the two. With respect to exempt traffic, it is best that traffic for
which rates can be determined by the competitive marketplace not be
subject to economic regulation. That type of regulation proved
disastrous before the transportation industries were largely
deregulated. However, times change and as they change so does the
competitive landscape. I believe we need to look at existing class
exemptions periodically to determine whether exemptions that are
premised on the availability of intermodal competition remain warranted.
Many of these exemptions were sought and granted in the 1980's when the
transportation landscape was quite different than it is today.

Finally, to ensure that the Board has the requisite power to take action
on issues of concern to the industry and its stakeholders, the Congress
may want to consider returning a general power to investigate to the
Board. Currently, under 49 U.S.C 11701, the Board may begin an
investigation on a potential violation of the rail portions of its
statute "only on complaint". It may be appropriate to revise this
language by striking "only" and adding "or on its own initiative." If
the Congress wants the Board to continue to actively seek out problems,
and to solve them, guidance in this form would be helpful.

Thank you for the opportunity to testify today. I look forward to
answering any questions you may have.

[^1]: [Paducah & Louisville Ry. -- Acquisition -- CSX Transp.,
    Inc.]{.underline}, STB Finance Docket No. 34738 (STB served Nov. 18,
    2005) (Comm'r Mulvey dissenting, at 6-7); [Columbus & Ohio River
    R.R. -- Acquisition and Operation Exemption -- Rail Lines of CSX
    Transp., Inc.]{.underline}, STB Finance Docket No. 34540 (STB served
    Nov. 18, 2005) (Comm'r Mulvey dissenting, at 9); [Indiana & Ohio
    Centr. R.R. -- Acquisition and Operation Exemption -- CSX Transp.,
    Inc.]{.underline}, STB Finance Docket No. 34536 (STB served Aug. 23,
    2005) (Comm'r Mulvey dissenting, at 9-10); [Buckingham Branch R.R.
    -- Lease -- CSX Transp., Inc.]{.underline}, STB Finance Docket No.
    34495 (STB served Nov. 5, 2004) (Vice Chr. Mulvey dissenting, at
    13).

[^2]: Safe, Accountable, Flexible, Efficient Transportation Equity Act:
    A Legacy for Users (SAFETEA-LU), Pub. L. No. 109-59, sec. 9007
    (2005).