Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-caDC-06-01421/USCOURTS-caDC-06-01421-0/pdf.json

Parties Involved:
Surface Transportation Board
Respondent
United States of America
Respondent
Western Coal Traffic League
Petitioner

Document Text:

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued February 5, 2008 Decided May 20, 2008 

No. 06-1372 

BNSF RAILWAY COMPANY, 

PETITIONER

v. 

SURFACE TRANSPORTATION BOARD AND

UNITED STATES OF AMERICA, 

RESPONDENTS

WESTERN COAL TRAFFIC LEAGUE, ET AL., 

INTERVENORS

Consolidated with 

06-1373, 06-1374, 06-1398, 06-1399, 06-1401, 06-1404, 

06-1409, 06-1421 

On Petitions for Review of an Order of the 

Surface Transportation Board 

John H. LeSeur argued the cause for Shipper Petitioners. 

With him on the briefs were Christopher A. Mills, William L. 

Slover, Kelvin J. Dowd, C. Michael Loftus, Andrew B. 

Kolesar III, and Peter A. Pfohl. 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 1 of 25
2 

Samuel M. Sipe, Jr. and Michael L. Rosenthal argued the 

cause for Railroad Petitioners. With them on the briefs were 

Richard E. Weicher, Anthony J. LaRocca, Peter J. Shudtz, 

Paul R. Hitchcock, George A. Aspatore, John M. Hemmer, 

Louise A. Rinn, Terence M. Hynes, G. Paul Moates, and Paul 

A. Hemmersbaugh. 

Raymond A. Atkins, Associate General Counsel, Surface 

Transportation Board, argued the cause for respondents. With 

him on the brief were Robert B. Nicholson and John P. Fonte, 

Attorneys, U.S. Department of Justice, and Ellen D. Hanson, 

General Counsel. 

Richard E. Weicher, Samuel M. Sipe, Jr., and Anthony J. 

LaRocca were on the brief for intervenor BNSF Railway 

Company. 

C. Michael Loftus, Andrew B. Kolesar III, and Peter A. 

Pfohl were on the brief for intervenor Western Coal Traffic 

League. 

Before: GINSBURG, ROGERS, and KAVANAUGH, Circuit 

Judges. 

Opinion for the Court filed by Circuit Judge 

KAVANAUGH. 

KAVANAUGH, Circuit Judge: In a recent rulemaking, the 

Surface Transportation Board changed aspects of its rail ratesetting methodology. Railroads and shippers both petition for 

review – railroads arguing that certain changes improperly 

benefit shippers and shippers arguing that certain changes 

improperly benefit railroads. We conclude that the Board’s 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 2 of 25
3 

changes are reasonable and reasonably explained. We 

therefore deny the petitions. 

I 

 

Since Congress enacted the Interstate Commerce Act in 

1887, the Federal Government has regulated the rates of 

interstate railroads. Until 1995, the Interstate Commerce 

Commission regulated the rates; since then, the Surface 

Transportation Board has done so. See ICC Termination Act 

of 1995, Pub. L. No. 104-88, §§ 101, 201, 109 Stat. 803, 804, 

933-34. 

Under federal law, a party may file a complaint with the 

Board challenging a railroad’s rate. See 49 U.S.C. 

§ 10704(b). After receiving a complaint, the Board first must 

determine whether it has jurisdiction over the challenged rate. 

The Board’s jurisdiction covers only those railroads that 

possess “market dominance.” See §§ 10701(d)(1), 10707(b)-

(c). To have market dominance, a railroad must have revenue 

that meets or exceeds 180 percent of its variable costs for the 

traffic to which the rate applies. See §10707(d)(1)(A). 

(Variable costs are those costs that increase as traffic over the 

railroad increases – for example, the cost of fuel.) 

After the Board determines that it has jurisdiction over a 

challenged rate, the Board must decide whether the rate is 

reasonable. See § 10701(d)(1). If the Board finds the rate 

unreasonable, it sets the maximum rate the railroad may 

charge. See §10704(a)(1). In setting that rate, the Board must 

permit the railroad to cover its costs “plus a reasonable and 

economic profit or return (or both) on capital employed in the 

business.” §10704(a)(2). 

Part of what makes railroad rate regulation complex is 

that a railroad incurs many costs that cannot be attributed to 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 3 of 25
4 

any one shipper – costs that the Board has appropriately 

termed “unattributable costs.” See Rate Guidelines – NonCoal Proceedings, 1 S.T.B. 1004, at 2-5 (1996) (Non-Coal 

Guidelines). For example, how does the railroad allocate the 

cost of a railroad terminal shared by multiple shippers? 

Allocation is difficult, moreover, because railroads serve a 

mix of “competitive” shippers and “captive” shippers – 

competitive shippers can secure alternative transportation 

relatively cheaply but captive shippers cannot. See id. 

Therefore, a railroad cannot simply charge each shipper a pro 

rata share of the unattributable costs without the risk of losing 

competitive shippers to other carriers. See id.

In 1985, the Board promulgated guidelines to calculate 

rates for shipping coal. See Coal Rate Guidelines, 

Nationwide, 1 I.C.C.2d 520 (1985) (Guidelines). The 

Guidelines approach, which has since been extended to noncoal rates, established certain principles to resolve rate 

disputes. Those principles sought to approximate “Ramsey 

pricing,” which sets rates for individual shippers in inverse 

proportion to those shippers’ demand elasticities. See NonCoal Guidelines, at 2-5. Ramsey pricing enables a railroad to 

collect a higher share of unattributable costs from captive 

shippers than from competitive shippers. Because captive 

shippers have inelastic demand, the railroads can charge them 

higher rates with a lower risk of losing their business. 

Recently, however, the Board decided that the Guidelines

approach had become increasingly complex and costly, and in 

some respects contrary to congressional intent. To address 

those problems, it began a rulemaking proceeding in early 

2006. The Board completed the rulemaking later that year, 

changing how to determine its jurisdiction and how to 

evaluate rate reasonableness. Both railroads and shippers 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 4 of 25
5 

filed timely petitions for review challenging various aspects 

of those changes. 

We review Board decisions under the deferential 

standards of the Administrative Procedure Act. As relevant 

here, we will set aside a Board decision if it is “arbitrary, 

capricious, an abuse of discretion, or otherwise not in 

accordance with law.” 5 U.S.C. § 706(2)(A). The Board may 

depart from its own precedent, moreover, so long as it 

provides a reasoned explanation. PPL Mont., LLC v. STB, 

437 F.3d 1240, 1246 (D.C. Cir. 2006). In the rate-making 

area, our review is particularly deferential, as the Board is the 

expert body Congress has designated to weigh the many 

factors at issue when assessing whether a rate is just and 

reasonable. 

II 

We first consider the Board’s new method for 

determining whether it possesses jurisdiction over a 

challenged rate. 

As a general matter, the Board has jurisdiction over a rate 

if the railroad’s ratio of revenue to variable costs (R/VC) for 

the traffic to which that rate applies is at least 180 percent. 

Therefore, to determine whether it has jurisdiction, the Board 

must have a method to calculate variable costs. The statute 

requires that the Board use a method called the Uniform Rail 

Costing System, referred to as URCS, or an adequate 

substitute. See 49 U.S.C. § 10707(d)(1)(B); Adoption of the 

Uniform R.R. Costing Sys., 5 I.C.C.2d 894 (1989). The 

railroad submits various data to the Board, and the Board, via 

a computer program, plugs the data into URCS to produce a 

figure for system-wide average variable costs. See generally

Surface Transp. Bd., Industry Data – Economic Data: URCS, 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 5 of 25
6 

http://www.stb.dot.gov. The amount of revenue from the 

relevant traffic is then divided by a figure incorporating the 

system-wide average variable costs and a number of operating 

characteristics of the shipment to arrive at the R/VC ratio. If 

the R/VC ratio is less than 180 percent, the Board has no 

jurisdiction. 

 

In the past, the Board has permitted parties to propose 

“movement-specific adjustments” to the average variable 

costs figure produced by URCS. In other words, parties could 

argue that a higher or lower figure better reflected the variable 

costs of a particular movement. Shippers, of course, propose 

adjustments that would lower the variable-costs figure, 

because that would result in higher R/VC ratios and thus 

make Board review more likely. Railroads favor adjustments 

that would raise the variable-costs figure, thereby lowering 

R/VC ratios and making Board review less likely. 

In the rulemaking at issue here, the Board eliminated the 

ability of parties to suggest movement-specific adjustments. 

Both the railroads and the shippers challenge that change as 

an unreasonable departure from agency precedent. The Board 

acknowledged that permitting movement-specific adjustments 

has been its “longstanding practice,” but nevertheless 

concluded that “these adjustments may not serve a useful 

public purpose.” Major Issues in Rail Rate Cases, STB Ex 

Parte No. 657, at 48 (Oct. 30, 2006). The Board gave seven 

interrelated reasons for the change: 

First, the analysis of proposals for movementspecific adjustments is complex, expensive, and time 

consuming. Second, the Board believed that 

Congress intended, in adopting the 180% R/VC 

limitation on Board rate review, to create an 

administratively quick and easy-to-determine 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 6 of 25
7 

regulatory safe harbor for the railroads. Third, the 

URCS program already tailors the variable cost 

calculation to the movement at issue. Fourth, 

disallowing movement-specific variable cost 

adjustments would eliminate substantial uncertainty 

in the current rail rate adjudication process. Fifth, 

railroads do not consistently keep certain types of 

information that shippers have relied on for 

favorable movement-specific adjustments. Sixth, 

adjustments to URCS may not provide more reliable 

results than using the system-average expenses. 

Finally, piecemeal or incomplete adjustments to 

URCS are suspect. 

 

Id. (emphases added). The Board ultimately concluded that it 

“must balance the costly burden and complexity created by 

movement-specific adjustments against any improvements in 

the resulting variable cost,” and it found that “notwithstanding 

[its] past allowance of these adjustments, such expense and 

complexity are not justified.” Id. at 50. 

 The railroads, except BNSF, challenge the Board’s 

decision on statutory grounds. Section 10707 of Title 49 

directs that “variable costs for a rail carrier shall be 

determined only by using such carrier’s unadjusted costs, 

calculated using the Uniform Rail Costing System cost 

finding methodology . . . with adjustments specified by the 

Board.” 49 U.S.C. § 10707(d)(1)(B). The railroads claim 

that the last phrase – “with adjustments specified by the 

Board” – means that the Board may not eliminate all

movement-specific adjustments. We disagree. To begin 

with, the railroads did not raise this argument before the 

Board, so it is forfeited. See Univ. of D.C. Faculty Ass’n v. 

D.C. Fin. Responsibility & Management Assistance Auth., 

163 F.3d 616, 625 (D.C. Cir. 1998). In any event, it is 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 7 of 25
8 

meritless. The statute does nothing more than broadly 

delegate to the Board the authority to make reasonable 

adjustments to the variable-costs figures produced by URCS. 

It does not require the Board to adopt any adjustments. The 

Board’s interpretation is therefore consistent with the 

statutory text. 

 The railroads also claim that the Board did not give 

adequate consideration to alternative proposals that would 

allow the Board to take into account certain categories of 

adjustments. We reject that argument as well. The Board 

explained that it had considered the alternatives and found 

none of them preferable in light of the seven considerations 

listed above. The Board said that the elimination of 

movement-specific adjustments would save up to $1 million 

per party, per case. Moreover, the Board cited its years of 

experience in dealing with those adjustments as the basis for 

concluding that they are not especially accurate. In short, the 

Board made a policy judgment that the cost savings and 

increase in predictability of the Board’s jurisdiction, among 

other factors, outweigh any gains in accuracy from the 

railroads’ or shippers’ adjustment proposals. That kind of 

judgment call, which balances inherently incommensurable 

costs and benefits, falls within the expertise of the agency, 

and we will not disturb it. Cf. Central & Southern Motor 

Freight Tariff Ass’n v. United States, 757 F.2d 301, 321-22 

(D.C. Cir. 1985) (“Deference is particularly appropriate when 

– as here – the delegation of . . . power is very broad and 

necessarily involves the administrative weighing of the costs 

and benefits of regulation.”). 

 For the same reason, we reject the shippers’ arguments 

that the Board’s decision to eliminate movement-specific 

adjustments was unjustified. The shippers contend that the 

Board placed too much emphasis on the expense of litigating 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 8 of 25
9 

movement-specific adjustments and that the Board 

underestimated the increase in accuracy effected by those 

adjustments. Again, the Board possesses the responsibility to 

balance those kinds of competing considerations. The 

shippers have not demonstrated that the Board’s decision was 

unreasonable or unsupported by substantial evidence. 

 

 The fact that both the railroads and shippers contest the 

Board’s elimination of movement-specific adjustments is not 

enough to persuade us that the Board’s decision was arbitrary 

and capricious. The Board has an institutional interest in 

reducing the cost for parties litigating rate cases. And the 

Board has discretion to consider the interests of the railroads 

and shippers that could not afford to participate in the 

rulemaking proceeding. 

III 

We turn now to petitioners’ challenges to the changes in 

the Board’s rate-evaluation methodology. To provide 

necessary context for our discussion, we begin with a brief 

overview of how the Board evaluates railroad rates. 

As we have said, railroads serve a mix of competitive and 

captive traffic. Because of the varying demand elasticities of 

the different shippers, a railroad has no interest in 

apportioning costs evenly among the shippers for facilities or 

services that the shippers share. If it imposes a pro rata share 

of unattributable costs on each shipper, competitive shippers 

with lower-cost transportation alternatives may opt for those 

alternatives, and the railroad would lose revenue. Despite that 

problem, the railroads cannot go too far in the other direction 

and overload captive shippers with excessively high rates. 

Even though captive shippers do not have practical access to 

alternative carriers, they do have access to Board review, and 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 9 of 25
10 

the Board has a statutory duty to ensure that their rates are 

reasonable. 

 

 The Board’s solution to the railroads’ problem, adopted 

in Guidelines, has been the principle of Constrained Market 

Pricing. See Coal Rate Guidelines, Nationwide, 1 I.C.C.2d 

520 (1985) (Guidelines). Constrained Market Pricing sets 

three constraints on a railroad’s rates, including the StandAlone-Cost constraint, which ensures that a captive shipper 

does not pay for services that provide it no benefits – in other 

words, that it does not cross-subsidize other shippers. See 

BNSF Ry. Co. v. STB, 453 F.3d 473, 476-77 (D.C. Cir. 2006); 

Guidelines, 1 I.C.C.2d at 523-24. 

 To determine whether a complaining captive shipper is 

paying for only those services that benefit it, the Board uses 

an approach called the Stand-Alone-Cost test. The StandAlone-Cost test posits a hypothetical railroad that serves a 

subset of the movements in the railroad’s network, including 

the route used by the complaining shipper. That hypothetical 

railroad is called a Stand-Alone Railroad, known as a SARR, 

and it is designed to be optimally efficient. The Stand-AloneCost test determines the rate that the shippers using the SARR 

(the “traffic group”) would be charged by taking into account 

the costs of running the SARR, including a reasonable return 

on investment, (the “Stand-Alone Costs”). See PPL Mont., 

LLC v. STB, 437 F.3d 1240, 1242 (D.C. Cir. 2006). The 

amount of those costs becomes the maximum amount that the 

railroad may collect from the traffic group. See id. 

The underlying logic is that there are cost savings when 

the portion of the railroad that constitutes the SARR is 

combined with the rest of the real railroad; therefore, the costs 

of that segment as part of the real railroad could never exceed 

the costs of that segment if it stood alone. With a StandUSCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 10 of 25
11 

Alone-Cost ceiling, “no shipper (or shipper group) subsidizes 

others, at least in a strict sense of the term: though some bear 

a higher share of fixed costs than others, they still pay no 

more than what they would for a facility designed to serve 

only them.” Burlington Northern R.R. Co. v. ICC, 985 F.2d 

589, 596 (D.C. Cir. 1993). 

 The Board’s rulemaking changed various aspects of the 

Stand-Alone-Cost test. Petitioners challenge three of those 

changes: (i) the method the Board uses to determine 

maximum reasonable rates; (ii) the degree to which 

productivity gains are taken into account when forecasting the 

SARR’s operating expenses; and (iii) the allocation of 

revenue to the SARR from shippers that use both the SARR 

and other, off-SARR facilities. Shippers also challenge the 

Board’s application of its new revenue-allocation rule to a 

case that was pending when the Board issued its notice for 

proposed rulemaking. 

A 

 We first address the Board’s change to its method of 

determining a complaining shipper’s maximum reasonable 

rate. 

Under the Stand-Alone-Cost test, if the hypothetical 

SARR’s total revenue from the Stand-Alone-Cost traffic 

group exceeds the Stand-Alone Cost, then the traffic group in 

real life is covering more of the costs of the real railroad than 

are attributable to it, and the rates of the shippers in the traffic 

group are reduced. Once the Board decides to reduce the 

rates of the traffic group (for purposes of the test), it then 

must determine how to allocate that reduction among various 

members of the traffic group to set maximum reasonable 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 11 of 25
12 

rates. In the rulemaking, the Board changed the way that it 

performs that allocation. 

In the past, the Board reduced the excessive rates in a 

relatively straightforward way. Using the Percent Reduction 

Method, the Board would reduce the rate of each shipper in 

the traffic group by the same percentage: the percentage by 

which the revenue from the traffic group exceeded the StandAlone Costs. Thus, if revenue exceeded the Stand-Alone 

Costs by 20 percent, the Board lowered the rate of each 

shipper, including the complaining shipper, by 20 percent. 

The rationale for that approach was that it maintained the 

same proportion of rates among members of the traffic group. 

For example, if one shipper initially paid twice the rate of 

another shipper, that would continue to be true after the 

reduction. The underlying assumption was that the existing 

rate structure reflected the varying demand elasticities among 

members of the traffic group. Under the Ramsey pricing 

principle discussed above, which sets shippers’ rates in 

inverse proportion to their demand elasticities, the Board 

thought it important to maintain that rate structure – even 

though the rates are entirely within the control of the railroad. 

The railroads, of course, favor that assumption: In their view, 

the Board should assume that the rates they set adequately 

reflect differences in demand between the complaining 

captive shipper and the other shippers. 

In recent Stand-Alone-Cost cases, however, the Board 

realized that railroads can easily manipulate the Percent 

Reduction Method. In particular, a railroad can game the 

system by initially setting an exceedingly high rate for a 

captive shipper. If the shipper then challenges the rate and the 

Board uses the Percent Reduction Method to reduce it, the 

new rate will still be a function of the initial rate; the higher 

the initial rate, the higher the final rate. 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 12 of 25
13 

To prevent “gaming,” the Board adopted a new method 

to correct excessive rates: the Maximum Markup 

Methodology. Rather than requiring an across-the-board cut 

for every shipper, this new methodology lowers only the rates 

of those shippers that make excessive revenue contributions 

relative to the variable costs that they impose on the railroad. 

And it requires that those shippers’ ratios of revenue to 

variable cost be the same. The railroads cannot manipulate 

this methodology because the higher they set the initial rate of 

a captive shipper, the higher that shipper’s revenue 

contribution relative to the variable costs it imposes on the 

railroad – and the bigger the percentage cut for that shipper. 

The railroads argue that the Board failed to sufficiently 

explain what it meant by “gaming.” We, however, have no 

trouble understanding the Board’s concern: A railroad could 

charge any rate, including an inefficient monopoly rate, 

simply by setting the rate incrementally higher than the rate it 

wanted prior to the SAC proceeding. 

The railroads further argue that the Board’s decision is 

arbitrary and capricious because there is no evidence of 

gaming by railroads. They cite our decision in National Fuel 

Gas Supply Corp. v. FERC, which vacated a prophylactic rule 

aimed at preventing market manipulation. See 468 F.3d 831 

(D.C. Cir. 2006). In that case, FERC had specifically relied 

on a supposed record of abuse to justify a rule, yet FERC had 

not produced any evidence of abuse. See id. at 841. The 

Court’s order instructed FERC to either compile the record of 

abuse or “try to support [its rule] by setting out its best case 

for relying solely on a theoretical threat of abuse.” Id. at 844. 

In this case, the Board reasonably explained that the 

undetectable nature of the problem plainly justifies the 

Board’s reliance on the theoretical threat. To discern whether 

an initial rate is set because it reflects a railroad’s perception 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 13 of 25
14 

of relative demand or a railroad’s effort to game the system 

would require the Board to either divine the motives of the 

railroad in setting the challenged rate or undertake the costly 

task of estimating the railroad’s marginal costs and the 

complaining shipper’s demand elasticity. The Board 

reasonably concluded that either endeavor would be utterly 

impracticable. 

In addition to the anti-gaming rationale, the Board 

offered another justification for adopting the Maximum 

Markup Methodology: By statute, railroads must maximize 

revenue from competitive shippers before increasing captive 

shippers’ rates. See 49 U.S.C. § 10701(d)(2)(B); Guidelines, 

1 I.C.C.2d at 539 (Under Constrained Market Pricing, “a 

carrier must charge its competitive traffic as much of the 

unattributable costs as the demand will permit.”). According 

to the Board, this “reflects a Congressional directive” that 

captive shippers “not bear a differentially larger share of the 

joint and common expenses” until the railroad has charged its 

competitive shippers “as much of the unattributable costs as 

demand will permit.” STB Ex Parte No. 657, at 18. The 

Board determined that the Maximum Markup Methodology 

better implemented that statutory directive: Unlike the 

Percent Reduction Method, it allows captive shippers, which 

tend to contribute more revenue relative to the variable costs 

they impose on railroads, to receive a disproportionately 

higher share of a rate reduction. 

The railroads counter that giving a disproportionately 

higher share of a rate reduction to captive traffic runs directly 

counter to the Ramsey pricing principle that the Guidelines

approach adopted. Those principles instruct that rates should 

be set in inverse proportion to shippers’ demand elasticities. 

The railroads argue that once the rate structure has been 

established in that way, it should be maintained. The Percent 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 14 of 25
15 

Reduction Method preserved the rate structure because the 

Board would reduce the rates of all shippers in the traffic 

group by the same percentage when it would conclude that a 

railroad was receiving excessive revenue. 

The Board’s Maximum Markup Methodology is not a 

departure from Ramsey pricing principles as reflected in 

Guidelines unless one assumes that railroads set the initial 

rate structure in inverse proportion to the shippers’ demand 

elasticities. The Board’s conclusion that rate structures are 

susceptible to gaming rejects that assumption. Moreover, the 

Maximum Markup Methodology preserves demand-based 

differential pricing to a significant degree: Shippers that pay 

low rates relative to the variable costs attributable to them will 

still bear considerably less of the railroad’s unattributable 

costs than shippers that pay high rates relative to the variable 

costs attributable to them. 

There is therefore no contradiction between the 

Maximum Markup Methodology and the Board’s goal under 

Guidelines: Under both approaches, the objective is for 

railroads to “ensure that competitive traffic contributes as 

much as possible toward [unattributable] costs,” which 

includes ensuring that competitive traffic does not leave the 

railroad for transportation alternatives. 1 I.C.C.2d at 524. As 

the Board put it, “Congress envisioned that captive shippers 

would be the residual suppliers of capital, but only where the 

competitive traffic cannot provide a sufficient share of the 

contribution needed to support the rail infrastructure that it 

uses.” STB Ex Parte No. 657, at 18. The Board has simply 

changed its mind about how best to achieve that goal. It no 

longer assumes that whenever it finds a railroad to be 

receiving excessive revenue in a Stand-Alone-Cost case, 

every shipper’s rate is too high and the railroad must lower all 

of its shippers’ rates by the same percentage to maximize 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 15 of 25
16 

revenue from competitive traffic. Now the Board believes 

that it makes the most sense to lower the rates of only those 

shippers that are paying a high rate relative to the variable 

costs attributable to them. The Board has license to change 

how it implements its statutory duties, “either with or without 

a change in circumstances,” so long as it supplies “a reasoned 

analysis.” Motor Vehicle Mfrs. Ass’n v. State Farm Mut. 

Auto. Ins. Co., 463 U.S. 29, 57 (1983) (internal quotation 

marks omitted). The Board has met that requirement here, 

and we find no reason to overturn its decision. 

Finally, the railroads argue that the Maximum Markup 

Methodology violates this Court’s decision in Burlington 

Northern Railroad Co. v. ICC, 985 F.2d 589 (D.C. Cir. 1993). 

But that decision addressed a substitute for the entire StandAlone-Cost analysis, not a different method of reducing rates 

after performing the Stand-Alone-Cost test. We found 

multiple defects in the approach at issue in Burlington, 

including a flaw that deprived the ICC’s approach of “any 

glimmer of supporting principle or intellectual coherence.” 

Id. at 597. By contrast, the Board here responded to a flaw in 

its existing Percent Reduction Method, and adopted the 

Maximum Markup Methodology to correct the problem. This 

new methodology, as explained above, furthers the Board’s 

goals under Guidelines and § 10701(d)(2)(B). Therefore, we 

are satisfied that the Board’s decision is consistent with 

Burlington. 

B 

 We next address the Board’s change to its method for 

forecasting the SARR’s future operating expenses. 

 To calculate the costs that the hypothetical SARR would 

likely incur over the 10-year Stand-Alone-Cost analysis 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 16 of 25
17 

period, the Board must estimate the operating expenses that 

the SARR would face. Since 1980, the Board has used some 

form of the “Rail Cost Adjustment Factor,” established by 

statute, as an index to track changes in railroad costs. Before 

this rulemaking, the Board’s operating-expense forecasts did 

not take into account the possibility that the SARR could 

experience productivity gains – gains in efficiency that would 

reduce operating expenses. The Board figured that, because 

“the SARR is designed to be an efficient replacement for the 

railroad, it would not be able to realize the same productivity 

gains as the rest of the industry, particularly in the early 

years.” STB Ex Parte No. 657, at 40. In its Stand-Alone-Cost 

tests, the Board thus had used the Rail Cost Adjustment 

Factor-U index, which measures “the change in the prices of 

inputs, such as labor and fuel, used to produce railroad 

services,” but does not factor in anticipated industry-wide 

productivity gains. Id. at 39. A separate index, the Rail Cost 

Adjustment Factor-A index, takes into account the industry’s 

productivity gains. Shippers have urged the Board to adopt 

that index because, if there are productivity gains, then 

operating expenses will be lower. And the lower the 

forecasted operating expenses of the SARR, the lower the 

revenue needed to cover the SARR’s costs, and the lower the 

maximum permissible rate for shippers. The railroads, by the 

same logic, have favored the status quo. 

 In the rulemaking, the Board settled on a hybrid 

approach. Based on its special expertise in rail regulation, the 

Board posited that a new hypothetical railroad would not 

immediately experience the same level of productivity growth 

as the anticipated industry average: “[A] SARR is presumed 

to begin the analysis period at a higher productivity level than 

the industry as a whole,” and as a result, in the early years, it 

would not have as much room to increase productivity in 

certain areas. Id. at 43. For example, “railroads realize 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 17 of 25
18 

productivity gains in locomotives as they replace old 

locomotives with newer technologies. The SARR would not 

experience those same productivity gains in the short term, 

because it would begin its operations with all new 

locomotives.” Id. at 40. The Board, however, concluded that 

a SARR would experience some productivity increases 

“where gains derive from more efficient use of existing assets 

such as improved management techniques, more flexible 

work rules and learning by doing.” Id. at 43. Also, the SARR 

could experience productivity gains for “short-lived assets” 

whose replacement would “introduce the latest available 

technology.” Id.

 The Board posited that, within 20 years, the SARR’s 

productivity growth rate would match that of the industry 

because at that time the SARR would have about the same 

mix of old and new assets as the industry generally. “[A]s the 

SARR approaches the industry’s vintage of technology over 

time, both the productivity level and the rate of growth for the 

industry and the SARR would converge.” Id. at 44. 

Therefore, the Board decided to phase in the Rail Cost 

Adjustment Factor-A index – the measure of costs that takes 

into account productivity gains – into its operating-expense 

forecast gradually over a 20-year span. To accomplish this, 

the Board calculates operating expenses based solely on the 

Rail Cost Adjustment Factor-U index (no productivity gain) 

for year 1 and factors in the Rail Cost Adjustment Factor-A 

index (full productivity gain) at a rate of 5 percent per year 

until it is fully phased in at year 20. 

 Unsurprisingly, both the shippers and the railroads object 

to the Board’s hybrid approach, with each favoring an 

opposite end of the spectrum. The shippers argue that the 

Board ignored “substantial evidence of record before the STB 

demonstrating the rapid rate at which the railroad industry 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 18 of 25
19 

renews its assets and its technology.” Shippers’ Br. 36. The 

shippers note that the average age of rail assets in 2002 was 

only seven years. For their part, the railroads argue that 

“there was no evidence that any [productivity] improvements 

would occur in equal amounts over a 20-year period.” 

Railroads’ Br. 34. The railroads believe that most 

productivity gains would not be realized until many years in 

the future. As a result, the railroads argue, even if the Board 

is correct that the SARR would converge with the industry in 

20 years, because the Stand-Alone-Cost analysis period 

covers only the first 10 years, underestimating productivity 

gains in years 11 through 20 will not balance out the 

inaccuracy created by overestimating productivity gains in 

years 1 through 10. 

 We decline to enter this hyper-technical fray. “It is well 

established that an agency’s predictive judgments about areas 

that are within the agency’s field of discretion and expertise 

are entitled to particularly deferential review, so long as they 

are reasonable.” Wis. Pub. Power, Inc. v. FERC, 493 F.3d 

239, 260 (D.C. Cir. 2007) (internal quotation marks omitted); 

see also Nuvio Corp. v. FCC, 473 F.3d 302, 306 (D.C. Cir. 

2007) (We owe “substantial deference [to an agency’s] 

predictive judgments.”). That maxim is especially true here, 

where we are reviewing the Board’s predictive judgment 

about hypothetical railroads. The agency has adopted a 

straight-line, phase-in approach that is routinely used to 

estimate the depreciation of assets, and we cannot conclude 

that the approach is unreasonable. Although the parties have 

submitted evidence that they claim supports their conflicting 

views on how a SARR would experience productivity gains, 

“[p]articularly where, as here, an agency issues a regulation 

reflecting reasoned predictions about technical issues, logic 

suggests that the record may well contain evidence sufficient 

to support more than one possible outcome.” Ass’n of Pub.-

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 19 of 25
20 

Safety Communications Officials-Int’l Inc. v. FCC, 76 F.3d 

395, 398 (D.C. Cir. 1996). And as for the railroads’ claim 

that imperfections in the 20-year phase in may inure to the 

benefit of the shippers, at some point simplicity outweighs 

accuracy, and the Board “is free to make reasonable trade-offs 

between the quality and cost of possible regulatory 

approaches.” Burlington Northern, 985 F.2d at 597. 

C 

We now consider the Board’s change to its method of 

allocating to the SARR the revenue from shippers that use 

both the SARR and other, off-SARR parts of the railroad. 

 As we have said, the Stand-Alone-Cost analysis posits a 

hypothetical railroad – the SARR – that would serve the route 

that the complaining shipper uses. The Stand-Alone-Cost 

analysis then determines the total costs that the SARR would 

incur – the Stand-Alone Costs – and what percentage of those 

costs is attributable to the complaining shipper. If the total 

revenue that the railroad collects from the SARR’s services 

(calculated based on the real-world rates that the railroad 

charges the traffic group that uses the SARR) exceeds the 

Stand-Alone Costs, then the rate of the complaining shipper 

may be lowered in accordance with the Maximum Markup 

Methodology discussed above. 

 In determining the total revenue that a SARR generates, a 

problem arises: Unlike the complaining shipper, the other 

shippers do not necessarily use only the SARR. In the real 

world, other shippers may use both on-SARR and off-SARR 

parts of the railroad. For those shippers, the Board must 

allocate to the SARR only a portion of the revenue that they 

contribute in the real world. If the Board attributed all of their 

revenue contribution to the SARR, it would overestimate the 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 20 of 25
21 

SARR’s revenue because some of those shippers’ revenue 

contributions go to covering off-SARR costs. The Board has 

termed the traffic that uses both on-SARR and off-SARR 

facilities “cross-over traffic.” 

 In this rulemaking, the Board changed the way that it 

allocates the revenue of cross-over traffic between on-SARR 

and off-SARR facilities. The Board previously allocated 

revenue based essentially on the percentage of miles the 

shipper used the SARR. Thus, if 60 percent of a shipper’s 

route was on-SARR and 40 percent was off-SARR, roughly 

60 percent of its revenue contribution would be allocated to 

the SARR. 

 Although the old approach had the virtue of simplicity, it 

had a critical flaw, which we identified in BNSF Railway Co. 

v. STB, 453 F.3d 473 (D.C. Cir. 2006). The mileage-based 

approach did not take into account “economies of density” – 

the principle that the more traffic on a given stretch of rail, the 

lower the average cost (and hence the lower the cross-overtraffic revenue that should be attributed to it). 

To take an example, imagine a toll road that five drivers 

use. If the annual upkeep for the road costs $100, each driver 

would need to contribute $20 annually. If those drivers pay 

$40 per year in taxes, then 50 percent of their tax contribution 

is attributable to the road. Now imagine that 50 drivers use 

the road – that is, that its density has increased tenfold. Each 

driver would need to contribute only $2 annually. Of their 

$40 tax liability, only five percent would be attributable to the 

road. The same logic applies here. For cross-over traffic, the 

higher the density of the on-SARR facilities, the smaller the 

proportion of their overall revenue contribution should be 

attributed to the SARR. In other words, more of their revenue 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 21 of 25
22 

contribution must be going to cover costs for off-SARR 

facilities. 

In BNSF, the complaining railroad proposed a method of 

allocating revenue from cross-over traffic that would have 

taken into account economies of density. We concluded, 

however, that the Board had reasonably declined to adopt that 

alternative because the proposal ignored the diminishing 

nature of economies of density – that is, the fact that at some 

point, higher density no longer results in lower average costs. 

See id. at 483-84. As the Board summarized the principle, 

“the railroad industry is characterized by economies of 

density, meaning the average total cost for a network of a 

given size initially decreases with increases in output. But 

economies of density also diminish with higher output and at 

some point are exhausted.” STB Ex Parte No. 657, at 26. 

 Although we were not convinced in BNSF that the Board 

had acted unreasonably in rejecting the incomplete alternative 

proposed by the railroad, we stated that “[w]ere the Board 

presented with a model that took account both of the 

economies of density and of the diminishing returns thereto, a 

decision to adhere to [the old] model would be on shaky 

ground indeed. But that day is yet to come.” BNSF Ry., 453 

F.3d at 484. 

 In this rulemaking, the Board determined that the day had 

arrived. It adopted an approach that takes into account both 

economies of density and their diminishing nature. The 

Board’s new approach – called the Average-Total-Cost 

method – allocates revenues based partly on the average total 

cost of a segment rather than just on mileage. Because 

average total cost for a given segment of rail decreases as 

density increases (up to a point), basing the revenue allocation 

in part on average total costs solves the problem that we 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 22 of 25
23 

identified in BNSF. As the Board recognizes, our decision in 

BNSF strongly suggested that the Board would be required to 

adopt an appropriate density-based approach if one were 

presented to it. The Average-Total-Cost method “takes 

account of both economies of density and diminishing 

returns.” STB Ex Parte No. 657, at 34. The Board thus 

concluded that continued use of the mileage-based approach 

“would be on shaky ground.” Id. 

 The shippers nonetheless claim that the Board’s new 

revenue-allocation formula arbitrarily departs from 

Guidelines. Their argument can be summarized in the 

following syllogism: Guidelines does not permit the Board, 

when setting rates, to allocate a percentage of fixed costs to a 

given shipper, but rather requires the Board to set rates on the 

basis of shipper demand. The new revenue-allocation 

formula for cross-over traffic, which is a fundamental 

component of the Stand-Alone-Cost analysis, is based on the 

average total costs of the on-SARR and off-SARR segments, 

not shipper demand. Therefore, the cost-based, revenueallocation formula violates Guidelines. 

 

We do not agree that the Board’s change to the AverageTotal-Cost method was unreasonable or contrary to precedent. 

We have already held that the Board may allocate revenue 

between on-SARR and off-SARR facilities without taking 

into account shipper demand. In BNSF, we upheld the 

mileage-based approach because the Board had reasonably 

assumed that “average costs are a continuous function of 

distance.” BNSF Ry., 453 F.3d at 483 (internal quotation 

marks omitted). The new method simply refines that 

approach by taking into account economies of density. 

Although Guidelines may favor a demand-based approach 

generally for setting rail rates, the Board has acted reasonably 

in using a cost-based approach, for the Stand-Alone-Cost test, 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 23 of 25
24 

to estimate the costs that cross-over traffic imposes on the 

SARR. “The pursuit of precision in rate proceedings, as in 

most things in life, must at some point give way to the 

constraints of time and expense, and it is the agency’s 

responsibility to mark that point. Our role is limited to 

determining whether the balance it struck is arbitrary.” Id. at 

482. In this case, it follows from our decision in BNSF that 

the Board’s action was reasonable. 

D 

The shippers contend that the Board’s application of the 

Average-Total-Cost method to a case that was pending when 

the Board issued its notice for proposed rulemaking was 

impermissibly retroactive and otherwise arbitrary and 

capricious. See Western Fuels Ass’n, Inc. v. BNSF Ry. Co., 

2007 WL 2590251 (STB Sept. 7, 2007). The shippers argue 

that the Board should not have applied its new Average-TotalCost revenue-allocation formula because they had relied on 

the mileage-based approach in incurring significant costs to 

design and defend a SARR for the Stand-Alone-Cost analysis. 

We reject the shippers’ argument. “A new rule may be 

applied retroactively to the parties in an ongoing adjudication, 

so long as the parties before the agency are given notice and 

an opportunity to offer evidence bearing on the new standard, 

and the affected parties have not detrimentally relied on the 

established legal regime.” Consol. Edison Co. v. FERC, 315 

F.3d 316, 323 (D.C. Cir. 2003) (internal citations omitted). 

Here, there was no established legal regime on which the 

parties litigating before the Board could have reasonably 

relied: They were on notice that the Board had not settled on 

any one method for allocating the revenue contribution of 

cross-over traffic. As we said in BNSF, “[t]he appropriate 

allocation of revenue from cross-over traffic is a perennial 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 24 of 25
25 

issue in [Stand-Alone-Cost] proceedings and one the Board 

even now [in 2006] has not resolved definitively.” 453 F.3d 

at 483; see also, e.g., Duke Energy Corp. v. Norfolk Southern 

Ry. Co., 2003 WL 22673026, at *10 (STB Nov. 5, 2003) 

(“The Board has long recognized, however, that this 

methodology may not work in all cases, and it has been open 

to suggestions for other methods to allocate cross-over 

revenues.”). The shippers do not respond to the Board’s 

argument that, before adopting the Average-Total-Cost 

method, the Board had repeatedly warned that it sought to 

adopt a methodology that would take density into account. 

As the Board made clear both in the rulemaking and in 

Western Fuels, the shippers had no basis for relying on the 

prior revenue-allocation formula. See STB Ex Parte No. 657, 

at 75; Western Fuels, 2007 WL 2590251, at *20. 

Nevertheless, the Board gave the shippers an opportunity to 

redesign or defend their SARR using the new formula. See

Western Fuels, 2007 WL 2590251, at *20. 

Moreover, given that the new methodology was 

“designed in large part to improve the reliability of [the 

Stand-Alone-Cost] analysis, and given the possibility of rate 

prescriptions of nearly 20 years,” it was reasonable for the 

Board to immediately discard the flawed procedure and apply 

its new rule to pending cases when the parties were on notice 

of the potential change. STB Ex Parte No. 657, at 76. 

* * * 

 For the reasons stated above, we deny the petitions for 

review. 

So ordered. 

USCA Case #06-1421 Document #1117120 Filed: 05/20/2008 Page 25 of 25