# United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued February 5, 2008 Decided May 20, 2008

No. 06-1372

BNSF R AILWAY C OMPANY

, P ETITIONER

v.

S URFACE T RANSPORTATION B OARD AND
U NITED S TATES OF A MERICA

, R ESPONDENTS

W ESTERN C OAL T RAFFIC L EAGUE

, ET AL

., I NTERVENORS

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

.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 cau se 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 interv enor Western Coal Traffic League.

Before: G INSBURG , R OGERS , and K AVANAUGH

, Circuit Judges

.

Opinion for the Court filed by Circuit Judge

K AVANAUGH

.

K AVANAUGH

, Circuit Judge : In a recent rulemaking, the Surface Transportation Board cha nged aspects of its rail ratesetting methodology. Railroads and shippers both petition for review – railroads arguing th at certain changes improperly benefit shippers and shippers arguing that certain changes improperly benefit railroads. We conclude that the Board’s3

changes are reasonable and reasonably explained. We therefore deny the petitions.

I

Since Congress enacted the In terstate Commerce Act in 1887, the Federal Government has regulated the rates of

interstate railroads. Until 1995, the Interstate Commerce Commission regulated the rate s; 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 comp laint, 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 percen t of its variable costs for the traffic to which the rate applies. See §10707(d)(1)(A). (Variable costs are those costs th at 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 th at rate, the Board must permit the railroad to cover it s costs “plus a reasonable and economic profit or return (or bo th) on capital employed in the business.” §10704(a)(2).

Part of what makes railroad rate regulation complex is that a railroad incurs many cost s that cannot be attributed to4

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 cost s 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 prici ng enables a railroad to collect a higher share of unattr ibutable 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 increasingl y complex and costly, and in
some respects contrary to cong ressional 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 shippers5

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 disc retion, 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 de signated 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,6

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

relevant traffic is then divi ded by a figure incorporating the system-wide average variable co sts 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 figur e 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 m ovement-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 pr actice,” but nevertheless concluded that “these adjust ments 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 comp lex, 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-determine7

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 consisten tly 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,” a nd 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 ra ise this argument before the Board, so it is forfeited. See Univ. of D.C. Faculty Ass’n v. D.C. Fin. Responsibility & M anagement Assistance Auth.

, 163 F.3d 616, 625 (D.C. Cir. 1998). In any event, it is8

meritless. The statute does nothing more than broadly delegate to the Board the authority to make reasonable adjustments to the variable-cos ts 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 al ternative 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 consider ed 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 espe cially 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’ adjust ment 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 administ rative 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. Th e shippers contend that the Board placed too much emphasis on the expense of litigating9

movement-specific adjustments and that the Board

underestimated the in crease in accuracy effected by those adjustments. Again, the Board possesses the responsibility to balance those kinds of comp eting considerations. The shippers have not demonstrated that the Board’s decision was unreasonable or unsupported by substantial evidence.

The fact that both the railro ads 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 a fford 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 th e varying demand elasticities of the different shippers, a rail road has no interest in apportioning costs evenly among th e 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 woul d lose revenue. Despite that problem, the railroads cannot go to o far in the other direction and overload captive shippers w ith excessively high rates. Even though captive shippers do not have practical access to alternative carriers, they do ha ve access to Bo ard review, and10

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 setsthree constraints on a railroad’s rates, including the StandAlone-Cost constraint, which en sures that a captive shipper does not pay for services that provi de 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 th at benefit it, the Board uses an approach called the Stand- Alone-Cost test. The StandAlone-Cost test posits a hypotheti cal railroad that serves a subset of the movements in the railroad’s network, including the route used by the complaini ng shipper. That hypothetical

railroad is called a Stand-Al one 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 “S tand-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 th ere are cost savings when the portion of the railroad that constitutes the SARR is

combined with the rest of the re al 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 Stand-11

Alone-Cost ceiling, “no shipper (o r shipper group) subsidizes others, at least in a strict sens e 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. Petitione rs 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; an d (iii) the allocation of revenue to the SARR from shippe rs 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 th e Stand-Alone-Cost traffic group exceeds the Stand-Alone Co st, 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 pu rposes of the test), it then

must determine how to alloca te that reduction among various members of the traffic group to set maximum reasonable12

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 th e rate of each shipper in the traffic group by the same pe rcentage: the percentage bywhich the revenue from the traffic group exceeded the StandAlone Costs. Thus, if reve nue exceeded the Stand-Alone Costs by 20 percent, the Board lowered the rate of each shipper, including the complaini ng shipper, by 20 percent. The rationale for that approach was that it maintained the same proportion of rates among me mbers of the traffic group. For example, if one shipper initially paid twice the rate of another shipper, that would c ontinue to be true after the reduction. The underlying assumption was that the existing

rate structure reflected the va rying demand elasticities among members of the traffic group. Under the Ramsey pricing principle discussed above, which sets shippers’ rates in inverse proportion to their de mand 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 th at assumption: In their view,

the Board should assume that th e rates they se t adequately reflect differences in demand between the complaining captive shipper and th e 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 Reduc tion Method to reduce it, the new rate will still be a function of the initial rate; the higher the initial rate, the high er the final rate.13

To prevent “gaming,” the Board adopted a new method to correct excessive rates: the Maximum Markup Methodology. Rather than requi ring 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 th at they impose on the railroad. And it requires that those sh ippers’ 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 highe r that shipper’s revenue contribution relative to the variable costs it imposes on the railroad – and the bigger the per centage 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 increm entally higher than the rate it wanted prior to the SAC proceeding.

The railroads further argue th at 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 ca se, 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 re asonably explained that the undetectable nature of the pr oblem plainly justifies the

Board’s reliance on the theoretical threat. To discern whether an initial rate is set because it reflects a railroad’s perception14

of relative demand or a railroad’s effort to game the system would require the Board to eith er divine the motives of the railroad in setting the challeng ed 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 justificati on for adopting the Maximum Markup Methodology: By statut e, 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 a llows 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 gi ving a disproportionately higher share of a rate reduction to captive traffic runs directly counter to the Ramsey pr icing principle that the Guidelines approach adopted. Those principl es instruct th at 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 shoul d be maintained. The Percent15

Reduction Method preserved the rate structure because the Board would reduce the rates of all shippers in the traffic group by the same percentage wh en it would conc lude that a

railroad was receivi ng excessive revenue.

The Board’s Maximum Ma rkup 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 conclu sion that rate structures are susceptible to gaming rejects th at assumption. Moreover, the Maximum Markup Methodology preserves demand-based differential pricing to a significan t 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 hi gh rates relative to the variable

costs attributable to them.

There is therefore no contradiction between the Maximum Markup Methodology a nd the Board’s goal under

Guidelines : Under both approaches, the objective is for railroads to “ensure that comp etitive 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 th e 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 maximize16

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. Th e 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 diffe rent method of reducing rates after performing the Stand-Al one-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 co rrect the problem. This new methodology, as explained ab ove, 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 Boar d’s change to its method for forecasting the SARR’s future operating expenses.

To calculate the costs th at the hypothetical SARR would likely incur over the 10-year Stand-Alone-Cost analysis17

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 cha nges in railroad costs. Before this rulemaking, the Board’s operating-expense forecasts did not take into account the possi bility that the SARR could experience productivity gains – ga ins 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 indus try, 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 fu el, 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, ta kes 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 SA RR’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 hypothe tical railroad would not immediately experience the same level of productivity growth as the anticipated industry aver age: “[A] SARR is presumed to begin the analysis period at a higher pr oductivity 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 realize18

productivity gains in locomotives as they replace old locomotives with newer technologies. The SARR would not experience those same productiv ity gains in th e short term, because it would begin its operations with all new

locomotives.” Id. at 40. The Board, however, concluded that a SARR would experience so me 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 ga ins 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 woul d 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 industr y’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 – th e 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 eviden ce of record before the STB demonstrating the rapid rate at which the railroad industry19

renews its assets and its tec hnology.” 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 rail roads 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-Al one-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 overestim ating 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 defe rential 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 ma xim is especially true here, where we are reviewing the Board’s predictive judgment

about hypothetical railroads. The agency has adopted a straight-line, phase-i n approach that is routinely used to estimate the depreciation of assets, and we cannot conclude that the approach is unreasonabl e. Although the parties have submitted evidence that they cl aim supports their conflicting views on how a SARR would expe rience 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.-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 so me point simplicity outweighs accuracy, and the Board “is free to make reasonable trade-offs between the quality and co st 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-SA RR parts of the railroad.

As we have said, the Sta nd-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 coll ects 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 accordan ce 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 t hose 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 SA RR, it would overestimate the21

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 th e percentage of miles the shipper used the SARR. Thus, if 60 percent of a shipper’s route was on-SARR and 40 perc ent was off-SARR, roughly 60 percent of its revenue contri bution 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 traffi c on a given stretch of rail, thelower 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 a nnually. If thos e 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 percen t 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 re venue contribution should be

attributed to the SARR. In othe r words, more of their revenue22

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 reas onably declined to adopt that alternative because the propos al ignored the diminishing nature of economies of density – that is, the fact that at some point, higher density no longer resu lts in lower average costs.

See id. at 483-84. As the Board summarized the principle, “the railroad industry is ch aracterized by economies of density, meaning the average to tal cost for a network of a given size initially decreases wi th 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 reject ing the incomplete alternative proposed by the railroad, we st ated 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 appro ach 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 base d 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 we23

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

BNSF strongly suggested that the Board would be required to adopt an appropriate density-b ased approach if one were presented to it. The Averag e-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 cl aim 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 require s the Board to set rates on the basis of shipper demand. The new revenue-allocation

formula for cross-over traffi c, which is a fundamental component of the Stand-Alone-C ost analysis, is based on the average total costs of the on-SARR and off-SARR segments, not shipper demand. Therefor e, the cost-based, revenueallocation formula violates Guidelines

.

We do not agree that the Boar d’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 acc ount 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 approac h, for the Stand-Alone-Cost test,24

to estimate the costs that cr oss-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 expens e, and it is the agency’s responsibility to mark that poi nt. Our role is limited to determining whether the balance it struck is arbitrary.” Id. at 482. In this case, it follo ws 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 formul a 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’ argum ent. “A new rule may be applied retroactively to the par ties 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 perennial25

issue in [Stand-Alone-Cost] pr oceedings and one the Board even now [in 2006] has not reso lved 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 met hods 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 ba sis 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 th e 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 th e flawed procedure and apply its new rule to pending cases wh en 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.