Canadian system, receives fair compensation for the costs in providing inter-switching
services,

USDA recommends using the average of Canadian inter-switching rates for the access
price. They are already calculated with a sound methodology and are readily available to
be used as a model. Under the Canadian system, adjusted to the 30-mile criteria of the
NITL proposal, the average access fee for moves are $279/car for single car moves from
1 to 59 cars, and $84/car for moves above 59 cars.

Table 12: Canadian Inter-switching Rates per Car

Interswitching Fewer Interswitching More
Than 60 Cars Than 60 Cars

Interswitching Curent Proposed Current Proposed
Distance Zones Rates (C$) Rates (C$) Rates (C$) Rates (C$)
Zone 1 $185 $229 $50 $46
Zone 2 $200 $248 $60 » $55
Zone 3 $240 $284 $75 $65
Zone 4 $315 $251 $90 $74
Rate per additional kilometer over 40 $3.75 $3.38 $1.45 $1.20
Rate per additional mile $6.04 $5.44 $2.33 $1.93
30-mile Rate $346 $279 $102 $84

In the analysis prepared by Escalation Consultants, the fees were assumed to be $299/car
for single car move from | to 59 cars, and $88 for moves above 59 cars. These
assumptions were derived by calculating the simple average of the rates from Zones 3
and 4 of the Canadian system adjusted for the appropriate additional mileage charges for
the 30-mile criteria of the NITL proposal. Due to time constraints and because these
assumptions are close to the adjusted averages of the Canadian inter-switching rates for
all four zones in Table 12, USDA did not have Escalation Consultants adjust the analysis
to match USDA’s proposal for access fees.

Recommendations
USDA recommends the Board adopt guidelines for competitive switching that eliminate

the market-power standard. Instead, USDA believes competitive switching should be
available for all shipments where the R/VC is above 180 percent and not limited to
movements with an R/VC above 240 percent as proposed by NITL, or to the 4-year
average RSAM benchinark as suggested by the Board. As shown in Table 1A, this
would reduce railroad freight revenues for grain and oilseeds by only $30.5 million,
which is 0.6 percent of total Class I railroad grain revenues and 4 percent of the net
income from those movements. In addition, USDA recommends that the Board use a
rebuttable presumption that the shipper is entitled to receive competitive switching, with
the burden placed on the railroads to prove otherwise. Finally, USDA recommends using
the average of Canadian access fees for the competitive switching.

20



Short Line Involvement in the Move

The estimates of the impacts of competitive switching include Waybill movements that
originated or terminated on short line railroads, but were billed as a Class I railroad on
the Waybill. These movements are not subject to competitive switching under the NITL
proposal and need to be accounted for when estimating the change in railroad revenue.
The potential amount of these types of moves is significant.

It is very difficult and time consuming to estimate short line movements from the Waybill
Sample and in most cases impossible. Escalation Consultants removed some short line
moves from the Waybill Sample where they knew that paper barriers existed, but could
not identify many, and certainly not all, movements that had short line railroad
participation.

During 2010, short line railroads handled 639,000 carloads of farm products’ (STCC 1),
or about 32 percent of the 2,010,406 carloads of grain’? handled by U.S. and Canadian
Class I railroads within the United States. From the Waybill, it is unknown to USDA
how many carloads were originated by short line railroads, how many were terminated,
how many were local moves, and how many were bridge movements. However, USDA
believes that the impacts shown previously based upon Waybill results could be further
reduced by up to 32 percent due to short line involvement in the move. Therefore, a
more accurate assessment would require the Board to factor in a reduction for this
anomaly. Due to a lack of information, USDA could not provide an accurate reduction
factor for short line moves in this analysis.

Contract Moves

Twenty-four percent of grain and oilseed movements were contract shipments in 2008."
USDA presumes that contract movements are “locked in” and are not subject to
competitive switching during the term of the contract, but do not have access to the terms
of such agreements, Some analysts would say that contract moves just delay the impact
on railroad revenue, as changes could be made as contracts are renegotiated. At the
expiration of a contract there are several outcomes possible: (1) conversion of contract
rates to tariff rates, (2) renewal of the contract with provisions for competitive switching,
or (3) renewal of the contract without competitive switching provisions. Since we
understand from shippers that Class I railroads often present an “all or nothing” contract
proposal, some shippers might find themselves in a position where they would need to
balance the value of competitive shipping against lower contract rail rates.

Because contract moves are imbedded in the Waybill data in this analysis, the impacts
shown previously are too high. In evaluating the proposal, USDA believes it is
reasonable to make an adjustment for contract movements, but there was not enough
information available to USDA for us to accurately determine how an adjustment should
be made. The impacts based upon the Waybill results in this analysis could potentially be
reduced up to 24 percent due to contract moves of grain and oilseeds.

” American Short Line and Regional Railroad Association, 2012 Facts and Figures.

'8 Association of American Railroads, Freight Commodity Statistics, Annual 2010 Revised.

" Bahizi, Pierre. Grain Transportation Report, “Contract vs, Tariff Rate Shipments of Grain and Oilseeds
in 2008,” U.S. Department of Agriculture, Agricultural Marketing Service, June 17, 2010.

14



V. Rules to Determine Movements for which EP 711 Will Have a Revenue
Effect

EC used the following rules to determine which movements will be impacted by
(ie., experience a benefit from) EP 711:

Single Line Hauls (including Rule 11 rates)

Existing Move
Origin Destination | Needed for a Station to be Impacted |
Captive Captive Both origin and destination stations must be impacted to '
reduce the rate
Captive Competitive | If origin station is impacted the rate is reduced
Competitive | Captive Tf destination station is impacted the rate is reduced
Multiple Railroad Hauls Under Single Factor Joint Line Rates
Existing Move
Origin Destination | Needed for a Station to be Impacted
If only the origin station is impacted, the rate for the
origin segment is reduced
. . i impe ‘ both t
Captive Captive If both stations are impacted, the rates at both segments |
are reduced
If only the destination station is impacted, the rate for
the destination segment is reduced
Competitive | Captive If the destination station is impacted, the rate for the
destination segment is reduced
Captive Competitive _ | If the origin station is impacted, the rate for the origin
segment is reduced

Note - Movements that are already competitive at both the origin and destination are not
considered as they are not impacted by EP 711.


USDA appreciates the time and effort that NITL spent on its proposal. The elimination
of current rules and precedent and the development of new reciprocal switching rules are
excellent first steps in the development of the NITL proposal. Furthermore, USDA
agrees with the NITL that the proposal should apply only to Class I railroads in order to
protect the short line industry from losing crucial traffic volume. If short line railroads
were subject to competitive switching and lost high volume customers as a result, they
may be unable to cover their fixed costs. This would be not be good for the entire rail
network given the critically important role short line railroads currently serve.

The NITL proposal for competitive switching has the potential to give some grain and
oilseed shippers access to markets that are now closed to them due to the lack of
competitive switching. Agricultural shippers have indicated they sometimes face a
situation where they do not have access to a desired market because the railroad serving
them will not switch with a competing railroad. In instances where railroads will provide
switching services, agricultural shippers have said the charge can be more than $500 per
carload," which is excessive and often forces shippers to ship only to markets located on
the railroad serving them, When railroads are allowed to determine the markets in which
a shipper may sell, market inefficiencies are introduced.

USDA Concerns Regarding the NITL Proposal

Agricultural shippers have indicated to USDA they are concerned the NITL proposal
would benefit too few grain and oilseed shippers. The two main concerns expressed to
USDA ate: (1) the high threshold of 240-percent R/VC is so high that it excludes many
agricultural shippers, and (2) in the sparsely populated areas of the Rocky Mountain and
Plains States, most grain and oilseed shippers would not benefit from competitive
switching that is limited to a distance of 30 rail miles to a switching point.

From a philosophical point of view, USDA is not in favor of restricting switching based
on an arbitrary threshold because the Staggers Act and Interstate Commerce Commission
Termination Act (ICCTA) have provisions for competitive switching, but do not require
any threshold for eligibility.” Secondly, the Canadian competitive switching system does
not involve a threshold, making it available to all shippers within 30 kilometers of a
switching point. The Canadian railroads are still profitable and the Canadian system
works for both railroads and shippers.

Similarly, USDA is concerned that the Board’s suggestion of a Revenue Shortfall
Allocation Method (RSAM) benchmark for each railroad would provide even fewer
benefits to agricultural shippers than the NITL’s suggestion of a 240 R/VC benchmark
for establishing the right to competitive switching. The RSAM threshold is unreasonably

* Joint Comments of the Agricultural Retailers Association, National Association of Wheat Growers,
National Barley Growers Association, National Chicken Council, National Corn Growers Association,
National Cotton Council, National Council of Farmer Cooperatives, National Grain and Feed
Association, National Oilseed Processors Association, Renewable Fuels Association, The Fertilizer
Institute, USA Rice Federation in Surface Transportation Board Ex Parte 705, Competition in the Rail
Industry, pg. 4.

5 The NITL Petition for Rulemaking to Adopt Revised Competitive Switching Rules, Ex Parte No. 711,
pg. 10-11, discusses this very clearly,



Respectfully submitted,

Ss

Edward Avalos

Under Secretary

Marketing and Regulatory Programs
U.S. Department of Agriculture
Washington, D.C, 20250



VIL. Access Fee

The access fee used in calculating impacts is the average Canadian access fee
for moves of | to 30 miles. This is $299 per car for single car moves (1 to 59
cars) and $88 per car for unit train moves (above 59 cars).

VIII.Summary Results

Ix.

Each movement, both single-line and joint-line, was analyzed to determine the
savings under EP 711. For joint-line movements revenue was broken down
according to the STB’s breakdown of revenue (mileage for each segment was
used). For each movement, whether joint line/Rule 11 or single line, the
benchmark rate and access fee at the origin and/or destination are totaled and
compared to the actual rate for the movement on the Waypbill to determine if the
rate will be reduced by EP 711, and therefore the effect of EP 711 on the
shipper and on the carrier.

Treatment of Paper Barriers

There is no way to distinguish with certainty from the Waybill Sample, or from
any other source, whether a station served by a Class II or Class III carrier is
impacted by a paper barrier. EC tentatively included all Class II or Class III
carriers as competitors, unless: (1) it is known that there is a paper barrier at a
particular location that would restrict the ability of a Class II or III carrier to be
a competitor; or, (2) it would take more than a single movement on a Class II or
Class III carrier to connect to a Class I carrier.

EC excluded a Class II or III carrier as a competitor if known independently that
the Class II or III carrier is restricted by a paper barrier at a particular location.
Class II or III carriers in this situation are excluded because it is not clear what
effect, if any, EP 711 would have on paper barriers, and whether the Board
would have to lift a paper barrier through a separate proceeding.



shipper’s facility were in fact captive to a single carrier, even though they are
located at a station that is served by more than one carrier.

EC used the following rules, under which if movements at a competitive station
meet any one of the following criteria, the movements are considered captive:

1. Ifacommodity at a competitive station has at least 300 cars with more
than a 240% R/VC (or alternatively 180% R/VC or the RSAM) on any
railroad and more than 90% of these high R/VC carloads are on one
railroad, then this station will be designated as captive at the industry for
all movements of this commodity on that one railroad with an R/VC
above 240% (or alternatively 180% R/VC or the RSAM) at that station.

2. If acompetitive station has more than 15% percent of its carloads with
an R/VC above 180% and more than 75% of the traffic at the station is
on one railroad, then this station will be designated as captive at the
industry for all movements at that station with an R/VC above 240% (or
alternatively 180% R/VC or the RSAM) on that one railroad.

3. If there are more than 3,000 cars at a competitive station with an R/VC
more than 240% (or alternatively 180% RVC or the RSAM) (this could
be less than 15% of the carloads at a station) and these cars ave all served
by the same railroad, then this station will be designated as captive at the
industry for all movements with an R/VC more than 240% (or
alternatively 180% R/VC or the RSAM).

4, If competitive station has more than 3,000 cars with more than a 300%
R/VC, then this station will be designated as captive at the industry for
all movements with an R/VC more than 300%.

These rules were adopted on the basis of extensive analysis of the Waybill and on
what EC considered reasonable assumptions to indicate captivity.

IV. Rule for Determining Stations at Which Cars Are “Regularly Switched”

Shippers within 30 miles of an interchange at which cars are “regularly
switched” are presumed to be eligible for competitive switching, assuming that
the shipper meets the other qualifications. The Railroad Station Master List
indicates that there are thousands of valid “interchanges” (“Active Junctions”),
but the Waybill Sample reveals that there are only about 500 points at which the
Waybill Sample shows that cars are actually switched (“Working Junctions”).

EC used only the 500 Working Junctions on the Waybill to show the effect of
EP 711 on shippers and railroads. This is because the focus is on the existence
of “regular” switching, and the use of the more numerous Active Junctions
might not be places where “regular” switching occurs.


competitive through competitive switching, these shippers are likely to increase their
negotiating power and minimize rate increases over the remaining captive portion of their
traffic.

For completely captive shippers, their rates are likely to rise by the amount not recaptured
by the railroads through increased traffic volumes. This amount would likely be minimal
given the maximum reduction in grain and oilseed revenue represents at most 2.2 percent
of Class I railroads’ grain revenue.

Impact on the Rail Industry
Competitive switching could result in a more integrated rail network in the United States.
Shippers would be better able to access parts of the rail network that railroads currently
do not allow due to excessive switching fees. Grain and oilseed shippers need access to
all the markets in order to be able to get the best price for their products—currently, they
are restricted from some nearby rail =
markets, In addition, network 30
efficiencies could accrue from
moving freight by the most direct
routes. Finally, some portion of the
decrease in railroad revenues will be
offset by increased volumes and

Figure 1: Class I Railroad Profitability

revenue through traffic creation. 0 48, BS py —r
Reese ze25 2825
SRR A AAR AAR AR OR

‘o=Net income —eEBIT -EBITDA.

When considering the robust financial
condition of the railroad industry,
now is an ideal time for the Board to Figure 2: Net Income as a Percent
change its rules for competitive of Total Operating Revenue
switching. Since 2004, railroad net
income has increased 279 percent to a
record level of $11 billion (see Figure
1). Earnings before interest, taxes,
depreciation, and amortization

Source: AAR, Analjsis of Clas | Ralroeds

(EBITDA) have increased 165 0% ee?

percent to $24.6 billion. gE & 82 - ‘e828 3 25 £228
Sin gapienlcoetnanvan:

Similarly, net income as a percent of Figure3: Class I Railroad Cost of Capital and

total operating revenue has risen from Return on Net Investment, 1997-2011

7.08 percent in 2004 to 16.39 percent 2
in 2011 (see Figure 2), This is a 131 £
percent increase in railroad net é
markup on it freight rates, As a result

= aS

of profitability growth, railroad stocks keeeadE geed
are now in high demand. ERRRR HAE aa RRR RA

pcr CAPM = -s-ROL ~e- CAPM +MSDCF
Searces: AAR,Raikoud Pc; Sauce Deepertatin Bout

When the Board used the Capital
Asset Pricing Method (CAPM), the railroad industry was revenue adequate in 2005S and
2006, and nearly revenue adequate in 2002 to 2004 (see Figure 3). Since the Board

18


1, however, should not be used as an estimate of the expected impact. In a later section
on Sensitivity Analysis, we discuss in further detail several other factors that also need to
be taken into consideration when considering the expected impact. However, it is
important to note that even if these theoretical, top-end estimates are used, it is USDA’s
opinion that a reduction of railroad revenue from grain and oilseed moves of 2.2 percent
is not a huge change, especially in the context of exchanging this for the introduction of a
small amount of additional rail competition, as the Staggers Act intended.

Table 1: Estimated Impact for Grain, Near Perfect Competition—30 Miles, 180
R/VC

Impacted Revenue Before Revenue After Change in Percent Reduction

STCC Commodity Carloads Reduction Reduction Revenue in Revenue
1131 Barley 1,496 $2,071,356 $1,410,831 $660,525 31.9%
1132 Corn 44,421 $85,472,793 $65,948,400 $19,524,393 22.8%
1133 Oats 376 $723,000 $527,678 $195,322 27.0%
1134 Rice 400 $1,290,744 $1,075,079 $215,665 16.7%
1136 Sorghum 4,216 $9,066,360 $5,441,045 $3,625,314 40.0%
1137. Wheat 88,058 $199,070,980 $129,802,860 $69,268,120 34.8%
1139 Other grain 40 $186,589 $108,831 $77,758 41.7%
1141 Cottonseeds 144 $498,036 $358,442 $139,594 28.0%
1144 Soybeans 23,345 $79,975,550 $67,725,066 $12,250,484 15.3%

Totals 162,496 $378,355,408 $272,398,232 $105,957,176 28.0%
Percent of Class | Railroad Grain Revenues 2.2%
Percent of Class | Railroad Grain Net Income 13.8%

Under the assumption of duopolistic competition, the impacts of competitive switching i
totaled $62.5 million, resulting in an 18.7 percent reduction in revenue (see Table 1A).

This reduction in rates represents 1.3 percent of Class I railroad grain revenue and 8.1

percent of Class I railroad net income from grain and oilseeds.

Table 1A: Estimated Impact for Grain, Duopoly Coimpetition—30 Miles, 180 R/VC
Impacted Revenue Before Revenue After Change in —_Percent Reduction
STCC Commodity Carloads Reduction Reduction Revenue in Revenue
1131 Barley 1,280 $1,822,903 $1,445,629 $377,273 20.7%
1132 Corn 33,836 $64,352,531 $54,236,091 $10,116,440 15.7%
1133 Oats 376 $723,000 $592,565 $130,435 18.0%
1134 Rice 400 $1,290,744 $1,246,406 $44,338 3.4%
1136 Sorghum 4,136 $8,960,074 $6,155,857 $2,804,217 31.3%
1137 Wheat 82,402 $186,465,095, $143,646,110 $42,818,985 23.0%
1141 Cottonseeds 144 $498,036 $399,836 $98,200 19.7%
1144 Soybeans 20,531 $69,927,817 $63,825,867 $6,101,949 8.7%
Totals 143,105 $334,040,200 $271,548,363 $62,491,837 18.7%
Percent of Class | Railroad Grain Revenues 13%
Percent of Class | Railroad Grain Net Income 8.1%

Scenario 2: 240 Percent R/VC Threshold for Eligibility (NITL Proposal

The impacts of competitive switching, under a qualifying threshold of 240 percent R/VC
and an assumption of near perfect competition, totaled $70.9 million, resulting in a 40.2
percent reduction in revenue (see Table 2). This reduction in rates represents 1.5 percent

10


NITL has specified the conclusive presumption be applied to terminals that exist as of
July 7, 2011 in order to prevent “‘backsliding” by the carrier, whereby terminal
designations are eliminated to prevent implementing the proposed rule. USDA agrees
with this approach, but believes the specification should also be extended to cover
interchanges between Class I carriers that existed as of July 7, 2011, in order to prevent
backsliding on these interchanges, as well. Furthermore, the closure of terminals and
interchanges must be subject to litigation and decision by the STB. This is necessary to
prevent railroads from avoiding compliance simply by closing terminals and interchanges
in the future. Closures must be viewed from an overall economic standpoint, where the
costs and benefits to both railroads and shippers are taken into consideration before the
Board.

Finally, the availability of competitive switching should not affect a railroad’s market
dominance for rate appeals because there is substantial testimony that the Class I
railroads do not compete.° For a shipper to gain access to competitive switching only to
lose the market dominance test when making a rate appeal would be a perverse result.
The Board can rule that the market dominance test is met when a shipper can demonstrate
the absence of effective transportation competition, even if the rail shipper is physically
connected to two railroad systems or has competitive access to another railroad.

Methodology
Given that the Waybill Sample is not a perfect instrument for deriving the information

requested by the Board, Escalation Consultants had to develop rules and impose
assumptions on the Waybill data in order to undertake the task.’ Thus, several specific
items the Board requested cannot be ascertained from the Waybill, such as the number of
shippers who can currently obtain competitive switching or the number of shippers who
will qualify under the NITL proposal. Instead, Escalation Consultants was able to
determine the stations at which movements were billed and the number of qualifying
carloads.

Escalation Consultants determined the R/VC for each movement qualifying under the
NITL proposal for eight major agricultural commodities (see Table | for full list). USDA
limited the analysis to these commodities because they comprise 96 percent of the rail
movements of farm products classification. During 2010, Class I railroads moved 171.5
million tons of grain and oilseeds.

In order to determine how rates for qualifying movements would change, Escalation
Consultants developed benchmark R/VCs for similar competitive movements to serve as
a comparison. Under the assumption that the R/VC for a qualifying movement would fall
to the level of a similar competitive movement with the introduction of competition, the
change in rates and revenues could be calculated. Competitive benchmark R/VCs were
established using the competitive R/VCs on each railroad, stratified by STCC codes at the

6 Testimony of Ameren Corporation, STB Ex Parte No. 705, Competition in the Railroad Industry, June
23,2011. Also other testimony in the same proceeding from National Rural Electric Cooperative
Association, Highroad Consulting, and Western Coal Traffic League.

7 See Appendix for complete set of rules and assumptions.



high because it implies that shippers should only have this right if a rail rate is above
what the railroad would need to average for shipments having an R/VC above 180
percent in order to become revenue adequate. Setting the threshold at the REAM
benchmark level would exclude many agricultural shippers and therefore is not
acceptable from USDA’s perspective. As will be shown later in these comments, such a
threshold in USDA’s opinion simply would not allow enough agricultural shippers access
to competitive shipping in order to reach the objective of meaningfully increasing rail
competition.

Nevertheless, USDA understands from a practical standpoint, a threshold may be
necessary to provide at least some degree of competitive switching. Therefore, in
subsequent sections of these comments, USDA provides analysis of the difference in
expected impacts on grain and oilseed shippers among three different R/VC thresholds:
180-percent R/VC, 240-percent R/VC, and a RSAM benchmark. If a threshold is
necessary, USDA believes an R/VC of 180 percent may be more appropriate, as it is the
level at which the Board gains jurisdiction over rail rates. An added advantage from the
agricultural standpoint is that it would allow more agricultural shippers to benefit from
competitive switching.

USDA believes special provisions may be needed for grain and oilseed movements
because those shippers are often located in sparsely populated regions having fewer rail
lines, unlike some shippers, who originate shipments in suburban regions having more
rail-to-rail competition. In addition, unlike other high-volume bulk shippers that move
from one location to a few destinations, grain and oilseed shippers often ship smaller
quantities to many destinations. Furthermore, grain and oilseeds are comparatively
lower-value commodities competing in highly competitive world markets. Therefore, the
Board should consider establishing the threshold for eligibility at a 180 percent R/VC for
grain and oilseed movements.

USDA is also concerned that the NITL proposal places much of the burden of proof on
the shipper, which could cost the shipper considerable time and effort. USDA believes
the only time the burden of proof should be on the shipper is to show that the railroad has
hauled 75 percent or more of the volume transported in the past twelve months for which
competitive switching is sought. When the burden of proof is on the shipper, the Class I
railroad serving the shipper could create too many hoops for the shipper to go through
that would increase the cost and time of what should be a simple determination.

Therefore, USDA believes the entire eligibility process must be simple, well-defined, and
transparent. The process should be simplified by a rebuttable presumption that the
shipper is eligible for competitive switching and leave it to the railroad to show why not.
By establishing a threshold of 180 percent R/VC, the process would be simplified. To
prevent competitive switching, railroads would only have to show that the track miles to
a switching point exceed 30 miles and/or that the R/VC was below 180 percent.

In determining where cars can be switched, NITL has outlined conclusive presumptions
for two areas, terminal facilities and interchanges between Class I carriers. However,



switched to the average of CAPM and Multi-Stage Discounted Cash Flow (MSDCF) in
2008, the railroad industry has approached revenue adequacy in 2008, 2010, and 2011.
In addition, several Class I railroads have individually been revenue adequate for a
number of years. Indeed, some shippers have begun to wonder when and how the
revenue adequacy constraint will be applied to those railroads.

As a result of strong profitability,
railroads have invested record
amounts in capital expenditures,
$11.6 billion in 2011 (see Figure 4).
Railroads invested even more in
2012, although the numbers are not
available yet.

Figure 4; U.S, Class I
Railroad Capital Expenditures

Billions of dollars

There is a strong relationship
between operating revenue and
railroad capital expenditures (Figure
4). With the exception of 2009, a
recessionary year, railroad capital expenditures have hovered in the range of 16 to 17
percent of operating revenue. This strong level of investment has improved the rail
infrastructure of the United States.

Percent of operating revenue

Source: AAR, Analysis of Class 1 Railroads

Despite the strong investment in capital expenditures, railroads have also doubled
dividend payments to their shareholders and spent billions on repurchasing publicly-
traded shares to boost the short-term value of their stocks, The four major railroads spent
$13 billion to repurchase shares from 2006 through 2008. '°

Although the railroads are spending record amounts on capital expenditures, it is likely
that competitive switching would reduce these expenditures by the amount not recovered
from other captive shippers.

Methodologies for the Access Price

The methodology for determining the access price must be simple, easily calculated, and
applied to all switching under the competitive access rules. The access price should be a
predictable and fair price that is applied equally to all carriers providing switching
services and allows shippers to negotiate, through normal commercial processes, suitable
terms and conditions of carriage with competing carriers from the interchange point
onward, for the line haul portion of the overall car movement. The inter-switching access
fee should be set at a level that benefits shippers by extending their access to the lines of
competing rail carriers at a rate that adequately covers the cost of moving the traffic to or
from the interchange point.

The Canadian inter-switching rates provide a real-world model where the access fee is set
at a level that ensures shippers derive, where available, the benefits of price competition,
improved service levels, and varying routing options. Likewise, the rail carrier, under the

'S United States Senate, Committee on Commerce, Science, and Transportation, The Current Financial
State of the Class I Freight Industry, Staff Report for Chairman Rockefeller, September 15, 2010.

19


Lerner Index is used in economic theory to show an oligopolist’s markup in price above
its marginal cost (the competitive price) based upon its market share.® By using the
average captive benchmark R/VC for qualifying movement’s R/VC as the monopoly rate
and the competitive benchmark R/VC as the competitive rate, an elasticity of demand? for
each shipment was calculated using the Lerner Index formula. © The duopoly benchmark
R/VC was calculated, using the same formula, by holding the elasticity of demand and
competitive benchmark R/VC constant but adjusting the market share to account for two
firms.

The results in Tables 1A, 2A, and 3A assume the Class I railroads are able to retain
market power, as exercised through differential pricing, over shippers subject to
competitive switching but must now share it between two railroads.

Impact on Qualifying Captive Rail Shippers

USDA presents three scenarios estimating the impacts of competitive switching in
regards to agricultural movements based upon three different thresholds for qualification—
180 percent R/VC, the NITL’s proposed 240 percent R/VC, and the Board’s suggested 4-
year average RSAM benchmark. These scenarios are evaluated under two different
assumptions on rates—fully competitive (near perfect competition) and duopolistic
competition. All scenarios assume a 30-mile “reasonable distance” criterion for the Class
T railroads and use the access fees discussed above. The summary results provide
estimates on impacted carloads, commodity impacts, and changes in revenue, Also
included are expected impacts by State.

Scenario 1: U Proposal

The impacts of competitive switching, under a qualifying threshold of 180 percent R/VC
and an assumption of near perfect competition, totaled $105.9 million, resulting in a 28
percent reduction in railroad revenue from grain and oilseed moves for the Class I
railroads (see Table 1). This reduction in rates represents 2.2 percent of Class | railroad
grain and oilseed revenue and 13.8 percent of Class I railroad net income from grain and
oilseeds.'' Wheat accounts for nearly 65 percent of this total, corn accounts for 18
percent, and soybeans account for 12 percent.

Because the assumption of near perfect competition is not a realistic outcome, USDA
believes these estimates are substantially inflated. Nevertheless, they are useful to gauge
an upper end, highest theoretical level of potential impact on railroad revenue from
allowing competitive switching for grain and oilseed movements. The estimates in Table

® Lerner, A.P. “The Concept of Monopoly and the Measurement of Monopoly Power,” The Review of
Economic Studies, 1(3), 157-175, 1934.

The price elasticity of demand measures the responsiveness of consumers to changes in price. It is the
percentage change in quantity demanded for a given percentage change in price.

'0 See Appendix for detailed explanation of applying the Lerner Index.

" Total 2010 Class I railroad grain revenues were $4.84! billion according to the Association of American
Railroads (AAR) Rail Transportation of Grain. Class I railroad net income was $9.262 billion during
2010 according to the AAR, Railroad 10-Year Trends, which was 15.9 percent of their total revenue.
Net income from grain was estimated to be $767,683,834 (Grain Revenue x Net Income as a percent of
total operating revenue).



VI. Rules to Determine the Revenue Effect on Shippers and Carriers under
Assumption of Nearly Perfect Competition

If a movement qualifies, it will move from captive to competitive status and
presumably, the rate will decrease. i

To determine reduced revenue, the R/VC for all single-line movements in the
Waybill Sample has been calculated for each major railroad. The change in
R/VC for each movement is calculated under two different assumptions.

Calculations under assumption of nearly perfect competition

Competitive Benchmark rates were calculated by analyzing the single line hauls
on each railroad (since the revenue split in a single-factor joint line movement
rate cannot be determined from the Waybill Sample).

Competitive Benchmark R/VCs are calculated using the competitive R/VC’s on
each railroad, stratified by STCC codes at the 5-digit commodity code (if
sufficient movements are available; if not, then 4-, 3- or 2-digit commodity
codes were used). In addition, the R/VCs were summarized by mileage range.
The mileage ranges determined at the 5-digit STCC level were:

0 to 50 miles

>50 to 150 miles
>150 to 500 miles
>500 to 1000 miles
>1000 to 1800 miles
>1800 miles

If sufficient moves were not available for the specific mileage range for a
movement at the 5-digit level, then the mileage range above or below was used.
If sufficient data was still not available, the same process was followed at the 4-,
3-, or 2-digit level until sufficient data was available.

If the movement has an R/VC of less than 180%, it will be included in the
calculation of the Competitive Benchmark R/VC for that mileage range for that
carrier for that commodity.

If a movement qualifies under EP 711, then it will be assumed that a savings
will occur to the shipper, with the savings equal to the difference between the
Captive and the Competitive R/VC for that commodity at that mileage range.

Calculations under assumption of duopoly competition
The duopolistic R/VCs were calculated by applying a Lerner Index to the

Competitive Benchmark R/VCs, as calculated above, and the Captive R/VCs for
each qualifying movement. The Lerner Index is used in economic theory to
show an oligopolist’s markup in price above its marginal cost (the competitive
price) based upon its market share.



Date: March 1, 2013

Before the U.S. Surface Transportation Board

STB Ex Parte No. 711
Petition for Rulemaking to Adopt Revised

Competitive Switching Rules

Comments of the

U.S. Department of Agriculture

Edward Avalos

Under Secretary

Marketing and Regulatory Programs
U.S. Department of Agriculture
Washington, D.C. 20250



Table 3: Estimated Impact for Grain, Near Perfect Competition—30 Miles, RSAM

Percent Reduction

Impacted Revenue Before Revenue After Change in
STCC Commodity _Carloads Reduction Reduction Revenue in Revenue
1131 Barley 992 $999,026 $605,346 $393,680 39.4%
1132. Corn 16,857 $20,271,120 $11,956,167 $8,314,953, 41.0%
1133 Oats 376 $723,000 $527,678 $195,322 27.0%
1136 Sorghum 2,854 $5,460,040 $2,797,523 $2,662,517 48.8%
1137 Wheat 55,781 $100,760,403 $57,693,497 $43,066,906 42.7%
1141 Cottonseeds R $247,692 $175,698 $71,994 29.1%
1144_ Soybeans 4,752 $5,424,481 $3,188,385 $2,236,096 41.2%
Totals 81,684 $13,885,763 $76,944,294 $56,941,469 42.5%
Percent of Class | Railroad Grain Revenues 1.2%
Percent of Class | Railroad Grain Net Income 7.4%

Under the assumption of duopolistic competition, the impacts of competitive switching
totaled $40.8 million, resulting in a 30.7 percent reduction in revenue for affected moves
(see Table 3A). This reduction in rates represents 0.8 percent of Class I railroad grain
revenue and 5.3 percent of Class I railroad net income from grain and oilseeds.

Table 3A: Estimated Impact for Grain, Duopoly Competition—30 Miles, RSAM

Impacted  RevenueBefore Revenue After Change in Percent Reduction

STCC Commodity Carloads Reduction Reduction Revenue in Revenue
1131 Barley 992 $999,026 $710,234 $288,792 28.9%
1132. Corn 16,019 $19,735,160 $13,989,882 $5,745,278 29.1%
1133 Oats 376 $723,000 $592,565 $130,435 18.0%
1136 Sorghum 2,854 $5,460,040 $3,243,214 $2,216,826 40.6%
1137 Wheat 55,245 $10,217,188 $69,651,207 $30,565,981 30.5%
1141 Cottonseeds 7 $247,692 $195,932 $51,760 20.9%
1144 Soybeans 4,536 $5,302,961 $3,544,978 $1,757,983 33.2%

Totals 80,094 ___$132,685,067 $91,928,012 $40,757,055 30.7%
Percent of Class | Railroad Grain Revenues 0.8%
Percent of Class | Railroad Grain Net Income 5.3%

Comparing the Three Scenarios

Under these three scenarios, the upper end, theoretical ranges of the impacts on railroad
revenue and savings to shippers can be compared (see Table 4 below).

Table 4: Summary Table on Estimated Impacts for Grain—30 Miles

‘Threshold Impacted Change in % of Class 1 % of Class 1 RR

Table R/VC Assumption Carloads Revenue ___ RR Grain Reyenue Grain Net Income.
1 180 Near Perfect Competition 162,496 $105,957,176 2.2% 13.8%
2 240 Near Perfect Competition 102,022 $70,884,394 1.5% 9.2%
3 RSAM_ Near Perfect Competition 81,684 $56,941,469 1.2% 74%
1A 180 Duopoly Competition 143,105 $62,491,837 1.3% 8.1%
2A 240 Duopoly Competition 99,032 $49,260,759 1.0% 6.4%
3A RSAM__Duopoly Competition 80,094 $40,757,055 0.8% 5.3%

Interestingly, the financial impact under a 240 percent R/VC threshold assuming near
perfect competition is greater than under a 180 percent R/VC threshold assuming duopoly
competition. This observation illustrates a concern of USDA. That is, if the merits of a
particular proposal are evaluated under invalid assumptions, an unintended consequence
could be fewer real savings to shippers and a lost opportunity to introduce more benefits

12


of Class I railroad grain revenue and 9.2 percent of Class I railroad net income from grain
and oilseeds. Wheat accounts for nearly 73 percent of this total, corn accounts for 16
percent, and soybeans and sorghum account for 5 percent each. As was mentioned in the
discussion of Scenario |, this represents the highest theoretical level of potential impact
on railroad revenue from grain and oilseed movements and does not represent a realistic
estimate of the expected impact with this threshold level.

Table 2: Estimated Impact for Grain, Near Perfect Competition—30 Miles, 240 R/VC

Impacted Revenue Before Revenue After Change in Percent Reduction

STCC_ Commodity Carloads Reduction Reduction Revenue in Revenue
1131 Barley 1,052 $1,124,126 $693,761 $430,366 38.3%
1132 Corn 22,642 $30,284,808 $18,873,759 $11,411,049 37.7%
1133 Oats 376 $723,000 $527,678 $195,322 27.0%
1136 Sorghum 3,686 $7,776,394 $4,357,576 $3,418,818 44.0%
1137 Wheat 66,466 $126,261,957 $74,644,520 $51,617,437 40.9%
1139 Other grain 40 $186,589 $108,831 $77,758 41.7%
1141 Cottonseeds 144 $498,036 $358,442 $139,594 28.0%
1144 Soybeans 7,616 $9,317,057 $5,723,008 $3,594,049 38.6%

Totals 102,022 $176,171,968 $105,287,574 $70,884,394 40.2%
Percent of Class | Railroad Grain Revenues 1.5%
Percent of Class | Railroad Grain Net Income 9.2%

Under the assumption of duopolistic competition, the impacts of competitive switching
totaled $49.3 million, resulting in a 28.4 percent reduction in revenue (see Table 2A).
This reduction in rates represents 1.0 percent of Class I railroad grain revenue and 6.4
percent of Class J railroad net income from grain and oilseeds.

Table 2A: Estimated Impact for Grain, Duopoly Competition—30 Miles, 240 R/VC |

Impacted Revenue Before Revenue After Change in Percent Reduction

STCC_Commodity Carloads Reduction Reduction Revenue in Revenue
1131 Barley 1,052 $1,124,126 $816,523 $307,604 27.4%
1132 Corn 21,328 $29,281,826 $21,413,280 $7,868,546 26.9%
1133 Oats 376 $723,000 $592,565 $130,435 18.0%
1136 Sorghum 3,686 $7,776,394 $5,046,223 $2,730,171 35.1%
1137 Wheat 65,330 $125,099,410 $89,555,655, $35,543,754 28.4%
1141 Cottonseeds 144 $498,036 $399,836 $98,200 19.7%
1144 Soybeans 7,116 $8,949,890 $6,367,840 $2,582,050 28.9%
Totals 99,032 $173,452,682 $124,191,923 $49,260,759 28.4%
Percent of Class | Railroad Grain Revenues 1.0%

Percent of Class | Railroad Grain Net Income 6.4%

Scenario 3: 4-Year Average RSAM Threshold for Eligibility (STB Inquir:
The impacts of competitive switching, under a qualifying threshold of the 4-year average
RSAM for each railroad and an assumption of pure competition, totaled $56.9 million,
resulting in a 42.5 percent reduction in revenue (see Table 3), This reduction in rates
represents 1.2 percent of Class I railroad grain revenue and 7.4 percent of Class I railroad
net income from grain and oilseeds.



5-digit level. In addition, the R/VCs were summarized according to mileage range. Only
R/VCs léss than 180 were included in the competitive benchmarks.

Access fees were based upon the average of Canadian inter-switching rates for the access
price, In the analysis, the access fee used for moves from | to 30 miles is $299/car for
single car moves between | and 59 cars, and $88/car for unit train moves above 59 cars.
A more detailed discussion on these assumptions can be seen in a later section of these
comments (see Methodologies for the Access Price).

Escalation Consultants’ analyses on impacted moves included both single-line haul
movements and interline movements. Single-line haul movements were included in the
analysis if a movement changed to be competitive at both ends of the haul under the
NITL proposal. In calculating the impact of such changes, the reduced rate (using the
competitive benchmark based on near perfect competition)—after adding the access
fee—had to be lower than the incumbent rate. Interline movements were included in the
analysis if the NITL proposal changed a movement to be competitive at only one end of
the move. .

Through this methodology, Escalation Consultants could determine the impact on rates to
qualifying shippers and the resulting change in revenue for Class I railroads. By using
filters, they were able to examine different outcomes based upon if movements qualified |
at different thresholds using 180 R/VC, 240 R/VC, and the 4-year average RSAM
benchmark (see Tables 1, 2, and 3).

Accounting for Less Vigorous Rail-to-Rail Competition

In addition to varying the threshold level of qualification, USDA had Escalation
Consultants quantify the results for the three scenarios under the assumption rates fell
only to a duopolistic benchmark instead of the competitive benchmark discussed above.
This changes the more unrealistic assumption embedded in the scenarios above that
competitive switching automatically introduces rate changes that approximate near
perfect competition. Instead, it assumes Class I railroads will not compete as vigorously
for competitive switching traffic as they might at stations subject to either intramodal
competition from three or more railroads or stations subject to intermodal competition.
This is appropriate and more accurate when railroads lack interest in fully competing
based on their competitive status in the market.

Grain and oilseed shippers have told USDA that even if competitive switching is required

they do not think railroads will significantly lower rates. Numerous shippers testified

during Ex Parte 705, Competition in the Railroad Industry, that Class I railroads often do

not compete with each other. This type of behavior can be explained by economic and |
game theory, which indicates duopolies are unlikely to engage in pure competition under |
certain circumstances. Most economics textbooks discussing the pricing practices of

oligopolies show that competition can vary according to the number of competitors in the

industry and other characteristics of the industry.

The duopolistic benchmarks were calculated by applying a Lerner Index to the qualifying
R/VC ratios and competitive benchmark ratios for each qualifying movement. The


Appendix

Rules for Calculating the Impact of Ex-Parte 711

In order to analyze the impact of EP 711, Escalation Consultants (EC) developed rules
and procedures for the study of the Confidential Waybill. These rules were necessary
because of the limitations of the Waybill Sample. For example, the Waybill Sample only
specifies “stations,” i.e., the points at which a movement is billed (¢.g., “Chicago, IL”),
not industries, i.c., the actual location of the shipper’s facility. The Waybill Sample does
not provide “local miles,” i.e., the distance from the station (usually the location of the

switch yard) to the industry, except on an average basis per carrier (i.e., the average local
movement on the NS is x miles). Thus, EC developed rules to determine what industries
are captive at stations, and what the distances are from the industry to the station. There
are other situations that similarly required rules and procedures to be developed for
analyzing the Waybill Sample and the impact of EP 711 on Qualifying Shippers and
catriers, These rules are explained below.

1.

Il.

Til.

Rule for Determining the 30-Mile Distance to a Competitive Interchange

There are two possibilities for measuring the 30 mile distance: rail miles (miles
along the track from the competitive interchange to the shipper’s facility) or
“radial” miles (“as-the-crow-flies” miles, drawing a 30-mile radius around the
competitive interchange).

EC adopted the use of rail miles to measure the 30-mile distance. Radial miles
resulted in anomalies, where a shipper’s facility was 30 radial miles from the
competitive interchange, but sometimes hundreds of miles along the rail line
from the competitive interchange to the shippet’s station.

Rule for Determining Whether a Shipper Served at a Captive Station is
Within 30 Miles of a Competitive Station

If a captive station is within 30 rail miles of a competitive station, all
movements at the captive station will qualify for competitive switching, since
there is no way to tell the actual distance from the shipper’s facility to the
competitive station.

Rules for Determining Whether a Shipper’s Facility Served by a
Competitive Station is Captive to a Single Carrier

Even though the Waybill Sample might show that movements are located at a
competitive station, there are frequently movements served by that station that
are in fact located at a shipper’s facility that is captive to a single carrier. Thus,
for example, “Chicago, IL” is a station served by more than one carrier. But,
there are many facilities in the city of Chicago that are captive to a single
carrier. Thus, EC needed rules to determine when movements to or froma


CERTIFICATE OF SERVICE

I, Bruce Blanton, certify that on this 28th day of February, 2013, caused a copy of the
foregoing document to be served by first-class mail, postage prepaid, on all parties of

record in STB Docket Number EP 711.

Bruce Blanton

Director

Transportation Services Division
U.S. Department of Agriculture
Washington, D.C. 20250


The NITL Proposal
Summary of the NITL Competitive Switching Proposal:?

A) Elimination of Current Rules and Current Precedent on Reciprocal Switching
The Board should eliminate the agency’s current competitive access rules in Ex Parte
445 (Sub No, 1), Intramodal Rail Competition (49 C.F.R. Part 1144) insofar as such
rules apply to reciprocal switching. The Board should also vacate the agency’s
existing precedent insofar as such precedent applies to reciprocal switching under the
agency’s existing rules.

B) Establishment of New Rules on Competitive Switching
The Board should adopt new rules for reciprocal switching, under which the Board
“shall require” a Class I rail carrier to enter into a competitive switching agreement if
the following four conditions are met for a shipper (or group of shippers) and/or a
receiver (or group of receivers):

1) The petitioner shows that the shipper’ s/receiver’s facility(ies) for which
competitive switching is/are sought are served by rail only by a single, Class I rail
carrier (the “Landlord Class I Carrier”).

2) The petitioner shows that there is no effective inter- or intramodal competition for
the movements for which competitive switching is sought. There would be no
consideration of product or geographic competition. There would be a conclusive
presumption that there is no such effective competition where either: (a) a
movement for which competitive switching is sought has an R/VC ratio of 240%
or more; or (b) the Landlord Class I carrier has handled 75% or more of the
freight volume transported for a movement for which competitive switching is
sought in the twelve months prior to the petition seeking switching.

3) The petitioner shows that there “is or can be” a “working interchange” between
the Landlord Class I Carrier and another carrier within a “reasonable distance” of
such facility(ies). There would be a conclusive presumption that there is a
“working interchange” within a “reasonable distance” if either one of two
circumstances exist:

a) the shipper’s/receiver’s facility(ies) for which competitive switching is/are
sought are within the boundaries of a “terminal” of the Landlord Class I
Carrier existing on July 7, 2011, the date of the Petition for Rulemaking; or
are within the boundaries of any new “terminal” established by the Landlord
Class I Carrier; or

b) such facility(ies) are within a radius of 30 miles of an interchange between the
Landlord Class I Carrier and another carrier, at which cars are “regularly
switched.”

4) Competitive switching shall not be imposed if either rail carrier between which
competitive switching is to be established shows that the proposed switching is
not feasible or is unsafe; or that the presence of reciprocal switching will unduly
hamper the ability of that carrier to serve its own shippers.

3 Copied verbatim from National Industrial Transportation League, Surface Transportation Board, Ex Parte
711, Petition for Rulemaking to Adopt Revised Competitive Switching Rules, pg. 8.



Traffic Creation

Common sense would indicate that as rail rates fall, the quantity demanded for rail
service should increase. The elasticity of demand for freight rail transportation for corn
and wheat is estimated between -1.2 and -0.5,'5 Economic theory asserts that monopolies
operate where the elasticity of demand is less than -1. Given that railroads may act as a
monopoly over captive shippers, it is reasonable to assume the elasticity of demand for
rail service by captive shippers would be less than -1 whereas it would increase above -1
as shippers gain competitive options.

For purposes of this sensitivity analysis, the elasticity of demand for rail service by
qualifying agricultural shippers is assumed to increase from -1.2 to -0.6 with the
introduction of a second rail carrier through the option of competitive switching. Using
this assumption, the reduction in rail rates would induce a corresponding increase in
demand for rail service. Thus, for each of the three scenarios presented, between 30 and
50 percent of the revenue lost due to competitive switching could be recaptured through
traffic creation.

Lack of Shipper Interest in Competitive Switching

Some shippers eligible to receive competitive switching, for various reasons, may not
apply for competitive switching. These reasons could range from inertia, fear of either
the unknown or retribution by the railroad in rates and/or service, bundling of origins-
destinations in contracts, lack of awareness of the opportunity to obtain competitive
switching, or increased shipping time by using a new carrier. Although a very real factor,
it is unknown how many shippers would fall into this category. Therefore, any estimate
of the impacts based upon Waybill results must take into account the possibility that
some percentage of shippers may choose not to elect competitive switching. This will
likely be related to how easily switching may be obtained under a given set of rules and
the expected benefits. This factor could range between zero and 100 percent and is not
accounted for in this analysis.

Combined Effects

In the sensitivity analysis presented below, USDA has calculated a range of possible
impacts based upon the results under the scenarios and taking into account the mitigating
factors discussed above. Although the above four factors have very real effects, the most
likely combination of their effects is hard to estimate. In each table, the mitigating
factors are first manipulated independently and then in combination. We have only
calculated results for two possible outcomes for each mitigating factor—zero effect or a
100 percent effect. By seeing each extreme, the universe of possible outcomes can be
roughly defined as lying somewhere in between the two. When applied in combination, a
particular subset of this universe can be highlighted to show a range of possible outcomes
of the impact from competitive switching. In this analysis, USDA does not pick a most
likely outcome because we do not have enough information available to us to do so.

‘5 Oum, Tae H., W.G, Waters II, and Jong-Say Yong. (1992). “Concepts of Price Elasticities of Transport
Demand and Recent Empirical Estimates: An Interpretative Survey.” Journal of Transport Economics
and Policy, 26(2), 139-69.

1S



Table 9: Sensitivity Analysis at 240 R/VC, 30 Miles, Duopoly Competition

Adjustments
Adis tts ______trpacted Revenue Revenne Change Percent
; Contact Shorting Traffic AGopION Carigags Before After in Revenue Reduction
Scenarios Creation

‘Waybill results (Table 2A) 0% 0% 0% 100% 99,032 $175452682 124,191,923 $49,260,159 28%
1. Contract movements excluded” 100% 0% 0% 100% 75,264 $131,824,038 $ 94,385,861 $37,438,177 BS
2. Shortline movements exclnded” 0% — 100% © 0% ~—«100% ~——6T,342._SHIT.947.824 § 84450508 $33,497,116 28%
3, Traffic creation through lower prices” 0% 0% 100% 100% 115,907 $173,452,682 $145,354,311 $28,098,371 16%
4, Combination of (1) axl (2) 100% 100% 0% +—«100% «51,180 § 89,610,646 S 64,182,386 $25,457,960 28%
5. Combination of (1) and 3) 100% 0% — 100% + 100% —BB,08D $131,824,038 $110,469,277 $21,354,762 16%
6. Combination of (2) and 3) 0% — 100% 100% + 100% 78,817 $17,947,824 § 98,840,932 $19,106,892 16%
7. Combination of (1) and (2) and (3) 100% 100% 100% 100% 59,901 $ 89,640,346 $ 75,119,108 $14,521,238 16%
8.No shippers adopt 0% __0_$473,452,682_$173.452682 $0 0%

‘) Contract movernents represent about 24 percent of agricultural shipments.
b.) Shortines originate about 32 percent of agsicultural movements but are inchided as Class I movements on Waybil.
€.) Based on elasticity of demand of -0.6.

Table 10: Sensitivity Analysis at RSAM, 30 Miles, Near Perfect Competition

———_Adiustments —_____tnpacted Revenue Revenne Change Percent
, Contract Shortline Trae AGODTION Coronds Before ‘Mer inRevemse-Redeton
Scenarios Creation
‘Waybill results (Table 3) 0% 0% 0% 100% 81,684 $133,885,763 § 76,914,294 $56 941,469 4366
1. Contract movements excluded" 100% 0% 0% 100% 62,080 $101,753,180 S$ 58,477,663 $43,275,516 3%
2. Shortline movemnis excluded” 0% — 100% 0% ~—«100%H»~—«S5,545 $91,082,319 § 52,322,120 $38,720,199 43%
3. Traffic creation through lower prices’ 0% 0% 100% 100% 102,528 $13,885,763 $ 96,578,889 $37,306874 28%
4, Combination of (1) an (2) 100% 100% 0% ©~—« 100% ~—42,214 $69,192,162 $39,764,811 $29,427,351 43%
5. Combination of (1) and (3) 100% 0% — 100% 100% 77,921 $101,753,180 $ 73,399955 $28,353,225 28% i
6. Combination of (2) and (3) 0% 100% 100% + 100% 69,719 § 91,042,319 S 65,673,614 $25,368,675 28%
7.Conbination of (1) al (2) and (3) 100% 100% «100% + «100% «52,987 § 69,192,162 $ 49,911,970 $19,280,193 28%
8.No shippers adopt 0% __0__$133,885,763_$193,885,763___0 0%

‘2. Contract movements represcat about 24 percent of agricultural shipments.
1.) Shortines originate about 32 percent of agricultural movements but ate included as Class T movements on Waybill.
¢.) Based on elasticity of demand of -0.6.

Table 11: Sensitivity Analysis at RSAM, 30 Miles, Duopoly Competition |

iments

Impacted Revers —-—=Reveue—=—Chunge.-—_Pereent |
A Contit Sortine Trae AdCRION Coeass Below ‘Mor inReveme Redon
Scenarios Creation,

‘Waybill results (Table 34) 0% 0% 0% 100% 80,094 $132,685,067 § 91,928,012 $40,757,055 31%
1. Contract movements excluded” 100% 0% +0 ~—«100% 6,871 S100.840651 $ 69,865,289 $30,975,362 31%
2, Shortline movements excluded” 0% — 100% 0% ~——:100%-—SHAGE § 90,225,846 $ 62,511,018 $27,714,197 1%
3, Traffic creation tirough lower prices’ 0% 0% «100% «100% 94,856 $132,685,067 108,870,605 $23,814,162 18%
4. Combination of (1) and (2) 100% 100% 0% 100% 41,393 § 68,571,643 S 47,508,397 $21,063,246. 3%
'5, Combination of (1) and (3) 100% 0% — 100 100% 72,090 $100,840,651 $ 82,741,659 $18,098,991 18%
6. Combination of (2) and (3) 0% — 100% += -100% + 100% = G4,502 § 90,225,846 $ 74,032,011 $16,193,834 18%
7.Combinationof (1) and (2) and (3) 100% 100% 100% 100% 49,021 $ 68,571,643 $ 56,264,328 $12,307,314 185%
8. No shippers adopt 0% 0 __$132,685,067_$132,685067__ $0 o%

‘.) Contract movements represent about 24 percent of agricultural shipments
b.) Shontines originate about 32 percent of agricultural movements but are inctoded as Class I movements on Waybil

¢.) Based on elasticity of demand of -0.6.

Impact on Captive Rail Shippers Who Do Not Qualify

The effects of competitive switching on captive shippers that do not qualify will vary.
For many shippers, railroads are maximizing profits by charging the highest price they
can relative to other transportation modes. Thus, rail rates for many shippers are already
capped by competition from other transportation modes.

Captive rail shippers with no practical alternative to rail will have mixed results. Many
shippers have portions of their traffic classified as captive while the rest is classified as
competitive. These shippers are still likely to have some negotiating power with the

railroad over the captive portion of their traffic. By expanding the amount classified as

17


that industries sheltered from competition are less vigorous and successful than industries
subject to competition. As such, USDA commends NITL for submitting this petition.

In the comments presented in this filing USDA provides empirical analysis that estimates
the impact of various competitive switching scenarios; and provides recommendations.

Board Request for Empirical Analysis
In this proceeding, the Board asked for information on the following with regard to the

NITL proposal:

1, Impact on rates for qualifying captive shippers.

2. Impact on rates for captive shippers who do not qualify.

3, Impact on the railroad industry.

4. Access pricing proposals,

5. Impacts of the above aspects of a modified NITL proposal, such as the Board

using a different revenue-to-variable cost ratio (R/VC) threshold or mileage
criteria.

In order to provide the requested information related to the agricultural sector, USDA
contracted the services of Escalation Consultants, who analyzed the 2010 confidential
Waybill Sample consisting of 580,928 records. The analysis was conducted on 245,662
records, excluding 335,266 records classified as either intermodal movements, waybill
records with miscellaneous problems, and records with origin and destination stations
that were not in the United States. They covered the following types of analysis:

¢ Determining the status and designation of origin and destination stations.

e Analyzing captive industries served by competitive stations.

e Determining the mileages of competitive junctions within 30 miles of captive
stations.

e Analyzing the levels of reduced rates for impacted movements, analyzing the
competitive revenue to variable cost ratios, and the captive revenue to variable
cost ratios of each railroad by the 5-digit Standard Transportation Commodity
Code (STCC) and mileage ranges.

¢ Determining the revenue distribution for multiple railroad moves, using the
Board’s breakdown of revenue.

e Analyzing changes in revenue using access fees equal to the average of Canadian
inter-switching rates as a proxy.

The detailed assumptions and rules used to conduct the analysis on the expected impact
of Ex Parte 711 are outlined in the Appendix (see attached).

? Porter, Michael, The Competitive Advantage of Nations, 1990, pp. 117-20, 225-238, 416, 708.



La Se P-—MC
Eq P

The Lerner Index (Z) is equal to the firm’s market share (sq) divided by the price
elasticity of demand (Ez). Market share is equal to 1 for a monopoly and % for
aduopoly. Alternatively, the Lerner Index is equal to a firm’s price (P) minus
its marginal cost (MC) divided by its price. This demonstrates a firm’s market
power by showing its ability to set its price above marginal cost. With perfect
competition, price is equal to marginal cost and L=0, demonstrating no price
markup. As market power increases, L increases towards |.

By assuming the Competitive Benchmark R/VC is close to a railroad’s marginal
cost, MC is set equal to the Competitive Benchmark R/VC. Because railroads
price to the market, prices under 180 R/VC (used in calculating the Competitive
Benchmark) would be those where railroads face a high level of competition,
whether intramodal, intermodal, product, or geographic. Similarly, by assuming
the Captive R/VC is a monopoly price, P is set equal to the Captive R/VC.
Because railroads are allowed to exercise price discrimination in order to
capture their fixed costs, prices for captive shippers should approach the
monopoly rate. While these assumptions are not perfect, they do serve the
purpose of identifying a scenario that would lie between nearly perfect
competition and no competition, which is what may occur under competitive
switching.

In places where railroads serve captive shippers, market share (sg) would be
equal to 1. By substituting the Competitive Benchmark R/VC, Captive R/VC,
and market share into the rearranged Lerner Index, the estimated elasticity of
demand (Eq) for each movement can be calculated as:
Eg Sq*P 1* Captive R/VC
4" P—MC Captive R/VC — Competitive R/VC

Once the elasticity of demand is known, the duopoly R/VC resulting from
competitive switching can be found, Resolving the Lerner Index formula for B
and adjusting the market share for a duopoly scenario (sy= 2) gives the
following formula:

rn MC Competitive R/VC

p= =
1- 12
Eq

= Duopoly R/VC

Fe

If a movement qualifies under EP 711, then it will be assumed that a savings
will occur to the shipper, with the savings equal to the difference between the
Captive and the Duopoly R/VC for that commodity at that mileage range.



Authority and Interest

The Secretary of Agriculture is charged with the responsibility under the Agricultural
Adjustment Act of 1938 and the Agricultural Marketing Act of 1946 to represent the
interests of agricultural producers and shippers in improving transportation services and
facilities by, among other things, initiating and participating in Surface Transportation
Board (Board) proceedings involving rates, charges, tariffs, practices, and services.

Introduction

The U.S, Department of Agriculture (USDA) appreciates the opportunity to respond to
the Board’s request for empirical input on the National Industrial Transportation
League’s (NITL) petition for a rulemaking to adopt revised competitive switching rules.
The NITL proposal has the potential to promote more rail-to-rail competition and reduce
the Board’s role in regulating the reasonableness of transportation rates. USDA believes
there is substantial evidence and testimony in favor of promoting competitive switching
by the Board and agrees with NITL that the Board must abandon its current competitive
access rules in Ex Parte 445 (Sub-No. 1) and related precedent in order to do so. Existing
rules and precedent governing reciprocal switching have made it all but inaccessible
despite that it was expressly written into the Staggers Rail Act! in order to provide for the
“public interest” or where “necessary to provide competitive rail service.”

Shippers have filed only four requests for reciprocal switching in the 28 years since Ex
Parte 445. Testimony in Ex Parte 705 indicates the lack of requests is not because
shippers are satisfied by competitive rates provided through a well-functioning market
based system. Rather, it appears that the nearly impossible barrier of proving competitive
abuse through an antitrust type inquiry has not only prevented the only four attempts by
shippers to obtain reciprocal switching, but stymied any further attempt since 1996.

USDA believes adequate railroad competition has suffered since the last rounds of mega-
mergers. Within the agricultural sector, grain producers and shippers in regions with
more transportation competition have benefited the most from rail deregulation even as
producers with few transportation options, such as wheat farmers who pay among the
highest rates, have benefitted to a lesser extent. Agricultural producers and shippers
continue to express concern about decreased rail-to-rail competition, which has
diminished the benefits of deregulation. Although these mergers cannot be undone, the
Staggers Rail Act provides for ways, such as competitive switching, to promote
competition and help ensure deregulation works as intended.

Many shipper groups have supported increased rail-to-rail competition as a means to
preserve the benefits of railroad economic deregulation in comments prepared for various
Board proceedings. Competition requires businesses to become efficient and effective in
providing the kinds and quality of goods and services the consumer desires. Competitive
markets reduce market distortions and result in the efficient allocation of resources,
providing a basis for economic development. Furthermore, Dr. Michael Porter observes

' 49 U.S.C. §11103(c).



of increased competition. In the context of rapidly increasing rates and record rail
income, introducing some limited levels of rail competition through competitive
switching is reasonable, necessary and desirable. This should not be denied on the basis
of upper bound, theoretically derived estimates that by assumption are not realistic, but
nevertheless designed to show the most extreme scenario.

USDA believes that all of the impacts shown (for both the near perfect competition
benchmark and the duopoly benchmark) are overstated in that they do not consider any of
the mitigating factors discussed below. Still, none of the unadjusted impacts are greater
than 2.2 percent of Class I railroad grain revenue. USDA sees no reason why a threshold
level of 180 percent R/VC cannot be used instead of 240 percent R/VC or the RSAM
benchmark based on this analysis, especially for agricultural movements. This would
allow more agricultural shipments to be included in the associated benefits that could
accrue, which is a desirable outcome for the requested change in Board policy.

Impacts for Grain Movements by State

Table 5 shows the impacts of competitive switching on railroad revenue by State.
Kansas, Texas, Nebraska, Oklahoma, and Iowa benefit the most from competitive
switching. In addition, the four-State grouping of Minnesota, Montana, North Dakota,
and South Dakota has a large benefit.

Table 5: Impacts for Grain by State—30 Miles, 180 R/VC

Total Impacted Percent Impacted Revenue Before Revenue After Change in Percent Reduction

State Stations Stations Impacted __Carloads Reduction Reduction Revenue in Revenue.
KS 91 27___-29.7% 19,386 $55,323,835 $40,403,832 $14,920,004 27.0%
TX 88 26 29.5% 29,377 $48,363,396 $34,189,703 $14,173,693 29.3%
MN, MT, ND, SD__369 39 (10.6% 32,732 $115,925,392__$103,212,934 $12,712,459 11.0%
NE 98 33 33.7% 13,064 $40,643,293 $35,343,399 $5,299,894 13.0%
OK 26 623.1% 8,502 $14,288,663 $10,309,270 $3,979,393 27.9%
1A 97 1B 13.4% 8,381 $15,362,137 _ $11,823,927 $3,538,210 23.0%
LL 124 14 13% 6404 $10,943,573 $9,743,737 $1,199,836 11.0%
IN a 18 23.4% 4,956 $5,666,285 $4,572,383 $1,093,902 19.3%
OH 82 7 8.5% 3,144 $3,309,487 $2,526,054 $783,433 23.7%
Other States! 546 44 8.1% 12,159 $24,214,139 $19,423,125, $4,791,014 19.8%
Total 1,598 227 14.2% 143,105 _$334,040,200 _$271,548,363__ $62,491,837 18.7%

" Grouped to protect confidentiality of railroads and shippers.
2 Grouped to protect confidentiality, Includes AL, AR, AZ, CA, CO, GA, KY, LA, MI, MO, NC, NJ, NM, NV, OR, PA, UT, WA, WI

Sensitivity Analysis
No matter how accurately mathematical formulas can be applied to the Waybill, there

remains a cloud of doubt as to the actual outcomes. Due to unknowns, one cannot
analyze the Waybill and expect to predict the actual outcome of competitive switching.
At best, it can help narrow the boundaries of the possible universe of outcomes that may
arise from competitive switching. The results produced from the Waybill under both the
assumptions of near perfect competition and duopolistic competition likely overestimate
the true revenue impact of competitive switching due to mitigating factors not accounted
for in the Waypbill data. This includes the following factors: (1) short line involvement in
the move, (2) the effects of contracts, (3) the possibility of traffic creation offsetting
revenue reductions, and (4) the possibility that some eligible shippers may not try to
obtain competitive switching.

13



Table 6: Sensitivity Analysis at 180 R/VC, 30 Miles, Near Perfect Competition

Adjustmenis -
= —~TInpacted Revenue Revenue Change Percent
. Contract Shortline Traffic Adoption Corioads Before After inRevense Reduction
Scenarios Creation
Waybill results (Table 1) 0% 0% 0% 100% 162,496 $378,355,408 $272,398,232 $105,957,176 28%
1, Contract movernenis excluded" 100% 0% 0% 100% — 123,497 $287,550,1]0 $207,022,656 $ 80,527,454 28%
2. Shoriline movements excluded” 0% 100% 0% 100% 110,497 $257,281,677 $185,230,798 $ 72,050,880 28%
3. Traftic creation through lower prices” 0% 0% 100% 100% 189,800 $378,355,408 $318,168,764 S 60,186,644 16%
4, Combination of (1) and (2) 100% 100% 0% 100% 83,978 $195,594,075 $140,775,406 $ 54,758,669 28%
5. Conbi n of (1) and (3) 100% 0% 100% 100% 144,248 $287,550,110 S241,808,261 $ 45,741,849 16%
6. Combination of (2) and (3) 0% 100% 100% 100% 129,064 $257,281,677  $216,354,760 S$ 40,926,918 16%
7. Combination of (1) and (2) and (3) 100% 100% 100% 100% 98,089 $195,534,075 $164,429,617  $ 31,104,457 16%
8.No shippers adopt, 0% 0 $378,355,408__$378,355,408_ $0. 0%
'2.) Contract movements represent about 24 percent of agricultural shipments.
'b.) Shontlines originate about 32 percent of agricuhural movements but are included as Class ] movements on Waybill.,
¢.) Based on chsticity of demand of -0.6.
Table 7: Sensitivity Analysis at 180 R/VC, 30 Miles, Duopoly Competition
——____Adjustments_ yy, ve ve
— — — Impacted Revenue Revenue Change Percent
Contract Shortline Traffic AdopLION Corioads Before Aer inRevenue Reduction
Scenarios Creation,
Waybill results (Table 1A) 0% 0% 0% 100% 143,105 $334,040,200  $271,548,363 $62,491,837 19%
1. Contract movements excluded” 100% 0% 0% 100% — 108,760 $253,870,552  $206,376,756 $47,493,796 19%
2. Shoriline movements exelnded” 0% 100% 0% 100% 97,311 $227,147,396 $184,652,887 $42,494,449 19%
3. Traffic creation through lower prices® 0% 0% 100% 100% 159,168 $334,040,200 $302,028,927 $32,011,273 10%
4. Combination of (1) and (2) 100% 100% 0% 100% 73,957 $172,631,975 $140,336,194 $32,295,781 19%
5. Combination of (1) and (3) 100% 0% 100% 100% 120,968 $253,870,552  $229,541,984 $24,328,568 10%
6. Combination of (2) and (3) 0% 100% 100% 100% 108,234 $227,147,336 $205,379,670 $21,767,666 10%
7. Combination of (1) and (2) aud (3) 100% 100% 100% 100% 82,258 $172,631,975 $156,088,549 $16,543,426 10%
8.No shippers adopt 0% 0 $334,040,200___$334,040,200 $0. 0%
ents represent about 24 percent of agricultural shipments.
inate about 32 percent of agricukural movements bat are inchided as Class I movements oa Waybill.
icity of demand of -0.6.
Table 8: Sensitivity Analysis at 240 R/VC, 30 Miles, Near Perfect Competition
— ——~ Impacted Revenue. Revenue ‘Change Percent
, Contract Shortline Tralfic Adoption Corioads Before After inReverue Reduction
Scenarios Creation
Waybill results (Table 2) 0% 0% 0% 100% — 102,022 $176,171,968 $105,287,574 $70,884,394 40%
1. Contract movements excluded” 100% 0% 0% 100% 77,537 $133,890,696  S 80,018,556 $53,872,139 40%
2. Shortline movements excluded” 0% 100% 0% 100% 69,375 $119,796,938 $ 71,595,550 $48,201,388 40%
4. Traflic creation through lower prices” 0% 0% += -100% += 100% 126,652 $176,171,968 $130,705,622 $45,166,346 26%
4, Combination of (£) and (2) 100% = 100% 0% 100% 52,725 S$ 91,045,673 $ 54,412,618 $36,633,055 40%
5S. Combination of (1) and (3) 100% 0% 100% 100% 96,255 $133,890,696 § 99,336,273 $34,554,423 26%
6. Combination of (2) and (3) 0% 100% 100% += 100% 86,123 $119,796,938 $ 88,879,823 $30,917,115 26% i
7, Combination of (1) and (2) and (3) 100% 100% 100% 100% 65,454 $ 91,045,673 $ 67,548,665 $23,497,008 26%
8. No shippers adopt 0% $176,171,968_$176,171,968 $0. 0%
3.) Contract movenients represent about 24 percent of agrisoloral shipments,
2) Shomlineseviginae about 32 percent of agricultural movements but are includ as Cass I movements on Waybll
¢.) Based 02 elasticity of demand of -0.6,

16