productivity, increased only 28 percent (table 1). Very few industries in this country, in a down
economy, could similarly raise their prices well above costs, boost their profits, and continue to
maintain their customers. We raise this point to suggest that railroads can and sometimes do use
market power in their pricing and, therefore, there is a legitimate need to find a way for grain
shippers without competitive transportation options to challenge rail rates they believe are
unreasonable with a process that is simple, cost effective, and fair.

00 for unadjusted RCAI

Year RCAF (adjusted)
2003 0,334
2004 0.341
2005 0.360
2006 0.369
2007 0.365
2008 0.426
2009 0.358
2010 0,396
2011 0.430
2012 0,429

Source: Association of American Railroads, Railroad Cost Indexes

A Need for an Accessible Rail Rate Challenge for Grain Shippers

Effective regulatory mechanisms are critical to rounding out the Rail Transportation Policy’s
complementary directive of allowing competition to establish reasonable rates. USDA had
previously found that States lacking rail-to-rail competition do not necessarily pay higher rates
than States with more transportation competition.$ Some of the possible reasons behind this
included individual railroads being sensitive to shippers’ needs and greater engagement at the
State government level. However, another reason discussed by rail carriers during the course of
this proceeding is the presence of rate reasonableness remedies through the Board. Said another
way, where competition does not exist, some rail carriers are likely to temper rates in the face of
possible litigation. As such, rail carriers often choose to preserve customer relations and avoid
litigation.

Thus, the mere possibility of litigation serves as a check on the rail industry, disciplining markets
that might not otherwise produce a competitive rate, The possibility of litigation is only effective
if it is credible. This underscores the importance of designing an effective rail rate challenge
procedure through this proceeding that is accessible to grain shippers and producers, thereby
ensuring its credibility as a check against rail rates for this class of shippers.

® USDA, Agricultural Marketing Service, Study of Rural Transportation Issues at 231 (April 2010).



CERTIFICATE OF SERVICE

I, Bruce Blanton, certify that on this 25th day of August, 2014, 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 665 (Sub-No. 1).

bieW2—h—

Bruce Blanton

Director

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



USDA Recommendations

USDA asserted in its opening comments the most accessible rail rate challenge procedure for
grain shippers would be characterized by: (1) significantly lower costs than the Board’s three
current procedures, (2) a predictable set of outcomes through a simple to use and easy to
understand process, and (3) a preferably formula-based process using data that is easy to obtain
and deterministic in nature.

Mediation and Arbitration

Based on these criteria, USDA recommended in its opening comments and would again like to
lend support for private-sector mediation and arbitration for grain, such as the system operated
by the National Grain and Feed Association (NGFA), which is fair, easily understood,
accessible, and affordable. However, USDA postulates the use, expansion, and success of these
procedures is contingent upon the Board encouraging railroads to participate in rate disputes
through these types of systems and assisting in facilitating their expansion or creation.

Additional Procedures for Consideration

USDA also believes the Ag Commodity Maximum Rate Methodology (ACMRM) proposed by
the NGFA and the Two-Benchmark test proposed by the Alliance for Rail Competition in the
opening round of this proceeding adhere to the criteria of simplicity, practicality, and
predictability, and could also be promising new approaches. Their inclusion and treatment of
railroad revenue adequacy make them especially strong candidates for challenging rail rates
moving forward as the regulatory environment increasingly incorporates this concept.

While one of the many benefits offered by mediation and arbitration is the opportunity to address
rate related issues through a more informal process, USDA considers the ACMRM and the Two-
Benchmark test could be viable alternatives for grain shippers unwilling to challenge rail rates
through the Board’s three established procedures but who still require a formal rate challenge
process. Both approaches represent a significant improvement from the status quo. Their
straightforward, formulaic designs are appropriate for the unique characteristics of the
agricultural sector. They rely upon readily available data, which bypasses much of the
unpredictability and costs that surround grain rail shippers’ hesitation from using the Board’s
current procedures. Furthermore, they offer reasonable approaches that build upon the sound
framework underpinning the Board’s three-benchmark procedure.

In fact, because of the agricultural sector’s unique needs, USDA believes it could be quite useful
to have two processes available, such as mediation and arbitration to address problems more
informally, and another formal process such as ACMRM or a two-benchmark procedure.
Having both informal and formal processes that are specifically designed for the needs of
agriculture would provide the mechanisms to tackle the wide range of problems that can arise.

Conclusion

As the Board has discovered, there is not a single rail rate challenge process that works best for
all shippers under all circumstances. Similarly, it would seem that having a choice of rate



USDA realizes that some railroads are more active in responding to and working to address their
customers’ needs and commends these efforts. However, other railroads are less proactive in this
regard. And, just because some rail carriers are currently active in working with their customers
to identify markets and provide competitive rates, does not ensure this will always be the case.
Effective regulatory policy ensures markets will continue to function properly through socially
optimal incentives regardless of how future circumstances and opportunities change.

Railroad Reyenue Adequacy

USDA established in its opening comments the pertinence of linking the rail rate challenge
process with railroad revenue adequacy. When the railroads were in poor financial health, it was
arguably appropriate that shippers seeking regulatory redress for high rates faced a heavy burden.
However, as a result of decades of efficiency improvements and recent but consistent rate
increases, the railroads are now earning approximately their cost of capital.’ There can be no
doubt that the rail industry is in far better financial health today than it was in the immediate
post-deregulation period.

It is in everyone’s interest for the railroads to earn sufficient returns on their investments to be
able to maintain, improve, expand, and safely operate their extensive and expensive
infrastructure and rolling stock. As rail revenues become persistently adequate, the tradeoff
between the short-run interests of shippers (in lower rates) and the long-run interests of shippers
(in rail revenues that are high enough to ensure adequate investment) begins to shift in favor of
lower rates. In particular, though the high rates paid by captive shippers may be considered
“reasonable” so long as a railroad is earning less overall than the cost of maintaining and
improving the railroad network, as discussed below, even current policy recognizes that the same
rates may be judged “unreasonable” when the railroad is earning more overall than this cost.

There is general agreement that, in order for the railroads to efficiently recover high fixed costs,
it is necessary and appropriate that shippers without competitive options pay a higher share of
these fixed costs than other shippers.® However, it is neither appropriate nor the law that the
degree to which these captive shippers are discriminated against be unlimited.” Under
Constrained Market Pricing precedent, a captive shipper is not to be “required to continue to pay
differentially higher rates than other shippers when some, or all, of that differential is no longer
necessary to ensure a financially sound carrier capable of meeting its current and future service
needs.”!° ‘This principle is called the “revenue adequacy constraint” on differential pricing to
captive shippers.

7 Laurits R. Christensen Associates, Inc., A Study of Competition in the U.S. Freight Railroad Industry and Analysis
of Proposals that Might Enhance Competition, November 2008 (“Christensen Report”). Also, USDA Opening

Comments at pg. 3.
8 This approach is known as Ramsey pricing or 3rd degree price discrimination. Coal Rate Guidelines, Nationwide,

I LC.C, 2d 520 (1985).
° Coal Rate Guidelines, Nationwide, 1 I.C.C. 2d 520 (1985).
10 Major Issues in Rail Rate Cases, STB Ex Parte No. 657 (Sub-No, 1), October 30, 2006, at 7.



Respectfully submitted,

Edward Avalos

Under Secretary

Marketing and Regulatory Programs
U.S. Department of Agriculture

Washington, D.C, 20250



Before the U.S. Surface Transportation Board

STB Ex Parte No. 665 (Sub-No. 1)

Rail Transportation of Grain, Rate Regulation Review

Reply Comments of the

US. Department of Agriculture

Edward Avalos

Under Secretary

Marketing and Regulatory Programs
U.S. Department of Agriculture

Washington, D.C. 20250

Date: August 25, 2014



challenge options may be optimal for grain shippers. Mediation and arbitration would most
likely be the preferred solution from the perspectives of shippers, producers, and rail carriers as
this would preserve business relationships and avoid the costs of litigation. Conceptually,
however, having a more formal process at shippers’ disposal would serve in instances where
mediation and arbitration ave impractical, may encourage railroads to pursue mediation and
arbitration who might not otherwise, and may act to discipline uncompetitive markets, helping
avoid the need for any rate challenge in the first place.

For these reasons, USDA encourages the Board to consider: (1) USDA’s recommendations on
mediation and arbitration, (2) the ACMRM proposed by NGFA, and (3) the Two-Benchmark test
proposed by ARC, et al. as workable concepts to ensure rail rate challenge procedures are
accessible and effective for grain shippers and producers. These proposed concepts address cost,
timeliness, and predictability, which USDA identified as the major impediments to the Board’s
established procedures. Furthermore, the rail revenue adequacy component of the ACMRM and
Two-Benchmark test address an important and emerging issue, making them relevant potential
solutions for future rate challenges. :



lower incomes as producers absorbed much of the increased transportation cost. In turn, lower
producer incomes adversely affect the ability of individual producers to borrow funds and reduce
economic prosperity in rural areas.

An analogous example is the record high premiums being paid in the primary railcar market to
secure guaranteed service due to substandard service, which have reached unprecedented levels
in excess of $3,000 per car. In this case, substandard service has translated into additional rail
reyenue, Where competitive alternatives are prevalent, rail carriers would be unable to
command these premiums. This is not to say that rail carriers necessarily charge uncompetitive
rates over these segments when their service is functioning optimally. Rather, this illustrates the
ability to do so. It is this ability that warrants careful consideration of prescriptions by the Board
because markets are not driven by the benevolence of its participants but ultimately by their
profit maximizing motivations. It is for this reason why the Rail Transportation Policy requires
the Board to maintain reasonable rates where there is an absence of effective competition and
why developing a workable rate complaint process for grain shippers is so important.

Rail Profitability

In comments provided to the Board in this proceeding, various rail interests have asserted that
shippers have no incentive to challenge rail rates where the rates are reasonable, and implied this
is the major reason behind the lack of rate challenges from grain shippers. Yet, this is certainly
not true for all grain shippers. The record in this proceeding and many other past proceedings is
replete with testimony that contradicts this argument. Even in an environment where rates are
generally reasonable, there are likely to be at least some grain shippers who could be
disadvantaged and deserve a fair process to seek relief. USDA believes they deserve a process
that is not only fair, but one that is inexpensive and doesn’t require a battery of lawyers and
economists to prove the case. If what the rail interests claim is true, then designing a more
accessible rail rate challenge procedure for grain shippers would not lead to any new rail rate
challenges. However, if the rail interests are wrong and a more accessible rate challenge
procedure is not implemented as a result of this proceeding, then at least some grain shippers
would continue to be left without access to a useable rail rate challenge process—a hard pill to
swallow in light of continued record-breaking railroad profitability.

The fact that inflation-adjusted
rail rates have increased faster

Figure 1: Inflation-adjusted rail revenue for grain

than the rail cost adjustment 3.50 (20098) 3,32
factor is at least an anecdotal 3.30 1319 ia
indication of the market power of $3.10 1 S
Class I railroads. Since 2003, & 2.90 Heo A
inflation-adjusted rail rates for 2 2.70 ail aS
grain have increased 43 percent, | 2.50 2°32 "
from 2.32 cents per ton-mile to § 2.30 |
3.32 cents per ton-mile (figure 3 2.10
1). In contrast, the rail cost 2 1.90
adjustment factor, adjusted for 8 ma
thnerwyacntanrtuverweacria
SRARRARSRRRARARRARR
Source: USDA analysis of Surface Transportation Board Confidential Waybill



monopolies, and the Rail Transportation Policy? requires the Board to maintain reasonable rates
where there is an absence of effective competition. Producers with few transportation options,
such as wheat farmers in remote areas, have the highest rates and bear the brunt of any rail
service disruptions.

Previous studies have concluded that many agricultural shippers have a range of transportation
alternatives, that grain transportation markets are largely competitive, and that different modes of
transportation often compete head-to-head to move grain. Yet, no findings claim ail agricultural
shippers have competitive transportation options or that grain transportation markets are always
competitive. As such, this characteristic of grain transportation markets underlies the impetus
behind this proceeding. This proceeding is being held to address the concerns of those grain
shippers without competitive transportation options who wish to have some means for
challenging rail rates they believe are unreasonable.

One need look no further than the current, ongoing rail service problems for clear examples of
where grain shippers lack competitive transportation options. Many grain shippers were left with
severely reduced transportation options, leading to skyrocketing premiums paid in the primary
and secondary railcar markets which widened the grain basis and depressed the net prices that
farmers received, A North Dakota State University study estimated a $67 million loss in North
Dakota farm level revenue for crops that were sold from January through April. In addition, the
study estimated another potential $95 million loss in farm revenue if crop basis levels did not
improve.’ Another study estimated that delays in railroad shipping have cost Minnesota corn,
soybean, and wheat farmers nearly $100 million and has cut deeply into the value of grain still in
storage.” Were competitive options available, either through other rail carriers or other modes
such as track or barge, these shippers and producers would most likely have availed themselves
of these alternatives to avoid sustaining such significant losses.

The losses occurred because of unexpected increases in transportation costs, such as
skyrocketing costs of grain cars on the secondary railcar market that peaked at $6,000 per grain
car, and other transportation related costs associated with the rail service crisis. Early on, some
of these additional costs were likely borne by the exporter through reduced margins, but as the
situation progressed, were more likely reflected in the prices paid to producers for their crops.

Because there are many agricultural producers with operations that are relatively small in size,
and their products are homogeneous, individual agricultural producers of grain and oilseed crops
are considered “price-takers.” That is, they have little or no ability to influence the price
received for their products, and therefore, are unable to pass cost increases forward to buyers.
Instead, these producers tend to absorb cost increases, especially in the short-run. Consequently,
these increases in transportation costs resulted in decreased producer prices and, ultimately,

3 ICC Termination Act of 1995, §10101.

* Olson, Frayne, Effects of 2013/14 Rail Transportation Problems on North Dakota Farm Income, Executive
Summary to Senator Heidi Heitkamp, North Dakota State University, May 2014.

5 Usset, Edward, University of Minnesota, presentation at Envisioning the Future of Agricultural Freight in
Minnesota, Alexandria, Minnesota, July 10, 2014.



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 U.S. Surface Transportation Board (Board)
proceedings involving rates, charges, tariffs, practices, and services.

Introduction

The U.S. Department of Agriculture (USDA) appreciates the opportunity to offer reply
comments in this important proceeding impacting grain shippers and producers. USDA finds the
record for this proceeding highlights the need and desire for a more accessible rail rate challenge
process for grain shippers and producers. USDA believes the proceeding record has presented
the Board with several workable concepts and hopes the Board is able to find a meaningful
resolution on behalf of agricultural shippers and producers.

It seems clear from both the record and the perspective of agricultural interests that the Board’s
current rail rate challenge procedures do not provide effective protection against unreasonable
rail transportation rates for grain because the nature and needs of this important sector do not
lend themselves to the existing processes. Instead, new rate relief methodologies have been
suggested in the record that are tailored specifically for agricultural commodities—mediation
and arbitration, the Ag Commodity Maximum Rate Methodology, and a Two-Benchmark test.
USDA believes these concepts show promise towards achieving the Board’s stated goal of
ensuring accessible and effective rate challenge procedures for grain shippers and producers and
therefore should be examined and seriously considered by the Board.

_ The Extent of Competition

Railroads are natural monopolies.' ‘Though they generally operate in competitive grain
transportation markets, they are not wholly competitive participants, nor in competition for every
movement. As such, there is a history of rail regulation in this country. USDA acknowledges
that the partial deregulation of the rail industry under the Staggers Act brought many innovations
and efficiency gains to carriers and shippers alike. Many of these innovations have benefitted
agricultural shippers, such as auctions for allocating grain cars, shuttle trains, and larger railcars.

Within the agricultural sector, grain producers and shippers in regions with more transportation
competition have benefited the most from rail deregulation? Yet, railroads are still natural

' Characteristics of a natural monopoly are such that its costs are lower if it consists as the single supplier to a
market, rather than two or more competing firms. ‘The importance of the service and consequent elasticity of
demand create the need for regulation to protect the consumer. This concept is described more fully in:

Kahn, Alfred E, The Economics of Regulation: Principles and Institutions, MIT Press, 1988.

? Bitzan, John, Kimberly Vachal, Tamara VanWechel, and Dan Vinge, The Differential Effects of Rail Rate
Deregulation: U.S. Corn, Wheat, and Soybean Markets, Upper Great Plains Transportation Institute, June 2003.

2