Competitive Switching may Improve Market Efficiency. The additional costs associated with
switching will be accounted for in the competing railroad’s price. If the competing railroad can
still charge a lower price than the incumbent railroad, then economic theory would indicate a
shipper should utilize the services of the competing railroad. By not allowing the more efficient
railroad to perform the movement, market inefficiency is being perpetuated, resulting in a
misallocation of scarce capital by railroads and a deadweight loss to shippers. Therefore,
competitive switching offers a method to improve market efficiency.

Competitive Switching may Provide Shippers Additional Markets, Competitive switching offers
shippers the option to access additional markets not served by an incumbent railroad. If
economically feasible, these new markets could translate into additional revenue for shippers, but
may create less efficient routes from the railroad’s point of view. In such a case, the inefficiency
to the railroad is realized as a service component, convenience, or competitive option to the
shipper. On the other hand, shippers’ needs should not unilaterally bind the financial and
logistical independence of the railroads. Thus, a market based solution would seem to strike a
balance whereby additional inefficiencies can be captured through prices. This would present
shippers with an expanded array of choices, priced accordingly by the railroads, ensuring the
most efficient market outcome is achieved by weighing all the costs and benefits of a particular
movement.

Prices Set by Market Forces Result in Economic Efficiency. If an incumbent railroad is pricing
to the market, the magnitude of any rate reduction would be by the amount the incumbent’s price
exceeds the competing railroad’s ability to price the movement. Accordingly, it is not the policy

itself imposing an artificial rate reduction. Subject to competitive market forces, three possible
scenarios emerge:

1. The competing railroad has higher costs than the incumbent railroad and is unable to
price movements below the incumbent’s price. Under this scenario, no switching would
occur as the shipper has no incentive to utilize the higher cost railroad. As such, railroad
operations and revenue would remain unchanged.

2. The competing railroad has lower costs than the incumbent railroad and is able to price
movements below the incumbent’s price. Under this scenario, the shipper has a clear
incentive to utilize competitive switching. The incumbent railroad would lose revenue
but the competing railroad would gain revenue. This ensures market efficiency.

3. The competing railroad and the incumbent railroad have similar costs. Both railroads
would compete on price for the shipper’s traffic. If the services are similar, the shipper
would utilize the railroad offering the lowest price. How much the price is lowered in
this situation depends upon how similar each railroad’s costs are. Price could fall by a
little or a lot, resulting in a small or large revenue loss to the incumbent railroad or a
consequent large or zero revenue gain to the competing railroad.

It is important to keep these possible scenarios in context. Only in the second and third scenarios
does a price decrease occur; but in the third scenario the price decrease could affect the railroads’
combined ability to contribute to their overhead costs. There is no guarantee that competitive
switching will necessarily lower prices for all eligible shippers and the consequent revenue to

5





opportunity for competition should not foreclose other means of rate relief available to shippers
or else competitive switching may have the unintended consequence of leaving shippers in a
worse position.

Respectfully submitted,

Se Affe
Sdward Avalos
Under Secretary
Marketing and Regulatory Programs

US. Department of Agriculture
Washington, D.C. 20250



--—--competitive market

railroads. On the flipside, as prices move towards the competitive market price, any unfavorable
decrease in a railroad’s ability to contribute to its overhead costs will be matched by a beneficial
decrease in the deadweight loss to society that results from prices above the competitive price.
Economic theory explains that total economic revenue increases as prices approach the
competitive price. This ensures the most efficient market outcome as the full amount of shipper
demand for rail service is met that otherwise could not in a less competitive market.

The empirical analysis provided by USDA in its opening comments takes into account these
three scenarios. As best as possible, only situations from the second and third scenarios are
reflected in USDA’s impacted carloads and revenue. Stations eligible for competitive switching
that fell under the first scenario were excluded.

Additional Benefits of Competitive Switching

Differential pricing is meant to help railroads achieve revenue adequacy, but once reached, it is
no longer required under Staggers. With the railroads either being or closely approaching
revenue adequacy, the proposal before the Board would appear to present a timely solution for
lessening the burden of differential pricing on captive shippers.

In many ways, competitive switching offers some of the benefits of the Stand-Alone Cost (SAC)
rate appeals procedure without the accompanying costs. Recognizing the barriers to entry into
the rail industry, the Interstate Commerce Commission (ICC) and the Board have both relied
upon the SAC test to simulate the competitive rates that would exist in a contestable market. The
ICC stated that the “use of SAC introduces the competitive standard of contestability into a non-

Similarly, competitive switching introduces competition into a non-competitive market via an
actual railroad instead of a hypothetical one. Actual railroad competition could help judge the
reasonableness of rates instead of a costly, lengthy, and time consuming SAC test. Furthermore,
the financial and legal burdens of a SAC test are discriminatory in that the ability to judge rate
reasonableness is only available to shippers with sufficiently large means. To the contrary,
competitive switching would enable all eligible shippers to have actual railroad competition
judge the reasonableness of rates, regardless of a shipper’s means.

Nevertheless, as shipper testimony in Ex Parte 705 indicated, the opportunity for competition is
not always a sufficient condition guaranteeing competition. Thus, the implementation of
competitive switching should not foreclose any existing options for rate relief available to
shippers.

Conclusion

USDA reaffirms the empirical analysis submitted in its opening comments and believes the
empirical evidence demonstrates the proposal for competitive switching before the Board will
have only a minor effect on railroad revenues, traffic volumes, and efficiency. Competitive
switching offers a market based solution to balance the needs of railroads and shippers and is in
keeping with the goals of the Staggers Act. However, USDA believes establishing the

? ICC Ex Parte No. 347 (Sub-No.1) Coal Rate Guidelines-Nationwide
6



CERTIFICATE OF SERVICE

I, Brian McGregor, certify that on this 30th day of May, 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.

UN eg —

Brian McGregor

Acting Director

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



Before the U.S. Surface Transportation Board

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

Competitive Switching Rules

Date: May 30, 2013

Reply 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





Introduction of Competitive Market Forces into Non-competitive Markets. Opponents to
competitive switching have expressed concerns that the proposed policy will interfere with the
functioning of market forces. However, market forces do not operate ina vacuum. A well-
functioning market operates under a well-conceived set of rules, ensuring transparency for
market participants, predictability from market interactions, and penalties when rules are broken.
Rather than overriding market forces, a new competitive switching policy would introduce
competitive market forces into non-competitive markets.

Currently, there are two broad classes of shippers—those with competitive options and those
captive to a single railroad. ‘The proposal before the Board offers a market-based solution to
expand the benefits of competition to some shippers while avoiding a major restructuring of the
railroad industry. Thus, by expanding the class of shippers with competitive options, more
shippers would be able to compete more vigorously in the world market. Meanwhile, the class
of shippers left without competitive options would be reduced slightly.

The public interest is best served when the market determines that switching should occur. Yet,
a market is composed of sellers and buyers. Railroads enter into voluntary switching
arrangements where it makes economic sense to do so. Similarly, this proposal enables
additional shippers to enter into voluntary switching arrangements where it makes economic
sense to do so. If another carrier can provide more efficient service at a lower cost, a shipper has
a clear incentive to take advantage of the alternative service through voluntary switching. In this
fact, lies the crux of competitive switching—switching will only occur in instances where
another Class I carrier is able to provide more efficient service at a lower cost than the incumbent

railroad.

Inefficiencies from Interswitching will be Limited in Scope and Compensated by Shippers.
Opponents to the proposal claim that competitive switching will unconditionally lower revenues
while simultaneously increasing railroad costs for each eligible shipment. However, prices and
revenues will only decrease in instances where railroads actually choose to compete. The act of
granting shipper eligibility for competitive switching will not on its own affect railroad prices or
costs; only through competition will any change occur to railroad prices or costs.

In instances where railroads choose to compete, USDA believes the resulting prices offered by
each railroad will not be arbitrarily reached but will instead reflect market forces. As such,
railroads will still have the ability to price to the market.

Based on testimony in Ex Parte 705 and 711, railroads indicated that interchanges bring
inefficiencies into the system, which result in higher costs. However, no additional costs would
be incurred if the movement remains with the incumbent railroad, supporting the conclusion that
only a small subset of eligible shipments will actually be interchanged under competitive
switching.

In instances where interswitching does occur, the switching fee paid by shippers should cover the
costs associated with any inefficiencies resulting from interswitching. Thus, the additional costs
related to interswitching should be passed on to shippers and not borne by the railroads
themselves.



be lowered to an R/VC ratio of 180 percent from an R/VC ratio of 240 percent. Such a change
would provide an additional $35 million in savings to agricultural shippers, assuming near
perfect competition, or an additional $13.2 million in savings, assuming duopoly competition
(Table 2). Even at this lower threshold of eligibility, the change in Class I revenue from grains
and oilseeds is still no more than 2.2 and 1,3 percent, respectively.

Table 2: USDA Estimates of Impacted Class I Carloads and Revenue for Grain and Oilseeds
Using Eligibility Threshold of 30 Miles

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

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

Evidence Suggests Competitive Switching Can Work

USDA’s estimates of the expected impacts of the NITL competitive switching proposal are
bolstered by the real world outcome between shippers and railroads under Canadian
interswitching policy.

~The comments of Highroad Consulting and the verified statement of Thomas Maville' for NITE
provide evidence competitive switching does work under the Canadian system. According to
Highroad Consulting, 38.7 percent of Canadian National (CN) and Canadian Pacific (CP) traffic
was eligible for interswitching at both origin and destination and 91.4 percent was eligible at
either origin or destination in 1999. A similar analysis by Maville showed that roughly 37
percent of all CN and CP traffic was eligible for interswitching in 2011. Yet, statistics show that
less than 4 percent of all CN and CP freight traffic is interswitched annually.

Canadian interswitching has neither impeded railroad efficiency nor decreased customer
satisfaction. Accordingly, USDA expects a similar outcome for competitive switching in the
United States, if it is adopted. That is, the majority of traffic will likely remain with its current
rail carrier rather than being switched. Under the conditions being considered by the Board,
competitive switching should have a minor impact on the status quo rather than a wholesale
restructuring of the railroad industry.

Addressing Concerns

In the sections below USDA provides comments addressing some of the concerns raised by the
rail industry in opening comment phase.

' Opening Comments filed in STB Ex Parte No. 71 1, Petition for Rulemaking to Adopt Revised Competitive
Switching Rules, by Neil Thurston of Highroad Consulting, Ltd. (filed March 1, 2013) and Maville V.S. for the
National Industrial Transportation League (filed March 1, 2013).

3



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.

Comments

The U.S. Department of Agriculture (USDA) appreciates the opportunity to offer reply
comments in this important proceeding and herein reaffirms its methodology and empirical
analysis. We also address some of the concerns expressed by the rail industry in the opening

comment phase.

Reaffirmation of USDA Position

As differing comments in the opening round illustrated, various understandings of how the
National Industrial Transportation League (NITL) proposal would be implemented resulted in
different methodologies to address the Board’s request for an empirical analysis of the proposal.
Nevertheless, the parties which supplied empirical analysis had similar findings, namely that
impacted railroad revenues and traffic volumes would be relatively small. For example, while
the analysis of USDA and the U.S. Department of Transportation (DOT) differed in
methodology and scope, the conclusions showed the impacted carloads ranged between 1 and 6
percent (see Table 1 below). The estimates of percentages impacted by USDA were higher than

neon those-by- DOF, but-were-focused-only-on-grain-and-oilseed-traffic instead-of covering -allrait-——----_---—
traffic. Because the percentage estimates of both Departments were within the “ballpark” of one i:
another, USDA is confident its estimates and the underlying methodology used present an
accurate representation of the proposal’s expected effects on agricultural shippers and related
railroad revenue, given the limitations inherent in analysis of the STB Waybill data that was
provided to USDA.

Table 1. Estimates of Impacted Class I Carloads and Revenue from Competitive Switching
Using an Eligibility Threshold of 30 miles at a 240 Percent R/VC
Carloads Percentage Revenue (000) Percentage
Total Impacted Total Impacted
U.S. Dep. of Transportation (all traffic) 26,800,000 360,142 1.3% $51,800,000 $1,086,300 2.1%

U.S, Dep, of Agriculture (grain and oilseeds)
Near Perfect Competition 1,831,575 102,022 5.6% — $ 4,841,000 $ 176,172 3.6%
Duopoly Competition 1,831,575 99,032 5.4% $4,841,000 $ 173,453 3.6%

Furthermore, USDA was able to show through its sensitivity analysis that while 3.6 percent of
total grain and oilseed revenue is potentially subject to competitive switching at a threshold of 30
miles and R/VC ratio of 240 percent, the actual change in revenue would likely be much smaller.
Given these parameters, rail revenue would only fall by as much as $70.9 million, assuming near
perfect competition, and by as much as $49.3 million, assuming duopoly competition. This
represents 1.5 and 1 percent, respectively, of total Class I revenue from grains and oilseeds
(Table 2). This is why USDA suggested that the threshold for eligibility for agricultural shippers

2