# United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued November 6, 2013 Decided May 23, 2014

No. 12-1042

BNSF R AILWAY C OMPANY , P ETITIONER

v.

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

A RIZONA E LECTRIC P OWER C OOPERATIVE , I NC ., I NTERVENOR

Consolidated with 12-1045, 12-1046, 12-1246

On Petitions for Review of Final Orders of the Surface Transportation Board

Michael L. Rosenthal argued the cause for petitioners BNSF Railway Company a nd Union Pacific Railroad Company. With him on the briefs were Carolyn F. Corwin

, Henry B. Liu
, Gayla L. Thal

, Louise A. Rinn

, Danielle E. Bode

, Samuel M. Sipe, Jr.
, Anthony J. LaRocca

, Linda S. Stein

, Richard E. Weicher , and Jill K. Mulligan

.2

Robert D. Rosenberg argued the cause for petitioner Arizona Electric Power Cooperative, Inc. With him on the briefs were William L. Slover

, Christopher A. Mills , and Daniel M. Jaffe

.

James A. Read , Attorney, Surface Transportation Board, argued the cause for respondents. With him on the brief were William J. Baer , Assistant Attorney Gene ral, U.S. Department of Justice, Robert B. Nicholson and Nickolai G. Levin

, Attorneys, Raymond A. Atkins , General Counsel at the time the brief was filed, Surface Transportation Board, and Craig M. Keats , Deputy General Counsel. John P. Fonte , Attorney, entered an appearance.

Carolyn F. Corwin

, Michael L. Rosenthal

, Henry B. Liu
, Gayla L. Thal

, Louise A. Rinn

, Danielle E. Bode

, Samuel M. Sipe, Jr.
, Anthony J. LaRocca

, Linda S. Stein

, Richard E. Weicher , and Jill K. Mulligan were on the brief for intervenors BNSF Railway Company and Union Pacific Railroad Company.

William L. Slover

, Robert D. Rosenberg

, Christopher A. Mills , and Daniel M. Jaffe were on the brief for intervenor Arizona Electric Power Cooperative, Inc.

Before: T ATEL and K AVANAUGH , Circuit Judges , and W ILLIAMS , Senior Circuit Judge

. Opinion for the Court filed by Circuit Judge K AVANAUGH

.

K AVANAUGH , Circuit Judge : Congress has directed an independent agency, the Surface Transportation Board, to ensure that railroads with market dominance charge3

reasonable rates to shippers. To assess whether a dominant railroad’s rate is reasonable, the Board employs a sophisticated methodology derived from economic principles. If the Board determines that the current rate is not reasonable, the Board sets the maximum rate that the railroad may charge. In setting the maximum rate in such cases, the Board relies on a formula that ensures that th e railroad can still receive a reasonable rate of return.

In this case, the Bo ard addressed a rate dispute between a shipper and two railroads. In cross-petitions coming from their contrary perspectives, the shipper and the railroads separately challenge the Boar d’s decision. The railroads contend that the Board’s deci sion was too favorable to the shipper. The shipper contends that the Board’s decision was too favorable to the railroads. We deny the petitions for review.

I

The Surface Transportation Board, an independent federal agency, regulates the rates charged by interstate railroads. See 49 U.S.C. § 10501. Under federal law, a shipper may file a complaint with the Board challenging as unreasonable the rate that is “charged or collected” by a railroad for “transportation” of the shipper’s goods. Id. § 10704(a)(1); see id. §§ 10704(b), 11701(b).

After receiving a complaint, the Board first determines whether it has authority over the challenged rate.

As relevant here, the Board has authority to review a railroad’s rate only if the complaining shipper is “captive” to the railroad. See id. §§ 10701(d)(1), 10707(b)-(c). A shipper is captive if a railroad has “market dominance” over the4

transportation of the shipper’s freight; that is, if there is “an absence of effective competition from other rail carriers or modes of transportation for [that] transportation.” Id. § 10707(a).

The Board has devised the Stand-Alone-Cost test to ensure that railroads charge cap tive shippers reasonable rates. See Coal Rate Guidelines, Nationwide , 1 I.C.C.2d 520, 542- 46 (1985), affirmed sub nom. Consolidated Rail Corp. v. United States , 812 F.2d 1444 (3d Cir. 1987). That test “ensures that a captive shipper doe s not pay for services that provide it no benefits – in othe r words, that it does not crosssubsidize other shippers.” BNSF Railway Co. v. STB , 526 F.3d 770, 776-77 (D.C. Cir. 2008). The ultimate aim of the Stand-Alone-Cost test is to requ ire that “railroa ds functioning in a noncompetitive market . . . pric e as if alternatives to their services were available” to the captive shipper. Coal Rate Guidelines , 1 I.C.C.2d at 542.

To achieve that aim, the Board allows the complaining captive shipper to propose a hypot hetical railroad that the shipper could use as an altern ative source of transportation. See BNSF Railway Co. , 526 F.3d at 777. That hypothetical railroad is called a Stand-Alone Railroad and is designed to be optimally efficient. See id.

In order to simulate a competitive market for the captive shipper’s business, the complain ing shipper may construct the hypothetical Stand-Alone Railroad as if there were no barriers to entry or exit in the railroad industry. See PPL Montana, LLC v. STB , 437 F.3d 1240, 1242 (D.C. Cir. 2006). For example, to simulate the absence of entry barriers, the hypothetical Stand-Alone Railroad can be cons tructed using track that has not been laid in reality and facilities that do not5

exist in reality. See Coal Rate Guidelines , 1 I.C.C.2d at 543. Or it could traverse a circuit ous route of ex isting track in order to take advantage of hi gher density traffic on certain segments. The hypothetical Stand-Alone Railroad does not even have to be a railroad at all, if a pipeline or other alternative form of transportati on would be more efficient. See id. & nn.60-61. The Board requires only that the complaining shipper explain and justify the elements of the hypothetical Stand-Alone Railroad. See id. at 543-44.

Ordinarily, the Board considers the rate that the hypothetical Stand-Alone Ra ilroad would charge the complaining shipper in a competitive market to be the maximum rate that the actual railroad may reasonably charge. The theory is that the rate of the hypothetical Stand-Alone Railroad represents the rate th at the actual railroad would charge if the industry were competitive. But under the statute, the Board may not set a maximum rate that results in revenues of less than 180 percent of the actua l railroad’s variable costs. See 49 U.S.C. § 10707(d)(1)(A). So the Board will not require that a railroad charge less than that threshold. See Burlington Northern Railroad Co. v. STB , 114 F.3d 206, 210 (D.C. Cir. 1997). Thus, if the rate deemed reasonable under the Stand-Alone-Cost methodology would result in actual revenues of less than 180 percen t of the actual railroad’s variable costs, the Board will set the maximum reasonable rate to be a rate resulting in revenues equal to 180 percent of the actual railroad’ s variable costs.

This case involves Arizona Electric Power Cooperative, Inc., which supplies its power plant near Cochise, Arizona, with coal brought from mines in New Mexico, Wyoming, and Montana. Two railroads transport coal from the mines to Arizona Electric’s plant: Burlington Northern Santa Fe6

Railway Company and Union Pacific Railroad Company. Depending on the origin of the coal, Burlington Northern transports it to either De ming, New Mexico, or Pueblo, Colorado. Burlington Northern contracts with a smaller, short-line railroad, Southwest Railroad, to transport the coal part of the way to Deming over track owned by Burlington Northern. From Deming and Pueblo, Union Pacific transports the coal to Arizona Electric’s power plant in Arizona. Because the railroads transfer responsibility for Arizona Electric’s coal at Deming and Pueblo, those two cities are known as the “interchange locati ons” for the routes taken by that coal.

Under the statute, a route wh ere two railroads must carry the shipment to get from origin to destination is known as a “through route.” On a through route, as relevant here, the railroads typically either together charge a single “joint rate” or individually charge “proportional rates.” See, e.g.

, Western Resources, Inc. v. STB , 109 F.3d 782, 789 (D.C. Cir. 1997).

In 2008, Arizona Electric chal lenged the reasonableness of the joint rates charged by Burlington Northern and Union Pacific for transportation of Ar izona Electric’s coal over these through routes. To demonstrate that the rates charged were unreasonably high, Arizona Electric submitted into evidence a proposed hypothetical Stand- Alone Railroad. Arizona Electric’s proposed hypothetical St and-Alone Railroad did not use Deming and Pueblo as its interchange locations. The Board accepted Arizona Electri c’s hypothetical Stand-Alone Railroad.

Relying on that hypothetical Stand-Alone Railroad, the Board concluded that the railroads’ joint rates were unreasonable. The Board then prescribed the maximum rates7

that the railroads could charge for the service provided to Arizona Electric. Those rates or dinarily would be equivalent to the rates charged by the hypot hetical Stand-Alone Railroad. But the Board concluded that the hypothetical Stand-Alone Railroad’s rates would result in revenue that is less than 180 percent of Burlington Northern and Union Pacific’s actual variable costs in providing serv ice to Arizona Electric, which is the statutory floor in these circumstances. See 49 U.S.C. § 10707(d)(1)(A). The Board therefore prescribed maximum rates that would provide revenue equal to 180 percent of the railroads’ variable costs.

In this Court, the railroads argue that their prior rates were not unreasonable. For it s part, Arizona Electric argues that the Board correctly determined that the railroads’ prior rates were unreasonably high, but it contends that the Board’s remedy was flawed because the Board prescribed rates that were still too high.

This Court reviews the Boar d’s authoritative statutory interpretations under the Chevron framework. See Village of Barrington v. STB , 636 F.3d 650, 658-60 (D.C. Cir. 2011). We must uphold the Board’s interp retation if it is dictated by statute or is a reasonable interpretation of an ambiguity or gap in the statute. To review the Board’s exercise of its statutory discretion, the Court applies the Administrative Procedure Act’s arbitrary and caprici ous standard of review. See 5 U.S.C. § 706(2)(A); Manufacturers Railway Co. v. STB , 676 F.3d 1094, 1096 (D.C. Cir. 2012). “[ T]he APA requires that an agency’s exercise of its statutory authority be reasonable and reasonably explained.” Manufacturers Railway Co. , 676 F.3d at 1096

.8

II

We first address the railroads’ argument that their prior rates were reasonable and that the Board erred in concluding otherwise.

The Board’s unreasonableness determination was based on a hypothetical Stand-Alone Rail road that used interchange locations different from those actually used by the railroads when they haul Arizona Electric’s coal. The railroads argue that the hypothetical Stand-Alone Railroad should have used the railroads’ actual interchange locations. The railroads contend that the Board would have found the existing rates reasonable if the Board used a hypothetical Stand-Alone Railroad with the railroads’ actual interchange locations.

In considering the railroads’ argument, we start with the statutory text. In determining the reasonableness of a rate, the Board assesses the rate actually “charged or collected” by the railroad. 49 U.S.C. § 10704(a )(1). Section 10701(d)(2) of Title 49 in turn outlines three broad factors that the Board should consider when assessing th e reasonableness of the rate:

(A) the amount of traffic which is transported at revenues which do not contribute to going concern value and the efforts made to minimize such traffic;

(B) the amount of traffi c which contributes only marginally to fixed costs and the extent to which, if any, rates on such traffic can be changed to maximize the revenues from such traffic; and

(C) the carrier’s mix of rail traffic to determine whether one commodity is paying an unreasonable share of the carrier’s overall revenues.9

Id. § 10701(d)(2). Under the stat ute, the Board is not limited to those three factors when determining the reasonableness of
a rate.
To help account for those three broad reasonableness factors and to determine reasonableness, the Board has used a Stand-Alone-Cost test that employs a hypothetical StandAlone Railroad that is optimally efficient. The rate that the hypothetical Stand-Alone Railroad would charge is generally considered the maximum reasonable rate because it represents what the actual railroad would charge if the railroad industry were competitive. See Coal Rate Guidelines, Nationwide , 1 I.C.C.2d 520, 542 (1985), affirmed sub nom. Consolidated Rail Corp. v. United States , 812 F.2d 1444 (3d Cir. 1987).

The statute does not dictat e how the hypothetical StandAlone Railroad may be constructed. Importantly, under longstanding Board rules and precedent, the hypothetical Stand-Alone Railroad need not fo llow the same route used by the actual railroad. See id. at 542-46 & nn.60-61. Indeed, in practice, the hypothetical railroa d almost never reproduces the operations of the existing real -world carrier. Rather, it typically operates ove r hypothetical routes.

The one wrinkle here, according to the railroads, is that this case involves “through rout es.” Those are routes where two or more railroads are needed to move the traffic from the origin to the ultimate destin ation. The traffic goes “through” an interchange location where the two railroads connect. See 49 U.S.C. § 10703. Often, and as is true in this case, the railroads will charge a single “j oint rate” to the shipper for a through route.

In a case like this that involves a “through route,” the railroads argue that the hypothe tical Stand-Alone Railroad10

must use the actual interchange locations used by the actual railroads, even when the railroads charge and collect a single joint rate from the shipper. In other words, the railroads want to make the hypothetical St and-Alone Railroad less hypothetical. But Congress did not unambiguously mandate that the reasonableness inquiry for through routes focus on the reasonableness of the rates for the constituent segments rather than the reasonableness of the rates for the route as a whole. See Western Resources, Inc. v. STB , 109 F.3d 782, 789 (D.C. Cir. 1997) (“Shippers[,] . . . if charged either a joint or proportional rate, must challenge the rate for the entire through movement; they canno t challenge individual segments.”). Nor has Congress mandated that the hypothetical Stand-Alone Railroad in a through route case use the same interchange locations as the actual railroads. As the Board reasonably explained in this case, the hypothetical Stand-Alone Railroad in a thr ough route case is logically and legally no different from the hypothetical Stand-Alone Railroad in an ordinary single -railroad case. In neithersituation, the Board reasoned, must the hypothetical StandAlone Railroad use the same rout e that is used by the actual railroads.

The railroads point to Sec tion 10703 of Title 49, which states, as relevant here, that railroads “shall es tablish through routes (including physical connec tions) with each other.” 49 U.S.C. § 10703. The railroads focus on the phrase “including physical connections.” That phrase requires railroads to establish physical connections with one another on through routes. But the Board could reasonably conclude that Section 10703 does not tell the Bo ard how to assess the reasonableness of a rate on a through route. And the Board likewise could reasonably conc lude that Section 10703 does11

not say how the hypothetical Stan d-Alone Railroad should be constructed in a through route case. 1

Contrary to the railroads’ ar gument, moreover, the statute does not distinguish joint rates from other rates for purposes of the Board’s reasonableness determination. On the contrary, as the Board explai ned in its decision here, the relevant legislative history states that “the rate standard for the reasonableness of joint rates shall be the same as for all rates.” H.R. R EP

. N O . 96-1430, at 90 (1980) (Conf. Rep.), reprinted in 1980 U.S.C.C.A.N. 4110, 4121. That history supports the Board’s conclusion that the hypothetical StandAlone Railroad in joint rate cases, like the hypothetical Stand-

1 The railroads argue that regardless of the merit of their Section 10703 point, the Board failed to respond to it. We disagree. The Board explained that the stat utory scheme treats interchange locations no differently from other features of railroad “transportation.” See 49 U.S.C. § 10102(9) (defining “transportation” as including the facilities and equipment of a railroad); id. § 10704(a)(1) (allowing shippers to challenge the reasonableness of rates “charged or collected by a rail carrier for transportation”). Under the Board’ s interpretation, the interchange locations of the actual railroads do not constrain the flexibilityshippers generally enjoy when designing the hypothetical StandAlone Railroad any more than do the facilities or equipment of the actual railroads. In the course of rejecting the railroads’ arguments on interchange locations, the Board thus at least implicitly rejected the railroads’ Section 10703 point. We grant significant deference to the Board’s determinations of the reasonableness of a rate, and we can “uphold a decision of less th an ideal clarity if the agency’s path may reasonably be discerned.” FCC v. Fox Television Stations, Inc. , 556 U.S. 502, 513-14 (2009) (internal quotation marks omitted). We conclude that the Board adequately addressed the railroads’ Section 10703 point.12

Alone Railroad in single-railroad cases, need not follow the actual route used by the railroads.

The necessary implication of the railroads’ argument is that a joint rate (for a route from A to C) must be divided into two rates (between A and B and between B and C), each of which must be assessed for reasonableness. Congress has not said as much. And that argument overlooks the unity of joint rates, a principle that the Board and the courts have long recognized. See generally Great Northern Railway Co. v. Sullivan , 294 U.S. 458 (1935). As the Board stated here, “for practical purposes, when carrier s elect to offer a through rate, they are treated as a single legal entity.” Arizona Electric Power Cooperative, Inc. v. BNSF Railway Co. , 2011 WL 5872084, at *12 (STB served Nov. 22, 2011). So the Board concluded that “the reasonablen ess of the joint rates charged and collected is in this case properly being judged against asimulated competitive price of a single hypothetical” StandAlone Railroad. Id. at *14 (emphasis omitted) (internal quotation marks omitted).

In short, the railroads concede that the hypothetical Stand-Alone Railroad ordinari ly may travel any route between the freight’s origin a nd destination. The railroads offer no persuasive reason why th e same principle should not govern when the Board evaluates a unitary joint rate charged by multiple railroads on a through route.

We conclude that the Board’s interpretation and application of the statute on this issue were at least reasonable, and also were reasonably explained.13

III

From the other direction, Arizona Electric argues that the Board correctly determined that the railroads’ prior rates were unreasonably high, but that th e Board’s remedy did not suffice because the Board prescribed maximum rates that were still too high.

Recall that the Board may not set a maximum rate that results in revenues of less th an 180 percent of the actual railroads’ variable costs, as required by statute. See 49 U.S.C. § 10707(d)(1)(A). (The railroads’ variable costs are the costs that vary depending on the volume of traffic, such as the cost of fuel.) The dispute here tu rns on what those variable costs were for the railroads.

Pursuant to statute, the Board calculates variable costs using a methodology called the Un iform Rail Costing System. See id. § 10707(d)(1)(B); BNSF Railway Co. v. STB , 526 F.3d 770, 774-75 (D.C. Cir. 2008). The system receives numerous inputs about the charact eristics of the transportation at issue and computes the variable cost for that transportation based on average costs associated with each characteristic. See BNSF Railway Co. , 526 F.3d at 774-75

. Burlington Northern leases a portion of its line to Southwest Railroad. Pursuant to the lease, Southwest Railroad carries Arizona Electric’ s coal over a s hort distance. When calculating the variable costs of that portion of the route, the Board inputted Sout hwest Railroad as the relevant railroad. Arizona Electric ar gues that the Board instead should have inputted Burlington Northern and, had it done so, would have found lower variable costs for the railroads and thus would have further reduced the maximum rates that the railroads could charge Arizona Electric.14

When inputting Southwest Railr oad, the Board relied on its prior decision in Kansas City Power & Light Co. v. Union Pacific Railroad Co. , 2008 WL 2091413 (STB served May 19, 2008). In Kansas City Power , the Board decided that when one railroad moves a shippe r’s freight over lines leased from another railroad, the ra ilroad that actually moves the shipper’s freight must be inputte d as the relevant railroad for purposes of the Uniform Rail Costing System. See id. at *5-6. As the Board explained in its decision in this case, the Kansas City Power rule ensures that the Uniform Rail Costing System output reflects reality: that even when a shipment occurs over lines owned exclusively by one railroad, there may be costs associated with moving the shipper’s freight between railroads operating on thos e lines. Basing the cost determination on an assumption that only one railroad was moving the freight would in some cases inaccurately reflect the railroad’s actual costs. He re, Southwest Railroad actually moved Arizona Electric’s freight over the relevant portion of the route. Following Kansas City Power , the Board thus inputted Southwest Railroad in to the Uniform Rail Costing System to reflect the real-wor ld operation of the railroads carrying Arizona Electric’s coal.

Put simply, Arizona Electric has not demonstrated that the Board’s reasoning in Kansas City Power is unreasonable or contrary to statute, or th at the Board unreasonably applied Kansas City Power to the facts here. We conclude that the Board’s calculation of the ra ilroads’ variable costs was reasonable and reasonably explained.

IV

After the Board’s decision, th e railroads switched from joint to proportional rates. In response to a complaint from15

Arizona Electric that the switch would lead to over-charging, the Board denied relief. See Arizona Electric Power Cooperative, Inc. v. BNSF Railway Co. , 2012 WL 1864787 (STB served May 22, 2012). The Board allowed the proportional rates. See id. But importantly, the Board made clear that the combined proportional rates may not exceed the maximum rates prescribed by the Board. See id. at *2-3. For that reason, we detect no curren t injury to Arizona Electric from the Board’s decision on th is point. Arizona Electric therefore lacks standing to rais e this issue at this time.

* * *

We have carefully consider ed all of the parties’ arguments. We deny the petitions for review.

So ordered.