Railroad Regulation: Changes in Freight Railroad Rates from 1997 through 2000
Published: 2002-06-07T00:00:00

Fast Facts:

Highlights:
section_title: What GAO Found
paragraphs: The Railroad Revitalization and Regulatory Reform Act of 1976 and the Staggers Rail Act of 1980 gave freight railroads increased freedom to price their services according to market conditions. A number of shippers are concerned that freight railroads have used these pricing freedoms to unreasonably exercise their market power in setting rates for shippers with fewer alternatives to rail transportation. This report updates the rate information in GAO's 1999 report (RCED-99-93) using selected commodities and with effective competitive transportation alternatives. From 1997 through 2000, rail rates generally decreased, both nationwide and for many of the specific commodities and markets that GAO examined. However, rail rates for some commodities and distance categories--such as wheat moving long distances and coal moving short distances--have stayed about the same or increased. In other instances, such as wheat moving medium distances, rail rates stayed about the same or decreased. Overall, the proportion of rail shipments above the Surface Transportation Board's statutory jurisdictional threshold for considering rate relief actions--where railroad revenues for the shipment exceed 180 percent of variable costs--stayed relatively constant at 30 percent from 1997 through 2000. However, the proportion of shipments for which revenues exceeded variable costs by 180 percent varied, depending on commodity and markets.

section_title: Letter
paragraphs: The Railroad Revitalization and Regulatory Reform Act of 1976 and the  Staggers Rail Act of 1980 gave freight railroads increased freedom to price  their services according to market conditions.  A number of shippers are  concerned that freight railroads have used these pricing freedoms to  unreasonably exercise their market power in setting rates for shippers with  fewer alternatives to rail transportation.  In 1999, we generally reported  that most rail rates had decreased from 1990 through 1996, and that rates  for shipments of selected commodities with effective competitive  transportation alternatives—such as from other railroads, trucks, or  barges—generally had decreased to a greater extent than rates for  shipments without such alternatives.  However, some rates had increased.   These results were consistent with the pricing freedoms provided by  federal law that allows railroads to price their service in relation to market  demand and competition.
This report responds to your request that we update the rate information in  our 1999 report using the same commodities and markets.  For the period  from 1997 through 2000, we (1) examine changes in rates and (2) describe  changes in the proportion of shipments above the Surface Transportation  Board’s statutory jurisdictional threshold for rate relief actions (shipments  in which revenues exceed 180 percent of variable costs).  To do so, we  used the Carload Waybill Sample maintained by the Surface  Transportation Board to determine rates for coal, grain (wheat and corn),  chemicals (potassium and sodium compounds and plastic materials or  synthetic fibers, resins, or rubber), and transportation equipment (finished  motor vehicles and motor vehicle parts or accessories).  These  commodities represented a substantial portion of total industry revenue.   We analyzed rate changes for these commodities in the top five  transportation corridors (measured by tons shipped) according to length of  haul (short, medium, and long).   (See app. I for additional discussion of our  methodology.)   Although the focus of our work centered on the 1997–2000  period, we also present the results of our previous work covering the 1990– 1996 period for perspective.
subsections: section_title: Background
paragraphs: Railroads are the primary mode of transportation for many products,  especially for such bulk commodities as coal and grain.  Yet by the 1970s,  American freight railroads were in a serious financial decline.  Congress  responded by passing the Railroad Revitalization and Regulatory Reform  Act of 1976 and the Staggers Rail Act of 1980.  These acts reduced rail  regulation and encouraged greater reliance on competition to set rates.   Railroads have also continued to consolidate  (through such actions as  mergers, purchases, changes in control, and acquisitions) to reduce costs,  increase efficiencies, and improve their financial health.
The 1976 act limited the authority of the Interstate Commerce Commission  (now the Surface Transportation Board) to regulate rates to instances in  which there is an absence of effective competition—that is, where a  railroad is “market dominant.”  The 1980 act made it federal policy to rely,  where possible, on competition and the demand for rail services (called  demand-based differential pricing) to establish reasonable rates.   Differential pricing recognizes that inherent in the rail industry cost  structure are joint and common costs that cannot be attributed to  particular traffic.  Under demand-based differential pricing, railroads  recover a greater proportion of these unattributable costs from rates  charged to those with a greater dependency on rail transportation.  Among  other things, the 1980 act also (1) allowed railroads to market their services  more effectively by negotiating transportation contracts (generally offering  reduced rates in return for guaranteed volumes) containing confidential  terms and conditions; (2) limited collective rate-setting to those railroads  actually involved in a joint movement of goods; and (3) permitted railroads  to change their rates without challenge in accordance with a rail cost  adjustment factor.  Furthermore, both acts required the Interstate  Commerce Commission to exempt railroad transportation from economic  regulation in certain instances.  The Staggers Rail Act required exemptions  where regulation is not necessary to carry out rail transportation policy and  where a transaction or service is of limited scope, or where regulation is  not needed to protect shippers from an abuse of market power.  During the  1980s and 1990s, railroads used their increased pricing freedoms to  improve their financial health and competitiveness.
In addition, the railroad industry has continued to consolidate in the last 2  decades to become more competitive by reducing costs and increasing  efficiencies.  (This consolidation continues a trend that has been occurring  since the nineteenth century.)  In 1976, there were 30 independent Class I  railroad systems, consisting of 63 Class I railroads.  (Class I railroads are  the nation’s largest railroads.)  Currently there are 7 railroad systems,  consisting of 8 Class I railroads.  Half of that reduction was attributable to  consolidations.  The 8 Class I railroads are the Burlington Northern and  Santa Fe Railway Co.; CSX Transportation, Inc.; Grand Trunk Western  Railroad, Inc.; Illinois Central Railroad Co.; Kansas City Southern Railway  Co.; Norfolk Southern Railroad Co.; Soo Line Railroad Co., and Union  Pacific Railroad Co.
The Surface Transportation Board is the industry’s economic regulator.   The board is a decisionally independent adjudicatory agency  administratively housed within the Department of Transportation.  Among  other things, board approval is needed for market entry and exit of  railroads and for railroad mergers and consolidations.  The board also  adjudicates complaints concerning the quality of rail service and the  reasonableness of rail rates.  Under the ICC Termination Act of 1995, the  board may review the reasonableness of a rate only upon a shipper’s  complaint.  Moreover, the board may consider the reasonableness of a rate  only if (1) the revenue produced is equal to or greater than 180 percent of  the railroad’s variable costs for providing the service and (2) it finds that  the railroad in question has market dominance for the traffic at issue.  If the  revenue produced by that traffic equals or exceeds the statutory threshold,  then the board examines intramodal and intermodal competition to  determine whether the railroad has market dominance for that traffic and,  if so, whether the challenged rates are reasonable.
From 1997 through 2000, there were two periods during which major  portions of the rail industry experienced serious service problems.  The  first began in July 1997, during implementation of the Union Pacific  Railroad and Southern Pacific Transportation Company merger.  As a result  of aging infrastructure in the Houston, Texas, area that was inadequate to  cope with a surge in demand, congestion on this system began affecting rail  service throughout the western United States.  Rail service disruptions and  lengthy shipment delays continued through the rest of 1997 and into 1998.   The board issued a series of decisions that generally were designed to  enhance the efficiency of freight movements by changing the way rail  service is provided in and around the Houston area.  These decisions  principally focused on the Houston/Gulf Coast area and included an  emergency service order to address the service crisis.  In addition, CSX  Transportation and Norfolk Southern Corporation began experiencing  service problems in the summer and early fall of 1999, shortly after they  began absorbing their respective parts of the Consolidated Rail  Corporation (Conrail).  These service problems caused congestion and  shipment delays, primarily in the Midwest and Northeastern parts of the  country.  By early 2000, those service problems had largely been resolved  without formal board action.
section_title: Rail Rates Generally Continued to Fall
paragraphs: Rail rates generally have continued to fall nationwide for the commodities  we studied and in the specific markets we reviewed.  However, in several  markets rates either increased over the 4-year period for certain  commodities or increased and then later fell, resulting in an overall  decrease for the period.  There may be a variety of reasons why rail rates  change over time, including increases or decreases in production or export  of various commodities (such as coal or grain); changes in railroad costs;  changes in use of contracts that tie rates to specific volumes of business;  service problems that could affect the ability of railroads to supply railcars,  crews, and locomotive power to meet the demand for rail transportation; or  the degree of competition.  We do not attempt to identify and explain all the  various reasons for changes in the rail rates we examined.  Rather, our aim  is to put rate changes for particular commodities into context with some of  the economic or rail industry conditions that might have affected them  from 1997 through 2000.
subsections: section_title: Rates for Selected Commodities Have Generally Continued to Fall Nationally
paragraphs: Rates for coal, grain (wheat and corn), chemicals (potassium and sodium  compounds and plastic materials or synthetic fibers, resins, or rubber), and  transportation equipment (finished motor vehicles and motor vehicle parts  or accessories) generally fell from 1997 through 2000.  (See fig. 1.)  These  decreases followed the general trend we previously reported on for the  1990–1996 period and, as before, tended to reflect railroad cost reductions  brought about by continuing productivity gains in the railroad industry that  have allowed railroads to reduce rates in order to be competitive.
From 1997 through 2000, the rates for coal decreased slightly but steadily  from about 1.5 cents per ton-mile to about 1.4 cents per ton-mile.  Coal  production fluctuated over this period but generally decreased from about  1.12 billion tons in 1998 to about 1.08 billion tons in 2000.  The production  of coal shipped for export also generally decreased from about 83.5 million  tons in 1997 to 58.5 million tons in 2000.  The Energy Information  Administration attributed these decreases to, among other things, a draw  down in coal stocks by utilities and reluctance on the part of some coal  producers to expand production.  Lower demand for rail transportation  resulting from lower production generally results in lower rail rates.   However, the demand for rail transportation (and consequently rail rates)  can also be affected by changes in coal held as inventory and other supply- related factors.  Board officials suggested that the decrease in coal rates  during this period could also be attributed in part to increasing competition  between low-sulfur Powder River Basin coal from the West and higher- sulfur Eastern coal, and to the expiration and resulting renegotiation of  many long-term coal transportation contracts.
The rates for wheat increased slightly from 1997 to 1998—from about 2.46  cents per ton-mile in 1997 to about 2.47 cents per ton-mile—before falling  back in 1999 and 2000 to just under 2.4 cents per ton-mile.  Rates for wheat  may have decreased because overall production decreased, from 67.5  million tons for the 1997–1998 season to 60.5 million tons for the 2000–2001  season, despite a modest increase in demand for exports (from 28.1 million  tons to 30.0 million tons over the same period).  Preliminary information  indicates that in 1998, the most recent year for which data were available,  railroads transported over half (about 55 percent) of all wheat shipments.
Corn rates generally decreased from about 2 cents per ton-mile in 1997 to  about 1.8 cents per ton-mile in 2000.  Corn production fluctuated between  1997 and 1999 (the latest year for which data are available), increasing from  9.2 million bushels in 1997 to 9.8 million bushels in 1998 before falling back  to 9.4 million bushels in 1999.  However, the domestic use of corn (the  primary use of corn) increased by about 4 percent—from 7.3 million  bushels in 1997 to 7.6 million bushels in 1999.  This increase suggests, all  else being equal (including rail costs), greater demand for transportation  and possibly higher rail rates.  Yet, rail rates for corn are influenced by a  number of factors.  Significant amounts of corn are produced in areas  accessible to navigable waterways and, therefore, the transportation of  corn is less dependent on rail.  (About 25 percent of corn was shipped by  rail in 1998, the latest year for which data are available.)  In addition, rates  may be affected by the supply of corn.  From 1997 through 1999 (the latest  year for which data are available) the total supply of corn increased from  10.1 million bushels to 11.2 million bushels.  It is possible that intermodal competition, increased domestic use of corn, and an increasing supply of  corn may have all influenced rail rates for corn.
The rates for chemicals (as illustrated by rates for potassium/sodium and  plastics) decreased slightly from 1997 through 2000 at a steady rate.   According to data from the American Chemistry Council, the production of  chemicals in the potassium/sodium classification increased between 1997  and 1999.  Plastics production also steadily increased over the period.  These data suggest that, all things being equal, rail rates should have  increased over the period because of a higher demand for rail  transportation.  However, over 65 percent of chemicals are transported less  than 250 miles, a distance that is truck competitive, which may indicate  that railroad rates are sensitive to truck competition.  In addition, not all  chemicals that are produced require immediate transportation.  An official  with the American Chemistry Council told us that chemical manufacturers  often produce a product, load it onto railcars, and store the railcars until  the product is sold, at which point it is transported to destination.   Although the tonnage of chemicals shipped by rail generally increased  between 1997 and 2000, railroads accounted for only 20 percent of the  tonnage transported in 2000.  This is up slightly from the 19 percent  transported in 1997.
Rates for motor vehicles and parts also generally decreased over the 4-year  period, but not at a steady rate.  This occurred during a time when U.S. car  and truck production generally fluctuated between 12 million and 13  million units.  Car production, in particular, generally decreased over the  period from about 5.9 million units to about 5.5 million units, according to  Crain Communications, Inc., a publisher of Automotive News.  The  automotive industry is heavily dependent on railroads, and the Association  of American Railroads—a railroad trade group—estimates that railroads  transport about 70 percent of finished motor vehicles.  Automotive  production declines, among other things, might have contributed to  generally decreasing rail rates.  Data on auto parts production were not  available.
In its own study, the board found that the average, inflation-adjusted rail  rate had continued a multi-year decline in 1999 and that, since 1984, real  rail rates had fallen 45 percent. It found that real rail rates had decreased  for both eastern and western railroads.  According to the board, the results  of its study implied that, although railroads retain a degree of pricing power  in some instances, nearly all productivity gains achieved by railroads since  the 1980s (when railroad economic regulation was reduced) have been  passed on to rail customers in the form of lower rates.  The board  estimated that rail shippers would have paid an additional $31.7 billion for  rail service in 1999 if revenue per ton-mile had remained equal to its 1984  inflation-adjusted level.  The board acknowledged, however, that even  though real rail rates had decreased overall, individual rates might have  increased and, further, that some rail customers might feel disadvantaged if  their rates did not fall to the same extent as their competitors’ rates.
section_title: Rail Rates for Specific Markets Generally Have Continued to Fall
paragraphs: Our analysis of rail rates for coal, grain (corn and wheat), chemicals  (potassium, sodium, plastics, and resins), and motor vehicles and motor  vehicle parts in selected high-volume transportation markets generally  showed that rates continued to decrease from 1997 through 2000.   However, this was not true in all markets.  Rail rates may have been  sensitive to competition, and rail rates were generally higher in areas  considered to have less railroad-to-railroad competition.
subsections: section_title: Coal
paragraphs: Real rail rates for coal, although fluctuating in some markets, generally  decreased from 1997 through 2000.  In virtually every market we  analyzed—both in the East (Appalachia) and in the West (Powder River  Basin)—rates decreased.  For example, on a medium-distance route from  Central Appalachia to Orlando, Florida, rates decreased from about 2.2  cents per ton-mile in 1997 to 1.7 cents per ton-mile in 2000. (See fig. 2.)  The 2000 rate was also substantially less than the rate of 2.6 cents per ton- mile in 1990.
Competition may have played a role in the decrease in coal rates that we  examined.  In the West, the two Class I railroads that served the Powder  River Basin during the 1990–1996 period, the Burlington Northern and  Santa Fe Railway and the Union Pacific, continued to serve the market  from 1997–2000.  In the East, three Class I railroads served Central  Appalachia until mid-1999:  Conrail, CSX Transportation, and Norfolk  Southern. Following its acquisition by the latter two carriers, Conrail  began being absorbed into CSX Transportation and Norfolk Southern in  June 1999, with the latter two carriers continuing to serve the market.  As  part of this transaction, certain areas of Pennsylvania and West Virginia  (part of the Appalachia Coal Supply Region) that had been served  exclusively by Conrail, although conveyed to Norfolk Southern, are  available to CSX on an equal-access basis for 25 years, subject to renewal.
Finally, rail rates for coal can be influenced by coal production as well as  existing supplies of coal.  In general, coal production in the Appalachian  area decreased from 1997 to 2000—from about 468 million tons to about  421 million tons.  On the other hand, coal production in the Western region  (which includes the Powder River Basin) increased between 1997 and  1999—from about 451 million tons to about 512 million tons—before falling  back to 510 million tons in 2000.  In its 2000 review, the Energy Information  Administration noted that coal production in Wyoming (which dominates  coal production in both the West and the United States) was driven higher  by an increasing penetration of Powder River Basin coal into Eastern  markets—an action creating competition for coal produced in the East.  Board officials told us that in order for Powder River Basin coal to  penetrate Eastern markets, railroads have had to offer very low  transportation rates.  In addition, they suggested that rail rates for Powder  River Basin coal are lower than rail rates for Appalachian coal because of  the ability of railroads to use larger (110-car unit) trains to pick up the coal  and because of more favorable terrain (flatter and straighter routes) to  transport the coal from the mines.  Coal supply (as measured by year-end  coal stocks) generally fluctuated over the 1997 through 2000 period— increasing from about 140 million tons in 1997 to 183 million tons in 1999,  before falling back to 142 million tons in 2000.
section_title: Wheat and Corn
paragraphs: From 1997 through 2000, real rail rates for shipments of wheat and corn  generally stayed the same or decreased for the markets that we reviewed.  For example, wheat shipments moving over medium-distance (501 miles to  1,000 miles) routes generally followed this pattern.  (See fig. 3.)  The  exception was wheat shipped from the Oklahoma City, Oklahoma,  economic area to the Houston, Texas, economic area. On this route, rail  rates generally increased by 12 percent—from 1.9 cents per ton-mile in  1997 to 2.2 cents per ton-mile in 2000.  The largest increase occurred  between 1997 and 1998, when rates went from 1.9 to 2.1 cents per ton-mile.   This increase came at about the same time as the service crisis in the  Houston/Gulf Coast area that delayed the delivery of railcars and, in some  cases, halted freight traffic.  Although board officials did not think railroads  used rail rates to allocate the supply of railcars during this time, such an  action could have occurred for particular commodities on particular  routes.  The increases also came at the same time as wheat production in  Oklahoma rose from about 170 million bushels in 1997 to just under 200  million bushels in 1998.  This may be consistent with an increase in the  handling of bulk grain by the Port of Houston Authority between 1997 and  1998, from about 388,000 tons to 1.2 million tons. These factors may also  have contributed to a general increase in rail rates for these movements.   Even with these increases, the rail rate in 2000 was still less than it was in  1990—about 2.2 cents per ton-mile in 2000, as compared with 2.5 cents per  ton-mile in 1990.
Rail rates for wheat from the northern plains locations of the Great Falls,  Montana, and Grand Forks, North Dakota, economic areas on medium- distance routes generally decreased over the period. Wheat production  and demand for rail transportation may have been influencing factors.   Although the volume of export wheat was increasing over the 1997 to 2000  period, wheat production in various states fluctuated.  For example, wheat  production in Montana steadily declined between 1997 and 2000, from  about 182 million bushels to about 154 million bushels.  In contrast, wheat  production in North Dakota (the second highest wheat producing state  behind Kansas in 2000) fluctuated between about 240 million bushels and  315 million bushels, alternately increasing and decreasing beginning in  1997.  Whether wheat is transported or not depends on many factors,  including the price of wheat and the amount of carryover stocks from year  to year.  In 2001, the U.S. Department of Agriculture reported that grain car  loadings on railroads had steadily decreased over the previous 5 years, with  the exception of 1999. This was attributed, at least partially, to farmers  holding on to grain because of large harvests, large carryover stocks, and  low prices.
Rate trends between 1997 and 2000 for the shipment of corn were similar to  those for wheat.  Again, rate trends for corn can be illustrated in the rail  rates for medium-distance routes.  (See fig. 4.)  The rates for most of these  routes generally either stayed about the same or decreased over the period.   Similar patterns are seen in the other distance categories.  However, some  rail rates on short-distance routes increased between 1999 and 2000.  This  was particularly true for corn shipments within the Minneapolis,  Minnesota, economic area, where rates went from about 3.5 cents per ton- mile in 1999 to about 4.2 cents per ton-mile in 2000.  The specific reasons  for this increase are not clear.  Corn production in Minnesota generally  decreased during this period, from about 990 million bushels in 1999 to  about 957 million bushels in 2000.  However, in November 1999, the U.S.  Department of Agriculture reported that, while corn production and  exports were expected to decrease, the domestic use of corn was expected  to remain strong, and that domestic use of corn was heavily dependent on  rail and truck transportation. Other than livestock feed, domestic use of  corn includes corn sweeteners (used in the soft drink industry) and ethanol  (a fuel additive).  Minnesota also has an active livestock industry, and the  state ranked third highest in the country in the number of hogs and pigs  produced and hogs marketed in 1999 (behind Iowa and North Carolina).
Rail rates for wheat and corn shipments appear to be sensitive to both  inter- and intramodal competition.  As shown in figure 3, rates for wheat  shipments from the Duluth, Minnesota, to the Chicago, Illinois, economic  areas—a potential Great Lakes water competitive route—continued to be  between 0.72 cents to just under 2 cents per ton-mile lower in 2000 than  rates on other medium-distance routes we examined that potentially had  fewer transportation alternatives (for example, shipments from Great  Falls).  In addition, as shown in figure 4, rail rates for corn shipments from  the Chicago and Champaign, Illinois, economic areas to the New Orleans,  Louisiana, economic area—potentially barge-competitive routes—were  substantially lower (up to 1.7 cents per ton-mile in 2000) than rates on  other medium-distance corn routes we examined that potentially had fewer  transportation choices (for example, shipments from the northern plains  states).  Sensitivity to intramodal (railroad-to-railroad) competition also  continued to be evident.  For example, rail rates from 1997 through 2000 for  wheat shipments originating in the Wichita, Kansas, and Oklahoma City,  Oklahoma, economic areas were about 1.4 cents per ton-mile lower than  rail rates for wheat shipments from the Great Falls economic area to the  Portland, Oregon, economic area over the same period.  The central plains  area is considered to have more railroad competition than the northern  plains area.
Shipment size can also influence railroad costs and, therefore, rates.   Loading more cars at one time increases efficiency and reduces a railroad’s  costs.  From 1997 through 2000, the average shipment size for wheat  continued to be higher in the central plains than in the northern plains.  For  example, the average shipment size for wheat from the Wichita economic  area from 1997 through 2000 was about 88 railcars, as compared with about  43 railcars for wheat shipments from the Great Falls economic area.  In  both instances, the average shipment size increased in the 1997 through  2000 period as compared with the 1990 through 1996 period—by about 17  railcars for wheat shipments from the Wichita area (from about 71 railcars  to about 88 railcars) and by about 5 railcars for wheat shipments from the  Great Falls area (from about 38 railcars to about 43 railcars).  As discussed  above, rates in the central plains states were typically lower than those in  the northern plains states for the routes we examined.
section_title: Chemicals and Transportation Equipment
paragraphs: Real rail rate changes for chemical and transportation equipment (motor  vehicles and motor vehicle parts) shipments were mixed for the 1997  through 2000 period for the markets we reviewed—some rates fell while  others stayed the same or increased.  These trends can be seen in short- distance (500 miles or less) shipments of plastics. (See fig. 5.)  Two of the  more notable trends are shipments within the Beaumont, Texas, and Lake  Charles, Louisiana, economic areas.  In the Beaumont economic area, real  rail rates increased from 42.6 cents per ton-mile in 1997 to 55.8 cents in  1998 before falling to 29.1 cents in 2000.  In the Lake Charles economic  area, rail rates increased from 25.9 cents per ton-mile in 1996 to 29.7 cents  per ton-mile in 1997 before falling (by about 78 percent) to 6.5 cents per  ton-mile in 1998.  After increasing again in 1999, the rates decreased to 4.8  cents per ton-mile in 2000 on this route.  Rates in the other markets  generally stayed about the same or decreased.  While it is not clear why  these rates changed the way they did, the changes came at the time (1997– 1998) of a severe service crisis in the Houston/Gulf Coast area.  Board  officials said that generally, in their view, it did not appear that railroads  used rail rates to allocate resources during the service crisis; they  suggested that the erratic nature of the year-by-year rate changes reported  for certain of these intra-terminal movements (which, according to the  board, tend to be small shipment sizes) may have been related to the  heterogeneous nature of this chemicals traffic and to the low sampling  rates for smaller shipment sizes—1 in 40 waybills for movements of 1 to 2  car shipments, and 1 in 12 waybills for 3 to 15 car shipments—in the  stratified Carload Waybill Sample.
Real rail rates for shipments of finished motor vehicles and motor vehicle  parts or accessories also showed a variety of trends.  In 1999, we reported  that one of the more dramatic changes in rates was for the transportation  of finished motor vehicles from Ontario, Canada, to Chicago.  (See fig. 6.)   The rates on this route decreased about 40 percent between 1990 and 1996.   Since that time, the rates on this route have largely stabilized at about 12  cents per ton-mile, with a slight increase between 1997 and 2000.  In  general, rail rates for the transportation of motor vehicle parts or  accessories on both long- and medium-distance routes decreased.  The  notable exception is rates for the transportation of motor vehicle parts or  accessories between the Detroit, Michigan, and Dallas, Texas, economic  areas.  On this route, the rates generally increased from about 9 cents per  ton-mile in 1997 to about 22 cents per ton-mile in 2000—about a 139  percent increase.  Most traffic in motor vehicles and motor vehicle parts or  accessories is either under contract or exempt from economic regulation.   Use of contracts suggests that rate decreases may be related to price  discounts offered in return for guaranteed volumes of business.  However,  board officials noted that in recent years, railroads have increasingly been  offering motor vehicle manufacturers service packages in which railroads  provide premium service for higher rates.  This may account for rate  increases on specific routes.
section_title: Proportion of Rail Industry Revenues Exceeding 180 Percent of Variable Costs Generally Were Stable
paragraphs: Between 1997 and 2000, the proportion of all railroad revenue that came  from shipments transported at rates that generated revenues exceeding 180  percent of variable costs stayed relatively constant at just under 30 percent.   (See fig. 7.)  This result is about 2 percentage points less than the average  for the 1990–1996 period.  In addition to being a jurisdictional threshold for  the board to review the reasonableness of rates, revenue-to-variable cost  ratios are sometimes used as indicators of shippers’ captivity to railroads.   If used in this way, the higher the R/VC ratio, the more likely it is that a  shipper can use only rail to meet its transportation needs.
Individual commodity results differed markedly.  In 2000, 62 percent of  chemicals (which include potassium, sodium, and plastics) and 42 percent  of coal were transported at rates generating revenues exceeding 180  percent of variable costs. However, only 17 percent of transportation  equipment (which includes motor vehicles and motor vehicle parts or  accessories) and 32 percent of farm products (which includes wheat and  corn) were transported at rates above this level.  Board officials suggested  that the comparatively high and rising R/VC ratios for chemicals traffic is  likely attributable in part to the fact that the railroads’ greater liability  exposure associated with transporting hazardous materials is not reflected  in the costs attributable to this traffic under the board’s rail costing system.   Board officials told us that higher rail rates for transporting hazardous  chemicals are reflected in higher revenues for a railroad.  However,  additional costs incurred because of the higher liability exposure (such as  court judgments against a company and set asides for future claims) are  shown as special or extraordinary charges that do not become part of the  variable costs of a movement in the board’s rail costing system.
In contrast to the fairly constant overall proportion of goods shipped with  revenues exceeding 180 percent, the results for four broad classes of  commodities decreased or increased noticeably.  For example, the  proportion of farm products transported at above 180 percent R/VC  increased from 23 percent to 32 percent from 1997 through 2000, following  an increase from 1990 to 1994 (from 22 to 32 percent) and a decline from  1994 to 1996 (from 32 to 23 percent).  The proportion of coal shipped above  this ratio decreased from 50 percent to 42 percent from 1997 through 2000,  continuing a gradual overall decrease from 1990.
In some instances, the average R/VC ratios for the 1997–2000 period were  considerably higher or lower than the average R/VC ratios for the 1990– 1996 period.  For example, the largest increase in average R/VC ratios for  the routes that we reviewed was for medium-distance shipments of plastics  from the Houston, Texas, economic area to the Little Rock, Arkansas,  economic area.  On this route, the average R/VC ratio increased by about 64  percentage points—from an average of 154 percent (1990–1996) to an  average of 218 percent (1997–2000).  The R/VC ratio on this route peaked at  250 percent in 1999.  The R/VC ratio on this route was generally increasing  while the rail rate was generally decreasing, suggesting that both rates and  variable costs were decreasing and that railroads did not pass on all cost  reductions to customers in the form of rate reductions.  In contrast, the  largest decrease in average R/VC ratios for the routes we examined was  about 116 percentage points, which occurred for motor vehicle shipments  between the Chicago economic area and the Dallas economic area—from  an average of 240 percent (1990–1996) to an average of 124 percent (1997– 2000).  Over this latter period, rail rates on this route decreased from about  8.7 cents per ton-mile in 1997 to about 8 cents per ton-mile in 2000.  This  suggests that variable costs increased during this period.
The R/VC ratios we observed are consistent with railroads’ ability to use  differential pricing, and they are sensitive to competition.  For example,  over the 1997–2000 period and the 1990–1996 period, the R/VC ratio for  medium-distance shipments of wheat from the Great Falls economic area  (a northern plains location) exceeded those for wheat shipments from the  Wichita, Oklahoma City, and Duluth economic areas for the specified  destinations.  (See fig. 8.)   There are fewer potentially competitive  alternatives to rail in the northern plains states.  In contrast, shipments  originating in the central plains states (for example, from Wichita and  Oklahoma City) are considered by some to have more alternatives to rail  than in the northern plains.  Duluth (a northern plains origin) offers a  competitive alternative of transportation by water.  The anomaly appears to  be medium-distance wheat shipments originating in the Grand Forks,  North Dakota, economic area (a northern plains origin) transported to the  St. Louis, Missouri, economic area.  The R/VC ratio for this route, although  consistently above the R/VC ratio for shipments from the Duluth economic  area (with potential water competition), was generally below that of  Wichita and Oklahoma City (with potentially more rail competition) from  1997 through 2000.  This suggests that wheat shipments on this route may  have been sensitive to barge competition from the Mississippi River or rail  competition in the central plains states or the Midwest.
The use of R/VC ratios has limitations.  In particular, the ratios are subject  to misinterpretation because they are simple divisions of revenues by  variable costs.  It is possible for rates paid by shippers to be dropping while  the R/VC ratio is increasing—a seemingly contradictory result.  For  example, if revenues (which are the rates paid by shippers) are $2 and  variable costs are $1, then the R/VC ratio is 200 percent.  If costs decrease  by 50 cents and railroads pass this cost decrease on to shippers by  decreasing rates by 50 cents, the R/VC ratio becomes 300 percent.   Therefore, by itself, the R/VC ratio could suggest that railroads are using  their market power to make shippers worse off when this might not be the  case.  Board officials suggested that the R/VC ratio shown in figure 8 for the  movement of wheat from the Great Falls economic area to the Portland  economic area is one such instance of this.  In this case, rail rates from  Great Falls generally decreased over the 1997 through 2000 period from  about 3.5 cents per ton-mile in 1997 to about 3.2 cents per ton-mile in 2000.   Board officials said unit costs were also decreasing, in part, because of  increases in shipment size and various carrier-specific productivity  improvements related to the 1995 Burlington Northern Railroad merger  with the Atchison Topeka & Santa Fe Railway Company.  The R/VC ratio on  this route increased from 240 percent in 1997 to 308 percent in 2000.   Similarly, using the example above, if variable costs increase by 50 cents  (from $1 to $1.50) and railroads increase their rates by the same amount  (from $2 to $2.50), then the R/VC ratio becomes 167 percent.  Again, the  R/VC ratio alone would suggest that shippers are better off—because the  R/VC ratio decreased from 200 percent—when this might not necessarily  be the case.
Although R/VC ratios have limitations, they can be useful indicators of  railroad pricing and of whether railroads may be using their market power  to set rates.  As described previously, the R/VC ratio is a jurisdictional  threshold for the Surface Transportation Board to consider rate relief  cases.  The board uses other analytical techniques to determine whether  rates are reasonable.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to the Surface Transportation Board and  the Department of Transportation for their review and comment.  The  board provided its comments in a meeting that included its general counsel  and chief economist.  In general, the board agreed with the material  presented in our draft report and stated that it accurately portrayed rail  rate trends over the period of our study.  It said that the overall trend of  declining rates that we found is consistent with studies and analyses  prepared by the board.  Board officials said that, while it can be difficult to  identify with specificity the reasons why rail rates might change in the  short run, especially rates for specific commodities over specific routes,  the draft report did an admirable job in discussing factors that could  influence rate changes.  Among the specific comments made were (1) that  low rail rates have allowed Western coal to penetrate Eastern coal markets  and (2) that R/VC ratios for chemicals may not fully reflect the costs of  increased liability exposure faced by railroads in transporting hazardous  chemicals.  We made changes to the report to reflect the board’s comments.
The board offered additional clarifying, presentational, and technical  comments that, with few exceptions, we incorporated into our report.
The Department of Transportation, in oral comments made by the director,  Office of Intermodal Planning and Economics, Federal Railroad  Administration, said that the report fairly and accurately portrayed the  changes in railroad freight rates over the study period, and that rail rates  were responsive to market conditions and competition.  The department  suggested that our Results in Brief section should indicate that R/VC ratios  cannot be relied upon as measures of railroad market power.  We modified  the Results in Brief to provide a fuller discussion of R/VC limitations.
As arranged with your office, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 21 days after the  date of this letter. At that time, we will send copies of this report to  congressional committees with responsibilities for freight railroad  competition issues; the administrator, Federal Railroad Administration; the  chairman, Surface Transportation Board; and the director, Office of  Management and Budget.  We will also make copies available to others  upon request.  This report will also be available on our home page at  http://www.gao.gov.
If you or your staff have any questions about this report, please contact  either James Ratzenberger at ratzenbergerj@gao.gov or me at  heckerj@gao.gov.  Alternatively, we may be reached at (202) 512-2834.  Key  contributors to this report were Stephen Brown, Richard Jorgenson, and  James Ratzenberger.
section_title: Scope And Methodology
paragraphs: As for our 1999 report, we used the board’s Carload Waybill Sample to  identify railroad rates from 1997 through 2000 (the latest data available at  the time of our review), which we then analyzed to determine rate changes.   The Carload Waybill Sample is a sample of railroad waybills (in general,  documents prepared from bills of lading authorizing railroads to move  shipments and collect freight charges) submitted by railroads annually.  We  used these data to obtain information on rail rates for specific commodities  in specific markets by shipment size and length of haul.  According to  board officials, revenues derived from the Carload Waybill Sample are not  adjusted for such things as year-end rebates and refunds that may be  provided by railroads to shippers who exceed certain volume  commitments.
Some railroad movements contained in the Carload Waybill Sample are  governed by contracts between shippers and railroads.  To avoid disclosure  of confidential business information, the board disguises the revenues  associated with these movements before making this information available  to the public.  Consistent with our statutory authority to obtain agency  records, we obtained a version of the Carload Waybill Sample that did not  disguise revenues associated with railroad movements made under  contract.  Therefore, the rate analysis presented in this report presents a  truer picture of rail rate trends than analyses that may be based solely on  publicly available information.  Since much of the information contained in  the Carload Waybill Sample is confidential, rail rates and other data  contained in this report that were derived from this database have been  aggregated at a level sufficient to protect this confidentiality.
As in our 1999 report, we analyzed coal, grain (wheat and corn), chemicals  (potassium and sodium compounds and plastic materials or synthetic  fibers, resins, or rubber), and transportation equipment (finished motor  vehicles and motor vehicle parts or accessories) shipments.  These  commodities represented about 52 percent of total industry revenue in  2000 and, in some cases, had a significant portion of their rail traffic  transported on routes where the ratio of revenue to variable costs equaled  or exceeded 180 percent.
We used rate indexes and average rates on selected corridors to measure  rate changes over time.  A rate index attempts to measure price changes  over time by holding constant the underlying collection of items that are  consumed (in the context of this report, items shipped).  This approach  differs from comparing average rates in each year because, over time,  higher- or lower-priced items can constitute different shares of the items  consumed.  Comparing average rates can confuse changes in prices with  changes in the composition of the goods consumed.  In the context of  railroad transportation, rail rates and revenues per ton-mile are influenced,  among other things, by average length of haul.  Therefore, comparing  average rates over time can be influenced by changes in the mix of long-  and short-haul traffic.  Our rate indexes attempted to control for the  distance factor by defining the underlying traffic collection to be  commodity flows occurring in 2000 between pairs of census regions.
To examine the rate trends on specific traffic corridors, we first chose a  level of geographic aggregation for corridor endpoints.  For grain,  chemical, and transportation equipment traffic, we defined endpoints to be  regional economic areas defined by the Department of Commerce’s Bureau  of Economic Analysis.  For coal traffic, we used economic areas to define  destinations and used coal supply regions—developed by the Bureau of  Mines and used by the Department of Energy—to define origins.  An  economic area is a collection of counties in and about a metropolitan area  (or other center of economic activity); there are 172 economic areas in the  United States, and each of the 3,141 counties in the country is contained in  an economic area.  As in our 1999 report, we placed each corridor in one of  three distance-related categories: 0–500 miles, 501–1,000 miles, and more  than 1,000 miles.  Although these distance categories are somewhat  arbitrary, they represent reasonable proxies for short-, medium-, and long- distance shipments by rail.
To address issues related to revenue-to-variable cost ratios we obtained  data from the board identifying revenues, variable costs, and R/VC ratios  for commodities shipped by rail at the two-digit Standard Transportation  Commodity Code level.  We used data from the Carload Waybill Sample to  identify the specific revenues and variable costs and to compute R/VC  ratios for the commodities and markets we examined.  Using this  information we then identified those commodities and markets whose  R/VC ratios were consistently above or below the 180 percent R/VC level.
We performed our work from December 2001 through May 2002, in  accordance with generally accepted government auditing standards.
section_title: Real Rail Rates for Coal
paragraphs: The following are real (inflation-adjusted) rail rates for coal shipments in  the various markets and distance categories we reviewed.  The distance  categories are as follows:  short is 0 to 500 miles, medium is 501 to 1,000  miles, and long is greater than 1,000 miles.
section_title: Real Rail Rates for Wheat and Corn Shipments
paragraphs: The following are real (inflation-adjusted) rail rates for wheat and corn  shipments in the various markets and distance categories we reviewed.   The distance categories are as follows:  short is 0 to 500 miles, medium is  501 to 1,000 miles, and long is greater than 1,000 miles.
section_title: Real Rail Rates for Chemicals and Transportation Equipment
paragraphs: The following are real (inflation-adjusted) rail rates for selected chemical  and transportation equipment shipments in the various markets and  distance categories we reviewed.  The distance categories are as follows:   short is 0 to 500 miles, medium is 501 to 1,000 miles, and long is greater  than 1,000 miles.
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