Freight Railroads: Industry Health Has Improved, but Concerns about Competition and Capacity Should Be Addressed
Published: 2006-10-06T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Staggers Rail Act deregulated the freight rail industry, relying on competition to set rates, and allowed for differential pricing (charging higher rates to those more dependent on rail). The act gave the Surface Transportation Board (STB) authority to develop remedies for shippers "captive" to one railroad and set a threshold for shippers to apply for rate relief. GAO was asked to review (1) changes in the railroad industry since the Staggers Rail Act, including rates and competition; (2) STB actions to address competition and captivity concerns and alternatives that could be considered; and (3) freight demand and capacity projections and potential federal policy responses. GAO examined STB data, conducted interviews, and held an expert panel.
section_title: What GAO Found
paragraphs: Changes in the railroad industry since the Staggers Rail Act are widely viewed as positive, as the industry's financial health has improved and most rates have declined; however, concerns over competition and captivity remain. Rail rates generally declined between 1985 and 2000, then increased slightly from 2001 through 2004. Concerns about competition and captivity remain as traffic is concentrated in fewer railroads. It is difficult to determine the number of "captive" shippers as proxy measures can overstate or understate captivity. Nevertheless, GAO's analysis of limited available measures indicates that the extent of captivity appears to be dropping, but the percentage of traffic traveling at rates substantially over the threshold for rate relief has increased. Also, some areas with access to only one major railroad have higher percentages of traffic traveling at rates above the threshold. These findings may reflect reasonable economic practices by the railroads or a possible abuse of market power. GAO's analysis is limited by available data and proxy measures but suggests that shippers in selected markets may be paying excessive rates, meriting further inquiry and analysis. While STB has taken action, further efforts to improve its rate relief processes and assess competition could help address competition and captivity concerns and inform the merits of proposed alternative approaches. STB's rate relief processes are largely inaccessible and rarely used. STB recognizes this and is taking steps to improve its processes. STB has broad statutory authority to inquire into and report on railroad industry practices and, given a reasonable possibility that some shippers may be paying excessive rates, an assessment of competition could determine whether there is sufficient evidence that market power is being abused in specific markets. While competition between railroads may not always be feasible, alternative approaches have costs and benefits that should be carefully considered to ensure the balance envisioned in the Staggers Rail Act--including the railroads' need for adequate revenues. Significant increases in freight traffic are forecast, and the industry's ability to meet them is largely uncertain. Investments in rail projects can produce public benefits, such as reducing highway congestion. As a result, federal and state governments have increasingly participated in freight rail projects. In 2005, for example, Congress provided $100 million for rail improvements in the Chicago area. Congress faces additional decisions about potential federal policy responses in years ahead. Responses should recognize that the freight transportation system includes many modes that are treated differently by the federal government and functions in a competitive marketplace and a constrained federal funding environment. In developing a National Freight Policy, the Department of Transportation (DOT)has made a good start by providing context for those decisions and DOT can help sustain the role of the competitive marketplace through strategies that promote a level playing field for freight transportation decision making and acknowledge the constrained federal fiscal environment by focusing federal involvement where demonstrable, wide-ranging public benefits exist.

section_title: Letter
paragraphs: Over 25 years ago, Congress transformed federal regulation of the railroad  industry. After almost 100 years of economic regulation, the railroad  industry was in serious economic trouble in the 1970s, with rising costs,  losses, and bankruptcies. In response, Congress passed the Railroad  Revitalization and Regulatory Reform Act of 1976 and the Staggers Rail  Act of 1980. Together, these pieces of legislation substantially deregulated  the railroad industry. In particular, the 1980 act encouraged greater  reliance on competition to set rates and gave railroads increased freedom  to price their services according to market conditions, including the  freedom to use differential pricing—that is, to recover a greater proportion  of their costs from rates charged to shippers with a greater dependency on  rail transportation. At the same time, the 1980 act anticipated that some  shippers might not have competitive alternatives—commonly referred to  as “captive shippers”—and gave the Interstate Commerce Commission  (ICC), and later the Surface Transportation Board (STB), the authority to  establish a process so that shippers could obtain relief from unreasonably  high rates. However, only a rate that produces revenue equal to at least  180 percent of the variable cost of transporting the shipment can be  challenged. Since the passage of the Staggers Rail Act in 1980, we have  issued several reports on the freight railroad industry. These reports  described the significant changes that have taken place in the railroad  industry and reported that rates have generally decreased, but shippers  and others have found the rate relief process long, complex, and  expensive.
Policymakers continue to believe that the federal government should  provide a viable process to protect shippers against unreasonably high  rates, as well as address competition issues, while still balancing the  interests of both railroads and shippers. Over the past 10 years, significant  consolidation has taken place in the freight railroad industry, while  railroads—particularly Class I railroads— have seen their productivity  and financial health improve. Railroad officials worry that any attempt to  increase economic regulation will reduce carriers’ ability to earn sufficient  revenues and limit future infrastructure investment. At the same time, a  number of academic and government studies are predicting a significant  increase in the demand for freight rail over the next 10 to 15 years. In light  of these concerns, we reviewed  the changes that have occurred in the freight railroad industry since the  enactment of the Staggers Rail Act, including changes in rail rates and  competition in the industry;  the actions STB has taken to address concerns about competition and  captivity and any alternative approaches that could be considered to  address remaining concerns; and the projections for freight traffic demand over the next 15 to 25 years, the  freight railroad industry’s projected ability to meet that demand, and  potential federal policy responses.
To fulfill our objectives, we examined STB’s Carload Waybill Sample from  1985 through 2004 (the latest data available at the time of our review).  This database includes information on rail rates, tonnage, federal  regulation, and other statistics but disguises some revenues to avoid  disclosing confidential business information to the public. We obtained a  version of the Carload Waybill Sample that did not disguise revenues. We  held an expert panel consisting of 11 individuals with expertise in the  freight railroad industry and the economics of transportation deregulation.  Those individuals are listed in appendix I. We also interviewed, and  reviewed information from, representatives of each Class I railroad in  North America, shipper groups, economists, and experts in the rail  industry. In addition, we reviewed pending legislation, transportation  planning literature, and forecasts of future freight rail demand and  capacity, including syntheses of such forecasts; and interviewed federal  and state transportation officials, financial market analysts, national  association representatives, and transportation experts. We determined  that the data used in this report were sufficiently reliable for the purpose  of our review. We conducted our review from June 2005 to August 2006 in  accordance with generally accepted government auditing standards.  Details of our objectives, scope, and methodology appear in appendix II.
subsections: section_title: Background
paragraphs: In the past, the ICC regulated almost all of the rates that railroads charged  shippers. The Railroad Revitalization and Regulatory Reform Act of 1976  and the Staggers Rail Act of 1980 greatly increased reliance on competition  to set rates in the railroad industry. Specifically, these acts allowed  railroads and shippers to enter into confidential contracts that set rates  and prohibited ICC from regulating rates where railroads had either  effective competition or rates negotiated between the railroad and the  shipper. Furthermore, the ICC Termination Act of 1995 abolished ICC and  transferred its regulatory functions to STB. Taken together, these acts  anchor the federal government’s role in the freight rail industry by  establishing numerous goals for regulating the industry, including to    allow, to the maximum extent possible, competition and demand for  services to establish reasonable rates for transportation by rail;    minimize the need for federal regulatory control over the rail  transportation system and require fair and expeditious regulatory  decisions when regulation is required;   promote a safe and efficient rail transportation system by allowing rail  carriers to earn adequate revenues, as determined by STB;   ensure the development and continuation of a sound rail transportation  system with effective competition among rail carriers and with other  modes to meet the needs of the public and the national defense; foster sound economic conditions in transportation and ensure effective  competition and coordination between rail carriers and other modes:   maintain reasonable rates where there is an absence of effective  competition and where rail rates provide revenues that exceed the amount  necessary to maintain the rail system and attract capital;    prohibit predatory pricing and practices to avoid undue concentrations of    provide for the expeditious handling and resolution of all proceedings.
While the Staggers Rail and ICC Termination Acts reduced regulation in  the railroad industry, they maintained STB’s role as the economic  regulator of the industry. The federal courts have upheld STB’s general  powers to monitor the rail industry, including its ability to subpoena  witnesses and records and to depose witnesses. In addition, STB can  revisit its past decisions if it discovers a material error, or new evidence,  or if circumstances have substantially changed.
Two important components of the current regulatory structure for the  railroad industry are the concepts of revenue adequacy and demand-based  differential pricing. Congress established the concept of revenue adequacy  as an indicator of the financial health of the industry. STB determines the  revenue adequacy of a railroad by comparing the railroad’s return on  investment with the industrywide cost of capital. For instance, if a  railroad’s return on investment is greater than the industrywide cost of  capital, STB determines that railroad to be revenue adequate. Historically,  ICC and STB have rarely found railroads to be revenue adequate—a result  that many observers relate to characteristics of the industry’s cost  structure. Railroads incur large fixed costs to build and operate networks  that jointly serve many different shippers. Some fixed costs can be  attributed to serving particular shippers, and some costs vary with  particular movements, but other costs are not attributable to particular  shippers or movements. Nonetheless, a railroad must recover these costs  if the railroad is to continue to provide service over the long run. To the  extent that railroads have not been revenue adequate, they may not have  been fully recovering these costs.
The Staggers Rail Act recognized the need for railroads to use demand- based differential pricing to promote a healthy rail industry and enable it  to raise sufficient revenues to operate, maintain and, if necessary, expand  the system in a deregulated environment. Demand-based differential  pricing, in theory, permits a railroad to recover its joint and common  costs—those costs that exist no matter how many shipments are  transported, such as the cost of maintaining track— across its entire  traffic base by setting higher rates for traffic with fewer transportation  alternatives than for traffic with more alternatives. Differential pricing  recognizes that some customers may use rail if rates are low—and have  other options if rail rates are too high or service is poor. Therefore, rail  rates on these shipments generally cover the directly attributable  (variable) costs, plus a relatively low contribution to fixed costs. In  contrast, customers with little or no practical alternative to rail—”captive”  shippers—generally pay a much larger portion of fixed costs. Moreover,  even though a railroad might incur similar incremental costs while  providing service to two different shippers that move similar volumes in  similar car types traveling over similar distances, the railroad might charge  the shippers different rates. Furthermore, if the railroad is able to offer  lower rates to the shipper with more transportation alternatives, that  shipper still pays some of the joint and common costs. By paying even a  small part of total fixed cost, competitive traffic reduces the share of those  costs that captive shippers would have to pay if the competitive traffic  switched to truck or some other alternative. Consequently, while the  shipper with fewer alternatives makes a greater contribution toward the  railroad’s joint and common costs, the contribution is less than if the  shipper with more alternatives did not ship via rail.
The Staggers Rail Act further requires that the railroads’ need to obtain  adequate revenues to be balanced with the rights of shippers to be free  from, and to seek redress from, unreasonable rates. Railroads incur  variable costs—that is, the costs of moving particular shipments—in  providing service. The Staggers Rail Act stated that any rate that was  found to be below 180 percent of a railroad’s variable cost for a particular  shipment could not be challenged as unreasonable and authorized ICC,  and later STB, to establish a rate relief process for shippers to challenge  the reasonableness of a rate. STB may consider the reasonableness of a  rate only if it finds that the carrier has market dominance over the traffic  at issue—that is, if (1) the railroad’s revenue is equal to or above 180  percent of the railroad’s variable cost (R/VC) and (2) the railroad does not  face effective competition from other rail carriers or other modes of  transportation.
section_title: Railroad Industry Increasingly Healthy and Rates Generally Down Since Enactment of the Staggers Rail Act, but Concerns about Competition and Captivity Remain
paragraphs: The changes that have occurred in the railroad industry since the  enactment of the Staggers Rail Act are widely viewed as positive. The  railroad industry’s financial health improved substantially as it cut costs,  boosted productivity, and right-sized its networks. Rail rates generally  declined between 1985 and 2000 but increased slightly from 2001 through  2004. Likewise, rail rates have declined since 1985 for certain commodity  groups and routes despite some increases since 2001, but rates have not  declined uniformly, and some commodities are paying significantly higher  rates than others. For example, from 1985 through 2004, coal rates  declined 35 percent while grain rates increased 9 percent. Concerns about  competition and captivity in the industry remain because traffic is  concentrated in fewer railroads. It is difficult to determine precisely how  many shippers are captive to one railroad. Nevertheless, our analysis  indicates that the extent of potential captivity appears to be dropping, but  that the percentage of all industry traffic running at rates substantially  over the statutory threshold for rate relief—traffic traveling at rates over  180 percent R/VC—has increased. Furthermore, some areas with access to  only one Class I railroad have higher percentages of traffic traveling at  rates that exceed the statutory threshold for rate relief. This situation may  reflect reasonable economic practices by the railroads in an environment  of excess demand, or it may represent an abuse of market power.
subsections: section_title: Railroad Industry’s Financial Health Has Improved Substantially
paragraphs: There is widespread consensus that the freight rail industry has benefited  from the Staggers Rail Act. Ten of the 11 members of our expert panel  believed that the Staggers Rail Act has had a strongly positive overall  effect on freight railroad companies, while 8 believed the Staggers Rail Act  had a strongly positive effect on shipping companies. In addition, various  measures indicate an increasingly strong freight railroad industry. Freight  railroads’ improved financial health is illustrated by a general increase in  return on investment since 1980, as shown in figure 1. Freight railroads  have also cut costs by streamlining their workforces; right-sizing their rail  networks; and reducing track miles, equipment, and facilities to more  closely match demand.
Freight railroads have also expanded their business into new markets— such as the intermodal market—and implemented new technologies,  including larger cars, and are currently developing new scheduling and  train control systems. Some observers believe that the competition faced  by railroads from other modes of transportation has created incentives for  innovative practices, and that the ability to enter into confidential  contracts with shippers has permitted railroads to make specific  investments and to develop service arrangements tailored to the  requirements of different shippers.
Clifford Winston, Deregulation of Network Industries – What’s Next? (Washington: AEI- Brookings Joint Center for Regulatory Studies: 2000), pp. 43-44.
Freight rail is an important component of our nation’s economy.  Approximately 42 percent of all intercity freight in the United States,  measured in ton-miles, moves on rail lines. Freight rail is particularly  important to producers and users of certain commodities. For example,  about 70 percent of automobiles manufactured domestically and about 70  percent of coal delivered to power plants moves on freight rail.
section_title: Industrywide Rates Declined from 1985 through 2000 and Rose Slightly from 2001 through 2004
paragraphs: Rail rates across the freight railroad industry have generally declined since  the enactment of the Staggers Rail Act. Because changes in traffic patterns  over time (for example, hauls over longer distances) can result in a  decrease in the average revenue per ton-mile, purely relying on cents per  ton-mile can present misleading industrywide rate trends. Therefore, we  developed a set of rail rate indexes to examine trends in rail rates over  the 1985 through 2004 period. These indexes account for changes in traffic  patterns over time that could affect revenue statistics but do not account  for inflation. To provide a measure for inflation, we also included the price  index for the gross domestic product (GDP) in figure 2.
From 1985 through 1987, rail rates dropped by 10 percent and then  continued to decline, although not as steeply, through 1998. Rates  increased in 1999, then dropped again in 2000. In 2001 and 2002 rates rose  again. Rates were nearly flat in 2003 and 2004, finishing approximately 3  percent above rates in 2000, but were 20 percent below 1985 rates (These  trends are shown in figure 2). While our rail rate index does not reflect the  general effects of inflation, the continuous increases in the GDP price  index over this period indicate that real rates decreased by more than 20  percent from 1985 through 2004. Rate data are not available for 2005 and  2006, but shippers, railroad officials, and financial analysts with whom we  spoke told us that rates have generally increased during those years.
section_title: For Many Commodities and Particular Routes, Rates Have Also Declined Since 1985, but Declines Are Not Uniform
paragraphs: Similar to industrywide changes in rail rates, the rates for many  commodities have declined since 1985 and have recently increased. In  2004, four commodities each made up 5 percent or more of freight railroad  revenue—grain, coal, motor vehicles, and miscellaneous mixed shipments.  In both the 1985 through 1989 and the 1990 through 1999 intervals, the  rates for most of these commodities declined, while in 2000 through 2004,  the rates increased for two commodities and decreased for two (see fig. 3).
Although many rates have decreased, rates have not declined uniformly,  and rates for some commodities are significantly higher than for others.  Figure 4 compares commodity rates for coal, grain, miscellaneous mixed  shipments, and motor vehicles from 1985 through 2004 using our rail rate  index. Over the 20-year period most rates declined, with coal rates  dropping the most sharply by 35 percent. Miscellaneous mixed shipments  and motor vehicle rates also declined, although to a lesser extent than coal  rates. Grain rates initially declined from 1985 through 1987, but then  diverged from the other commodity trends and increased, resulting in a  net 9 percent increase by 2004.
We examined rate changes for commodities traveling along hundreds of  particular routes and found that the rates on a majority of the routes we  analyzed decreased from 2000 through 2004. Figure 5 shows that from  2000 through 2004 rail rates decreased on about 55 percent of the routes in our analysis(334 of 604 routes). More specifically, the rates for most  long-distance (over 1,000 miles) and medium-distance (501 to 1,000 miles) routes decreased. In one distance category, short-distance routes (up to  500 miles), there were more routes with increases (103) than decreases (94), from 2000 through 2004. While figure 5 shows that, for the long- distance routes we examined, the number of routes with rate decreases  was nearly twice the number of routes with rate increases. Many of the  largest rate increases were on long-distance routes carrying miscellaneous  mixed shipments—which include intermodal goods—that originated in the  Los Angeles-Long Beach-Riverside, California, economic area and  terminated at various destinations across the country. Several shipper  groups reported that many rate increases occurred after 2004; however,  data are not available for 2005 and 2006.
section_title: Many Factors May Have Contributed to Recent Rate Increases
paragraphs: Several factors could have contributed to recent rate increases. Ongoing  industry and economic changes have influenced how railroads have set  their rates. Since the Staggers Rail Act was enacted, the railroad industry  and the economic environment in which it operates have changed  considerably. After years of reducing the size of its workforce and  shedding track capacity, the industry is increasingly operating in a  capacity-constrained environment in which the demand for its services  exceeds its capacity in some areas. In addition, the industry has more  recently increased employment and invested in increased capacity in key  traffic corridors. Additionally, changes in broader domestic and world  economic conditions have led to changes in the mix and profitability of  traffic carried by railroads. For example, railroads have developed high- volume traffic by shipping import and export containers, leading them to  price these shipments differently. According to DOT officials, some  shippers—such as those in the automobile and chemical industries—may  pay higher rates in order to secure higher quality service or due to liability  issues. Lastly, the rail industry has continued to consolidate, potentially  increasing the market power of the largest railroads. Our analysis included  rate data through 2004, and according to freight railroad officials,  shippers, and financial analysts, since 2004, rates have continued to  increase as the demand for freight rail service has increased, and rail  capacity has not kept pace with demand.
section_title: Other Costs Have Shifted to Shippers, and Some Charges Are Not Accurately Tracked
paragraphs: While rates have generally decreased since 1985, other costs have been  passed on to shippers, some of which STB has not accurately tracked.  Several shippers with whom we spoke agreed that rates have dropped  over the long-term, but they also said that rates do not reflect the total cost  of shipping by rail. According to some shippers, costs have shifted from  the railroads to shipping companies, including the costs of railcar  ownership. Figure 6 shows that tons carried by railcar ownership has  shifted nearly 20 percent since 1985, indicating less tonnage shipped on  railcars owned by freight railroad companies.
Besides rates, other costs that shippers reported were infrastructure  upgrade costs, fuel surcharges,  and congestion fees. Conversely, one  Class I railroad told us that some rates in the Carload Waybill Sample do  not account for rebates or incentives that may change the actual rate paid by the shipper. We are unable to report on the full extent of all costs  because STB has not accurately tracked the railroad revenues associated  with some of these charges. For example, freight railroad companies do  not consistently report revenues raised from fuel surcharges for use in the  Carload Waybill Sample. Some railroads report fuel surcharges as part of their general revenues, while others categorize the surcharges separately  under a miscellaneous revenue category, and still other railroads may not report revenue collected from fuel surcharges at all. Shippers have  expressed deep concerns over how fuel surcharges relate to actual fuel  costs. Other railroad revenues, such as those generated at railcar auctions and through congestion fees, may not be included in the waybill  sample either. Understanding what railroads do and do not report as  miscellaneous revenue in the waybill sample may be of increasing  importance because fuel surcharges have become more prevalent, and  railroad revenue reported as miscellaneous revenue has substantially risen  in recent years. From 2000 through 2004, the miscellaneous revenue  reported in the waybill sample has more than quadrupled in value, from  $141 million to $614 million (see fig. 7). Although an increase in value,  $614 million still represents less than 1.5 percent of the approximately $42  billion in freight railroad revenue reported for 2004. Since 2004,  miscellaneous revenue may have further increased as railroad and shipper  groups with whom we spoke said that many fuel surcharge increases took  effect in 2005. During our review, STB proposed to more closely track and  otherwise monitor revenues associated with fuel surcharges.
section_title: Competition and Captivity Concerns Remain
paragraphs: Concerns about competition and captivity in the railroad industry remain  because traffic is concentrated in fewer railroads, although there is  disagreement on the state of competition in the industry. It is difficult to  determine the number of captive shippers, because proxy measures can  overstate or understate captivity, but our analysis of available measures  indicates that the extent of captivity is dropping. At the same time, the  percentage of all industry traffic running substantially over the statutory  threshold for rate relief has increased from about 4 percent of tonnage in  1985 to about 6 percent of tonnage in 2004. Furthermore, some economic  areas with access to one Class I railroad have higher percentages of traffic  traveling at rates that exceed the statutory threshold for rate relief.
subsections: section_title: The Freight Railroad Industry Has Become More Concentrated
paragraphs: During the past 30 years, the freight railroad industry has become more  concentrated. In 1976, there were 30 independent Class I railroad systems,  consisting of 63 Class I railroads operating in the United States. Currently  there are seven railroad systems, consisting of seven Class I railroads.  Nearly half of that reduction was attributable to consolidations. The  railroad industry is dominated by four Class I railroads—two in the East  and two in the West. As figure 8 shows, the market share of these four  Class I railroads has been increasing and accounted for over 89 percent of  the industry’s revenues in 2004.
There is significant disagreement on the state of competition in the rail  industry and on whether or not federal regulation—resulting from  legislation such as the Staggers Rail Act—has ensured effective  competition among railroads. This disagreement was represented on our  panel of 11 experts, 6 of whom indicated that rail-to-rail competition has  been achieved (either “greatly” or “somewhat”) and 4 of whom maintained  that effective competition had not been achieved. One member of our  panel viewed less competition among rail carriers as a negative  development because it can result in less efficient railroad companies and  fewer options for shipping companies. Another member of our panel said  that industry consolidation was essential to achieving an efficient and  complete rail network under fewer, but ultimately stronger, railroad  companies. Other experts also pointed to the hundreds of short-line  railroads that have come into being since the enactment of the Staggers  Rail Act, as well as increases in other competitive options for shippers  from other modes such as trucks and barges.
A reduction in competitive options can have a significant impact on the  rates railroads charge shippers. There are a variety of contexts that affect  how railroads compete with each other and with other modes, such as  when route origins and destinations can both be reached by more than one  railroad, or by multiple modes of transportation. Comparing two routes  for shipping the same commodity, but using a different number of rail  carriers, can illustrate this effect. Figure 9 shows two long-distance grain  routes that both terminate in the Portland, Oregon, economic area from  different origin points. Both routes carry comparable tonnage, but the  route originating in the economic area in and around Sioux Falls, South  Dakota, is served by two Class I railroads, whereas the route from the  Minot, North Dakota, economic area is served by one Class I railroad. The  rates for the Minot route are roughly double the rates for the Sioux Falls  route.
The ability to build out to another railroad can also create competition and  improve railroad rates for some shippers. For example, following a build- out, a shipper gained access to a second railroad at an origin point that  had previously been served by one Class I railroad. Figure 10 shows that  within a few years after the introduction of service by the second railroad,  the rates had dropped significantly. Because even a short segment build- out can be quite costly, shippers are unlikely to pursue build-out options  without a substantial traffic base. Some experts with whom we spoke said  that situations like the one depicted in figure 9 reflect the reality of  differential pricing in the freight railroad industry, or they suggest that  other factors such as differences in the length of two different routes may  be the cause of rate discrepancies. Others believe that a significant rate  decrease after the introduction of competition is evidence that railroads  are extracting monopoly rates from captive shippers.
While competition between rail carriers is particularly important in some  cases, in other cases, competition between rail and other transportation  modes, such as trucks and barges, may be more important. Particularly for  bulk commodities (i.e., grain), when shipper locations can be served by  barge transportation, rail rates will be lower relative to rail costs than on  routes that are not conducive to barge competition. Figure 11 depicts costs  and revenues for two routes, one (from the Champaign, Illinois economic  area to the New Orleans, Louisiana economic area) with rail and barge  options, and the other (from the Champaign, Illinois economic area to the  Atlanta, Georgia economic area) with just a rail option. Although both  routes have the same origin, for shipping the same commodity over a  comparable distance, the route with the barge option has consistently  lower rates than the route with just rail service.
Besides the number of rail carriers serving a location, the use of contracts  for rail service can affect the competitive landscape. The Staggers Rail Act  allowed railroad and shipping companies to enter into confidential  contracts for rail service and also placed all traffic running under contract  outside the remaining rate regulations. According to railroad and shipper  groups, the duration of contracts has declined, in part because of the  railroads’ desire to quickly react to shifting market demand, which can  result in charging higher rates. Other shippers were concerned that  moving away from confidential contracts to public pricing could represent  price signaling and further reduce competition between railroads. In 2004,  70 percent of tonnage and 71 percent of industry revenue moved under  contract.
section_title: Captive Shippers Are Difficult to Identify, but Available Measures Indicate Captivity Dropping in the Railroad Industry
paragraphs: It is difficult to determine precisely how many shippers are “captive” to  one railroad because the proxy measures that provide the best indication  can overstate or understate captivity. One way of determining potential  captivity is to identify which Bureau of Economic Analysis (BEA)  economic areas were served by only one Class I railroad. In 2004, 27 of  the 177 BEA economic areas were served by only one Class I railroad. As  shown in figure 12, these areas include parts of Montana, North Dakota,  New Mexico, Maine, and smaller areas in several states.
Another way of looking at potential captivity is to calculate how much  route tonnage originating in a given economic area has access to only one  Class I railroad. Figure 13 shows the percentage in 2004 of all industry  tonnage originating in economic areas with access to only one Class I  railroad. In particular, economic areas with more than 75 percent of  tonnage shipped on one railroad appear most prevalent in states such as  Montana, Idaho, North Dakota, and Texas. Tonnage originating in these  economic areas varies widely, from a little over 55,000 tons to over 36  million tons.
According to our analysis of available measures, the overall extent of  captivity appears to be dropping in the freight railroad industry. We  examined tonnage, revenue, and access statistics for all routes— originating and terminating in economic areas—captured in the Carload  Waybill Sample and other DOT data. In 2004, origin and destination routes  with access to only one Class I railroad carried 12 percent of industry  revenue and 10 percent of industry tonnage, which represents a decline  from 1994, when 22 percent of industry revenue and 21 percent of industry  tonnage moved on routes served by one Class I railroad (see table 1).
This decline suggests that more railroad traffic is traveling on routes with  access to more than one Class I railroad. While overall industry tonnage  with access to more than one Class I railroad appears to have increased,  some economic areas have a higher percentage of all industry traffic  tonnage shipping on one Class I railroad. From 1994 through 2004, parts of  states such as Texas, Tennessee, and Montana experienced increases of 25  percent or more in tonnage with access to one Class I railroad while parts  of other states such as Oregon, New York, and Florida saw their  percentages of tonnage with access to one Class I railroad drop by more  than 25 percent (see fig. 14).
While examining BEA areas provides a proxy measure for captivity, a  number of factors may understate or overstate whether shippers are  actually captive. The first three factors may work to understate the extent  of captivity among shippers. First, routes originating within economic  areas served by multiple Class I railroads may still be captive if only one  Class I railroad serves their destination, and a shipper must use that one  railroad for that particular route. Second, some BEA areas are quite large,  so a shipper within the area may have access to only one railroad, even  though there are two or more railroads within the broader area. Third, an  origin may only be served by one Class I railroad, but one Class I railroad  does not serve the entire route, meaning the route may be partially captive,  although more than one Class I railroad provides service between its  origin and destination. Two additional limitations may work to overstate  the number of locations captive to one railroad. First, this analysis  accounts for Class I railroads only and does not account for competitive  rail options that might be offered by Class II or III railroads such as the  Guilford Rail System, which operates in northern New England. Second,  this analysis considers only competition among rail carriers and does not  examine competitive options offered by rail and other transportation  alternatives such as trucks and barges.
section_title: Amount of Potentially Captive Traffic Traveling at Rates at Levels Substantially above the Threshold for Rate Relief Has Increased
paragraphs: To determine potential captivity, we applied another measure— traffic  traveling at rates equal to or greater than 180 percent R/VC, which is part  of the statutory threshold for bringing a rate relief case before STB. STB  regards traffic at or above this threshold as “potentially captive.” As with  BEA areas, examining R/VC levels as a proxy measure for captivity can  also understate or overstate captivity. For example, it is possible for the  R/VC ratio to increase while the rate paid by a shipper is declining.  Assume that in Year 1, a shipper is paying a rate of $20 and the railroad’s  variable cost is $12; the R/VC ratio—a division of the rate and the variable  cost—would be 167 percent. If in Year 2, the variable costs decline by $2  from $12 to $10 and the railroad passes this cost savings directly on to the  shipper in the form of a reduced rate, the shipper would pay $18 instead of  $20. However, as shown in table 2, because both revenue and variable cost  decline, the R/VC ratio increases to 180 percent.
Since 1985, and as a percentage of all traffic, the amount of potentially  captive traffic traveling at rates over 180 percent R/VC and the revenue  generated from that traffic have both declined. Revenue generated from  traffic traveling at rates over 180 percent R/VC decreased from 41 percent  of all industry revenue in 1985 to 29 percent in 2004 (see fig. 15).
However, since 1985, tonnage from traffic traveling at rates substantially  over the threshold for rate relief has increased. Total industry tonnage has  increased significantly (from 1.37 billion tons in 1985 to 2.14 billion tons in  2004), with the tonnage traveling at rates above 300 percent R/VC more  than doubling—from about 53 million tons in 1985 to over 130 million tons  in 2004 (see fig. 16).
As a percentage of all industry traffic, traffic traveling at rates between 180  and 300 percent R/VC decreased from 36 percent in 1985 to 25 percent in  2004. In contrast, the percentage of all industry traffic traveling at rates  above 300 percent R/VC increased from 4 percent in 1985 to 6 percent in  2004 (see fig. 17).
Increases in traffic traveling at rates over 300 percent R/VC appear widely  distributed throughout the country, although in some areas increases have  been higher than in others. Four economic areas located in parts of  Montana, New Mexico, North Dakota, and West Virginia had the largest  increases in traffic traveling at rates over 300 percent R/VC, with an  increase of more than 25 percent from 1985 through 2004 (see fig. 18).
In addition to national changes, significant increases in traffic traveling at  rates over 300 percent R/VC can be seen in certain states, for certain  commodities, and for certain routes. For example, in 1985 virtually no coal  originating in Ohio traveled at rates over 300 percent R/VC. In 2004, nearly  half of coal traffic originating in Ohio traveled at rates over 300 percent  R/VC. Increases in traffic traveling at rates over 300 percent R/VC can also  be seen at the route level. Figure 19 shows the amount of traffic traveling  at rates over 300 percent R/VC on long-distance grain routes from the  Minot, North Dakota, and Billings, Montana, economic areas to the  Portland-Vancouver-Beaver Falls, Oregon, economic area. Of the routes  we examined, these two had the highest percentage of traffic traveling at  rates over 300 percent R/VC for 2004, and on both routes, this traffic had  substantially increased over 1985 levels.
For both the Minot and Billings routes, increases in R/VC from 1985  through 2004 were driven more by increases in revenue than by changes in  variable cost. From 1985 through 2004, revenue from all grain traffic—not  just traffic traveling at rates above the statutory threshold for rate relief— on the Minot, North Dakota, to the Portland-Vancouver-Beaver Falls,  Oregon, economic area increased from approximately $18.4 million to  approximately $30.8 million. Variable cost increased at a much slower  pace, rising from approximately $12.2 million to approximately $12.4  million. For the route from the Billings, Montana, economic area to the  Portland-Vancouver-Beaver Falls, Oregon, economic area, grain revenue  more than tripled, from approximately $11.2 million in 1985 to  approximately $42.7 million in 2004. Variable cost also increased  substantially—although still not as much as revenue—rising from  approximately $5.5 million to approximately $15.1 million.
section_title: Some Areas with Access to One Railroad Have Higher Percentages of Traffic Traveling at Rates That Exceed the Threshold for Rate Relief
paragraphs: Some economic areas with access to one Class I railroad also have more  than half of their traffic traveling at rates that exceed the statutory  threshold for rate relief. For example, parts of New Mexico and Idaho with  access to one Class I railroad have more than half of all traffic originating  in those same areas traveling at rates over 180 percent R/VC (see fig. 20).  However, there are instances in which an economic area may have access  to two or more Class I railroads and still have more than 75 percent of its  traffic traveling at rates over 180 percent R/VC, as well as other instances  in which an economic area may have access to one Class I railroad and  have less than 25 percent of its traffic traveling at rates over 180 percent  R/VC. Yet there are parts of the country with access to one Class I railroad  that also have higher percentages of traffic traveling at rates over the  statutory threshold for rate relief.
Our analysis shows that some areas of the country with access to only one  Class I railroad have higher levels of traffic traveling at rates over the  statutory threshold for rate relief. This situation may reflect reasonable  economic practices by railroads in an environment of excess demand, or it  may represent an abuse of market power. Our analysis provides an  important first step in assessing competitive markets nationally, but it is  imperfect given the inherent limitations of the Carload Waybill Sample  and of the proxy measures available for weighing captivity. When  combined with comments from participants on our expert panel and  interviews with shipper and railroad groups, the results of our analysis  suggest that shippers in selected markets may be paying excessive rates,  meriting further inquiry and analysis.
section_title: Despite STB’s Actions, Analysis of Competitive Markets Is Needed to Address Lack of Effective Relief for Captive Shippers
paragraphs: The Staggers Rail and ICC Termination Acts promoted greater reliance on  competition as the preferred method to protect shippers from  unreasonable rates and granted STB broad authority to monitor the  performance of the railroad industry. STB has taken a number of actions  to provide protections for captive shippers from unreasonable rates in the  absence of effective competition, including establishing a process for  captive shippers to obtain relief from unreasonable rates. Despite STB’s  actions, there is little effective relief for captive shippers because STB’s  standard rate relief process is largely inaccessible. While STB continues to  refine its practices, an assessment of competitive markets would provide  further information about the extent of captivity among shippers and the  merits of a range of proposed actions to enhance competitive options  available to shippers. In addition, changes to the rate relief process could  provide greater protection from unreasonable rates.
subsections: section_title: STB Has Broad Authority to Monitor the Railroad Industry
paragraphs: The Staggers Rail and ICC Termination Acts encourage competition as the  preferred way to protect shippers and to promote the financial health of  the railroad industry. At the same time, the acts give STB the authority to    adjudicate rate cases to resolve disputes between captive shippers and  railroads upon receiving a complaint from a shipper;   approve rail transactions, such as mergers, consolidations, acquisitions,    prescribe new regulations, such as rules for competitive access and  inquire into and report on rail industry practices, including obtaining  information from railroads on its own initiative and holding hearings to  inquire into areas of concern, such as competition.
The federal courts have upheld STB’s general powers to monitor the rail  industry, including its ability to subpoena witnesses and records and  depose witnesses.
STB has the authority and ability to inquire into and report on railroad  practices, and it also has authority to take a number of actions based on  the results of that inquiry. First, STB could issue a general rule making that  would alter the administrative rules for the industry. For example, STB has  the authority to require a railroad to make their terminal facilities available  to another railroad under certain circumstances. Second, STB could  reopen a past decision if it found a material error in the case, new  evidence emerged, or circumstances affecting the case substantially  changed. Finally, if STB received a complaint from a shipper, it could then  launch a formal investigation and prescribe specific remedies to address  the complaint.
section_title: STB Has Taken Actions to Protect Captive Shippers
paragraphs: Under its adjudicatory authority, STB has taken a number of actions to  provide protection for captive shippers. STB determines the  reasonableness of challenged rates in the absence of competition upon  receiving a complaint from a shipper. The rate relief process is the  principal method by which shippers seek relief from unreasonable rates.  STB developed standard rate case guidelines, under which captive  shippers can challenge a rail rate and appeal to STB for rate relief. Under  the standard rate relief process, STB assesses whether the railroad  dominates the shipper’s transportation market and, if it finds market  dominance, proceeds with further assessments to determine whether the  actual rate the railroad charges the shipper is reasonable. STB requires  that the shipper demonstrate how much an optimally efficient railroad  would need to charge the shipper and construct a hypothetical, perfectly  efficient railroad that would replace the shipper’s current carrier. As part  of the rate relief process, both the railroad and the shipper have the  opportunity to present their facts and views to STB, as well as to present  new evidence. In 1999, we reported that shippers and shippers’  associations indicated that constructing a hypothetical railroad is difficult,  particularly for small shippers, because the time and cost associated with  the model’s development may outweigh the compensation afforded the  shipper should STB determine that the challenged rate was unreasonable.  Since we reported on the process in 1999, STB has taken several actions to  reduce potential barriers for filing a complaint. For example, STB now  conducts mediation to begin cases, has added staff to process cases, and  has eliminated certain criteria for assessing whether a railroad dominates  a shipper’s market.
STB also created alternatives to the standard rate relief process,  developing simplified guidelines, as Congress required, for cases in which  the standard rate guidelines would be too costly or infeasible given the  value of the cases. Under these simplified guidelines, captive shippers who  believe that their rate is unreasonable can appeal to STB for rate relief,  even if the value of the disputed traffic makes it too costly or infeasible to  apply the standard guidelines. In addition, STB created a voluntary  arbitration option that parties can use to resolve disputes over rates.
Under its authority to approve rail transactions, STB has approved railroad  mergers that it finds consistent with the public interest. STB has also  taken action to ensure that any potential merger-related harm to  competition is mitigated. STB’s mitigation efforts have focused on  preserving competition where it could be lost at 2-to-1 points, for  example, by imposing conditions that allow one railroad to operate over  the tracks of another railroad (called trackage rights). STB has historically  not taken action to introduce service where shippers have service by only  one carrier.
Under its authority to prescribe new regulations, STB established a  process by which shippers can file a complaint if they are captive to one  railroad and believe that the railroad is engaged in anticompetitive  behavior. Under this process, if the shipper proves that the railroad is  engaged in anticompetitive behavior, STB can prescribe remedies such as  trackage rights that would give the shipper access to another railroad.
Finally, under its authority to inquire into and report on the rail industry,  STB instituted proceedings to review rail access and competition issues.  For example, in April 1998, at the request of Congress, STB commenced a  review of access and competitive service in the rail industry. In April 1998,  STB decided to consider revising its competitive access rules. However, in  its December 1998 report to Congress, STB declined to take further action  on this issue because it had adopted new rules giving shippers temporary  access to alternative routing options during periods of poor service. In  addition, STB observed that the competitive access issue raises basic  policy questions that are more appropriately resolved by Congress. In  2001, STB adopted new regulations for rail mergers that require the  applicant to demonstrate that the merger would enhance, not just  preserve, competition.
section_title: Efforts Have Led to Little Effective Relief
paragraphs: Despite STB’s efforts, there is widespread agreement that STB’s standard  rate relief process is inaccessible to most shippers and does not provide  for expeditious handling and resolution of complaints. The process  remains expensive, time consuming, and complex. While STB does not  keep records of the cost of a rate case, shippers we interviewed agreed  that the process can cost approximately $3 million per litigant. Shippers  told us that, to initiate a case, the case would need to involve several  million dollars so that it would be worthwhile to spend $3 million on a  case that they could possibly lose. Thus, shippers noted that only large- volume shippers, such as coal shippers, with set origins and destinations  have the money to be able to afford the STB rate relief process. In  addition, shippers said that they do not use the process because it takes so  long for STB to reach a decision. Lastly, shippers continue to state that the  process is both time consuming and difficult because it calls for them to  develop a hypothetical competing railroad to show what the rate should be  and to demonstrate that the existing rate is unreasonable. Since 2001, only  10 cases have been filed, and these cases took between 2.6 and 3.6 years— an average of 3.3 years per case—to complete. Of those 10 cases, 9 were  filed by coal shippers.
The simplified guidelines also have not effectively provided relief for  captive shippers. Although these simplified guidelines have been in place  since 1997, a rate case has not been decided under the process set out by  the guidelines. STB held public hearings in April 2003 and July 2004 to  examine why shippers have not used the guidelines and to explore ways to  improve them. At these hearings, numerous organizations provided  comments to STB on measures that could clarify the simplified guidelines,  but no action was taken. STB observed that parties urged changes to make  the process more workable, but disagreed on what those changes should  be. Several shipper organizations told us that shippers are concerned  about using the simplified guidelines because they believe the guidelines  will be challenged in court, resulting in lengthy litigation. STB officials told  us that they—not the shippers—would be responsible for defending the  guidelines in court. STB officials also said that if a shipper won a small  rate case, STB could order reparations to the shipper before the case was  appealed to the courts.
STB’s arbitration option has never been used. Under this approach, an  arbitrator would decide the rate, using a “give and take” approach—that is,  the arbitrator would determine the rate without being required to pick one  of the two offers. According to STB officials, this option has not been  used, in part, because the cases that go before STB are contentious, with  high monetary stakes. As a result, there is less willingness from either side  to arbitrate.
Shippers have not obtained relief through STB’s “competitive access”  rules. Under these rules, shippers can file a complaint to request that one  railroad obtain access to another railroad’s tracks when necessary to  remedy anticompetitive behavior by the owning railroad. Shippers who file  a complaint must show that the owning railroad has engaged in  anticompetitive behavior. To date, STB has found that all complaints have  failed to prove that the owning railroad has engaged in anticompetitive  behavior.
section_title: STB Continues to Refine the Process
paragraphs: During our review, STB has continued to refine its processes for shippers  to obtain relief from unreasonable rates and competitive access. For  example, STB recently proposed a rule making to make changes to the  simplified guidelines in order to respond to comments gathered at the STB  hearings held in April 2003 and July 2004 to examine why those guidelines  have not been used by shippers and to explore ways to improve the  guidelines. In addition, STB is seeking public comment on several  measures it has proposed to adopt regarding railroad practices involving  fuel surcharges. The proposals follow STB’s May 2006 public hearing on  how railroads calculate and charge fuel surcharges and respond to  extensive testimony on these charges submitted to STB by the rail  industry, the public, and railroad customers. STB announced its intent to  hold a public hearing on certain issues related to rail transportation rates  for grain. Lastly, STB recently requested written comments and held a  public hearing in response to a petition filed by a shipper group to prevent,  or put a time limit on, paper barriers, which are contractual agreements  that may be made when a Class I railroad either sells or leases some of its  track to another railroad (typically a short line railroad or regional  railroad), but stipulates that virtually all traffic that originates on that line  must interchange with the Class I railroad that sold the tracks or pay a  penalty.
section_title: Assessment of Competitive Markets and Changes to Rate Relief Process Could Provide More Relief
paragraphs: The results of our analysis suggest a reasonable possibility that shippers in  selected markets may be paying excessive rates related to a lack of  competition in these markets. While our analysis of available measures  shows that the extent of captivity appears to be dropping in the freight  railroad industry, shippers that may be captive are paying substantially  over the statutory threshold for initiating a rate relief case. This situation  may simply reflect reasonable economic practices by railroads in an  increasingly constrained environment in which demand for rail services  increasingly exceeds supply, or it may represent an abuse of market  power. Our analysis provides an important first step in assessing  competitive markets nationally, but it is imperfect given the inherent  limitations of the Carload Waybill Sample and the proxy measures  available for weighing captivity. A more rigorous analysis of competitive  markets nationally is needed—one that identifies the state of competition  nationwide and inquires into pricing practices in specific markets. If this  assessment determines that market power is being abused or the goals of  the Staggers Rail Act are not being met, STB could consider several  methods to ease competition concerns, such as initiating a generally  applicable rule making; or, if a complaint is filed, providing specific  remedies to increase competition.
Shipper groups, economists, and other experts in the rail industry have  suggested several alternative approaches as remedies that could provide  more competitive options to shippers in areas of inadequate competition  or excessive market power. These groups view these approaches as more  effective than the rate relief process in promoting a greater reliance on  competition to protect shippers against unreasonable rates. Some  proposals would require legislative change, or a reopening of past STB  decisions.
These approaches each have potential costs and benefits. On the one  hand, they could expand competitive options, reduce rail rates, and  decrease the number of captive shippers as well as reduce the need for  both federal regulation and a rate relief process. On the other hand,  reductions in rail rates could affect railroad revenues and limit the  railroads’ ability and potential willingness to invest in their infrastructure.  In addition, some markets may not have the level of demand needed to  support competition among railroads. However, in markets that do, the  targeted approaches frequently proposed by shipper groups and others  include the following:    Reciprocal switching: This approach would allow STB to require railroads  serving shippers that are close to another railroad to transport cars of a  competing railroad for a fee. The shippers would then have access to  railroads that do not reach their facilities. This approach is similar to the  mandatory interswitching in Canada, which enables a shipper to request a  second railroad’s service if that second railroad is within approximately 18  miles. Some Class I railroads already interchange traffic using these  agreements, but they oppose being required to do so. Under this approach,  STB would oversee the pricing of switching agreements. This approach  could also reduce the number of captive shippers by providing a  competitive option to shippers with access to a proximate but previously  inaccessible railroad and thereby reduce traffic eligible for the rate relief  process (see fig. 21).
Terminal agreements: This approach would require one railroad to grant  access to its terminal facilities or tracks to another railroad, enabling both  railroads to interchange traffic or gain access to traffic coming from  shippers off the other railroad’s lines for a fee. Current regulation requires  a shipper to demonstrate anticompetitive conduct by a railroad before  STB will grant access to a terminal by a nonowning railroad unless there is  an emergency or when a shipper can demonstrate poor service and a  second railroad is willing and able to provide the service requested. This  approach would require revisiting the current requirement that railroads  or shippers demonstrate anticompetitive conduct in making a case to gain  access to a railroad terminal in areas where there is inadequate  competition. The approach would also make it easier for competing  railroads to gain access to the terminal areas of other railroads and could  increase competition between railroads. However, it could also reduce  revenues to all railroads involved and adversely affect the financial  condition of the rail industry. Also, shippers could benefit from increased  competition but might see service decline (see fig. 22).
Trackage rights: This approach would require one railroad to grant access  to its tracks to another railroad, enabling railroads to interchange traffic  beyond terminal facilities for a fee. In the past, STB has imposed  conditions requiring that a merging railroad must grant another railroad  trackage rights to preserve competition when a merger would reduce a  shipper’s access to railroads from two to one. While this approach could  potentially increase rail competition and decrease rail rates, it could also  discourage owning railroads from maintaining the track or providing high- quality service, since the value of lost use of track may not be  compensated by the user fee and may decrease return on investment (see  fig. 23). “Bottleneck” rates: This approach would require a railroad to establish a  rate, and thereby offer to provide service, for any two points on the  railroad’s system where traffic originates, terminates, or can be  interchanged. Some shippers have more than one railroad that serves them  at their origin and/or destination points, but have at least one portion of a  rail movement for which no alternative rail route is available. This portion  is referred to as the “bottleneck segment.” STB’s decision that a railroad is  not required to quote a rate for the bottleneck segment has been upheld in  federal court. STB’s rationale was that statute and case law precluded it  from requiring a railroad to provide service on a portion of its route when  the railroad serves both the origin and destination points and provides a  rate for such movement. STB requires a railroad to provide service for the  bottleneck segment only if the shipper had prior arrangements or a  contract for the remaining portion of the shipment route. On the one hand,  requiring railroads to establish bottleneck rates would force short-distance  routes on railroads when they served an entire route and could result in  loss of business and potentially subject the bottleneck segment to a rate  complaint. On the other hand, this approach would give shippers access to  a second railroad, even if a single railroad was the only railroad that  served the shipper at its origin and/or destination points, and could  potentially reduce rates (see fig. 24).
Paper barriers: This approach would prevent or, put a time limit on, paper  barriers, which are contractual agreements that can occur when a Class I  railroad either sells or leases long term some of its track to other railroads  (typically a short-line railroad and/or regional railroad). These agreements  stipulate that virtually all traffic that originates on that line must  interchange with the Class I railroad that originally leased the tracks or  pay a penalty. Since the 1980s, approximately 500 short lines have been  created by Class I railroads selling a portion of their lines; however, the  extent to which paper barriers are a standard practice is unknown because  they are part of confidential contracts. When this type of agreement exists,  it can inhibit smaller railroads that connect with or cross two or more  Class I rail systems from providing rail customers access to competitive  service. Eliminating paper barriers could affect the railroad industry’s  overall capacity since Class I railroads may abandon lines instead of  selling them to smaller railroads and thereby increase the cost of entering  a market for a would-be competitor. In addition, an official from a railroad  association told us that it is unclear if a federal agency could invalidate  privately negotiated contracts (see fig. 25).
It will be important for policymakers, in evaluating these alternative  approaches, to carefully consider the impact of each approach on the  balance set out in the Staggers Rail Act. One significant consideration is  the revenue adequacy of the railroads. The Staggers Rail Act established  revenue adequacy as a goal for the industry and allowed the railroads to  use differential pricing to increase their revenues. While the specific  method for determining revenue adequacy has been controversial, the  overall trend in revenue adequacy may be more important. In its last  report for 2004, STB determined that one railroad is revenue adequate and  that others are approaching revenue adequacy. It is too early to determine  that the industry as a whole is achieving revenue adequacy. Nevertheless,  this improvement in the railroads’ financial condition represents a  significant shift in the rail industry because for decades after the  enactment of the Staggers Rail Act, the railroads were all considered  revenue inadequate. The railroads need sufficient revenue for  infrastructure investment to keep pace with increased demand. However,  each of these changes could decrease the amount of revenue the railroads  receive. Yet, as the railroad’s revenue adequacy improves, the question  arises as to what degree the railroads should continue to rely, for their  investment needs, on obtaining significantly higher prices from those with  greater reliance on rail transportation.
To prevent problems with unreasonable rates, some shipper groups  propose targeted approaches that would provide them with more  competitive options. A number of different approaches have also been  suggested to make the rate relief process less expensive, more  expeditious, and therefore potentially more accessible. Each of the  proposed approaches has both advantages and drawbacks. These  approaches include the following:  Increase the use of simplified guidelines: The simplified guidelines use  standard industry average figures for revenue data instead of requiring the  shipper to create a hypothetical railroad. This approach would reduce the  time and complexity of the process; however, it may not provide such an  accurate and precise a measure as the standard process. Both shippers  and railroad officials with whom we spoke agree that it is confusing to  determine who is eligible to use the process and how it would work. STB  recently issued a proposed rule making to pursue changes to the simplified  guidelines to provide captive shippers greater access to regulatory  remedies for unreasonable rail rates.
Increase the use of arbitration: Under arbitration, two parties present  their case before an arbitrator, who determines the rate. This process  replaces the shipper’s requirement to create a hypothetical railroad.  Proponents of arbitration argue that the threat of arbitration can induce  railroads and shippers to resolve their own problems and limit the need  for federal regulation. In addition, the process is quicker and cheaper than  the standard rate relief process. For example, Canada offers an arbitration  process known as Final Offer Arbitration (FOA), under which both parties  submit their best and final offers, and the arbitrator considers the  argument from both sides and picks one rate offer from either the railroad  or the shipper. FOA is quicker—statutorily, once the process begins it has  to be completed within 60 days, or 30 days for disputes involving freight  charges of less than $750,000, unless the parties agree to a different time  frame. In addition, FOA is cheaper—estimates ranged up to $1 million  Canadian dollars, for both parties. On the other hand, the decisions are  good for only 1 year, so the process could in theory be revisited annually.  Critics of this approach suggest that arbitration decisions may not be  based on economic principles, such as the revenue and cost structure of  the railroad, and arbitrators may not be knowledgeable about the railroad  industry. Furthermore, opinions differ significantly about which types of  disputes should be covered and what standards (if any) should apply.
Develop an alternative cost methodology: STB could develop an  alternative to the cost methodology used under the standard process in  which a shipper must demonstrate how much an optimally efficient  railroad would need to charge a shipper by constructing a hypothetical,  perfectly efficient railroad that would replace its current carrier. For  example, STB could use a long-run incremental cost approach to evaluate  and decide rate cases. This process, which is used by the Federal Energy  Regulatory Commission for regulating rates charged by pipeline  companies, bases rates on the actual incremental cost of moving a  particular shipment, plus a reasonable rate of return. This approach allows  for a quick, standard method for setting prices, but does not take into  account the need for differential pricing or the railroad’s need to charge  higher rates in order to become revenue adequate. Structuring rate  regulation around actual costs can also create potential disincentives for  the regulated entity to control its costs.
section_title: Uncertainty about Future Freight Rail Demand and Capacity Points to Opportunities for a More Strategic Federal Approach to Rail Infrastructure
paragraphs: Recent forecasts predict that the demand for freight and freight rail  transport will grow significantly in the future. While forecasts have  limitations as guides to investing in new transportation infrastructure, they  can present a plausible picture of future freight demand and capacity.  Whether private rail companies will be able and willing to invest in new  infrastructure capacity to meet projected future demand is uncertain. New  rail capacity not only benefits each private rail company network, but it  also has the potential to benefit the public by improving traffic flow, air  quality, and safety at the national, state, and local levels. As a result, the  public sector has increasingly been investing in freight rail projects.  Federal involvement in the freight system should be consistent with the  competitive marketplace and ensure that funding decisions reflect  widespread public priorities.
subsections: section_title: Forecasts of Significant Freight Rail Traffic Growth Provide a Plausible Outlook for the Future
paragraphs: The demand for freight transportation in general and freight rail  specifically is forecasted to increase, according to recent studies. Several  of these studies also quantify their projections of the volume and value of  future freight demand. The Freight Analysis Framework (FAF) is a  comprehensive database and policy analysis tool maintained by DOT to  help identify needed freight capacity improvements. In 2002, DOT  projected, using this tool, that overall domestic and international freight  demand would increase by more than 65 percent and 84 percent,  respectively, by 2020. In 2003, the American Association of State Highway  and Transportation Officials (AASHTO) released the Freight Rail Bottom  Line Report, prepared by a consulting firm. This report describes the  industry and its benefits to the nation, estimates the industry’s investment  needs and capacity to meet these needs, and quantifies the consequences  of underinvestment, including highway deterioration and congestion. The  AASHTO study projected that, by 2020, overall domestic freight demand by  ton would increase by 57 percent and international demand would  increase by 99 percent. In 2005, the American Trucking Association’s  (ATA) report U.S. Freight Transportation Forecast to 2016 projected  tonnage and revenues for all freight modes. The report predicted that  overall freight volume would increase by about 32 percent between 2004  and 2016.
Freight rail demand is projected to increase less than overall freight  demand and to grow at a slower rate than demand for other modes—such  as truck and air freight. FAF projects that freight rail tonnage will grow  about 55 percent by 2020, but this growth will not be as dramatic as for  truck and air, and will account for a much smaller share of the market  when measured on the basis of shipment value. AASHTO predicts that  freight rail tonnage will increase 44 percent by 2020. However, it notes that  this forecast actually indicates that rail will lose some market share. This  estimate also assumes that considerable investment will be required—up  to about $4 billion annually—to meet future demand. According to ATA’s  forecast, freight rail tonnage will grow annually by 2.4 percent to 2010 and  by 2.1 percent to 2016. While rail intermodal traffic is forecast to grow  rapidly, the study anticipates that rail’s overall share of total freight  tonnage will decrease slightly from about 15.6 percent in 2004 to about  15.4 percent in 2016.
However, ow many factors can affect the accuracy of these predictions.  Freight markets are volatile and unpredictable, and thus freight demand  forecasts may prove to be off the mark. Similarly, much freight traffic is  determined by trade that originates outside the United States. Moreover,  since the data and models used to develop these freight demand forecasts  are largely proprietary, we could not assess the validity or  reasonableness of the assumptions used to develop the predictions.  Nevertheless, forecasts of freight and freight rail demand are useful as one  plausible scenario for the future. As the Congressional Budget Office  (CBO) observed in a January 2006 report, forecasts of demand are best  viewed as illustrative rather than quantitatively accurate.
section_title: Railroads’ Investments in Capacity to Meet Potential Demand Are Uncertain
paragraphs: If demand does develop as forecasted, it is uncertain how able and willing  railroads will be to invest in new capacity. Railroads do not prepare long- term capacity plans because of concern about the potential for significant  economic changes—for example, officials at one Class I railroad stated  that they prepare capacity improvements plans and demand projections  for 3 to 5 years into the future, with frequent revisions. In addition, the  railroads we interviewed were generally unwilling to discuss their future  investment plans with us in any detail because this is business proprietary  information. It is therefore difficult to comment on how railroads are  likely to choose among their competing investment priorities for the future  compared with various demand scenarios.
Railroads’ ability and willingness to invest in new capacity to meet  demand reflects a number of key considerations. For privately owned rail  companies, a key business consideration is maximizing returns for  shareholders. To do so, realizing the greatest return on investment from  each investment decision is essential and is reinforced by pressure from  shareholders. Rail investment involves private companies taking a  substantial risk which becomes a fixed cost on their balance sheets, one  on which they are accountable to stockholders and for which they must  make capital charges year in and year out for the life of the investment. A  railroad contemplating such an investment must be confident that the  market demand for that infrastructure will hold up for 30 to 50 years. This  is in sharp contrast to other modes such as highway infrastructure, which  is paid for largely by public funds. Maximizing a rail company’s  competitive position in key markets is important in deciding on  investments in the company network’s size and facilities. For example, the  growth of intermodal transport is a major development for freight rail  because it stands to be the largest revenue generator for the Class I  railroads. As a result, there is intense competition for this business,  although intermodal business also means that freight rail both competes  and cooperates with other freight modes. However, intermodal growth  depends on the railroads’ ability to invest in the new capacity needed to  meet this demand.
Investment considerations are complicated by the current status of rail  infrastructure. Although the rail network has been downsized, the  infrastructure remains extensive but aging. Replacing, maintaining, and  upgrading this infrastructure is extremely costly, as the Transportation  Research Board emphasized in its analysis of critical transportation  issues. Predicting the extent to which future rail investments will keep  pace with projected freight rail demand is complicated by the extent of  current rail needs. For example, an annual assessment of America’s  infrastructure conducted by the American Society of Civil Engineering  gave rail infrastructure a “C-” grade and noted that, for the first time in 90  years, limited capacity has created significant bottlenecks in the national  rail network. However, railroads must invest in new infrastructure, new  equipment, and substantial new capacity to handle additional traffic in  order to remain viable and effective, a rail industry representative told our  expert panel.
Today, freight railroads are sufficiently profitable to be investing at record  levels. Major freight railroads have reported that they expect to invest  about $8 billion in infrastructure during 2006—a 21 percent increase over  2005—and have told us that they plan to continue making infrastructure  investments. However, not all of this investment is planned for capital or  new capacity. Although we requested additional detail about how the rail  industry’s $8 billion estimated investment was divided between new  capacity and maintenance or renewal of existing capacity, the Association  of American Railroads indicated that this information is not currently  available but will be part of a special study on railroad spending trends.
section_title: Rail Capacity Investments Can Produce Private and Public Sector Benefits
paragraphs: While private rail networks obtain benefits and improve their profitability  from investments in their capacity, these investments also can benefit the  public. In fact, some public benefits can be large in comparison to  anticipated benefits to the private rail network, as the CBO report pointed  out. For example, shifting truck freight traffic to railroads can reduce  highway congestion for passenger and commercial vehicles, potentially  reducing or avoiding public expenditures that otherwise would be needed  to build additional highway capacity or provide additional maintenance to  accommodate growing truck traffic. Depending on the rail infrastructure  project, the public could realize several types of benefits, as described in  table 3.
Rail projects can vary widely in the extent to which they may generate  public as well as private benefits; whether benefits are realized by the  private or public sector at the national, state, and local levels; and how the  benefits are quantified for the purpose of fairly apportioning project  financing. Determining what benefits and costs are associated with a rail  infrastructure project and who benefits is important in deciding whether  public funds for public benefits are justified—but this is a difficult  determination. For example, one rail infrastructure project that reduces  system bottlenecks may generate benefits to the national economy by  lowering the costs of producing and distributing goods. Another rail  project that eliminates or improves highway-rail crossings may primarily  produce local benefits by reducing accidents, time lost waiting for trains  to pass, pollution and noise from idling trains, and delays of emergency  vehicles at crossings. The same project also may produce national benefits  by reducing the impact of train delays on the system.
section_title: Public Sector’s Growing Freight Rail Investments Focus on Securing Public Benefits
paragraphs: Increasingly, governments at all levels have been investing in freight rail  improvement projects that offer potential public benefits. At the state and  local levels, government involvement has ranged from planning and  coordination to collaboration and investment with freight rail companies  and other stakeholders. Some states have been investing to help short-line  railroads maintain track in their states for almost 20 years. Other states— such as Florida, Virginia, New York, and Pennsylvania—are creating  significant new programs to invest in rail projects. Over 30 states have  published freight plans that describe their goals and approach to freight  and freight rail.
The scope of state and local freight rail investments continues to expand.  For example, Missouri state and local governments, in partnership with  railroads and other stakeholders, supported two major rail bridge flyover  projects to reduce rail delays in Kansas City. These projects—totaling $134  million—were expected to provide economic benefits and reduce rail  transit time through the city by about 2 hours. The project also used an  innovative institutional arrangement that created a special type of  corporation to facilitate its funding. Colorado’s Department of  Transportation (CDOT), other public entities, and two Class I railroads are  exploring an ambitious partnership to relocate freight train facilities away  from the heavily populated Front Range area of the state, as the two  railroads proposed. CDOT initiated a benefit-cost study that found  sufficient public transportation, economic development, land use, safety,  environmental, and passenger rail facilitation benefits to warrant investing  public dollars in the project—estimated to cost about $1.17 billion.
The federal government also has been involved in freight rail projects. In  1997, DOT provided a $400 million loan for the $2.4 billion Alameda  Corridor project to leverage funds from ports, railroads, and local  governments. As a result, a 20-mile trench for trains was constructed to  eliminate numerous rail-highway crossings and reduce rail transport time  to and from the ports of Los Angeles and Long Beach—a significant  gateway for freight imported from Asia and distributed throughout the  United States. In 2005, Congress provided $100 million to the $1.5 billion  Chicago Region Environmental and Transportation Efficiency (CREATE)  program. Its objective is to cut train delays and congestion and improve  passenger rail service by separating 25 rail-highway crossings, building 6  passenger/freight train flyovers, and upgrading tracks and controls to  improve service for the one-third of the nation’s rail traffic that comes  through Chicago each day. Railroads and state and local governments are  contributing to the program’s financing. In 2005, Congress also passed the  Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy  for Users (SAFETEA-LU), which increased the authorized level of funds  available under the Railroad Rehabilitation and Improvement Financing  (RRIF) program from $3.5 billion to $35 billion over a 5-year period. This  program provides loans or loan guarantees that are available to states or  railroads for projects to acquire, improve, or rehabilitate rail  infrastructure.
A number of proposals before Congress would increase federal funding for  freight railroad projects. One proposal calls for the creation of a Railroad  Trust Fund that would be similar to the Highway Trust Fund, which is  used to pay for highway construction and improvements. Another  proposal calls for a railroad investment tax credit. Under this proposal,  railroads or shippers would receive a 25 percent tax credit for money  spent to expand rail infrastructure.
section_title: Federal Response to Freight Investments Should Reflect a National Policy That Is Impartial Toward All Modes and Produces Maximum Public Benefits from Public Investments
paragraphs: Federal decision makers face considerable uncertainty about the future of  freight transportation coupled with considerable certainty that the federal  deficit will be a long-term constraint on federal investment. At the same  time, Congress will continue to face policy and funding decisions that will  affect all freight modes and have a critical impact in shaping the nation’s  rail system and infrastructure. As we have noted in our past work, a  strategic systemwide approach to transportation planning and funding that  focuses on all modes is increasingly important to meet expectations for  more efficient freight transport, growing freight demand, and more  connections between modes.
Federal funding constraints enhance the need for a strategic federal  approach to freight infrastructure investment, and the implications of  these constraints are a critical feature of a national freight policy. Given  major projected demographic shifts and future federal health and  retirement commitments, federal revenues may barely cover interest on  the federal debt by 2040—leaving no money for either mandatory or  discretionary programs. According to our simulations, balancing the  budget could require cutting federal spending by as much as 60 percent,  raising taxes by up to 2-1/2 times their current level, or some combination  of the two. We have concluded that the impending federal fiscal crisis  will require a fundamental reexamination of all federal programs. For  example, our assessment of the federal highway grant program raised  significant issues, such as the absence of a clear federal mission and role  since the completion of the interstate highway system and the absence of a  link between federal funding and goals or outcome measures.
DOT has taken an important step toward a more comprehensive freight  strategy by publishing a draft Framework for a National Freight Policy  for comment. It is a step for which we found considerable support among  public and private freight stakeholders. A systemwide, rather than a  modal, perspective is critical to a national freight policy. As the AASHTO  study emphasized, investments at the freight system level are needed to  respond to nationally significant corridor choke points, intermodal  connections, and urban rail interchanges.
With federal fiscal constraints as the backdrop, two major policy  principles will need to be considered as DOT continues to develop this  national policy. These principles are, first, to adopt a mode-neutral  approach—one that takes a consistent policy and funding approach to all  modes and establishes a level playing field for competition in the freight  marketplace—and, second, to maximize public benefits—particularly  benefits to the national transportation system—from public transportation  investments.
subsections: section_title: Adopting a Mode-Neutral Approach
paragraphs: Under a mode-neutral approach, each mode would pay the full costs for  the infrastructure facilities and services that it used as well as the costs  that its use imposed on others—such as added air pollution, congestion,  and accident risks—through taxes and user fees. No single mode would  be at a competitive disadvantage. A mode-neutral federal freight policy  and investment strategy would be consistent with the competitive  market’s central role in the freight system. Encouraging a market-based  approach and competition that fosters economic efficiency and innovation  is a key consideration in dealing with the privately owned freight rail  industry, as we have reported.
Currently, as we have pointed out, federal programs treat different freight  modes differently. For example, trucks and barges use infrastructure that  is owned and maintained by the government, while rail companies use  infrastructure that they pay to own and maintain. The trucking and barge  industries pay fees and taxes to use this government-funded infrastructure,  but their payments generally do not cover the costs they impose on  highways and waterways, thereby giving the trucking and barge industries  a competitive price advantage over railroads. The most recent Federal  Highway Administration (FHWA) highway cost allocation study evaluates  highway costs attributable to different vehicle classes and the extent to  which their user fees cover their responsibility for highway costs.  According to the study, combination unit trucks paid 80 percent of their  cost responsibility and the heaviest combinations paid half of their cost  responsibility. The study concluded that only the very lightest combination  trucks pay their share of federal highway cost responsibility. A recent CBO  report also concluded that trucks and barges do not pay their full share of  highway costs and reported that rail may be at a competitive disadvantage,  since other modes are effectively being subsidized. CBO also observed  that if all modes do not pay their full costs, the result is inefficient use of  roads and waterways and greater government spending than otherwise  would be necessary if capacity investments are made in anticipation of  demand that does not occur.
section_title: Maximizing Public Benefits from Public Transportation Investments
paragraphs: As DOT develops and applies a national freight policy, our second critical  principle will be an important consideration—public investments should  depend on clearly defined public benefits. Benefit-cost analysis can be a  useful tool to define benefits, as our expert panel on this subject  concluded. Because this analysis identifies the greatest net benefits by  comparing the monetary value of each project’s benefits and costs, it can  help public and private stakeholders evaluate project alternatives.
States have had experience in evaluating whether rail projects could yield  sufficient public benefits to warrant investments of public dollars in the  projects, and their experience can inform a national freight policy. For  example, the state of Washington’s Freight Mobility Strategic Investment  Board leverages transportation dollars by working with public and private  stakeholders to fund projects that deliver public benefits. The board’s  project scoring criteria reflect anticipated benefits, such as freight mobility  for the project area; freight mobility for the region, state, and nation;  general mobility; safety; freight and economic value; environment; project  partnership; consistency with regional and state plans; location on a  Strategic Freight Corridor; and cost benefit.
However, federal decision makers have no such criteria to use in  considering potential freight rail investments. As we have pointed out, the  federal funding structure for surface transportation and federal program  incentives tend to focus decision makers’ attention on highway and transit  projects, rather than on freight or freight rail concerns. And, although state  and local transportation decision makers consider benefit-cost analyses,  these analyses often do not have a decisive impact on investment  decisions. As DOT has noted, a fair, balanced approach to allocating  public and private funding is a prerequisite for public-private  partnerships. We have also raised concerns about federal tax policies.  For railroads, some industry groups have proposed freight rail tax credits  to encourage investment. However, our work has shown that it is difficult  to target tax credits to the desired activities and outcomes and ensure that  tax credits generate the desired new investments, as opposed to  substituting for investment that would have occurred anyway.
section_title: Conclusions
paragraphs: The Staggers Rail Act achieved far-ranging benefits in helping to create  and sustain a healthy and vibrant freight railroad industry, as well as an  efficient rail transportation system that supports the important role freight  plays in the nation’s economy. Critical to the Staggers Rail Act was the  concept of balance—on one hand, the act sought to allow rail carriers to  earn adequate revenues so that they could meet their current and future  capital needs. On the other hand, the act recognized the need for a  remnant regulatory regime that would maintain reasonable rates and  prohibit undue concentrations of market power in areas where no  effective competition existed. The act recognized that it was vital for the  federal government to promote competition and rely on it to set rates.  Without a doubt, rates have decreased for most shippers, and most  shippers are better off in the post-Staggers environment than they were  previously. This outcome suggests that widespread and fundamental  changes to the relationship between the railroads and their customers are  not needed. Nevertheless, the evidence also suggests some basis for  believing that—more than 25 years after the act’s passage—the balance it  envisioned has not been fully achieved.
The continued existence of pockets of potential captivity, together with  the increase in traffic at higher thresholds, at a time when the railroads  are, for the first time in decades, experiencing increasing economic health,  raises the question whether rail rates in selected markets reflect justified  and reasonable pricing practices, or an abuse of market power by the  railroads. Answering this question requires a rigorous, national analysis of  competitive markets. Our analysis provides an important first step;  however, we are constrained by the inherent limitations of the Carload  Waybill Sample and the available proxy measures for assessing captivity.  In contrast, STB has the statutory authority to inquire into and report on  railroad practices and could conduct a rigorous analysis of competition in  the freight rail industry that would rely on more than sample data and  could determine whether the inappropriate exercise of market power is  occuring in specific markets. Should STB find evidence of abuse, it could  consider several methods for creating the balance envisioned by the  Staggers Rail Act. For example, STB could consider initiating a generally  applicable rule making to address competition issues or prescribe specific  remedies in response to a complaint.
In assessing competition within the freight rail industry, STB needs  accurate data on railroad revenues. The data that STB currently collects— in particular, the use of the Carload Waybill Sample to report on the  railroads’ finances—are not always captured consistently, making it  difficult to accurately track railroad revenues. Specifically, while we  determined that, in general, the data in the Waybill were suitably reliable  for our reporting purposes, we also found that some data, including data  on fuel surcharges, were not accurately captured. Accurate data would  provide for more accurate tracking of railroad revenues and railroad  charges to potentially captive shippers and other shippers. This  information would help STB to obtain a clearer picture of the actual fees  paid by shippers.
STB is also responsible for ensuring the expeditious handling and  resolution of rate disputes, but the current process for settling these  disputes is ineffective. There are a number of potential alternatives to the  current process, and STB has recognized the limits of the process and  taken further action to improve it. These actions are commendable and  need to be pursued; absent further action, the promise of the Staggers Rail  Act and the balance it envisioned may never be fully realized.
These are difficult issues that require careful balancing of the railroads’  need to earn adequate revenues with shippers’ need for competition and  reasonable rates during a time of uncertainty about the capacity of freight  railroads to meet future demand for freight rail service. While predictions  and scenarios for the future of freight rail vary, it is likely that multiple  levels of government will continue to be involved in the nation’s freight  system. Additional investment in freight rail infrastructure can produce  public benefits, and many state and local governments are involved in  freight rail infrastructure projects. Congress has provided federal  assistance as well, and further requests for and decisions about federal  assistance to rail infrastructure are likely. Decision makers will be  challenged to ensure that federal involvement is consistent with  competition in the freight marketplace, reflects widespread public  priorities, and offers benefits that warrant the commitment of federal  funds. DOT’s draft National Freight Policy represents a good start in this  direction.
section_title: Recommendations for Executive Action
paragraphs: To ensure an appropriate balance between the interests of railroads and  shippers, we recommend that the Chairman of the Surface Transportation  Board take the following two actions:    Undertake a rigorous analysis of competitive markets to identify the state  of competition nationwide; in specific markets, determine whether the  inappropriate exercise of market power is occuring; and, where  appropriate, consider the range of actions available to address problems  associated with the potential abuse of market power. If the Chairman  determines that STB requires more resources to conduct this analysis,  then STB should request additional resources from Congress.
Review STB’s method of data collection to ensure that all freight railroads  are consistently and accurately reporting all revenues collected from  shippers, including fuel surcharges and other costs not explicitly captured  in all railroad rate structures.
To ensure the efficiency and effectiveness of our nation’s freight system,  we are making the following recommendation to the Secretary of  Transportation:    As DOT continues to develop a national freight policy and a possible  federal policy response, consider strategies to (1) sustain the role of  competitive market forces by creating a level playing field for all freight  modes and (2) recognize the fiscally constrained federal funding  environment by developing mechanisms to assess and maximize public  benefits from federally financed freight transportation investments.
section_title: Agency Comments and Our Evaluation
paragraphs: STB provided written comments on a draft of this report. These comments  are presented and evaluated in appendix III. STB generally agreed with our  assessment of the improving financial health of the freight railroad  industry and potential public benefits for freight rail infrastructure  projects. However, STB disagreed with our recommendation to undertake  a rigorous analysis of competitive markets in the rail industry because it  believed the findings underlying the recommendation were inconclusive,  their on-going efforts will address many of our concerns, and a rigorous  analysis would divert resources from other efforts. Specifically, STB stated  that our recommendation was based on two findings—first, that rail rates  have increased for some shippers and, second, that the amount of traffic  with rates reflecting high R/VC ratios has increased in some areas. STB  stated that recent increases in rail rates are not surprising and that R/VC  ratios can increase when rates and costs are falling and that these findings  do not suggest market abuses. STB also noted that it has several rule  makings under way related to the standard rate relief process and the  simplified rate relief process. STB suggested that, given the limitations on  its resources and the aggressive agenda already under way, rather than  undertake this competitive markets analysis, a more practical approach  would be for STB to finish its reforms to ensure that captive shippers have  an effective forum to seek rate relief if a railroad is charging unreasonable  rates. Concerning our recommendation that STB review its method of data  collection to ensure that all freight railroads are consistently and  accurately reporting all revenues collected from shippers, STB stated that  the revenue in question represents a small portion of all revenues and that  revenue data submitted by freight railroads are audited and otherwise  checked to ensure quality. Furthermore, STB has initiated a rule making to  improve the tracking of fuel surcharges.
While STB’s efforts have been helpful, we continue to believe that STB  should undertake a rigorous analysis of competitive markets to identify  the state of competition nationwide; in specific markets, determine  whether the inappropriate exercise of market power is occuring; and,  where appropriate, consider the range of actions available to address  problems associated with the potential abuse of market power. STB’s  comments do not accurately characterize the underlying support for our  recommendation. We did not base this recommendation on an increase in  rail rates or suggest that rate increases alone suggest increased captivity.  On the contrary, we recognize that rates have declined and that available  measures suggest that the extent of captivity has dropped. Furthermore,  STB’s response suggests that rail rates and the amount of traffic with high  R/VC ratios were the only data we examined—they were not. We  examined several factors, including data on the amount of tonnage  originating in economic areas that have access to only one Class I railroad,  data on the amount of tonnage traveling over 300 percent R/VC, and the  amount of tonnage that originates in areas with access to only one Class I  railroad and travels at rates that exceed the statutory threshold for rate  relief. Our report explicitly acknowledges the limitations in the Carload  Waybill Sample and of the proxy measures available for weighing  captivity, including R/VC levels. At the same time, our analyses, when  combined with comments from participants on our expert panel and  interviews with shipper and railroad groups, suggest a reasonable  possibility that shippers in selective markets may be paying excessive  rates related to a lack of competition. This provides the impetus for STB— which has the statutory authority to inquire into and report on railroad  practices—to analyze competitive markets in the rail industry and, where  appropriate, consider the range of actions to address problems associated  with the potential abuse of market power. Also, this analysis would rely on  more than sample data and could analyze the exercise of market power in  specific markets.
Regarding STB’s position that it has several rule makings under way that  address many of our concerns, we commend STB for recognizing and  taking action to address problems with the rate relief process, but we  believe action is needed beyond improvements to the rate relief process.  These rule makings, if implemented, are designed to improve the  processes available to shippers, after shippers have been charged a rate  that they consider to be unreasonable. In contrast, we believe that an  analysis of the state of competition and the possible abuse of market  power, along with the range of options STB has to address competition  issues, could more directly further legislatively defined goals to ensure  effective competition among rail carriers as the preferred means to both  promoting a sound rail transportation system and maintaining reasonable  rates. Regarding STB’s assertion that conducting a rigorous analysis of  competition would divert resources away from its on-going initiatives, we  modified our draft to recommend that STB request additional resources  from Congress if it determines it needs more resources to conduct an  analysis of competition. We also believe that STB should review its  method of data collection to ensure that all freight railroads are  consistently and accurately reporting all revenues. STB commented that it  had already responded to this concern by proposing a standardized report  for fuel surcharges; however, while we commend STB for its efforts to  capture these data, we also note STB has not yet implemented  standardized reporting of fuel surcharges and that other revenues besides  fuel surcharges may not be included in the Waybill. STB also provided  technical comments that we incorporated in this report, as appropriate.
We requested comments on a draft of this report from the Acting Secretary  of Transportation or her representative. On September 21, 2006, DOT  officials, including the Deputy Associate Administrator for Policy, Federal  Railroad Administration, and the Chief Economist, Office of  Transportation Policy, Office of the Secretary, provided us with oral  comments on the draft. In its comments, DOT emphasized the need for the  report to clearly recognize the rationale and importance of differential  pricing; the nature and relatively small extent of potentially unreasonable  pricing in the rail freight marketplace; and the impact of capacity  constraints on rail pricing and services. DOT also suggested that our  report should recognize certain factors, including that competition  between railroads is not possible in all markets because the level of  demand may not support more than one railroad, and that investment in  freight rail infrastructure entails substantial private risk. In contrast,  highway investment has been largely publicly financed. DOT did not take a  position on our recommendation concerning the draft National Freight  Policy, but stated that efforts are under way to develop more effective  tools for gauging the extent to which proposed freight investments provide  public benefits. DOT also endorsed the views contained in STB’s  September 15, 2006, letter (see app. III). We made changes to this report to  reflect DOT’s comments, as appropriate. DOT also provided a number of  technical corrections, which we incorporated as appropriate.
We will send copies to the appropriate congressional committees, the  Chair and Vice-Chairs of the Surface Transportation Board, and the  Secretary of Transportation. We will also make copies available to others  on request. In addition, the report will be available at no charge on the  GAO Web site at http://www.gao.gov.
If you or your staff has any questions, please contact me at (202) 512-2834  or heckerj@gao.gov. Contact points for our Offices of Congressional  Relations and Public Affairs may be found on the last page of this report.  See appendix V for a list of major contributors to this report.
section_title: Appendix I: Participants in GAO’s Expert Panel
paragraphs: Louis S. Thompson (Moderator)   Principal   Thompson, Galenson and Associates, LLC  George Borts   Department of Economics   Brown University   George Eads  Vice President  CRA International   Robert Gallamore   Director   Transportation Center   Northwestern University   Darius Gaskins  Founding Partner  Norbridge, Inc.
section_title: Appendix II: Objectives, Scope, and Methodology
paragraphs: We used the Surface Transportation Board’s (STB) Carload Waybill  Sample to identify railroad rates from 1985 through 2004 (the latest rate  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 across the industry, for certain commodities and for certain  routes by shipment size and length of haul. According to STB 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 that 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, STB 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.
We used rate indexes and average rates 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 the average length of haul. Therefore, comparisons of  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 as 2004 commodity flows  between pairs of census regions. To examine the rate trends on specific  traffic corridors, we first chose a level of geographic aggregation for  corridor end points. We defined end points as the regional economic areas  defined by the Department of Commerce’s Bureau of Economic Analysis.  An economic area is a collection of counties in and about a metropolitan  area (or other center of economic activity); there are 179 economic areas  in the United States, and each of the nation’s 3,141 counties is included in  an economic area. We placed each corridor in one of three distance- related categories: 0 to 500 miles, 501 to 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 determine the areas with access to one or more Class I railroads, we  obtained railroad systems data from the Department of Transportation,  which accounted for trackage rights, mergers, and other industry  developments affecting access. For issues related to revenue-to-variable  cost ratios, 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 areas whose R/VC ratios were above or  below the 180 percent R/VC level, as well as those areas above the 300  percent R/VC level.
To identify the actions STB has taken to address competition and captivity  concerns, we interviewed officials and reviewed information from all  seven North American Class I railroads, several shipper groups and  associations and STB officials; and we met with experts in the railroad  industry. We reviewed characteristics of STB’s current rate relief process,  as well as changes STB has made to the process, and conducted a  comprehensive analysis of STB cases since 2000. We also held an expert  panel through the National Academy of Sciences, consisting of 11  individuals with expertise in the freight railroad industry and the  economics of transportation deregulation. Moreover, we conducted a legal  analysis of current statutes related to STB’s authority. To discern potential  alternatives, we reviewed pending legislation, testimonies before  Congress, previous GAO reports, STB decisions, rule makings, and  proposed rule makings, and conducted a summary analysis of interviews.
To assess future freight demand and the freight railroad industry’s ability  to meet such demand, we reviewed transportation planning literature and  forecasts of future freight rail demand and capacity in the United States.  This review also included state freight plans and major freight rail  projects. We synthesized information on freight and freight rail, as well as  various forecasts to identify similar and dissimilar themes. We also  reviewed involvement by the federal government in freight railroad  projects, including related legislation and funding decisions. We  interviewed several state and federal transportation officials to gather  further information on public-private partnerships, freight railroad  projects, and DOT’s draft National Freight Policy. We also interviewed  freight railroad representatives, financial market analysts, national  association representatives, and transportation experts. For selected  public-private partnerships, we analyzed the genesis of such projects,  motivations for involvement from the public and private sectors, and  benefit-cost analyses that were conducted to support project funding  decisions.
We determined that the data used in this report were sufficiently reliable  for the purpose of our review. We conducted our review from June 2005 to  August 2006 in accordance with generally accepted government auditing  standards.
section_title: Appendix III: Comments from the Surface Transportation Board
paragraphs: The following are GAO’s comments on the Surface Transportation Board’s  letter dated September 15, 2006.
subsections: section_title: GAO Comments
paragraphs: 1.  STB commented that we conducted a national study into the state of  competition. We did not conduct such a study. Our study included a  broad focus on changes in the freight railroad industry since the  Staggers Rail Act, the actions STB has taken to address concerns about  competition and captivity, and future freight demand and capacity. The  data we collected and analysis we performed—such as a review of rate  changes over 20 years—were too broad to represent a national study  of the state of competition. It is the limitations in the scope of our  analysis of competition, along with limitations in the data available to  us and a reasonable possibility that shippers in selected markets may  be paying excessive rates, which led us to recommend that STB  conduct a more rigorous analysis of competition.  2.  STB commented that it has already addressed our recommendation to  improve data collection by proposing standardized monthly reports of  fuel surcharges and also described its efforts to ensure the accuracy  and reliability of data in the Waybill. We commend STB for its recent  action on fuel surcharges, which occurred during our review, but we  also note STB has not yet implemented standardized reporting of fuel  surcharges. In addition, other revenues besides fuel surcharges may  not be included in the Waybill. Specifically, revenues generated  through railcar auctions and congestion fees may not be included.  While the reported miscellaneous revenue is a small percentage of all  revenue, it is not known how much miscellaneous revenue is not  reported. Complete data would provide for more accurate tracking of  railroad revenues and would help STB to obtain a clearer picture of  actual fees paid by shippers. While we commend STB for its actions to  audit and review Waybill data, these accuracy checks do not address  our concern that STB is not collecting the full range of revenue data.  3.  STB commented that our recommendation for STB to conduct an  analysis of competition is based on two findings—that rail rates have  increased since 1980 and that the amount of traffic with high R/VC  ratios has increased in some areas. Our recommendation is not based  on these two findings, but on an analysis of multiple sources, such as  data on the amount of tonnage originating in economic areas that have  access to only one Class I railroad, data on the amount of tonnage  traveling over 300 percent R/VC, and the amount of tonnage that  originates in areas with access to only one Class I railroad and travels  at rates that exceed the statutory threshold for rate relief. This analysis  provides an important first step in assessing competitive markets  nationally; but it is imperfect, given the limitations of measures used to  weigh captivity and limitations in the Carload Waybill Sample. The  results of our analysis, when combined with comments from  participants on our expert panel and interviews with shipper and  railroad groups, suggest a reasonable possibility that shippers in  selective markets may be paying excessive rates related to a lack of  competition in these markets. It is precisely the inconclusiveness of  the available data—and STB’s authority and responsibility to monitor  and ensure effective competition in the freight rail industry—that led  us to recommend a rigorous analysis of competition by STB. Also, we  examined rates since 1985, not 1980.  4.  STB commented that an increase in rates does not suggest market  abuses and that the rate changes in our report were not adjusted for  inflation. We agree that a change in a rate does not necessarily suggest  the exercise of market power. While our rates were not adjusted for  inflation, we constructed rate indexes, which account for changes in  traffic patterns over time that could affect revenue statistics. We also  included the price index for the GDP to provide a measure for  inflation. However, our recommendation is not based on recent rate  increases. Our recommendation is based on our analyses of multiple  sources, such as data on the amount of tonnage originating in  economic areas that have access to only one Class I railroad, data on  the amount of tonnage traveling over 300 percent R/VC, and the  amount of tonnage that originates in areas with access to only one  Class I railroad and travels at rates that exceed the statutory threshold  for rate relief.  5.  STB commented that figure 19 shows an increase in grain traffic which  traveled at rates above 300 percent R/VC and figure 9 shows that grain  rates per ton-mile had fallen along that same route, so the change in  R/VC must be due to a drop in costs per ton-mile. We disagree that the  change in R/VC in figure 19 must be due to a drop in costs per ton-mile.  Figure 19 shows only the amount of traffic on the route that traveled at  rates above 300 percent R/VC, while figure 9 shows the cents per ton- mile for all traffic along that route (not just traffic that traveled at rates  above 300 percent R/VC). Therefore, the decrease in cents per ton mile  shown in figure 9 may reflect a decrease in rates for traffic along that  route that traveled at rates below 300 percent R/VC.  6.  STB commented that the measures used in our analysis are not  conclusive. The fact that our analysis is inherently limited by available  data and proxy measures lends more weight to our recommendation.
Specifically, our analysis provides an important first step in assessing  competitive markets nationally, but it is imperfect given the limitations  of measures used to weigh captivity and limitations in the Carload  Waybill Sample. We do not conclusively state that there are shippers  who are captive to one railroad and paying rates that reflect an abuse  of market power. However, the results of our analysis, when combined  with comments from participants on our expert panel and interviews  with shipper and railroad groups, suggest a reasonable possibility that  shippers in selective markets may be paying excessive rates related to  a lack of competition in these markets. We believe that STB is the  agency that has the authority and responsibility to conduct an inquiry  into the potential abuse of market power and utilize its range of  options to address competition issues.  7.  STB commented that R/VC levels do not provide a reliable measure of  changes in captivity because they can increase when rates are falling.  We agree that an analysis of R/VC levels is not a conclusive measure of  the use of market power. However, the use of R/VC as an indicator of  railroad pricing power is well-documented both by Congress in the  Staggers Rail Act and by STB, which uses R/VC levels in its process for  determining unreasonable rates. While we acknowledge the limitations  of the ratio in our report, and even include an example like the one  cited above, we believe that R/VC ratios can be used as one of several  proxy measure to determine potential captivity. In fact, STB refers to  traffic traveling at or above 180 percent R/VC as “potentially captive.”  8.  STB commented that they have several important rule makings under  way which bear directly on our concerns, including changes to the  standard and simplified rate relief processes. While we commend STB  for taking action to improve its rate relief processes, we note that  these rule makings are designed to make changes to the standard and  simplified rate relief processes and are not designed to analyze the  state of competition or the possible abuse of market power. In  contrast, we believe that an analysis of the state of competition or the  possible abuse of market power, along with the range of options STB  has to address competition issues, could more directly further  legislatively defined goals to ensure effective competition among rail  carriers as the preferred means to both promoting a sound rail  transportation system and maintaining reasonable rates.  9.  STB commented that it is hesitant to divert resources away from its  pending initiatives to respond to our recommendation. We have  modified our draft to recommend that, if STB determined that it needs  more resources to undertake a rigorous analysis of competitive  markets to identify the state of competition nationwide, it should  request additional resources from Congress.  10. STB commented that, as a small agency, a more practical approach to  addressing concerns about captive shippers would be for STB to  continue reforming its rate complaint procedures, rather than conduct  another analysis. While we commend STB for continuing its efforts to  improve its standard and simplified rate relief processes, these rule  makings will not address our concerns. Specifically, these rule  makings are designed to improve processes available to shippers after  they have been charged a rate they consider to be unreasonable; these  rule makings are not designed to analyze the state of competition or  the possible abuse of market power. In contrast, we believe that an  analysis of the state of competition or the possible abuse of market  power, along with the range of options STB has to address competition  issues, could more directly further legislatively defined goals to ensure  effective competition among rail carriers as the preferred means to  both promoting a sound rail transportation system and maintaining  reasonable rates. We believe that STB is the agency that is uniquely  positioned to inquire into and report on railroad practices and could  conduct an analysis of competition that would rely on more than  sample data and could determine whether the inappropriate exercise  of market power is occuring in specific markets. STB has the authority  to subpoena witnesses and records. Following its inquiry, STB could  also consider initiating a generally applicable rule making to address  competition issues or prescribe specific remedies in response to a  complaint. We recognize that STB has limited resources, and we have  modified our draft to recommend that, if STB determines that it needs  more resources to conduct an analysis of competition, it should  request additional resources from Congress.
section_title: Appendix IV: GAO Contact and Staff Acknowledgments
subsections: section_title: Staff Acknowledgments
paragraphs: In addition to those named above, individuals making key contributions to  this report include Ashley Alley, Steve Brown, Matthew T. Cail, Sheranda  S. Campbell, Steve Cohen, Elizabeth Eisenstadt, Libby Halperin, Richard  Jorgenson, Tom McCool, John Mingus, Josh Ormond, and John W.  Shumann.
section_title: Related GAO Products
paragraphs: Freight Railroads: Preliminary Observations on Rates, Competition,  and Capacity Issues. GAO-06-898T. Washington, D.C.: June 21, 2006.
Freight Transportation: Short Sea Shipping Option Shows Importance of  Systematic Approach to Public Investment Decisions. GAO-05-768.  Washington, D.C.: July 29, 2005.
Freight Transportation: Strategies Needed to Address Planning and  Financing Limitations. GAO-04-165. Washington, D.C.: December 19,  2003.
Railroad Regulation: Changes in Freight Railroad Rates from 1997  through 2000. GAO-02-524. Washington, D.C.: June 7, 2002.
Freight Railroad Regulation: Surface Transportation Board’s Oversight  Could Benefit from Evidence Better Identifying How Mergers Affect  Rates. GAO-01-689. Washington, D.C.: July 5, 2001.
Railroad Regulation: Current Issues Associated with the Rate Relief  Process. GAO/RCED-99-46. Washington, D.C.: April 29, 1999.
Railroad Regulation: Changes in Railroad Rates and Service Quality  Since 1990. GAO/RCED-99-93. Washington, D.C.: April 6, 1999.
Interstate Commerce Commission: Key Issues Need to Be Addressed in  Determining Future of ICC’s Regulatory Functions. GAO-T-RCED-94-261  Washington, D.C.: July 12, 1994.
Railroad Competitiveness: Federal Laws and Policies Affect Railroad  Competitiveness. GAO/RCED-92-16. Washington, D.C.: November 5, 1991.
Railroad Regulation: Economic and Financial Impacts of the Staggers  Rail Act of 1980. GAO/RCED-90-80. Washington, D.C.: May 16, 1990.
Railroad Regulation: Shipper Experiences and Current Issues in ICC  Regulation of Rail Rates. GAO/RCED-87-119. Washington, D.C.:  September 9, 1987.
Railroad Regulation: Competitive Access and Its Effects on Selected  Railroads and Shippers. GAO/RCED-87-109, Washington, D.C.: June 18,  1987.
Railroad Revenues: Analysis of Alternative Methods to Measure Revenue  Adequacy. GAO/RCED-87-15BR. Washington, D.C.: October 2, 1986.
Shipper Rail Rates: Interstate Commerce Commission’s Handling of  Complaints. GAO/RCED-86-54FS. Washington, D.C.: January 30, 1986.