Freight Rail Pricing: Contracts Provide Shippers and Railroads Flexibility, but High Rates Concern Some Shippers
Released: 2016-12-07T00:00:00


Highlights: section_title: Why GAO Did This Study
paragraphs: The nation's freight rail network is vital to the economy, moving about 40 percent of U.S. freight and generating over $73 billion in revenue in 2013. Railroads charge various rates for moving freight from a particular origin to a particular destination. A rate may be set by the railroad in a public pricing document—known as a tariff—or negotiated through a private contract with a shipper. While most freight ships under contract, some shippers have raised concerns with how railroads negotiate contracts that contain multiple origin-to-destination routes. Though shippers that use rail to transport freight under tariff may seek relief from STB for rates they view as unreasonable, STB has authority to review tariff rates, but not contract rates.

The Surface Transportation Board Reauthorization Act of 2015 included a provision for GAO to review rail transportation contract proposals containing multiple origin-to-destination routes. This report addresses (1) similarities and differences in shipping freight under a tariff versus a contract, and the potential benefits to using each, and (2) views of selected stakeholders on the implications of shipping freight under a tariff versus a contract. GAO analyzed STB data from 2005 to 2014, reviewed documents provided by and interviewed representatives of the four largest freight railroads, the Association of American Railroads, STB officials, and representatives of nine shippers selected to represent a mix of commodities transported by rail.

section_title: What GAO Found
paragraphs: While rail contracts and tariffs are similar, contracts offer the flexibility to customize rates and terms to a specific shipper, according to selected stakeholders GAO interviewed. Both contract and tariff rates are based on market factors, such as competition, according to representatives from the four largest U.S. freight railroads. However, they noted that in developing contract rates, a railroad will also examine factors specific to each shipper and may negotiate discounts in exchange for the shipper committing to provide a specified volume over the contract's duration. According to railroad representatives, the volume commitments negotiated in a contract allow the railroad to more efficiently allocate its resources and ensure consistent revenues. Also, selected shippers told GAO that they can more efficiently manage multiple shipping routes under one contract because of the stability in rates over the duration of the contract. In contrast, tariffs may be preferred for smaller shipments.

Despite the volume discounts contracts can offer, some selected shippers said that contracts that include rates for multiple origin-to-destination routes can contain high rates on some routes. This is particularly an issue for shippers that are “captive”—that is, shippers served by a single railroad without an economically viable transportation alternative.

Representatives of the four largest freight railroads said they charge what shippers are willing to pay to cover infrastructure costs for the entire rail network. However, according to selected shippers GAO interviewed, combining captive and non-captive routes together in one contract can compel shippers to accept some unreasonable rates. Shippers subject to contract rates they view as unreasonable cannot challenge those rates at the Surface Transportation Board (STB) because contracts are not subject to STB oversight. A railroad official said that a shipper may ask the railroad to switch rates the shipper views as unreasonable to a tariff. However, selected shippers said that tariff rates are generally higher than contract rates, so they are reluctant to forgo a contract with a mix of rates in favor of using a tariff. While the STB process for reviewing tariff rates was designed, in part, to protect captive shippers from unreasonably high rates, selected shippers said the process is complicated, time-consuming, and expensive. In 2016, STB began to reform the tariff review process with the goal of improving its efficiency.

section_title: Letter
paragraphs: The nation’s freight transportation network is vital to the functioning of the  national economy. The national rail network accounts for the movement  of about 40 percent of U.S. freight. U.S. railroads reported over $73  billion in revenue in 2013. Shippers have two options for arranging  transport with railroads: a contract—which is a private agreement of  terms, conditions, and rates for moving freight—or a tariff, which is a  published rate railroads are required to provide to shippers when  requested. Most freight ships under contract, but some freight-rail  shippers have raised concerns about how railroads negotiate certain  contracts. Specifically, these shippers claim that railroads package a mix  of reasonable and unreasonable rates in contracts that contain multiple  routes between multiple origins and destinations. The Surface  Transportation Board (STB) is the economic regulator of the railroads and  resolves rate and service disputes between shippers and railroads for  regulated goods shipped under tariff, but does not have authority to  address rate and service disputes for freight shipped by contract.

The Surface Transportation Board Reauthorization Act of 2015 included a  provision for us to review the effects of railroad freight contracts that  contain multiple origin-to-destination (O-D) routes. This report presents  information on: (1) known similarities and differences in shipping freight  under a tariff versus a contract, and the potential benefits to using each;  and (2) views of selected stakeholders on the implications of shipping  freight under a tariff versus a contract.

To address the similarities and differences in shipping freight under a  tariff versus a contract, and the potential benefits to using each, we  reviewed our past reports and other academic and governmental studies  on the economics of rail rates. We also reviewed sample tariffs provided  by the four largest Class I railroads (BNSF Railway, CSX, Norfolk  Southern, and Union Pacific), as well as redacted sample contract  templates provided by some of these railroads. We interviewed  representatives from these four railroads and the Association of American  Railroads. As contracts between railroads and shippers are private, we  were not able to analyze specific contract language, including specific  rates and terms for a particular shipper. We also initially selected 20  shippers or shipper associations to interview. We selected these shippers  to represent five commodities: agriculture, chemicals, coal, food, and  nonmetallic minerals. We chose these commodities because they were  the five commodities with the largest shipments by weight in 2014 that are  either wholly or partially subject to rate regulation by STB. To select  shippers and associations, we reviewed comments filed by shippers in a  2011 STB proceeding “Competition in the Railroad Industry” that discuss  terms and rates of contracts as compared to tariffs. About half of the  shippers and associations we contacted either did not respond to our  requests or declined to meet with us. Some of these shippers stated that  they or their members have no views on these issues. However, we  interviewed representatives from nine shipper associations and  companies and reviewed documents they provided. As a result, we are  reporting aggregate statements from the nine shippers across  commodities. Further, these interviews are not generalizable to all  shippers or all railroads.

To identify the views of selected stakeholders on the implications of  shipping freight under a tariff versus a contract, we analyzed relevant  economic literature on freight rail contracts and shipping rates to provide  additional context for evaluating what we heard in interviews with  railroads and shippers. We also interviewed representatives of the four  Class I railroads and shippers selected as described above about their  views. Finally, we reviewed documents filed in the 2011 STB proceeding  that discuss terms and rates of contracts as compared to tariffs. We also  interviewed STB staff about the agency’s rate-relief process for  addressing unreasonable rates in tariffs and their efforts to improve it.

In addition, to provide contextual information on shippers using contracts  and tariffs, we analyzed STB’s Carload Waybill Sample, from 2005 to  2014 (the most recent year available) to determine the total volume and  trends of freight moved under contract and tariff, by commodity, in ton- miles, which is a measurement of weight and distance. STB requires the  railroads to compile a random sample of their waybills (a document that  accompanies a shipment and describes its characteristics). The Carload  Waybill Sample consists of over 600,000 records and contains  information on various characteristics of the freight being shipped,  including tonnage, revenue, and miles, among others. The sample is  statistically weighted to be nationally representative of all rail freight  movements that occur in the United States each year. We used agency  technical documentation for the Carload Waybill Sample and guidance  from STB to estimate the sampling error associated with our estimates  derived from the waybill data. We express our confidence in the precision  of estimates derived from the Carload Waybill Sample as 95 percent  confidence intervals. This is the interval that would contain the actual  population values for 95 percent of the waybill samples that STB could  have drawn. We determined that STB’s Carload Waybill Sample data  were sufficiently reliable for our purposes of our reporting objectives by comparing our analysis with published STB figures and by interviewing  STB staff and STB’s contractor about their data collection and validation  efforts.

We conducted this performance audit from February 2016 to December  2016 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: Freight shipped by rail travels over an extensive network that consists of  140,000 route-miles across the United States. Freight railroads are  generally privately owned and rely on their revenues to invest in  maintenance and operations that support safe and efficient transportation  services. During the last 40 years, the freight railroad industry has  consolidated. Currently, the U.S. railroad industry includes seven major  Class I freight railroads. Railroads carry a variety of commodities and may  compete with each other and other shipping modes such as trucks and  barges for business.

The Interstate Commerce Commission (ICC) was established in 1887,  originally to regulate almost all of the rates that railroads charged  shippers to ensure that the rates were reasonable and just. The Railroad  Revitalization and Regulatory Reform act of 1976 and the Staggers Rail  Act of 1980 were enacted in response to economic slowdown in the  1970s, with rising costs, losses in traffic and revenues to motor carriers,  and bankruptcies affecting the railroad industry. These laws substantially  reduced federal regulation and encouraged greater reliance on  competition to set rates. In particular, the Staggers Rail Act gave railroads  increased freedom to price their services according to market conditions,  including the freedom to use differential pricing, a practice in which  railroads can charge higher rates to shippers of commodities such as coal  and chemicals, which are more dependent on the rail network. The ICC  Termination Act of 1995 transferred the ICC’s regulatory functions to the  Surface Transportation Board (STB), an independent adjudicatory body.  The STB now serves as the industry’s economic regulator, resolving rate  and service disputes between shippers and railroads for regulated goods  shipped under tariff. The acts also allowed railroads and shippers to enter  into confidential contracts to set terms and rates. STB has no authority to  review the terms or rates for freight shipped by contract. To protect  shippers served by only one railroad with no competitive shipping  alternatives—known as “captive” shippers—from unreasonably high  rates, STB established a process in which shippers that transport their  freight by tariff could potentially challenge the reasonableness of a rail  rate and seek financial relief from the railroads, a process that we refer to  as a “rate-relief” process.

Some commodities were later exempted from STB’s jurisdiction, primarily  commodities that could be shipped by boxcar or intermodal containers, in  part because these goods can also be transported by other competitive  alternatives such as barge or truck and are therefore unlikely to be  captive. According to a Department of Agriculture report, these  exemptions, in addition to contracts, effectively freed about 75 to 85  percent of freight traffic from economic regulation by STB. Currently, the  most frequently transported commodities that could be subject to STB  rate regulation, by tons shipped, are agricultural, specifically, grain  soybeans, and sunflower seeds; assorted food items; coal; chemicals;  and nonmetallic minerals.

Railroads are required, upon request, to offer tariff terms and rates to  shippers, but railroads are not required to offer a contract. Contracts are  confidential, mutually agreed upon, and may contain rates for specific  routes and other service terms for a specific shipper. According to the  selected railroads and shippers we spoke to, contracts generally contain  multiple, shipper-specific O-D routes—agreements on terms and rates for  specific shipments over specific shipping routes—because a shipper may  have multiple routes. For example, according to a Class I railroad  representative, a chemical production facility may receive its raw  materials from multiple origins, with each route having agreed upon terms  and rates, as shown in figure 1.

STB has the authority to review the reasonableness of rates and service  terms for regulated commodities if shipped by tariff. Tariffs are a pricing  document issued by the railroads showing rates that are usually not  customer-specific. Tariffs also spell out the standard terms of the railroad.  These standard terms differ by commodity, covering everything from  loading specifications to billing procedures.

Under STB’s rate-relief process, in which it resolves disputes regarding  the terms or rates in a tariff, in order for STB to review a rate as  potentially unreasonable, the rate must not be under contract and the  commodity must not be exempt from STB rate regulation. STB may then  consider the reasonableness of a rate only if it also finds that the railroad  has market dominance over the shipment at issue—that is, if (1) the rate  is equal to or exceeds 180 percent of the railroad’s variable costs for  providing specific services to the shipper and (2) the railroad does not  face effective competition from other railroads or other modes of  transportation. If STB decides the rate is unreasonable, it can order the  railroad to pay reparations to the shipper for past shipments and decide  the maximum rate the railroad is permitted to charge for future shipments.

Under its authority, STB considers the reasonableness of a challenged  rate using one of its three tests, as chosen by the shipper. There is a  financial limit imposed on the relief available depending on the test  chosen:

Stand-Alone Cost (SAC): The most commonly used test is the Stand- Alone Cost test, which requires the shipper to design a hypothetical  railroad, tailored to serve the specific route(s), to simulate the  competitive rate that would exist in a perfectly efficient network. STB  then compares the challenged rate to the hypothetical rate. During the  rate relief process, both the railroad and the shipper have the  opportunity to present their views to STB.

Simplified SAC: The simplified SAC seeks to create a cost-effective  alternative to the SAC test. The simplified test eliminates or restricts  the evidence parties can submit to the actual operations and services  provided by the railroad.

Three Benchmark: The Three Benchmark test is faster and less  rigorous, but limits the potential return for a successful rate challenge.  STB determines the reasonableness of a challenged rate by  examining three benchmarks, or tests, that assess rate markups.

Between 1996 and 2016, STB reviewed 50 rate reasonableness cases.  Of these cases, 36 used the SAC rate case process, 5 used the simplified  SAC, 5 used the three benchmark process, and 4 used a different  methodology. To date, most of the 50 STB rate cases have been for  coal (32) or chemical (16) shippers. Among the 50 cases brought before  STB since 1996, about half (26) were settled without an STB decision,  while those that were decided by STB were split fairly evenly in favor of  the shippers (11) or the railroads (10).

section_title: Contracts Provide Certain Advantages, and Their Use by Certain Shippers Has Increased
subsections: section_title: Contracts Are Private and Include Negotiable Terms
paragraphs: According to representatives of the four Class I railroads we spoke to,  while contracts’ and tariffs’ terms and rates are developed using similar  methodologies, they may contain key differences. For example, selected  stakeholders said that contracts are often customized to a specific  shipper and may reflect the railroad’s and shipper’s preferences for a  given route or shipment. Figure 2 describes the similarities and  differences between contracts and tariffs, based on our interviews with  representatives from the four largest Class I railroads and selected  shippers, pertinent laws, as well as sample contract language and tariffs  provided by the railroads.

Railroad representatives said they rely on publicly available standard  terms to govern shipments over their network, regardless of whether the  shipments are moving under contract or tariff. These terms are unique to  each railroad and potentially negotiable for shipments under contract—as  are all aspects of a contract. A railroad’s standard terms cover all aspects  of a shipment, from loading specifications to billing procedures, and may  be contained in multiple documents. As a result, according to one railroad  representative, contracts typically incorporate or reference all of the  railroad’s applicable standard terms unless certain terms are specifically  negotiated by the shipper.

Sample contract language provided by three Class I railroads show  contracts may also include negotiable terms not typically found in tariffs,  such as volume commitments, discounts, and service standards.  However, according to two shipping associations representing coal  shippers, in recent years, contracts have become more standardized and  often reference other governing documents that spell out additional rules  and conditions. More specifically, a representative from one of these  shipper associations said that some contract features have become more  difficult to negotiate, in part, because of the increased standardization.  For example, they told us most contract negotiations now are generally  limited to rates, fuel surcharges, train size, loading and unloading  timeframes, and volume commitments.

According to three of the selected Class I railroads and a representative  from a shipper association, to start a contract negotiation, typically a  shipper may issue a request for proposal outlining its needs or informally  contact the railroad. Railroad representatives said the railroad will  typically respond with a standard contract. One railroad representative  told us the railroad may administer thousands of contracts at any given  time, so maintaining standard terms across their contracts allows the  railroad to manage its business portfolio and operations more efficiently.  For example, a representative from another Class I railroad said its  standard terms allow it to efficiently handle different shippers’ cars on the  same train.
subsections: section_title: Contract and Tariff Rates Are Based on Similar Market Factors
paragraphs: According to representatives from the four Class I railroads we  interviewed, they individually determine contract and tariff rates based on  a number of similar market factors associated with the supply and  demand for the commodity the shipper plans to transport. Because  railroads must offer a tariff rate upon request, railroad representatives  said they consider more general market factors in determining tariff rates.  Selected shippers told us that tariff rates are usually, but not always,  higher than contract rates, and sometimes are the same, in part, because  contract rates, according to a railroad representative, can be negotiated  and reflect market factors specific to the shipper as well as discounts for  volume commitments. In our discussions with the four Class I railroads,  they said they look at the extent of competition when determining contract  and tariff rates. According to one railroad representative, this includes  considering customer feedback, past experience, and market research to  determine the level of three types of competition:

Competition from other forms of transportation: Generally, a railroad  can charge more if it does not have to compete with another railroad  or other transportation forms, such as barge, pipeline, or truck. As a  result, a shipper served by more than one railroad or competitive  alternative can create more leverage during contract negotiations. For  example, representatives of the selected railroads told us if they are  competing with the trucking industry for business, they may offer  lower rates to obtain the shipper’s business.

Competition from other freight being shipped to the same market: A  chemical shipper, as part of its comments to STB’s 2011 competition  proceeding, stated that rail rates may impact a shipper’s ability to  compete nationally and globally. According to railroad representatives  we spoke to, they examine commodity markets to ensure they are  pricing rates to allow shippers to be competitive. For example, a  railroad representative told us it examines the rates it charges  domestic crude oil shippers to ensure it remains competitive with  imported crude oil. Representatives from the railroad industry also  said understanding the extent of geographic competition within a  market ensures the railroad maintains volume over their network. If  rates are priced too high, a shipper may lose business and transport  less freight. However, according to coal and grain shippers we  interviewed, tariff rates may not always reflect current commodity  market conditions.

Competition through substitution: Some shippers may be able to  obtain a commodity it needs from a different location, or it may use an  alternative commodity. For example, a railroad told us a power plant  may choose to obtain its coal from another mine or switch from coal to  natural gas if prices make doing so advantageous and the plant is  able and configured to do so.

Contract and tariff rates also reflect the characteristics of a given  shipment. More specifically, representatives from the four Class I  railroads we interviewed said the rates reflect the characteristics of the  commodity being shipped and its particular origin and destination. For  example, a shipper association representing chemical shippers and a  railroad representative said that commodities such as toxic inhalation  hazards are more expensive to ship under contract and tariff because of  their hazardous nature and liability concerns. In addition, railroad  representatives also told us rates may vary by distance, and longer routes  may be more expensive.

Railroads rely on selling freight transportation services at a particular rate  to recover their operating and infrastructure costs. However, while  representatives from all four Class I railroads we spoke to told us they do  not develop their rates to provide transportation based on these costs,  they also said they will not typically set rates below the cost of providing  rail transportation. According to a Department of Agriculture report, the  costs associated with providing rail transportation for each shipment, such  as maintenance and rail crew costs, serve only as a floor below which  rates should not go and bears little relationship to individual rail rates,  which are closer to what the shippers are willing and able to pay.  According to a representative from one Class I railroad, competitive  factors may sometimes require the railroad to charge less than its costs to  ship. However, railroads can also charge higher rates where its network is  highly valuable to its shippers.

section_title: Volume Commitments and Other Contract Features Provide Advantages to Shippers and Railroads
paragraphs: Selected shippers and railroad representatives also said contracts  generally provide key advantages by allowing for increased financial and  logistical certainty for both parties. According to selected shippers we  spoke to, they prefer to maintain the minimal number of contracts to meet  their transportation needs. A shipper association said shippers can more  efficiently manage multiple routes under one contract because of the  stability in rates over the duration of the contract. As a result, according to  the railroad representatives, shippers often request contracts covering  multiple routes—potentially up to thousands of routes, according to one  railroad representative—because managing each route under a separate  contract, or by tariff, would be too complex to administer. For example,  one chemical shipper told us it may move one or two carloads per day  across 1,000 separate routes over a year. In addition, contracts allow  shippers and railroads to customize terms to better fit their shipping  needs, such as offering guaranteed pickup and delivery times or specific  services. For example, according to one railroad representative, in a  contract with multiple routes, a railroad may offer a lower rate on some  routes, while increasing rates on others, to allow a shipper to break into a  new market. Another railroad representative said the railroad can also  provide additional logistics services at a lower cost within a contract that  contains multiple routes because the economy of scale offered by a large  contract allows the railroad to provide services at a lower rate due to  gains in efficiency.

Furthermore, according to representatives from three Class I railroads, a  contract’s overall volume commitment and certainty helps the railroads  better plan future investments. Specifically, one railroad representative  said a contract allows the railroad to allocate locomotives and rail crews  more efficiently and ensure a consistent source of revenue. As a result,  contracts generally include agreements on the amount of volume a  shipper is willing to commit. Railroad representatives and selected  shippers told us that the guaranteed volume from a contract may also  create additional leverage for the shipper during contract negotiations. To  gain additional volume guarantees, railroads and shippers said railroads  typically offer discounted rates to shippers in exchange for volume  commitments. Railroad representatives also said these discounts may be  for one, multiple, or all of the routes in contract, and they said the more  volume a shipper is willing to commit, the better deal it can expect to  receive. However, if the shippers fail to meet their expected volume  commitment, they may be subject to financial penalties. Moreover,  according to one railroad representative, higher-volume shippers are also  more likely to request custom terms.

However, some selected shippers said tariffs may provide advantages in  certain situations. For example, they said contract negotiations may be  too long and costly for shippers with infrequent or small volume  shipments. Furthermore, according to coal shippers, in some instances,  the tariff rate may be the same as the contract rate, and shippers incur  potential penalties associated with failing to meet contractual volume  commitments.

section_title: Freight by Contract Has Increased, and Shippers Said Some Contract Features Have Changed
paragraphs: Contract usage across the most frequently transported commodities  regulated by STB has generally increased or stayed relatively the same in  recent years. Specifically, from 2005 through 2014, the ton-miles  shipped under contract for these commodities have increased by 6  percent, from about 705,000 ton-miles to about 800,000 ton-miles, a  measurement that combines weight and mileage. In 2014, about 76  percent of regulated freight was shipped by contract. However,  according to railroad representatives, each railroad’s business differs.  Figure 3 shows the percent of selected commodities with regulated rates  by ton-miles shipped under contract from 2005 through 2014.

From 2005 to 2014, the percentage of coal and chemicals shipped under  contract has increased when measured on a ton-mile basis. Specifically,  in 2005, 55 percent of all chemical shipments, measured in ton-miles,  were shipped by contract; by 2014, that percentage had increased to 85  percent. Similarly, over the same time period, the ton-miles of coal  shipped increased from 86 percent to 94 percent. A representative of a  shipper association said chemical shipments under contract increased, in  part, because the potential for improved negotiated terms may provide  additional certainty and lower rates. Both coal and chemicals are also  heavily dependent on the railroad’s network.

We were unable to obtain contract duration data from selected railroads  and shippers, but selected coal and grain shippers as well as a railroad  representative told us that the duration of contracts has generally  decreased during the last 10 years. According to another rail  representative, contract duration depends on the commodity and the  market; for example, this official said shippers in markets that change  frequently may prefer shorter contracts. Additionally, representatives from  two selected shipper associations that represent various commodities told  us the duration of contracts has decreased over the years, with longer  contracts becoming increasingly uncommon, though they prefer longer  contracts because of their rate stability. A coal-shipper association  representative also told us current coal contracts are typically for about 3  to 5 years, in part because a shorter contract would result in more  frequent contract renegotiation. Another coal shipper association  representative said the duration of contracts to transport coal has gotten  shorter, mostly because of the increased uncertainty in the energy  market. In the past, we have reported that the duration of contracts has  declined, in part, because of the railroads’ desire to quickly react to  shifting market demand. One railroad representative we spoke to said  as markets become more dynamic, shippers can continue to expect to  receive shorter contracts.

In addition, selected shippers told us the railroads may also be shifting  certain costs to shippers. More specifically, according to a grain shipper,  railroad service commitments that used to be common are no longer  included in contracts. Further, one coal shipper said the railroad  previously supplied its own personnel to load the coal, but now, with no  reduction in rates, the shipper is required to do so.

section_title: Some Selected Shippers with Fewer Shipping Options Said They Have High Rates for Some Contract Routes and Limited Recourse for Rate Relief for Tariffs
subsections: section_title: Selected Shippers with Fewer Options Said They May Have High Rates for Some Routes in Contracts
paragraphs: Despite the volume discounts and other advantages to contracts with  multiple O-D routes, some shippers said that contracts effectively  constrain them into paying higher rates on some routes, because  railroads will propose contracts with multiple O-D routes where some of  the routes are priced unreasonably high, in the shippers’ view. This is  particularly an issue for shippers that are “captive”—that is, shippers  served by a single railroad without an economically viable transportation  alternative because a trucking or barge route either does not exist or  would be too costly. Figure 4 below illustrates the ways in which a  shipper can be captive on all routes or just some routes.

Eight of the nine shippers we interviewed stated that captive shippers  have no other options than the one railroad that serves them, which can  result in higher freight rail rates. Further, according to our analysis of a  2011 STB proceeding on rail competition, 6 of the 11 shippers that  provided comments to the proceeding about being a captive shipper said  that captive shippers have no other options than the railroad that serves  them, which can result in higher rates. Additionally, a 2010 study  commissioned by the STB concluded that captive shippers tend to pay  higher shipping rates than otherwise similar shippers with access to  additional railroad or water competition.

As previously discussed, the selected railroads we interviewed said they  develop prices based on market forces and the railroad’s supply of  available equipment and rail lines. This is the basis for differential pricing,  a pricing strategy where railroads charge shippers with few or no other  options more than shippers with more options for their freight. Differential  pricing is permitted and encouraged in the rail freight market by design.  The Staggers Rail Act of 1980, which reduced the economic regulation of  railroads, provided that rail rates should be set by the competitive market  forces to the maximum extent possible. According to railroad officials,  railroads make up for lower revenues from highly competitive routes by  charging higher rates in less competitive routes where they have market  dominance. All four railroads and the Association of American Railroads  also said that railroads use differential pricing to charge the highest rate  shippers are willing to pay so railroads can cover infrastructure costs.

Although shippers have the option of challenging a tariff rate before the  STB, they do not have this option for challenging rates they view as unfair  if agreed to in a contract, since the STB has authority to review tariff rates  but not contract rates. Although contracts are negotiated between  railroads and shippers, some shippers told us that because contracts  often contain rates for multiple routes, they may be pressured to accept  higher rates they view as unfair as part of the package of rates they agree  to, particularly if some of the shipper’s routes are captive. Specifically,  three selected shippers said this situation can arise when faced with a  contract containing multiple O-D routes where they view some routes as  priced too high by the railroads. In this situation, they have two choices:  1) accept the contract and pay higher rates for some routes, or 2) reject  the contract and opt instead to move their freight by tariff, which could  result in higher prices for all the routes since, as previously discussed,  shippers and railroads said that tariff rates are generally higher than  contract rates. According to two of the shippers we interviewed, combining captive and competitive routes together in one large contract  can create high rates on captive routes. In contrast, officials from one  railroad said that the STB tariff rate-relief process prevents railroads from  forcing shippers to pay unreasonable rates, even in contracts. The  railroad representatives said this occurs because railroads do not want to  have a rail rate case before the STB and a shipper that thought a contract  rate was unreasonable could always ask for the tariff in place of the  contract to be able to file a rate case.

section_title: The STB Tariff Rate-Relief Process Can Be Complicated and Expensive
paragraphs: When an STB rate case is an option, six of the interviewed shippers said  that STB tariff rate-relief cases are complicated, time consuming, and  expensive, in part, due to the challenges in determining reasonable and  unreasonable rates. Consequently, these shippers said they are deterred  from pursuing cases or from requesting tariff rates from railroads in order  to pursue a rate case. An STB staff member said that when a rate case  involves hundreds of O-D pairs, resolving the case can take substantial  resources and time for STB, the railroads, and the shippers involved in  the litigation. This STB staff member also stated that cases can take up to  3 years and be so costly that some shippers may think it is not worth  bringing a case.

The STB rate-relief process was designed, in part, to maintain reasonable  rates for captive shippers. However, determining reasonable versus  unreasonable rates can be challenging given the market forces involved.  Once a rate case is filed, STB must determine whether the rate is  reasonable because it allows a railroad to earn adequate revenue for its  fixed costs, or whether the rate is unreasonable because it allows the  railroad to earn more than adequate revenue from its market dominance.  According to economic literature, differential pricing allows railroads to  collect adequate revenue to cover all costs and earn a reasonable return  on their investments. Railroads not earning adequate revenue to remain  in business and to adapt their network to meet future shipper demands  would be problematic for both railroads and the shippers that rely on  them. However, some research shows that railroads may be recovering  from the rising costs, losses, and bankruptcies in the 1970s. For example,  according to two economic studies of railroad economics, the Class I  railroads may now be earning adequate returns on investment, and  perhaps sometimes in excess of adequate returns, so measures to  reduce the amount contributed by captive shippers to railroad returns may  be appropriate. More recently, in September 2016, STB determined that  four Class I railroads were revenue-adequate for the year 2015,  specifically that these railroads achieved a rate of return equal to or  greater than STB’s calculation of the average cost of capital to the freight  rail industry.

STB is currently reviewing its rate relief process as required in the  Surface Transportation Board Reauthorization Act of 2015. In June 2016,  STB released an Advance Notice of Proposed Rulemaking outlining  measures to expedite its handling of SAC rate cases. Comments were  due in August 2016. STB staff said that measures such as standardizing  evidence submissions would expedite SAC cases for purposes of fairness  to litigants and improving overall agency efficiency. They also said that  since the current proceeding on expediting SAC rate cases had just  begun, it was too soon to know how changes might affect the SAC  process.

section_title: Agency Comments
paragraphs: We provided a draft of this product to STB for comment prior to finalizing  this report. We received technical comments from STB which we  incorporated as appropriate.

We will send copies of this report to appropriate congressional  committees. In addition, we will make copies available to others upon  request, and the report will be available at no charge on the GAO website  at http://www.gao.gov.

If you or your staff have any questions about this report, please contact  me at (202) 512-2834 or Flemings@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on   the last page of this report. GAO staff who made key contributions to this  report are listed in appendix I.

section_title: Appendix I: Contact and Staff Acknowledgments
subsections: section_title: GAO Contact

section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, other key contributors to this  report were Andrew Huddleston, Assistant Director; Sarah R. Jones,  Analyst-in-Charge; Namita Bhatia Sabharwal; Herbert J. Bowsher;  Stephen M Brown; Russell C. Burnett; Ross A. Gauthier; Richard A.  Jorgenson; Grant M. Mallie; Cheryl M. Peterson; Malika Rice; Kelly L.  Rubin; Amelia (Michelle) Weathers; Alwynne Wilbur; and William T.  Woods.


Question-summary annotations: questions: question: What flexibility do contracts offer?
answer: While rail contracts and tariffs are similar, contracts offer the flexibility to customize rates and terms to a specific shipper, according to selected stakeholders GAO interviewed.

question: How are contract and tariff rates similar?
answer: Both contract and tariff rates are based on market factors, such as competition, according to representatives from the four largest U.S. freight railroads.
child_questions: question: What does a railroad also need to consider in developing contract rates?
answer: However, they noted that in developing contract rates, a railroad will also examine factors specific to each shipper and may negotiate discounts in exchange for the shipper committing to provide a specified volume over the contract's duration.

question: What do volume commitments in a contract allow for?
answer: According to railroad representatives, the volume commitments negotiated in a contract allow the railroad to more efficiently allocate its resources and ensure consistent revenues.

question: Why might tariffs or contracts be preferred over the other?
answer: Also, selected shippers told GAO that they can more efficiently manage multiple shipping routes under one contract because of the stability in rates over the duration of the contract. In contrast, tariffs may be preferred for smaller shipments.

questions: question: What do representatives of freight railroads charge?
answer: Representatives of the four largest freight railroads said they charge what shippers are willing to pay to cover infrastructure costs for the entire rail network.
child_questions: question: How could this be problematic for shippers?
answer: However, according to selected shippers GAO interviewed, combining captive and non-captive routes together in one contract can compel shippers to accept some unreasonable rates.
child_questions: question: How is this even more problematic for shippers subject to contract rates?
answer: Shippers subject to contract rates they view as unreasonable cannot challenge those rates at the Surface Transportation Board (STB) because contracts are not subject to STB oversight.

question: Why are shippers reluctant to forgo a contract?
answer: However, selected shippers said that tariff rates are generally higher than contract rates, so they are reluctant to forgo a contract with a mix of rates in favor of using a tariff.

question: What is the problem with the STB process for reviewing tariff rates?
answer: While the STB process for reviewing tariff rates was designed, in part, to protect captive shippers from unreasonably high rates, selected shippers said the process is complicated, time-consuming, and expensive.
child_questions: question: What is the STB beginning to do in order to assuage this problem?
answer: In 2016, STB began to reform the tariff review process with the goal of improving its efficiency.

questions: question: Why is the nation's freight rail network vital to the economy?
answer: The nation's freight rail network is vital to the economy, moving about 40 percent of U.S. freight and generating over $73 billion in revenue in 2013.

question: How are railroad rates determined?
answer: Railroads charge various rates for moving freight from a particular origin to a particular destination. A rate may be set by the railroad in a public pricing document—known as a tariff—or negotiated through a private contract with a shipper.

question: What concerns do shippers have?
answer: While most freight ships under contract, some shippers have raised concerns with how railroads negotiate contracts that contain multiple origin-to-destination routes.
child_questions: question: Why do shippers that transport freight under tariff not have these concerns?
answer: Though shippers that use rail to transport freight under tariff may seek relief from STB for rates they view as unreasonable, STB has authority to review tariff rates, but not contract rates.

questions: question: Why did GAO review rail transportation contract proposals?
answer: The Surface Transportation Board Reauthorization Act of 2015 included a provision for GAO to review rail transportation contract proposals containing multiple origin-to-destination routes.

question: What does this report address?
answer: This report addresses (1) similarities and differences in shipping freight under a tariff versus a contract, and the potential benefits to using each, and (2) views of selected stakeholders on the implications of shipping freight under a tariff versus a contract.
child_questions: question: How did GAO get information for this report?
answer: GAO analyzed STB data from 2005 to 2014, reviewed documents provided by and interviewed representatives of the four largest freight railroads, the Association of American Railroads, STB officials, and representatives of nine shippers selected to represent a mix of commodities transported by rail.