Slover &

Loftus

Ratemaking at the Surface Transportation Board

Presented by Daniel M. JaffeSlover & Loftus

APPA Legal SeminarOctober 10, 2006

2

BackgroundSlover

& Loftus 100 Years of History

• The Interstate Commerce Commission (“ICC”) was the principal railroad regulatory agency for over 100 years

• In 1996, the ICC was abolished and many of its functions were deregulated

• Remaining regulatory powers were transferred to a new agency, the STB.

The ICC became a symbol of “big government”

3

BackgroundSlover

& Loftus STB Jurisdiction

• The STB has jurisdiction over common carrier railroads such as the Union Pacific and BNSF Railway. 49 U.S.C. § 10501

• The STB’s jurisdiction over rates charged by common carriers extends only to published rates (e.g., tariffs)

• The Board has no jurisdiction over railroad rates established by contract. 49 U.S.C. § 10709

Recent public pricing schemes have raised the “contract” issue

4

BackgroundSlover

& Loftus Statutory Authority

• One of the statutory goals of the STB is to “to maintain reasonable rates where there is an absence of effective competition and where rail rates provide revenues which exceed the amount necessary to maintain the rail system and to attract capital . . . .” 49 U.S.C. § 10101

• The STB has the power to determine the reasonableness of a rate charged by a railroad. 49 U.S.C. § 10701(d)

The ratemaking process is not defined in statutes

5

BackgroundSlover

& Loftus Market Dominance

• The STB only has jurisdiction if the carrier has market dominance. 49 U.S.C. §§ 10701, 10707 (c)

• Quantitative Market Dominance – if carrier charges less than 180% of variable cost the rate is lawful. 49 U.S.C. § 10707 (d)(1)(A)

• Qualitative Market Dominance – absence of effective competition from other carriers or modes of transportation. 49 U.S.C. § 10707 (a)

Railroads have, more recently, waived market dominance

6

BackgroundSlover

& Loftus CMP

• Carrier rate >180% of variable cost rate might still be lawful under constrained market pricing (“CMP”) theories

• Coal Rate Guidelines, 1 I.C.C.2d 520 (1985), established CMP tests

Railroads largely opposed the tests they now embrace

7

How It WorksSlover

& Loftus CMP Goals

• A captive shipper should not be required to pay more than is necessary for the carrier involved to earn adequate revenues.

• A captive shipper should not be required to pay more than is necessary for efficient service.

• A captive shipper should not bear the cost of any facilities or services from which it derives no benefit.

Railroads have countered that they are not “revenue adequate”

8

How It WorksSlover

& Loftus CMP Tests

• Stand-Alone Cost – what could a least-cost, most-efficient competitor charge if there were no barriers to entry or exit

• Revenue Adequacy – additional revenues are not necessary if the carrier is “revenue adequate,” as determined by annual decisions of the Board with certain further requirements

• Management efficiency – the shipper is not responsible for revenue needs caused by the carrier’s avoidable inefficiencies

Revenue adequacy is a technical term

9

How It WorksSlover

& Loftus Stand-Alone Cost Test

• The Stand-Alone Cost test is the only CMP test in use today in maximum reasonable rate proceedings

• The SAC test requires that the complainant develop, test and cost a hypothetical stand-alone railroad (SARR)

• The development of a SARR is extremely complex

Burden of proof on shippers has grown

10

How It WorksSlover

& Loftus SAC Guidelines

• Traffic group

• Stand-Alone railroad system

• Operating plan

• Operating expenses

• Road property investment

• Discounted cash flow analysis

• Results of SAC analysis

Each major area has many subparts

11

How It WorksSlover

& Loftus Data Development

Raw Traffic Data

Selection of Traffic Group

Many Files Develop SARR System

Test SARR System

Operating Costs

Working SARR System

Road Property

Investment

DCF CalculationFinal Rate

SARR development is not always linear

12

How It WorksSlover

& Loftus Capacity Analysis

• Board is insistent that shipper demonstrate that its railroad network can sustain traffic

• Typical test of capacity models the peak traffic in the peak week of the peak year

• Shippers and railroads use capacity simulators

Board does not accept expert’s testimony alone

13

How It WorksSlover

& Loftus Capacity Analysis

• Railroad Network Must Be Manually Entered Into the Capacity Model

• Individual Train Records Must Be Extracted From Real Train Data Or Developed On The Same Basis

• Each Train And All Events For The Trains Must Be Entered

• Recent Case Had Over 1500 Train Entries

Train data required is result of traffic group development

14

How It WorksSlover

& Loftus Capacity Analysis

• l

Each Point Includes Data Such As Elevation, Curve And Speed Limits

15

How It WorksSlover

& Loftus Capacity Analysis

• Once the SARR system is successful down stream costs can be finalized

• Certain operating statistics must be manually extracted and checked

Critical data includes information such as cycle times

16

How It WorksSlover

& Loftus Results

• The STB has consistently raised new barriers to relief for shippers– Cross-subsidies– Evidentiary requirements– Supplemental filings– Revisiting decided issues

• Variable cost used to set rates, but now SAC costs usually set the rates

STB decisions have emboldened the railroads

17

How It WorksSlover

& Loftus Shipper Complaints

• The STB defaults to the railroads

• The method for setting a rate using the SAC test is easily manipulated by the defendant railroad

• Shifting the rules mid-stream

The STB has “pulled” the rug out

18

The FutureSlover

& Loftus Rulemaking

• The STB has instituted a rulemaking (Ex Parte 657 Sub-No. 1) that will reshape rate cases

• Written comments have already been received – APPA participated

• A decision is due in November

Rulemaking put pending cases on hold

19

The FutureSlover

& Loftus Rulemaking Basics

• Maximum Rate Determinations – eliminate possible railroad manipulation

• SARR Revenues – ignore what the SARR could actually earn in the market place when a movement requires two or more railroads and instead use a cost-based, density-neutral revenue split that generally benefits the defendant

Railroads have long argued for an end to “cross-over” traffic

20

The FutureSlover

& Loftus Rulemaking Basics

• Indexing of Expenses – grant productivity improvements to the SARR over time thereby decreasing total expenses over the DCF period

• Variable Costs – eliminate any movement-specific adjustments

• Other

Indexing of revenues and expenses is inconsistent

21

The FutureSlover

& Loftus Shipper Request

• Fix cross-subsidy problems

• PPL Montana introduced a threshold test of cross-subsidy that hurts low density lines

• Otter Tail suggests that every segment on the SARR could be vulnerable to a cross-subsidy test that could severely limit rate relief

Cross-subsidy has been distorted

22

The FutureSlover

& Loftus Summary

• Ratemaking at the STB is difficult and uncertain

• Shippers have a future at the STB

• Rulemaking will define the future

• Revenue adequacy could alter playing field in favor of shippers

Questions?

Slover &

Loftus

Ratemaking at the Surface Transportation Board

Presented by Daniel M. JaffeSlover & Loftus

APPA Legal SeminarOctober 10, 2006