Surface Transportation Board

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Surface Transportation Board

An Examination of the STB's Approach to Freight Rail Rate Regulation and Options for Simplification

Project FY14-STB-157

Draft Interim Report Task 1

PREPARED FOR

Surface Transportation Board

PREPARED BY

InterVISTAS Consulting Inc. September 14, 2016

Contents

Project FY14 ? STB - 157

Executive Summary ...................................................................................................... v Introduction .......................................................................................................................... v Legislative and Regulatory Context ..................................................................................... vi STB's Rate Regulation Procedures ................................................................................... viii Applying the Three-Benchmark and Simplified-SAC Tests to Settled Cases ........................ ix Conclusions ......................................................................................................................xvii

1 Introduction ............................................................................................................ 1 1.1 Objectives of this Report ...............................................................................................4 1.2 Organization of the Report ............................................................................................4 1.3 Methodology.................................................................................................................5 1.4 Acknowledgements.......................................................................................................6

2 Legislative and Regulatory Context...................................................................... 7 2.1 Regional Rail Reorganization Act of 1973 .....................................................................7 2.2 Railroad Revitalization and Regulatory Reform Act of 1976 ...........................................9 2.3 The Staggers Rail Act of 1980 ....................................................................................10 2.4 Constrained Market Pricing Principles.........................................................................13 2.5 The Stand-Alone Cost Test .........................................................................................15 2.6 ICC Termination Act of 1995 .......................................................................................16 2.7 The STB's Rate Case Simplification Efforts.................................................................16

3 Economies of Scope and Ramsey Pricing ......................................................... 21 3.1 Optimal Pricing for Multiproduct Firms: Ramsey Pricing ..............................................23

4 Rate Reasonableness Standards and Challenges in Their Uses...................... 34 4.1 The Full-SAC Procedure .............................................................................................34 4.2 The Three-Benchmark Procedure ...............................................................................44 4.3 The Simplified-SAC.....................................................................................................54

5 Simplifying the SAC Procedure: Two Cases, Two Procedures ........................ 58 5.1 Introduction.................................................................................................................58 5.2 Adapting the Three-Benchmark Test...........................................................................59 5.3 Findings of the Three-Benchmark Adaptation..............................................................63 5.4 Adaptation of the Simplified-SAC Methodology ...........................................................67 5.5 Conclusions................................................................................................................74

6 Alternatives to Maximum Rate Regulation: Are There Lessons from Other Countries?............................................................................................................ 75 6.1 Constraining Rail Rates in Canada..............................................................................75 6.2 The UK ? Access Charges for Freight .........................................................................79 6.3 Australia ? Access Charges ........................................................................................82

7 Maximum Rate Methodologies from Other Regulated Industries ..................... 86 7.1 Rate-Base Rate-of-Return and Price Cap Regulation Are Not Appropriate for U.S. Rail Transport ............................................................................................................86 7.2 Structural (Access) vs. Conduct (Rates) Regulation ....................................................86

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Project FY14 ? STB - 157

7.3 Overview of Federal Regulation of Electricity Transmission and Gas Pipeline Transportation Rates and Service ..............................................................................87

7.4 Experience in U.S. Telecommunications with TELRIC.................................................99 7.5 Is TELRIC Applicable to the Railroad Industry? .........................................................103 7.6 Application of TELRIC to Allocate Common Costs for the Two Rail Cases.................105 7.7 Efficient Components Pricing Rule (ECPR) - Concepts .............................................108 7.8 Using URCS Data to Illustrate ECPR Access Pricing for Two Cases .........................111 7.9 How M-ECPR Might be Applied to Maximum Shipper Rates for US Freight Rail ........115 7.10 Illustrative Example of an M-ECPR Method 2 (Build-in) Regulated Rate ....................117

8 Summary and Conclusions ............................................................................... 119 8.1 Context.....................................................................................................................119 8.2 Objectives of the Study .............................................................................................120 8.3 Review of Regulatory Methods Applied to Network Industries ...................................120 8.4 Is the SAC Test Still Valid? .......................................................................................124 8.5 Testing Two Variants of CMP and an Alternative Methodology, ECPR ......................126 8.6 Can the SAC Test Be Simplified?..............................................................................128 8.7 Are There Methodologies Other Than CMP that are Simpler? ...................................130

9 Synopsis of Key Conclusions ........................................................................... 132

Appendices ............................................................................................................... 135 Appendix I: Comments on the Debate on the Boundaries of Economies of Scope ............135 Appendix II: Three-Benchmark Adaptation for Otter Tail v. BNSF using Eagle Butte as Point of Origin..........................................................................................................141 Appendix III: Development of the ECPR Concept for Freight Rail ....................................144 Appendix IV: Bibliography ................................................................................................150

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List of Figures

Project FY14 ? STB - 157

Figure 3-1: Ramsey Pricing ................................................................................................................... 26 Figure 3-2: Different Measures of Rate Reasonableness ....................................................................... 31 Figure 4-1: Comparison of Two Hypothetical Stand-Alone Railroad Configurations ................................ 42 Figure 4-2: Major Regulatory Changes to the Three-Benchmark Method................................................ 46 Figure 5-1: Results of the Three-Benchmark Analysis Using the 2007 RSAM......................................... 64 Figure 5-2: Results of the Three-Benchmark Approach Using the Pre-2007 RSAM ................................ 65 Figure 5-3: Results of the DCF Analysis Using Eagle Butte as Point of Origin ........................................ 73 Figure 7-1: Structure of the Electric Power System ................................................................................ 90 Figure 7-2: Regional Transmission Organizations / Independent System Operators ............................... 93 Figure 7-3: Estimates of Percentage Markups from Applying Different TELRIC Methodologies to Two Rail Cases.................................................................................................................................................. 107 Figure 7-4: Railroad Bottleneck............................................................................................................ 108 Figure 7-5: Alternative Routings for WFA Traffic on Incumbent (BNSF) and Hypothetical Entrant (UP). 112 Figure 7-6: Computation of ECPR Access Charge for WFA Case ($ per Trainload).............................. 112 Figure 7-7: Alternative Routings for Otter Tail Traffic on Incumbent (BNSF) and Hypothetical Entrant (UP) ............................................................................................................................................................ 114 Figure 7-8: Computation of ECPR Access Charge for Otter Tail Power Case ($ per Trainload) ............ 115 Figure 7-9: Threatened Build-Out by Gainesville Regional Utilities ....................................................... 118

List of Tables

Table 5-1: RSAM and R/VC>180 Example Tables, 1998-2001 ................................................................. 61 Table 5-2: Summary of Three-Benchmark Method Analysis: 2007 RSAM Methodology.......................... 66 Table 5-3: Summary of Three-Benchmark Method Analysis: Pre-2007 RSAM Methodology ................... 67 Table 5-4: Traffic Group Determination .................................................................................................. 69 Table 5-5: Operating Expenses Estimation Using Modified URCS Data ................................................. 70 Table 5-6: Estimated Value of the Simplified-SAC RPI Category using Eagle Butte Point of Origin......... 72

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Abbreviations Used

Project FY14 ? STB - 157

3B 3R Act 4R Act AC ACCC ARTC ATC BNSF BPW CLR CMP COAG Conrail CTAR DCF DOT ECPR ELRA EP FCC FERC FOA GAO ICAct ICC ICCTA

Three-Benchmark Test Regional Rail Reorganization Act of 1973 Railroad Revitalization and Regulatory Reform Act Average costs Australia Competition and Consumer Commission Australian Rail Track Corporation Average Total Cost Burlington Northern and Santa Fe Railway Company Baumol, Panzar and Willig Competitive Line Rates Constrained Market Pricing Council of Australian Governments Consolidated Rail Corporation Canada Transportation Act Review Discounted Cash Flow Department of Transportation Efficient Component Pricing Rule Enterprise Level Revenue Adequacy Ex Parte Federal Communications Commission Federal Energy Regulatory Commission Final Offer Arbitration Government Accountability Office Interstate Commerce Act Interstate Commerce Commission ICC Termination Act of 1995

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