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Safety

Captive Shippers Demand Options

Rail shippers face uphill battle in effort to persuade Congress to increase freight competition

by Glenn Hess
October 24, 2005 | A version of this story appeared in Volume 83, Issue 43

Deregulation
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Credit: Courtesy of Canadian National Railway Co.
Railroads say reforms have raised traffic volume and productivity while lowering rates for most freight shippers.
Credit: Courtesy of Canadian National Railway Co.
Railroads say reforms have raised traffic volume and productivity while lowering rates for most freight shippers.

Rail shippers bound to a single carrier are fighting to bring greater competition and reduced rates to freight rail transportation. This isn't the first time that shippers captive to only one railroad have asked Congress for help, and it probably won't be the last. Captive shippers, which include many chemical and plastics manufacturers, utilities, agriculture, and other large commodity freight customers, are lobbying for passage of legislation that they argue is needed to end many long-standing monopolistic practices of the railroads and restore balanced commercial relationships.

Since the U.S. railroad industry was partially deregulated by the 1980 Staggers Rail Act, it has undergone dramatic consolidation, shrinking from more than 40 large Class I railroads to just five dominant carriers serving North America today-Norfolk Southern, CSX, Burlington Northern Sante Fe, Union Pacific, and Canadian National.

As a result of this concentration, shippers with no transportation alternatives are paying exorbitant rates for unreliable service, claim advocates for federal legislation that would remove the artificial protections that have led to rail monopolies. This is a rapidly growing national problem, says former congressman Glenn English, who now heads the National Rural Electric Cooperative Association (NRECA).

Captive shippers, which account for an estimated 2030% of railroads' traffic volume, pay rail rates of up to 450% above railroads' costs, as opposed to the 6% premium paid by shippers where rail competition exists, according to NRECA, which represents coal-burning electric utilities. The situation reflects the miserable failure of the promise of rail deregulation, says English. Deregulation has resulted in massive consolidation-only a handful of national railroads exist today-and a corresponding decline in competition and accountability.

Rail operators say consolidation was inevitable and that it led to cost reduction, new economies of scale, and increased efficiency across the industry. The Staggers Act was designed to permit railroads to use some of the market forces that are out there to respond more directly to what the marketplace wanted. It has been extraordinarily successful in that respect, says Tom White, spokesman for the Association of American Railroads (AAR). Today, the infrastructure is in better condition than it has ever been. The result is that we are able to handle more freight than we ever did before. And, in spite of what some of the reregulators would like you to believe, the fact is that average rates today are still less than they were in 1980.

Szabo
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Credit: Courtesy of Consumers United for Rail Equity
Credit: Courtesy of Consumers United for Rail Equity

Captivity is a concern for U.S. chemical companies because nearly two-thirds (63%) of their facilities that rely on rail for transportation have access to only one railroad, according to an American Chemistry Council (ACC) survey. A 2003 analysis by Gaithersburg, Md.-based Escalation Consultants found that captive rail customers pay anywhere from 106 to 137% more per ton to ship commodities on the country's four largest railroads than noncaptive rail customers.

English
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Credit: National Rural Electric Cooperative Association
Credit: National Rural Electric Cooperative Association

For some of the products in the chemical industry, transportation is a very high cost, says ACC Assistant General Counsel Thomas E. Schick. Companies have said that for certain lines of products, it's their second highest cost after feedstock. So it makes a huge difference in terms of being competitive. That's really the key issue. But it's not just the rate. It's not just the dollars. There's also the service component. If you're captive, you're not going to get the same kind of service that a competitive customer gets. There's no reason for the railroads to be concerned about how precise their delivery times are or whether they've picked up your traffic or dropped off enough empty cars for you to load, because you've got no choice. By definition, you're captive.

Congress began taking steps to deregulate the industry in the mid-1970s after one of the nation's largest railroads-Penn Central-and nearly a dozen other freight carriers declared bankruptcy. Toward the end of the decade, railroads accounting for more than 21% of the nation's track mileage were being operated under the protection of bankruptcy courts. Because railroads were no longer able to finance capital investment, their track and equipment deteriorated.Between 1966 and 1976, the number of train accidents caused by track defects increased by nearly 400%, and almost 50,000 miles of track-about 15% of the nation's track mileage-could be operated only at speeds as slow as 10 mph because of the unsafe conditions.

As the 1980s approached, the railroad industry was near collapse. AAR says this dismal state was due in large part to 90 years of heavy regulation by the powerful Interstate Commerce Commission, the first regulatory agency in the U.S. government. ICC controlled rates, routes, equipment acquisition and utilization, labor practices, service offerings, and just about every other aspect of railroad finances and operations. With taxpayers already paying $250 million per year in subsidies to keep some rail companies afloat, Congress began talking about nationalizing the industry, a move that would have cost taxpayers billions of additional dollars. Instead, lawmakers took the opposite course and partially deregulated the railroads by passing the Staggers Act. As a result of the legislation, railroads and customers were allowed to negotiate rates of service, a significant change from previous practice. The law limited the authority of ICC—now the Surface Transportation Board, or STB—to regulate rates only for traffic where competition is not effective to protect shippers.

By all accounts, deregulation has transformed the railroad industry. From 1980 to 2004, rail traffic volume rose some 81%, according to AAR. The industry group says rail share of intercity freight in the post-Staggers era rebounded after years of decline and has stabilized at about 42%. Return on investment now averages around 7%, up from a 2% average in the 1970s. And with the industry's improved financial condition, railroads have invested more than $340 billion in capital improvements and maintenance of track and equipment. Safety has also improved, with train accident rates declining by 64% over the past 25 years.

Average rail rates are also down. According to the Federal Railroad Administration, freight rates adjusted for inflation have declined by 1–2% per year since passage of the Staggers Act, compared with an increase of nearly 3% per year in the five years prior to enactment of the law. However, captive shippers say Congress did not anticipate that mergers and acquisitions would leave just a handful of railroads in control of more than 95% of the U.S. industry. The number of captive shippers has grown each time the industry has shrunk.

Congress recognized that some consolidation would take place, but I don't think they believed it would be down to this level of railroads. I also don't think they thought there would be this many captive shippers 25 years after deregulation occurred, says Robert G. Szabo, executive director of Consumers United for Rail Equity (CURE), a coalition of captive shippers whose members include Basell USA, Lyondell Chemical, Equistar Chemical, and Total Petrochemicals. I believe they thought that captivity was more of a transitory condition.

In addition to giving railroads the freedom to establish their own routes and tailor rates to market conditions, the Staggers Act also allowed carriers to differentiate rates on the basis of demand. Rail operators contend that variable prices for competitive and single-source routes are necessary for railroads to survive. They argue that income from traffic on competitive freight routes is inadequate for railroads to earn a profit. Shippers with the greatest demand for rail service pay higher margins than shippers with lower demand, White says.

In a policy paper, AAR describes differential pricing as the fairest, most pro-efficiency, and most procompetitive pricing system consistent with the continued viability of freight railroads. The group notes that railroads have enormous infrastructure costs. If shippers with the greatest demand for service paid less because of regulation, these costs would not be covered, and private capital would flee the industry. To prevent rail service from collapsing, taxpayers would eventually have to pay dearly to make up for the revenue shortfall, according to AAR.

What happens in any business is determined very much by the competitive forces that are out there. In every industry, those with fewer competitive options generally are going to pay a higher price than those with many competitive options, White says. The so-called captive shipper really should be paying more because that is the shipper who is most dependent upon rail service. Those who have more options don't need that same service to the same degree. To the degree that they contribute anything toward fixed costs, so-called captive shippers actually end up paying less than they would otherwise have to pay. If they had to pay for the entire system, they'd end up having to pay higher rates than they're paying now.

Captive shippers say the problem is abuse of differential pricing. Clearly, differential pricing is embedded in the Staggers Act because captives are always going to pay more than the competitive shippers, says Szabo. Our complaint is that there is no meaningful ceiling. It's outrageous when they're charging some of our people five times more than the cost of transportation.

Schick agrees that differential pricing is a valid economic concept. Nobody's complaining about that. But there's no recourse. The sky's the limit, he remarks. The problem, according to the ACC attorney, occurs when differential pricing results in a rate that the shipper believes is unreasonable. What do you do about it? The answer is: STB does not provide an effective means of resolution, Schick says.

White says shipper complaints about pricing are self-serving. I don't see where you can find any real abuse. I think their definition of abuse in differential pricing is when they pay a rate higher than they would like to pay, he says. We cannot engage in average pricing. It simply would not work.

Under current law, the only recourse for dissatisfied shippers is to file a rate case with STB, the regulatory body charged with overseeing the railroad industry and resolving rate and service disputes. The board presumes rates are reasonable if they are below a certain threshold, which is set at 180% of the costs of serving a particular shipper. For rates above that threshold, STB decides whether the rate is reasonable based on several criteria, including whether the rate charged the customer is more than it would cost an efficient railroad or other mode of transportation to serve that customer. If the board determines that the rate is unreasonable, it can order the railroad to reduce the rate and pay reparations to the shipper.

The problem that many shippers face, however, is the amount of time and money that must be devoted to a rate case: about $5 million and two to three years, according to Szabo. They've set up a system that frankly doesn't work. The burden of proof is all on the complainant, and all the information is in the hands of the railroads, he says. Schick says the process only works for large utility coal shippers because they transport large volumes in repetitive cycles. It's not unusual for them to move 2 million to 3 million tons from one coal mine to one power plant every year for 25 years, he notes. If you take a case like that to STB and get the rate knocked down by 50 cents or $1.00 per ton, you've more than paid for the cost of the litigation.

Although STB's small rate case guidelines have been in effect since 1996, not a single rail customer had filed a complaint until this summer. It was well understood that the first shipper to bring a rate case to the STB would not only have to spend lots of money and lots of time, but would also get a costly trip through the appellate court system, Schick says.

Consolidation
[+]Enlarge
Credit: Courtesy of Canadian National Railway Co.
Mergers and acquisitions have reduced the number of Class I railroads serving North America from more than 40 in 1980 to five dominant carriers today.
Credit: Courtesy of Canadian National Railway Co.
Mergers and acquisitions have reduced the number of Class I railroads serving North America from more than 40 in 1980 to five dominant carriers today.

In May, BP Amoco, the nation's third-largest chemical producer, filed a complaint against Norfolk Southern, claiming that the rates the railway was charging to haul p-xylene from Decatur, Ala., to Kingsport, Tenn., were unreasonable. Just one month later, however, BP Amoco withdrew its complaint and agreed to a settlement. Terms were not disclosed. STB Chairman Roger P. Nober hailed the outcome in a statement, saying the settlement shows that problems can best be solved at the negotiating table and that the agency's small rate case guidelines can provide an effective process for resolving disputes.

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Schick says the early disposition of the case leaves open some critical questions. There's no record that anyone can look at if they want to bring a small rate case. It's not a case that sets a precedent. There's nothing I can look at if I'm an attorney for another chemical company that explains what the guidelines are and how they're going to work, he says.

One undecided issue, Schick notes, is what constitutes a small rate case. If you are Dow Chemical, can you bring a small rate case? What if Dow is shipping one car a week to a plant somewhere? One car a week is not a lot of traffic. Is that a small shipment? Or do you also have to be a small company? The ACC attorney says it shouldn't matter, because whether you're Dow, DuPont, ExxonMobil, or anybody else, if you're captive, you're captive, and the railroads take advantage of you.

To address these issues, captive shippers are trying to build support for three pieces of legislation pending on Capitol Hill that they say would enhance competition in the freight rail marketplace. In July, Rep. Mark Green (R-Wis.) introduced the Railroad Antitrust & Competition Enhancement Act. The bill would give shippers, states, and the U.S. Justice Department the ability to bring antitrust cases against the railroads if they believe anticompetitive measures are being taken, as well as give the department a role in reviewing proposed railroad mergers.

For years, it's been full steam ahead' for our rail carriers, Green said in a statement introducing his bill. While businesses in virtually every other sector of our economy have been shaped by healthy competitive forces, railroad companies have been immune to laws that thwart monopolies and foster competition. Simply put, it's an erosion of our free-market system, and it's time to tell the railroads that they need to modernize their industry and compete like every other sector.

In addition, companion railroad competition bills were introduced this spring in the House and the Senate. The measures call for more effective competition among rail carriers at origins and destinations, more reasonable rates for captive shippers, and more affordable access to STB. The legislation would also establish a final offer arbitration of rail rate disputes between shippers and railroad companies. Captive shippers have found that there is no realistic possibility of meaningful relief from STB, said Rep. James L. Oberstar (D-Minn.), a chief sponsor of the House bill. This is hardly the competitive environment envisioned when Congress voted to deregulate the railroad industry.

Similar legislation has been introduced periodically since 1999, but it has been bottled up in committee. Captive shippers acknowledge that they face long odds in overcoming formidable opposition from the railroads, as well as STB. Congress is much happier not to get involved in an issue, especially a tough issue like this, Szabo says. The railroads have been constantly working Congress since the 1860s. Their CEOs are very eager to walk the halls of Congress to defend their franchise. They also have a very compelling message: Don't reregulate us.

AAR's White says the proposed legislation would reregulate the freight railroad industry and let the federal government artificially lower freight rates for a limited class of rail shippers. If the bills were to become law, he says rail profits-which already trail those of most other U.S. industries-would dwindle, and railroads would be forced to defer maintenance, abandon lines and services, and disinvest in the nation's 143,000-mile rail network. You're looking at reducing revenues by billions of dollars annually, White says. If we don't continually reinvest in the industry, our capital assets begin to deteriorate and eventually fall apart. We went through that cycle back in the 1970s, and more than 20% of the railroad industry went into bankruptcy.

White says there is no need for freight competition legislation because railroads face extensive competition for the vast majority of their business, including when a customer is served by only one railroad. There's plenty of competition out there, he remarks. Railroads in some cases do compete directly with each other. In other cases, though, there are plants served by one railroad that are competing with plants served by another railroad. When the ultimate buyer has choices of plants served by different railroads, that has a competitive impact; that's competition. Or in the case where product can move by truck or barge, that's competition.

Schick says the Staggers Act isn't the problem. What captive shippers object to, he explains, is the way STB has interpreted the statute. In implementing the act, the agency has created a number of rulings and precedents that are adverse to competition and not based on any words in the Staggers Act, he remarks. The primary procompetitive provisions in the legislation we are supporting are things that in effect tell STB to reverse their administrative determinations, not to change the words in the law. The concerns we have are with these particular interpretations, doctrines that have been developed by STB that preclude competition.

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