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Testimony: 

Before the Subcommittee on Surface Transportation and Merchant Marine, 

Senate Committee on Commerce, Science, and Transportation, U.S. Senate: 

United States Government Accountability Office: 

GAO: 

For Release on Delivery Expected at 10:00 a.m. EDT: 

Tuesday, October 23, 2007: 

Freight Railroads: 

Updated Information on Rates and Other Industry Trends: 

Statement of JayEtta Z. Hecker, Director: 

Physical Infrastructure Issues: 

Freight Railroads: 

GAO-08-218T: 

GAO Highlights: 

Highlights of GAO-08-218T, a report to Subcommittee on Surface 
Transportation and Merchant Marine, Committee on Commerce, Science, and 
Transportation, U.S. Senate. 

Why GAO Did This Study: 

The Staggers Rail Act of 1980 largely deregulated the freight railroad 
industry, encouraging greater reliance on competition to set rates. The 
act recognized the need for railroads to recover costs by setting 
higher rates for shippers with fewer transportation alternatives but 
also recognized that some shippers might be subject to unreasonably 
high rates. It established a threshold for rate relief and granted the 
Interstate Commerce Commission and the Surface Transportation Board 
(STB) the authority to develop a rate relief process for “captive” 
shippers. Since 1980 GAO has issued several reports on the freight 
railroad industry and issued the most recent report in October 2006 
and, at the request of this Subcommittee, issued an updated report in 
August 2007. This statement is based on these recent reports and 
discusses (1) recent changes that have occurred in railroad rates and 
how those changes compare to changes in rail rates since 1985, (2) the 
extent of captivity in the industry and STB’s efforts to protect 
captive shippers, and (3) STB’s actions to address GAO’s recent 
recommendations. 

What GAO Found: 

While railroad rates have generally declined and declined for most 
shippers since 1985, in 2005 rates experienced a 9 percent annual 
increase over 2004 —the largest annual increase in twenty years—and 
rates increased for all 13 commodities that GAO reviewed. For example, 
rates for coal increased by nearly 8 percent while rates for grain 
increased by 8.5 percent. However, despite these increases, rates for 
2005 remain below their 1985 levels and below the rate of inflation 
over the 1985 through 2005 period. Revenues that railroads report as 
“miscellaneous”—a category that includes some fuel surcharges—increased 
more than ten-fold from about $141 million in 2000 to over $1.7 billion 
in 2005. 

It is difficult to precisely determine how many shippers are “captive” 
because available proxy measures can overstate or understate captivity. 
However some data indicate that the extent of potentially captive 
traffic appears to have decreased, while at the same time, data also 
indicates that traffic traveling at rates significantly above the 
threshold for rate relief has increased. In October 2006, GAO reported 
that STB’s rate relief process to protect captive shippers have 
resulted in little effective relief for those shippers. GAO also 
reported that economists and shipper groups have proposed a number of 
alternatives to address remaining concerns about competition—however, 
each of these alternative approaches have costs and benefits and should 
be carefully considered. 

STB has taken some actions to address our past recommendations, but it 
is too soon to determine the effect of these actions. Our October 2006 
report noted that the continued existence of pockets of potentially 
“captive” shippers raised questions as to whether rail rates in 
selected markets reflected reasonable pricing practices, or an abuse of 
market power. GAO recommended that the Board undertake a rigorous 
analysis of competitive markets to identify the state of competition. 
STB has awarded a contract to conduct this study. It will be important 
that these analysts have STB’s authority and access to information to 
determine whether rail rates in selected markets reflect reasonable 
pricing practices--the Chairman of the STB recently testified that 
these analysts would have that authority and access. GAO also 
recommended that STB ensure that freight railroads are consistently 
reporting all revenues, including miscellaneous revenues. While STB has 
revised its rules on fuel surcharges, these rules did not address how 
fuel surcharges are reported and STB has not yet taken steps to 
accurately collect data on other miscellaneous revenues. STB has also 
taken a number of steps to revise its rate relief process. While these 
appear to be promising steps, it is too soon to tell what effect these 
changes will have. 

What GAO Recommends: 

In October 2006, GAO recommended that STB analyze the state of 
competition and consider appropriate actions. GAO also recommended that 
STB review their method of data collection to ensure that all freight 
railroads are consistently reporting all revenues collected from 
shippers. 

To view the full product, including the scope and methodology, click on 
[hyperlink, http://wwww.GAO-08-218T]. For more information, contact 
JayEtta Z. Hecker at (202) 512-2834 or heckerj@gao.gov. 

[End of section] 

Mr. Chairman and Members of the Committee: 

We appreciate the opportunity to testify on the freight railroad 
industry. As you know, 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. 

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[Footnote 1]-
-have seen their productivity and financial health improve. Railroad 
officials express concern that any attempt to increase economic 
regulation will reduce carriers' ability to earn sufficient revenues 
and limit future infrastructure investment. 

Since the passage of the Staggers Rail Act in 1980, we have issued 
several reports on the freight railroad industry.[Footnote 2] We issued 
our most recent report in October 2006 and, at your request and the 
request of other members of this Subcommittee, issued an updated report 
in August 2007 to include 2005 data that was not yet available in 
October 2006. My comments today are based on those recent reports and 
will focus primarily on the updated information, including (1) recent 
changes that have occurred in railroad rates and how those changes 
compare to changes in rail rates since 1985, (2) the extent of 
captivity in the industry and STB's efforts to protect captive 
shippers, and (3) STB's actions to address our recent recommendations. 
We reviewed STB documents in September and October 2007 to update the 
information in our recent reports and conducted our review in 
accordance with generally accepted government auditing standards. 

In summary: 

* While railroad rates have generally declined and declined for most 
shippers since 1985, rates began to increase in 2001. In 2005 rates 
experienced a 9 percent annual increase over 2004[Footnote 3]--the 
largest annual increase in twenty years--and rates increased for all 13 
commodities that we reviewed. For example, rates for coal increased by 
nearly 8 percent while rates for grain increased by 8.5 percent. 
However, despite these increases, rates for 2005 remain below their 
1985 levels and below the rate of inflation over the 1985 through 2005 
period. In addition, over 20 years, railroad companies have shifted 
other costs to shippers, including railcar ownership. Revenues that 
railroads report as "miscellaneous revenue"--a category that includes 
some fuel surcharges--increased more than ten-fold from $141 million in 
2000 to over $1.7 billion in 2005. We have recommended that STB revise 
its data collection methods to more accurately collect data on railroad 
revenue. 

* It is difficult to precisely determine how many shippers are 
"captive" because available proxy measures can overstate or understate 
captivity. However some data indicate that potentially captive traffic 
appears to have decreased, while at the same time, data also indicates 
that traffic traveling at rates significantly above the threshold for 
rate relief has increased. This trend continued in 2005 as tonnage and 
revenue from traffic traveling at rates above the statutory threshold 
for rate relief declined, while a subset of this traffic representing 
traffic traveling at rates substantially above the threshold (greater 
than 300 percent of the variable cost of transporting the shipment), 
increased in 2005. This increase followed declines in 2003 and 2004 but 
continued a general upward trend since 1985. In October 2006, we 
reported that STB's efforts to protect captive shippers have resulted 
in little effective relief for those shippers. We also reported that 
economists and shipper groups have proposed a number of alternatives to 
address remaining concerns about competition and capacity - however, 
each of these alternative approaches have costs and benefits and should 
be carefully considered to ensure the approach will achieve the 
important balance set out in the Staggers Act of allowing the railroads 
to earn adequate revenues and invest in its infrastructure while 
assuring protection for captive shippers from unreasonable rates. 

* STB has taken some actions to address our past recommendations, but 
it is too soon to determine the effect of these actions. Our October 
2006 report noted that the continued existence of pockets of 
potentially "captive shippers" raised questions as to whether rail 
rates in selected markets reflected justified and reasonable pricing 
practices, or an abuse of market power by the railroads. Based on STB's 
statutory authority to adjudicate unreasonable rates and to inquire 
into and report on railroad practices, we recommended that the Board 
undertake a rigorous analysis of competitive markets to identify the 
state of competition nationwide and to determine in specific markets 
whether the inappropriate exercise of market power is occurring and, 
where appropriate, to consider the range of actions available to 
address such problems. STB has awarded a contract to conduct this study 
and we commend STB for taking this action. It will be important that 
these analysts have the ability that STB has through its statutory 
authority to inquire into railroad practices as well as sufficient 
access to information to determine whether rail rates in selected 
markets reflect justified and reasonable pricing practices or an abuse 
of market power by the railroads. The Chairman of the STB recently 
testified that these analysts would have that authority and access. We 
also recommended that STB ensure that all freight railroads are 
consistently and accurately reporting all revenues collected from 
shippers. While STB has revised its rules on establishing and 
collecting fuel surcharges, these rules did not address how surcharges 
are reported in the Carload Waybill Sample and STB has not yet taken 
steps to accurately collect data on other miscellaneous revenues. STB 
has also taken a number of steps to revise its rate relief process. 
While these appear to be positive steps, it is too soon to tell what 
effect these changes will have and we have not evaluated the effect of 
these changes. 

Background: 

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 market power; and: 

* 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. 

Rail Rates Have Increased Recently But Have Generally Declined Since 
1985, While Railroads Have Shifted Other Costs To Shippers: 

Rail rates have generally declined since 1985, but experienced a 9 
percent annual increase between 2004 and 2005--the largest annual 
increase in 20 years. Although rates have generally declined, railroads 
have also shifted other costs to shippers, such as the cost of rail car 
ownership, and have increased the revenue they report as miscellaneous 
more than 10-fold between 2000 and 2005. 

Rail Rates Have Recently Increased But Generally Declined Since 1985: 

Following a period of general decline since 1985, rates began to 
increase in 2001. Rates experienced a 9 percent annual increase from 
2004-2005, which represents the largest annual increase in rates during 
the 20-year period from 1985 through 2005. This annual increase also 
outpaced inflation--about 3 percent in 2005. However, despite these 
increases, rates for 2005 remain below their 1985 levels and below the 
rate of inflation for the 1985 through 2005 period, and rates overall 
have declined since 1985[Footnote 4]. Because the set of rail rate 
indexes we used to examine trends in rail rates over time does not 
account for inflation we also included the price index for the gross 
domestic product (GDP) in figure 1. 

Figure 1: Trends in Industry Rail Rates, 1985-2005: 

This is a combination line graph showing GAO analysis of STB data. One 
line is showing the GDP price index, and the other line is showing 
industry. The rate index is being compared to the year. 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

While Generally Declining over the Long Term, Rates for Several 
Commodities Have Increased in Recent Years: 

Similar to overall industry trends, rates for individual commodities 
have increased from 2004-2005. In 2005, rates increased for all 13 
commodities that we reviewed. Rates for coal increased by 7.9 percent 
while rates for grain increased by 8.5 percent. In 2005, the largest 
rate increase (for fireboard and paperboard) exceeded 11 percent, while 
the smallest increase (for motor vehicles) was about 2.7 percent. 
Figure 2 depicts rate changes for coal, grain, miscellaneous mixed 
shipments, and motor vehicles from 1985 through 2005. 

Figure 2: Rate Changes for Coal, Grain, Miscellaneous Mixed Shipments, 
and Motor Vehicles, 1985-2005: 

This is a combination line graph showing GAO analysis of STB data. Each 
line represents coal, grain, miscellaneous mixed shipments, motor 
vehicles, and GDP price index. Rates are compared to years. 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

Railroads Have Shifted Costs to Shippers: 

In 2005, freight railroad companies continued a trend of shifting other 
costs to shippers. Our analysis shows a 20 percentage point increase 
shift in railcar ownership (measured in tons carried) since 1987. In 
1987, railcars owned by freight railroad companies moved 60 percent of 
tons carried. In 2005, they moved 40 percent of tons carried, meaning 
that freight railroad company railcars no longer carry the majority of 
tonnage (see fig. 3). 

Figure 3: Tonnage Carried by Railcar Ownership, 1987-2005: 

This is a combination line graph showing GAO analysis of STB data. The 
lines representing privately owned railcars, and railroad-owned 
railcars. Percentages of tons carried by railroad ownership are being 
compared to the year. 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

Reported Miscellaneous Revenue, Including Fuel Surcharges, Increased 
Ten-Fold Since 2000: 

In 2005 the amount of industry revenue reported as miscellaneous 
increased ten-fold over 2000 levels, rising from about $141 million to 
over $1.7 billion (see fig. 4). Miscellaneous revenue is a category in 
the Carload Waybill Sample for reporting revenue outside the standard 
rate structure. This miscellaneous revenue can include some fuel 
surcharges,[Footnote 5] as well as revenues such as those derived from 
congestion fees and railcar auctions (in which the highest bidder is 
guaranteed a number of railcars at a specified date). In 2004, 
miscellaneous revenue accounted for 1.5 percent of freight railroad 
revenue reported. In 2005, this percentage had risen to 3.7 percent. 
Also, in 2005, 20 percent of all tonnage moved in the United States 
generated miscellaneous revenue. 

Figure 4: Miscellaneous Revenue Tracked in Carload Waybill Sample, 2000-
2005: 

This is a line graph showing GAO analysis of STB data. The line 
represents the revenue in dollars being compared to the year in which 
it occurred. 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

Captive Shippers Are Difficult to Identify But Concerns Remain and Past 
STB Actions Have Led to Little Effective Relief: 

In October 2006 and August 2007, we reported that captive shippers are 
difficult to identify and STB's efforts to protect captive shippers 
have resulted in little effective relief for those shippers. We also 
reported that economists and shipper groups have proposed a number of 
alternatives to address remaining concerns about competition - however, 
each of these alternative approaches have costs and benefits and should 
be carefully considered to ensure the approach will achieve the 
important balance set out in the Staggers Act. 

Captive Shippers Remain Difficult to Identify, but Some Measures 
Indicate Captivity Is Dropping in the Railroad Industry: 

It remains 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 measure of 
potential captivity--traffic traveling at rates equal to or greater 
than 180 percent R/VC--is part of the statutory threshold for bringing 
a rate relief case before STB.[Footnote 6] STB regards traffic at or 
above this threshold as "potentially captive," but, like other 
measures, R/VC levels can understate or overstate captivity.[Footnote 
7] Since 1985, tonnage and revenue from traffic traveling at rates over 
180 percent R/VC have generally declined, while traffic traveling at 
rates substantially over the threshold for rate relief (greater than 
300 percent R/VC) has generally increased. This trend continued in 
2005, as industry revenue generated by traffic traveling at rates over 
180 percent R/VC dropped by roughly half a percent. Tonnage traveling 
at rates over 180 percent R/VC dropped by a smaller percentage. 

Figure 5: Tonnage and revenue generated from Traffic Traveling at Rates 
Equal to or Greater Than 180 percent R/VC, 1985-2005: 

This is a combination line graph showing GAO analysis of STB data. The 
lines are showing the percentage of industry revenue from tonnage equal 
to or greater than 180% R/VC and the percentage of industry tonnage 
equal to or greater than 180%R/VC. Industry percentage is compared to 
the year.

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

Traffic traveling at rates substantially over the threshold for rate 
relief has generally increased from 1985 to 2005 (see fig. 6). In 2003 
and 2004, the percentage of both tonnage and revenue traveling at rates 
above 300 percent R/VC declined from the previous year, but each 
increased again in 2005. For example, the share of tonnage traveling at 
rates over 300 percent R/VC increased from 6.1 percent in 2004 to 6.4 
percent in 2005. Figure 6 shows tonnage traveling at rates above 300 
percent R/VC from 1985 through 2005. 

Figure 6: Tonnage Traveling at Rates over 300 Percent R/VC, 1985-2005: 

This is line graph showing the tonnage traveling at rates over 300 
percent R/VC. Tons (in millions) are compared to the year. 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

Some 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 had more than half of all traffic originating 
in those same areas traveling at rates over 180 percent R/VC. However, 
we also found 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. 

STB Has Taken Actions to Protect Captive Shippers but Efforts Have Led 
to Little Effective Relief: 

STB has taken a number of actions to provide relief for captive 
shippers. While 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, they also 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, and trackage rights; 

* prescribe new regulations, such as rules for competitive access and 
merger approvals; 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. 

Under its adjudicatory authority, STB has 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. 

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. 

Despite STB's efforts, we reported in 2006 that there was widespread 
agreement that STB's standard rate relief process was inaccessible to 
most shippers and did not provide for expeditious handling and 
resolution of complaints. The process remained expensive, time 
consuming, and complex. Specifically, shippers we interviewed agreed 
that the process could cost approximately $3 million per litigant. In 
addition, shippers said that they do not use the process because it 
takes so long for STB to reach a decision. Lastly, shippers stated 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. 

We also reported that the simplified guidelines also had not 
effectively provided relief for captive shippers. Although these 
simplified guidelines had been in place since 1997, a rate case had not 
been decided under the process set out by the guidelines when we issued 
our report in 2006. STB had 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. We reported that several shipper organizations told 
us that shippers were 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. 

Since our report in October 2006, STB has taken steps to refine the 
rate relief process. Specifically, in October 2006, STB revised 
procedures for deciding large rate relief cases. By placing restraints 
on the evidence and arguments allowed in these cases, STB predicted 
that the expense and delay in resolving these rate disputes would be 
reduced substantially. In September 2007, STB altered its simplified 
guidelines for small shippers to enable shippers who are seeking up to 
$1 million in rate relief over a 5-year period to receive a STB 
decision within 8 months of filing a complaint. STB also created a new 
rate relief process for medium size shipments to allow shippers who are 
seeking up to $5 million in rate relief over a 5-year period to receive 
a STB decision within 17 months of filing a complaint. Additionally, 
STB also stated that all rail rate disputes would require nonbinding 
mediation. 

Shipper Groups and Others Have Suggested Alternative Approaches That 
Have Costs and Benefits: 

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.[Footnote 8] 

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. 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 Act. 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. 7). 

Figure 7: Reciprocal Switching: 

[See PDF for image] 

Source: GAO. 

[End of figure] 

* 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. 8). 

Figure 8: Terminal Agreements: 

[See PDF for image] 

Source: GAO. 

[End of figure] 

* 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. 9). 

Figure 9: Trackage Rights: 

[See PDF for image] 

Source: GAO. 

[End of figure] 

* "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.[Footnote 9] 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. 10). 

Figure 10: Bottleneck Rates: 

[See PDF for image] 

Source: GAO. 

[End of figure] 

* 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. 11). 

Figure 11: Paper Barriers: 

[See PDF for image] 

Source: GAO. 

[End of figure] 

STB Has Taken Steps to Address Problems, but Actions Are Too Recent to 
Be Evaluated: 

STB has taken some actions to address our past recommendations, but it 
is too soon to determine the effect of these actions. In October 2006 
we reported that the continued existence of pockets of potential 
captivity 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. While 
our analysis provided an important first step, we noted that STB has 
the statutory authority and access to information to inquire into and 
report on railroad practices and to conduct a more rigorous analysis of 
competition in the freight rail industry. As a result, we recommended 
that the Board undertake a rigorous analysis of competitive markets to 
identify the state of competition nationwide and to determine in 
specific markets whether the inappropriate exercise of market power is 
occurring and, where appropriate, to consider the range of actions 
available to address such problems. 

STB initially disagreed with our recommendation because it believed the 
findings underlying the recommendation were inconclusive, their on- 
going efforts would address many of our concerns, and a rigorous 
analysis would divert resources from other efforts. However, in June 
2007, STB stated that it intended to implement our recommendation using 
funding that was not available at the time of our October report to 
solicit proposals from analysts with no connection to the freight 
railroad industry or STB proceedings to conduct a rigorous analysis of 
competition in the freight railroad industry. On September 13, 2007, 
STB announced that it had awarded a contract for a comprehensive study 
on competition, capacity, and regulatory policy issues to be completed 
by the fall of 2008. We commend STB for taking this action. It will be 
important that these analysts have the ability that STB has through its 
statutory authority to inquire into railroad practices as well as 
sufficient access to information to determine whether rail rates in 
selected markets reflect justified and reasonable pricing practices, or 
an abuse of market power by the railroads. The Chairman of the STB has 
recently testified that these analysts would have that authority and 
access. 

We also recommended that STB review its 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. In January 2007, STB finalized rules that require railroads 
to ensure that fuel surcharges are based on factors directly affecting 
the amount of fuel consumed. In August 2007, STB finalized rules that 
require railroads to report their fuel costs and revenue from fuel 
surcharges. While these are positive steps, these rules did not address 
how surcharges are reported in the Carload Waybill Sample. In addition, 
STB has not taken steps to address collection and reporting of other 
miscellaneous revenues--revenues deriving from sources other than fuel 
surcharges. 

As stated earlier, STB has also taken steps to refine the rate relief 
process since our 2006 report. STB has made changes to the rate relief 
process that it believes will reduce the expense and delay of obtaining 
rate relief. While these appear to be positive steps that could address 
longstanding concerns with the rate relief process, it is too soon to 
determine the effect of these changes to the process, and we have not 
evaluated the effect of these changes. 

Mr. Chairman, this concluded my prepared statement. I would be happy to 
respond to any questions you or other Members of the Committee may have 
at this time. 

Contact and Acknowledgements: 

For questions regarding this testimony, please contact JayEtta Z. 
Hecker on (202) 512-2834 or heckerj@gao.gov. Individuals making key 
contributions to this testimony include Steve Cohen (Assistant 
Director), and Matt Cail. 

Related GAO Products: 

Freight Railroads: Updated Information on Rates and Competition Issues. 
GAO-07-1245T. Washington, D.C.: Sept. 25, 2007). 

Freight Railroads: Industry Health Has Improved, but Concerns About 
Competition and Capacity Should Be Addressed. GAO-07-94. Washington, 
D.C.: Oct. 6, 2006). 

Freight Railroads: Updated Information on Rates and Other Industry 
Trends. GAO-07-291R. Washington, D.C.: Aug. 15, 2007. 

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. 

[End of section] 

Footnotes: 

[1] As of 2004, a Class I railroad is any railroad with operating 
revenue above $277.7 million. 

[2] See GAO, Freight Railroads: Industry Health Has Improved, but 
Concerns About Competition and Capacity Should Be Addressed, GAO-07-94 
(Washington, D.C.: Oct. 6, 2006) and Freight Railroads: Updated 
Information on Rates and Other Industry Trends, GAO-07-291R 
(Washington, D.C.: Aug. 15, 2007). In addition, see the list of related 
GAO products at the end of this report. 

[3] We constructed rate indexes to examine trends in rail rates over 
the 1985 to 2005 period. In our August 2007 report, we reported a 7 
percentage point change in the rate index. Using 1.0 as our 1985 base 
we reported the change 0.8 to 0.87 from 2004-2005. This 7 percentage 
point change translates into an annual increase of 9 percent. In this 
testimony we refer to the annual increase and not the percentage change 
in the rate index. 

[4] We constructed rate indexes to examine trends in rail rates over 
the 1985 to 2005 period. These indexes define traffic patterns for a 
given commodity in terms of census region to census region flows of 
that commodity, and we calculated the average revenue per ton-mile for 
each of these traffic flows. The index is calculated as the weighted 
average of these traffic flows in each year, expressed as a percentage 
of the value for 1985, where the weights reflect the traffic patterns 
in 2005. By fixing the weights as of one period of time, we attempted 
to measure pure price changes rather than calculating the average 
revenue per ton- mile in each year. Over time, changes in traffic 
patterns could result in a substitution of lower priced traffic for 
higher priced traffic, or vice versa, so that a decrease in average 
revenue per ton-mile might partly reflect this change in traffic 
patterns. The rate index for the overall industry was defined 
similarly, except that the traffic pattern bundle was defined in terms 
of broad commodity, census region of origin, and mileage block 
categories. For comparison, we also present the price index for gross 
domestic product over this period. 

[5] Fuel surcharges are charges associated with recouping the cost of 
fuel. 

[6] Another condition of bringing a rate relief case before STB is a 
railroad not facing effective competition from other rail carriers or 
other modes of transportation. 

[7] 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, because both revenue and variable cost 
decline, the R/VC ratio--$18 divided by $10--increases to 180 percent. 

[8] Another proposal, articulated by economists Curtis Grimm and Cliff 
Winston, calls for the elimination of STB. This proposal recognizes 
that captive shippers have likely been hurt by a lack of competition, 
but it states that allowing the Department of Justice to review rail 
mergers instead of STB and ending the potential for reregulation of the 
industry could lead railroad officials and shippers to negotiate an 
agreement to address remaining rail competition concerns. Curtis Grimm 
and Clifford Winston, "Competition in the Deregulated Railroad 
Industry: Sources, Effects, and Policy Issues," (AEI - Brooking 
Institution. Washington, D.C.: 2000). 

[9] The U.S. Court of Appeals for the Eighth Circuit affirmed STB 
decision that a bottleneck carrier generally need not quote a separate 
rate for the bottleneck portion of the route. Mid-American Energy Co. 
v. Surface Transportation Board, 169 F. 3d 1099 (8th Cir.: Feb. 10, 
1999). The D.C. Circuit affirmed STB holding that separately 
challengeable bottleneck rates can be required whenever a shipper has a 
contract over the nonbottleneck segment of a through movement. Union 
Pacific Railroad v. Surface Transportation Board, 202 F. 3d 337 (D.C. 
Cir.: 2000).

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