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entitled 'Freight Railroads: Industry Health Has Improved, but Concerns 
about Competition and Capacity Should Be Addressed' which was released 
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Report to Congressional Requesters: 

United States Government Accountability Office: 

GAO: 

October 2006: 

Freight Railroads: 

Industry Health Has Improved, but Concerns about Competition and 
Capacity Should Be Addressed: 

Freight Railroads: 

GAO-07-94: 

GAO Highlights: 

Highlights of GAO-07-94, a report to congressional requesters 

Why GAO Did This Study: 

The Staggers Rail Act deregulated the freight rail industry, relying on 
competition to set rates, and allowed for differential pricing 
(charging higher rates to those more dependent on rail). The act gave 
the Surface Transportation Board (STB) authority to develop remedies 
for shippers“captive” to one railroad and set a threshold for shippers 
to apply for rate relief. GAO was asked to review (1) changes in the 
railroad industry since the Staggers Rail Act, including rates and 
competition; (2) STB actions to address competition and captivity 
concerns and alternatives that could be considered; and (3) freight 
demand and capacity projections and potential federal policy responses. 
GAO examined STB data, conducted interviews, and held an expert panel. 

What GAO Found: 

Changes in the railroad industry since the Staggers Rail Act are widely 
viewed as positive, as the industry’s financial health has improved and 
most rates have declined; however, concerns over competition and 
captivity remain. Rail rates generally declined between 1985 and 2000, 
then increased slightly from 2001 through 2004. Concerns about 
competition and captivity remain as traffic is concentrated in fewer 
railroads. It is difficult to determine the number of “captive” 
shippers as proxy measures can overstate or understate captivity. 
Nevertheless, GAO’s analysis of limited available measures indicates 
that the extent of captivity appears to be dropping, but the percentage 
of traffic traveling at rates substantially over the threshold for rate 
relief has increased. Also, some areas with access to only one major 
railroad have higher percentages of traffic traveling at rates above 
the threshold. These findings may reflect reasonable economic practices 
by the railroads or a possible abuse of market power. GAO’s analysis is 
limited by available data and proxy measures but suggests that shippers 
in selected markets may be paying excessive rates, meriting further 
inquiry and analysis. 

While STB has taken action, further efforts to improve its rate relief 
processes and assess competition could help address competition and 
captivity concerns and inform the merits of proposed alternative 
approaches. STB’s rate relief processes are largely inaccessible and 
rarely used. STB recognizes this and is taking steps to improve its 
processes. STB has broad statutory authority to inquire into and report 
on railroad industry practices and, given a reasonable possibility that 
some shippers may be paying excessive rates, an assessment of 
competition could determine whether there is sufficient evidence that 
market power is being abused in specific markets. While competition 
between railroads may not always be feasible, alternative approaches 
have costs and benefits that should be carefully considered to ensure 
the balance envisioned in the Staggers Rail Act—including the 
railroads’ need for adequate revenues. 

Significant increases in freight traffic are forecast, and the 
industry’s ability to meet them is largely uncertain. Investments in 
rail projects can produce public benefits, such as reducing highway 
congestion. As a result, federal and state governments have 
increasingly participated in freight rail projects. In 2005, for 
example, Congress provided $100 million for rail improvements in the 
Chicago area. Congress faces additional decisions about potential 
federal policy responses in years ahead. Responses should recognize 
that the freight transportation system includes many modes that are 
treated differently by the federal government and functions in a 
competitive marketplace and a constrained federal funding environment. 
In developing a National Freight Policy, the Department of 
Transportation (DOT) has made a good start by providing context for 
those decisions and DOT can help sustain the role of the competitive 
marketplace through strategies that promote a level playing field for 
freight transportation decision making and acknowledge the constrained 
federal fiscal environment by focusing federal involvement where 
demonstrable, wide-ranging public benefits exist. 

What GAO Recommends: 

GAO recommends that STB analyze the state of competition and consider 
appropriate actions. GAO also recommends that DOT consider strategies 
to level the playing field for all freight modes to maximize public 
benefits from federal investment. STB disagreed with our recommendation 
because it would take resources from efforts it believes will address 
GAO concerns, among other reasons. We recognize STB’s efforts, but 
believe further analysis is needed. STB should seek more resources from 
Congress if needed. DOT took no position on our recommendation. 

[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-94]. 

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact JayEtta Z. Hecker at 
(202) 512-2834 or heckerj@gao.gov. 

[End of Section] 

Contents: 

Letter: 

Results in Brief: 

Background: 

Railroad Industry Increasingly Healthy and Rates Generally Down Since 
Enactment of the Staggers Rail Act, but Concerns about Competition and 
Captivity Remain: 

Despite STB's Actions, Analysis of Competitive Markets Is Needed to 
Address Lack of Effective Relief for Captive Shippers: 

Uncertainty about Future Freight Rail Demand and Capacity Points to 
Opportunities for a More Strategic Federal Approach to Rail 
Infrastructure: 

Conclusions: 

Recommendations for Executive Action: 

Agency Comments and Our Evaluation: 

Appendix I: Participants in GAO's Expert Panel: 

Appendix II: Objectives, Scope, and Methodology: 

Appendix III: Comments from the Surface Transportation Board: 

GAO Comments: 

Appendix IV: GAO Contact and Staff Acknowledgments: 

Related GAO Products: 

Tables: 

Table 1: Changes in Percentage of Industry Revenue and Tonnage on 
Origin and Destination Routes with Access to One Class I Railroad: 

Table 2: Possible Changes in R/VC Ratios: 

Table 3: Potential Public Benefits of Rail Transportation Investments: 

Figures: 

Figure 1: Railroads' Tax-Adjusted Return on Investment, 1980-2004: 

Figure 2: Trends in Industry Rail Rates, 1985-2004: 

Figure 3: Commodity Rate Changes, 1985-1989, 1990-1999, and 2000-2004: 

Figure 4: Rate Changes for Coal, Grain, Miscellaneous Mixed Shipments, 
and Motor Vehicles, 1985-2004: 

Figure 5: Rail Rate Increases and Decreases across 604 Routes, and for 
Long-, Medium-, and Short-distance Routes, 2000 through 2004: 

Figure 6: Tonnage Carried by Railcar Ownership, 1987-2004: 

Figure 7: Miscellaneous Revenue Tracked in Carload Waybill Sample, 2000-
2004: 

Figure 8: Percentage of Railroad Market Represented by Four Largest 
Class I Railroads, 1985-2004: 

Figure 9: Comparison of Rates Charged on Long-distance Grain Routes, 
1997-2004: 

Figure 10: Rate Changes after the Introduction of a Second Carrier: 

Figure 11: Comparison of Rate Changes from Champaign, Illinois, 
Economic Area to New Orleans, Louisiana, Economic Area and Champaign, 
Illinois, Economic Area to Atlanta, Georgia, Economic Area, 1990-2004: 

Figure 12: Number of Class I Railroads Serving Economic Areas, 2004: 

Figure 13: Percentage of All Industry Tonnage Originating in Economic 
with Access to One Class I Railroad, 2004: 

Figure 14: Changes in Percentage of All Industry Traffic Tonnage with 
Access to One Class I Railroad Originating in Economic Areas, 1994 
through 2004: 

Figure 15: Percentage of Industry Tonnage and Revenue Generated from 
Traffic Traveling at Rates Equal to or Greater Than 180 Percent R/VC, 
1985-2004: 

Figure 16: Tonnage Traveling at Rates over 300 Percent R/VC, 1985-2004: 

Figure 17: Percentage of Tonnage by R/VC, 1985 and 2004: 

Figure 18: Changes in Percentage of Tonnage Traveling at Rates over 300 
Percent R/VC, by Originating Economic Area, 1985 through 2004: 

Figure 19: Long-distance Grain Route Changes in Percentage of Tonnage 
Traveling at Rates over 300 Percent R/VC, 1985-2004: 

Figure 20: Overlap between Percentage of Tonnage over Threshold for 
Rate Relief and Access to Only One Class I Railroad: 

Figure 21: Reciprocal Switching: 

Figure 22: Terminal Agreements: 

Figure 23: Trackage Rights: 

Figure 24: Bottleneck Rates: 

Figure 25: Paper Barriers: 

Abbreviations: 

AASHTO: American Association of State Highway and Transportation 
Officials: 
ATA: American Trucking Association: 
BEA: Bureau of Economic Analysis: 
CBO: Congressional Budget Office: 
CDOT: Colorado Department of Transportation: 
CREATE: Chicago Region Environmental and Transportation Efficiency 
program: 
DOT: Department of Transportation: 
FAF: Freight Analysis Framework: 
FHWA: Federal Highway Administration: 
FOA: Final Offer Arbitration: 
GDP: gross domestic product: 
ICC: Interstate Commerce Commission: 
RRIF: Railroad Rehabilitation and Improvement Financing: 
R/VC: revenue to variable cost: 
RRIF: Railroad Rehabilitation and Improvement Financing program: 
SAFETEA-LU: Safe, Accountable, Flexible, Efficient Transportation 
Equity Act: A Legacy for Users: 
STB: Surface Transportation Board: 

United States Government Accountability Office: 
Washington, DC 20548: 

October 6, 2006: 

Congressional Requesters: 

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. Since the passage of the Staggers Rail Act in 1980, we have 
issued several reports on the freight railroad industry.[Footnote 1] 
These reports described the significant changes that have taken place 
in the railroad industry and reported that rates have generally 
decreased, but shippers and others have found the rate relief process 
long, complex, and expensive. 

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 2]-
-have seen their productivity and financial health improve. Railroad 
officials worry that any attempt to increase economic regulation will 
reduce carriers' ability to earn sufficient revenues and limit future 
infrastructure investment. At the same time, a number of academic and 
government studies are predicting a significant increase in the demand 
for freight rail over the next 10 to 15 years. In light of these 
concerns, we reviewed: 

* the changes that have occurred in the freight railroad industry since 
the enactment of the Staggers Rail Act, including changes in rail rates 
and competition in the industry; 

* the actions STB has taken to address concerns about competition and 
captivity and any alternative approaches that could be considered to 
address remaining concerns; and: 

* the projections for freight traffic demand over the next 15 to 25 
years, the freight railroad industry's projected ability to meet that 
demand, and potential federal policy responses. 

To fulfill our objectives, we examined STB's Carload Waybill Sample 
from 1985 through 2004 (the latest data available at the time of our 
review).[Footnote 3] This database includes information on rail rates, 
tonnage, federal regulation, and other statistics but disguises some 
revenues to avoid disclosing confidential business information to the 
public. We obtained a version of the Carload Waybill Sample that did 
not disguise revenues. We held an expert panel consisting of 11 
individuals with expertise in the freight railroad industry and the 
economics of transportation deregulation. Those individuals are listed 
in appendix I. We also interviewed, and reviewed information from, 
representatives of each Class I railroad in North America, shipper 
groups, economists, and experts in the rail industry. In addition, we 
reviewed pending legislation, transportation planning literature, and 
forecasts of future freight rail demand and capacity, including 
syntheses of such forecasts; and interviewed federal and state 
transportation officials, financial market analysts, national 
association representatives, and transportation experts. We determined 
that the data used in this report were sufficiently reliable for the 
purpose of our review. We conducted our review from June 2005 to August 
2006 in accordance with generally accepted government auditing 
standards. Details of our objectives, scope, and methodology appear in 
appendix II. 

Results in Brief: 

The changes that have occurred in the railroad industry since the 
enactment of the Staggers Rail Act are widely viewed as positive, since 
the financial health of the industry has improved and most rates have 
declined since 1985. However, concerns about competition and captivity 
in the industry remain. The freight railroad industry's financial 
health improved substantially as railroads cut costs through 
productivity improvements; streamlined and right-sized their rail 
networks; implemented new technologies; and expanded business into new 
markets, such as the intermodal market.[Footnote 4] Between 1985 and 
2000, rail rates generally declined, but then increased slightly from 
2001 through 2004.[Footnote 5] Although rates have declined since 1985, 
they have not done so uniformly, and rates for some commodities are 
significantly higher than rates for others. Several factors could have 
contributed to recent rate increases, including broad changes in the 
domestic and world economy, the emergence of a capacity-constrained 
environment in which demand exceeds supply, and consolidation in the 
1990s in the industry leading to changes in competition. Other costs, 
such as fuel surcharges, have also shifted to shippers, and STB has not 
clearly tracked the revenues the railroads have raised from some of 
these charges. Some concerns about competition and captivity in the 
industry remain because traffic is concentrated in fewer railroads. It 
is difficult to determine precisely how many shippers are captive 
because available proxy measures can overstate or understate captivity. 
In addition, STB does not accurately collect railroad revenue data. 
Nevertheless, our analysis of available measures indicates that the 
extent of captivity appears to be dropping, but the percentage of 
industry traffic traveling at rates substantially over the statutory 
threshold for rate relief has increased. For example, the amount of 
traffic traveling at rates over 300 percent of the railroad's variable 
cost increased from 4 percent in 1985 to 6 percent in 2004. 
Furthermore, some areas with access to one Class I railroad have higher 
percentages of traffic traveling at rates that exceed the statutory 
threshold for rate relief. These findings may reflect reasonable 
economic practices by the railroads in an environment of excess demand, 
or they may indicate a possible abuse of market power. We are 
recommending that STB conduct a rigorous analysis of the state of 
competition nationwide and, where appropriate, consider the range of 
actions available to address problems associated with the potential 
abuse of market power. In addition, we are recommending that STB review 
its method of data collection to ensure consistent and accurate 
reporting of railroad revenues, including fuel surcharges. 

STB has taken a number of actions to improve the rate relief process 
and assess competition, but further actions could help address 
remaining competition and captivity concerns. The Staggers Rail Act and 
the ICC Termination Act encouraged competition as the preferred method 
to protect shippers from unreasonable rates and granted STB broad 
legislative authority to monitor the performance of the railroad 
industry. Under this authority, STB established both a standard and a 
simplified rate relief process so that captive shippers could obtain 
relief from unreasonable rates. However, these processes have proven to 
be largely inaccessible because the standard process is expensive, time 
consuming, and complex, and the simplified process has not been used. 
During our review, STB took steps to refine its processes, including 
issuing a proposed rule making to clarify eligibility for the 
simplified process. Ultimately, our analysis suggests a reasonable 
possibility that shippers in selected markets may be paying excessive 
rates, and an assessment of competition would determine if this 
situation reflects reasonable economic practices by the railroads in an 
environment of excess demand or an abuse of market power. This 
assessment could also provide further information about the extent of 
captivity and the merits of proposed approaches to enhance the 
competitive options available to shippers. These approaches--such as 
providing trackage rights to allow a railroad to run on another 
railroad's track for a fee--have been suggested by shipper groups, 
economists, and others. Each of these approaches has costs and benefits 
and should be carefully considered to ensure that the approach is 
designed to achieve the balance set out in the Staggers Rail Act, 
including consideration of the revenue adequacy of the railroads. 
However, not all markets may have the demand needed to support 
competition among railroads, and so some areas where shippers are 
captive are likely to persist. In this regard, there are also a number 
of proposals to make the rate relief process more accessible, such as 
the increased use of arbitration to settle disputes, and each of these 
proposals has advantages and drawbacks. 

Significant increases in freight traffic over the next 10 to 15 years 
are forecasted, and the railroad industry's ability to meet future 
demand is largely uncertain. Investments in rail projects can produce 
benefits for the public--for example, shifting truck freight traffic to 
railroads can reduce highway congestion. To obtain such benefits, 
governments have increasingly been participating in freight rail 
improvement projects. For example, Missouri state and local governments 
supported two major rail-bridge projects to reduce delays in Kansas 
City. At the federal level, Congress, in 2005, provided $100 million 
for rail infrastructure improvements in the Chicago area. In the years 
ahead, Congress is likely to receive further requests for funding and 
face additional decisions about potential federal policy responses and 
the federal role in the nation's freight railroad infrastructure. Such 
policy responses need to recognize that the freight transportation 
system encompasses many modes that are treated differently by the 
federal government and are on systems owned, funded, and operated by 
both the public and private sectors. Furthermore, the freight 
transportation system functions in a competitive marketplace, and the 
federal fiscal funding environment is highly constrained. As a result, 
policy and decision makers are challenged to ensure that federal 
involvement is consistent with competition in the freight marketplace 
and that federal funding decisions reflect widespread public 
priorities. In developing a draft National Freight Policy, the 
Department of Transportation (DOT) has made a good start by providing a 
context for decisions about how to apply a more strategic, systemwide 
approach, in general, and how to craft a federal policy response to 
freight rail investment needs in particular. We are recommending that 
DOT, as it continues to draft a National Freight Policy, consider 
strategies to sustain the role of competitive market forces by creating 
a level playing field for all freight modes and recognize the highly 
constrained federal fiscal environment by developing mechanisms to 
assess and maximize public benefits from federally financed freight 
transportation investments. 

We provided a draft of this report to DOT and STB. In oral comments, 
DOT took no position on our recommendation related to the National 
Freight Policy. In written comments, STB stated that it has already 
responded to our recommendation on its method of data collection 
through a proposed rule making on collecting fuel surcharge data. While 
we commend STB for its proposed rule making, STB has not yet 
implemented this change, and other revenues may still not be accurately 
tracked. STB also disagreed with our recommendation to conduct a 
rigorous analysis of competitive markets to identify the state of 
competition nationwide, inquire into pricing practices in specific 
markets, and consider appropriate actions available to address problems 
associated with the potential abuse of market power. STB commented that 
this recommendation was based on inconclusive findings and would divert 
resources away from current initiatives. We disagree that our 
recommendation was based on inconclusive findings. Our analysis of 
multiple sources suggests a reasonable possibility that shippers in 
some markets may be paying excessive rates. We believe that such a 
possibility merits further inquiry and analysis. We recognize that STB 
has limited resources and modified our draft to recommend that STB 
request additional resources from Congress if it determines that it 
needs more resources to conduct an analysis of competition. STB also 
stated that it has several rule makings under way that are designed to 
improve the rate relief process and would address many of our concerns. 
STB stated that it would be far more practical for STB to finish these 
reforms to ensure that captive shippers have an effective forum to seek 
rate relief. While we commend STB for recognizing and taking action to 
address problems with the rate relief process, we believe action beyond 
improvements to the rate relief process is needed. In particular, these 
STB rule makings are designed to improve processes available to 
shippers after they have been charged a rate they consider to be 
unreasonable. In contrast, we believe that an analysis of the state of 
competition and the possible abuse of market power, along with the 
range of options STB has to address competition issues, could more 
directly further the legislatively defined goal of ensuring effective 
competition among rail carriers. STB's comments are in appendix III. 

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. 

Railroad Industry Increasingly Healthy and Rates Generally Down Since 
Enactment of the Staggers Rail Act, but Concerns about Competition and 
Captivity Remain: 

The changes that have occurred in the railroad industry since the 
enactment of the Staggers Rail Act are widely viewed as positive. The 
railroad industry's financial health improved substantially as it cut 
costs, boosted productivity, and right-sized its networks. Rail rates 
generally declined between 1985 and 2000 but increased slightly from 
2001 through 2004. Likewise, rail rates have declined since 1985 for 
certain commodity groups and routes despite some increases since 2001, 
but rates have not declined uniformly, and some commodities are paying 
significantly higher rates than others. For example, from 1985 through 
2004, coal rates declined 35 percent while grain rates increased 9 
percent.[Footnote 6] Concerns about competition and captivity in the 
industry remain because traffic is concentrated in fewer railroads. It 
is difficult to determine precisely how many shippers are captive to 
one railroad. Nevertheless, our analysis indicates that the extent of 
potential captivity appears to be dropping, but that the percentage of 
all industry traffic running at rates substantially over the statutory 
threshold for rate relief--traffic traveling at rates over 180 percent 
R/VC--has increased. Furthermore, some areas with access to only one 
Class I railroad have higher percentages of traffic traveling at rates 
that exceed the statutory threshold for rate relief. This situation may 
reflect reasonable economic practices by the railroads in an 
environment of excess demand, or it may represent an abuse of market 
power. 

Railroad Industry's Financial Health Has Improved Substantially: 

There is widespread consensus that the freight rail industry has 
benefited from the Staggers Rail Act. Ten of the 11 members of our 
expert panel believed that the Staggers Rail Act has had a strongly 
positive overall effect on freight railroad companies, while 8 believed 
the Staggers Rail Act had a strongly positive effect on shipping 
companies. In addition, various measures indicate an increasingly 
strong freight railroad industry. Freight railroads' improved financial 
health is illustrated by a general increase in return on investment 
since 1980, as shown in figure 1.[Footnote 7] Freight railroads have 
also cut costs by streamlining their workforces; right-sizing their 
rail networks; and reducing track miles, equipment, and facilities to 
more closely match demand.[Footnote 8] 

Figure 1: Railroads' Tax-Adjusted Return on Investment, 1980-2004: 

[See PDF for image] 

Source: STB. 

[End of figure] 

Freight railroads have also expanded their business into new markets-- 
such as the intermodal market--and implemented new technologies, 
including larger cars, and are currently developing new scheduling and 
train control systems. Some observers believe that the competition 
faced by railroads from other modes of transportation has created 
incentives for innovative practices, and that the ability to enter into 
confidential contracts with shippers has permitted railroads to make 
specific investments and to develop service arrangements tailored to 
the requirements of different shippers.[Footnote 9] 

Freight rail is an important component of our nation's economy. 
Approximately 42 percent of all intercity freight in the United States, 
measured in ton-miles,[Footnote 10] moves on rail lines. Freight rail 
is particularly important to producers and users of certain 
commodities. For example, about 70 percent of automobiles manufactured 
domestically and about 70 percent of coal delivered to power plants 
moves on freight rail. 

Industrywide Rates Declined from 1985 through 2000 and Rose Slightly 
from 2001 through 2004: 

Rail rates across the freight railroad industry have generally declined 
since the enactment of the Staggers Rail Act. Because changes in 
traffic patterns over time (for example, hauls over longer distances) 
can result in a decrease in the average revenue per ton-mile, purely 
relying on cents per ton-mile can present misleading industrywide rate 
trends. Therefore, we developed a set of rail rate indexes[Footnote 11] 
to examine trends in rail rates over the 1985 through 2004 period. 
These indexes account for changes in traffic patterns over time that 
could affect revenue statistics but do not account for inflation. To 
provide a measure for inflation, we also included the price index for 
the gross domestic product (GDP) in figure 2. 

From 1985 through 1987, rail rates dropped by 10 percent and then 
continued to decline, although not as steeply, through 1998. Rates 
increased in 1999, then dropped again in 2000. In 2001 and 2002 rates 
rose again. Rates were nearly flat in 2003 and 2004, finishing 
approximately 3 percent above rates in 2000, but were 20 percent below 
1985 rates (These trends are shown in figure 2). While our rail rate 
index does not reflect the general effects of inflation, the continuous 
increases in the GDP price index over this period indicate that real 
rates decreased by more than 20 percent from 1985 through 2004. Rate 
data are not available for 2005 and 2006, but shippers, railroad 
officials, and financial analysts with whom we spoke told us that rates 
have generally increased during those years. 

Figure 2: Trends in Industry Rail Rates, 1985-2004: 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

For Many Commodities and Particular Routes, Rates Have Also Declined 
Since 1985, but Declines Are Not Uniform: 

Similar to industrywide changes in rail rates, the rates for many 
commodities have declined since 1985 and have recently increased. In 
2004, four commodities each made up 5 percent or more of freight 
railroad revenue--grain, coal, motor vehicles, and miscellaneous mixed 
shipments. In both the 1985 through 1989 and the 1990 through 1999 
intervals, the rates for most of these commodities declined, while in 
2000 through 2004, the rates increased for two commodities and 
decreased for two (see fig. 3). 

Figure 3: Commodity Rate Changes, 1985-1989, 1990-1999, and 2000-2004: 

[See PDF for image] 

Source: GAO analysis of STB data. 

Note: From 2000 to 2004, the rate index for coal was largely unchanged. 

[End of figure] 

Although many rates have decreased, rates have not declined uniformly, 
and rates for some commodities are significantly higher than for 
others. Figure 4 compares commodity rates for coal, grain, 
miscellaneous mixed shipments, and motor vehicles from 1985 through 
2004 using our rail rate index. Over the 20-year period most rates 
declined, with coal rates dropping the most sharply by 35 percent. 
Miscellaneous mixed shipments and motor vehicle rates also declined, 
although to a lesser extent than coal rates. Grain rates initially 
declined from 1985 through 1987, but then diverged from the other 
commodity trends and increased, resulting in a net 9 percent increase 
by 2004. 

Figure 4: Rate Changes for Coal, Grain, Miscellaneous Mixed Shipments, 
and Motor Vehicles, 1985-2004: 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

We examined rate changes for commodities traveling along hundreds of 
particular routes and found that the rates on a majority of the routes 
we analyzed decreased from 2000 through 2004. Figure 5 shows that from 
2000 through 2004 rail rates decreased on about 55 percent of the 
routes in our analysis[Footnote 12] (334 of 604 routes). More 
specifically, the rates for most long-distance (over 1,000 miles) and 
medium-distance (501 to 1,000 miles) routes decreased. In one distance 
category, short-distance routes (up to 500 miles), there were more 
routes with increases (103) than decreases (94), from 2000 through 
2004. While figure 5 shows that, for the long-distance routes we 
examined, the number of routes with rate decreases was nearly twice the 
number of routes with rate increases. Many of the largest rate 
increases were on long-distance routes carrying miscellaneous mixed 
shipments--which include intermodal goods--that originated in the Los 
Angeles-Long Beach-Riverside, California, economic area and terminated 
at various destinations across the country. Several shipper groups 
reported that many rate increases occurred after 2004; however, data 
are not available for 2005 and 2006. 

Figure 5: Rail Rate Increases and Decreases across 604 Routes, and for 
Long-, Medium-, and Short-distance Routes, 2000 through 2004: 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

Many Factors May Have Contributed to Recent Rate Increases: 

Several factors could have contributed to recent rate increases. 
Ongoing industry and economic changes have influenced how railroads 
have set their rates. Since the Staggers Rail Act was enacted, the 
railroad industry and the economic environment in which it operates 
have changed considerably. After years of reducing the size of its 
workforce and shedding track capacity, the industry is increasingly 
operating in a capacity-constrained environment in which the demand for 
its services exceeds its capacity in some areas. In addition, the 
industry has more recently increased employment and invested in 
increased capacity in key traffic corridors. Additionally, changes in 
broader domestic and world economic conditions have led to changes in 
the mix and profitability of traffic carried by railroads. For example, 
railroads have developed high-volume traffic by shipping import and 
export containers, leading them to price these shipments differently. 
According to DOT officials, some shippers--such as those in the 
automobile and chemical industries--may pay higher rates in order to 
secure higher quality service or due to liability issues. Lastly, the 
rail industry has continued to consolidate, potentially increasing the 
market power of the largest railroads. Our analysis included rate data 
through 2004,[Footnote 13] and according to freight railroad officials, 
shippers, and financial analysts, since 2004, rates have continued to 
increase as the demand for freight rail service has increased, and rail 
capacity has not kept pace with demand. 

Other Costs Have Shifted to Shippers, and Some Charges Are Not 
Accurately Tracked: 

While rates have generally decreased since 1985, other costs have been 
passed on to shippers, some of which STB has not accurately tracked. 
Several shippers with whom we spoke agreed that rates have dropped over 
the long-term, but they also said that rates do not reflect the total 
cost of shipping by rail. According to some shippers, costs have 
shifted from the railroads to shipping companies, including the costs 
of railcar ownership. Figure 6 shows that tons carried by railcar 
ownership has shifted nearly 20 percent since 1985, indicating less 
tonnage shipped on railcars owned by freight railroad companies. 

Figure 6: Tonnage Carried by Railcar Ownership, 1987-2004: 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

Besides rates, other costs that shippers reported were infrastructure 
upgrade costs, fuel surcharges,[Footnote 14] and congestion fees. 
Conversely, one Class I railroad told us that some rates in the Carload 
Waybill Sample do not account for rebates or incentives that may change 
the actual rate paid by the shipper. We are unable to report on the 
full extent of all costs because STB has not accurately tracked the 
railroad revenues associated with some of these charges. For example, 
freight railroad companies do not consistently report revenues raised 
from fuel surcharges for use in the Carload Waybill Sample. Some 
railroads report fuel surcharges as part of their general revenues, 
while others categorize the surcharges separately under a miscellaneous 
revenue category, and still other railroads may not report revenue 
collected from fuel surcharges at all. Shippers have expressed deep 
concerns over how fuel surcharges relate to actual fuel costs. Other 
railroad revenues, such as those generated at railcar auctions[Footnote 
15] and through congestion fees, may not be included in the waybill 
sample either. Understanding what railroads do and do not report as 
miscellaneous revenue in the waybill sample may be of increasing 
importance because fuel surcharges have become more prevalent, and 
railroad revenue reported as miscellaneous revenue has substantially 
risen in recent years. From 2000 through 2004, the miscellaneous 
revenue reported in the waybill sample has more than quadrupled in 
value, from $141 million to $614 million (see fig. 7). Although an 
increase in value, $614 million still represents less than 1.5 percent 
of the approximately $42 billion in freight railroad revenue reported 
for 2004. Since 2004, miscellaneous revenue may have further increased 
as railroad and shipper groups with whom we spoke said that many fuel 
surcharge increases took effect in 2005. During our review, STB 
proposed to more closely track and otherwise monitor revenues 
associated with fuel surcharges. 

Figure 7: Miscellaneous Revenue Tracked in Carload Waybill Sample, 2000-
2004: 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

Competition and Captivity Concerns Remain: 

Concerns about competition and captivity in the railroad industry 
remain because traffic is concentrated in fewer railroads, although 
there is disagreement on the state of competition in the industry. It 
is difficult to determine the number of captive shippers, because proxy 
measures can overstate or understate captivity, but our analysis of 
available measures indicates that the extent of captivity is dropping. 
At the same time, the percentage of all industry traffic running 
substantially over the statutory threshold for rate relief has 
increased from about 4 percent of tonnage in 1985 to about 6 percent of 
tonnage in 2004. Furthermore, some economic areas with access to one 
Class I railroad have higher percentages of traffic traveling at rates 
that exceed the statutory threshold for rate relief. 

The Freight Railroad Industry Has Become More Concentrated: 

During the past 30 years, the freight railroad industry has become more 
concentrated. In 1976, there were 30 independent Class I railroad 
systems, consisting of 63 Class I railroads operating in the United 
States. Currently there are seven railroad systems, consisting of seven 
Class I railroads. Nearly half of that reduction was attributable to 
consolidations.[Footnote 16] The railroad industry is dominated by four 
Class I railroads--two in the East and two in the West. As figure 8 
shows, the market share of these four Class I railroads has been 
increasing and accounted for over 89 percent of the industry's revenues 
in 2004. 

Figure 8: Percentage of Railroad Market Represented by Four Largest 
Class I Railroads, 1985-2004: 

[See PDF for image] 

source: GAO analysis of STB data. 

[End of figure] 

There is significant disagreement on the state of competition in the 
rail industry and on whether or not federal regulation--resulting from 
legislation such as the Staggers Rail Act--has ensured effective 
competition among railroads. This disagreement was represented on our 
panel of 11 experts, 6 of whom indicated that rail-to-rail competition 
has been achieved (either "greatly" or "somewhat") and 4 of whom 
maintained that effective competition had not been achieved.[Footnote 
17] One member of our panel viewed less competition among rail carriers 
as a negative development because it can result in less efficient 
railroad companies and fewer options for shipping companies. Another 
member of our panel said that industry consolidation was essential to 
achieving an efficient and complete rail network under fewer, but 
ultimately stronger, railroad companies. Other experts also pointed to 
the hundreds of short-line railroads[Footnote 18] that have come into 
being since the enactment of the Staggers Rail Act, as well as 
increases in other competitive options for shippers from other modes 
such as trucks and barges. 

A reduction in competitive options can have a significant impact on the 
rates railroads charge shippers. There are a variety of contexts that 
affect how railroads compete with each other and with other modes, such 
as when route origins and destinations can both be reached by more than 
one railroad, or by multiple modes of transportation.[Footnote 19] 
Comparing two routes for shipping the same commodity, but using a 
different number of rail carriers, can illustrate this effect. Figure 9 
shows two long-distance grain routes that both terminate in the 
Portland, Oregon, economic area from different origin points. Both 
routes carry comparable tonnage, but the route originating in the 
economic area in and around Sioux Falls, South Dakota, is served by two 
Class I railroads, whereas the route from the Minot, North Dakota, 
economic area is served by one Class I railroad. The rates for the 
Minot route are roughly double the rates for the Sioux Falls route. 

Figure 9: Comparison of Rates Charged on Long-distance Grain Routes, 
1997-2004: 

[See PDF for image] 

Source: GAO analysis of STB data. 

Note: For some years, data have been removed due to insufficient sample 
size. 

[End of figure] 

The ability to build out to another railroad can also create 
competition and improve railroad rates for some shippers. For example, 
following a build-out,[Footnote 20] a shipper gained access to a second 
railroad at an origin point that had previously been served by one 
Class I railroad.[Footnote 21] Figure 10 shows that within a few years 
after the introduction of service by the second railroad, the rates had 
dropped significantly. Because even a short segment build-out can be 
quite costly, shippers are unlikely to pursue build-out options without 
a substantial traffic base. Some experts with whom we spoke said that 
situations like the one depicted in figure 9 reflect the reality of 
differential pricing in the freight railroad industry, or they suggest 
that other factors such as differences in the length of two different 
routes may be the cause of rate discrepancies. Others believe that a 
significant rate decrease after the introduction of competition is 
evidence that railroads are extracting monopoly rates from captive 
shippers. 

Figure 10: Rate Changes after the Introduction of a Second Carrier: 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

While competition between rail carriers is particularly important in 
some cases, in other cases, competition between rail and other 
transportation modes, such as trucks and barges, may be more important. 
Particularly for bulk commodities (i.e., grain), when shipper locations 
can be served by barge transportation, rail rates will be lower 
relative to rail costs than on routes that are not conducive to barge 
competition. Figure 11 depicts costs and revenues for two routes, one 
(from the Champaign, Illinois economic area to the New Orleans, 
Louisiana economic area) with rail and barge options, and the other 
(from the Champaign, Illinois economic area to the Atlanta, Georgia 
economic area) with just a rail option. Although both routes have the 
same origin, for shipping the same commodity over a comparable 
distance, the route with the barge option has consistently lower rates 
than the route with just rail service. 

Figure 11: Comparison of Rate Changes from Champaign, Illinois, 
Economic Area to New Orleans, Louisiana, Economic Area and Champaign, 
Illinois, Economic Area to Atlanta, Georgia, Economic Area, 1990-2004: 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

Besides the number of rail carriers serving a location, the use of 
contracts for rail service can affect the competitive landscape. The 
Staggers Rail Act allowed railroad and shipping companies to enter into 
confidential contracts for rail service and also placed all traffic 
running under contract outside the remaining rate regulations. 
According to railroad and shipper groups, the duration of contracts has 
declined, in part because of the railroads' desire to quickly react to 
shifting market demand, which can result in charging higher rates. 
Other shippers were concerned that moving away from confidential 
contracts to public pricing could represent price signaling and further 
reduce competition between railroads. In 2004, 70 percent of tonnage 
and 71 percent of industry revenue moved under contract. 

Captive Shippers Are Difficult to Identify, but Available Measures 
Indicate Captivity Dropping in the Railroad Industry: 

It is 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.[Footnote 22] One way 
of determining potential captivity is to identify which Bureau of 
Economic Analysis (BEA) economic areas were served by only one Class I 
railroad.[Footnote 23] In 2004, 27 of the 177 BEA economic areas were 
served by only one Class I railroad.[Footnote 24] As shown in figure 
12, these areas include parts of Montana, North Dakota, New Mexico, 
Maine, and smaller areas in several states. 

Figure 12: Number of Class I Railroads Serving Economic Areas, 2004: 

[See PDF for image] 

Source: GAO analysis of BEA and GIS data. 

[End of figure] 

Another way of looking at potential captivity is to calculate how much 
route tonnage originating in a given economic area has access to only 
one Class I railroad. Figure 13 shows the percentage in 2004 of all 
industry tonnage originating in economic areas with access to only one 
Class I railroad. In particular, economic areas with more than 75 
percent of tonnage shipped on one railroad appear most prevalent in 
states such as Montana, Idaho, North Dakota, and Texas. Tonnage 
originating in these economic areas varies widely, from a little over 
55,000 tons to over 36 million tons. 

Figure 13: Percentage of All Industry Tonnage Originating in Economic 
with Access to One Class I Railroad, 2004: 

[See PDF for image] 

Source: GAO analysis of BEA, DOT, and STB data. 

[End of figure] 

According to our analysis of available measures, the overall extent of 
captivity appears to be dropping in the freight railroad industry. We 
examined tonnage, revenue, and access statistics for all routes-- 
originating and terminating in economic areas--captured in the Carload 
Waybill Sample and other DOT data. In 2004, origin and destination 
routes with access to only one Class I railroad carried 12 percent of 
industry revenue and 10 percent of industry tonnage, which represents a 
decline from 1994, when 22 percent of industry revenue and 21 percent 
of industry tonnage moved on routes served by one Class I railroad (see 
table 1).[Footnote 25] 

Table 1: Changes in Percentage of Industry Revenue and Tonnage on 
Origin and Destination Routes with Access to One Class I Railroad: 

Year: 1994; 
Percentage of revenue: 22.87; 
Percentage of tonnage: 20.59. 

Year: 2004; 
Percentage of revenue: 12.29; 
Percentage of tonnage: 10.43. 

Source: GAO analysis of BEA, DOT, and STB data. 

[End of table] 

This decline suggests that more railroad traffic is traveling on routes 
with access to more than one Class I railroad. While overall industry 
tonnage with access to more than one Class I railroad appears to have 
increased, some economic areas have a higher percentage of all industry 
traffic tonnage shipping on one Class I railroad. From 1994 through 
2004, parts of states such as Texas, Tennessee, and Montana experienced 
increases of 25 percent or more in tonnage with access to one Class I 
railroad while parts of other states such as Oregon, New York, and 
Florida saw their percentages of tonnage with access to one Class I 
railroad drop by more than 25 percent (see fig. 14). 

Figure 14: Changes in Percentage of All Industry Traffic Tonnage with 
Access to One Class I Railroad Originating in Economic Areas, 1994 
through 2004: 

[See PDF for image] 

Source: GAO analysis of BEA, DOT, and STB data. 

[End of figure] 

While examining BEA areas provides a proxy measure for captivity, a 
number of factors may understate or overstate whether shippers are 
actually captive. The first three factors may work to understate the 
extent of captivity among shippers. First, routes originating within 
economic areas served by multiple Class I railroads may still be 
captive if only one Class I railroad serves their destination, and a 
shipper must use that one railroad for that particular route. Second, 
some BEA areas are quite large, so a shipper within the area may have 
access to only one railroad, even though there are two or more 
railroads within the broader area. Third, an origin may only be served 
by one Class I railroad, but one Class I railroad does not serve the 
entire route, meaning the route may be partially captive, although more 
than one Class I railroad provides service between its origin and 
destination. Two additional limitations may work to overstate the 
number of locations captive to one railroad. First, this analysis 
accounts for Class I railroads only and does not account for 
competitive rail options that might be offered by Class II or III 
railroads[Footnote 26] such as the Guilford Rail System, which operates 
in northern New England. Second, this analysis considers only 
competition among rail carriers and does not examine competitive 
options offered by rail and other transportation alternatives such as 
trucks and barges. 

Amount of Potentially Captive Traffic Traveling at Rates at Levels 
Substantially above the Threshold for Rate Relief Has Increased: 

To determine potential captivity, we applied another measure--traffic 
traveling at rates equal to or greater than 180 percent R/VC, which is 
part of the statutory threshold for bringing a rate relief case before 
STB. STB regards traffic at or above this threshold as "potentially 
captive." As with BEA areas, examining R/VC levels as a proxy measure 
for captivity can also understate or overstate captivity. 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, as shown in table 2, because both revenue and variable cost 
decline, the R/VC ratio increases to 180 percent. 

Table 2: Possible Changes in R/VC Ratios: 

Year: Year 1; 
Revenue collected: $20.00; 
Variable costs: $12.00; R/VC: 167%. 

Year: Year 2; 
Revenue collected: $18.00; 
Variable costs: $10.00; R/VC: 180%. 

Source: GAO. 

[End of table] 

Since 1985, and as a percentage of all traffic, the amount of 
potentially captive traffic traveling at rates over 180 percent R/VC 
and the revenue generated from that traffic have both declined. Revenue 
generated from traffic traveling at rates over 180 percent R/VC 
decreased from 41 percent of all industry revenue in 1985 to 29 percent 
in 2004 (see fig. 15). 

Figure 15: Percentage of Industry Tonnage and Revenue Generated from 
Traffic Traveling at Rates Equal to or Greater Than 180 Percent R/VC, 
1985-2004: 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

However, since 1985, tonnage from traffic traveling at rates 
substantially over the threshold for rate relief has increased. Total 
industry tonnage has increased significantly (from 1.37 billion tons in 
1985 to 2.14 billion tons in 2004), with the tonnage traveling at rates 
above 300 percent R/VC more than doubling--from about 53 million tons 
in 1985 to over 130 million tons in 2004 (see fig. 16). 

Figure 16: Tonnage Traveling at Rates over 300 Percent R/VC, 1985-2004: 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

As a percentage of all industry traffic, traffic traveling at rates 
between 180 and 300 percent R/VC decreased from 36 percent in 1985 to 
25 percent in 2004. In contrast, the percentage of all industry traffic 
traveling at rates above 300 percent R/VC increased from 4 percent in 
1985 to 6 percent in 2004 (see fig. 17). 

Figure 17: Percentage of Tonnage by R/VC, 1985 and 2004: 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

Increases in traffic traveling at rates over 300 percent R/VC appear 
widely distributed throughout the country, although in some areas 
increases have been higher than in others. Four economic areas located 
in parts of Montana, New Mexico, North Dakota, and West Virginia had 
the largest increases in traffic traveling at rates over 300 percent R/ 
VC, with an increase of more than 25 percent from 1985 through 2004 
(see fig. 18). 

Figure 18: Changes in Percentage of Tonnage Traveling at Rates over 300 
Percent R/VC, by Originating Economic Area, 1985 through 2004: 

[See PDF for image] 

Source: GAO analysis of BEA, DOT, and STB data. 

[End of figure] 

In addition to national changes, significant increases in traffic 
traveling at rates over 300 percent R/VC can be seen in certain states, 
for certain commodities, and for certain routes. For example, in 1985 
virtually no coal originating in Ohio traveled at rates over 300 
percent R/VC. In 2004, nearly half of coal traffic originating in Ohio 
traveled at rates over 300 percent R/VC. Increases in traffic traveling 
at rates over 300 percent R/VC can also be seen at the route level. 
Figure 19 shows the amount of traffic traveling at rates over 300 
percent R/VC on long-distance grain routes from the Minot, North 
Dakota, and Billings, Montana, economic areas to the Portland- 
Vancouver-Beaver Falls, Oregon, economic area. Of the routes we 
examined, these two had the highest percentage of traffic traveling at 
rates over 300 percent R/VC for 2004, and on both routes, this traffic 
had substantially increased over 1985 levels.[Footnote 27] 

Figure 19: Long-distance Grain Route Changes in Percentage of Tonnage 
Traveling at Rates over 300 Percent R/VC, 1985-2004: 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

For both the Minot and Billings routes, increases in R/VC from 1985 
through 2004 were driven more by increases in revenue than by changes 
in variable cost. From 1985 through 2004, revenue from all grain 
traffic--not just traffic traveling at rates above the statutory 
threshold for rate relief--on the Minot, North Dakota, to the Portland- 
Vancouver-Beaver Falls, Oregon, economic area increased from 
approximately $18.4 million to approximately $30.8 million. Variable 
cost increased at a much slower pace, rising from approximately $12.2 
million to approximately $12.4 million. For the route from the 
Billings, Montana, economic area to the Portland-Vancouver-Beaver 
Falls, Oregon, economic area, grain revenue more than tripled, from 
approximately $11.2 million in 1985 to approximately $42.7 million in 
2004. Variable cost also increased substantially--although still not as 
much as revenue--rising from approximately $5.5 million to 
approximately $15.1 million. 

Some Areas with Access to One Railroad Have Higher Percentages of 
Traffic Traveling at Rates That Exceed the Threshold for Rate Relief: 

Some economic 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 have more than half of all traffic 
originating in those same areas traveling at rates over 180 percent R/ 
VC (see fig. 20). However, there are 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. Yet there are parts 
of the country with access to one Class I railroad that also have 
higher percentages of traffic traveling at rates over the statutory 
threshold for rate relief. 

Figure 20: Overlap between Percentage of Tonnage over Threshold for 
Rate Relief and Access to Only One Class I Railroad: 

[See PDF for image] 

Source: GAO analysis of BEA, DOT, and STB data. 

[End of figure] 

Our analysis shows that some areas of the country with access to only 
one Class I railroad have higher levels of traffic traveling at rates 
over the statutory threshold for rate relief. This situation may 
reflect reasonable economic practices by railroads in an environment of 
excess demand, or it may represent an abuse of market power. Our 
analysis provides an important first step in assessing competitive 
markets nationally, but it is imperfect given the inherent limitations 
of the Carload Waybill Sample and of the proxy measures available for 
weighing captivity. When combined with comments from participants on 
our expert panel and interviews with shipper and railroad groups, the 
results of our analysis suggest that shippers in selected markets may 
be paying excessive rates, meriting further inquiry and analysis. 

Despite STB's Actions, Analysis of Competitive Markets Is Needed to 
Address Lack of Effective Relief for Captive Shippers: 

The Staggers Rail and ICC Termination Acts promoted greater reliance on 
competition as the preferred method to protect shippers from 
unreasonable rates and granted STB broad authority to monitor the 
performance of the railroad industry. STB has taken a number of actions 
to provide protections for captive shippers from unreasonable rates in 
the absence of effective competition, including establishing a process 
for captive shippers to obtain relief from unreasonable rates. Despite 
STB's actions, there is little effective relief for captive shippers 
because STB's standard rate relief process is largely inaccessible. 
While STB continues to refine its practices, an assessment of 
competitive markets would provide further information about the extent 
of captivity among shippers and the merits of a range of proposed 
actions to enhance competitive options available to shippers. In 
addition, changes to the rate relief process could provide greater 
protection from unreasonable rates. 

STB Has Broad Authority to Monitor the Railroad Industry: 

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. At the same time, the acts 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. 

The federal courts have upheld STB's general powers to monitor the rail 
industry, including its ability to subpoena witnesses and records and 
depose witnesses. 

STB has the authority and ability to inquire into and report on 
railroad practices, and it also has authority to take a number of 
actions based on the results of that inquiry. First, STB could issue a 
general rule making that would alter the administrative rules for the 
industry. For example, STB has the authority to require a railroad to 
make their terminal facilities available to another railroad under 
certain circumstances. Second, STB could reopen a past decision if it 
found a material error in the case, new evidence emerged, or 
circumstances affecting the case substantially changed. Finally, if STB 
received a complaint from a shipper, it could then launch a formal 
investigation and prescribe specific remedies to address the complaint. 

STB Has Taken Actions to Protect Captive Shippers: 

Under its adjudicatory authority, STB has taken a number of actions to 
provide protection for captive shippers. STB determines the 
reasonableness of challenged rates in the absence of competition upon 
receiving a complaint from a shipper. The rate relief process is the 
principal method by which shippers seek relief from unreasonable rates. 
STB 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. In 1999,[Footnote 
28] we reported that shippers and shippers' associations indicated that 
constructing a hypothetical railroad is difficult, particularly for 
small shippers, because the time and cost associated with the model's 
development may outweigh the compensation afforded the shipper should 
STB determine that the challenged rate was unreasonable. Since we 
reported on the process in 1999, STB has taken several actions to 
reduce potential barriers for filing a complaint. For example, STB now 
conducts mediation to begin cases, has added staff to process cases, 
and has eliminated certain criteria for assessing whether a railroad 
dominates a shipper's market.[Footnote 29] 

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. In 
addition, STB created a voluntary arbitration option that parties can 
use to resolve disputes over rates. 

Under its authority to approve rail transactions, STB has approved 
railroad mergers that it finds consistent with the public interest. STB 
has also taken action to ensure that any potential merger-related harm 
to competition is mitigated. STB's mitigation efforts have focused on 
preserving competition where it could be lost at 2-to-1 
points,[Footnote 30] for example, by imposing conditions that allow one 
railroad to operate over the tracks of another railroad (called 
trackage rights). STB has historically not taken action to introduce 
service where shippers have service by only one carrier. 

Under its authority to prescribe new regulations, STB established a 
process by which shippers can file a complaint if they are captive to 
one railroad and believe that the railroad is engaged in 
anticompetitive behavior. Under this process, if the shipper proves 
that the railroad is engaged in anticompetitive behavior, STB can 
prescribe remedies such as trackage rights that would give the shipper 
access to another railroad. 

Finally, under its authority to inquire into and report on the rail 
industry, STB instituted proceedings to review rail access and 
competition issues. For example, in April 1998, at the request of 
Congress, STB commenced a review of access and competitive service in 
the rail industry. In April 1998, STB decided to consider revising its 
competitive access rules. However, in its December 1998 report to 
Congress, STB declined to take further action on this issue because it 
had adopted new rules giving shippers temporary access to alternative 
routing options during periods of poor service. In addition, STB 
observed that the competitive access issue raises basic policy 
questions that are more appropriately resolved by Congress. In 2001, 
STB adopted new regulations for rail mergers that require the applicant 
to demonstrate that the merger would enhance, not just preserve, 
competition. 

Efforts Have Led to Little Effective Relief: 

Despite STB's efforts, there is widespread agreement that STB's 
standard rate relief process is inaccessible to most shippers and does 
not provide for expeditious handling and resolution of complaints. The 
process remains expensive, time consuming, and complex. While STB does 
not keep records of the cost of a rate case, shippers we interviewed 
agreed that the process can cost approximately $3 million per litigant. 
Shippers told us that, to initiate a case, the case would need to 
involve several million dollars so that it would be worthwhile to spend 
$3 million on a case that they could possibly lose. Thus, shippers 
noted that only large-volume shippers, such as coal shippers, with set 
origins and destinations have the money to be able to afford the STB 
rate relief process. In addition, shippers said that they do not use 
the process because it takes so long for STB to reach a decision. 
Lastly, shippers continue to state 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. Since 2001, only 10 
cases have been filed, and these cases took between 2.6 and 3.6 years-
-an average of 3.3 years per case--to complete. Of those 10 cases, 9 
were filed by coal shippers. 

The simplified guidelines also have not effectively provided relief for 
captive shippers. Although these simplified guidelines have been in 
place since 1997, a rate case has not been decided under the process 
set out by the guidelines. STB 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. Several shipper organizations told us that shippers 
are 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. 

STB's arbitration option has never been used. Under this approach, an 
arbitrator would decide the rate, using a "give and take" approach-- 
that is, the arbitrator would determine the rate without being required 
to pick one of the two offers. According to STB officials, this option 
has not been used, in part, because the cases that go before STB are 
contentious, with high monetary stakes. As a result, there is less 
willingness from either side to arbitrate. 

Shippers have not obtained relief through STB's "competitive access" 
rules. Under these rules, shippers can file a complaint to request that 
one railroad obtain access to another railroad's tracks when necessary 
to remedy anticompetitive behavior by the owning railroad. Shippers who 
file a complaint must show that the owning railroad has engaged in 
anticompetitive behavior. To date, STB has found that all complaints 
have failed to prove that the owning railroad has engaged in 
anticompetitive behavior. 

STB Continues to Refine the Process: 

During our review, STB has continued to refine its processes for 
shippers to obtain relief from unreasonable rates and competitive 
access. For example, STB recently proposed a rule making to make 
changes to the simplified guidelines in order to respond to comments 
gathered at the STB hearings held in April 2003 and July 2004 to 
examine why those guidelines have not been used by shippers and to 
explore ways to improve the guidelines. In addition, STB is seeking 
public comment on several measures it has proposed to adopt regarding 
railroad practices involving fuel surcharges. The proposals follow 
STB's May 2006 public hearing on how railroads calculate and charge 
fuel surcharges and respond to extensive testimony on these charges 
submitted to STB by the rail industry, the public, and railroad 
customers. STB announced its intent to hold a public hearing on certain 
issues related to rail transportation rates for grain. Lastly, STB 
recently requested written comments and held a public hearing in 
response to a petition filed by a shipper group to prevent, or put a 
time limit on, paper barriers, which are contractual agreements that 
may be made when a Class I railroad either sells or leases some of its 
track to another railroad (typically a short line railroad or regional 
railroad), but stipulates that virtually all traffic that originates on 
that line must interchange with the Class I railroad that sold the 
tracks or pay a penalty. 

Assessment of Competitive Markets and Changes to Rate Relief Process 
Could Provide More Relief: 

The results of our analysis suggest a reasonable possibility that 
shippers in selected markets may be paying excessive rates related to a 
lack of competition in these markets. While our analysis of available 
measures shows that the extent of captivity appears to be dropping in 
the freight railroad industry, shippers that may be captive are paying 
substantially over the statutory threshold for initiating a rate relief 
case. This situation may simply reflect reasonable economic practices 
by railroads in an increasingly constrained environment in which demand 
for rail services increasingly exceeds supply, or it may represent an 
abuse of market power. Our analysis provides an important first step in 
assessing competitive markets nationally, but it is imperfect given the 
inherent limitations of the Carload Waybill Sample and the proxy 
measures available for weighing captivity. A more rigorous analysis of 
competitive markets nationally is needed--one that identifies the state 
of competition nationwide and inquires into pricing practices in 
specific markets. If this assessment determines that market power is 
being abused or the goals of the Staggers Rail Act are not being met, 
STB could consider several methods to ease competition concerns, such 
as initiating a generally applicable rule making; or, if a complaint is 
filed, providing specific remedies to increase competition. 

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 31] 

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. However, in 
markets that do, 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. 21). 

Figure 21: 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. 22). 

Figure 22: 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. 23). 

Figure 23: 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 32] 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. 24). 

Figure 24: 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. 25). 

Figure 25: Paper Barriers: 

[See PDF for image] 

Source: GAO. 

[End of figure] 

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 Rail Act. One significant consideration 
is the revenue adequacy of the railroads. The Staggers Rail Act 
established revenue adequacy as a goal for the industry and allowed the 
railroads to use differential pricing to increase their revenues. While 
the specific method for determining revenue adequacy has been 
controversial, the overall trend in revenue adequacy may be more 
important. In its last report for 2004, STB determined that one 
railroad is revenue adequate and that others are approaching revenue 
adequacy. It is too early to determine that the industry as a whole is 
achieving revenue adequacy. Nevertheless, this improvement in the 
railroads' financial condition represents a significant shift in the 
rail industry because for decades after the enactment of the Staggers 
Rail Act, the railroads were all considered revenue inadequate. The 
railroads need sufficient revenue for infrastructure investment to keep 
pace with increased demand. However, each of these changes could 
decrease the amount of revenue the railroads receive. Yet, as the 
railroad's revenue adequacy improves, the question arises as to what 
degree the railroads should continue to rely, for their investment 
needs, on obtaining significantly higher prices from those with greater 
reliance on rail transportation. 

To prevent problems with unreasonable rates, some shipper groups 
propose targeted approaches that would provide them with more 
competitive options. A number of different approaches have also been 
suggested to make the rate relief process less expensive, more 
expeditious, and therefore potentially more accessible. Each of the 
proposed approaches has both advantages and drawbacks. These approaches 
include the following: 

* Increase the use of simplified guidelines: The simplified guidelines 
use standard industry average figures for revenue data instead of 
requiring the shipper to create a hypothetical railroad. This approach 
would reduce the time and complexity of the process; however, it may 
not provide such an accurate and precise a measure as the standard 
process. Both shippers and railroad officials with whom we spoke agree 
that it is confusing to determine who is eligible to use the process 
and how it would work. STB recently issued a proposed rule making to 
pursue changes to the simplified guidelines to provide captive shippers 
greater access to regulatory remedies for unreasonable rail rates. 

* Increase the use of arbitration: Under arbitration, two parties 
present their case before an arbitrator, who determines the rate. This 
process replaces the shipper's requirement to create a hypothetical 
railroad. Proponents of arbitration argue that the threat of 
arbitration can induce railroads and shippers to resolve their own 
problems and limit the need for federal regulation. In addition, the 
process is quicker and cheaper than the standard rate relief process. 
For example, Canada offers an arbitration process known as Final Offer 
Arbitration (FOA), under which both parties submit their best and final 
offers, and the arbitrator considers the argument from both sides and 
picks one rate offer from either the railroad or the shipper. FOA is 
quicker--statutorily, once the process begins it has to be completed 
within 60 days, or 30 days for disputes involving freight charges of 
less than $750,000, unless the parties agree to a different time frame. 
In addition, FOA is cheaper--estimates ranged up to $1 million Canadian 
dollars, for both parties. On the other hand, the decisions are good 
for only 1 year, so the process could in theory be revisited annually. 
Critics of this approach suggest that arbitration decisions may not be 
based on economic principles, such as the revenue and cost structure of 
the railroad, and arbitrators may not be knowledgeable about the 
railroad industry. Furthermore, opinions differ significantly about 
which types of disputes should be covered and what standards (if any) 
should apply. 

* Develop an alternative cost methodology: STB could develop an 
alternative to the cost methodology used under the standard process in 
which a shipper must demonstrate how much an optimally efficient 
railroad would need to charge a shipper by constructing a hypothetical, 
perfectly efficient railroad that would replace its current carrier. 
For example, STB could use a long-run incremental cost approach to 
evaluate and decide rate cases. This process, which is used by the 
Federal Energy Regulatory Commission for regulating rates charged by 
pipeline companies, bases rates on the actual incremental cost of 
moving a particular shipment, plus a reasonable rate of return. This 
approach allows for a quick, standard method for setting prices, but 
does not take into account the need for differential pricing or the 
railroad's need to charge higher rates in order to become revenue 
adequate. Structuring rate regulation around actual costs can also 
create potential disincentives for the regulated entity to control its 
costs. 

Uncertainty about Future Freight Rail Demand and Capacity Points to 
Opportunities for a More Strategic Federal Approach to Rail 
Infrastructure: 

Recent forecasts predict that the demand for freight and freight rail 
transport will grow significantly in the future. While forecasts have 
limitations as guides to investing in new transportation 
infrastructure, they can present a plausible picture of future freight 
demand and capacity. Whether private rail companies will be able and 
willing to invest in new infrastructure capacity to meet projected 
future demand is uncertain. New rail capacity not only benefits each 
private rail company network, but it also has the potential to benefit 
the public by improving traffic flow, air quality, and safety at the 
national, state, and local levels. As a result, the public sector has 
increasingly been investing in freight rail projects. Federal 
involvement in the freight system should be consistent with the 
competitive marketplace and ensure that funding decisions reflect 
widespread public priorities. 

Forecasts of Significant Freight Rail Traffic Growth Provide a 
Plausible Outlook for the Future: 

The demand for freight transportation in general and freight rail 
specifically is forecasted to increase, according to recent 
studies.[Footnote 33] Several of these studies also quantify their 
projections of the volume and value of future freight demand. The 
Freight Analysis Framework (FAF) is a comprehensive database and policy 
analysis tool maintained by DOT to help identify needed freight 
capacity improvements. In 2002, DOT projected, using this tool, that 
overall domestic and international freight demand would increase by 
more than 65 percent and 84 percent, respectively, by 2020. In 2003, 
the American Association of State Highway and Transportation Officials 
(AASHTO) released the Freight Rail Bottom Line Report, prepared by a 
consulting firm. This report describes the industry and its benefits to 
the nation, estimates the industry's investment needs and capacity to 
meet these needs, and quantifies the consequences of underinvestment, 
including highway deterioration and congestion. The AASHTO study 
projected that, by 2020, overall domestic freight demand by ton would 
increase by 57 percent and international demand would increase by 99 
percent. In 2005, the American Trucking Association's (ATA) report U.S. 
Freight Transportation Forecast to 2016 projected tonnage and revenues 
for all freight modes. The report predicted that overall freight volume 
would increase by about 32 percent between 2004 and 2016. 

Freight rail demand is projected to increase less than overall freight 
demand and to grow at a slower rate than demand for other modes--such 
as truck and air freight. FAF projects that freight rail tonnage will 
grow about 55 percent by 2020, but this growth will not be as dramatic 
as for truck and air, and will account for a much smaller share of the 
market when measured on the basis of shipment value. AASHTO predicts 
that freight rail tonnage will increase 44 percent by 2020. However, it 
notes that this forecast actually indicates that rail will lose some 
market share. This estimate also assumes that considerable investment 
will be required--up to about $4 billion annually--to meet future 
demand. According to ATA's forecast, freight rail tonnage will grow 
annually by 2.4 percent to 2010 and by 2.1 percent to 2016. While rail 
intermodal traffic is forecast to grow rapidly, the study anticipates 
that rail's overall share of total freight tonnage will decrease 
slightly from about 15.6 percent in 2004 to about 15.4 percent in 2016. 

However, ow many factors can affect the accuracy of these predictions. 
Freight markets are volatile and unpredictable, and thus freight demand 
forecasts may prove to be off the mark. Similarly, much freight traffic 
is determined by trade that originates outside the United States. 
Moreover, since the data and models used to develop these freight 
demand forecasts are largely proprietary,[Footnote 34] we could not 
assess the validity or reasonableness of the assumptions used to 
develop the predictions.[Footnote 35] Nevertheless, forecasts of 
freight and freight rail demand are useful as one plausible scenario 
for the future. As the Congressional Budget Office (CBO) observed in a 
January 2006 report, forecasts of demand are best viewed as 
illustrative rather than quantitatively accurate.[Footnote 36] 

Railroads' Investments in Capacity to Meet Potential Demand Are 
Uncertain: 

If demand does develop as forecasted, it is uncertain how able and 
willing railroads will be to invest in new capacity. Railroads do not 
prepare long-term capacity plans because of concern about the potential 
for significant economic changes--for example, officials at one Class I 
railroad stated that they prepare capacity improvements plans and 
demand projections for 3 to 5 years into the future, with frequent 
revisions. In addition, the railroads we interviewed were generally 
unwilling to discuss their future investment plans with us in any 
detail because this is business proprietary information. It is 
therefore difficult to comment on how railroads are likely to choose 
among their competing investment priorities for the future compared 
with various demand scenarios. 

Railroads' ability and willingness to invest in new capacity to meet 
demand reflects a number of key considerations. For privately owned 
rail companies, a key business consideration is maximizing returns for 
shareholders. To do so, realizing the greatest return on investment 
from each investment decision is essential and is reinforced by 
pressure from shareholders. Rail investment involves private companies 
taking a substantial risk which becomes a fixed cost on their balance 
sheets, one on which they are accountable to stockholders and for which 
they must make capital charges year in and year out for the life of the 
investment. A railroad contemplating such an investment must be 
confident that the market demand for that infrastructure will hold up 
for 30 to 50 years. This is in sharp contrast to other modes such as 
highway infrastructure, which is paid for largely by public funds. 
Maximizing a rail company's competitive position in key markets is 
important in deciding on investments in the company network's size and 
facilities. For example, the growth of intermodal transport is a major 
development for freight rail because it stands to be the largest 
revenue generator for the Class I railroads. As a result, there is 
intense competition for this business, although intermodal business 
also means that freight rail both competes and cooperates with other 
freight modes. However, intermodal growth depends on the railroads' 
ability to invest in the new capacity needed to meet this demand. 

Investment considerations are complicated by the current status of rail 
infrastructure. Although the rail network has been downsized, the 
infrastructure remains extensive but aging. Replacing, maintaining, and 
upgrading this infrastructure is extremely costly, as the 
Transportation Research Board emphasized in its analysis of critical 
transportation issues.[Footnote 37] Predicting the extent to which 
future rail investments will keep pace with projected freight rail 
demand is complicated by the extent of current rail needs. For example, 
an annual assessment of America's infrastructure[Footnote 38] conducted 
by the American Society of Civil Engineering gave rail infrastructure a 
"C-" grade and noted that, for the first time in 90 years, limited 
capacity has created significant bottlenecks in the national rail 
network. However, railroads must invest in new infrastructure, new 
equipment, and substantial new capacity to handle additional traffic in 
order to remain viable and effective, a rail industry representative 
told our expert panel. 

Today, freight railroads are sufficiently profitable to be investing at 
record levels. Major freight railroads have reported[Footnote 39] that 
they expect to invest about $8 billion in infrastructure during 2006-- 
a 21 percent increase over 2005--and have told us that they plan to 
continue making infrastructure investments. However, not all of this 
investment is planned for capital or new capacity. Although we 
requested additional detail about how the rail industry's $8 billion 
estimated investment was divided between new capacity and maintenance 
or renewal of existing capacity, the Association of American Railroads 
indicated that this information is not currently available but will be 
part of a special study on railroad spending trends. 

Rail Capacity Investments Can Produce Private and Public Sector 
Benefits: 

While private rail networks obtain benefits and improve their 
profitability from investments in their capacity, these investments 
also can benefit the public. In fact, some public benefits can be large 
in comparison to anticipated benefits to the private rail network, as 
the CBO report pointed out. For example, shifting truck freight traffic 
to railroads can reduce highway congestion for passenger and commercial 
vehicles, potentially reducing or avoiding public expenditures that 
otherwise would be needed to build additional highway capacity or 
provide additional maintenance to accommodate growing truck traffic. 
Depending on the rail infrastructure project, the public could realize 
several types of benefits, as described in table 3. 

Table 3: Potential Public Benefits of Rail Transportation Investments: 

Category: Economic; 
Potential public benefit: 
* Lower transportation costs through higher productivity, making it 
cheaper to produce and distribute goods/services; 
* Improve global competitiveness through increased efficiency; 
* Strengthen local, regional, state economies; 
* Expand industry, employment, tax base. 

Category: Transportation system; 
Potential public benefit: 
* Capture each mode's advantages in moving passengers/freight; 
* Improve overall system performance; 
* Strengthen intermodal connections; 
* Improve transportation network efficiency for the future; 
* Improve passenger/ freight rail interactions. 

Category: Mobility/Congestion; 
Potential public benefit: 
* Relieve highway congestion by shifting highway freight to rails; 
* Reduce public investment to prevent highway deterioration by 
preventing diversion of heavy rail freight to roads; 
* Give passengers/freight access to more modes; 
* Decrease travel time, increase reliability. 

Category: Environmental/Air quality; 
Potential public benefit: 
* Reduce emissions/improve air quality by reducing congestion; 
* Consume about one-fourth to one-third less fuel than trucks. 

Category: Safety and security; 
Potential public benefit: 
* Reduce crashes through redesigned/eliminated highway-rail crossings; 
* Provide redundant capacity to respond to operational/congestion, 
national security, and weather problems. 

Source: GAO analysis. 

[End of table] 

Rail projects can vary widely in the extent to which they may generate 
public as well as private benefits; whether benefits are realized by 
the private or public sector at the national, state, and local levels; 
and how the benefits are quantified for the purpose of fairly 
apportioning project financing. Determining what benefits and costs are 
associated with a rail infrastructure project and who benefits is 
important in deciding whether public funds for public benefits are 
justified--but this is a difficult determination.[Footnote 40] For 
example, one rail infrastructure project that reduces system 
bottlenecks may generate benefits to the national economy by lowering 
the costs of producing and distributing goods. Another rail project 
that eliminates or improves highway-rail crossings may primarily 
produce local benefits by reducing accidents, time lost waiting for 
trains to pass, pollution and noise from idling trains, and delays of 
emergency vehicles at crossings. The same project also may produce 
national benefits by reducing the impact of train delays on the system. 

Public Sector's Growing Freight Rail Investments Focus on Securing 
Public Benefits: 

Increasingly, governments at all levels have been investing in freight 
rail improvement projects that offer potential public benefits. At the 
state and local levels, government involvement has ranged from planning 
and coordination to collaboration and investment with freight rail 
companies and other stakeholders. Some states have been investing to 
help short-line railroads maintain track in their states for almost 20 
years. Other states--such as Florida, Virginia, New York, and 
Pennsylvania--are creating significant new programs to invest in rail 
projects. Over 30 states have published freight plans that describe 
their goals and approach to freight and freight rail. 

The scope of state and local freight rail investments continues to 
expand. For example, Missouri state and local governments, in 
partnership with railroads and other stakeholders, supported two major 
rail bridge flyover[Footnote 41] projects to reduce rail delays in 
Kansas City. These projects--totaling $134 million--were expected to 
provide economic benefits and reduce rail transit time through the city 
by about 2 hours. The project also used an innovative institutional 
arrangement that created a special type of corporation to facilitate 
its funding. Colorado's Department of Transportation (CDOT), other 
public entities, and two Class I railroads are exploring an ambitious 
partnership to relocate freight train facilities away from the heavily 
populated Front Range area of the state, as the two railroads proposed. 
CDOT initiated a benefit-cost study[Footnote 42] that found sufficient 
public transportation, economic development, land use, safety, 
environmental, and passenger rail facilitation benefits to warrant 
investing public dollars in the project--estimated to cost about $1.17 
billion. 

The federal government also has been involved in freight rail projects. 
In 1997, DOT provided a $400 million loan for the $2.4 billion Alameda 
Corridor project to leverage funds from ports, railroads, and local 
governments. As a result, a 20-mile trench for trains was constructed 
to eliminate numerous rail-highway crossings and reduce rail transport 
time to and from the ports of Los Angeles and Long Beach--a significant 
gateway for freight imported from Asia and distributed throughout the 
United States. In 2005, Congress provided $100 million to the $1.5 
billion Chicago Region Environmental and Transportation Efficiency 
(CREATE) program. Its objective is to cut train delays and congestion 
and improve passenger rail service by separating 25 rail-highway 
crossings, building 6 passenger/freight train flyovers, and upgrading 
tracks and controls to improve service for the one-third of the 
nation's rail traffic that comes through Chicago each day. Railroads 
and state and local governments are contributing to the program's 
financing. In 2005, Congress also passed the Safe, Accountable, 
Flexible, Efficient Transportation Equity Act: A Legacy for Users 
(SAFETEA-LU), which increased the authorized level of funds available 
under the Railroad Rehabilitation and Improvement Financing (RRIF) 
program from $3.5 billion to $35 billion over a 5-year period. This 
program provides loans or loan guarantees that are available to states 
or railroads for projects to acquire, improve, or rehabilitate rail 
infrastructure. 

A number of proposals before Congress would increase federal funding 
for freight railroad projects. One proposal calls for the creation of a 
Railroad Trust Fund that would be similar to the Highway Trust Fund, 
which is used to pay for highway construction and improvements. Another 
proposal calls for a railroad investment tax credit. Under this 
proposal, railroads or shippers would receive a 25 percent tax credit 
for money spent to expand rail infrastructure. 

Federal Response to Freight Investments Should Reflect a National 
Policy That Is Impartial Toward All Modes and Produces Maximum Public 
Benefits from Public Investments: 

Federal decision makers face considerable uncertainty about the future 
of freight transportation coupled with considerable certainty that the 
federal deficit will be a long-term constraint on federal investment. 
At the same time, Congress will continue to face policy and funding 
decisions that will affect all freight modes and have a critical impact 
in shaping the nation's rail system and infrastructure. As we have 
noted in our past work,[Footnote 43] a strategic systemwide approach to 
transportation planning and funding that focuses on all modes is 
increasingly important to meet expectations for more efficient freight 
transport, growing freight demand, and more connections between modes. 

Federal funding constraints enhance the need for a strategic federal 
approach to freight infrastructure investment, and the implications of 
these constraints are a critical feature of a national freight policy. 
Given major projected demographic shifts and future federal health and 
retirement commitments, federal revenues may barely cover interest on 
the federal debt by 2040--leaving no money for either mandatory or 
discretionary programs. According to our simulations, balancing the 
budget could require cutting federal spending by as much as 60 percent, 
raising taxes by up to 2-1/2 times their current level, or some 
combination of the two.[Footnote 44] We have concluded that the 
impending federal fiscal crisis will require a fundamental 
reexamination of all federal programs.[Footnote 45] For example, our 
assessment of the federal highway grant program raised significant 
issues, such as the absence of a clear federal mission and role since 
the completion of the interstate highway system and the absence of a 
link between federal funding and goals or outcome measures. 

DOT has taken an important step toward a more comprehensive freight 
strategy by publishing a draft Framework for a National Freight 
Policy[Footnote 46] for comment. It is a step for which we found 
considerable support among public and private freight stakeholders. A 
systemwide, rather than a modal, perspective is critical to a national 
freight policy. As the AASHTO study emphasized, investments at the 
freight system level are needed to respond to nationally significant 
corridor choke points, intermodal connections, and urban rail 
interchanges. 

With federal fiscal constraints as the backdrop, two major policy 
principles will need to be considered as DOT continues to develop this 
national policy. These principles are, first, to adopt a mode-neutral 
approach--one that takes a consistent policy and funding approach to 
all modes and establishes a level playing field for competition in the 
freight marketplace--and, second, to maximize public benefits-- 
particularly benefits to the national transportation system--from 
public transportation investments. 

Adopting a Mode-Neutral Approach: 

Under a mode-neutral approach, each mode would pay the full costs for 
the infrastructure facilities and services that it used as well as the 
costs that its use imposed on others--such as added air pollution, 
congestion, and accident risks[Footnote 47]--through taxes and user 
fees. No single mode would be at a competitive disadvantage. A mode- 
neutral federal freight policy and investment strategy would be 
consistent with the competitive market's central role in the freight 
system. Encouraging a market-based approach and competition that 
fosters economic efficiency and innovation is a key consideration in 
dealing with the privately owned freight rail industry, as we have 
reported.[Footnote 48] 

Currently, as we have pointed out, federal programs treat different 
freight modes differently. For example, trucks and barges use 
infrastructure that is owned and maintained by the government, while 
rail companies use infrastructure that they pay to own and maintain. 
The trucking and barge industries pay fees and taxes to use this 
government-funded infrastructure, but their payments generally do not 
cover the costs they impose on highways and waterways, thereby giving 
the trucking and barge industries a competitive price advantage over 
railroads.[Footnote 49] The most recent Federal Highway Administration 
(FHWA) highway cost allocation study[Footnote 50] evaluates highway 
costs attributable to different vehicle classes and the extent to which 
their user fees cover their responsibility for highway costs. According 
to the study, combination unit trucks[Footnote 51] paid 80 percent of 
their cost responsibility and the heaviest combinations paid half of 
their cost responsibility. The study concluded that only the very 
lightest combination trucks pay their share of federal highway cost 
responsibility. A recent CBO report[Footnote 52] also concluded that 
trucks and barges do not pay their full share of highway costs and 
reported that rail may be at a competitive disadvantage, since other 
modes are effectively being subsidized. CBO also observed that if all 
modes do not pay their full costs, the result is inefficient use of 
roads and waterways and greater government spending than otherwise 
would be necessary if capacity investments are made in anticipation of 
demand that does not occur. 

Maximizing Public Benefits from Public Transportation Investments: 

As DOT develops and applies a national freight policy, our second 
critical principle will be an important consideration--public 
investments should depend on clearly defined public benefits.[Footnote 
53] Benefit-cost analysis can be a useful tool to define benefits, as 
our expert panel on this subject concluded.[Footnote 54] Because this 
analysis identifies the greatest net benefits by comparing the monetary 
value of each project's benefits and costs, it can help public and 
private stakeholders evaluate project alternatives. 

States have had experience in evaluating whether rail projects could 
yield sufficient public benefits to warrant investments of public 
dollars in the projects, and their experience can inform a national 
freight policy. For example, the state of Washington's Freight Mobility 
Strategic Investment Board leverages transportation dollars by working 
with public and private stakeholders to fund projects that deliver 
public benefits. The board's project scoring criteria reflect 
anticipated benefits, such as freight mobility for the project area; 
freight mobility for the region, state, and nation; general mobility; 
safety; freight and economic value; environment; project partnership; 
consistency with regional and state plans; location on a Strategic 
Freight Corridor; and cost benefit. 

However, federal decision makers have no such criteria to use in 
considering potential freight rail investments. As we have pointed out, 
the federal funding structure for surface transportation and federal 
program incentives tend to focus decision makers' attention on highway 
and transit projects, rather than on freight or freight rail concerns. 
And, although state and local transportation decision makers consider 
benefit-cost analyses, these analyses often do not have a decisive 
impact on investment decisions.[Footnote 55] As DOT has noted, a fair, 
balanced approach to allocating public and private funding is a 
prerequisite for public-private partnerships.[Footnote 56] We have also 
raised concerns about federal tax policies. For railroads, some 
industry groups have proposed freight rail tax credits to encourage 
investment. However, our work has shown that it is difficult to target 
tax credits to the desired activities and outcomes and ensure that tax 
credits generate the desired new investments, as opposed to 
substituting for investment that would have occurred anyway.[Footnote 
57] 

Conclusions: 

The Staggers Rail Act achieved far-ranging benefits in helping to 
create and sustain a healthy and vibrant freight railroad industry, as 
well as an efficient rail transportation system that supports the 
important role freight plays in the nation's economy. Critical to the 
Staggers Rail Act was the concept of balance--on one hand, the act 
sought to allow rail carriers to earn adequate revenues so that they 
could meet their current and future capital needs. On the other hand, 
the act recognized the need for a remnant regulatory regime that would 
maintain reasonable rates and prohibit undue concentrations of market 
power in areas where no effective competition existed. The act 
recognized that it was vital for the federal government to promote 
competition and rely on it to set rates. Without a doubt, rates have 
decreased for most shippers, and most shippers are better off in the 
post-Staggers environment than they were previously. This outcome 
suggests that widespread and fundamental changes to the relationship 
between the railroads and their customers are not needed. Nevertheless, 
the evidence also suggests some basis for believing that--more than 25 
years after the act's passage--the balance it envisioned has not been 
fully achieved. 

The continued existence of pockets of potential captivity, together 
with the increase in traffic at higher thresholds, 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. Answering this question requires a 
rigorous, national analysis of competitive markets. Our analysis 
provides an important first step; however, we are constrained by the 
inherent limitations of the Carload Waybill Sample and the available 
proxy measures for assessing captivity. In contrast, STB has the 
statutory authority to inquire into and report on railroad practices 
and could conduct a rigorous analysis of competition in the freight 
rail industry that would rely on more than sample data and could 
determine whether the inappropriate exercise of market power is 
occuring in specific markets. Should STB find evidence of abuse, it 
could consider several methods for creating the balance envisioned by 
the Staggers Rail Act. For example, STB could consider initiating a 
generally applicable rule making to address competition issues or 
prescribe specific remedies in response to a complaint. 

In assessing competition within the freight rail industry, STB needs 
accurate data on railroad revenues. The data that STB currently 
collects--in particular, the use of the Carload Waybill Sample to 
report on the railroads' finances--are not always captured 
consistently, making it difficult to accurately track railroad 
revenues. Specifically, while we determined that, in general, the data 
in the Waybill were suitably reliable for our reporting purposes, we 
also found that some data, including data on fuel surcharges, were not 
accurately captured. Accurate data would provide for more accurate 
tracking of railroad revenues and railroad charges to potentially 
captive shippers and other shippers. This information would help STB to 
obtain a clearer picture of the actual fees paid by shippers. 

STB is also responsible for ensuring the expeditious handling and 
resolution of rate disputes, but the current process for settling these 
disputes is ineffective. There are a number of potential alternatives 
to the current process, and STB has recognized the limits of the 
process and taken further action to improve it. These actions are 
commendable and need to be pursued; absent further action, the promise 
of the Staggers Rail Act and the balance it envisioned may never be 
fully realized. 

These are difficult issues that require careful balancing of the 
railroads' need to earn adequate revenues with shippers' need for 
competition and reasonable rates during a time of uncertainty about the 
capacity of freight railroads to meet future demand for freight rail 
service. While predictions and scenarios for the future of freight rail 
vary, it is likely that multiple levels of government will continue to 
be involved in the nation's freight system. Additional investment in 
freight rail infrastructure can produce public benefits, and many state 
and local governments are involved in freight rail infrastructure 
projects. Congress has provided federal assistance as well, and further 
requests for and decisions about federal assistance to rail 
infrastructure are likely. Decision makers will be challenged to ensure 
that federal involvement is consistent with competition in the freight 
marketplace, reflects widespread public priorities, and offers benefits 
that warrant the commitment of federal funds. DOT's draft National 
Freight Policy represents a good start in this direction. 

Recommendations for Executive Action: 

To ensure an appropriate balance between the interests of railroads and 
shippers, we recommend that the Chairman of the Surface Transportation 
Board take the following two actions: 

* Undertake a rigorous analysis of competitive markets to identify the 
state of competition nationwide; in specific markets, determine whether 
the inappropriate exercise of market power is occuring; and, where 
appropriate, consider the range of actions available to address 
problems associated with the potential abuse of market power. If the 
Chairman determines that STB requires more resources to conduct this 
analysis, then STB should request additional resources from Congress. 

* Review STB's 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. 

To ensure the efficiency and effectiveness of our nation's freight 
system, we are making the following recommendation to the Secretary of 
Transportation: 

* As DOT continues to develop a national freight policy and a possible 
federal policy response, consider strategies to (1) sustain the role of 
competitive market forces by creating a level playing field for all 
freight modes and (2) recognize the fiscally constrained federal 
funding environment by developing mechanisms to assess and maximize 
public benefits from federally financed freight transportation 
investments. 

Agency Comments and Our Evaluation: 

STB provided written comments on a draft of this report. These comments 
are presented and evaluated in appendix III. STB generally agreed with 
our assessment of the improving financial health of the freight 
railroad industry and potential public benefits for freight rail 
infrastructure projects. However, STB disagreed with our recommendation 
to undertake a rigorous analysis of competitive markets in the rail 
industry because it believed the findings underlying the recommendation 
were inconclusive, their on-going efforts will address many of our 
concerns, and a rigorous analysis would divert resources from other 
efforts. Specifically, STB stated that our recommendation was based on 
two findings--first, that rail rates have increased for some shippers 
and, second, that the amount of traffic with rates reflecting high R/VC 
ratios has increased in some areas. STB stated that recent increases in 
rail rates are not surprising and that R/VC ratios can increase when 
rates and costs are falling and that these findings do not suggest 
market abuses. STB also noted that it has several rule makings under 
way related to the standard rate relief process and the simplified rate 
relief process. STB suggested that, given the limitations on its 
resources and the aggressive agenda already under way, rather than 
undertake this competitive markets analysis, a more practical approach 
would be for STB to finish its reforms to ensure that captive shippers 
have an effective forum to seek rate relief if a railroad is charging 
unreasonable rates. Concerning our recommendation that STB review its 
method of data collection to ensure that all freight railroads are 
consistently and accurately reporting all revenues collected from 
shippers, STB stated that the revenue in question represents a small 
portion of all revenues and that revenue data submitted by freight 
railroads are audited and otherwise checked to ensure quality. 
Furthermore, STB has initiated a rule making to improve the tracking of 
fuel surcharges. 

While STB's efforts have been helpful, we continue to believe that STB 
should undertake a rigorous analysis of competitive markets to identify 
the state of competition nationwide; in specific markets, determine 
whether the inappropriate exercise of market power is occuring; and, 
where appropriate, consider the range of actions available to address 
problems associated with the potential abuse of market power. STB's 
comments do not accurately characterize the underlying support for our 
recommendation. We did not base this recommendation on an increase in 
rail rates or suggest that rate increases alone suggest increased 
captivity. On the contrary, we recognize that rates have declined and 
that available measures suggest that the extent of captivity has 
dropped. Furthermore, STB's response suggests that rail rates and the 
amount of traffic with high R/VC ratios were the only data we examined-
-they were not. We examined several factors, including data on the 
amount of tonnage originating in economic areas that have access to 
only one Class I railroad, data on the amount of tonnage traveling over 
300 percent R/VC, and the amount of tonnage that originates in areas 
with access to only one Class I railroad and travels at rates that 
exceed the statutory threshold for rate relief. Our report explicitly 
acknowledges the limitations in the Carload Waybill Sample and of the 
proxy measures available for weighing captivity, including R/VC levels. 
At the same time, our analyses, when combined with comments from 
participants on our expert panel and interviews with shipper and 
railroad groups, suggest a reasonable possibility that shippers in 
selective markets may be paying excessive rates related to a lack of 
competition. This provides the impetus for STB--which has the statutory 
authority to inquire into and report on railroad practices--to analyze 
competitive markets in the rail industry and, where appropriate, 
consider the range of actions to address problems associated with the 
potential abuse of market power. Also, this analysis would rely on more 
than sample data and could analyze the exercise of market power in 
specific markets. 

Regarding STB's position that it has several rule makings under way 
that address many of our concerns, we commend STB for recognizing and 
taking action to address problems with the rate relief process, but we 
believe action is needed beyond improvements to the rate relief 
process. These rule makings, if implemented, are designed to improve 
the processes available to shippers, after shippers have been charged a 
rate that they consider to be unreasonable. In contrast, we believe 
that an analysis of the state of competition and the possible abuse of 
market power, along with the range of options STB has to address 
competition issues, could more directly further legislatively defined 
goals to ensure effective competition among rail carriers as the 
preferred means to both promoting a sound rail transportation system 
and maintaining reasonable rates. Regarding STB's assertion that 
conducting a rigorous analysis of competition would divert resources 
away from its on-going initiatives, we modified our draft to recommend 
that STB request additional resources from Congress if it determines it 
needs more resources to conduct an analysis of competition. We also 
believe that STB should review its method of data collection to ensure 
that all freight railroads are consistently and accurately reporting 
all revenues. STB commented that it had already responded to this 
concern by proposing a standardized report for fuel surcharges; 
however, while we commend STB for its efforts to capture these data, we 
also note STB has not yet implemented standardized reporting of fuel 
surcharges and that other revenues besides fuel surcharges may not be 
included in the Waybill. STB also provided technical comments that we 
incorporated in this report, as appropriate. 

We requested comments on a draft of this report from the Acting 
Secretary of Transportation or her representative. On September 21, 
2006, DOT officials, including the Deputy Associate Administrator for 
Policy, Federal Railroad Administration, and the Chief Economist, 
Office of Transportation Policy, Office of the Secretary, provided us 
with oral comments on the draft. In its comments, DOT emphasized the 
need for the report to clearly recognize the rationale and importance 
of differential pricing; the nature and relatively small extent of 
potentially unreasonable pricing in the rail freight marketplace; and 
the impact of capacity constraints on rail pricing and services. DOT 
also suggested that our report should recognize certain factors, 
including that competition between railroads is not possible in all 
markets because the level of demand may not support more than one 
railroad, and that investment in freight rail infrastructure entails 
substantial private risk. In contrast, highway investment has been 
largely publicly financed. DOT did not take a position on our 
recommendation concerning the draft National Freight Policy, but stated 
that efforts are under way to develop more effective tools for gauging 
the extent to which proposed freight investments provide public 
benefits. DOT also endorsed the views contained in STB's September 15, 
2006, letter (see app. III). We made changes to this report to reflect 
DOT's comments, as appropriate. DOT also provided a number of technical 
corrections, which we incorporated as appropriate. 

We will send copies to the appropriate congressional committees, the 
Chair and Vice-Chairs of the Surface Transportation Board, and the 
Secretary of Transportation. We will also make copies available to 
others on request. In addition, the report will be available at no 
charge on the GAO Web site at [Hyperlink, http://www.gao.gov]. 

If you or your staff has any questions, please contact me at (202) 512- 
2834 or heckerj@gao.gov. Contact points for our Offices of 
Congressional Relations and Public Affairs may be found on the last 
page of this report. See appendix V for a list of major contributors to 
this report. 

Signed by: 

JayEtta Z. Hecker: 
Director, Physical Infrastructure Issues: 

List of Congressional Requesters: 

The Honorable Daniel K. Inouye: 
Co-Chairman, Committee on Commerce, Science, and Transportation: 
United States Senate: 

The Honorable Conrad Burns: 
United States Senate: 

The Honorable Byron Dorgan: 
United States Senate: 

The Honorable Frank Lautenberg: 
United States Senate: 

The Honorable Trent Lott: 
United States Senate: 

The Honorable John McCain: 
United States Senate: 

The Honorable Mark Pryor: 
United States Senate: 

The Honorable Gordon Smith: 
United States Senate: 

[End of section] 

Appendix I: Participants in GAO's Expert Panel: 

Louis S. Thompson (Moderator): 
Principal: 
Thompson, Galenson and Associates, LLC: 

Paul Bingham: 
Global Insights: 

George Borts: 
Department of Economics: 
Brown University: 

George Eads: 
Vice President: 
CRA International: 

Robert Gallamore: 
Director: 
Transportation Center Northwestern University: 

Darius Gaskins: 
Founding Partner Norbridge, Inc. 

Carl Martland: 
Senior Research Associate: 
Massachusetts Institute of Technology: 
Department of Civil and Environmental Engineering: 

Michael F. McBride: 
Partner LeBouef, Lamb, Greene & MacRae, LLP: 

Gerard McCullough: 
Department of Applied Economics: 
University of Minnesota: 

Linda Morgan: 
Chair of the Transportation Practice Group: 
Covington & Burling, LLP: 

John V. Wells: 
Chief Economist: 
U.S. Department of Transportation: 

[End of section] 

Appendix II: Objectives, Scope, and Methodology: 

We used the Surface Transportation Board's (STB) Carload Waybill Sample 
to identify railroad rates from 1985 through 2004 (the latest rate data 
available at the time of our review), which we then analyzed to 
determine rate changes. The Carload Waybill Sample is a sample of 
railroad waybills (in general, documents prepared from bills of lading 
authorizing railroads to move shipments and collect freight charges) 
submitted by railroads annually. We used these data to obtain 
information on rail rates across the industry, for certain commodities 
and for certain routes by shipment size and length of haul. According 
to STB officials, revenues derived from the Carload Waybill Sample are 
not adjusted for such things as year-end rebates and refunds that may 
be provided by railroads to shippers that exceed certain volume 
commitments. 

Some railroad movements contained in the Carload Waybill Sample are 
governed by contracts between shippers and railroads. To avoid 
disclosure of confidential business information, STB disguises the 
revenues associated with these movements before making this information 
available to the public. Consistent with our statutory authority to 
obtain agency records, we obtained a version of the Carload Waybill 
Sample that did not disguise revenues associated with railroad 
movements made under contract. Therefore, the rate analysis presented 
in this report presents a truer picture of rail rate trends than 
analyses that may be based solely on publicly available information. 
Since much of the information contained in the Carload Waybill Sample 
is confidential, rail rates and other data contained in this report 
that were derived from this database have been aggregated at a level 
sufficient to protect this confidentiality. 

We used rate indexes and average rates to measure rate changes over 
time. A rate index attempts to measure price changes over time by 
holding constant the underlying collection of items that are consumed 
(in the context of this report, items shipped). This approach differs 
from comparing average rates in each year because, over time, higher-or 
lower-priced items can constitute different shares of the items 
consumed. Comparing average rates can confuse changes in prices with 
changes in the composition of the goods consumed. In the context of 
railroad transportation, rail rates and revenues per ton-mile are 
influenced, among other things, by the average length of haul. 
Therefore, comparisons of average rates over time can be influenced by 
changes in the mix of long-and short-haul traffic. Our rate indexes 
attempted to control for the distance factor by defining the underlying 
traffic as 2004 commodity flows between pairs of census regions. To 
examine the rate trends on specific traffic corridors, we first chose a 
level of geographic aggregation for corridor end points. We defined end 
points as the regional economic areas defined by the Department of 
Commerce's Bureau of Economic Analysis. An economic area is a 
collection of counties in and about a metropolitan area (or other 
center of economic activity); there are 179 economic areas[Footnote 58] 
in the United States, and each of the nation's 3,141 counties is 
included in an economic area.[Footnote 59] We placed each corridor in 
one of three distance-related categories: 0 to 500 miles, 501 to 1,000 
miles, and more than 1,000 miles. Although these distance categories 
are somewhat arbitrary, they represent reasonable proxies for short-, 
medium-, and long-distance shipments by rail. 

To determine the areas with access to one or more Class I railroads, we 
obtained railroad systems data from the Department of Transportation, 
which accounted for trackage rights, mergers, and other industry 
developments affecting access. For issues related to revenue-to- 
variable cost ratios, we used data from the Carload Waybill Sample to 
identify the specific revenues and variable costs and to compute R/VC 
ratios for the commodities and markets we examined. Using this 
information, we then identified those commodities and areas whose R/VC 
ratios were above or below the 180 percent R/VC level, as well as those 
areas above the 300 percent R/VC level. 

To identify the actions STB has taken to address competition and 
captivity concerns, we interviewed officials and reviewed information 
from all seven North American Class I railroads, several shipper groups 
and associations and STB officials; and we met with experts in the 
railroad industry. We reviewed characteristics of STB's current rate 
relief process, as well as changes STB has made to the process, and 
conducted a comprehensive analysis of STB cases since 2000. We also 
held an expert panel through the National Academy of Sciences, 
consisting of 11 individuals with expertise in the freight railroad 
industry and the economics of transportation deregulation. Moreover, we 
conducted a legal analysis of current statutes related to STB's 
authority. To discern potential alternatives, we reviewed pending 
legislation, testimonies before Congress, previous GAO reports, STB 
decisions, rule makings, and proposed rule makings, and conducted a 
summary analysis of interviews. 

To assess future freight demand and the freight railroad industry's 
ability to meet such demand, we reviewed transportation planning 
literature and forecasts of future freight rail demand and capacity in 
the United States. This review also included state freight plans and 
major freight rail projects. We synthesized information on freight and 
freight rail, as well as various forecasts to identify similar and 
dissimilar themes. We also reviewed involvement by the federal 
government in freight railroad projects, including related legislation 
and funding decisions. We interviewed several state and federal 
transportation officials to gather further information on public- 
private partnerships, freight railroad projects, and DOT's draft 
National Freight Policy. We also interviewed freight railroad 
representatives, financial market analysts, national association 
representatives, and transportation experts. For selected public- 
private partnerships, we analyzed the genesis of such projects, 
motivations for involvement from the public and private sectors, and 
benefit-cost analyses that were conducted to support project funding 
decisions. 

We determined that the data used in this report were sufficiently 
reliable for the purpose of our review. We conducted our review from 
June 2005 to August 2006 in accordance with generally accepted 
government auditing standards. 

[End of section] 

Appendix III: Comments from the Surface Transportation Board: 

Note: GAO comments supplementing those in the report text appear at the 
end of this appendix. 

Office of the Chairman: 
Surface Transportation Board: 
Washington, D.C. 20423-DODI: 

September 15, 2006: 

Ms. JayEtta Z. Hecker: 
Director: 
Physical Infrastructure Issues: 
Government Accountability Office: 
441 G Street, NW: 
Washington, DC 20548: 

Dear Ms. Hecker: 

The Surface Transportation Board has received the draft version of the 
Government Accountability Office (GAO) report entitled "Freight 
Railroads: Industry Health Has Improved, but Concerns about Competition 
and Captivity Should Be Addressed" (GAO-06-1057). 

We have reviewed the draft and are submitting the agency's formal 
comments which are attached. If you have any questions, please contact 
William Huneke, Chief Economist and Associate Director, at 202-565- 
1538. 

We appreciate the opportunity to work with you on this matter. 

Signed by: 

Charles D. Nottingham: 

Enclosure: 

cc: Steve Cohen, Assistant Director, GAO: 
Vice Chairman Mulvey: 
Commissioner Buttrey: 
William Huneke: 

Comments of the Surface Transportation Board: 

"Freight Railroads: Industry Health Has Improved, but Concerns about 
Competition and Captivity Should be Addressed" (GAO-06-1057): 

September 15, 2006: 

The STB appreciates the opportunity to comment on this report and 
commends the GAO staff for their efforts in studying these complex 
issues. We are pleased with the report's finding that the changes in 
the rail industry since the Staggers Act have been positive. As the 
report shows, railroads have seen their productivity and financial 
health improve, and inflation-adjusted rail rates have fallen as 
carriers have passed cost savings back to their customers. We share 
GAO's concern that further rail investment is needed to meet the 
significant rise in demand predicted over the next 10 to 15 years, and 
that further investment would provide broad public benefits by 
improving highway traffic flow, air quality, and safety at the 
national, state and local levels. We also agree with GAO's ultimate 
finding that "widespread and fundamental changes to the relationship 
between the railroads and their customers are not needed." 

Based on its national study into the state of competition, GAO offers 
two recommendations for Board action. One recommendation is that the 
Board review its data collection methods to ensure that all freight 
revenues are consistently and accurately reported. For example, the 
report highlights the current inconsistent treatment by railroads of 
their fuel surcharge revenues. The agency has already responded to this 
industry concern by proposing standardized monthly reports of Class I 
railroads' fuel surcharges. Moreover, as GAO notes, the amount of 
revenues reported as "miscellaneous revenue" represents less than 1.5% 
of the total freight rail revenue reported for 2004. 

The Board will continue its ongoing efforts to ensure the accuracy and 
reliability of the data collected from railroads. Each year, the Class 
I railroads submit to the STB reports containing extensive financial 
and operational data needed to assist the agency in fulfilling its 
regulatory responsibilities. This information is audited and reviewed 
by the Board and by independent accounting firms. Railroads also submit 
waybill data for a sample of individual movements. The waybill data are 
carefully reviewed for accuracy each year by two contractors, and the 
Board conducts its own series of checks on the waybill data as well. If 
at any of these stages there appears to be inconsistent or questionable 
data, the reporting railroad is immediately contacted for clarification 
or correction. And where a significant recurring problem is detected, 
the STB will take the steps necessary to ensure it has the information 
it needs to carry out its statutory responsibilities. 

The other recommendation for the Board is that the STB conduct its own 
rigorous analysis of competitive markets to identify the state of 
competition nationwide; inquire into railroad pricing practices in 
specific markets where it finds evidence of an inappropriate exercise 
of market power; and consider actions to address any potential market 
abuses. This recommendation is based on two findings in the report: (1) 
that rail rates have increased in nominal terms since 1980 for some 
shippers; and (2) that, even though the overall extent of shipper 
captivity has dropped, the amount of traffic with rates reflecting high 
revenue-to- variable cost (RNC) ratios has increased in some areas. 

These observations, however, do not suggest market abuses. The rate 
changes shown in this report have not been adjusted for inflation. The 
reported 9% increase in rates for grain shipments (from 1985 to 2004) 
has not kept pace with inflation over that same time period. And the 
modest increase in rates from 2000 to 2004 is not surprising, given the 
escalation in costs during that time period. 

The analysis of RNC ratios is also inconclusive. For example, in Figure 
19, it is reported that the amount of grain traffic transported from 
Minot to Portland at rates with an RNC ratio above 300% increased from 
1985-2004. But as shown in Figure 9, even without accounting for 
inflation, grain rates per ton-mile from Minot to Portland had fallen. 
Thus, the change in R/VC ratios must be due to a drop in costs per ton-
mile, as more grain is shipped in lower-cost shuttle trains or the 
railroad has implemented other cost-saving measures. RNC ratios do not 
provide a reliable measure of changes in captivity over time, because 
they can increase even when rates are falling where a carrier's costs 
are also falling. For example, as GAO has previously observed, if rail 
revenues are $2 and variable costs are $1, the RNC ratio would be 200%. 
However, if revenues decreased to $1.50 and variable costs decreased to 
$0.50, the ratio becomes 300%. Under this scenario, "although railroads 
have passed all cost reductions along to shippers in terms of lower 
rates, the increased RNC ratio makes it appear as though the shipper is 
worse off." GAO/RCED-99- 93, Railroad Regulation at 65 (April 1999). 

It is noteworthy that the STB has several important rulemakings 
underway which bear directly on most of GAO's concerns. Specifically, 
GAO reports widespread belief that the STB's standard rate relief 
process is inaccessible to most shippers because it is too expensive, 
time consuming, and complex. Earlier this year, the agency instituted a 
rulemaking intended to resolve contentious issues in its standard rate 
relief process. If implemented, these changes should reduce the 
complexity of those cases and dramatically reduce the cost by 
simplifying the evidentiary inquiry. Final rules will be issued this 
fall. 

GAO also concludes that the agency's simplified guidelines - which were 
defended vigorously by the STB and the shipper community when 
challenged by the railroad community in federal court - have not proven 
effective because no captive shipper has used them. However, earlier 
this year the STB launched a major rulemaking to reform and modernize 
its simplified rate relief guidelines to ensure that all shippers have 
an effective forum to bring rate complaints. The proposed revisions are 
the culmination of public hearings and considerable internal study by 
STB staff. Comments from over 65 parties are expected by the end of 
this year, with final rules to follow early next year. These important 
reforms will be pursued concurrently with the agency's regular docket 
of cases requiring Board adjudication. 

Given the aggressive agenda already underway at the Board, we are 
hesitant to divert resources and attention away from these pending 
initiatives to undertake another prolonged national study. GAO has 
already used its full resources to carefully review the only 
comprehensive dataset for railroad pricing; interviewed and reviewed 
information from the railroads, shippers, economists, and experts in 
the rail industry; and heard from a panel of experts in the freight 
rail industry and in the economics of freight rail transportation. 
Finding nothing conclusive, GAO recommends that this far-smaller agency 
conduct yet another analysis. Because most of GAO's concerns involve 
the possibility that some shippers may be paying excessive rates, we 
believe that a far more practical approach is for the STB to finish the 
important reforms to its rate complaint procedures to ensure that 
captive shippers have an effective forum to seek rate relief if a 
railroad is charging unreasonably high rates. 

The STB will remain vigilant in monitoring the rail industry and will 
initiate inquiries, regulatory proceedings, and recommendations to 
Congress as future facts and circumstances require. 

The following are GAO's comments on the Surface Transportation Board's 
letter dated September 15, 2006. 

GAO Comments: 

1. STB commented that we conducted a national study into the state of 
competition. We did not conduct such a study. Our study included a 
broad focus on changes in the freight railroad industry since the 
Staggers Rail Act, the actions STB has taken to address concerns about 
competition and captivity, and future freight demand and capacity. The 
data we collected and analysis we performed--such as a review of rate 
changes over 20 years--were too broad to represent a national study of 
the state of competition. It is the limitations in the scope of our 
analysis of competition, along with limitations in the data available 
to us and a reasonable possibility that shippers in selected markets 
may be paying excessive rates, which led us to recommend that STB 
conduct a more rigorous analysis of competition. 

2. STB commented that it has already addressed our recommendation to 
improve data collection by proposing standardized monthly reports of 
fuel surcharges and also described its efforts to ensure the accuracy 
and reliability of data in the Waybill. We commend STB for its recent 
action on fuel surcharges, which occurred during our review, but we 
also note STB has not yet implemented standardized reporting of fuel 
surcharges. In addition, other revenues besides fuel surcharges may not 
be included in the Waybill. Specifically, revenues generated through 
railcar auctions and congestion fees may not be included. While the 
reported miscellaneous revenue is a small percentage of all revenue, it 
is not known how much miscellaneous revenue is not reported. Complete 
data would provide for more accurate tracking of railroad revenues and 
would help STB to obtain a clearer picture of actual fees paid by 
shippers. While we commend STB for its actions to audit and review 
Waybill data, these accuracy checks do not address our concern that STB 
is not collecting the full range of revenue data. 

3. STB commented that our recommendation for STB to conduct an analysis 
of competition is based on two findings--that rail rates have increased 
since 1980 and that the amount of traffic with high R/VC ratios has 
increased in some areas. Our recommendation is not based on these two 
findings, but on an analysis of multiple sources, such as data on the 
amount of tonnage originating in economic areas that have access to 
only one Class I railroad, data on the amount of tonnage traveling over 
300 percent R/VC, and the amount of tonnage that originates in areas 
with access to only one Class I railroad and travels at rates that 
exceed the statutory threshold for rate relief. This analysis provides 
an important first step in assessing competitive markets nationally; 
but it is imperfect, given the limitations of measures used to weigh 
captivity and limitations in the Carload Waybill Sample. The results of 
our analysis, when combined with comments from participants on our 
expert panel and interviews with shipper and railroad groups, suggest a 
reasonable possibility that shippers in selective markets may be paying 
excessive rates related to a lack of competition in these markets. It 
is precisely the inconclusiveness of the available data--and STB's 
authority and responsibility to monitor and ensure effective 
competition in the freight rail industry--that led us to recommend a 
rigorous analysis of competition by STB. Also, we examined rates since 
1985, not 1980. 

4. STB commented that an increase in rates does not suggest market 
abuses and that the rate changes in our report were not adjusted for 
inflation. We agree that a change in a rate does not necessarily 
suggest the exercise of market power. While our rates were not adjusted 
for inflation, we constructed rate indexes, which account for changes 
in traffic patterns over time that could affect revenue statistics. We 
also included the price index for the GDP to provide a measure for 
inflation. However, our recommendation is not based on recent rate 
increases. Our recommendation is based on our analyses of multiple 
sources, such as data on the amount of tonnage originating in economic 
areas that have access to only one Class I railroad, data on the amount 
of tonnage traveling over 300 percent R/VC, and the amount of tonnage 
that originates in areas with access to only one Class I railroad and 
travels at rates that exceed the statutory threshold for rate relief. 

5. STB commented that figure 19 shows an increase in grain traffic 
which traveled at rates above 300 percent R/VC and figure 9 shows that 
grain rates per ton-mile had fallen along that same route, so the 
change in R/VC must be due to a drop in costs per ton-mile. We disagree 
that the change in R/VC in figure 19 must be due to a drop in costs per 
ton-mile. Figure 19 shows only the amount of traffic on the route that 
traveled at rates above 300 percent R/VC, while figure 9 shows the 
cents per ton-mile for all traffic along that route (not just traffic 
that traveled at rates above 300 percent R/VC). Therefore, the decrease 
in cents per ton mile shown in figure 9 may reflect a decrease in rates 
for traffic along that route that traveled at rates below 300 percent 
R/VC. 

6. STB commented that the measures used in our analysis are not 
conclusive. The fact that our analysis is inherently limited by 
available data and proxy measures lends more weight to our 
recommendation. Specifically, our analysis provides an important first 
step in assessing competitive markets nationally, but it is imperfect 
given the limitations of measures used to weigh captivity and 
limitations in the Carload Waybill Sample. We do not conclusively state 
that there are shippers who are captive to one railroad and paying 
rates that reflect an abuse of market power. However, the results of 
our analysis, when combined with comments from participants on our 
expert panel and interviews with shipper and railroad groups, suggest a 
reasonable possibility that shippers in selective markets may be paying 
excessive rates related to a lack of competition in these markets. We 
believe that STB is the agency that has the authority and 
responsibility to conduct an inquiry into the potential abuse of market 
power and utilize its range of options to address competition issues. 

7. STB commented that R/VC levels do not provide a reliable measure of 
changes in captivity because they can increase when rates are falling. 
We agree that an analysis of R/VC levels is not a conclusive measure of 
the use of market power. However, the use of R/VC as an indicator of 
railroad pricing power is well-documented both by Congress in the 
Staggers Rail Act and by STB, which uses R/VC levels in its process for 
determining unreasonable rates. While we acknowledge the limitations of 
the ratio in our report, and even include an example like the one cited 
above, we believe that R/VC ratios can be used as one of several proxy 
measure to determine potential captivity. In fact, STB refers to 
traffic traveling at or above 180 percent R/VC as "potentially 
captive." 

8. STB commented that they have several important rule makings under 
way which bear directly on our concerns, including changes to the 
standard and simplified rate relief processes. While we commend STB for 
taking action to improve its rate relief processes, we note that these 
rule makings are designed to make changes to the standard and 
simplified rate relief processes and are not designed to analyze the 
state of competition or the possible abuse of market power. In 
contrast, we believe that an analysis of the state of competition or 
the possible abuse of market power, along with the range of options STB 
has to address competition issues, could more directly further 
legislatively defined goals to ensure effective competition among rail 
carriers as the preferred means to both promoting a sound rail 
transportation system and maintaining reasonable rates. 

9. STB commented that it is hesitant to divert resources away from its 
pending initiatives to respond to our recommendation. We have modified 
our draft to recommend that, if STB determined that it needs more 
resources to undertake a rigorous analysis of competitive markets to 
identify the state of competition nationwide, it should request 
additional resources from Congress. 

10. STB commented that, as a small agency, a more practical approach to 
addressing concerns about captive shippers would be for STB to continue 
reforming its rate complaint procedures, rather than conduct another 
analysis. While we commend STB for continuing its efforts to improve 
its standard and simplified rate relief processes, these rule makings 
will not address our concerns. Specifically, these rule makings are 
designed to improve processes available to shippers after they have 
been charged a rate they consider to be unreasonable; these rule 
makings are not designed to analyze the state of competition or the 
possible abuse of market power. In contrast, we believe that an 
analysis of the state of competition or the possible abuse of market 
power, along with the range of options STB has to address competition 
issues, could more directly further legislatively defined goals to 
ensure effective competition among rail carriers as the preferred means 
to both promoting a sound rail transportation system and maintaining 
reasonable rates. We believe that STB is the agency that is uniquely 
positioned to inquire into and report on railroad practices and could 
conduct an analysis of competition that would rely on more than sample 
data and could determine whether the inappropriate exercise of market 
power is occuring in specific markets. STB has the authority to 
subpoena witnesses and records. Following its inquiry, STB could also 
consider initiating a generally applicable rule making to address 
competition issues or prescribe specific remedies in response to a 
complaint. We recognize that STB has limited resources, and we have 
modified our draft to recommend that, if STB determines that it needs 
more resources to conduct an analysis of competition, it should request 
additional resources from Congress. 

[End of section] 

Appendix IV: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

JayEtta Z. Hecker, (202) 512-2834: 

Staff Acknowledgments: 

In addition to those named above, individuals making key contributions 
to this report include Ashley Alley, Steve Brown, Matthew T. Cail, 
Sheranda S. Campbell, Steve Cohen, Elizabeth Eisenstadt, Libby 
Halperin, Richard Jorgenson, Tom McCool, John Mingus, Josh Ormond, and 
John W. Shumann. 

[End of section] 

Related GAO Products: 

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. 

FOOTNOTES 

[1] See the list of related GAO products at the end of this report. 

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

[3] The Carload Waybill Sample is a sample of railroad waybills (in 
general, documents prepared from bills of lading that authorize 
railroads to move shipments and collect freight charges); the sample 
contains information on rail rates. 

[4] The intermodal market consists of containers and trailers that can 
be carried on ships, trucks, or rail. 

[5] While rate data are not available for 2005 and 2006, shippers, 
railroads, and financial analysts with whom we spoke told us that rates 
have generally increased during those years. 

[6] All of our rate changes--increases and decreases--are presented in 
nominal terms. 

[7] Return on investment measures the profit made on assets used to 
provide transportation services. Return on investment is based on STB's 
methodology for determining revenue adequacy. 

[8] Clifford Winston, Deregulation of Network Industries - What's Next? 
(Washington: AEI-Brookings Joint Center for Regulatory Studies: 2000), 
pp. 43-44. 

[9] Gallamore, pp. 511-515. 

[10] A ton-mile is a standard industry measure that represents 1 ton of 
freight transported 1 mile. 

[11] We constructed rate indexes to examine trends in rail rates over 
the 1985 to 2004 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 2004. 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 purposes, we also present the price index 
for gross domestic product over this period. 

[12] Our initial route universe consisted of 932 commodity routes, but 
we removed 328 routes that did not have large enough samples in some 
years to be valid, or they were not collected in the Carload Waybill 
Sample in either 2000 or 2004. 

[13] According to STB officials, the 2005 waybill data will become 
available in Fall 2006. 

[14] Fuel surcharges are charges associated with recouping the cost of 
fuel. How fuel surcharges are calculated varies among Class I railroads 
because some use a mileage-based system while others use a percentage 
of the base rate. 

[15] At railcar auctions, railroad companies auction to the highest 
bidder the guaranteed delivery of a set number of railcars at specified 
future delivery dates. If railroads fail to deliver the railcars at the 
specified time, the railroads may pay a penalty to the shippers; if 
shippers find they cannot use the railcars at the time delivered then 
the shipper may pay a penalty to the railroad. 

[16] Other reasons for the reduction in the number of Class I railroads 
include carrier bankruptcies and a series of changes in the threshold 
for qualifying as a Class I railroad (from $5 million in annual revenue 
in 1976 to $250 million in 1992). 

[17] One participant did not respond to this question. 

[18] A short-line railroad is an independent railroad company that 
operates over a short distance. 

[19] Winston, pp. 54-57. 

[20] A build-out is a shipper's option to build (or have some other 
party build) a track connection to a competing railroad. 

[21] We do not provide information identifying the location or the 
shipper involved because doing so could reveal proprietary information. 

[22] Jerry Ellig, "Railroad Deregulation and Consumer Welfare," Journal 
of Regulatory Economics (The Netherlands: Klower Academic Publishers: 
2002), p. 156. 

[23] Economic areas are those areas defined by BEA, which defines the 
relevant regional economic markets in the United States. 

[24] The number of carriers serving a given location is not indicated 
in the Carload Waybill Sample. We obtained this additional information 
from DOT. 

[25] For our analysis of access to one or more Class I railroads, we 
examined data for 1994 and 2004, the earliest and latest years for 
which such data were available. 

[26] STB classifies railroads according to operating revenues. Class II 
railroads had revenues of $20 million to $250 million, and class III 
railroads had revenues of less than $20 million in 1991 dollars. 

[27] By contrast, the long-distance grain route shown in figure 9 (from 
the Sioux Falls, South Dakota, economic area to the Portland, Oregon, 
economic area) had no traffic traveling at rates over 300 percent R/VC 
for 2004. 

[28] GAO, Railroad Regulation: Current Issues Associated with the Rate 
Relief Process, GAO/RCED-99-46 (Washington, D.C.: Feb. 26, 1999). 

[29] In December 1998 and July 1999, STB excluded product and 
geographic competition as factors to be considered in market dominance 
proceedings, finding that the applicable law did not require 
consideration of those factors; that consideration of those factors 
unduly burdened shippers attempting to bring rate cases; and that the 
exclusion of those factors would not have any substantial effect on the 
rates that the railroads could charge in the marketplace (See Surface 
Transportation Board "News" releases Nos. 99-32, issued on Jul. 2, 
1999, and 98-82, issued on Dec. 21, 1998). The railroad industry sought 
judicial review of the Board's decisions, and in Association of Am. 
Railroads v. STB, 237 F.3d 676 (D.C. Cir. 2001), the United States 
Court of Appeals for the District of Columbia Circuit (Court) remanded 
(returned) the matter for the Board's further consideration. On remand, 
STB provided additional analysis to support its earlier decision, and 
the court then affirmed (upheld) STB's action, in Association of Am. 
Railroads v. STB, 306 F.3d 1108 (D.C. Cir. 2002). 

[30] 2-to-1 points are where shippers currently have access to two 
carriers but could lose access to one of them through a merger or 
acquisition. 

[31] 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). 

[32] 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). 

[33] Studies by the AASHTO, DOT, and American Trucking Association made 
specific freight and freight rail forecasts. Studies by the 
Transportation Research Board (TRB), the National Cooperative Research 
Program (NCHRP 20-24(33)) administered by TRB, and a consortium of 
Midwestern states and universities (Upper Midwest Freight Corridor 
Study) also assessed future freight demand and capacity issues. 

[34] The 2002 FAF used proprietary models to describe domestic and 
international commodity flows for rail, water, air, and highways and 
forecasted freight flows for 2010 and 2020. A second generation DOT FAF 
(being published in 2006) does not use proprietary models and covers 
commodity flows for 2002 to 2035. 

[35] We were able to interview some of the consultants who authored 
these reports and other rail experts. We also independently 
corroborated information in these reports through our expert panel. 

[36] Congressional Budget Office, Freight Rail Transportation: Long 
Term Issues (Washington, D.C.: January 2006). 

[37] Transportation Research Board, Critical Issues in Transportation 
(Washington, D.C.: Jan. 2006). 

[38] American Society of Civil Engineering, 2005 Report Card for 
America's Infrastructure (Washington, D.C.: 2005). 

[39] Association of American Railroads (AAR), (Washington, D.C.: Mar. 
16, 2006). 

[40] GAO, Highway and Transit Investments: Options for Improving 
Information on Projects' Benefits and Costs and Increasing 
Accountability for Results, GAO-05-172 (Washington, D.C.: Jan. 24, 
2005). 

[41] Railroad flyover bridges separate one set of tracks from another-
-such as freight and passenger trains. 

[42] DMJM+Harris and HDR (the Consultant Team), Final Report Project 
No. C SWOO-242 Public Benefits & Costs Study of the Proposed BNSF/UP 
Front Range Railroad Infrastructure Rationalization Project (May 18, 
2005). 

[43] GAO, 21st Century Challenges, GAO-05-325SP (Washington, D.C.: Feb. 
1, 2005), GAO, Freight Transportation: Short Sea Shipping Option Shows 
Importance of Systematic Approach to Public Investment Decisions, GAO-
05-768 (Washington, D.C.: July 29, 2005), and GAO, Freight 
Transportation: Strategies Needed to Address Planning and Financing 
Limitations, GAO-04-165 (Washington, D.C.: Dec. 19, 2003). 

[44] GAO, Highway Finance: States' Expanding Use of Tolling Illustrates 
Diverse Challenges and Strategies, GAO-06-554 (Washington, D.C.: Jun. 
28, 2006). 

[45] GAO-05-325SP. 

[46] DOT, (Draft) A Framework for a National Freight Policy, 
(Washington, D.C.: Apr. 10, 2006). 

[47] Transportation Research Board/National Research Council, Paying 
Our Way: Estimating Marginal Social Costs of Freight Transportation, 
National Academy Press (Washington, D.C.: 1996). 

[48] GAO, Physical Infrastructure: Crosscutting Issues Planning 
Conference Report, GAO-02-139 (Washington, D.C.: Oct. 1, 2001). 

[49] GAO, Railroad Competitiveness: Federal Laws and Policies Affect 
Railroad Competitiveness, GAO/RCED-92-16 (Washington, D.C.: Nov. 5, 
1991). 

[50] DOT/Federal Highway Administration. Office of Transportation 
Policy Studies, Addendum to the 1997 Federal Highway Cost Allocation 
Study Final Report (Washington, D.C.: May 2000). 

[51] Combination unit trucks are trucks that weigh 50,000-100,000 
pounds. 

[52] CBO, Freight Rail Transportation: Long-Term Issues, p. 22. 

[53] This observation parallels the conclusion and recommendations by 
the Transportation Research Board (TRB), which called for the 
development of a national policy to promote better management and 
investment decisions to maintain and improve freight capacity. TRB 
described detailed principles to guide future decisions about using, 
enlarging, funding or regulating the freight transportation system. 
TRB, Freight Capacity for the 21st Century, (Washington, D.C.: 2003) 
pp. 5-13. 

[54] GAO, Highlights of an Expert Panel: The Benefits and Costs of 
Highway and Transit Investments, GAO-05-423SP (Washington, D.C.: May 6, 
2005). 

[55] GAO, Surface Transportation: Many Factors Affect Investment 
Decisions, GAO-04-744 (Washington, D.C.: Jun. 30, 2004). 

[56] U.S. Department of Transportation, Report to Congress on Public- 
Private Partnerships (Washington, D.C.: December 2004). 

[57] GAO, Government Performance and Accountability: Tax Expenditures 
Represent a Substantial Federal Commitment and Need to be Reexamined, 
GAO-05-690 (Washington, D.C.: Sept. 23, 2005). 

[58] Our analysis included 177 economic areas because we did not 
include the two economic areas in Alaska and Hawaii. 

[59] The Bureau of Economic Analysis updated definitions of each 
economic area in November 2004. 

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