Transportation Research Board report calls for changes to freight railroad industry regulations

A report issued today by the National Research Council’s Transportation Research Board (TRB) takes the freight railroad sector to task, stating that current federal railroad regulations have not “kept pace with the industry’s transformation” and need to be replaced with a system that better matches what is needed today.

The report, entitled “Modernizing Freight Rail Regulation, stemmed from the 2005 federal surface transportation bill SAFETEA-LU, which called for the TRB to conduct a comprehensive study of the Nation’s railroad transportation system since the enactment of the Staggers Rail Act of 1980, which effectively deregulated the industry. Research for the study began in September 2013.

Focus areas of the study included: the performance of the railroads’ service levels, quality, and rates; the projected demand for freight transportation over the next two decades and the constraints limiting the railroads; ability to meet that demand; the effectiveness of public policy in balancing the need for railroads to earn adequate returns with those of shippers for reasonable rates and adequate service; and the future role of the Surface Transportation Board in regulating railroad rates, service levels, and railroads’ common carrier obligations as railroads may become revenue adequate.

The report is issued against the longstanding backdrop of efforts led by members of Congress and railroad shipper groups to “re-regulate” the freight railroad industry on the grounds that there are multiple barriers to competitive access for captive shippers such as improving the rate challenge process at the STB, getting relief from what shippers view as monopoly pricing power held by the railroad, among other things.

But from the railroads’ perspective, pricing power is a necessity, because in order to be able to make investments into their networks and infrastructure, railroads need to maintain their current pricing leverage, which has been firmly intact for the last 10 years. This is where things get prickly with rail shippers—many of whom maintain that they’re not getting what they pay for in terms of service and value as annual rates rise about 5 percent year over year. While there has been much made by shipper groups about re-regulating the industry, addressing the lack of railroad antitrust, fuel surcharges applied by the rails, and reciprocal switching (which is a major point of contention between the Association of American Railroads and the National Industrial Transportation League), these efforts have largely stalled out in Washington.

As expected, the topic of rate relief and service levels was front and center in the report. That was highlighted by the report’s thesis that “examinations of rate and service levels in the post-Staggers railroad industry since 2000 find that rates have been rising in real terms and that service disturbances have been episodic and occasionally widespread, particularly after abrupt increases in freight demand and bouts of severe weather,” adding that “rising rates have coincided with productivity gains-since many of the largest opportunities for improvements had been exploited-and by volatility in input prices, particularly for fuel.”

The report also pointed out that even though the Staggers Act gave way to modernizing freight railroads for the general benefit of shippers, questions remain about the continued applicability of some of its provisions to the financially strong freight railroad sector.  And while Staggers eased or ended various regulations giving railroads more pricing and operating freedom, some regulatory provisions were preserved and others were added for various reasons, including: enabling railroads to earn the revenues needed to pay for their capital intensive systems (the AAR said earlier this year that U.S. freight railroads are set to spend an estimated $29 billion on the country’s rail network, ahead of 2014’s $27 billion); protecting shippers dependent on rail transportation from the loss of vital service and from railroads’ taking advantage of less competition in certain markets to charge unreasonably high rates.

Even with this report taking the position that U.S. railroads are unfairly taking advantage of shippers through excessive rates, railroad stakeholders maintain that is not the case, explaining there is no more important issue for the railroad industry than preserving a balanced regulatory environment.

To that end, they maintain that “The existing regulatory railroad environment has produced—for North American railroad shippers—a freight railroad system that is the envy of the world,”

“It is not perfect,” a Class I executive said at a recent industry conference, “but to deprive the industry of our ability to earn our cost of capital could have a chilling effect on capital investments to support traffic growth and it could begin to reverse the great strides we have made after Staggers in the areas of rail safety and service reliability.”

In the report, TRB took a close look at five key railroad regulatory provisions that even 35 years removed from the Staggers Act remain highly scrutinized, due to changes in the railroad industry’s structure, as well as have shippers’ service expectations, while the industry has subsequently become modernized and financially stable.

The regulatory provisions include: maximum rate protections; common carrier obligation; annual determination of revenue adequacy of each major railroad; railroad merger and acquisition approvals; and the seldom-exercised authority to order a railroad to allow competitors to its sole-served traffic.

Among the key reccomendations TRB made to Congress in its findings was that the DOT develop, test, and refine a more reliable model to compare disputed rates to those charged in competitve rail markets for comparable shipments, noting that a repeal of the current formula needs Congressional approval.

For reciprocal switching, it said it recommended permitting parties in rate arbitrations to propose reciprocal switching, which allows shippers to transfer freight at the interchange of tracks owned by competing railroads, as a fix for unreasonable shipping rates.

Opinions on the TRB’s findings were mixed.

“The committee’s two main recommendations go hand-in-hand,” said committee chair Richard Schmalensee, Howard W. Johnson Professor of Management Emeritus and professor of economics emeritus at the Massachusetts Institute of Technology.  “Currently, burdensome STB rate hearings compensate for an unreliable initial process for identifying unusually high rates and in effect, they safeguard railroad revenues by making it too costly for most shippers to litigate a case.  So, a more credible method for identifying unusually high rates would permit the use of less burdensome arbitration procedures, while not risking the adequacy of railroad revenue.”

Not surprisingly, Ed Hamberger, AAR president and CEO, had a much different take on the findings.

“The TRB report is a solution in search of a problem,” said Hamberger. “The United States already enjoys the most efficient, safest freight rail network in the world.  In fact, freight rail customers today pay rates that are on average 43 percent less than they paid in 1980. The report is a theoretical exercise that would upend the real world concrete successes achieved since the Staggers Act passed in 1980.”