Railroads Seek Changes in Revenue Adequacy Determinations
Date: September 03, 2020
On September 1, three Class I railroads (Union Pacific, Norfolk Southern and Canadian National) filed a petition for rulemaking at the Surface Transportation Board (STB) in Docket No. EP 766, Joint Petition for Rulemaking to Modernize Railroad Revenue Adequacy Determinations. The petition proposes the most significant changes to how the STB determines revenue adequacy since Congress first required such determinations annually in the Staggers Rail Act of 1980. This issue has become increasingly important in recent years as several Class I railroads have achieved a sustained level of revenue adequacy over multiple years for the first time under the existing measure. This proposal would raise the bar for revenue adequacy to a degree that none of the seven Class I railroads would be deemed revenue adequate.
By statute, the STB is required to determine annually whether each Class I railroad is revenue adequate. The statutory objective is for railroads to earn revenues “that are adequate, under honest, economical, and efficient management, for the infrastructure and investment needed to meet the present and future demand for rail services and to cover total operating expenses, including depreciation and obsolescence, plus a reasonable and economic profit or return (or both) on capital employed in the business.” 49 USC §10704(a)(2). For the past 40 years, the STB has employed a book value accounting standard to measure revenue adequacy. In recent decades, as rail revenue has grown significantly, the industry has pressed for a replacement cost alternative, but the STB has rejected those efforts because replacement costs are too difficult and impractical to quantify.
In the current petition, several railroads present a new alternative that, although not a replacement cost measure of revenue adequacy, nevertheless has a similar effect of making revenue adequacy more difficult to attain. At a high level, the petition requests the following two actions:
- Measure revenue adequacy using a comparison approach to other companies in the S&P 500. This approach contrasts the STB’s annual revenue adequacy determinations (however calculated) against the performance of other companies in the S&P 500, using the same methodology for both. The proposal would define annual revenue adequacy to mean that a railroad’s return on investment (ROI) exceeded the rail industry cost of capital by more than the median S&P 500 firm’s ROI exceeded its cost of capital. Using data from 2006–2019, the petition claims that the railroad industry was outperformed by 87% of those unregulated firms with which they compete for capital in the S&P 500, where the median adjusted ROI over the cost of capital was 10%. Because no Class I railroad earned 10% above its cost of capital, none would be deemed revenue adequate under this approach.
- Modify the STB’s treatment of deferred taxes in annual revenue adequacy determinations by adopting a flow-through method. The STB has changed its treatment of deferred taxes several times over the decades. This proposal would revert to a flow-through method. Without this change, the petition asserts that the rail industry would be even further below revenue adequacy using the comparison approach described in the preceding bullet.
The rationale for these proposals is that revenue adequacy measures a railroad’s ability to compete in the marketplace against all other companies for capital. Therefore, when the median firm in the S&P 500 is earning an accounting return 10% over its cost of capital—and given the alleged measurement errors with the STB’s existing calculation and a congressional directive to help carriers earn “a reasonable and economic profit or return” — the petition concludes that it is indefensible for the STB to declare a railroad has achieved “revenue adequacy” after earning an accounting ROI equal to its cost of capital.
How the STB measures revenue adequacy has taken on greater importance in recent years, as several railroads have attained revenue adequacy under the existing measure, because the STB has long held that “[c]aptive shippers should not be required to continue to pay differentially higher rates than other shippers when some or all of that differential is no longer necessary to ensure a financially sound carrier capable of meeting its current and future service needs.” The STB thus has determined that revenue adequacy is a constraint upon captive rail rates because “[c]arriers do not need greater revenues than this standard permits, and we believe that, in a regulated setting, they are not entitled to any higher revenues.” Many shippers have begun to focus on this rate constraint in recent efforts to develop standards for rate reasonableness that are less complex, lengthy and expensive than existing standards, thereby making rate remedies more accessible to a greater number of captive shippers.
FOR MORE INFORMATION
For more information, please contact:
Karyn A. Booth
Sandra L. Brown
David E. Benz
Jason D. Tutrone
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