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The Great Plains Robbery

Railway freight rates for captive shippers, those who have no access to rail competition, are on a runaway train. Will the Surface Transportation Board (STB) step in to save the day? Will Congress have to take the lead? In any case, rural America is looking for relief from the price gouging of monopoly railroads caused by their ability to price for service to captive shippers as they see fit.

Basin Electric Power Cooperative - June 24, 2005

Ron Harper, Basin Electric Power Cooperative CEO and general manager, explains that the Laramie River Station (LRS) is a “captive” customer at the power plant end of the track, which means the station has no competitive alternatives to the railroad serving its location.

Ron Harper

He says Western Fuels Association (Western Fuels) and Basin Electric, on behalf of all the participants of the Missouri Basin Power Project (of which LRS is a part), filed a complaint to the U.S. Surface Transportation Board (STB) on Oct. 19, 2004, against the Burlington Northern and Santa Fe Railway (BNSF) after they were notified their rates would double. “We want the STB to set aside rate increases the BNSF recently imposed on coal deliveries to the Laramie River Station, near Wheatland, Wyoming,” he says.

“We are facing initial 100 percent increases in shipping rates for the coal to LRS due to the lack of competition for rail service,” says Duane Richards, Western Fuels CEO. Western Fuels provides the coal to Basin Electric for LRS. Western Fuels is a not-for-profit fuel supply cooperative consisting of 19 consumer-owned utilities, including Basin Electric.

Basin Electric owns about 42 percent of the 1,650-megawatt station and is the operating agent for it for the group of five other cooperative, municipal and public power owners. BNSF currently transports more than 8 million tons of coal approximately 200 miles between Western Fuel’s Dry Fork Mine and other mines in Wyoming’s Powder River Basin and LRS. A 20-year contract for that service recently expired, and BNSF published new “common carrier” rates for the service after negotiations for a new contract failed. Basin Electric and Western Fuels’ STB complaint contends BNSF unlawfully exerts its monopoly power over LRS coal deliveries by imposing unreasonably high common carrier rates.

“BNSF’s imposed rate increases are without precedent in my working career,” Richards says. Prior to working for Western Fuels, Richards worked to procure fuel and transportation for Xcel Energy and its predecessor Northern States Power Company for nearly 20 years.

Duane Richards

“You can’t justify an increase of this magnitude based on any increase in BNSF’s costs,” Richards says. “I’m not aware of any BNSF costs of service that have doubled. You can’t come up with any legitimate rationale to justify this dramatic increase in their rates, except unfettered market-power desires. Also, BNSF knows about existing regulatory loopholes, and it has a fairly good idea from recent experience the information needed to predict what the outcome of the STB process will be, and it can work backwards from there to set your initial tariff rates.”

The Great Plains Robbery

“The BNSF gave us no choice but to file a complaint with the STB,” Harper says. “Our experts tell us that their rate actions are exploiting loopholes in the regulatory procedures that in effect allow BNSF to set its own rates as high as it wants. These procedures are supposed to protect captive shippers, but how they are being used is doing the opposite. What’s taking place is what I call, ‘The Great Plains Robbery.’”

Harper says the LRS rail movement provides a strong case to bring before the STB to shed some light on railroad rate gouging. “We plan to use whatever resources we have to bring this case and the need for real reform in the law to the attention of government officials, not only to protect our electric consumers from electric rate increases, but also to help small grain and other shippers – many of which are also our consumers. Those small captive shippers really don’t have an avenue through which to bring a rate case.”

A hidden tax on rural America

Claire Olson

Harper says the nation’s railroads are being financed on the backs of rural Americans by this hidden tax on rail transportation, and he thinks the BNSF is finally feeling some heat on the issue. “Just last week (April 15) BNSF temporarily lowered its shipping rates for wheat shipped to the West Coast from four states: Montana, North Dakota, South Dakota and Minnesota,” he says. “A bill in the Montana Legislature that would have increased the company’s property tax in accordance with the shipping cost discrepancy with other states undoubtedly played a role in that decision. The bill that passed the North Dakota Legislature appropriating more than $800,000 to help a grain shipper finance a rate case probably played a role as well.”

Western Fuels and Basin Electric submitted opening evidence to the STB on their complaint on April 19, 2005.

Claire Olson, Basin Electric general counsel, explains that the rate case involves a three-part process including submissions of opening evidence, reply testimony currently slated for mid-July and rebuttal scheduled for mid-September.

“Each side presents a multiple-witness written record about the size of 15 phone books,” Olson says. “All of the testimony is submitted in written form until the very end when oral arguments are usually made. When the record is closed, the STB has nine months to decide the case, which will bring us well into 2006.”

How a rate case works

Olson says the law requires that rates on rail traffic subject to the STB’s jurisdiction “must be reasonable.” The first step in a rate case is a two-part test to determine whether the railroad has monopoly power or “market dominance” over the transportation to which the rate applies. Only if the railroad is market dominant does the STB have jurisdiction to review the rate. The first part of the test determines if the freight rate charged produces revenue above 180 percent of the variable costs of providing the service. Therefore, this 180 percent revenue-to-variable cost (r/vc) percentage is the floor for regulatory scrutiny.

He says variable costs are those that vary in direct proportion to an increase or decrease in traffic levels. Olson explains that the STB has a formula it uses called URCS (Uniform Rail Costing System) to determine what the involved variable costs are – with adjustments – to reflect the actual movement-specific parameters, such as the type and number of locomotives and railcars, and the number of train-miles involved. These parameters are plugged into the cost formula to come up with a cost per car, and then the average tons per car are factored in to develop a cost per ton. Finally, per ton costs are multiplied by 1.8. “If the rate is higher than the 180 revenue-to-variable cost percentage, it is over the so-called quantitative part of the market dominance test,” Olson says. “Western Fuels and Basin Electric’s opening evidence shows that the challenged rates average 481 percent of variable costs – well above the 180 percent threshold standard.”

If the rate the railroad charges exceeds the 180 percent r/vc threshold, Olson says the second part of the market dominance test involves an assessment of whether there are any feasible competitive transportation alternatives that could be used for the involved service, or so-called qualitative market-dominance. The STB considers whether there is competition from other railroads (intramodal competition) or from other modes of transportation such as trucks, pipelines, or barges (intermodal competition) for transporting the same traffic moving between the same points. “If there are effective competitive alternatives for the transportation, then the STB does not have jurisdiction to regulate the rate, even if the rate charged yields an
r/vc ratio greater than 180 percent,” Olson says.

“Western Fuels and Basin Electric show in their opening evidence that BNSF has qualitative market dominance over the involved LRS traffic,” Olson says. “This is also reflected in the fact that BNSF has imposed massive rate increases on the LRS traffic, and Western Fuels and Basin Electric have not had any effective marketplace options to employ to counter these rate abuses. To date, BNSF has not contested the issue of qualitative market dominance in its evidence.”

Stand-alone cost analysis

Olson says if the shipper can show the railroad is market dominant, then the STB applies its stand-alone cost (SAC) analysis to assess whether the rates being charged a shipper are in fact unreasonable. SAC is one of four general “constraints” on rail pricing of market-dominant rail traffic as set forth in controlling STB decisions, and is the test regularly employed in coal rate cases. “Under SAC, a railroad may not charge a shipper more than what a hypothetical new, optimally efficient carrier, referred to as a ‘stand-alone railroad’ would need to charge the shipper if such a carrier were to design, build, and operate a new railroad,” Olson says.

SAC analysis is supposed to provide a framework for the STB to regulate rates while affording railroads the opportunity to cover their costs. Olson says it is premised on differential pricing, that is, pricing based on the demand for the service provided. However, a basic tenant of the SAC standard is that a captive shipper is not required to bear the costs of any facilities or services from which it derives no benefit. SAC is designed to ensure such cross-subsidization does not occur.

Olson says to determine stand-alone costs, the shipper must put together a proposed stand-alone rail system consisting of its traffic and any other traffic it wants to add to its system, and then calculate the per-ton cost of providing service to itself by its stand-alone railroad. This stand-alone rate then equals the STB prescribed maximum rate unless the rate is less than 180 percent of variable costs, in which case the maximum rate will equal 180 percent of variable costs.

Basically, Olson says the complainant determines what the traffic and expenses are going to be over a 20-year period based on various projections including some the BNSF has provided. “Then, the net present value is discounted, so if one has
$100 million of revenue in its first year from all the shippers on its stand-alone railroad and the total annual costs for that year, including both a return on invested capital (basically construction costs) and operating expenses, are $75 million. Then the revenue exceeds the expenses by 25 percent and under the way the STB now administers the process, the rate would be reduced by 25 percent.”

Olson says that there are various problems with the test recently applied by the STB. “An obvious problem is ‘gaming,’” he says. “Let’s say the challenged common carrier rate is $4 dollars a ton. If you reduce that rate by 25 percent, the rate becomes $3 per ton. However, let’s say the railroad starts at a rate of $8 a ton, and they have the freedom to do that the way the law works now. It’s not going to affect the total revenue very much, and the percentage reduction is still going to be the same, about 25 percent. So instead of getting a rate of $3 per ton, just because they started out at a higher level (of $8), the 25 percent reduction produces a rate of $6 a ton. Double!”

Olson explains one of the problems with the process as currently being administered is that the railroads control what rate a customer starts out with because the railroad is free under the law to start with whatever rate it wants. Only if a shipper files a complaint with the STB, and the STB holds that it is unreasonable and prescribes a lower rate, is that rate subject to being reduced. “So this percentage reduction method is a real problem,” Olson says. “The STB has recognized this and Western Fuels and Basin Electric are proposing fair and economically sound ways to address the problem.”

Western Fuels and Basin Electric's requested rate relief

The maximum reasonable rates being sought by Western Fuels and Basin Electric in their opening evidence average approximately 256 percent of BNSF’s variable costs of service – resulting in handsome profits to BNSF, according to Olson. “Western Fuels and Basin Electric are requesting the STB to establish reasonable rates at these levels, effective Oct. 1, 2004, when the challenged rates were imposed by BNSF, and order that BNSF not take any actions to increase the prescribed rates. Western Fuels and Basin Electric are also asking the STB to award them reparations, plus interest, for excessive payments that have been made since BNSF imposed its common carrier rates on the LRS traffic.”

Editor’s note:
On April 27, U.S. Sen. Conrad Burns (R-MT), along with Sens. Byron Dorgan (D-ND), Jay Rockefeller (D-WV), Larry Craig (R-ID), Mark Dayton (D-MN), David Vitter (R-LA), John Thune (R-SD), Norm Coleman (R-MN), Tim Johnson (D-SD) and Max Baucus (D-MT) introduced bipartisan legislation to combat monopolistic practices facing coal consumers, agriculture producers and others that ship their product by rail and are suffering from exorbitant rail rates.

The Railroad Competition Act of 2005 would help limit the impact of railroad monopolies on captive shippers – rail customers who don’t have access to rail competition. Since the railroad industry was partially deregulated in 1980, the industry has consolidated from more than 40 major railroads to seven, four of which handle 90 percent of the nation’s rail traffic.

Among other things, the bill would clarify existing laws and direct the STB to ensure effective competition among rail carriers; maintain reasonable rates in the absence of effective competition; and maintain consistent and efficient rail transportation service for rail shippers. It would reverse what many rail customers believe are one-sided decisions by the STB in favor of the railroads by denying the use of pro-competitive remedies as authorized under existing law. In addition, the legislation also increases tenfold the availability of funds for railroad infrastructure investment. A large coalition of coal, agriculture, chemical, and other bulk commodity railroad customers support this legislation.

On May 4, a companion bill was introduced in the U.S. House of Representatives by Rep. James L. Oberstar (D- MN). He mentioned the massive freight rate hikes to the Laramie River Station in his remarks.

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