The Board Opens a Rulemaking Proceeding to Consider a Petition by Three Class I Railroads to Modernize Annual Revenue Adequacy Determinations

On December 30, 2020, the Surface Transportation Board (the Board or STB) issued a decision initiating a rulemaking proceeding to consider a joint petition by several Class I railroads, Union Pacific Railroad Company (UP), Norfolk Southern Railway Company (NS), and the U.S. rail operating affiliates of Canadian National Railway Company (collectively, CN), to change the Board’s procedures for annually determining whether Class I rail carriers are revenue adequate under 49 U.S.C. § 10704(a)(3).  Joint Petition for Rulemaking—Annual Revenue Adequacy Determinations, Ex Parte 766 (STB served Dec. 30, 2020). 

Petitioners had filed a joint petition on September 1, 2020, urging the Board to initiate a rulemaking proceeding to adopt rules that would revise and modernize annual revenue adequacy determinations under 49 U.S.C. § 10704(a).  Joint Petition for Rulemaking to Modernize Annual Revenue Adequacy Determinations, Ex Parte 766 (filed Sept. 1, 2020).  

Petitioners stated that Congress charged the Board with annually measuring the financial health of the rail industry and assisting each railroad in achieving revenue adequacy, and the Board has committed itself to “evidence-based decision-making,” using tools that were designed three decades ago.  Id., slip op. at 1.  According to Petitioners, the Board currently relies on accounting measures of return on investment (ROI), rather than the current economic value of those investment assets, then removes billions of dollars of accumulated deferred taxes from that investment base, which adds yet another distortion, and analyzes these findings without considering evidence about typical rates of return for the companies with which railroads compete for capital.  Id., slip op. at 1-2.

The petition focuses on the following question: “are the Board’s annual revenue adequacy determinations designed so that the Board may fulfill its statutory duties in accurately measuring and properly promoting railroad revenue adequacy?”  Id., slip op. at 2.  Petitioners state that “[t]he answer is clearly no.”  Id.

On behalf of Petitioners, two University of Chicago professors, Kevin Murphy and Mark Zmijewski, analyzed data on the relative performance of every company in the S&P 500 from 2006 to 2019, and used the Board’s methodologies to derive a revenue adequacy calculation for nonrailroads in the S&P 500.  Id., slip op. at 4.  The results were “striking,” finding that “a substantial majority of major public companies in nearly every industry is ‘revenue adequate’ under the Board’s current definition—but by margins that dwarf those achieved by any railroad.”  Id., slip op. at 5.  The professors applied economic principles to develop a methodology to modernize how the STB monitors the financial health of the freight rail industry.

Petitioners set forth two proposals to address the “flaws” in the Board’s current approach, and “improve the evidence the Board considers to assist railroads in earning ‘a reasonable and economic profit or return (or both) on capital employed in the business.’”  Id., citing 49 U.S.C. § 10704(a)(2).  First, Petitioners proposed that “the Board should use a comparison approach that contrasts its annual revenue adequacy determinations (however calculated) against the performance of other companies in the S&P 500, using the same methodology for both” (the Comparison Proposal).  Id., slip op. at 3.  Under this proposal, “the Board should define annual revenue adequacy to mean that a railroad’s Adjusted STB ROI exceeded the industry cost of capital by more than the median S&P 500 firm’s ROI exceeded its cost of capital.”  Id., slip op. at 20-21.  The Comparison Proposal is the centerpiece of the petition. 

Second, Petitioners proposed that “the Board should modify its treatment of deferred taxes in annual revenue adequacy determinations in order to provide an accurate view of railroad returns” (the Flow-Through Proposal).  Id., slip op. at 3.  Petitioners stated that the Board should use the flow-through method for deferred taxes when calculating ROI.  Id., slip op. at 8.  This method was originally advocated by the U.S. Department of Transportation in the mid-1980’s.  Id., slip op. at 38.

According to Petitioners, the Comparison Proposal provides a “reasoned way to include a ‘reasonable and economic profit or return’ in the annual determination, as directed by Congress,” and provides a reasoned way to address the known measurement error in the current annual calculations.  See id., slip op. at 25-32.  Additionally, the Comparison Proposal would offer a richer dataset to measure the relative financial success of the rail industry, and it is easily implemented and verifiable.  See id., slip op. at 32-37.  Petitioners also argued that the flow-through approach avoids absurd results, unlike the current utility-based method; it is a better fit for the rail industry; and it has many benefits.  Id., slip op. at 40-46.

Petitioners stated that the modernization of annual revenue adequacy determinations would bring these determinations closer to Congress’s original purpose, and they urged the Board to initiate a rulemaking proceeding to solicit public comment on the proposals.  Id., slip op. at 2, 8.

            The Board received three replies to the petition on September 21, 2020: one from CSX Transportation, Inc. (CSXT); one from the Western Coal Traffic League (WCTL); and one from a group of shippers (collectively, the Joint Shippers).  Joint Petition for Rulemaking—Annual Revenue Adequacy Determinations, Ex Parte 766., slip op. at 2 (STB served Dec. 30, 2020).  CSXT urged the Board to grant the petition, while WCTL and the Joint Shippers opposed the petition.  Id.

On October 13, 2020, Petitioners submitted a motion for leave to respond to the reply comments, along with a response to address the arguments against the proposals by WCTL and the Joint Shippers.  Id., slip op. at 3.  The Board noted that a reply to a reply is not permitted under 49 C.F.R. § 1104.13(c).  However, “in the interest of a more complete record,” the Board granted the Petitioners’ motion and accepted their reply into the record.  Id., slip op. at 3 n.6. 

The Board thus opened a rulemaking proceeding to further consider the petition and the issues that it raises.  Id., slip op. at 3.  The Board invites general comments on the petition, as well as comments on several specific questions.  Id.  Comments are due on or before March 1, 2021.  Replies are due on or before March 31, 2021.

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