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Industry Performance, Competition, and Capacity' which was released on 
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United States Government Accountability Office: 
Washington, DC 20548: 

November 2, 2006: 

The Honorable Charles D. Nottingham: 
Chairman: 
Surface Transportation Board: 

Subject: Freight Railroads: Highlights of GAO Report on Freight Rail 
Industry Performance, Competition, and Capacity: 

Mr. Chairman and Members of the Surface Transportation Board: 

We appreciate the opportunity to testify on our recently issued report 
on the freight railroad industry. As you know, over 25 years ago, 
Congress transformed federal freight rail transportation policy. At 
that time, after almost 100 years of economic regulation, the railroad 
industry was in serious economic decline, 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. As you know, this process establishes a threshold for rate 
relief, allowing a rate to be challenged if it produces revenue equal 
to or greater than 180 percent of the variable cost of transporting a 
shipment. Since the passage of the Staggers Rail Act in 1980, we have 
issued several reports on the freight railroad industry. 

In October 2006, we issued our most recent report on the freight rail 
industry.[Footnote 1] The objectives of this report were to determine 
(1) 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; (2) 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 
(3) the projections for freight traffic demand over the next 15 to 25 
years, the freight railroad industry's ability to meet that demand, and 
potential federal policy responses. Among other things, this report 
describes the significant changes that have taken place in the railroad 
industry and reports that from 1985 through 2004, rates generally 
decreased, but nominal grain rates increased 9 percent. We also found 
that, on some routes, the amount of grain traveling at rates 
significantly above the threshold for rate relief had increased since 
1985. 

In light of these findings, you asked us to testify today on the 
results of our work. The findings and conclusions we reported are 
reflected in the attached slides. A copy of the report can be found at 
www.gao.gov. 

Mr. Chairman, this concludes my prepared statement. I would be happy to 
respond to any questions you or other Members of the Board may have at 
this time. 

Sincerely yours, 

Signed by: 

JayEtta Z. Hecker: 
Director, Physical Infrastructure Issues: 

[End of Section]

Enclosure I: Freight Railroads: Highlights of GAO Report on Freight 
Rail Industry Performance, Competition, and Capacity: 

Freight Railroads: 

Highlights of GAO Report on Freight Rail Industry Performance, 
Competition, and Capacity: 

Surface Transportation Board: 

November 2, 2006: 

Statement of JayEtta Z. Hecker: 
Director, Physical Infrastructure Issues: 

Objectives of GAO Review: 

1. Changes in the railroad industry since the Staggers Rail Act of 
1980, including changes in rates and competition; 

2. STB actions to address competition and captivity concerns and 
alternatives that could be considered; and: 

3. freight traffic demand and capacity projections and potential 
federal policy responses. 

Report issued October 6, 2006; GAO-07-94 is available at www.gao.gov: 

Scope and Methodology: 

Reviewed STB data, including the unmasked Carload Waybill 
Sample[Footnote 2], from 1985 through 2004: 

Interviewed railroad officials, shippers, and other parties: 

Reviewed and analyzed projections for freight rail demand and capacity: 

Convened an expert panel: 

Review conducted from June 2005 to August 2006 in accordance with 
generally accepted government auditing standards: 

Changes Since Staggers: Industry's Financial Health Has Improved 
Substantially: 

Railroads' Tax-adjusted Return on Investment: 

[See PDF for image] 

Source: STB. 

[End of figure] 

Changes Since Staggers: Industry Rail Rates Declined from 1985 through 
2000 and Rose Slightly from 2001 through 2004: 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

Changes Since Staggers: Some Revenues Have Increased, Some Costs Have 
Been Shifted to Shippers, and Some Charges Are Not Accurately Tracked: 

Some revenues reported as miscellaneous have increased (e.g. fuel 
surcharges): 

Some costs have been shifted to shippers (e.g. railcars): 

Some charges are not accurately tracked (e.g. "miscellaneous revenue") 
which limits completeness of Waybill data: 

Changes Since Staggers: Unlike Rates for Other Commodities, Nominal 
Grain Rates Have Increased: 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

Changes Since Staggers: Competition and Captivity Concerns Remain: 

Accountability * Integrity * Reliability: 

Industry Has Become More Concentrated: 

Market Share of Four Largest Class I Railroads: 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

Changes Since Staggers: Competition and Captivity Concerns Remain: 

Competition can lower some rates: 

Rate changes after shipper gained access to a second railroad at an 
origin point that had previously been served by one Class I railroad. 
We do not provide information on the location of the shipper involved 
because doing so could reveal proprietary information. 

Cents per ton mile-masked: 

[See PDF for Image] 

Source: GAO analysis of STB data. 

[End of Figure] 

Captive Shippers are difficult to identify because available proxy 
measures can overstate or understate captivity: 

* The Bureau of Economic Analysis' (BEA) economic areas can be quite 
large and our analysis does not include other transportation 
alternatives: 

* Revenue to variable cost (R/VC) ratios can increase when the rate 
decreases: 

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] 

GAO's analysis of limited available measures indicates that: 

* extent of captivity appears to be dropping: 

* the percentage of traffic traveling at rates substantially over the 
threshold for rate relief (over 300 percent R/VC) has increased: 

Less traffic is traveling at rates equal to or greater than 180 percent 
R/VC: 

Tonnage and revenue generated from traffic traveling at rates equal to 
or greater than 180 percent R/VC: 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

Tonnage with access to more than 1 Class I railroad appears to have 
increased: 

Change in Percentage of Tonnage with Access to One Class I Railroad, 
1994 through 2004: 

[See PDF for image] 

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

[End of figure] 

Amount of traffic traveling at rates over 300 percent R/VC has 
increased: 

Tonnage traveling at Rates Over 300 Percent R/VC: 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

Amount of traffic traveling at rates over 300 percent R/VC has 
increased: 

Percentage of Tonnage by RNC, 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: 

[See PDF for image] 

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

[End of figure] 

Changes Since Staggers: Grain Routes with High RNC Ratio: 

Some grain routes had significant increases in traffic traveling at 
rates over 300 percent R/VC: 

Percentage of tonnage traveling over 300 percent R/VC from Minot to 
Portland and Billings to Portland: 

[See PDF for image] 

Source: GAO analysis of STB data. 

[End of figure] 

Changes Since Staggers: Competition and Captivity Concerns Remain: 

Some areas with access to only one Class I railroad have a higher 
percentage of traffic traveling at rates over 180 percent R/VC: 

[See PDF for image] 

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

[End of figure] 

STB Actions and Alternative Approaches: 

STB has broad statutory authority to monitor the railroad industry, 
including the authority to inquire into and report on rail industry 
practices: 

STB has taken actions to protect captive shippers: 

* simplified guidelines: 

* reviewed rail access and competition: 

Efforts have led to little effective relief: 

Assessment of competitive markets could more clearly identify areas for 
targeting STB action: 

* The results of our analysis suggest a reasonable possibility that 
shippers in selected markets may b e paying excessive rates related to 
a lack o competition in these markets: 

A number of approaches could make the rate relief process more 
accessible but each has both advantages and drawbacks: 

* Increase the use of simplified guidelines: 

* Increase the use of arbitration: 

* Develop an alternative cost methodology: 

Any alternative approach requires careful balancing between the 
railroads' need for revenue and shippers' need for reasonable rates: 

Future Demand, Capacity, and Potential Federal Response: 

Forecasts of significant future freight rail traffic growth: 

* DOT projects domestic and international freight demand increases of 
more than 65 percent and 84 percent, respectively, from 2002 to 2020: 

Railroads' ability and willingness to invest in new capacity to meet 
demand reflects a number of key considerations, and capacity to meet 
potential demand is uncertain: 

Rail capacity investments can produce private and public sector 
benefits: 

* Reduces highway traffic congestion: 

* Improves air quality: 

* Enhances intermodal connections: 

Public sector investment in freight rail is growing: 

* Over 30 states have published freight rail plans: 

* Federal investment includes $100 million for Chicago's freight rail 
infrastructure: 

The Department of Transportation (DOT) is developing a national freight 
policy: 

The federal response to freight investments should be impartial toward 
all modes and produce maximum public benefits from public investments: 

A mode neutral approach: 

* Federal programs treat different freight modes differently: 

Maximizing public benefits: 

* Benefit-cost tools often not effectively used: 

* States have experience evaluating whether freight rail projects 
warrant investing public dollars: 

* Federal decision makers have no such criteria: 

Conclusions: 

The Staggers Rail Act achieved far-ranging benefits, most shippers are 
better off, and widespread changes to the relationship between 
railroads and their customers are not needed: 

Pockets of potential captivity and other factors raise the question of 
whether some rates reflect reasonable pricing practices or an abuse of 
market power: 

Although our analysis is constrained by the limitations in the Waybill 
and available proxy measures, it is an important first step: 

STB has broad statutory authority to inquire into and report on rail 
industry practices: 

Further actions require careful balancing between the railroads' need 
for revenue and shippers' need for reasonable rates: 

Federal policy responses on rail capacity should reflect a mode- 
neutral national policy that produces maximum public benefits: 

Recommendations (from October 6, 2006 report): 

STB should undertake a rigorous analysis of competitive markets, 
determine whether the inappropriate exercise of market power is 
occurring in specific markets, and, where appropriate, consider the 
range of access available to address problems associated with the 
potential abuse of market power. 

* If STB determines that it requires more resources to conduct this 
analysis, then STB should request additional resources from Congress: 

STB should review its method of data collection to ensure railroads are 
consistently and accurately reporting all revenues: 

As DOT continues to develop a national freight policy and a possible 
federal policy response, it should consider strategies to (1) create a 
level playing field for all freight modes and (2) develop mechanisms to 
assess and maximize public benefits from federal investments. 

Report available at GAO-07-94: 

[End of Section] 

(544133): 

FOOTNOTES 

[1] GAO, Freight Railroads: Industry Health Has Improved, but Concerns 
about Competition and Capacity Should Be Addressed, GAO-07-94 
(Washington, D.C.: Oct. 6, 2006). 

[2] The unmasked Waybill Sample does not disguise revenue data. 

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