This is the accessible text file for GAO report number GAO-07-207R entitled 'Freight Railroads: Highlights of GAO Report on Freight Rail Industry Performance, Competition, and Capacity' which was released on November 8, 2006. This text file was formatted by the U.S. Government Accountability Office (GAO) to be accessible to users with visual impairments, as part of a longer term project to improve GAO products' accessibility. Every attempt has been made to maintain the structural and data integrity of the original printed product. Accessibility features, such as text descriptions of tables, consecutively numbered footnotes placed at the end of the file, and the text of agency comment letters, are provided but may not exactly duplicate the presentation or format of the printed version. The portable document format (PDF) file is an exact electronic replica of the printed version. We welcome your feedback. Please E-mail your comments regarding the contents or accessibility features of this document to Webmaster@gao.gov. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. Because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately. 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. GAO's Mission: The Government Accountability Office, the investigative arm of Congress, exists to support Congress in meeting its constitutional responsibilities and to help improve the performance and accountability of the federal government for the American people. GAO examines the use of public funds; evaluates federal programs and policies; and provides analyses, recommendations, and other assistance to help Congress make informed oversight, policy, and funding decisions. GAO's commitment to good government is reflected in its core values of accountability, integrity, and reliability. 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