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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.

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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.

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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:

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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&amp;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.”<a title="" href="#_edn1" name="_ednref1">[1]</a> 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.”<a title="" href="#_edn2" name="_ednref2">[2]</a> 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.

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Karyn A. Booth 202.263.4108 <a href="mailto:Karyn.Booth@ThompsonHine.com">Karyn.Booth@ThompsonHine.com</a>

Sandra L. Brown 202.263.4101 <a href="mailto:Sandra.Brown@ThompsonHine.com">Sandra.Brown@ThompsonHine.com</a>

Jeff Moreno 202.263.4107 <a href="mailto:Jeff.Moreno@ThompsonHine.com">Jeff.Moreno@ThompsonHine.com</a>

David E. Benz 202.263.4116 <a href="mailto:David.Benz@ThompsonHine.com">David.Benz@ThompsonHine.com</a>

Jason D. Tutrone 202.263.4143 <a href="mailto:Jason.Tutrone@ThompsonHine.com">Jason.Tutrone@ThompsonHine.com</a>

This advisory bulletin may be reproduced, in whole or in part, with the prior permission of Thompson Hine LLP and acknowledgment of its source and copyright. This publication is intended to inform clients about legal matters of current interest. It is not intended as legal advice. Readers should not act upon the information contained in it without professional counsel.

This document may be considered attorney advertising in some jurisdictions.

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<a title="" href="#_ednref1" name="_edn1">[1]</a> Coal Rate Guidelines, Nationwide, 1 I.C.C. 2d 520, 535-36 (1985).

<a title="" name="_edn2" href="#_ednref2">[2]</a> Id. at 535. [emphasis added].

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Railroads Seek Changes in Revenue Adequacy Determinations

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