    Freight Railroads: Industry Health Has Improved, but Concerns
    about Competition and Capacity Should Be Addressed (06-OCT-06,
    GAO-07-94).

    The Staggers Rail Act deregulated the freight rail industry,
    relying on competition to set rates, and allowed for differential
    pricing (charging higher rates to those more dependent on rail).
    The act gave the Surface Transportation Board (STB) authority to
    develop remedies for shippers "captive" to one railroad and set a
    threshold for shippers to apply for rate relief. GAO was asked to
    review (1) changes in the railroad industry since the Staggers
    Rail Act, including rates and competition; (2) STB actions to
    address competition and captivity concerns and alternatives that
    could be considered; and (3) freight demand and capacity
    projections and potential federal policy responses. GAO examined
    STB data, conducted interviews, and held an expert panel.
    -------------------------Indexing Terms-------------------------
    REPORTNUM:   GAO-07-94
        ACCNO:   A61944
      TITLE:     Freight Railroads: Industry Health Has Improved, but
    Concerns about Competition and Capacity Should Be Addressed
         DATE:   10/06/2006
      SUBJECT:   Competition
    	     Cost analysis
    	     Economic analysis
    	     Financial analysis
    	     Freight transportation
    	     Freight transportation rates
    	     Prices and pricing
    	     Railroad industry
    	     Railroad regulation
    	     Shipping industry
    	     Strategic planning
    	     Transportation rates

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    GAO-07-94

         * Industry Health Has Improved, but Concerns about Competition
         * GAO-07-94
              * Contents
                   * Results in Brief
                   * Background
                   * Railroad Industry Increasingly Healthy and Rates Generally D
                        * Railroad Industry's Financial Health Has Improved
                          Substantia
                        * Industrywide Rates Declined from 1985 through 2000 and
                          Rose
                        * For Many Commodities and Particular Routes, Rates Have
                          Also
                        * Many Factors May Have Contributed to Recent Rate
                          Increases
                        * Other Costs Have Shifted to Shippers, and Some Charges
                          Are N
                        * Competition and Captivity Concerns Remain
                             * The Freight Railroad Industry Has Become More
                               Concentrated
                        * Captive Shippers Are Difficult to Identify, but
                          Available Me
                        * Amount of Potentially Captive Traffic Traveling at
                          Rates at
                        * Some Areas with Access to One Railroad Have Higher
                          Percentag
                   * Despite STB's Actions, Analysis of Competitive Markets Is Ne
                        * STB Has Broad Authority to Monitor the Railroad
                          Industry
                        * STB Has Taken Actions to Protect Captive Shippers
                        * Efforts Have Led to Little Effective Relief
                        * STB Continues to Refine the Process
                        * Assessment of Competitive Markets and Changes to Rate
                          Relief
                   * Uncertainty about Future Freight Rail Demand and Capacity Po
                        * Forecasts of Significant Freight Rail Traffic Growth
                          Provide
                        * Railroads' Investments in Capacity to Meet Potential
                          Demand
                        * Rail Capacity Investments Can Produce Private and
                          Public Sec
                        * Public Sector's Growing Freight Rail Investments Focus
                          on Se
                        * Federal Response to Freight Investments Should Reflect
                          a Nat
                             * Adopting a Mode-Neutral Approach
                        * Maximizing Public Benefits from Public Transportation
                          Invest
                   * Conclusions
                   * Recommendations for Executive Action
                   * Agency Comments and Our Evaluation
              * Appendix I: Participants in GAO's Expert Panel
              * Appendix II: Objectives, Scope, and Methodology
              * Appendix III: Comments from the Surface Transportation Board
                   * GAO Comments
              * Appendix IV: GAO Contact and Staff Acknowledgments
                   * GAO Contact
                   * Staff Acknowledgments
              * Related GAO Products
                   * Order by Mail or Phone

    Report to Congressional Requesters

    United States Government Accountability Office

    GAO

    October 2006

    FREIGHT RAILROADS

    Industry Health Has Improved, but Concerns about Competition and Capacity
    Should Be Addressed

    GAO-07-94

    Contents

    Letter 1

    Results in Brief 3
    Background 6
    Railroad Industry Increasingly Healthy and Rates Generally Down Since
    Enactment of the Staggers Rail Act, but Concerns about Competition and
    Captivity Remain 9
    Despite STB's Actions, Analysis of Competitive Markets Is Needed to
    Address Lack of Effective Relief for Captive Shippers 38
    Uncertainty about Future Freight Rail Demand and Capacity Points to
    Opportunities for a More Strategic Federal Approach to Rail Infrastructure
    53
    Conclusions 64
    Recommendations for Executive Action 66
    Agency Comments and Our Evaluation 67
    Appendix I Participants in GAO's Expert Panel 72
    Appendix II Objectives, Scope, and Methodology 74
    Appendix III Comments from the Surface Transportation Board 77
    GAO Comments 83
    Appendix IV GAO Contact and Staff Acknowledgments 87
    Related GAO Products 88

    Tables

    Table 1: Changes in Percentage of Industry Revenue and Tonnage on Origin
    and Destination Routes with Access to One Class I Railroad 28
    Table 2: Possible Changes in R/VC Ratios 30
    Table 3: Potential Public Benefits of Rail Transportation Investments 58

    Figures

    Figure 1: Railroads' Tax-Adjusted Return on Investment, 1980-2004 10
    Figure 2: Trends in Industry Rail Rates, 1985-2004 12
    Figure 3: Commodity Rate Changes, 1985-1989, 1990-1999, and 2000-2004 13
    Figure 4: Rate Changes for Coal, Grain, Miscellaneous Mixed Shipments, and
    Motor Vehicles, 1985-2004 14
    Figure 5: Rail Rate Increases and Decreases across 604 Routes, and for
    Long-, Medium-, and Short-distance Routes, 2000 through 2004 15
    Figure 6: Tonnage Carried by Railcar Ownership, 1987-2004 17
    Figure 7: Miscellaneous Revenue Tracked in Carload Waybill Sample,
    2000-2004 18
    Figure 8: Percentage of Railroad Market Represented by Four Largest Class
    I Railroads, 1985-2004 20
    Figure 9: Comparison of Rates Charged on Long-distance Grain Routes,
    1997-2004 22
    Figure 10: Rate Changes after the Introduction of a Second Carrier 23
    Figure 11: Comparison of Rate Changes from Champaign, Illinois, Economic
    Area to New Orleans, Louisiana, Economic Area and Champaign, Illinois,
    Economic Area to Atlanta, Georgia, Economic Area, 1990-2004 24
    Figure 12: Number of Class I Railroads Serving Economic Areas, 2004 26
    Figure 13: Percentage of All Industry Tonnage Originating in Economic with
    Access to One Class I Railroad, 2004 27
    Figure 14: Changes in Percentage of All Industry Traffic Tonnage with
    Access to One Class I Railroad Originating in Economic Areas, 1994 through
    2004 29
    Figure 15: Percentage of Industry Tonnage and Revenue Generated from
    Traffic Traveling at Rates Equal to or Greater Than 180 Percent R/VC,
    1985-2004 31
    Figure 16: Tonnage Traveling at Rates over 300 Percent R/VC, 1985-2004 32
    Figure 17: Percentage of Tonnage by R/VC, 1985 and 2004 33
    Figure 18: Changes in Percentage of Tonnage Traveling at Rates over 300
    Percent R/VC, by Originating Economic Area, 1985 through 2004 34
    Figure 19: Long-distance Grain Route Changes in Percentage of Tonnage
    Traveling at Rates over 300 Percent R/VC, 1985-2004 35
    Figure 20: Overlap between Percentage of Tonnage over Threshold for Rate
    Relief and Access to Only One Class I Railroad 37
    Figure 21: Reciprocal Switching 45
    Figure 22: Terminal Agreements 47
    Figure 23: Trackage Rights 48
    Figure 24: Bottleneck Rates 50
    Figure 25: Paper Barriers 51

    Abbreviations

    AASHTO American Association of State Highway and Transportation Officials
    ATA American Trucking Association BEA Bureau of Economic Analysis CBO
    Congressional Budget Office CDOT Colorado Department of Transportation
    CREATE Chicago Region Environmental and Transportation Efficiency program
    DOT Department of Transportation FAF Freight Analysis Framework FHWA
    Federal Highway Administration FOA Final Offer Arbitration GDP gross
    domestic product ICC Interstate Commerce Commission RRIF Railroad
    Rehabilitation and Improvement Financing R/VC revenue to variable cost
    RRIF Railroad Rehabilitation and Improvement Financing program SAFETEA-LU
    Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy
    for Users STB Surface Transportation Board

    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. However, 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

    October 6, 2006

    Congressional Requesters:

    Over 25 years ago, Congress transformed federal regulation of the railroad
    industry. After almost 100 years of economic regulation, the railroad
    industry was in serious economic trouble in the 1970s, 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. However, only a rate that
    produces revenue equal to at least 180 percent of the variable cost of
    transporting the shipment can be challenged. Since the passage of the
    Staggers Rail Act in 1980, we have issued several reports on the freight
    railroad industry.1 These reports described the significant changes that
    have taken place in the railroad industry and reported that rates have
    generally decreased, but shippers and others have found the rate relief
    process long, complex, and expensive.

    Policymakers continue to believe that the federal government should
    provide a viable process to protect shippers against unreasonably high
    rates, as well as address competition issues, while still balancing the
    interests of both railroads and shippers. Over the past 10 years,
    significant consolidation has taken place in the freight railroad
    industry, while railroads-particularly Class I railroads2- have seen their
    productivity and financial health improve. Railroad officials worry that
    any attempt to increase economic regulation will reduce carriers' ability
    to earn sufficient revenues and limit future infrastructure investment. At
    the same time, a number of academic and government studies are predicting
    a significant increase in the demand for freight rail over the next 10 to
    15 years. In light of these concerns, we reviewed

    1See the list of related GAO products at the end of this report.

    2As of 2004, a Class I railroad is any railroad with operating revenue
    above $277.7 million.

               o  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;
               o  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
               o  the projections for freight traffic demand over the next 15 to
               25 years, the freight railroad industry's projected ability to
               meet that demand, and potential federal policy responses.

               To fulfill our objectives, we examined STB's Carload Waybill
               Sample from 1985 through 2004 (the latest data available at the
               time of our review).3 This database includes information on rail
               rates, tonnage, federal regulation, and other statistics but
               disguises some revenues to avoid disclosing confidential business
               information to the public. We obtained a version of the Carload
               Waybill Sample that did not disguise revenues. We held an expert
               panel consisting of 11 individuals with expertise in the freight
               railroad industry and the economics of transportation
               deregulation. Those individuals are listed in appendix I. We also
               interviewed, and reviewed information from, representatives of
               each Class I railroad in North America, shipper groups,
               economists, and experts in the rail industry. In addition, we
               reviewed pending legislation, transportation planning literature,
               and forecasts of future freight rail demand and capacity,
               including syntheses of such forecasts; and interviewed federal and
               state transportation officials, financial market analysts,
               national association representatives, and transportation experts.
               We determined that the data used in this report were sufficiently
               reliable for the purpose of our review. We conducted our review
               from June 2005 to August 2006 in accordance with generally
               accepted government auditing standards. Details of our objectives,
               scope, and methodology appear in appendix II.

               Results in Brief

    			  The changes that have occurred in the railroad industry since the
               enactment of the Staggers Rail Act are widely viewed as positive,
               since the financial health of the industry has improved and most
               rates have declined since 1985. However, concerns about
               competition and captivity in the industry remain. The freight
               railroad industry's financial health improved substantially as
               railroads cut costs through productivity improvements; streamlined
               and right-sized their rail networks; implemented new technologies;
               and expanded business into new markets, such as the intermodal
               market.4 Between 1985 and 2000, rail rates generally declined, but
               then increased slightly from 2001 through 2004.5 Although rates
               have declined since 1985, they have not done so uniformly, and
               rates for some commodities are significantly higher than rates for
               others. Several factors could have contributed to recent rate
               increases, including broad changes in the domestic and world
               economy, the emergence of a capacity-constrained environment in
               which demand exceeds supply, and consolidation in the 1990s in the
               industry leading to changes in competition. Other costs, such as
               fuel surcharges, have also shifted to shippers, and STB has not
               clearly tracked the revenues the railroads have raised from some
               of these charges. Some concerns about competition and captivity in
               the industry remain because traffic is concentrated in fewer
               railroads. It is difficult to determine precisely how many
               shippers are captive because available proxy measures can
               overstate or understate captivity. In addition, STB does not
               accurately collect railroad revenue data. Nevertheless, our
               analysis of available measures indicates that the extent of
               captivity appears to be dropping, but the percentage of industry
               traffic traveling at rates substantially over the statutory
               threshold for rate relief has increased. For example, the amount
               of traffic traveling at rates over 300 percent of the railroad's
               variable cost increased from 4 percent in 1985 to 6 percent in
               2004. Furthermore, some areas with access to one Class I railroad
               have higher percentages of traffic traveling at rates that exceed
               the statutory threshold for rate relief. These findings may
               reflect reasonable economic practices by the railroads in an
               environment of excess demand, or they may indicate a possible
               abuse of market power. We are recommending that STB conduct a
               rigorous analysis of the state of competition nationwide and,
               where appropriate, consider the range of actions available to
               address problems associated with the potential abuse of market
               power. In addition, we are recommending that STB review its method
               of data collection to ensure consistent and accurate reporting of
               railroad revenues, including fuel surcharges.

               STB has taken a number of actions to improve the rate relief
               process and assess competition, but further actions could help
               address remaining competition and captivity concerns. The Staggers
               Rail Act and the ICC Termination Act encouraged competition as the
               preferred method to protect shippers from unreasonable rates and
               granted STB broad legislative authority to monitor the performance
               of the railroad industry. Under this authority, STB established
               both a standard and a simplified rate relief process so that
               captive shippers could obtain relief from unreasonable rates.
               However, these processes have proven to be largely inaccessible
               because the standard process is expensive, time consuming, and
               complex, and the simplified process has not been used. During our
               review, STB took steps to refine its processes, including issuing
               a proposed rule making to clarify eligibility for the simplified
               process. Ultimately, our analysis suggests a reasonable
               possibility that shippers in selected markets may be paying
               excessive rates, and an assessment of competition would determine
               if this situation reflects reasonable economic practices by the
               railroads in an environment of excess demand or an abuse of market
               power. This assessment could also provide further information
               about the extent of captivity and the merits of proposed
               approaches to enhance the competitive options available to
               shippers. These approaches-such as providing trackage rights to
               allow a railroad to run on another railroad's track for a fee-
               have been suggested by shipper groups, economists, and others.
               Each of these approaches has costs and benefits and should be
               carefully considered to ensure that the approach is designed to
               achieve the balance set out in the Staggers Rail Act, including
               consideration of the revenue adequacy of the railroads. However,
               not all markets may have the demand needed to support competition
               among railroads, and so some areas where shippers are captive are
               likely to persist. In this regard, there are also a number of
               proposals to make the rate relief process more accessible, such as
               the increased use of arbitration to settle disputes, and each of
               these proposals has advantages and drawbacks.

               Significant increases in freight traffic over the next 10 to 15
               years are forecasted, and the railroad industry's ability to meet
               future demand is largely uncertain. Investments in rail projects
               can produce benefits for the public-for example, shifting truck
               freight traffic to railroads can reduce highway congestion. To
               obtain such benefits, governments have increasingly been
               participating in freight rail improvement projects. For example,
               Missouri state and local governments supported two major
               rail-bridge projects to reduce delays in Kansas City. At the
               federal level, Congress, in 2005, provided $100 million for rail
               infrastructure improvements in the Chicago area. In the years
               ahead, Congress is likely to receive further requests for funding
               and face additional decisions about potential federal policy
               responses and the federal role in the nation's freight railroad
               infrastructure. Such policy responses need to recognize that the
               freight transportation system encompasses many modes that are
               treated differently by the federal government and are on systems
               owned, funded, and operated by both the public and private
               sectors. Furthermore, the freight transportation system functions
               in a competitive marketplace, and the federal fiscal funding
               environment is highly constrained. As a result, policy and
               decision makers are challenged to ensure that federal involvement
               is consistent with competition in the freight marketplace and that
               federal funding decisions reflect widespread public priorities. In
               developing a draft National Freight Policy, the Department of
               Transportation (DOT) has made a good start by providing a context
               for decisions about how to apply a more strategic, systemwide
               approach, in general, and how to craft a federal policy response
               to freight rail investment needs in particular. We are
               recommending that DOT, as it continues to draft a National Freight
               Policy, consider strategies to sustain the role of competitive
               market forces by creating a level playing field for all freight
               modes and recognize the highly constrained federal fiscal
               environment by developing mechanisms to assess and maximize public
               benefits from federally financed freight transportation
               investments.

               We provided a draft of this report to DOT and STB. In oral
               comments, DOT took no position on our recommendation related to
               the National Freight Policy. In written comments, STB stated that
               it has already responded to our recommendation on its method of
               data collection through a proposed rule making on collecting fuel
               surcharge data. While we commend STB for its proposed rule making,
               STB has not yet implemented this change, and other revenues may
               still not be accurately tracked. STB also disagreed with our
               recommendation to conduct a rigorous analysis of competitive
               markets to identify the state of competition nationwide, inquire
               into pricing practices in specific markets, and consider
               appropriate actions available to address problems associated with
               the potential abuse of market power. STB commented that this
               recommendation was based on inconclusive findings and would divert
               resources away from current initiatives. We disagree that our
               recommendation was based on inconclusive findings. Our analysis of
               multiple sources suggests a reasonable possibility that shippers
               in some markets may be paying excessive rates. We believe that
               such a possibility merits further inquiry and analysis. We
               recognize that STB has limited resources and modified our draft to
               recommend that STB request additional resources from Congress if
               it determines that it needs more resources to conduct an analysis
               of competition. STB also stated that it has several rule makings
               under way that are designed to improve the rate relief process and
               would address many of our concerns. STB stated that it would be
               far more practical for STB to finish these reforms to ensure that
               captive shippers have an effective forum to seek rate relief.
               While we commend STB for recognizing and taking action to address
               problems with the rate relief process, we believe action beyond
               improvements to the rate relief process is needed. In particular,
               these STB rule makings are designed to improve processes available
               to shippers after they have been charged a rate they consider to
               be unreasonable. In contrast, we believe that an analysis of the
               state of competition and the possible abuse of market power, along
               with the range of options STB has to address competition issues,
               could more directly further the legislatively defined goal of
               ensuring effective competition among rail carriers. STB's comments
               are in appendix III.

               Background

    			  In the past, the ICC regulated almost all of the rates that
               railroads charged shippers. The Railroad Revitalization and
               Regulatory Reform Act of 1976 and the Staggers Rail Act of 1980
               greatly increased reliance on competition to set rates in the
               railroad industry. Specifically, these acts allowed railroads and
               shippers to enter into confidential contracts that set rates and
               prohibited ICC from regulating rates where railroads had either
               effective competition or rates negotiated between the railroad and
               the shipper. Furthermore, the ICC Termination Act of 1995
               abolished ICC and transferred its regulatory functions to STB.
               Taken together, these acts anchor the federal government's role in
               the freight rail industry by establishing numerous goals for
               regulating the industry, including to

               o  allow, to the maximum extent possible, competition and demand
               for services to establish reasonable rates for transportation by
               rail;
               o  minimize the need for federal regulatory control over the rail
               transportation system and require fair and expeditious regulatory
               decisions when regulation is required;
               o  promote a safe and efficient rail transportation system by
               allowing rail carriers to earn adequate revenues, as determined by
               STB;
               o  ensure the development and continuation of a sound rail
               transportation system with effective competition among rail
               carriers and with other modes to meet the needs of the public and
               the national defense;
               o  foster sound economic conditions in transportation and ensure
               effective competition and coordination between rail carriers and
               other modes:
               o  maintain reasonable rates where there is an absence of
               effective competition and where rail rates provide revenues that
               exceed the amount necessary to maintain the rail system and
               attract capital;
               o  prohibit predatory pricing and practices to avoid undue
               concentrations of market power; and
               o  provide for the expeditious handling and resolution of all
               proceedings.

               While the Staggers Rail and ICC Termination Acts reduced
               regulation in the railroad industry, they maintained STB's role as
               the economic regulator of the industry. The federal courts have
               upheld STB's general powers to monitor the rail industry,
               including its ability to subpoena witnesses and records and to
               depose witnesses. In addition, STB can revisit its past decisions
               if it discovers a material error, or new evidence, or if
               circumstances have substantially changed.

               Two important components of the current regulatory structure for
               the railroad industry are the concepts of revenue adequacy and
               demand-based differential pricing. Congress established the
               concept of revenue adequacy as an indicator of the financial
               health of the industry. STB determines the revenue adequacy of a
               railroad by comparing the railroad's return on investment with the
               industrywide cost of capital. For instance, if a railroad's return
               on investment is greater than the industrywide cost of capital,
               STB determines that railroad to be revenue adequate. Historically,
               ICC and STB have rarely found railroads to be revenue adequate-a
               result that many observers relate to characteristics of the
               industry's cost structure. Railroads incur large fixed costs to
               build and operate networks that jointly serve many different
               shippers. Some fixed costs can be attributed to serving particular
               shippers, and some costs vary with particular movements, but other
               costs are not attributable to particular shippers or movements.
               Nonetheless, a railroad must recover these costs if the railroad
               is to continue to provide service over the long run. To the extent
               that railroads have not been revenue adequate, they may not have
               been fully recovering these costs.

               The Staggers Rail Act recognized the need for railroads to use
               demand-based differential pricing to promote a healthy rail
               industry and enable it to raise sufficient revenues to operate,
               maintain and, if necessary, expand the system in a deregulated
               environment. Demand-based differential pricing, in theory, permits
               a railroad to recover its joint and common costs-those costs that
               exist no matter how many shipments are transported, such as the
               cost of maintaining track- across its entire traffic base by
               setting higher rates for traffic with fewer transportation
               alternatives than for traffic with more alternatives. Differential
               pricing recognizes that some customers may use rail if rates are
               low-and have other options if rail rates are too high or service
               is poor. Therefore, rail rates on these shipments generally cover
               the directly attributable (variable) costs, plus a relatively low
               contribution to fixed costs. In contrast, customers with little or
               no practical alternative to rail-"captive" shippers-generally pay
               a much larger portion of fixed costs. Moreover, even though a
               railroad might incur similar incremental costs while providing
               service to two different shippers that move similar volumes in
               similar car types traveling over similar distances, the railroad
               might charge the shippers different rates. Furthermore, if the
               railroad is able to offer lower rates to the shipper with more
               transportation alternatives, that shipper still pays some of the
               joint and common costs. By paying even a small part of total fixed
               cost, competitive traffic reduces the share of those costs that
               captive shippers would have to pay if the competitive traffic
               switched to truck or some other alternative. Consequently, while
               the shipper with fewer alternatives makes a greater contribution
               toward the railroad's joint and common costs, the contribution is
               less than if the shipper with more alternatives did not ship via
               rail.

               The Staggers Rail Act further requires that the railroads' need to
               obtain adequate revenues to be balanced with the rights of
               shippers to be free from, and to seek redress from, unreasonable
               rates. Railroads incur variable costs-that is, the costs of moving
               particular shipments-in providing service. The Staggers Rail Act
               stated that any rate that was found to be below 180 percent of a
               railroad's variable cost for a particular shipment could not be
               challenged as unreasonable and authorized ICC, and later STB, to
               establish a rate relief process for shippers to challenge the
               reasonableness of a rate. STB may consider the reasonableness of a
               rate only if it finds that the carrier has market dominance over
               the traffic at issue-that is, if (1) the railroad's revenue is
               equal to or above 180 percent of the railroad's variable cost
               (R/VC) and (2) the railroad does not face effective competition
               from other rail carriers or other modes of transportation.

               Railroad Industry Increasingly Healthy and Rates Generally
    			  Down Since Enactment of the Staggers Rail Act, but Concerns about
    			  Competition and Captivity Remain

               The changes that have occurred in the railroad industry since the
               enactment of the Staggers Rail Act are widely viewed as positive.
               The railroad industry's financial health improved substantially as
               it cut costs, boosted productivity, and right-sized its networks.
               Rail rates generally declined between 1985 and 2000 but increased
               slightly from 2001 through 2004. Likewise, rail rates have
               declined since 1985 for certain commodity groups and routes
               despite some increases since 2001, but rates have not declined
               uniformly, and some commodities are paying significantly higher
               rates than others. For example, from 1985 through 2004, coal rates
               declined 35 percent while grain rates increased 9 percent.6
               Concerns about competition and captivity in the industry remain
               because traffic is concentrated in fewer railroads. It is
               difficult to determine precisely how many shippers are captive to
               one railroad. Nevertheless, our analysis indicates that the extent
               of potential captivity appears to be dropping, but that the
               percentage of all industry traffic running at rates substantially
               over the statutory threshold for rate relief-traffic traveling at
               rates over 180 percent R/VC-has increased. Furthermore, some areas
               with access to only one Class I railroad have higher percentages
               of traffic traveling at rates that exceed the statutory threshold
               for rate relief. This situation may reflect reasonable economic
               practices by the railroads in an environment of excess demand, or
               it may represent an abuse of market power.

               There is widespread consensus that the freight rail industry has
               benefited from the Staggers Rail Act. Ten of the 11 members of our
               expert panel believed that the Staggers Rail Act has had a
               strongly positive overall effect on freight railroad companies,
               while 8 believed the Staggers Rail Act had a strongly positive
               effect on shipping companies. In addition, various measures
               indicate an increasingly strong freight railroad industry. Freight
               railroads' improved financial health is illustrated by a general
               increase in return on investment since 1980, as shown in figure
               1.7 Freight railroads have also cut costs by streamlining their
               workforces; right-sizing their rail networks; and reducing track
               miles, equipment, and facilities to more closely match demand.8

    3The Carload Waybill Sample is a sample of railroad waybills (in general,
    documents prepared from bills of lading that authorize railroads to move
    shipments and collect freight charges); the sample contains information on
    rail rates.

    4The intermodal market consists of containers and trailers that can be
    carried on ships, trucks, or rail.

    5While rate data are not available for 2005 and 2006, shippers, railroads,
    and financial analysts with whom we spoke told us that rates have
    generally increased during those years.

    6All of our rate changes-increases and decreases-are presented in nominal
    terms.

    7Return on investment measures the profit made on assets used to provide
    transportation services. Return on investment is based on STB's
    methodology for determining revenue adequacy.

    Figure 1: Railroads' Tax-Adjusted Return on Investment, 1980-2004

    Freight railroads have also expanded their business into new markets-such
    as the intermodal market-and implemented new technologies, including
    larger cars, and are currently developing new scheduling and train control
    systems. Some observers believe that the competition faced by railroads
    from other modes of transportation has created incentives for innovative
    practices, and that the ability to enter into confidential contracts with
    shippers has permitted railroads to make specific investments and to
    develop service arrangements tailored to the requirements of different
    shippers.9

    8Clifford Winston, Deregulation of Network Industries - What's Next?
    (Washington: AEI-Brookings Joint Center for Regulatory Studies: 2000), pp.
    43-44.

    9Gallamore, pp. 511-515.

    Freight rail is an important component of our nation's economy.
    Approximately 42 percent of all intercity freight in the United States,
    measured in ton-miles,10 moves on rail lines. Freight rail is particularly
    important to producers and users of certain commodities. For example,
    about 70 percent of automobiles manufactured domestically and about 70
    percent of coal delivered to power plants moves on freight rail.

    Industrywide Rates Declined from 1985 through 2000 and Rose Slightly from 2001
    through 2004

    Rail rates across the freight railroad industry have generally declined
    since the enactment of the Staggers Rail Act. Because changes in traffic
    patterns over time (for example, hauls over longer distances) can result
    in a decrease in the average revenue per ton-mile, purely relying on cents
    per ton-mile can present misleading industrywide rate trends. Therefore,
    we developed a set of rail rate indexes11 to examine trends in rail rates
    over the 1985 through 2004 period. These indexes account for changes in
    traffic patterns over time that could affect revenue statistics but do not
    account for inflation. To provide a measure for inflation, we also
    included the price index for the gross domestic product (GDP) in figure 2.

    From 1985 through 1987, rail rates dropped by 10 percent and then
    continued to decline, although not as steeply, through 1998. Rates
    increased in 1999, then dropped again in 2000. In 2001 and 2002 rates rose
    again. Rates were nearly flat in 2003 and 2004, finishing approximately 3
    percent above rates in 2000, but were 20 percent below 1985 rates (These
    trends are shown in figure 2). While our rail rate index does not reflect
    the general effects of inflation, the continuous increases in the GDP
    price index over this period indicate that real rates decreased by more
    than 20 percent from 1985 through 2004. Rate data are not available for
    2005 and 2006, but shippers, railroad officials, and financial analysts
    with whom we spoke told us that rates have generally increased during
    those years.

    10A ton-mile is a standard industry measure that represents 1 ton of
    freight transported 1 mile.

    11We constructed rate indexes to examine trends in rail rates over the
    1985 to 2004 period. These indexes define traffic patterns for a given
    commodity in terms of census region to census region flows of that
    commodity, and we calculated the average revenue per ton-mile for each of
    these traffic flows. The index is calculated as the weighted average of
    these traffic flows in each year, expressed as a percentage of the value
    for 1985, where the weights reflect the traffic patterns in 2004. By
    fixing the weights as of one period of time, we attempted to measure pure
    price changes rather than calculating the average revenue per ton-mile in
    each year. Over time, changes in traffic patterns could result in a
    substitution of lower priced traffic for higher priced traffic, or vice
    versa, so that a decrease in average revenue per ton-mile might partly
    reflect this change in traffic patterns. The rate index for the overall
    industry was defined similarly, except that the traffic pattern bundle was
    defined in terms of broad commodity, census region of origin, and mileage
    block categories. For comparison purposes, we also present the price index
    for gross domestic product over this period.

    Figure 2: Trends in Industry Rail Rates, 1985-2004

    For Many Commodities and Particular Routes, Rates Have Also Declined Since 1985,
    but Declines Are Not Uniform

    Similar to industrywide changes in rail rates, the rates for many
    commodities have declined since 1985 and have recently increased. In 2004,
    four commodities each made up 5 percent or more of freight railroad
    revenue-grain, coal, motor vehicles, and miscellaneous mixed shipments. In
    both the 1985 through 1989 and the 1990 through 1999 intervals, the rates
    for most of these commodities declined, while in 2000 through 2004, the
    rates increased for two commodities and decreased for two (see fig. 3).

    Figure 3: Commodity Rate Changes, 1985-1989, 1990-1999, and 2000-2004

    Note: From 2000 to 2004, the rate index for coal was largely unchanged.

    Although many rates have decreased, rates have not declined uniformly, and
    rates for some commodities are significantly higher than for others.
    Figure 4 compares commodity rates for coal, grain, miscellaneous mixed
    shipments, and motor vehicles from 1985 through 2004 using our rail rate
    index. Over the 20-year period most rates declined, with coal rates
    dropping the most sharply by 35 percent. Miscellaneous mixed shipments and
    motor vehicle rates also declined, although to a lesser extent than coal
    rates. Grain rates initially declined from 1985 through 1987, but then
    diverged from the other commodity trends and increased, resulting in a net
    9 percent increase by 2004.

    Figure 4: Rate Changes for Coal, Grain, Miscellaneous Mixed Shipments, and
    Motor Vehicles, 1985-2004

    We examined rate changes for commodities traveling along hundreds of
    particular routes and found that the rates on a majority of the routes we
    analyzed decreased from 2000 through 2004. Figure 5 shows that from 2000
    through 2004 rail rates decreased on about 55 percent of the routes in our
    analysis12 (334 of 604 routes). More specifically, the rates for most
    long-distance (over 1,000 miles) and medium-distance (501 to 1,000 miles)
    routes decreased. In one distance category, short-distance routes (up to
    500 miles), there were more routes with increases (103) than decreases
    (94), from 2000 through 2004. While figure 5 shows that, for the
    long-distance routes we examined, the number of routes with rate decreases
    was nearly twice the number of routes with rate increases. Many of the
    largest rate increases were on long-distance routes carrying miscellaneous
    mixed shipments-which include intermodal goods-that originated in the Los
    Angeles-Long Beach-Riverside, California, economic area and terminated at
    various destinations across the country. Several shipper groups reported
    that many rate increases occurred after 2004; however, data are not
    available for 2005 and 2006.

    12Our initial route universe consisted of 932 commodity routes, but we
    removed 328 routes that did not have large enough samples in some years to
    be valid, or they were not collected in the Carload Waybill Sample in
    either 2000 or 2004.

    Figure 5: Rail Rate Increases and Decreases across 604 Routes, and for
    Long-, Medium-, and Short-distance Routes, 2000 through 2004

    Many Factors May Have Contributed to Recent Rate Increases

    Several factors could have contributed to recent rate increases. Ongoing
    industry and economic changes have influenced how railroads have set their
    rates. Since the Staggers Rail Act was enacted, the railroad industry and
    the economic environment in which it operates have changed considerably.
    After years of reducing the size of its workforce and shedding track
    capacity, the industry is increasingly operating in a capacity-constrained
    environment in which the demand for its services exceeds its capacity in
    some areas. In addition, the industry has more recently increased
    employment and invested in increased capacity in key traffic corridors.
    Additionally, changes in broader domestic and world economic conditions
    have led to changes in the mix and profitability of traffic carried by
    railroads. For example, railroads have developed high-volume traffic by
    shipping import and export containers, leading them to price these
    shipments differently. According to DOT officials, some shippers-such as
    those in the automobile and chemical industries-may pay higher rates in
    order to secure higher quality service or due to liability issues. Lastly,
    the rail industry has continued to consolidate, potentially increasing the
    market power of the largest railroads. Our analysis included rate data
    through 2004,13 and according to freight railroad officials, shippers, and
    financial analysts, since 2004, rates have continued to increase as the
    demand for freight rail service has increased, and rail capacity has not
    kept pace with demand.

    Other Costs Have Shifted to Shippers, and Some Charges Are Not Accurately
    Tracked

    While rates have generally decreased since 1985, other costs have been
    passed on to shippers, some of which STB has not accurately tracked.
    Several shippers with whom we spoke agreed that rates have dropped over
    the long-term, but they also said that rates do not reflect the total cost
    of shipping by rail. According to some shippers, costs have shifted from
    the railroads to shipping companies, including the costs of railcar
    ownership. Figure 6 shows that tons carried by railcar ownership has
    shifted nearly 20 percent since 1985, indicating less tonnage shipped on
    railcars owned by freight railroad companies.

    13According to STB officials, the 2005 waybill data will become available
    in Fall 2006.

    Figure 6: Tonnage Carried by Railcar Ownership, 1987-2004

    Besides rates, other costs that shippers reported were infrastructure
    upgrade costs, fuel surcharges, 14 and congestion fees. Conversely, one
    Class I railroad told us that some rates in the Carload Waybill Sample do
    not account for rebates or incentives that may change the actual rate paid
    by the shipper. We are unable to report on the full extent of all costs
    because STB has not accurately tracked the railroad revenues associated
    with some of these charges. For example, freight railroad companies do not
    consistently report revenues raised from fuel surcharges for use in the
    Carload Waybill Sample. Some railroads report fuel surcharges as part of
    their general revenues, while others categorize the surcharges separately
    under a miscellaneous revenue category, and still other railroads may not
    report revenue collected from fuel surcharges at all. Shippers have
    expressed deep concerns over how fuel surcharges relate to actual fuel
    costs. Other railroad revenues, such as those generated at railcar
    auctions15 and through congestion fees, may not be included in the waybill
    sample either. Understanding what railroads do and do not report as
    miscellaneous revenue in the waybill sample may be of increasing
    importance because fuel surcharges have become more prevalent, and
    railroad revenue reported as miscellaneous revenue has substantially risen
    in recent years. From 2000 through 2004, the miscellaneous revenue
    reported in the waybill sample has more than quadrupled in value, from
    $141 million to $614 million (see fig. 7). Although an increase in value,
    $614 million still represents less than 1.5 percent of the approximately
    $42 billion in freight railroad revenue reported for 2004. Since 2004,
    miscellaneous revenue may have further increased as railroad and shipper
    groups with whom we spoke said that many fuel surcharge increases took
    effect in 2005. During our review, STB proposed to more closely track and
    otherwise monitor revenues associated with fuel surcharges.

    14Fuel surcharges are charges associated with recouping the cost of fuel.
    How fuel surcharges are calculated varies among Class I railroads because
    some use a mileage-based system while others use a percentage of the base
    rate.

    Figure 7: Miscellaneous Revenue Tracked in Carload Waybill Sample,
    2000-2004

    15At railcar auctions, railroad companies auction to the highest bidder
    the guaranteed delivery of a set number of railcars at specified future
    delivery dates. If railroads fail to deliver the railcars at the specified
    time, the railroads may pay a penalty to the shippers; if shippers find
    they cannot use the railcars at the time delivered then the shipper may
    pay a penalty to the railroad.

    Competition and Captivity Concerns Remain

    Concerns about competition and captivity in the railroad industry remain
    because traffic is concentrated in fewer railroads, although there is
    disagreement on the state of competition in the industry. It is difficult
    to determine the number of captive shippers, because proxy measures can
    overstate or understate captivity, but our analysis of available measures
    indicates that the extent of captivity is dropping. At the same time, the
    percentage of all industry traffic running substantially over the
    statutory threshold for rate relief has increased from about 4 percent of
    tonnage in 1985 to about 6 percent of tonnage in 2004. Furthermore, some
    economic areas with access to one Class I railroad have higher percentages
    of traffic traveling at rates that exceed the statutory threshold for rate
    relief.

      The Freight Railroad Industry Has Become More Concentrated

    During the past 30 years, the freight railroad industry has become more
    concentrated. In 1976, there were 30 independent Class I railroad systems,
    consisting of 63 Class I railroads operating in the United States.
    Currently there are seven railroad systems, consisting of seven Class I
    railroads. Nearly half of that reduction was attributable to
    consolidations.16 The railroad industry is dominated by four Class I
    railroads-two in the East and two in the West. As figure 8 shows, the
    market share of these four Class I railroads has been increasing and
    accounted for over 89 percent of the industry's revenues in 2004.

    16Other reasons for the reduction in the number of Class I railroads
    include carrier bankruptcies and a series of changes in the threshold for
    qualifying as a Class I railroad (from $5 million in annual revenue in
    1976 to $250 million in 1992).

    Figure 8: Percentage of Railroad Market Represented by Four Largest Class
    I Railroads, 1985-2004

    There is significant disagreement on the state of competition in the rail
    industry and on whether or not federal regulation-resulting from
    legislation such as the Staggers Rail Act-has ensured effective
    competition among railroads. This disagreement was represented on our
    panel of 11 experts, 6 of whom indicated that rail-to-rail competition has
    been achieved (either "greatly" or "somewhat") and 4 of whom maintained
    that effective competition had not been achieved.17 One member of our
    panel viewed less competition among rail carriers as a negative
    development because it can result in less efficient railroad companies and
    fewer options for shipping companies. Another member of our panel said
    that industry consolidation was essential to achieving an efficient and
    complete rail network under fewer, but ultimately stronger, railroad
    companies. Other experts also pointed to the hundreds of short-line
    railroads18 that have come into being since the enactment of the Staggers
    Rail Act, as well as increases in other competitive options for shippers
    from other modes such as trucks and barges.

    17One participant did not respond to this question.

    A reduction in competitive options can have a significant impact on the
    rates railroads charge shippers. There are a variety of contexts that
    affect how railroads compete with each other and with other modes, such as
    when route origins and destinations can both be reached by more than one
    railroad, or by multiple modes of transportation.19 Comparing two routes
    for shipping the same commodity, but using a different number of rail
    carriers, can illustrate this effect. Figure 9 shows two long-distance
    grain routes that both terminate in the Portland, Oregon, economic area
    from different origin points. Both routes carry comparable tonnage, but
    the route originating in the economic area in and around Sioux Falls,
    South Dakota, is served by two Class I railroads, whereas the route from
    the Minot, North Dakota, economic area is served by one Class I railroad.
    The rates for the Minot route are roughly double the rates for the Sioux
    Falls route.

    18A short-line railroad is an independent railroad company that operates
    over a short distance.

    19Winston, pp. 54-57.

    Figure 9: Comparison of Rates Charged on Long-distance Grain Routes,
    1997-2004

    Note: For some years, data have been removed due to insufficient sample
    size.

    The ability to build out to another railroad can also create competition
    and improve railroad rates for some shippers. For example, following a
    build-out,20 a shipper gained access to a second railroad at an origin
    point that had previously been served by one Class I railroad.21 Figure 10
    shows that within a few years after the introduction of service by the
    second railroad, the rates had dropped significantly. Because even a short
    segment build-out can be quite costly, shippers are unlikely to pursue
    build-out options without a substantial traffic base. Some experts with
    whom we spoke said that situations like the one depicted in figure 9
    reflect the reality of differential pricing in the freight railroad
    industry, or they suggest that other factors such as differences in the
    length of two different routes may be the cause of rate discrepancies.
    Others believe that a significant rate decrease after the introduction of
    competition is evidence that railroads are extracting monopoly rates from
    captive shippers.

    20A build-out is a shipper's option to build (or have some other party
    build) a track connection to a competing railroad.

    21We do not provide information identifying the location or the shipper
    involved because doing so could reveal proprietary information.

    Figure 10: Rate Changes after the Introduction of a Second Carrier

    While competition between rail carriers is particularly important in some
    cases, in other cases, competition between rail and other transportation
    modes, such as trucks and barges, may be more important. Particularly for
    bulk commodities (i.e., grain), when shipper locations can be served by
    barge transportation, rail rates will be lower relative to rail costs than
    on routes that are not conducive to barge competition. Figure 11 depicts
    costs and revenues for two routes, one (from the Champaign, Illinois
    economic area to the New Orleans, Louisiana economic area) with rail and
    barge options, and the other (from the Champaign, Illinois economic area
    to the Atlanta, Georgia economic area) with just a rail option. Although
    both routes have the same origin, for shipping the same commodity over a
    comparable distance, the route with the barge option has consistently
    lower rates than the route with just rail service.

    Figure 11: Comparison of Rate Changes from Champaign, Illinois, Economic
    Area to New Orleans, Louisiana, Economic Area and Champaign, Illinois,
    Economic Area to Atlanta, Georgia, Economic Area, 1990-2004

    Besides the number of rail carriers serving a location, the use of
    contracts for rail service can affect the competitive landscape. The
    Staggers Rail Act allowed railroad and shipping companies to enter into
    confidential contracts for rail service and also placed all traffic
    running under contract outside the remaining rate regulations. According
    to railroad and shipper groups, the duration of contracts has declined, in
    part because of the railroads' desire to quickly react to shifting market
    demand, which can result in charging higher rates. Other shippers were
    concerned that moving away from confidential contracts to public pricing
    could represent price signaling and further reduce competition between
    railroads. In 2004, 70 percent of tonnage and 71 percent of industry
    revenue moved under contract.

    Captive Shippers Are Difficult to Identify, but Available Measures Indicate
    Captivity Dropping in the Railroad Industry

    It is difficult to determine precisely how many shippers are "captive" to
    one railroad because the proxy measures that provide the best indication
    can overstate or understate captivity.22 One way of determining potential
    captivity is to identify which Bureau of Economic Analysis (BEA) economic
    areas were served by only one Class I railroad.23 In 2004, 27 of the 177
    BEA economic areas were served by only one Class I railroad.24 As shown in
    figure 12, these areas include parts of Montana, North Dakota, New Mexico,
    Maine, and smaller areas in several states.

    22Jerry Ellig, "Railroad Deregulation and Consumer Welfare," Journal of
    Regulatory Economics (The Netherlands: Klower Academic Publishers: 2002),
    p. 156.

    23Economic areas are those areas defined by BEA, which defines the
    relevant regional economic markets in the United States.

    24The number of carriers serving a given location is not indicated in the
    Carload Waybill Sample. We obtained this additional information from DOT.

    Figure 12: Number of Class I Railroads Serving Economic Areas, 2004

    Another way of looking at potential captivity is to calculate how much
    route tonnage originating in a given economic area has access to only one
    Class I railroad. Figure 13 shows the percentage in 2004 of all industry
    tonnage originating in economic areas with access to only one Class I
    railroad. In particular, economic areas with more than 75 percent of
    tonnage shipped on one railroad appear most prevalent in states such as
    Montana, Idaho, North Dakota, and Texas. Tonnage originating in these
    economic areas varies widely, from a little over 55,000 tons to over 36
    million tons.

    Figure 13: Percentage of All Industry Tonnage Originating in Economic with
    Access to One Class I Railroad, 2004

    According to our analysis of available measures, the overall extent of
    captivity appears to be dropping in the freight railroad industry. We
    examined tonnage, revenue, and access statistics for all
    routes-originating and terminating in economic areas-captured in the
    Carload Waybill Sample and other DOT data. In 2004, origin and destination
    routes with access to only one Class I railroad carried 12 percent of
    industry revenue and 10 percent of industry tonnage, which represents a
    decline from 1994, when 22 percent of industry revenue and 21 percent of
    industry tonnage moved on routes served by one Class I railroad (see table
    1).25

    Table 1: Changes in Percentage of Industry Revenue and Tonnage on Origin
    and Destination Routes with Access to One Class I Railroad

    Year Percentage of revenue Percentage of tonnage
    1994                 22.87                 20.59
    2004                 12.29                 10.43

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

    This decline suggests that more railroad traffic is traveling on routes
    with access to more than one Class I railroad. While overall industry
    tonnage with access to more than one Class I railroad appears to have
    increased, some economic areas have a higher percentage of all industry
    traffic tonnage shipping on one Class I railroad. From 1994 through 2004,
    parts of states such as Texas, Tennessee, and Montana experienced
    increases of 25 percent or more in tonnage with access to one Class I
    railroad while parts of other states such as Oregon, New York, and Florida
    saw their percentages of tonnage with access to one Class I railroad drop
    by more than 25 percent (see fig. 14).

    25For our analysis of access to one or more Class I railroads, we examined
    data for 1994 and 2004, the earliest and latest years for which such data
    were available.

    Figure 14: Changes in Percentage of All Industry Traffic Tonnage with
    Access to One Class I Railroad Originating in Economic Areas, 1994 through
    2004

    While examining BEA areas provides a proxy measure for captivity, a number
    of factors may understate or overstate whether shippers are actually
    captive. The first three factors may work to understate the extent of
    captivity among shippers. First, routes originating within economic areas
    served by multiple Class I railroads may still be captive if only one
    Class I railroad serves their destination, and a shipper must use that one
    railroad for that particular route. Second, some BEA areas are quite
    large, so a shipper within the area may have access to only one railroad,
    even though there are two or more railroads within the broader area.
    Third, an origin may only be served by one Class I railroad, but one Class
    I railroad does not serve the entire route, meaning the route may be
    partially captive, although more than one Class I railroad provides
    service between its origin and destination. Two additional limitations may
    work to overstate the number of locations captive to one railroad. First,
    this analysis accounts for Class I railroads only and does not account for
    competitive rail options that might be offered by Class II or III
    railroads26 such as the Guilford Rail System, which operates in northern
    New England. Second, this analysis considers only competition among rail
    carriers and does not examine competitive options offered by rail and
    other transportation alternatives such as trucks and barges.

    Amount of Potentially Captive Traffic Traveling at Rates at Levels Substantially
    above the Threshold for Rate Relief Has Increased

    To determine potential captivity, we applied another measure- traffic
    traveling at rates equal to or greater than 180 percent R/VC, which is
    part of the statutory threshold for bringing a rate relief case before
    STB. STB regards traffic at or above this threshold as "potentially
    captive." As with BEA areas, examining R/VC levels as a proxy measure for
    captivity can also understate or overstate captivity. For example, it is
    possible for the R/VC ratio to increase while the rate paid by a shipper
    is declining. Assume that in Year 1, a shipper is paying a rate of $20 and
    the railroad's variable cost is $12; the R/VC ratio-a division of the rate
    and the variable cost-would be 167 percent. If in Year 2, the variable
    costs decline by $2 from $12 to $10 and the railroad passes this cost
    savings directly on to the shipper in the form of a reduced rate, the
    shipper would pay $18 instead of $20. However, as shown in table 2,
    because both revenue and variable cost decline, the R/VC ratio increases
    to 180 percent.

    Table 2: Possible Changes in R/VC Ratios

    Year   Revenue collected Variable costs R/VC Year 1 $20.00 $12.00 167%
    Year 2            $18.00         $10.00 180%

    Source: GAO.

    26STB classifies railroads according to operating revenues. Class II
    railroads had revenues of $20 million to $250 million, and class III
    railroads had revenues of less than $20 million in 1991 dollars.

    Since 1985, and as a percentage of all traffic, the amount of potentially
    captive traffic traveling at rates over 180 percent R/VC and the revenue
    generated from that traffic have both declined. Revenue generated from
    traffic traveling at rates over 180 percent R/VC decreased from 41 percent
    of all industry revenue in 1985 to 29 percent in 2004 (see fig. 15).

    Figure 15: Percentage of Industry Tonnage and Revenue Generated from
    Traffic Traveling at Rates Equal to or Greater Than 180 Percent R/VC,
    1985-2004

    However, since 1985, tonnage from traffic traveling at rates substantially
    over the threshold for rate relief has increased. Total industry tonnage
    has increased significantly (from 1.37 billion tons in 1985 to 2.14
    billion tons in 2004), with the tonnage traveling at rates above 300
    percent R/VC more than doubling-from about 53 million tons in 1985 to over
    130 million tons in 2004 (see fig. 16).

    Figure 16: Tonnage Traveling at Rates over 300 Percent R/VC, 1985-2004

    As a percentage of all industry traffic, traffic traveling at rates
    between 180 and 300 percent R/VC decreased from 36 percent in 1985 to 25
    percent in 2004. In contrast, the percentage of all industry traffic
    traveling at rates above 300 percent R/VC increased from 4 percent in 1985
    to 6 percent in 2004 (see fig. 17).

    Figure 17: Percentage of Tonnage by R/VC, 1985 and 2004

    Increases in traffic traveling at rates over 300 percent R/VC appear
    widely distributed throughout the country, although in some areas
    increases have been higher than in others. Four economic areas located in
    parts of Montana, New Mexico, North Dakota, and West Virginia had the
    largest increases in traffic traveling at rates over 300 percent R/VC,
    with an increase of more than 25 percent from 1985 through 2004 (see fig.
    18).

    Figure 18: Changes in Percentage of Tonnage Traveling at Rates over 300
    Percent R/VC, by Originating Economic Area, 1985 through 2004

    In addition to national changes, significant increases in traffic
    traveling at rates over 300 percent R/VC can be seen in certain states,
    for certain commodities, and for certain routes. For example, in 1985
    virtually no coal originating in Ohio traveled at rates over 300 percent
    R/VC. In 2004, nearly half of coal traffic originating in Ohio traveled at
    rates over 300 percent R/VC. Increases in traffic traveling at rates over
    300 percent R/VC can also be seen at the route level. Figure 19 shows the
    amount of traffic traveling at rates over 300 percent R/VC on
    long-distance grain routes from the Minot, North Dakota, and Billings,
    Montana, economic areas to the Portland-Vancouver-Beaver Falls, Oregon,
    economic area. Of the routes we examined, these two had the highest
    percentage of traffic traveling at rates over 300 percent R/VC for 2004,
    and on both routes, this traffic had substantially increased over 1985
    levels.27

    Figure 19: Long-distance Grain Route Changes in Percentage of Tonnage
    Traveling at Rates over 300 Percent R/VC, 1985-2004

    For both the Minot and Billings routes, increases in R/VC from 1985
    through 2004 were driven more by increases in revenue than by changes in
    variable cost. From 1985 through 2004, revenue from all grain traffic-not
    just traffic traveling at rates above the statutory threshold for rate
    relief-on the Minot, North Dakota, to the Portland-Vancouver-Beaver Falls,
    Oregon, economic area increased from approximately $18.4 million to
    approximately $30.8 million. Variable cost increased at a much slower
    pace, rising from approximately $12.2 million to approximately $12.4
    million. For the route from the Billings, Montana, economic area to the
    Portland-Vancouver-Beaver Falls, Oregon, economic area, grain revenue more
    than tripled, from approximately $11.2 million in 1985 to approximately
    $42.7 million in 2004. Variable cost also increased substantially-although
    still not as much as revenue-rising from approximately $5.5 million to
    approximately $15.1 million.

    27By contrast, the long-distance grain route shown in figure 9 (from the
    Sioux Falls, South Dakota, economic area to the Portland, Oregon, economic
    area) had no traffic traveling at rates over 300 percent R/VC for 2004.

    Some Areas with Access to One Railroad Have Higher Percentages of Traffic
    Traveling at Rates That Exceed the Threshold for Rate Relief

    Some economic areas with access to one Class I railroad also have more
    than half of their traffic traveling at rates that exceed the statutory
    threshold for rate relief. For example, parts of New Mexico and Idaho with
    access to one Class I railroad have more than half of all traffic
    originating in those same areas traveling at rates over 180 percent R/VC
    (see fig. 20). However, there are instances in which an economic area may
    have access to two or more Class I railroads and still have more than 75
    percent of its traffic traveling at rates over 180 percent R/VC, as well
    as other instances in which an economic area may have access to one Class
    I railroad and have less than 25 percent of its traffic traveling at rates
    over 180 percent R/VC. Yet there are parts of the country with access to
    one Class I railroad that also have higher percentages of traffic
    traveling at rates over the statutory threshold for rate relief.

    Figure 20: Overlap between Percentage of Tonnage over Threshold for Rate
    Relief and Access to Only One Class I Railroad

    Our analysis shows that some areas of the country with access to only one
    Class I railroad have higher levels of traffic traveling at rates over the
    statutory threshold for rate relief. This situation may reflect reasonable
    economic practices by railroads in an environment of excess demand, or it
    may represent an abuse of market power. Our analysis provides an important
    first step in assessing competitive markets nationally, but it is
    imperfect given the inherent limitations of the Carload Waybill Sample and
    of the proxy measures available for weighing captivity. When combined with
    comments from participants on our expert panel and interviews with shipper
    and railroad groups, the results of our analysis suggest that shippers in
    selected markets may be paying excessive rates, meriting further inquiry
    and analysis.

    Despite STB's Actions, Analysis of Competitive Markets Is Needed to Address Lack
                        of Effective Relief for Captive Shippers

    The Staggers Rail and ICC Termination Acts promoted greater reliance on
    competition as the preferred method to protect shippers from unreasonable
    rates and granted STB broad authority to monitor the performance of the
    railroad industry. STB has taken a number of actions to provide
    protections for captive shippers from unreasonable rates in the absence of
    effective competition, including establishing a process for captive
    shippers to obtain relief from unreasonable rates. Despite STB's actions,
    there is little effective relief for captive shippers because STB's
    standard rate relief process is largely inaccessible. While STB continues
    to refine its practices, an assessment of competitive markets would
    provide further information about the extent of captivity among shippers
    and the merits of a range of proposed actions to enhance competitive
    options available to shippers. In addition, changes to the rate relief
    process could provide greater protection from unreasonable rates.

    STB Has Broad Authority to Monitor the Railroad Industry

    The Staggers Rail and ICC Termination Acts encourage competition as the
    preferred way to protect shippers and to promote the financial health of
    the railroad industry. At the same time, the acts give STB the authority
    to

               o  adjudicate rate cases to resolve disputes between captive
               shippers and railroads upon receiving a complaint from a shipper;
               o  approve rail transactions, such as mergers, consolidations,
               acquisitions, and trackage rights;
               o  prescribe new regulations, such as rules for competitive access
               and merger approvals; and
               o  inquire into and report on rail industry practices, including
               obtaining information from railroads on its own initiative and
               holding hearings to inquire into areas of concern, such as
               competition.

               The federal courts have upheld STB's general powers to monitor the
               rail industry, including its ability to subpoena witnesses and
               records and depose witnesses.

               STB has the authority and ability to inquire into and report on
               railroad practices, and it also has authority to take a number of
               actions based on the results of that inquiry. First, STB could
               issue a general rule making that would alter the administrative
               rules for the industry. For example, STB has the authority to
               require a railroad to make their terminal facilities available to
               another railroad under certain circumstances. Second, STB could
               reopen a past decision if it found a material error in the case,
               new evidence emerged, or circumstances affecting the case
               substantially changed. Finally, if STB received a complaint from a
               shipper, it could then launch a formal investigation and prescribe
               specific remedies to address the complaint.

               STB Has Taken Actions to  Protect Captive Shippers

               Under its adjudicatory authority, STB has taken a number of
               actions to provide protection for captive shippers. STB determines
               the reasonableness of challenged rates in the absence of
               competition upon receiving a complaint from a shipper. The rate
               relief process is the principal method by which shippers seek
               relief from unreasonable rates. STB developed standard rate case
               guidelines, under which captive shippers can challenge a rail rate
               and appeal to STB for rate relief. Under the standard rate relief
               process, STB assesses whether the railroad dominates the shipper's
               transportation market and, if it finds market dominance, proceeds
               with further assessments to determine whether the actual rate the
               railroad charges the shipper is reasonable. STB requires that the
               shipper demonstrate how much an optimally efficient railroad would
               need to charge the shipper and construct a hypothetical, perfectly
               efficient railroad that would replace the shipper's current
               carrier. As part of the rate relief process, both the railroad and
               the shipper have the opportunity to present their facts and views
               to STB, as well as to present new evidence. In 1999,28 we reported
               that shippers and shippers' associations indicated that
               constructing a hypothetical railroad is difficult, particularly
               for small shippers, because the time and cost associated with the
               model's development may outweigh the compensation afforded the
               shipper should STB determine that the challenged rate was
               unreasonable. Since we reported on the process in 1999, STB has
               taken several actions to reduce potential barriers for filing a
               complaint. For example, STB now conducts mediation to begin cases,
               has added staff to process cases, and has eliminated certain
               criteria for assessing whether a railroad dominates a shipper's
               market.29

               STB also created alternatives to the standard rate relief process,
               developing simplified guidelines, as Congress required, for cases
               in which the standard rate guidelines would be too costly or
               infeasible given the value of the cases. Under these simplified
               guidelines, captive shippers who believe that their rate is
               unreasonable can appeal to STB for rate relief, even if the value
               of the disputed traffic makes it too costly or infeasible to apply
               the standard guidelines. In addition, STB created a voluntary
               arbitration option that parties can use to resolve disputes over
               rates.

               Under its authority to approve rail transactions, STB has approved
               railroad mergers that it finds consistent with the public
               interest. STB has also taken action to ensure that any potential
               merger-related harm to competition is mitigated. STB's mitigation
               efforts have focused on preserving competition where it could be
               lost at 2-to-1 points,30 for example, by imposing conditions that
               allow one railroad to operate over the tracks of another railroad
               (called trackage rights). STB has historically not taken action to
               introduce service where shippers have service by only one carrier.

               Under its authority to prescribe new regulations, STB established
               a process by which shippers can file a complaint if they are
               captive to one railroad and believe that the railroad is engaged
               in anticompetitive behavior. Under this process, if the shipper
               proves that the railroad is engaged in anticompetitive behavior,
               STB can prescribe remedies such as trackage rights that would give
               the shipper access to another railroad.

               Finally, under its authority to inquire into and report on the
               rail industry, STB instituted proceedings to review rail access
               and competition issues. For example, in April 1998, at the request
               of Congress, STB commenced a review of access and competitive
               service in the rail industry. In April 1998, STB decided to
               consider revising its competitive access rules. However, in its
               December 1998 report to Congress, STB declined to take further
               action on this issue because it had adopted new rules giving
               shippers temporary access to alternative routing options during
               periods of poor service. In addition, STB observed that the
               competitive access issue raises basic policy questions that are
               more appropriately resolved by Congress. In 2001, STB adopted new
               regulations for rail mergers that require the applicant to
               demonstrate that the merger would enhance, not just preserve,
               competition.

               Efforts Have Led to Little Effective Relief

               Despite STB's efforts, there is widespread agreement that STB's
               standard rate relief process is inaccessible to most shippers and
               does not provide for expeditious handling and resolution of
               complaints. The process remains expensive, time consuming, and
               complex. While STB does not keep records of the cost of a rate
               case, shippers we interviewed agreed that the process can cost
               approximately $3 million per litigant. Shippers told us that, to
               initiate a case, the case would need to involve several million
               dollars so that it would be worthwhile to spend $3 million on a
               case that they could possibly lose. Thus, shippers noted that only
               large-volume shippers, such as coal shippers, with set origins and
               destinations have the money to be able to afford the STB rate
               relief process. In addition, shippers said that they do not use
               the process because it takes so long for STB to reach a decision.
               Lastly, shippers continue to state that the process is both time
               consuming and difficult because it calls for them to develop a
               hypothetical competing railroad to show what the rate should be
               and to demonstrate that the existing rate is unreasonable. Since
               2001, only 10 cases have been filed, and these cases took between
               2.6 and 3.6 years-an average of 3.3 years per case-to complete. Of
               those 10 cases, 9 were filed by coal shippers.

               The simplified guidelines also have not effectively provided
               relief for captive shippers. Although these simplified guidelines
               have been in place since 1997, a rate case has not been decided
               under the process set out by the guidelines. STB held public
               hearings in April 2003 and July 2004 to examine why shippers have
               not used the guidelines and to explore ways to improve them. At
               these hearings, numerous organizations provided comments to STB on
               measures that could clarify the simplified guidelines, but no
               action was taken. STB observed that parties urged changes to make
               the process more workable, but disagreed on what those changes
               should be. Several shipper organizations told us that shippers are
               concerned about using the simplified guidelines because they
               believe the guidelines will be challenged in court, resulting in
               lengthy litigation. STB officials told us that they-not the
               shippers-would be responsible for defending the guidelines in
               court. STB officials also said that if a shipper won a small rate
               case, STB could order reparations to the shipper before the case
               was appealed to the courts.

               STB's arbitration option has never been used. Under this approach,
               an arbitrator would decide the rate, using a "give and take"
               approach-that is, the arbitrator would determine the rate without
               being required to pick one of the two offers. According to STB
               officials, this option has not been used, in part, because the
               cases that go before STB are contentious, with high monetary
               stakes. As a result, there is less willingness from either side to
               arbitrate.

               Shippers have not obtained relief through STB's "competitive
               access" rules. Under these rules, shippers can file a complaint to
               request that one railroad obtain access to another railroad's
               tracks when necessary to remedy anticompetitive behavior by the
               owning railroad. Shippers who file a complaint must show that the
               owning railroad has engaged in anticompetitive behavior. To date,
               STB has found that all complaints have failed to prove that the
               owning railroad has engaged in anticompetitive behavior.

               STB Continues to Refine the Process

               During our review, STB has continued to refine its processes for
               shippers to obtain relief from unreasonable rates and competitive
               access. For example, STB recently proposed a rule making to make
               changes to the simplified guidelines in order to respond to
               comments gathered at the STB hearings held in April 2003 and July
               2004 to examine why those guidelines have not been used by
               shippers and to explore ways to improve the guidelines. In
               addition, STB is seeking public comment on several measures it has
               proposed to adopt regarding railroad practices involving fuel
               surcharges. The proposals follow STB's May 2006 public hearing on
               how railroads calculate and charge fuel surcharges and respond to
               extensive testimony on these charges submitted to STB by the rail
               industry, the public, and railroad customers. STB announced its
               intent to hold a public hearing on certain issues related to rail
               transportation rates for grain. Lastly, STB recently requested
               written comments and held a public hearing in response to a
               petition filed by a shipper group to prevent, or put a time limit
               on, paper barriers, which are contractual agreements that may be
               made when a Class I railroad either sells or leases some of its
               track to another railroad (typically a short line railroad or
               regional railroad), but stipulates that virtually all traffic that
               originates on that line must interchange with the Class I railroad
               that sold the tracks or pay a penalty.

               Assessment of Competitive Markets and Changes to Rate Relief Process
    			  Could Provide More Relief

               The results of our analysis suggest a reasonable possibility that
               shippers in selected markets may be paying excessive rates related
               to a lack of competition in these markets. While our analysis of
               available measures shows that the extent of captivity appears to
               be dropping in the freight railroad industry, shippers that may be
               captive are paying substantially over the statutory threshold for
               initiating a rate relief case. This situation may simply reflect
               reasonable economic practices by railroads in an increasingly
               constrained environment in which demand for rail services
               increasingly exceeds supply, or it may represent an abuse of
               market power. Our analysis provides an important first step in
               assessing competitive markets nationally, but it is imperfect
               given the inherent limitations of the Carload Waybill Sample and
               the proxy measures available for weighing captivity. A more
               rigorous analysis of competitive markets nationally is needed-one
               that identifies the state of competition nationwide and inquires
               into pricing practices in specific markets. If this assessment
               determines that market power is being abused or the goals of the
               Staggers Rail Act are not being met, STB could consider several
               methods to ease competition concerns, such as initiating a
               generally applicable rule making; or, if a complaint is filed,
               providing specific remedies to increase competition.

               Shipper groups, economists, and other experts in the rail industry
               have suggested several alternative approaches as remedies that
               could provide more competitive options to shippers in areas of
               inadequate competition or excessive market power. These groups
               view these approaches as more effective than the rate relief
               process in promoting a greater reliance on competition to protect
               shippers against unreasonable rates. Some proposals would require
               legislative change, or a reopening of past STB decisions.31

               These approaches each have potential costs and benefits. On the
               one hand, they could expand competitive options, reduce rail
               rates, and decrease the number of captive shippers as well as
               reduce the need for both federal regulation and a rate relief
               process. On the other hand, reductions in rail rates could affect
               railroad revenues and limit the railroads' ability and potential
               willingness to invest in their infrastructure. In addition, some
               markets may not have the level of demand needed to support
               competition among railroads. However, in markets that do, the
               targeted approaches frequently proposed by shipper groups and
               others include the following:

               o  Reciprocal switching: This approach would allow STB to require
               railroads serving shippers that are close to another railroad to
               transport cars of a competing railroad for a fee. The shippers
               would then have access to railroads that do not reach their
               facilities. This approach is similar to the mandatory
               interswitching in Canada, which enables a shipper to request a
               second railroad's service if that second railroad is within
               approximately 18 miles. Some Class I railroads already interchange
               traffic using these agreements, but they oppose being required to
               do so. Under this approach, STB would oversee the pricing of
               switching agreements. This approach could also reduce the number
               of captive shippers by providing a competitive option to shippers
               with access to a proximate but previously inaccessible railroad
               and thereby reduce traffic eligible for the rate relief process
               (see fig. 21).

    STB Has Taken Actions to Protect Captive Shippers

    28GAO, Railroad Regulation: Current Issues Associated with the Rate Relief
    Process, GAO/RCED-99-46 (Washington, D.C.: Feb. 26, 1999).

    29In December 1998 and July 1999, STB excluded product and geographic
    competition as factors to be considered in market dominance proceedings,
    finding that the applicable law did not require consideration of those
    factors; that consideration of those factors unduly burdened shippers
    attempting to bring rate cases; and that the exclusion of those factors
    would not have any substantial effect on the rates that the railroads
    could charge in the marketplace (See Surface Transportation Board "News"
    releases Nos. 99-32, issued on Jul. 2, 1999, and 98-82, issued on Dec. 21,
    1998). The railroad industry sought judicial review of the Board's
    decisions, and in Association of Am. Railroads v. STB, 237 F.3d 676 (D.C.
    Cir. 2001), the United States Court of Appeals for the District of
    Columbia Circuit (Court) remanded (returned) the matter for the Board's
    further consideration. On remand, STB provided additional analysis to
    support its earlier decision, and the court then affirmed (upheld) STB's
    action, in Association of Am. Railroads v. STB, 306 F.3d 1108 (D.C. Cir.
    2002).

    302-to-1 points are where shippers currently have access to two carriers
    but could lose access to one of them through a merger or acquisition.

    31Another proposal, articulated by economists Curtis Grimm and Cliff
    Winston, calls for the elimination of STB. This proposal recognizes that
    captive shippers have likely been hurt by a lack of competition, but it
    states that allowing the Department of Justice to review rail mergers
    instead of STB and ending the potential for reregulation of the industry
    could lead railroad officials and shippers to negotiate an agreement to
    address remaining rail competition concerns. Curtis Grimm and Clifford
    Winston, "Competition in the Deregulated Railroad Industry: Sources,
    Effects, and Policy Issues," (AEI - Brooking Institution. Washington,
    D.C.: 2000).

    Figure 21: Reciprocal Switching

               o  Terminal agreements: This approach would require one railroad
               to grant access to its terminal facilities or tracks to another
               railroad, enabling both railroads to interchange traffic or gain
               access to traffic coming from shippers off the other railroad's
               lines for a fee. Current regulation requires a shipper to
               demonstrate anticompetitive conduct by a railroad before STB will
               grant access to a terminal by a nonowning railroad unless there is
               an emergency or when a shipper can demonstrate poor service and a
               second railroad is willing and able to provide the service
               requested. This approach would require revisiting the current
               requirement that railroads or shippers demonstrate anticompetitive
               conduct in making a case to gain access to a railroad terminal in
               areas where there is inadequate competition. The approach would
               also make it easier for competing railroads to gain access to the
               terminal areas of other railroads and could increase competition
               between railroads. However, it could also reduce revenues to all
               railroads involved and adversely affect the financial condition of
               the rail industry. Also, shippers could benefit from increased
               competition but might see service decline (see fig. 22).

    Figure 22: Terminal Agreements

               o  Trackage rights: This approach would require one railroad to
               grant access to its tracks to another railroad, enabling railroads
               to interchange traffic beyond terminal facilities for a fee. In
               the past, STB has imposed conditions requiring that a merging
               railroad must grant another railroad trackage rights to preserve
               competition when a merger would reduce a shipper's access to
               railroads from two to one. While this approach could potentially
               increase rail competition and decrease rail rates, it could also
               discourage owning railroads from maintaining the track or
               providing high-quality service, since the value of lost use of
               track may not be compensated by the user fee and may decrease
               return on investment (see fig. 23).

    Figure 23: Trackage Rights

    "Bottleneck" rates: This approach would require a railroad to establish a
    rate, and thereby offer to provide service, for any two points on the
    railroad's system where traffic originates, terminates, or can be
    interchanged. Some shippers have more than one railroad that serves them
    at their origin and/or destination points, but have at least one portion
    of a rail movement for which no alternative rail route is available. This
    portion is referred to as the "bottleneck segment." STB's decision that a
    railroad is not required to quote a rate for the bottleneck segment has
    been upheld in federal court.32 STB's rationale was that statute and case
    law precluded it from requiring a railroad to provide service on a portion
    of its route when the railroad serves both the origin and destination
    points and provides a rate for such movement. STB requires a railroad to
    provide service for the bottleneck segment only if the shipper had prior
    arrangements or a contract for the remaining portion of the shipment
    route. On the one hand, requiring railroads to establish bottleneck rates
    would force short-distance routes on railroads when they served an entire
    route and could result in loss of business and potentially subject the
    bottleneck segment to a rate complaint. On the other hand, this approach
    would give shippers access to a second railroad, even if a single railroad
    was the only railroad that served the shipper at its origin and/or
    destination points, and could potentially reduce rates (see fig. 24).

    32The U.S. Court of Appeals for the Eighth Circuit affirmed STB decision
    that a bottleneck carrier generally need not quote a separate rate for the
    bottleneck portion of the route. Mid-American Energy Co. v. Surface
    Transportation Board, 169 F. 3d 1099 (8th Cir.: Feb. 10, 1999). The D.C.
    Circuit affirmed STB holding that separately challengeable bottleneck
    rates can be required whenever a shipper has a contract over the
    nonbottleneck segment of a through movement. Union Pacific Railroad v.
    Surface Transportation Board, 202 F. 3d 337 (D.C. Cir.: 2000).

    Figure 24: Bottleneck Rates

    Paper barriers: This approach would prevent or, put a time limit on, paper
    barriers, which are contractual agreements that can occur when a Class I
    railroad either sells or leases long term some of its track to other
    railroads (typically a short-line railroad and/or regional railroad).
    These agreements stipulate that virtually all traffic that originates on
    that line must interchange with the Class I railroad that originally
    leased the tracks or pay a penalty. Since the 1980s, approximately 500
    short lines have been created by Class I railroads selling a portion of
    their lines; however, the extent to which paper barriers are a standard
    practice is unknown because they are part of confidential contracts. When
    this type of agreement exists, it can inhibit smaller railroads that
    connect with or cross two or more Class I rail systems from providing rail
    customers access to competitive service. Eliminating paper barriers could
    affect the railroad industry's overall capacity since Class I railroads
    may abandon lines instead of selling them to smaller railroads and thereby
    increase the cost of entering a market for a would-be competitor. In
    addition, an official from a railroad association told us that it is
    unclear if a federal agency could invalidate privately negotiated
    contracts (see fig. 25).

    Figure 25: Paper Barriers

    It will be important for policymakers, in evaluating these alternative
    approaches, to carefully consider the impact of each approach on the
    balance set out in the Staggers Rail Act. One significant consideration is
    the revenue adequacy of the railroads. The Staggers Rail Act established
    revenue adequacy as a goal for the industry and allowed the railroads to
    use differential pricing to increase their revenues. While the specific
    method for determining revenue adequacy has been controversial, the
    overall trend in revenue adequacy may be more important. In its last
    report for 2004, STB determined that one railroad is revenue adequate and
    that others are approaching revenue adequacy. It is too early to determine
    that the industry as a whole is achieving revenue adequacy. Nevertheless,
    this improvement in the railroads' financial condition represents a
    significant shift in the rail industry because for decades after the
    enactment of the Staggers Rail Act, the railroads were all considered
    revenue inadequate. The railroads need sufficient revenue for
    infrastructure investment to keep pace with increased demand. However,
    each of these changes could decrease the amount of revenue the railroads
    receive. Yet, as the railroad's revenue adequacy improves, the question
    arises as to what degree the railroads should continue to rely, for their
    investment needs, on obtaining significantly higher prices from those with
    greater reliance on rail transportation.

    To prevent problems with unreasonable rates, some shipper groups propose
    targeted approaches that would provide them with more competitive options.
    A number of different approaches have also been suggested to make the rate
    relief process less expensive, more expeditious, and therefore potentially
    more accessible. Each of the proposed approaches has both advantages and
    drawbacks. These approaches include the following:

               o  Increase the use of simplified guidelines: The simplified
               guidelines use standard industry average figures for revenue data
               instead of requiring the shipper to create a hypothetical
               railroad. This approach would reduce the time and complexity of
               the process; however, it may not provide such an accurate and
               precise a measure as the standard process. Both shippers and
               railroad officials with whom we spoke agree that it is confusing
               to determine who is eligible to use the process and how it would
               work. STB recently issued a proposed rule making to pursue changes
               to the simplified guidelines to provide captive shippers greater
               access to regulatory remedies for unreasonable rail rates.
               o  Increase the use of arbitration: Under arbitration, two parties
               present their case before an arbitrator, who determines the rate.
               This process replaces the shipper's requirement to create a
               hypothetical railroad. Proponents of arbitration argue that the
               threat of arbitration can induce railroads and shippers to resolve
               their own problems and limit the need for federal regulation. In
               addition, the process is quicker and cheaper than the standard
               rate relief process. For example, Canada offers an arbitration
               process known as Final Offer Arbitration (FOA), under which both
               parties submit their best and final offers, and the arbitrator
               considers the argument from both sides and picks one rate offer
               from either the railroad or the shipper. FOA is
               quicker-statutorily, once the process begins it has to be
               completed within 60 days, or 30 days for disputes involving
               freight charges of less than $750,000, unless the parties agree to
               a different time frame. In addition, FOA is cheaper-estimates
               ranged up to $1 million Canadian dollars, for both parties. On the
               other hand, the decisions are good for only 1 year, so the process
               could in theory be revisited annually. Critics of this approach
               suggest that arbitration decisions may not be based on economic
               principles, such as the revenue and cost structure of the
               railroad, and arbitrators may not be knowledgeable about the
               railroad industry. Furthermore, opinions differ significantly
               about which types of disputes should be covered and what standards
               (if any) should apply.

               o  Develop an alternative cost methodology: STB could develop an
               alternative to the cost methodology used under the standard
               process in which a shipper must demonstrate how much an optimally
               efficient railroad would need to charge a shipper by constructing
               a hypothetical, perfectly efficient railroad that would replace
               its current carrier. For example, STB could use a long-run
               incremental cost approach to evaluate and decide rate cases. This
               process, which is used by the Federal Energy Regulatory Commission
               for regulating rates charged by pipeline companies, bases rates on
               the actual incremental cost of moving a particular shipment, plus
               a reasonable rate of return. This approach allows for a quick,
               standard method for setting prices, but does not take into account
               the need for differential pricing or the railroad's need to charge
               higher rates in order to become revenue adequate. Structuring rate
               regulation around actual costs can also create potential
               disincentives for the regulated entity to control its costs.

    			  Uncertainty about Future Freight Rail Demand and Capacity Points to
               Opportunities for a More Strategic Federal Approach to Rail
    			  Infrastructure

               Recent forecasts predict that the demand for freight and freight
               rail transport will grow significantly in the future. While
               forecasts have limitations as guides to investing in new
               transportation infrastructure, they can present a plausible
               picture of future freight demand and capacity. Whether private
               rail companies will be able and willing to invest in new
               infrastructure capacity to meet projected future demand is
               uncertain. New rail capacity not only benefits each private rail
               company network, but it also has the potential to benefit the
               public by improving traffic flow, air quality, and safety at the
               national, state, and local levels. As a result, the public sector
               has increasingly been investing in freight rail projects. Federal
               involvement in the freight system should be consistent with the
               competitive marketplace and ensure that funding decisions reflect
               widespread public priorities.

               Forecasts of Significant Freight Rail Traffic Growth Provide a
    			  Plausible Outlook for the Future

    			  The demand for freight transportation in general and freight rail
               specifically is forecasted to increase, according to recent
               studies.33 Several of these studies also quantify their
               projections of the volume and value of future freight demand. The
               Freight Analysis Framework (FAF) is a comprehensive database and
               policy analysis tool maintained by DOT to help identify needed
               freight capacity improvements. In 2002, DOT projected, using this
               tool, that overall domestic and international freight demand would
               increase by more than 65 percent and 84 percent, respectively, by
               2020. In 2003, the American Association of State Highway and
               Transportation Officials (AASHTO) released the Freight Rail Bottom
               Line Report, prepared by a consulting firm. This report describes
               the industry and its benefits to the nation, estimates the
               industry's investment needs and capacity to meet these needs, and
               quantifies the consequences of underinvestment, including highway
               deterioration and congestion. The AASHTO study projected that, by
               2020, overall domestic freight demand by ton would increase by 57
               percent and international demand would increase by 99 percent. In
               2005, the American Trucking Association's (ATA) report U.S.
               Freight Transportation Forecast to 2016 projected tonnage and
               revenues for all freight modes. The report predicted that overall
               freight volume would increase by about 32 percent between 2004 and
               2016.

               Freight rail demand is projected to increase less than overall
               freight demand and to grow at a slower rate than demand for other
               modes-such as truck and air freight. FAF projects that freight
               rail tonnage will grow about 55 percent by 2020, but this growth
               will not be as dramatic as for truck and air, and will account for
               a much smaller share of the market when measured on the basis of
               shipment value. AASHTO predicts that freight rail tonnage will
               increase 44 percent by 2020. However, it notes that this forecast
               actually indicates that rail will lose some market share. This
               estimate also assumes that considerable investment will be
               required-up to about $4 billion annually-to meet future demand.
               According to ATA's forecast, freight rail tonnage will grow
               annually by 2.4 percent to 2010 and by 2.1 percent to 2016. While
               rail intermodal traffic is forecast to grow rapidly, the study
               anticipates that rail's overall share of total freight tonnage
               will decrease slightly from about 15.6 percent in 2004 to about
               15.4 percent in 2016.

               However, ow many factors can affect the accuracy of these
               predictions. Freight markets are volatile and unpredictable, and
               thus freight demand forecasts may prove to be off the mark.
               Similarly, much freight traffic is determined by trade that
               originates outside the United States. Moreover, since the data and
               models used to develop these freight demand forecasts are largely
               proprietary,34 we could not assess the validity or reasonableness
               of the assumptions used to develop the predictions.35
               Nevertheless, forecasts of freight and freight rail demand are
               useful as one plausible scenario for the future. As the
               Congressional Budget Office (CBO) observed in a January 2006
               report, forecasts of demand are best viewed as illustrative rather
               than quantitatively accurate.36

               Railroads� Investments in Capacity to Meet Potential Demand Are
    			  Uncertain

               If demand does develop as forecasted, it is uncertain how able and
               willing railroads will be to invest in new capacity. Railroads do
               not prepare long-term capacity plans because of concern about the
               potential for significant economic changes-for example, officials
               at one Class I railroad stated that they prepare capacity
               improvements plans and demand projections for 3 to 5 years into
               the future, with frequent revisions. In addition, the railroads we
               interviewed were generally unwilling to discuss their future
               investment plans with us in any detail because this is business
               proprietary information. It is therefore difficult to comment on
               how railroads are likely to choose among their competing
               investment priorities for the future compared with various demand
               scenarios.

               Railroads' ability and willingness to invest in new capacity to
               meet demand reflects a number of key considerations. For privately
               owned rail companies, a key business consideration is maximizing
               returns for shareholders. To do so, realizing the greatest return
               on investment from each investment decision is essential and is
               reinforced by pressure from shareholders. Rail investment involves
               private companies taking a substantial risk which becomes a fixed
               cost on their balance sheets, one on which they are accountable to
               stockholders and for which they must make capital charges year in
               and year out for the life of the investment. A railroad
               contemplating such an investment must be confident that the market
               demand for that infrastructure will hold up for 30 to 50 years.
               This is in sharp contrast to other modes such as highway
               infrastructure, which is paid for largely by public funds.
               Maximizing a rail company's competitive position in key markets is
               important in deciding on investments in the company network's size
               and facilities. For example, the growth of intermodal transport is
               a major development for freight rail because it stands to be the
               largest revenue generator for the Class I railroads. As a result,
               there is intense competition for this business, although
               intermodal business also means that freight rail both competes and
               cooperates with other freight modes. However, intermodal growth
               depends on the railroads' ability to invest in the new capacity
               needed to meet this demand.

               Investment considerations are complicated by the current status of
               rail infrastructure. Although the rail network has been downsized,
               the infrastructure remains extensive but aging. Replacing,
               maintaining, and upgrading this infrastructure is extremely
               costly, as the Transportation Research Board emphasized in its
               analysis of critical transportation issues.37 Predicting the
               extent to which future rail investments will keep pace with
               projected freight rail demand is complicated by the extent of
               current rail needs. For example, an annual assessment of America's
               infrastructure38 conducted by the American Society of Civil
               Engineering gave rail infrastructure a "C-" grade and noted that,
               for the first time in 90 years, limited capacity has created
               significant bottlenecks in the national rail network. However,
               railroads must invest in new infrastructure, new equipment, and
               substantial new capacity to handle additional traffic in order to
               remain viable and effective, a rail industry representative told
               our expert panel.

               Today, freight railroads are sufficiently profitable to be
               investing at record levels. Major freight railroads have
               reported39 that they expect to invest about $8 billion in
               infrastructure during 2006-a 21 percent increase over 2005-and
               have told us that they plan to continue making infrastructure
               investments. However, not all of this investment is planned for
               capital or new capacity. Although we requested additional detail
               about how the rail industry's $8 billion estimated investment was
               divided between new capacity and maintenance or renewal of
               existing capacity, the Association of American Railroads indicated
               that this information is not currently available but will be part
               of a special study on railroad spending trends.

               Rail Capacity Investments Can Produce Private and Public Sector
    			  Benefits

               While private rail networks obtain benefits and improve their
               profitability from investments in their capacity, these
               investments also can benefit the public. In fact, some public
               benefits can be large in comparison to anticipated benefits to the
               private rail network, as the CBO report pointed out. For example,
               shifting truck freight traffic to railroads can reduce highway
               congestion for passenger and commercial vehicles, potentially
               reducing or avoiding public expenditures that otherwise would be
               needed to build additional highway capacity or provide additional
               maintenance to accommodate growing truck traffic. Depending on the
               rail infrastructure project, the public could realize several
               types of benefits, as described in table 3.

    33Studies by the AASHTO, DOT, and American Trucking Association made
    specific freight and freight rail forecasts. Studies by the Transportation
    Research Board (TRB), the National Cooperative Research Program (NCHRP
    20-24(33)) administered by TRB, and a consortium of Midwestern states and
    universities (Upper Midwest Freight Corridor Study) also assessed future
    freight demand and capacity issues.

    34The 2002 FAF used proprietary models to describe domestic and
    international commodity flows for rail, water, air, and highways and
    forecasted freight flows for 2010 and 2020. A second generation DOT FAF
    (being published in 2006) does not use proprietary models and covers
    commodity flows for 2002 to 2035.

    35We were able to interview some of the consultants who authored these
    reports and other rail experts. We also independently corroborated
    information in these reports through our expert panel.

    36Congressional Budget Office, Freight Rail Transportation: Long Term
    Issues (Washington, D.C.: January 2006).

    37Transportation Research Board, Critical Issues in Transportation
    (Washington, D.C.: Jan. 2006).

    38American Society of Civil Engineering, 2005 Report Card for America's
    Infrastructure (Washington, D.C.: 2005).

    39Association of American Railroads (AAR), (Washington, D.C.: Mar. 16,
    2006).

    Table 3: Potential Public Benefits of Rail Transportation Investments

    Category                  Potential public benefit
    Economic                     o  Lower transportation costs through higher
                                    productivity, making it cheaper to produce
                                    and distribute goods/services
                                    o  Improve global competitiveness through
                                    increased efficiency
                                    o  Strengthen local, regional, state
                                    economies
                                    o  Expand industry, employment, tax base
    Transportation system        o  Capture each mode's advantages in moving
                                    passengers/freight
                                    o  Improve overall system performance
                                    o  Strengthen intermodal connections
                                    o  Improve transportation network efficiency
                                    for the future
                                    o  Improve passenger/freight rail
                                    interactions
    Mobility/Congestion          o  Relieve highway congestion by shifting
                                    highway freight to rails
                                    o  Reduce public investment to prevent
                                    highway deterioration by preventing diversion
                                    of heavy rail freight to roads
                                    o  Give passengers/freight access to more
                                    modes
                                    o  Decrease travel time, increase reliability
    Environmental/Air quality    o  Reduce emissions/improve air quality by
                                    reducing congestion
                                    o  Consume about one-fourth to one-third less
                                    fuel than trucks
    Safety and security          o  Reduce crashes through
                                    redesigned/eliminated highway-rail crossings
                                    o  Provide redundant capacity to respond to
                                    operational/congestion, national security,
                                    and weather problems

    Source: GAO analysis.

    Rail projects can vary widely in the extent to which they may generate
    public as well as private benefits; whether benefits are realized by the
    private or public sector at the national, state, and local levels; and how
    the benefits are quantified for the purpose of fairly apportioning project
    financing. Determining what benefits and costs are associated with a rail
    infrastructure project and who benefits is important in deciding whether
    public funds for public benefits are justified-but this is a difficult
    determination.40 For example, one rail infrastructure project that reduces
    system bottlenecks may generate benefits to the national economy by
    lowering the costs of producing and distributing goods. Another rail
    project that eliminates or improves highway-rail crossings may primarily
    produce local benefits by reducing accidents, time lost waiting for trains
    to pass, pollution and noise from idling trains, and delays of emergency
    vehicles at crossings. The same project also may produce national benefits
    by reducing the impact of train delays on the system.

    40GAO, Highway and Transit Investments: Options for Improving Information
    on Projects' Benefits and Costs and Increasing Accountability for Results,
    GAO-05-172 (Washington, D.C.: Jan. 24, 2005).

    Public Sector's Growing Freight Rail Investments Focus on Securing Public
    Benefits

    Increasingly, governments at all levels have been investing in freight
    rail improvement projects that offer potential public benefits. At the
    state and local levels, government involvement has ranged from planning
    and coordination to collaboration and investment with freight rail
    companies and other stakeholders. Some states have been investing to help
    short-line railroads maintain track in their states for almost 20 years.
    Other states-such as Florida, Virginia, New York, and Pennsylvania-are
    creating significant new programs to invest in rail projects. Over 30
    states have published freight plans that describe their goals and approach
    to freight and freight rail.

    The scope of state and local freight rail investments continues to expand.
    For example, Missouri state and local governments, in partnership with
    railroads and other stakeholders, supported two major rail bridge
    flyover41 projects to reduce rail delays in Kansas City. These
    projects-totaling $134 million-were expected to provide economic benefits
    and reduce rail transit time through the city by about 2 hours. The
    project also used an innovative institutional arrangement that created a
    special type of corporation to facilitate its funding. Colorado's
    Department of Transportation (CDOT), other public entities, and two Class
    I railroads are exploring an ambitious partnership to relocate freight
    train facilities away from the heavily populated Front Range area of the
    state, as the two railroads proposed. CDOT initiated a benefit-cost
    study42 that found sufficient public transportation, economic development,
    land use, safety, environmental, and passenger rail facilitation benefits
    to warrant investing public dollars in the project-estimated to cost about
    $1.17 billion.

    The federal government also has been involved in freight rail projects. In
    1997, DOT provided a $400 million loan for the $2.4 billion Alameda
    Corridor project to leverage funds from ports, railroads, and local
    governments. As a result, a 20-mile trench for trains was constructed to
    eliminate numerous rail-highway crossings and reduce rail transport time
    to and from the ports of Los Angeles and Long Beach-a significant gateway
    for freight imported from Asia and distributed throughout the United
    States. In 2005, Congress provided $100 million to the $1.5 billion
    Chicago Region Environmental and Transportation Efficiency (CREATE)
    program. Its objective is to cut train delays and congestion and improve
    passenger rail service by separating 25 rail-highway crossings, building 6
    passenger/freight train flyovers, and upgrading tracks and controls to
    improve service for the one-third of the nation's rail traffic that comes
    through Chicago each day. Railroads and state and local governments are
    contributing to the program's financing. In 2005, Congress also passed the
    Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy
    for Users (SAFETEA-LU), which increased the authorized level of funds
    available under the Railroad Rehabilitation and Improvement Financing
    (RRIF) program from $3.5 billion to $35 billion over a 5-year period. This
    program provides loans or loan guarantees that are available to states or
    railroads for projects to acquire, improve, or rehabilitate rail
    infrastructure.

    41Railroad flyover bridges separate one set of tracks from another-such as
    freight and passenger trains.

    42DMJM+Harris and HDR (the Consultant Team), Final Report Project No. C
    SWOO-242 Public Benefits & Costs Study of the Proposed BNSF/UP Front Range
    Railroad Infrastructure Rationalization Project (May 18, 2005).

    A number of proposals before Congress would increase federal funding for
    freight railroad projects. One proposal calls for the creation of a
    Railroad Trust Fund that would be similar to the Highway Trust Fund, which
    is used to pay for highway construction and improvements. Another proposal
    calls for a railroad investment tax credit. Under this proposal, railroads
    or shippers would receive a 25 percent tax credit for money spent to
    expand rail infrastructure.

    Federal Response to Freight Investments Should Reflect a National Policy That Is
    Impartial Toward All Modes and Produces Maximum Public Benefits from Public
    Investments

    Federal decision makers face considerable uncertainty about the future of
    freight transportation coupled with considerable certainty that the
    federal deficit will be a long-term constraint on federal investment. At
    the same time, Congress will continue to face policy and funding decisions
    that will affect all freight modes and have a critical impact in shaping
    the nation's rail system and infrastructure. As we have noted in our past
    work,43 a strategic systemwide approach to transportation planning and
    funding that focuses on all modes is increasingly important to meet
    expectations for more efficient freight transport, growing freight demand,
    and more connections between modes.

    Federal funding constraints enhance the need for a strategic federal
    approach to freight infrastructure investment, and the implications of
    these constraints are a critical feature of a national freight policy.
    Given major projected demographic shifts and future federal health and
    retirement commitments, federal revenues may barely cover interest on the
    federal debt by 2040-leaving no money for either mandatory or
    discretionary programs. According to our simulations, balancing the budget
    could require cutting federal spending by as much as 60 percent, raising
    taxes by up to 2-1/2 times their current level, or some combination of the
    two.44 We have concluded that the impending federal fiscal crisis will
    require a fundamental reexamination of all federal programs.45 For
    example, our assessment of the federal highway grant program raised
    significant issues, such as the absence of a clear federal mission and
    role since the completion of the interstate highway system and the absence
    of a link between federal funding and goals or outcome measures.

    DOT has taken an important step toward a more comprehensive freight
    strategy by publishing a draft Framework for a National Freight Policy46
    for comment. It is a step for which we found considerable support among
    public and private freight stakeholders. A systemwide, rather than a
    modal, perspective is critical to a national freight policy. As the AASHTO
    study emphasized, investments at the freight system level are needed to
    respond to nationally significant corridor choke points, intermodal
    connections, and urban rail interchanges.

    43GAO, 21st Century Challenges, GAO-05-325SP (Washington, D.C.: Feb. 1,
    2005), GAO, Freight Transportation: Short Sea Shipping Option Shows
    Importance of Systematic Approach to Public Investment Decisions,
    GAO-05-768 (Washington, D.C.: July 29, 2005), and GAO, Freight
    Transportation: Strategies Needed to Address Planning and Financing
    Limitations, GAO-04-165 (Washington, D.C.: Dec. 19, 2003).

    44GAO, Highway Finance: States' Expanding Use of Tolling Illustrates
    Diverse Challenges and Strategies, GAO-06-554 (Washington, D.C.: Jun. 28,
    2006).

    45 GAO-05-325SP .

    46DOT, (Draft) A Framework for a National Freight Policy, (Washington,
    D.C.: Apr. 10, 2006).

    With federal fiscal constraints as the backdrop, two major policy
    principles will need to be considered as DOT continues to develop this
    national policy. These principles are, first, to adopt a mode-neutral
    approach-one that takes a consistent policy and funding approach to all
    modes and establishes a level playing field for competition in the freight
    marketplace-and, second, to maximize public benefits-particularly benefits
    to the national transportation system-from public transportation
    investments.

      Adopting a Mode-Neutral Approach

    Under a mode-neutral approach, each mode would pay the full costs for the
    infrastructure facilities and services that it used as well as the costs
    that its use imposed on others-such as added air pollution, congestion,
    and accident risks47-through taxes and user fees. No single mode would be
    at a competitive disadvantage. A mode-neutral federal freight policy and
    investment strategy would be consistent with the competitive market's
    central role in the freight system. Encouraging a market-based approach
    and competition that fosters economic efficiency and innovation is a key
    consideration in dealing with the privately owned freight rail industry,
    as we have reported.48

    Currently, as we have pointed out, federal programs treat different
    freight modes differently. For example, trucks and barges use
    infrastructure that is owned and maintained by the government, while rail
    companies use infrastructure that they pay to own and maintain. The
    trucking and barge industries pay fees and taxes to use this
    government-funded infrastructure, but their payments generally do not
    cover the costs they impose on highways and waterways, thereby giving the
    trucking and barge industries a competitive price advantage over
    railroads.49 The most recent Federal Highway Administration (FHWA) highway
    cost allocation study50 evaluates highway costs attributable to different
    vehicle classes and the extent to which their user fees cover their
    responsibility for highway costs. According to the study, combination unit
    trucks51 paid 80 percent of their cost responsibility and the heaviest
    combinations paid half of their cost responsibility. The study concluded
    that only the very lightest combination trucks pay their share of federal
    highway cost responsibility. A recent CBO report52 also concluded that
    trucks and barges do not pay their full share of highway costs and
    reported that rail may be at a competitive disadvantage, since other modes
    are effectively being subsidized. CBO also observed that if all modes do
    not pay their full costs, the result is inefficient use of roads and
    waterways and greater government spending than otherwise would be
    necessary if capacity investments are made in anticipation of demand that
    does not occur.

    47Transportation Research Board/National Research Council, Paying Our Way:
    Estimating Marginal Social Costs of Freight Transportation, National
    Academy Press (Washington, D.C.: 1996).

    48GAO, Physical Infrastructure: Crosscutting Issues Planning Conference
    Report, GAO-02-139 (Washington, D.C.: Oct. 1, 2001).

    49GAO, Railroad Competitiveness: Federal Laws and Policies Affect Railroad
    Competitiveness, GAO/RCED-92-16 (Washington, D.C.: Nov. 5, 1991).

    Maximizing Public Benefits from Public Transportation Investments

    As DOT develops and applies a national freight policy, our second critical
    principle will be an important consideration-public investments should
    depend on clearly defined public benefits.53 Benefit-cost analysis can be
    a useful tool to define benefits, as our expert panel on this subject
    concluded.54 Because this analysis identifies the greatest net benefits by
    comparing the monetary value of each project's benefits and costs, it can
    help public and private stakeholders evaluate project alternatives.

    States have had experience in evaluating whether rail projects could yield
    sufficient public benefits to warrant investments of public dollars in the
    projects, and their experience can inform a national freight policy. For
    example, the state of Washington's Freight Mobility Strategic Investment
    Board leverages transportation dollars by working with public and private
    stakeholders to fund projects that deliver public benefits. The board's
    project scoring criteria reflect anticipated benefits, such as freight
    mobility for the project area; freight mobility for the region, state, and
    nation; general mobility; safety; freight and economic value; environment;
    project partnership; consistency with regional and state plans; location
    on a Strategic Freight Corridor; and cost benefit.

    50DOT/Federal Highway Administration. Office of Transportation Policy
    Studies, Addendum to the 1997 Federal Highway Cost Allocation Study Final
    Report (Washington, D.C.: May 2000).

    51Combination unit trucks are trucks that weigh 50,000-100,000 pounds.

    52CBO, Freight Rail Transportation: Long-Term Issues, p. 22.

    53This observation parallels the conclusion and recommendations by the
    Transportation Research Board (TRB), which called for the development of a
    national policy to promote better management and investment decisions to
    maintain and improve freight capacity. TRB described detailed principles
    to guide future decisions about using, enlarging, funding or regulating
    the freight transportation system. TRB, Freight Capacity for the 21st
    Century, (Washington, D.C.: 2003) pp. 5-13.

    54GAO, Highlights of an Expert Panel: The Benefits and Costs of Highway
    and Transit Investments, GAO-05-423SP (Washington, D.C.: May 6, 2005).

    However, federal decision makers have no such criteria to use in
    considering potential freight rail investments. As we have pointed out,
    the federal funding structure for surface transportation and federal
    program incentives tend to focus decision makers' attention on highway and
    transit projects, rather than on freight or freight rail concerns. And,
    although state and local transportation decision makers consider
    benefit-cost analyses, these analyses often do not have a decisive impact
    on investment decisions.55 As DOT has noted, a fair, balanced approach to
    allocating public and private funding is a prerequisite for public-private
    partnerships.56 We have also raised concerns about federal tax policies.
    For railroads, some industry groups have proposed freight rail tax credits
    to encourage investment. However, our work has shown that it is difficult
    to target tax credits to the desired activities and outcomes and ensure
    that tax credits generate the desired new investments, as opposed to
    substituting for investment that would have occurred anyway.57

                                      Conclusions

    The Staggers Rail Act achieved far-ranging benefits in helping to create
    and sustain a healthy and vibrant freight railroad industry, as well as an
    efficient rail transportation system that supports the important role
    freight plays in the nation's economy. Critical to the Staggers Rail Act
    was the concept of balance-on one hand, the act sought to allow rail
    carriers to earn adequate revenues so that they could meet their current
    and future capital needs. On the other hand, the act recognized the need
    for a remnant regulatory regime that would maintain reasonable rates and
    prohibit undue concentrations of market power in areas where no effective
    competition existed. The act recognized that it was vital for the federal
    government to promote competition and rely on it to set rates. Without a
    doubt, rates have decreased for most shippers, and most shippers are
    better off in the post-Staggers environment than they were previously.
    This outcome suggests that widespread and fundamental changes to the
    relationship between the railroads and their customers are not needed.
    Nevertheless, the evidence also suggests some basis for believing
    that-more than 25 years after the act's passage-the balance it envisioned
    has not been fully achieved.

    55GAO, Surface Transportation: Many Factors Affect Investment Decisions,
    GAO-04-744 (Washington, D.C.: Jun. 30, 2004).

    56U.S. Department of Transportation, Report to Congress on Public-Private
    Partnerships (Washington, D.C.: December 2004).

    57GAO, Government Performance and Accountability: Tax Expenditures
    Represent a Substantial Federal Commitment and Need to be Reexamined,
    GAO-05-690 (Washington, D.C.: Sept. 23, 2005).

    The continued existence of pockets of potential captivity, together with
    the increase in traffic at higher thresholds, at a time when the railroads
    are, for the first time in decades, experiencing increasing economic
    health, raises the question whether rail rates in selected markets reflect
    justified and reasonable pricing practices, or an abuse of market power by
    the railroads. Answering this question requires a rigorous, national
    analysis of competitive markets. Our analysis provides an important first
    step; however, we are constrained by the inherent limitations of the
    Carload Waybill Sample and the available proxy measures for assessing
    captivity. In contrast, STB has the statutory authority to inquire into
    and report on railroad practices and could conduct a rigorous analysis of
    competition in the freight rail industry that would rely on more than
    sample data and could determine whether the inappropriate exercise of
    market power is occuring in specific markets. Should STB find evidence of
    abuse, it could consider several methods for creating the balance
    envisioned by the Staggers Rail Act. For example, STB could consider
    initiating a generally applicable rule making to address competition
    issues or prescribe specific remedies in response to a complaint.

    In assessing competition within the freight rail industry, STB needs
    accurate data on railroad revenues. The data that STB currently
    collects-in particular, the use of the Carload Waybill Sample to report on
    the railroads' finances-are not always captured consistently, making it
    difficult to accurately track railroad revenues. Specifically, while we
    determined that, in general, the data in the Waybill were suitably
    reliable for our reporting purposes, we also found that some data,
    including data on fuel surcharges, were not accurately captured. Accurate
    data would provide for more accurate tracking of railroad revenues and
    railroad charges to potentially captive shippers and other shippers. This
    information would help STB to obtain a clearer picture of the actual fees
    paid by shippers.

    STB is also responsible for ensuring the expeditious handling and
    resolution of rate disputes, but the current process for settling these
    disputes is ineffective. There are a number of potential alternatives to
    the current process, and STB has recognized the limits of the process and
    taken further action to improve it. These actions are commendable and need
    to be pursued; absent further action, the promise of the Staggers Rail Act
    and the balance it envisioned may never be fully realized.

    These are difficult issues that require careful balancing of the
    railroads' need to earn adequate revenues with shippers' need for
    competition and reasonable rates during a time of uncertainty about the
    capacity of freight railroads to meet future demand for freight rail
    service. While predictions and scenarios for the future of freight rail
    vary, it is likely that multiple levels of government will continue to be
    involved in the nation's freight system. Additional investment in freight
    rail infrastructure can produce public benefits, and many state and local
    governments are involved in freight rail infrastructure projects. Congress
    has provided federal assistance as well, and further requests for and
    decisions about federal assistance to rail infrastructure are likely.
    Decision makers will be challenged to ensure that federal involvement is
    consistent with competition in the freight marketplace, reflects
    widespread public priorities, and offers benefits that warrant the
    commitment of federal funds. DOT's draft National Freight Policy
    represents a good start in this direction.

                          Recommendations for Executive Action

    To ensure an appropriate balance between the interests of railroads and
    shippers, we recommend that the Chairman of the Surface Transportation
    Board take the following two actions:

               o  Undertake a rigorous analysis of competitive markets to
               identify the state of competition nationwide; in specific markets,
               determine whether the inappropriate exercise of market power is
               occuring; and, where appropriate, consider the range of actions
               available to address problems associated with the potential abuse
               of market power. If the Chairman determines that STB requires more
               resources to conduct this analysis, then STB should request
               additional resources from Congress.

               o  Review STB's method of data collection to ensure that all
               freight railroads are consistently and accurately reporting all
               revenues collected from shippers, including fuel surcharges and
               other costs not explicitly captured in all railroad rate
               structures.

               To ensure the efficiency and effectiveness of our nation's freight
               system, we are making the following recommendation to the
               Secretary of Transportation:

               o  As DOT continues to develop a national freight policy and a
               possible federal policy response, consider strategies to (1)
               sustain the role of competitive market forces by creating a level
               playing field for all freight modes and (2) recognize the fiscally
               constrained federal funding environment by developing mechanisms
               to assess and maximize public benefits from federally financed
               freight transportation investments.

               Agency Comments and Our Evaluation

               STB provided written comments on a draft of this report. These
               comments are presented and evaluated in appendix III. STB
               generally agreed with our assessment of the improving financial
               health of the freight railroad industry and potential public
               benefits for freight rail infrastructure projects. However, STB
               disagreed with our recommendation to undertake a rigorous analysis
               of competitive markets in the rail industry because it believed
               the findings underlying the recommendation were inconclusive,
               their on-going efforts will address many of our concerns, and a
               rigorous analysis would divert resources from other efforts.
               Specifically, STB stated that our recommendation was based on two
               findings-first, that rail rates have increased for some shippers
               and, second, that the amount of traffic with rates reflecting high
               R/VC ratios has increased in some areas. STB stated that recent
               increases in rail rates are not surprising and that R/VC ratios
               can increase when rates and costs are falling and that these
               findings do not suggest market abuses. STB also noted that it has
               several rule makings under way related to the standard rate relief
               process and the simplified rate relief process. STB suggested
               that, given the limitations on its resources and the aggressive
               agenda already under way, rather than undertake this competitive
               markets analysis, a more practical approach would be for STB to
               finish its reforms to ensure that captive shippers have an
               effective forum to seek rate relief if a railroad is charging
               unreasonable rates. Concerning our recommendation that STB review
               its method of data collection to ensure that all freight railroads
               are consistently and accurately reporting all revenues collected
               from shippers, STB stated that the revenue in question represents
               a small portion of all revenues and that revenue data submitted by
               freight railroads are audited and otherwise checked to ensure
               quality. Furthermore, STB has initiated a rule making to improve
               the tracking of fuel surcharges.

               While STB's efforts have been helpful, we continue to believe that
               STB should undertake a rigorous analysis of competitive markets to
               identify the state of competition nationwide; in specific markets,
               determine whether the inappropriate exercise of market power is
               occuring; and, where appropriate, consider the range of actions
               available to address problems associated with the potential abuse
               of market power. STB's comments do not accurately characterize the
               underlying support for our recommendation. We did not base this
               recommendation on an increase in rail rates or suggest that rate
               increases alone suggest increased captivity. On the contrary, we
               recognize that rates have declined and that available measures
               suggest that the extent of captivity has dropped. Furthermore,
               STB's response suggests that rail rates and the amount of traffic
               with high R/VC ratios were the only data we examined-they were
               not. We examined several factors, including data on the amount of
               tonnage originating in economic areas that have access to only one
               Class I railroad, data on the amount of tonnage traveling over 300
               percent R/VC, and the amount of tonnage that originates in areas
               with access to only one Class I railroad and travels at rates that
               exceed the statutory threshold for rate relief. Our report
               explicitly acknowledges the limitations in the Carload Waybill
               Sample and of the proxy measures available for weighing captivity,
               including R/VC levels. At the same time, our analyses, when
               combined with comments from participants on our expert panel and
               interviews with shipper and railroad groups, suggest a reasonable
               possibility that shippers in selective markets may be paying
               excessive rates related to a lack of competition. This provides
               the impetus for STB-which has the statutory authority to inquire
               into and report on railroad practices-to analyze competitive
               markets in the rail industry and, where appropriate, consider the
               range of actions to address problems associated with the potential
               abuse of market power. Also, this analysis would rely on more than
               sample data and could analyze the exercise of market power in
               specific markets.

               Regarding STB's position that it has several rule makings under
               way that address many of our concerns, we commend STB for
               recognizing and taking action to address problems with the rate
               relief process, but we believe action is needed beyond
               improvements to the rate relief process. These rule makings, if
               implemented, are designed to improve the processes available to
               shippers, after shippers have been charged a rate that they
               consider to be unreasonable. In contrast, we believe that an
               analysis of the state of competition and the possible abuse of
               market power, along with the range of options STB has to address
               competition issues, could more directly further legislatively
               defined goals to ensure effective competition among rail carriers
               as the preferred means to both promoting a sound rail
               transportation system and maintaining reasonable rates. Regarding
               STB's assertion that conducting a rigorous analysis of competition
               would divert resources away from its on-going initiatives, we
               modified our draft to recommend that STB request additional
               resources from Congress if it determines it needs more resources
               to conduct an analysis of competition. We also believe that STB
               should review its method of data collection to ensure that all
               freight railroads are consistently and accurately reporting all
               revenues. STB commented that it had already responded to this
               concern by proposing a standardized report for fuel surcharges;
               however, while we commend STB for its efforts to capture these
               data, we also note STB has not yet implemented standardized
               reporting of fuel surcharges and that other revenues besides fuel
               surcharges may not be included in the Waybill. STB also provided
               technical comments that we incorporated in this report, as
               appropriate.

               We requested comments on a draft of this report from the Acting
               Secretary of Transportation or her representative. On September
               21, 2006, DOT officials, including the Deputy Associate
               Administrator for Policy, Federal Railroad Administration, and the
               Chief Economist, Office of Transportation Policy, Office of the
               Secretary, provided us with oral comments on the draft. In its
               comments, DOT emphasized the need for the report to clearly
               recognize the rationale and importance of differential pricing;
               the nature and relatively small extent of potentially unreasonable
               pricing in the rail freight marketplace; and the impact of
               capacity constraints on rail pricing and services. DOT also
               suggested that our report should recognize certain factors,
               including that competition between railroads is not possible in
               all markets because the level of demand may not support more than
               one railroad, and that investment in freight rail infrastructure
               entails substantial private risk. In contrast, highway investment
               has been largely publicly financed. DOT did not take a position on
               our recommendation concerning the draft National Freight Policy,
               but stated that efforts are under way to develop more effective
               tools for gauging the extent to which proposed freight investments
               provide public benefits. DOT also endorsed the views contained in
               STB's September 15, 2006, letter (see app. III). We made changes
               to this report to reflect DOT's comments, as appropriate. DOT also
               provided a number of technical corrections, which we incorporated
               as appropriate.

               We will send copies to the appropriate congressional committees,
               the Chair and Vice-Chairs of the Surface Transportation Board, and
               the Secretary of Transportation. We will also make copies
               available to others on request. In addition, the report will be
               available at no charge on the GAO Web site at http://www.gao.gov.

               If you or your staff has any questions, please contact me at (202)
               512-2834 or heckerj@gao.gov . Contact points for our Offices of
               Congressional Relations and Public Affairs may be found on the
               last page of this report. See appendix V for a list of major
               contributors to this report.

               JayEtta Z. Hecker Director, Physical Infrastructure Issues

               List of Congressional Requesters

               The Honorable Daniel K. Inouye Co-Chairman, Committee on Commerce,
               Science, and Transportation United States Senate

               The Honorable Conrad Burns United States Senate

               The Honorable Byron Dorgan United States Senate

               The Honorable Frank Lautenberg United States Senate

               The Honorable Trent Lott United States Senate

               The Honorable John McCain United States Senate

               The Honorable Mark Pryor United States Senate

               The Honorable Gordon Smith United States Senate

    			  Appendix I: Participants in GAO�s Expert Panel

               Louis S. Thompson (Moderator) Principal Thompson, Galenson and
               Associates, LLC

               Paul Bingham Global Insights

               George Borts Department of Economics Brown University

               George Eads Vice President CRA International

               Robert Gallamore Director Transportation Center Northwestern
               University

               Darius Gaskins Founding Partner Norbridge, Inc.

               Carl Martland Senior Research Associate Massachusetts Institute of
               Technology Department of Civil and Environmental Engineering

               Michael F. McBride Partner LeBouef, Lamb, Greene & MacRae, LLP

               Gerard McCullough Department of Applied Economics University of
               Minnesota

               Linda Morgan Chair of the Transportation Practice Group Covington
               & Burling, LLP

               John V. Wells Chief Economist U.S. Department of Transportation

               Appendix II: Objectives, Scope, and Methodology

               We used the Surface Transportation Board's (STB) Carload Waybill
               Sample to identify railroad rates from 1985 through 2004 (the
               latest rate data available at the time of our review), which we
               then analyzed to determine rate changes. The Carload Waybill
               Sample is a sample of railroad waybills (in general, documents
               prepared from bills of lading authorizing railroads to move
               shipments and collect freight charges) submitted by railroads
               annually. We used these data to obtain information on rail rates
               across the industry, for certain commodities and for certain
               routes by shipment size and length of haul. According to STB
               officials, revenues derived from the Carload Waybill Sample are
               not adjusted for such things as year-end rebates and refunds that
               may be provided by railroads to shippers that exceed certain
               volume commitments.

               Some railroad movements contained in the Carload Waybill Sample
               are governed by contracts between shippers and railroads. To avoid
               disclosure of confidential business information, STB disguises the
               revenues associated with these movements before making this
               information available to the public. Consistent with our statutory
               authority to obtain agency records, we obtained a version of the
               Carload Waybill Sample that did not disguise revenues associated
               with railroad movements made under contract. Therefore, the rate
               analysis presented in this report presents a truer picture of rail
               rate trends than analyses that may be based solely on publicly
               available information. Since much of the information contained in
               the Carload Waybill Sample is confidential, rail rates and other
               data contained in this report that were derived from this database
               have been aggregated at a level sufficient to protect this
               confidentiality.

               We used rate indexes and average rates to measure rate changes
               over time. A rate index attempts to measure price changes over
               time by holding constant the underlying collection of items that
               are consumed (in the context of this report, items shipped). This
               approach differs from comparing average rates in each year
               because, over time, higher- or lower-priced items can constitute
               different shares of the items consumed. Comparing average rates
               can confuse changes in prices with changes in the composition of
               the goods consumed. In the context of railroad transportation,
               rail rates and revenues per ton-mile are influenced, among other
               things, by the average length of haul. Therefore, comparisons of
               average rates over time can be influenced by changes in the mix of
               long- and short-haul traffic. Our rate indexes attempted to
               control for the distance factor by defining the underlying traffic
               as 2004 commodity flows between pairs of census regions. To
               examine the rate trends on specific traffic corridors, we first
               chose a level of geographic aggregation for corridor end points.
               We defined end points as the regional economic areas defined by
               the Department of Commerce's Bureau of Economic Analysis. An
               economic area is a collection of counties in and about a
               metropolitan area (or other center of economic activity); there
               are 179 economic areas1 in the United States, and each of the
               nation's 3,141 counties is included in an economic area.2 We
               placed each corridor in one of three distance-related categories:
               0 to 500 miles, 501 to 1,000 miles, and more than 1,000 miles.
               Although these distance categories are somewhat arbitrary, they
               represent reasonable proxies for short-, medium-, and
               long-distance shipments by rail.

               To determine the areas with access to one or more Class I
               railroads, we obtained railroad systems data from the Department
               of Transportation, which accounted for trackage rights, mergers,
               and other industry developments affecting access. For issues
               related to revenue-to-variable cost ratios, we used data from the
               Carload Waybill Sample to identify the specific revenues and
               variable costs and to compute R/VC ratios for the commodities and
               markets we examined. Using this information, we then identified
               those commodities and areas whose R/VC ratios were above or below
               the 180 percent R/VC level, as well as those areas above the 300
               percent R/VC level.

               To identify the actions STB has taken to address competition and
               captivity concerns, we interviewed officials and reviewed
               information from all seven North American Class I railroads,
               several shipper groups and associations and STB officials; and we
               met with experts in the railroad industry. We reviewed
               characteristics of STB's current rate relief process, as well as
               changes STB has made to the process, and conducted a comprehensive
               analysis of STB cases since 2000. We also held an expert panel
               through the National Academy of Sciences, consisting of 11
               individuals with expertise in the freight railroad industry and
               the economics of transportation deregulation. Moreover, we
               conducted a legal analysis of current statutes related to STB's
               authority. To discern potential alternatives, we reviewed pending
               legislation, testimonies before Congress, previous GAO reports,
               STB decisions, rule makings, and proposed rule makings, and
               conducted a summary analysis of interviews.

               To assess future freight demand and the freight railroad
               industry's ability to meet such demand, we reviewed transportation
               planning literature and forecasts of future freight rail demand
               and capacity in the United States. This review also included state
               freight plans and major freight rail projects. We synthesized
               information on freight and freight rail, as well as various
               forecasts to identify similar and dissimilar themes. We also
               reviewed involvement by the federal government in freight railroad
               projects, including related legislation and funding decisions. We
               interviewed several state and federal transportation officials to
               gather further information on public-private partnerships, freight
               railroad projects, and DOT's draft National Freight Policy. We
               also interviewed freight railroad representatives, financial
               market analysts, national association representatives, and
               transportation experts. For selected public-private partnerships,
               we analyzed the genesis of such projects, motivations for
               involvement from the public and private sectors, and benefit-cost
               analyses that were conducted to support project funding decisions.

               We determined that the data used in this report were sufficiently
               reliable for the purpose of our review. We conducted our review
               from June 2005 to August 2006 in accordance with generally
               accepted government auditing standards.

    			  Appendix III: Comments from the Surface Transportation Board

               The following are GAO's comments on the Surface Transportation
               Board's letter dated September 15, 2006.

    			  Note: GAO comments supplementing those in the report text appear at the
    end of this appendix.

    See comment 1.

    See comment 4.

    See comment 2.

    See comment 3.

    See comment 8.

    See comment 5 and 6.

    See comment 7.

    See comment 10.

    See comment 6.

    See comment 9.

    See comment 8.

                                      GAO Comments

                            1. STB commented that we conducted a national study
                            into the state of competition. We did not conduct
                            such a study. Our study included a broad focus on
                            changes in the freight railroad industry since the
                            Staggers Rail Act, the actions STB has taken to
                            address concerns about competition and captivity, and
                            future freight demand and capacity. The data we
                            collected and analysis we performed-such as a review
                            of rate changes over 20 years-were too broad to
                            represent a national study of the state of
                            competition. It is the limitations in the scope of
                            our analysis of competition, along with limitations
                            in the data available to us and a reasonable
                            possibility that shippers in selected markets may be
                            paying excessive rates, which led us to recommend
                            that STB conduct a more rigorous analysis of
                            competition.
                            2. STB commented that it has already addressed our
                            recommendation to improve data collection by
                            proposing standardized monthly reports of fuel
                            surcharges and also described its efforts to ensure
                            the accuracy and reliability of data in the Waybill.
                            We commend STB for its recent action on fuel
                            surcharges, which occurred during our review, but we
                            also note STB has not yet implemented standardized
                            reporting of fuel surcharges. In addition, other
                            revenues besides fuel surcharges may not be included
                            in the Waybill. Specifically, revenues generated
                            through railcar auctions and congestion fees may not
                            be included. While the reported miscellaneous revenue
                            is a small percentage of all revenue, it is not known
                            how much miscellaneous revenue is not reported.
                            Complete data would provide for more accurate
                            tracking of railroad revenues and would help STB to
                            obtain a clearer picture of actual fees paid by
                            shippers. While we commend STB for its actions to
                            audit and review Waybill data, these accuracy checks
                            do not address our concern that STB is not collecting
                            the full range of revenue data.
                            3. STB commented that our recommendation for STB to
                            conduct an analysis of competition is based on two
                            findings-that rail rates have increased since 1980
                            and that the amount of traffic with high R/VC ratios
                            has increased in some areas. Our recommendation is
                            not based on these two findings, but on an analysis
                            of multiple sources, such as data on the amount of
                            tonnage originating in economic areas that have
                            access to only one Class I railroad, data on the
                            amount of tonnage traveling over 300 percent R/VC,
                            and the amount of tonnage that originates in areas
                            with access to only one Class I railroad and travels
                            at rates that exceed the statutory threshold for rate
                            relief. This analysis provides an important first
                            step in assessing competitive markets nationally; but
                            it is imperfect, given the limitations of measures

                            used to weigh captivity and limitations in the
                            Carload Waybill Sample. The results of our analysis,
                            when combined with comments from participants on our
                            expert panel and interviews with shipper and railroad
                            groups, suggest a reasonable possibility that
                            shippers in selective markets may be paying excessive
                            rates related to a lack of competition in these
                            markets. It is precisely the inconclusiveness of the
                            available data-and STB's authority and responsibility
                            to monitor and ensure effective competition in the
                            freight rail industry-that led us to recommend a
                            rigorous analysis of competition by STB. Also, we
                            examined rates since 1985, not 1980.
                            4. STB commented that an increase in rates does not
                            suggest market abuses and that the rate changes in
                            our report were not adjusted for inflation. We agree
                            that a change in a rate does not necessarily suggest
                            the exercise of market power. While our rates were
                            not adjusted for inflation, we constructed rate
                            indexes, which account for changes in traffic
                            patterns over time that could affect revenue
                            statistics. We also included the price index for the
                            GDP to provide a measure for inflation. However, our
                            recommendation is not based on recent rate increases.
                            Our recommendation is based on our analyses of
                            multiple sources, such as data on the amount of
                            tonnage originating in economic areas that have
                            access to only one Class I railroad, data on the
                            amount of tonnage traveling over 300 percent R/VC,
                            and the amount of tonnage that originates in areas
                            with access to only one Class I railroad and travels
                            at rates that exceed the statutory threshold for rate
                            relief.
                            5. STB commented that figure 19 shows an increase in
                            grain traffic which traveled at rates above 300
                            percent R/VC and figure 9 shows that grain rates per
                            ton-mile had fallen along that same route, so the
                            change in R/VC must be due to a drop in costs per
                            ton-mile. We disagree that the change in R/VC in
                            figure 19 must be due to a drop in costs per
                            ton-mile. Figure 19 shows only the amount of traffic
                            on the route that traveled at rates above 300 percent
                            R/VC, while figure 9 shows the cents per ton-mile for
                            all traffic along that route (not just traffic that
                            traveled at rates above 300 percent R/VC). Therefore,
                            the decrease in cents per ton mile shown in figure 9
                            may reflect a decrease in rates for traffic along
                            that route that traveled at rates below 300 percent
                            R/VC.
                            6. STB commented that the measures used in our
                            analysis are not conclusive. The fact that our
                            analysis is inherently limited by available data and
                            proxy measures lends more weight to our
                            recommendation. Specifically, our analysis provides
                            an important first step in assessing competitive
                            markets nationally, but it is imperfect given the
                            limitations of measures used to weigh captivity and
                            limitations in the Carload Waybill Sample. We do not
                            conclusively state that there are shippers who are
                            captive to one railroad and paying rates that reflect
                            an abuse of market power. However, the results of our
                            analysis, when combined with comments from
                            participants on our expert panel and interviews with
                            shipper and railroad groups, suggest a reasonable
                            possibility that shippers in selective markets may be
                            paying excessive rates related to a lack of
                            competition in these markets. We believe that STB is
                            the agency that has the authority and responsibility
                            to conduct an inquiry into the potential abuse of
                            market power and utilize its range of options to
                            address competition issues.
                            7. STB commented that R/VC levels do not provide a
                            reliable measure of changes in captivity because they
                            can increase when rates are falling. We agree that an
                            analysis of R/VC levels is not a conclusive measure
                            of the use of market power. However, the use of R/VC
                            as an indicator of railroad pricing power is
                            well-documented both by Congress in the Staggers Rail
                            Act and by STB, which uses R/VC levels in its process
                            for determining unreasonable rates. While we
                            acknowledge the limitations of the ratio in our
                            report, and even include an example like the one
                            cited above, we believe that R/VC ratios can be used
                            as one of several proxy measure to determine
                            potential captivity. In fact, STB refers to traffic
                            traveling at or above 180 percent R/VC as
                            "potentially captive."
                            8. STB commented that they have several important
                            rule makings under way which bear directly on our
                            concerns, including changes to the standard and
                            simplified rate relief processes. While we commend
                            STB for taking action to improve its rate relief
                            processes, we note that these rule makings are
                            designed to make changes to the standard and
                            simplified rate relief processes and are not designed
                            to analyze the state of competition or the possible
                            abuse of market power. In contrast, we believe that
                            an analysis of the state of competition or the
                            possible abuse of market power, along with the range
                            of options STB has to address competition issues,
                            could more directly further legislatively defined
                            goals to ensure effective competition among rail
                            carriers as the preferred means to both promoting a
                            sound rail transportation system and maintaining
                            reasonable rates.
                            9. STB commented that it is hesitant to divert
                            resources away from its pending initiatives to
                            respond to our recommendation. We have modified our
                            draft to recommend that, if STB determined that it
                            needs more resources to undertake a rigorous analysis
                            of competitive markets to identify the state of
                            competition nationwide, it should request additional
                            resources from Congress.
                            10. STB commented that, as a small agency, a more
                            practical approach to addressing concerns about
                            captive shippers would be for STB to continue
                            reforming its rate complaint procedures, rather than
                            conduct another analysis. While we commend STB for
                            continuing its efforts to improve its standard and
                            simplified rate relief processes, these rule makings
                            will not address our concerns. Specifically, these
                            rule makings are designed to improve processes
                            available to shippers after they have been charged a
                            rate they consider to be unreasonable; these rule
                            makings are not designed to analyze the state of
                            competition or the possible abuse of market power. In
                            contrast, we believe that an analysis of the state of
                            competition or the possible abuse of market power,
                            along with the range of options STB has to address
                            competition issues, could more directly further
                            legislatively defined goals to ensure effective
                            competition among rail carriers as the preferred
                            means to both promoting a sound rail transportation
                            system and maintaining reasonable rates. We believe
                            that STB is the agency that is uniquely positioned to
                            inquire into and report on railroad practices and
                            could conduct an analysis of competition that would
                            rely on more than sample data and could determine
                            whether the inappropriate exercise of market power is
                            occuring in specific markets. STB has the authority
                            to subpoena witnesses and records. Following its
                            inquiry, STB could also consider initiating a
                            generally applicable rule making to address
                            competition issues or prescribe specific remedies in
                            response to a complaint. We recognize that STB has
                            limited resources, and we have modified our draft to
                            recommend that, if STB determines that it needs more
                            resources to conduct an analysis of competition, it
                            should request additional resources from Congress.

    			  Appendix IV: GAO Contact and Staff Acknowledgments

               GAO Contact

    			  JayEtta Z. Hecker, (202) 512-2834

               Staff Acknowledgments

               In addition to those named above, individuals making key
               contributions to this report include Ashley Alley, Steve Brown,
               Matthew T. Cail, Sheranda S. Campbell, Steve Cohen, Elizabeth
               Eisenstadt, Libby Halperin, Richard Jorgenson, Tom McCool, John
               Mingus, Josh Ormond, and John W. Shumann.

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               Railroad Regulation: Economic and Financial Impacts of the
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               Railroad Revenues: Analysis of Alternative Methods to Measure
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               Shipper Rail Rates: Interstate Commerce Commission's Handling of
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    1Our analysis included 177 economic areas because we did not include the
    two economic areas in Alaska and Hawaii.

    2The Bureau of Economic Analysis updated definitions of each economic area
    in November 2004.

    (544105)

    www.gao.gov/cgi-bin/getrpt? GAO-07-94 .

    To view the full product, including the scope
    and methodology, click on the link above.

    For more information, contact JayEtta Z. Hecker at (202) 512-2834 or
    heckerj@gao.gov.

    Highlights of GAO-07-94 , a report to congressional requesters

    October 2006

    FREIGHT RAILROADS

    Industry Health Has Improved, but Concerns about Competition and Capacity
    Should Be Addressed

    The Staggers Rail Act deregulated the freight rail industry, relying on
    competition to set rates, and allowed for differential pricing (charging
    higher rates to those more dependent on rail). The act gave the Surface
    Transportation Board (STB) authority to develop remedies for
    shippers"captive" to one railroad and set a threshold for shippers to
    apply for rate relief. GAO was asked to review (1) changes in the railroad
    industry since the Staggers Rail Act, including rates and competition; (2)
    STB actions to address competition and captivity concerns and alternatives
    that could be considered; and (3) freight demand and capacity projections
    and potential federal policy responses. GAO examined STB data, conducted
    interviews, and held an expert panel.

    What GAO Recommends

    GAO recommends that STB analyze the state of competition and consider
    appropriate actions. GAO also recommends that DOT consider strategies to
    level the playing field for all freight modes to maximize public benefits
    from federal investment. STB disagreed with our recommendation because it
    would take resources from efforts it believes will address GAO concerns,
    among other reasons. We recognize STB's efforts, but believe further
    analysis is needed. STB should seek more resources from Congress if
    needed. DOT took no position on our recommendation.

    Changes in the railroad industry since the Staggers Rail Act are widely
    viewed as positive, as the industry's financial health has improved and
    most rates have declined; however, concerns over competition and captivity
    remain. Rail rates generally declined between 1985 and 2000, then
    increased slightly from 2001 through 2004. Concerns about competition and
    captivity remain as traffic is concentrated in fewer railroads. It is
    difficult to determine the number of "captive" shippers as proxy measures
    can overstate or understate captivity. Nevertheless, GAO's analysis of
    limited available measures indicates that the extent of captivity appears
    to be dropping, but the percentage of traffic traveling at rates
    substantially over the threshold for rate relief has increased. Also, some
    areas with access to only one major railroad have higher percentages of
    traffic traveling at rates above the threshold. These findings may reflect
    reasonable economic practices by the railroads or a possible abuse of
    market power. GAO's analysis is limited by available data and proxy
    measures but suggests that shippers in selected markets may be paying
    excessive rates, meriting further inquiry and analysis.

    While STB has taken action, further efforts to improve its rate relief
    processes and assess competition could help address competition and
    captivity concerns and inform the merits of proposed alternative
    approaches. STB's rate relief processes are largely inaccessible and
    rarely used. STB recognizes this and is taking steps to improve its
    processes. STB has broad statutory authority to inquire into and report on
    railroad industry practices and, given a reasonable possibility that some
    shippers may be paying excessive rates, an assessment of competition could
    determine whether there is sufficient evidence that market power is being
    abused in specific markets. While competition between railroads may not
    always be feasible, alternative approaches have costs and benefits that
    should be carefully considered to ensure the balance envisioned in the
    Staggers Rail Act-including the railroads' need for adequate revenues.

    Significant increases in freight traffic are forecast, and the industry's
    ability to meet them is largely uncertain. Investments in rail projects
    can produce public benefits, such as reducing highway congestion. As a
    result, federal and state governments have increasingly participated in
    freight rail projects. In 2005, for example, Congress provided $100
    million for rail improvements in the Chicago area. Congress faces
    additional decisions about potential federal policy responses in years
    ahead. Responses should recognize that the freight transportation system
    includes many modes that are treated differently by the federal government
    and functions in a competitive marketplace and a constrained federal
    funding environment. In developing a National Freight Policy, the
    Department of Transportation (DOT)has made a good start by providing
    context for those decisions and DOT can help sustain the role of the
    competitive marketplace through strategies that promote a level playing
    field for freight transportation decision making and acknowledge the
    constrained federal fiscal environment by focusing federal involvement
    where demonstrable, wide-ranging public benefits exist.
    *** End of document. ***