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

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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

           Railroadsï¿½ 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 [email protected] . 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 GAOï¿½s 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.
			  
			  Related GAO Products

           Freight Railroads: Preliminary Observations on Rates, Competition,
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           Freight Transportation: Short Sea Shipping Option Shows Importance
           of Systematic Approach to Public Investment Decisions. GAO-05-768
           . Washington, D.C.: July 29, 2005.

           Freight Transportation: Strategies Needed to Address Planning and
           Financing Limitations. GAO-04-165 . Washington, D.C.: December 19,
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           Railroad Regulation: Changes in Freight Railroad Rates from 1997
           through 2000. GAO-02-524 . Washington, D.C.: June 7, 2002.

           Freight Railroad Regulation: Surface Transportation Board's
           Oversight Could Benefit from Evidence Better Identifying How
           Mergers Affect Rates. GAO-01-689 . Washington, D.C.: July 5, 2001.

           Railroad Regulation: Current Issues Associated with the Rate
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           1999.

           Railroad Regulation: Changes in Railroad Rates and Service Quality
           Since 1990. GAO/ RCED-99-93 . Washington, D.C.: April 6, 1999.

           Interstate Commerce Commission: Key Issues Need to Be Addressed in
           Determining Future of ICC's Regulatory Functions.
           GAO-T-RCED-94-261 Washington, D.C.: July 12, 1994.

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

           Railroad Regulation: Economic and Financial Impacts of the
           Staggers Rail Act of 1980. GAO/RCED-90-80 . Washington, D.C.: May
           16, 1990.

           Railroad Regulation: Shipper Experiences and Current Issues in ICC
           Regulation of Rail Rates. GAO/ RCED-87-119 . Washington, D.C.:
           September 9, 1987.

           Railroad Regulation: Competitive Access and Its Effects on
           Selected Railroads and Shippers. GAO/ RCED-87-109 , Washington,
           D.C.: June 18, 1987.

           Railroad Revenues: Analysis of Alternative Methods to Measure
           Revenue Adequacy. GAO/ RCED-87-15BR . Washington, D.C.: October 2,
           1986.

           Shipper Rail Rates: Interstate Commerce Commission's Handling of
           Complaints. GAO/RCED-86-54FS . Washington, D.C.: January 30, 1986.
			  
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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
[email protected].

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. ***