NGFA Files Comments With Surface Transportation Board on Revenue Adequacy

By Max Fisher

Vice President of Economics and Government Relations

Arlington, VA — National Grain and Feed Association (NGFA) and a coalition of shipper associations filed on May 17 a financial study and opening comments on a proposal brought forward by Union Pacific, Norfolk Southern and Canadian National to change the Surface Transportation Board’s (STB) procedures for determining revenue adequacy of Class I rail carriers.

STB currently defines annual revenue adequacy as the carrier’s rate of return on investment (ROI) that equals or exceeds the rail industry’s cost of capital (COC).

The joint carriers propose to redefine revenue adequacy to equal or exceed the ROI - COC spread for at least half of the S&P 500 firms.

Revenue adequacy is a prerequisite before the reasonableness of a carrier’s rail rates can be challenged.

In recent years, several individual carriers have achieved STB’s revenue adequacy standard, qualifying their rates for challenge in markets where they have market dominance.

This potential for rate challenge has provided an incentive for the joint carriers to request a change to the revenue adequacy methodology.

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NGFA and the joint shippers said STB should continue to judge revenue adequacy by ROI = COC. They said a company that maintains ROI = COC is perfectly able to cover all costs, fund growth, repay debts, attract investors and provide them with a competitive return on their investment.

In addition, NGFA and the joint shippers said substituting replacement costs for book values is unnecessary and undesirable for determining revenue adequacy.

Maintaining ROI = COC guarantees an attractive return on the investments that are made to replace assets or to expand the business. Such investments would enter the books at their current replacement costs as they are acquired.

Changing the revenue adequacy calculation would clear the way for carriers to exert more market power and further raise rail rates in markets lacking effective competition.

NGFA and the joint shippers said all Class I railroads had very strong shareholder returns and free cash flow over the past decade while at the same time made significant capital investments, paid dividends, and repurchased stock.

Those metrics demonstrate the ability of the railroads to fulfill each of the factors that comprise the statutory definition of revenue adequacy.

Further, NGFA and the joint shippers said if there is anything to criticize about the STB’s application of the ROI = COC standard, it is the overstatement of COC, rather than an understatement of ROI, that warrants correcting because it has created too high of a bar for obtaining revenue adequacy.

If the STB’s estimate of the cost of capital is too high, then it also overstates both the railroads’ revenue adequacy needs and the amount of differential pricing that is necessary to ensure a financially sound carrier at the expense of fairness and economic efficiency.

As part of STB’s COC calculation, it uses the market risk premium (MRP), which represents the rate of return that investors could expect to earn by investing in the stock market compared to the prevailing risk-free return available from investing in the bond market.

A variety of techniques have emerged to estimate it, but none can claim to be definitive and generally accepted. The technique STB uses appears to be excessively high.

For example, the STB used an MRP of 7.15 percent in 2019. For reference, Institutional Shareholder Services, the world’s leading provider of corporate governance, uses an MRP of 4 percent. A 3.15 percent overstated cost of equity (7.15 percent minus 4 percent), provides at least a 2 percent overstatement of the weighted COC if 75 percent is weighted in the capital structure and 25 percent in debt.

Thus, while the joint carriers are proposing to raise the bar for revenue adequacy, it may be the bar already is too high and should be lowered, the shippers stated.

- From the May 21 NGFA Newsletter

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