Surface Transportation Board Proposes Revising Railroad Cost of Capital Methodology

Implications: The Surface Transportation Board has proposed to change its methodology for calculating the railroad industry cost of capital.  The cost of capital is used for several regulatory purposes.  Lowering the cost of capital, as proposed by the agency, could increase the rate relief available to captive shippers.

Analysis:  On August 14, 2007, the Surface Transportation Board (STB) issued a Notice of Proposed Rulemaking (NOPR) to revise its methodology for calculating the railroad cost of capital (COC), specifically the cost of equity component (COE). In the past, the STB has used a single-stage discounted cash flow (DCF) model. The STB now proposes to use the Capital Asset Pricing Model (CAPM) for the future, probably starting for 2006.

The NOPR indicates that the COC and the COE could be sharply lower. For example, for 2005, the STB had determined a COE of 15.2% and a COC of 12.2% using DCF. Using CAPM, the STB calculates a COE of 7.5% and a COC of 6.8%.

The STB uses the COC for several regulatory purposes including determining whether carriers are revenue adequate and calculating variable and stand-alone costs.

The STB’s NOPR, if adopted, could increase the regulatory relief available to captive railroad shippers, who have been very frustrated with the STB’s unwillingness to grant rate relief. However, considerable implementation would be required before such change occurred.