UP freight rates for Powder River coal are found to be excessive by STB

Implications: The Surface Transportation Board ruled that the freight rates that the Union Pacific Railroad unilaterally imposed upon Kansas City Power and Light in 2006 for the transportation of their Powder River Coal were in excess of the board’s guidelines for a carrier that had market dominance. Since the STB used an easily understood methodology in reaching this decision, this may be the first of many challenges to the railroad freight rate increases since 2006, often characterized as their newly discovered “pricing power”.

Analysis:  A common carrier can be deemed to have market dominance if there is no effective competition from other rail carriers or modes of transportation for the transportation to which a rate applies and for which it charges rates which are more than 180% its variable costs. In the case at hand, both the UP and KCPL agreed that there was no effective competition, but they disagreed on the percent of variable cost calculation. The UP’s computations of the latter were in the range of 155% to 164%, while the KCPL computed the railroad rates to be in the 207% to 229% region.   Railroads report their costs, revenues, and operating statistics to the STB each year in standardized formats that are used to compute the system-average variable unit costs for each carrier. In past rate case appeals, railroads and shippers were able to argue for modifications to the system average figures based on the operating characteristics of specific freight moves. In the UP/KCPL case however, the STB applied the system average unit costs and reiterated their intention of using average costs to simplify freight rate appeals.   The STB found that the UP’s rates were between 189% and 204% of their variable costs and ordered them the refund the excess freight revenue, with interests, to KCPL for shipments from the first quarter of 2006 to the first quarter of 2007.  Additional refunds will be required when the remaining data for 2007 and 2008 are supplied by the UP. Moreover, since the ruling will apply until 2015, the rates will either have to be reduced or the STB will be enforcing additional refunds.   The STB also used the new cost of capital methodology they recently published (April 15, 2008) to determine the unit variable cost. They estimated that this alone accounted for half of the overcharge amounts they computed for the five quarters between 2006 and 2007. If the old cost of capital procedures had been used, the rates would have been found to be between 185% and 193% of the variable unit costs.