Rail revenue control a compromise

U of S prof points out that the option was allowing other carriers on CP and CN lines

When it comes to understanding the present state of Canada’s grain transportation, it’s worth knowing a little history.

Back in the late 1990s, Justice Willard Estey chaired a grain handling and transportation system review, and recommended more rail competition, including open running rights. Canadian Pacific proposed the Maximum Revenue Entitlement (MRE), otherwise known as the revenue cap, instead.

“That fact tends to get lost in all this debate,” Dr. James Nolan says. Nolan is a professor with the University of Saskatchewan who researches transportation policy. He tapped out an email in response to an earlier Grainews article on myths and facts of the MRE.

The MRE is not perfect, but has worked reasonably well for both sides, says Nolan.

There are two primary ways to improve things in a concentrated industry, or a natural monopoly, like rail, he says. One is to encourage competition through new institutions such as open access. Open access would allow other carriers to run on CN and CP’s lines.

The other way to improve the transportation system is to regulate rates, Nolan writes. Under this system, CN and CP’s rates would have to be close to the rates of a similar, competitive company. But these rates would be below full cost recovery, and so the government would need to subsidize the revenue difference for the railways.

“In fact, this is essentially the old regulated system we used before the MRE — and while shippers were happy with it, railways were not,” Nolan writes.

MRE sits between these options. “Neither shipper nor carrier are fully satisfied by definition as it is a middle ground policy,” says Nolan. Under MRE, rates are below monopoly levels, but above competitive levels, he adds. It’s designed so that railways recover all their yearly operating costs, and more, he writes.

Overhead and capital costs might or might not be fully covered under MRE each year. But Nolan thinks the railways are doing well under the cap, given their recent expansions and CP’s attempt to buy U.S. railway Norfolk Southern.

“I guess in their minds they could do better.”

Nolan thinks railways mess with levels of service to try to game the system. Under MRE, the less they move, the more they charge for what they do move, he explains. “But CTA enforcement has kept this sort of strategizing mostly in check, so far,” he adds.

Regulatory policies such as the MRE are rarely used elsewhere, Nolan says. He sees the MRE as an economic experiment that has worked “reasonably well” for both shippers and the railways.

How to make it better

All that being said, Nolan isn’t necessarily the MRE’s biggest fan. Although the policy is working better than he thought it would when it was first implemented, he sees it as “a second-best solution to a fully deregulated market.”

Nolan cautions that “deregulated market” doesn’t mean railways should be free from all regulations like other industries. That’s because the cost structure of rail “lends itself to a monopoly by nature,” Nolan says.

The larger the railway, the lower the cost per unit, he explains. These economics are what transformed rail from an industry with many railways competing to a monopoly-like structure, he says.

Nolan would like to see two things to improve the system. The first is a full costing review. The last costing review was in 1992 and much has changed since then, he notes.

“I believe what that will reveal is that even under MRE, the railways are making a lot of overhead versus their actual costs of moving grain,” Nolan says. “This would take the wind out of the sails of those who side with removing the MRE.”

He also believes the gap might be so large that farmers would want changes to the MRE in their favour, “which is exactly what the railways don’t want,” he adds.

Next on Nolan’s wish list is to try full reciprocal switching or open-access systems, but perhaps only with grain.

This is basically what CP offered “as a quid quo pro to get their takeover bid to work with U.S. regulators,” Nolan says. In its proposed merger with Norfolk Southern, CP said it would allow other carriers to use its tracks if its own service was inadequate or rates not competitive.

Nolan says such a policy would create “marginal competition” in the rail industry, especially for captive shippers. And rates would still have a market cap, he adds.

“What (CP CEO) Hunter Harrison is telling us by even suggesting this is that he thinks even with possible fringe competition, there would not be ubiquitous access by other competing railways, which is something I have always also believed,” he says.

“It is my understanding that back in the late 1990s when this issue cropped up, CP had at least one VP who believed they could make money under access by charging competitors to use CP track in those instances when a shipper called for it,” says Nolan.

But the industry quickly shot down that idea. Nolan thinks it was a gut reaction to what the industry perceived as more regulation.

“I wonder if Hunter) Harrison has had his guys revisit open access and found that it could work under reasonable assumptions. My own research agrees with this conclusion.”

Open access in the United Kingdom

Not every rail industry operates the way Canada’s railways do. In the United Kingdom, rail freight has been open access for several years. There are several registered freight carriers that compete with each other for business.

A white paper authored by Tony Lodge of the Centre for Policy Studies notes that over a 10-year period, rail freight companies have cut unit costs by 35 per cent. The U.K.’s passenger operators, most of which are not open access, increased costs by 10 per cent.

The U.K..0’s rail freight was privatizaed in the 1990s. Since then, the industry has catered to growing container traffic as its traditional markets, such as locally mined coal, have shrunk. Lodge writes that if freight companies had been granted exclusive “franchises,” they wouldn’t have had the flexibility or incentive to adapt to the market changes.

Freight traffic has grown by 50 per cent, in tonnes kilometres, since rail freight was privatized. And they’ve done it with half the locomotives and two-thirds the wagons used before privatization.

But not everything is running perfectly. Lodge notes that the industry is struggling to move bigger containers. The problem is the network wasn’t designed for high or wide loads, he writes.

The Centre for Policy Studies is a free-market think tank based in the U.K. They look at everything from housing to energy to transportation. For more information, visit the Centre for Policy Studies website.

About the author

Field Editor

Lisa Guenther is field editor for Grainews based at Livelong, Sask. You can follow her on Twitter @LtoG.

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