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Chapter 5

Competitive Rail Access and Shipper Protections: Recommendations

Proposed Options for Changing Rail Access

The Panel's interim report provided a full account of the views and proposals of interested parties on competitive rail access.

Proposals for rail access take two distinct forms — track access and rate access — though they are not mutually exclusive and can occur simultaneously. All the proposals have roots in the existing legislation.

Track Access Options

The first category, track access, generally involves one operating entity (the guest railway) running trains or rail cars on the rail network owned by another operator (the host) in exchange for a fee. All track access options involve a regulatory authority granting an operator the right to run trains on another's lines — so-called running rights.

Operators do run trains over each other's track networks at present; however, this results from commercial agreements reached voluntarily. The proposed options generally envisage regulatory involvement in determining both the extent of the guest railway's rights on the host's system and the amount of compensation the guest railway pays to use the host's network.

The significant change from the current situation is that implicit in all options is the potential for a broader range of operators to gain access to a federal railway's lines, possibly at an access price set by a regulatory authority rather than by commercial negotiations.

Rate Access Options

The second type of access proposal — rate access options — involves requiring an incumbent or local railway to carry the traffic of shippers located on its lines to an interchange point with another railway or connecting carrier at a regulated rate. These options are based on modifying the pricing structure of rates that railways charge shippers. Rate access options are also variations on existing legislation and practice: expanding the limits for regulated interswitching to distances beyond 30 kilometres and changing the competitive line rate provisions. This category of options can be considered less intrusive, and it creates less regulatory complexity than track access, since no option involves a carrier operating trains over the lines of another.

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Observations on Proposed Rail Access Policies

To provide sound policy advice, the Panel had to achieve clarity about the issues at the core of the competing visions and establish a firm base of knowledge about the rail system, the economic environment, the financial circumstances of carriers and users, and the likely technical challenges.

The value of mandating an interim report on competitive rail access is now evident. After publication of the Panel's interim report, consultations continued. Although basic positions altered little (indeed, some have not changed in a generation), a key aim of the interim report — to clear the rhetorical thicket of competing claims and identify key issues — was realized.

Performance of the Rail System

In the Panel's view, Canada's rail freight transportation system works well for most users most of the time. The Panel's consultations with interested parties revealed consensus that the basic elements of a competitive and efficient rail transportation system are in place.

At one meeting with interested parties, the assembled group was asked to rank the system on a scale of one to ten, with one being completely dysfunctional and ten being perfect. The consensus ranking was between seven and eight. Though anecdotal, this conclusion is supported by the Panel's survey of shippers, and most available hard information also supports the view that the system works well in the main: Canada ranks with the U.S. at the top of international comparisons, and — as seen earlier — rail productivity has risen by nearly 50% in the last decade.

Extent of Competition System-Wide

Another precondition for framing policy guidance was an assessment of the state of competition: the extent to which shippers are subject to anti-competitive prices or other forms of market abuse. The difficulties in making definitive judgements on this based on hard data are many. The Panel is nevertheless confident in the view that Canada's rail system is not inherently anti-competitive; nor is market abuse systemic or widespread. Indeed, by all available indicators, most shippers in most markets in most parts of the country are well served.

Several technical and economic measures, read in combination, reinforce this conclusion:

The Panel believes, however, that there are cases where market forces are inadequate; in those situations, appropriate recourse is necessary to protect shippers against potential abuse of market dominance by a carrier.

Other Industries, Other Countries, Other Pricing Practices

In 1967 Canada began the transition from an under-capitalized, highly regulated, subsidized rail system to a commercially viable structure that provides better service at more competitive rates to the majority of users. The Panel's consultations showed little interest from any quarter in measures to reverse this course. Virtually all participants, even those with the most serious complaints, preferred commercial solutions to regulatory ones and, where regulation is necessary, targeted remedies to broad re-regulation.

Early in the mandate, the Panel undertook several assessments whose results add analytical weight to this caution about altering the existing legislative framework. Before formulating recommendations, the Panel needed answers to three questions:

Network Industries
Based on the perception that a rail system is technically and economically analogous to other network-type industries, restructuring of the natural gas, electricity and telecommunications industries has been suggested as a model for restructuring the rail network and engendering greater competition. In the Panel's view, these comparisons should be regarded with caution.

From a technical and operational perspective, railways are considerably more complicated than other network industries in terms of physical planning, co-ordination, safety, switching and administration. In many significant ways, railways are not industrial analogues of gas, electric or telecommunications utilities and cannot be treated as such.

There are important financial and economic differences too. Increased demand — in telecommunications and natural gas — and new low-cost technologies and sources of supply created space for new entrants. No such factors are at work in the rail industry: demand is static or rising slowly, and no innovative technologies offer the promise of greatly reduced costs or significantly new ways of doing business.1

National Railway Systems
The Panel heard frequent reference to steps in other countries — Sweden, Australia, and the UK were cited most often — to restructure their rail industries. The Panel's research on these and other examples indicates that none provides a very promising place to start remodelling Canada's rail system, for three broad reasons.

First, the major European countries and Australia began their railway restructuring to solve problems Canada's system does not have: government ownership, high levels of public subsidy, low productivity and rapidly declining shares of the freight market.

Second, open access policies in Sweden and the UK were designed to meet the demands of passenger traffic, with freight being secondary. In Canada the challenges are very different.

Third, in none of the countries examined have the results been what was hoped for. In the UK and Sweden, rail operations continue to be heavily subsidized. The Australian reforms, whether following the vertical separation model or not, have delivered some tangible benefits, but serious problems remain. In particular, the reforms have not resolved for Australia problems cited most often in the Canadian context as evidence of lack of competition.

Pricing Practices
There remains a serious divergence of perspective between shippers and railways on the matter of differential pricing. Some shippers — bulk commodity producers for the most part — see differential pricing as unfair and an abuse of market power. Railways see differential pricing as legitimate and essential to the long-term survival of their operations. Moreover, the railways believe differential pricing should be unfettered.

The Panel believes both are extreme views, not conducive to setting policies that will foster an efficient, effective and competitive rail system. The Panel rejects assertions that differential pricing should be unfettered. There are compelling economic and public interest arguments for putting some limits on its use or mitigating its more extreme effects. Similarly, the Panel rejects the argument that the existence of differential pricing is, in and of itself, evidence of a lack of competition. For a self-financing, unsubsidized network-type industry where non-allocable constant costs must be covered if firms are to survive, differential pricing improves efficiency. The only substitute would be a return to cumbersome rate regulation and possible heavy subsidies; these are notions Canada abandoned 30 years ago, and no one advocates their return.

Treatment of the issues surrounding differential pricing mirrors the Panel's approach to rail access generally. The recommendations are intended to foster a regulatory regime that identifies specific instances of potential market abuse or anti-competitive behaviour and provides focused and appropriate remedies.

Assessing Regulatory Viability

An important element in assessing access options is their viability as regulations that can be implemented practically and efficiently. Two factors loom as crucial tests for any change in rail access regulation: devising a sound scheme for compensating host railways, and appreciating fully the burden any new regulations might create.

Compensation for Access
The viability of any proposal for regulated enhancement of rail track access rests on devising a suitable and practicable compensation regime. A fee for running rights that is higher than warranted would bar competitors from gaining access to the lines of other companies and defeat the purpose of the provision. A fee that is too low, on the other hand, would induce the host railway to recover lost revenue either by raising rates for other shippers or cutting back on infrastructure maintenance and investment. An excessively low access fee could also effectively end up subsidizing less efficient operators.

The means of determining an access price is also significant, because it has the potential to substitute a regulatory decision for a commercial agreement. While some suggest that the access price could be set by commercial negotiation, with recourse to the Canadian Transportation Agency only if no agreement is reached, the Panel does not see this as very likely in a situation where access has been imposed. If running rights were non-consensual, it is difficult to envisage the disputing parties being of the same mind about what constitutes a fair or reasonable fee. It is far more likely, therefore, that the Agency or an arbitrator would have to set the access fee, or at least the ground rules for arriving at one — a significant reintroduction of regulation.

Increased Regulatory Burden
Legislative enhancements to rail access provisions can be expected to increase costs to both government — in the form of regulatory oversight — and to business — in the form of compliance and dispute resolution. The Panel believes that the anticipated results of new regulations must be weighed against the real costs they will entail.

Regulatory costs arise from several sources. A measure requiring a railway to take action it does not believe to be in its own commercial interests will more than likely be challenged — with costs for the disputing parties and the regulator. The U.S. experience shows that especially in challenges over running rights, fee negotiations often involved protracted and expensive dispute resolution. An additional cost to the regulator invariably arises after the dispute has been settled, in the form of compliance monitoring.

Finally, wholly new types of regulatory costs could arise from the imposed sharing of infrastructure under some access proposals. Such issues have arisen where other network industries have been opened to competition by regulatory means.

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Considerations and Recommendations

The competitive rail access and shipper protections provisions constitute a set of obligations on railways and rights for shippers. Together, they are intended to condition the normal market relationship between railways and shippers by giving shippers a degree of countervailing power they would not otherwise have, to protect them from potential abuse in situations where the railways have market dominance.

Some of the rail access and shipper protection provisions are interrelated. Others stand alone or overlap. The Panel believes the legislative framework should incorporate a systematic approach that encourages commercial transactions before regulatory intervention is applied, that stages regulatory intervention so that the most intrusive intervention is applied only in situations where it is required, and that avoids overlapping provisions. The Panel considers the provisions and presents recommendations in the following order:

Right to a Rate and Level of Service Obligations

Many shippers see the right to obtain a rate for moving traffic (section 118 of the Canada Transportation Act for movements by a single railway and section 121 for joint movements) and the level of service obligations placed on a railway when that traffic is shipped as the foundation on which competitive access provisions are built. As stated by the Canadian Shippers' Summit, "[w]ithout reasonable assurances of adequate rail service, rate levels are largely meaningless."

The Panel agrees. Level of service requirements, which define a railway's obligations, are essential; they allow for complaint to the Agency, with the Agency essentially determining whether the railway has fulfilled its obligations.

The Panel concluded, however, that the existing provisions are not as effective as they might be. Level of service is not properly defined in the legislation. A shipper using a published tariff rate does not necessarily have any assurance, in advance of shipping the freight, of the level of service that will be provided, particularly in respect of features such as timeliness and frequency of service. By contrast, in most commercial transactions, including confidential contracts between a railway and a shipper, the purchaser knows what service will be provided for the price charged. Although a railway must set a rate at a shipper's request, there can be a significant degree of uncertainty about what level of service is attached to the rate.

The Panel concluded that the confidential contract approach of specifying the level of service should also apply to tariff rates, reflecting a normal commercial approach. The level of service provisions (sections 113-115) would therefore be replaced by a requirement that a railway include in its tariffs the level of service it will provide in conjunction with its published rates. The final offer arbitration process would be available to shippers dissatisfied with either the rate charged or proposed to be charged or with the terms or conditions of service.

The Agency would continue to have authority to determine, on application, whether a railway had met its commitments and, in the event of non-compliance, to order the railway to take specific measures to meet these commitments. An aggrieved party could seek damages in a court of competent jurisdiction, as is now the case.

Recommendation 5.1
The Panel recommends that sections 113 to 115 of the Canada Transportation Act be replaced with a requirement that a railway publish in its tariff the level of service attached to rates in the tariff.

Recommendation 5.2
The Panel recommends that the Canadian Transportation Agency continue to have the authority to determine whether a railway has met the level of service commitments in a tariff or confidential contract and, in the event of a breach, to order the railway to take specific steps to meet those commitments.

Interswitching Provisions

Some participants in the Panel's consultations, especially in the West, called for expanded interswitching limits. Interswitching allows shippers within 30 kilometres of an interchange with another carrier to have their traffic transferred from one rail carrier to another at a regulated rate. The rate is based on the system average costs of the railways for such switching movements and includes a fixed contribution to constant costs. All shippers are entitled to take advantage of the regulated rates, regardless of market conditions or a shipper's competitive options. Interswitching rates originated in an era of rate regulation; they were designed to avoid overbuilding in urban areas and to ensure that a joint through rate could be calculated quickly and easily. Today, interswitching rates are advocated as a means of achieving competitive access.

In the Panel's view, expanding the interswitching limits would worsen the market-distorting aspects of the interswitching rate regime and would be a step backward. The proposal ignores market conditions and the averaging effects of a fixed rate — all shippers pay the same rate, regardless of their circumstances. Although interswitching rates have long been a feature of the regulatory landscape, the Panel sees them partly as an anomaly, representing a trade-off between regulation and the market. On the other hand, they induce an element of competition between connecting railways. The Panel is not convinced that upsetting this balance in favour of further regulation would serve the interests of shippers or Canada.

Government should be involved in regulating commercial relationships only when one party is abusing monopoly power. Proposals to extend the interswitching limit assume that railways are behaving in this manner. No evidence before the Panel suggests this kind of market power exists in every circumstance where expanded interswitching would be available. In any event, the Act already allows the Agency to deem that the origin or destination of traffic is within 30 kilometres of an interchange, if it believes, in the circumstances, that the origin or destination is reasonably close to the interchange. This, along with other existing and proposed measures, would deal more adequately with the potential abuse of market power.

Recommendation 5.3
The Panel recommends that the existing interswitching limits be retained.

At the same time, the Panel notes that the legislative provision requiring the Agency to determine fixed interswitching rates is a structural flaw that should be amended. It makes no sense to deny shippers and railways the opportunity to negotiate interswitching charges that are lower than the Agency's interswitching rates, where commercial considerations permit.

Recommendation 5.4
The Panel recommends that section 128 of the Act, requiring the Canadian Transportation Agency to determine fixed interswitching rates, be amended to allow the Agency to prescribe maximum rates, leaving it open to shippers and railways to enter into commercial arrangements for lower interswitching rates, if appropriate.

Competitive Line Rates

Competitive line rates (CLRs), first introduced in 1987 and subsequently amended in the 1996 legislation, allow a shipper served directly by only one railway and located outside the 30-kilometre interswitching limit to ask the Agency to establish a rate for transporting goods over the originating railway to an interchange point for transfer to a connecting railway. The CLR is calculated based on the current interswitching rate, plus system average revenue per tonne-kilometre for moving similar traffic over similar distances, if possible. As a precondition for obtaining a CLR, a shipper must have concluded an agreement with the connecting carrier to move the traffic. Access to CLRs is also limited to shippers that can meet the "substantial commercial harm" test of sections 27(2) and (3).

CLRs, like other mechanisms designed to enhance competition, inspire sharply divergent views among shippers and carriers. On one hand, railways have maintained historically that CLRs are an unwarranted intervention in the market. They also suggest that CLRs are used principally as a negotiating tool, rather than a means of correcting justifiable rate concerns, and that the Agency's formula for CLRs does not reflect railway prices adequately. On the other hand, shippers argue that too many barriers prevent them using this mechanism to obtain competitive prices.

The National Transportation Act Review Commission recommended several refinements to make CLRs fairer and more functional. The ensuing legislative amendments did not result in greater use of CLRs, however. CLRs came to the fore again during the Panel's consultations, with shippers claiming that three key barriers to effective use of CLRs remain:

The Shippers' Summit offered a proposal, drafted originally by the Canadian Fertilizer Institute, to replace the CLR provisions with a competitive access rate or CAR.2 As envisioned by the Summit, CAR would allow the originating or local railway and the connecting carrier to compete at the interchange for the traffic over the long haul. It would allow the shipper to determine what portion, if any, of the business would go to each railway in a dynamic framework of negotiations. Finally, the rate to the interchange would be based on the existing interswitching rate for the first 30 kilometres of the movement, plus an additional amount based on the railway's system average revenue per tonne kilometre for moving the commodity at issue. This would eliminate two of the current methods the Agency can use to calculate a CLR.3 The Shippers' Summit argues that this would allow the Agency to establish a CAR quickly, predictably and without the need for a hearing.

To the shipper, CAR's main strength is that it has the potential to increase competition significantly by eliminating the need for a prior agreement with a connecting carrier and the requirement to prove substantial commercial harm. Assessments of its impact on rail system efficiency are inconclusive, however. CAR advocates say it would encourage the most efficient routing of traffic. This may be true in certain circumstances, but it is not clear that it would always be the case. Furthermore, adopting CAR as proposed would make all traffic potential multiple line routings, with their added inefficiencies relative to single-line movements.

CAR as proposed would have broad application, since it would be available to any shipper served by only one railway, regardless of other competitive realities. Similarly, the proposed calculation method would make it attractive to shippers whose rates are above average, regardless of the numerous factors determining those rates. These elements are inconsistent with the Panel's goal of providing remedies only where warranted by inadequate market forces.

Finally, because CAR is based on system average revenues, successive applications would have the effect of reducing the average, thereby further reducing rates subsequently established under the proposed formula. This, combined with overly wide applicability, could set in motion a dynamic process that would drive railway revenues down to the point of affecting viability.

The Panel concluded that the risks of adopting CAR as proposed were too high — it would undermine a commercial rail market and lead to the substantial adoption of regulated rates based on average revenues. The Panel nevertheless sees merit in the basic premise of CAR and CLR — that is, creating a rate to connect with a second carrier — as an effective instrument for promoting competition in what are commonly referred to as 'bottleneck' situations. An alternative, which the Panel suggests be designated a Competitive Connection Rate (CCR), would achieve the same objective at reduced risk by targeting the remedy better.

To begin, the existing condition requiring a prior agreement with a connecting carrier should be eliminated. This would address a key shortcoming that apparently restricts shippers' access to the present remedy. Because the originating carrier would not necessarily lose the traffic to the connecting carrier, it would also discipline the originating carrier to encourage efficiency gains to retain the traffic. The provision should also be targeted to shippers with no effective competition to move their goods and should do so in a more direct manner than applying the substantial commercial harm test, whose relevance the Panel addresses later. In place of this test, the Panel proposes that CCR be available only to shippers with no "alternative, effective, adequate and competitive" means of transporting the goods that are the subject of the CCR. These are the words that currently guide arbitrators in FOA cases; in FOA proceedings, the Panel was told, arbitrators apply this consideration effectively. In such a case, where a shipper believes that a rate a railway proposes to charge constitutes an abuse of market dominance, the shipper can apply to the Agency for a CCR for movement of the traffic to the nearest interchange with a connecting carrier.

In reviewing the rate, the Agency would compare the rate paid by the shipper (or offered to the shipper) with rates paid by other shippers of the same commodity under similar circumstances. In general, the Panel believes that where a shipper without competitive alternatives is paying rates substantially above the rates paid by all shippers of a specific commodity under similar conditions and the situation cannot be explained by apparent cost and value of service considerations, a case could be made for the Agency to require a CCR. Where the Agency does conclude that a CCR is required, the railway and the shipper would be given a period of no more than 30 days to negotiate a new rate, either to the interchange or for the entire movement. If no new rate could be negotiated, the Agency would establish a CCR from the origin to the point of interchange (or from the point of interchange to destination) with the connecting carrier using the methodology set out below.

The simplest way to do this would be to use system average revenue per tonne-kilometre, but the Panel explicitly rejected this method, because the resulting rate would do more than remove the unreasonable portion of the rate, in effect unreasonably transferring revenue from the railway to the shipper.

The Panel concluded that a reasonable balance would likely be achieved by calculating CCR using rates in the range of the 75th percentile to the 90th percentile of revenue per tonne-kilometre for movements of the same commodity over distances similar to the CCR portion, together with the interswitching rate for the first 30 kilometres.4 This would ensure that CCR is available to shippers that are paying rates at the upper end of the scale to move a particular commodity while reducing the risk associated with any downward spiral of pricing based on average revenue per tonne-kilometre.

As is generally the case with a formula, there is a possibility that the result will treat the shipper or the railway unfairly. When identifying the traffic whose revenue will be used to calculate CCR, the Agency will need to ensure that it compares like with like in terms of traffic, distances moved, level of service provided and conditions of carriage. All are elements of price discrimination with which the Panel agrees; it is not price differentiation per se that the Panel wishes to address through CCR, but rather the abuse of railway market dominance where it exists.

To illustrate, if the Agency were determining a CCR for high-priority movements of metallurgical coal in railway-supplied cars, it should avoid using revenue figures for lower-priority movements of thermal coal in shipper-supplied cars. The parameters of the latter movement would exert unjustifiable downward pressure on the rate — low-priority service would have a lower value of service and a lower rate than high-priority service, thermal coal rates may be lower than those for metallurgical coal rates, and rates for movements in shipper-supplied cars would be lower to reflect the shipper's investment in equipment. As well, because of rate taper, revenue per tonne-kilometre would be lower for longer movements than for shorter ones.5 In extreme situations — for example where a CCR applied over a very short distance on a high-cost line — calculating a CCR using revenue figures for much longer movements could result in a rate that not only provides an inadequate contribution to constant costs but is also below the variable cost incurred by the railway. Any of these parameters could result in a CCR that is unfairly low for the railway. In other situations, the result could be a rate that is unfairly high for the shipper. The Agency should therefore retain the ability to adjust the rate resulting from application of the formula where the results are clearly unreasonable.

In applying the Panel's recommended CCR formula, the Agency must be mindful of all these elements and exercise its discretion under section 112 of the Act, which requires that the rate it sets be "commercially fair and reasonable to all parties".

As noted earlier in this chapter, the Panel believes the legislative framework should avoid overlapping shipper protection provisions. For this reason, the Panel recommends that a shipper seeking a CCR not be permitted to request FOA, for either the portion of the movement by the connecting carrier or the CCR itself. In addition, a shipper seeking a CCR should not be permitted to request FOA where the Agency has determined that the rate complained of does not merit the establishment of a CCR while that rate is in force. Similarly, a rate established pursuant to an FOA would not be eligible for review under the CCR provision. This would give a shipper the choice of either CCR or FOA but not allow two regulatory interventions on the same movement.

The existing CLR provisions also allow only one CLR on a traffic movement — CLRs are not available at both origin and destination. Similarly, CLRs cannot apply to more than 50% of the distance the traffic moves, or 1,200 kilometres, which ever is greater. The purpose of these restrictions is to minimize the use of regulated rates. The Panel favours commercial agreements and relationships between railways and shippers and therefore recommends no change in these restrictions under the CCR process.

The Panel is confident that this CCR proposal presents no significant risk of threatening the overall financial viability of the railways. In the event of unforeseen consequences that threaten railway viability, however, the Governor in Council should have the authority to suspend the CCR provision. A similar provision was included when CLRs were first enacted in 1987, but the Governor in Council has never been required to use it.

Recommendation 5.5
The Panel recommends transforming the competitive line rate provisions of the Canada Transportation Act into competitive connection rate (CCR) provisions by
  • removing the requirement that shippers obtain an agreement with a connecting carrier before requesting the rate from the Canadian Transportation Agency;
  • making the remedy available only to shippers with no "alternative, effective, adequate and competitive" means of transporting the goods that would be subject to the rate where the Agency determines that the rate is substantially above rates paid by other shippers of the specific commodity under similar conditions and that cannot be explained by apparent cost and value of service considerations;
  • requiring the shipper and the railway to attempt to negotiate a new rate within a 30-day period after the Agency determines that a CCR is required;
  • requiring the Agency, where the shipper and carrier do not agree on the rate, to establish a CCR, subject to the commercially fair and reasonable test of section 112, with the rate falling in the range of the 75th percentile to the 90th percentile of revenue per tonne-kilometre for movements of the same commodity over similar distances and under the same conditions and levels of service as the CCR portion, together with the interswitching rate for the first 30 kilometres;
  • allowing for a CCR to be established by the Agency for a period of one year;
  • prohibiting the shipper from requesting final offer arbitration of any rate being reviewed or established under the CCR process;
  • prohibiting the shipper from requesting final offer arbitration for the portion of the movement by the connecting carrier;
  • prohibiting the shipper from requesting a CCR for a rate established by final offer arbitration; and
  • giving the Governor in Council authority to suspend the CCR provision if it determines that railway viability is seriously affected by the operation of the CCR provision.

Other Provisions

Substantial Commercial Harm
The substantial commercial harm test became part of the Act in 1996. It was designed to ensure that only shippers that would suffer substantial commercial harm would be entitled to relief under the Act. Although the test applies broadly, in practice its real impact is on rail shippers, and then only in respect of certain remedies under the Act: competitive line rates and level of service, right to a rate, and extended interswitching limits.6 Regulated rate and revenue provisions, such as interswitching rates and the grain revenue cap, are not affected, since they do not require a shipper application. Nor is the most frequently used shipper relief provision — final offer arbitration — subject to the test. Nevertheless shippers and others, including the Competition Bureau, criticized the substantial commercial harm test, in particular its focus on the shipper's financial and operating condition.

The test focuses on the effect on the shipper, rather than the behaviour of the carrier. For this reason the Panel believes that the substantial commercial harm test should be repealed.

Recommendation 5.6
The Panel recommends that the substantial commercial harm test in sections 27(2), (3) and (5) of the Canada Transportation Act be repealed.

Commercially Fair and Reasonable
This provision (section 112) was also added to the Act in 1996. It was intended to provide guidance to the Agency, to ensure that rail rates or conditions of service it established were commercially fair and reasonable to all parties. Several parties suggested that the requirement is an unwarranted barrier to Agency relief. The Panel believes, however, that without such legislative guidance, a reasonable process of establishing a rate may yield an unreasonable result in some circumstances. For example, a rate based on single-car movements in railway-supplied cars could unfairly penalize a shipper seeking to have traffic moved in large blocks in shipper-supplied cars. Similarly, requiring a railway to provide service below its variable cost could unfairly penalize the railway.

The Act's shipper protections, modified in accordance with the Panel's recommendations, would give the Agency the authority to establish two types of rates — interswitching rates and CCRs. The Panel believes that where the Agency establishes rates under these provisions, the existing regulatory guidance should be retained.

Recommendation 5.7
The Panel recommends that the Canadian Transportation Agency, when establishing interswitching rates and competitive connection rates, continue to be guided by the requirement that rates it establishes be commercially fair and reasonable to all parties.

Final Offer Arbitration

The FOA provisions, introduced in 1987, allow a shipper dissatisfied with a rate or condition of service associated with a movement of goods to submit the matter for final offer arbitration. Since 1996 the provisions have applied to western grain and northern marine re-supply; they were also made available to commuter and passenger rail operators. Despite this broader application, FOA has been used most often by rail shippers.

The Panel believes that the FOA provisions have two important hallmarks of effective economic regulation:

Some carriers suggested replacing FOA with commercial arbitration. This suggestion ignores the fact that FOA exists to provide relief to shippers that find themselves without alternative, effective, adequate and competitive means of transporting their goods. The Panel finds it difficult to believe that a commercial arbitration scheme would provide effective relief to a shipper in these circumstances.

Railways claim that shippers that proceed with FOA are free to walk away if they are dissatisfied with the result. This argument ignores two points:

There are continued concerns about the complexity and expense of FOA. The Panel notes, however, that much of the complexity stems from the requirement that each side in an FOA know the other side's case (a requirement of natural justice) and from the value of rate disputes, which the Panel understands often exceeds $1 million. More simplicity in these matters could result in greater risk of inaccuracy and unfairness.

On balance, the Panel is satisfied that the FOA provisions, including the new simplified process for lower-value disputes, adequately address the problem of carrier dominance and potential abuse in a way that is fair to both shippers and carriers. Rail shippers have found FOA effective in obtaining relief, and the process is generally working well and as intended. One apparent anomaly should be addressed, however. When handling a dispute for matters over $750,000, an arbitrator must consider whether a shipper has alternative, effective, adequate and competitive means to transport the goods. There is no such requirement when dealing with disputes under $750,000. The Panel sees no reason why this requirement should not apply to the arbitrator's decision in such cases as well.

Recommendation 5.8
The Panel recommends that an arbitrator be required, in every arbitration, to consider whether a shipper has alternative, effective, adequate and competitive means to transport the goods that are the subject of the arbitration.

Revenue Cap on Western Grain Rates

Since the winter of 1996-97, considerable effort has been devoted to reform of the grain handling and transportation system in western Canada. Despite consensus that the system should be placed on a more commercial footing, agreement on the precise nature of reform has remained elusive, notwithstanding the excellent work of the Honourable Willard Estey and Mr. Arthur Kroeger. For the Panel, the issue is rail competition as it affects all shippers, including shippers of grain.

The regulatory process recommended in this report is designed to be adaptable to all circumstances of market abuse. The Panel sees no reason, therefore, why grain transported by rail should be treated any differently than other commodities. Furthermore we are concerned that the current crisis in the grain industry results in part from failure to move quickly enough to a system where commercial forces are allowed to work.

The Panel notes that when the Western Grain Transportation Act was repealed in 1995 and replaced with a cap on grain rates, the legislation contemplated the eventual sunsetting of the special regulatory regime for grain rates.

Recommendation 5.9
The Panel recommends that the grain handling and transportation system be moved to a more commercial basis, which could lead to repeal of the revenue cap on grain rates.

Enhanced Running Rights

Running rights have been a feature of Canadian railway legislation for more than a century. In most cases, they are voluntary commercial agreements between railways. The Agency can impose running rights, however, on application from a federally regulated railway. The Agency can grant running rights, subject to conditions it sets, having regard to the public interest. After granting running rights, the Agency can set compensation if the two railways are unable to agree.

The statutory authority for non-voluntary running rights can be traced back to the Railway Act of 1888, which allowed a railway to apply to the regulator to take possession of, use or occupy any lands belonging to any other railway company "for the purpose of obtaining a right of way... and for obtaining the use of tracks, stations or station grounds of another company".8 Appearing under the heading "Taking of Lands" until it was transferred from the Railway Act to the National Transportation Act, 1987, the provision was seen mainly as something similar to expropriation of property. Although railways had general expropriation powers for land, the powers were not available to acquire land from another railway; hence the need for the provision. It was also to avoid duplication of railway construction where existing lines could be used. The section was considered an extraordinary recourse and received conservative application. Notably absent were references to the provision being a measure to increase competition.

The experience of the Agency and its predecessors with the provision reflects this. Most applications did not deal with running rights, but rather with occupying the property of another railway. For example, in 1905, the Guelph and Goderich Railway company sought land from the Grand Trunk Railway in Goderich, Ontario, that was not used by the latter railway.9 In 1988, VIA Rail sought an order to possess, use and occupy CPR's railway maintenance facility at Victoria, B.C. In the latter half of the twentieth century, the regulator ordered no running rights, and traffic solicitation rights — an important element of running rights if the provision had been considered a means to enhance competition — were neither requested nor granted.

The National Transportation Agency did receive four running rights applications in the late 1980s. Its decisions on two of those applications confirmed that the law allows only federally regulated railways to apply for running rights. This raised the question now facing the Panel — whether the law should be amended to broaden its application. This is particularly significant in light of development of the short line railway industry; many short lines are provincially regulated and thus precluded from applying for running rights.

In February 2001, the Canadian Transportation Agency received two running rights applications. The first, from Ferroequus Railway Company Limited, sought running rights on about 2,000 kilometres of CN lines from North Battleford, Saskatchewan, to Prince Rupert, B.C. The second, from the Hudson Bay Railway Company, a subsidiary of OmniTRAX Canada, sought running rights on a network of approximately 3,500 kilometres of CN branch lines and mainlines in Saskatchewan and Manitoba. Both applicants have certificates of fitness as federal railways and both sought the right to solicit traffic on the CN lines over which they proposed to operate.

The applications appear to be the first instances where traffic solicitation rights have been sought as part of a running rights order. Whether traffic solicitation rights are contemplated under the Canada Transportation Act was a matter of considerable debate between the parties to the applications. CN, the infrastructure owner, asserted that traffic solicitation rights are inconsistent with the Act's regulatory framework and that the running rights provision allows only 'transit rights'. The railways seeking running rights asserted that the Act allows for traffic solicitation as part of a running rights application. On May 3, 2001, the Agency determined that the Act as now constructed does not empower the Agency to grant running rights for the express purpose of soliciting as well as carrying the freight of shippers.

What the Panel Heard
The Canadian Shippers' Summit argued that the running rights provisions do not promote a competitive rail system even though competition is the Act's clearly stated objective. Changes are therefore required, and expanding the availability of running rights is a critical part of the Summit's proposed legislative reforms to increase competition between railways. The Summit asserted that railways are no longer considered public utilities that need to be protected; they should be subject to the same competitive pressures as shippers.

The concept of expanded running rights was also supported by the provinces of Saskatchewan and Manitoba, the Canadian Wheat Board, the Competition Bureau, and two regional carriers, BC Rail and OmniTRAX.

CPR adamantly opposes legislating expanded running rights, suggesting that access proposals would give shippers lower rates only at the expense of the mainline railways. CN for its part urged caution suggesting that increased rail access would have to adhere to certain core principles such as reciprocity and commercially negotiated access fees. The railways also observe that expanded running rights would inevitably reduce efficiency, since more trains would be hauling essentially the same amount of traffic.

Running Rights to Enhance Competition
Running rights do not appear to have been designed originally to enhance competition. As is the case with any instrument called upon to perform a function it was not designed for, there are inevitably difficulties in applying the provision; the current debate highlights these difficulties.

There may be circumstances, however, where it is appropriate for running rights to be used as a means of enhancing competition. The Panel believes, therefore, that the Act's running rights provision should be transformed into a competitive access provision where circumstances require it. The Panel emphasizes that granting running rights as a measure for enhancing competition should continue to be an extraordinary step — imposed only where there is clear evidence that the railway providing the service is not acting in the public interest.

Transforming the running rights provision into a competitive access tool can be accomplished by several legislative amendments.

Applications for Running Rights
Only a federal railway can apply for a running rights order over the lines of another federal railway. The growth of the short line industry since 1996, made up mostly of railways not under federal jurisdiction, means that a significant segment of the railway sector is barred from even making an application.

There appears to be no valid reason to distinguish between a federally regulated railway operator and one that is provincially regulated, provided both meet the same operating safety standards, are adequately insured, and have adequately qualified personnel. The running rights provision should therefore be extended to all qualified railway operators, whether they have a federal certificate of fitness or are licensed as a railway by a provincial authority.

Recommendation 5.10
The Panel recommends that any railway operator, whether under federal or provincial jurisdiction, have the right to apply to the Canadian Transportation Agency for running rights, provided the operator meets all necessary operating and safety standards and is adequately insured.

Traffic Solicitation
If running rights are to become a competitive access provision where circumstances require, then traffic solicitation privileges must be included in the provision.

Recommendation 5.11
The Panel recommends that the running rights provision of the Canada Transportation Act be amended to allow an applicant to seek traffic solicitation rights.

Negotiations
The Act does not require a potential guest railway to negotiate with the infrastructure owner before applying to the Agency for running rights. In fact, it is the Panel's understanding that such negotiations have not been common — in many cases, applications for running rights have not been preceded by meaningful commercial negotiations.

Running rights require a continuing working relationship between the infrastructure owner and the guest. Myriad interactions between them help ensure that railway operations, including scheduled and unscheduled maintenance, are carried out safely and promptly. Communication between rail traffic controllers, track maintenance forces, and operating crews is critical — with no room for error. An adversarial relationship makes effective communication and co-operation much more difficult to achieve. Nor is it realistic to expect a regulator to oversee day-to-day interactions or be a referee.

As a general principle, the Panel favours commercial agreements and commercial relationships between railways and applicants for running rights and between railways and shippers. Negotiations aimed at agreeing on many elements of the interaction between a guest and a host railway provide a sound foundation for an enhanced running rights process. Experience in the United States, however, has been that commercial negotiations often prove difficult in imposed access situations.

The Panel therefore concludes that a potential guest operator should notify the infrastructure owner that it intends to apply for a running rights order. Like the notice shippers give carriers under final offer arbitration, this would allow the parties to enter into best-effort commercial negotiations to resolve as many issues as possible before the Agency deals with the application.

Recommendation 5.12
The Panel recommends that a railway operator proposing to apply to the Canadian Transportation Agency for running rights be required to advise the infrastructure owner at least 60 days before making the application to encourage negotiations between the parties.

Public Interest Test Considerations
Many proponents of enhanced running rights support a reverse onus public interest test. Under such a test a host railway opposing a running rights application would have to establish that granting the remedy would not be in the public interest. The Shippers' Summit suggested that
by placing the onus on an opponent to a running rights order to demonstrate that the order is not in the public interest, effect will be given to the pro-competitive intent of expanded running rights while conferring discretion upon the Agency to deny an order where appropriate.10

Similarly, the Western Canadian Shippers' Coalition suggested a reverse onus approach

to facilitate the granting of running rights applications as a pro-competitive remedy rather than retaining the status quo which is widely perceived as an extraordinary remedy.11

The Panel believes that imposed running rights should continue to be seen as an extraordinary measure, granted only where the public interest demands it. Given the exceptional nature of running rights, especially where traffic solicitation rights are sought, the Agency must continue to be satisfied that the granting of an application is in the public interest. Consequently, the Panel rejects the concept of a reverse onus test.

The Act allows the Agency to grant running rights, subject to conditions it sets, having regard to the public interest. The legislation does not define the public interest, however — a policy gap the Panel finds problematic. The regulatory body should have policy guidance on the criteria for and factors to be included in determining the public interest. In the absence of guidance, the process for considering running rights requests could be lengthy, open to legal challenge and expensive, hampering the provision's effectiveness.

Significant public interest considerations include the potential impact of granting running rights on all users and shippers on a line, the impact on system efficiency, the possible need to require reciprocal access on the applicant's lines where applicable as a condition of obtaining running rights, the ability of the guest operator to provide service into the future, and the impact on the financial viability of the host railway. In making its public interest determination, the Agency should be directed to take all these elements into consideration.

Such considerations will permit the Agency, as part of its public interest determination, to receive input from all interested parties on a line and decide whether the public interest is best served by granting running rights or by maintaining existing protections (interswitching, CCRs, FOA).

Recommendation 5.13
The Panel recommends that, as part of its public interest determination on a running rights application, the Canadian Transportation Agency consider, at a minimum,
  • the adequacy of existing service,
  • the existence of competitive alternatives,
  • the impact on all users and shippers on lines where running rights are sought,
  • the impact on system efficiency,
  • the financial and operational capability of the applicant,
  • the willingness of the applicant to allow reciprocal access to its lines where applicable, and
  • the impact on the financial viability of the infrastructure owner.

Carrier Obligations and Shipper Protections
Under the Panel's recommendations, the Act would continue to place obligations and restrictions on federally regulated railways, including the obligation to publish a rate on request by a shipper, the obligation to specify the level of service in a published tariff or confidential contract, and a restriction on how the railway can limit its liability for loss or damage of a shipper's goods.

The Panel believes that these same obligations and restrictions should apply to guest operators with traffic solicitation rights. There is no compelling reason for a guest operator to be exempt. In fact, only by including this requirement will the provision become a competitive access provision. That being the case, any shipper on a line could request a rate and level of service package from the infrastructure owner or the guest operator and select the package that best meets the shipper's needs.

The Panel therefore concludes that guest operators with traffic solicitation rights must be subject to the obligation to establish rates at the request of a shipper and to publish them in tariffs and have the right to enter into confidential contracts with shippers. Once a guest operator contracts with a shipper, the guest operator must be required to provide the level of service set out in its tariff or in the contract with the shipper for that traffic. The Agency would have authority to determine whether the operator had met its commitments. In the event of non-compliance, an aggrieved party could seek damages in a court of competent jurisdiction, as is now the case for federally regulated railways. Finally, the guest operator would be able to limit its liability for loss or damage to that traffic only in accordance with section 137 of the Act.

Recommendation 5.14
The Panel recommends that guest operators with traffic solicitation rights
  • have the obligation to publish rates at the request of a shipper and to specify the level of service to be provided as part of published tariffs,
  • have the right to enter into confidential contracts with shippers, and
  • have authority to limit liability for loss or damage of a shipper's goods only in accordance with section 137 of the Canada Transportation Act.

A shipper on a line served by more than one carrier has the benefit of direct competition. Such competition limits the ability of a railway — whether the infrastructure owner or the guest operator — to exercise market power. This makes several existing protections or forms of recourse redundant. Competitive connection rates and interswitching (discussed earlier in this chapter) would not be necessary on lines where more than one carrier operates. To eliminate potential confusion, it must be made clear that where running rights with traffic solicitation are in effect on a line, neither the infrastructure owner nor the guest operator would be subject to the interswitching and competitive connection rate provisions. Finally, a shipper would have an effective alternative for shipping goods; consequently final offer arbitration would not be necessary.

An order granting a guest operator running rights with traffic solicitation should therefore have the effect of suspending the interswitching, competitive connection rate and final offer arbitration provisions for traffic on the lines in question, as long as the order is in force or until the guest operator discontinues service on the line.

Recommendation 5.15
The Panel recommends that interswitching, competitive connection rates and final offer arbitration be suspended with respect to the movement of traffic on lines served by an infrastructure owner and one or more guest operators with traffic solicitation rights.

The Act requires an infrastructure owner to follow a set process for discontinuing service on a line. The existence of running rights should not affect that process.

One objective of the line transfer and discontinuance process is to give shippers adequate notice that service on a line may be discontinued. The Panel believes that shippers served by a guest operator should also have adequate notice of the operator's intention to discontinue service.

Recommendation 5.16
The Panel recommends that running rights orders issued by the Canadian Transportation Agency include a requirement that the guest operator provide reasonable notice when it intends to withdraw service on a line.

Rail Access Pricing
When running rights are granted — with or without traffic solicitation rights — the host continues to assume the risks and obligations associated with owning the infrastructure. In exchange for a chance to earn a return on these assets, the host's shareholders assumed the risks of investing in the infrastructure. Consequently, when another operator is allowed to use the host's assets and, more important, to solicit its clients, the host must receive appropriate compensation.

The Panel is determined to avoid access proposals that could create undue system inefficiencies or an unfair advantage for either the infrastructure owner or the guest operator. Under the current provision, once running rights are granted, the guest and host are expected to negotiate compensation. The Panel believes that encouraging commercial negotiations is the right approach but is cognizant that agreement may be difficult to achieve. The Agency should therefore continue to have authority to set compensation if no agreement is reached.

Recommendation 5.17
The Panel recommends that running rights compensation be negotiated between the parties. If the parties are unable to reach a commercial agreement in 90 days, either party could ask the Canadian Transportation Agency to set compensation in accordance with the Panel's rail access pricing proposals.

The Agency's ability to establish access charges that are fair to both the guest and the host has an important bearing on the overall success of the competitive access regime. The potential need for the Agency to establish compensation is recognized in section 138 of the Act, but the Act is silent on how compensation is to be established. This is a significant gap, and one that becomes all the more important in the context of the Panel's proposals to extend access to the provision to a broader group of market participants and to include traffic solicitation rights.

Participants in the Panel's consultations had varying perspectives on what constitutes appropriate compensation for track access. Some shippers appealed for low access charges that encourage competitive entry into rail markets. CN and CPR, on the other hand, were concerned that low access charges would invite 'cherry-picking' of the most lucrative traffic and jeopardize their ability to generate revenue to support future investment.

The Panel considered various pricing approaches and reviewed the charging systems other countries use in situations of imposed access. There tends to be widespread agreement that an access charge should consist of two components:

  1. a payment to compensate the infrastructure owner for the additional costs it incurs as a result of the guest's activities on the line; and
  2. payment to help cover the common costs of infrastructure ownership and management.

The Panel's interim report identified some of the additional costs a track owner may incur in this situation. The first payment component addresses the costs that may arise from

Where two or more railways are operating on a line, additional precautions are needed to ensure a high standard of safety. The host railway deserves compensation for the new investment it must make and the additional operating expenses it incurs to maintain a high standard of safety on shared track. Incremental costs will be influenced by the nature of the guest's track requirements. They in turn depend on the type and volume of traffic and the frequency of the guest's trips over the line. Incremental costs will also be influenced by the nature and condition of the line and by the host's own track use requirements.

The second access charge component recognizes that the host requires a return on its investment in the rail network. Without reasonable compensation, track owners have little incentive to maintain the network. Various methods can be used to calculate the guest's contribution to the common costs of track ownership. For example, the charge could be based on

  1. a contribution rate of 7.5% of variable costs, now used in calculating interswitching rates;
  2. a contribution rate of 20% of variable costs, legislated under the Western Grain Transportation Act;
  3. the so-called efficient component pricing rule (ECPR), under which the host is compensated for the opportunity costs of the business lost to the entrant, including any forgone profits. Economists have proposed ECPR for situations where a new entrant must gain entry to a 'bottleneck facility' if it is to compete with the incumbent carrier.12 It originated in a regulatory context where the focus was on creating a level playing field on which the guest and the host could compete, i.e., only carriers at least as efficient as the host could enter the market;
  4. the return a private corporation would require to make a green-field investment equivalent in amount to the replacement value of the line and involving comparable business risk;13 or
  5. the application of an appropriate cost of capital to the estimated market value of the capital stock used by the guest. The U.S. Surface Transportation Board has used this approach mainly to address track rights issues arising after rail mergers.14 The STB approximates the value of the line over which access is being sought by applying the amount paid per dollar of earnings to acquire the overall railroad property (i.e., excluding equipment and non-rail assets) to the earnings on the particular line. This estimated capital value is then apportioned between the host and the guest on the basis of their expected traffic shares.

System-wide rules, such as those specifying contribution rates as a percentage of variable cost, have appeal because of their ease of application, but calculated payments may bear little or no connection to the revenue required to give rail owners adequate investment incentives. The fourth and fifth proposals attempt to address this issue by explicitly relating the guest's payment to an estimate of the host's required return on investment. Some difficult and controversial judgements have to be made in applying these methodologies (especially the fourth approach). Moreover, a compensation formula based on average returns would skew the incentives facing prospective entrants, making lower-margin traffic on the line less attractive and higher-margin traffic more attractive.

In reviewing alternative pricing schemes, there is a need to recognize that the present commercial system is based on differential pricing. Along with paying a rate at least sufficient to cover its identifiable costs, all traffic must make some contribution to the unallocable or shared or 'constant' costs associated with the company's overall operations and network. The latter mark-up varies among shipments. As a result of commercial negotiations between carriers and shippers, traffic that is relatively insensitive to price tends to pay higher mark-ups than price-sensitive traffic.

The Panel accepts that, in some circumstances, competitive access would leave host railways vulnerable to cherry-picking by newcomers that do not bear the full costs of the existing infrastructure, unless the access charge is sufficiently high. In this environment, competitive access must retain elements of differential pricing while permitting additional competition. Although it could be complex, the Panel sees no alternative to requiring a commodity- or traffic-based access charge, where the access fee bears some relation to the existing revenue contribution of the traffic that is subject to competitive entry. This would approach the ECPR rule but need not conform exactly. The ECPR principle calls for access traffic to pay a charge equal to the revenue contribution being realized by the incumbent. The rationale is that this access fee makes entry attractive only if the new carrier is more efficient than the incumbent.15 In the approach the Panel recommends, the access fee could be somewhat less than what is indicated by the ECPR rule. A reduction from the ECPR rule could be because the incumbent carrier may not be as efficient as possible. The Agency could also make use of the 'stand-alone cost test' to deal with the issue of excessive mark-ups.

The Panel explicitly rejects access fees based on average revenues or average contributions to constant costs. This is precisely what allows cherry picking, and this approach would undermine the differential pricing necessary for a commercial rail system where much of the traffic is price-sensitive.

Beyond examining the mechanics of proposed pricing approaches, it is important to take account of why railways want the right to operate on other carriers' tracks. In particular, there is a need to distinguish between situations where

  1. a railway seeks access so that it can go after traffic now served by the track owner; and
  2. a railway simply wants the right to run its trains over the track of another carrier.

Different considerations apply in each situation, and these differences should figure in the determination of the rail access charge.

Rail Access with Traffic Solicitation
Where new entrants seek traffic solicitation rights, host railways have reason to be concerned that guest operators will skim their most profitable business. Promoting competition is desirable, but it must be tempered by considering the special burdens on the infrastructure provider. Access charges must be set high enough that new entrants cannot exploit a network in which they have no proprietary interest and track owners are encouraged to make the investments needed to sustain the infrastructure.

Recommendation 5.18
The Panel recommends that, where traffic solicitation is sought, the rail access charge consist of

  1. compensation for all incremental costs the guest railway imposes on the host; and
  2. a contribution to the common costs of rail ownership that approaches the implicit contribution the infrastructure owner is earning on the specific traffic being solicited.

The first component of the access charge covers the additional costs the host incurs, including the increased operating risks it faces and higher outlays for repair and maintenance, traffic control and other factors. The second component is aimed at ensuring the guest bears a fair share of the costs of infrastructure ownership and operation and that the guest and host compete on approximately equal footings.

The contribution of the host's traffic to common costs can be estimated by examining the difference between revenue and variable costs for specific commodities on specific lines. Under the Panel's proposal, the Agency would have discretion to set the second component of the access charge slightly below this estimated level where it believes the host carrier could offset the revenue reduction by improving operating efficiency.

To calculate the second component of the access charge, the Agency will need to know which traffic the entrant intends to solicit. It will then need information on the incumbent carrier's line-specific revenue and variable costs for each of the identified commodities. These data will allow the Agency to estimate the contribution to common costs per car-kilometre currently made by each of the commodities being solicited. There can be benefits from setting the commodity-based portion of the access fee slightly below this benchmark where there is scope for the infrastructure owner to improve efficiency. But while a slightly lower fee may generate some beneficial pressure for cost reduction, a charge significantly below the benchmark is likely to disadvantage track owners and jeopardize the investment needed to maintain and upgrade the network.

In summary, under the Panel's proposal, carriers seeking access with traffic solicitation would be required to identify the traffic they are pursuing. The Agency would then establish a two-part access fee consisting of a general charge and a commodity-based charge. As is generally the case in track access agreements, both charges would be specified as a function of traffic volume and transport distance. The second fee component would be related to, and not fall very much below, the estimated contribution of the host's own traffic to the common costs of infrastructure ownership and operation.

In the Panel's view, the two fee components should apply not only to current traffic, but also to new traffic. Although it does not forgo revenue when the guest's growth occurs through new business development, the host has an interest in such operations by virtue of its role as owner and manager of the line. In the case of new traffic, compensation arrangements must continue to give the host an incentive to maintain and, where necessary, expand and upgrade the line.16

Rail Access without Traffic Solicitation
Many trackage rights agreements are in place to facilitate rail freight operations and improve railroad efficiency. Often these are negotiated on a quid pro quo basis and adhere to accepted cost-sharing practices. CN and CPR, for example, have extensive track-sharing agreements covering Ontario, the U.S. midwest and the north-eastern United States.17 Track access agreements without solicitation rights also exist between infrastructure owners and passenger and commuter railways.

Where commercial negotiations for running rights fail, federal railways can apply to the Agency (under section 138) to resolve the dispute, including a determination of the appropriate level of compensation. As noted, however, the Act offers no guidance on the level of charges. Passenger and commuter rail providers can also use the Act's FOA provisions where they are dissatisfied with a railway's proposed track access rates.

Although carriers often exchange trackage rights, the sale of track capacity can reasonably be considered a distinct commercial activity. In this case, the host is simply providing rail track services instead of an integrated package of rail and carriage services. If track access were marketed on the same basis as other rail services, rental rates for track would likely be set at levels that reflected both differences in costs to the host and differences in the value of the service to guests. Users that placed a high value on trackage rights would pay a higher access charge than carriers that gained marginally from the increased convenience of having a rail 'bridge' available.

The Panel believes it is important to establish pricing principles that are consistent with the treatment of track operations as a commercial enterprise. Government policies should not discourage the railways from implementing more efficient structures, and they should allow for the possibility that corporate restructuring could result at some point in infrastructure operations becoming a self-supporting and organizationally distinct corporate activity. Differential pricing has a role as part of an efficient pricing regime for track access, but certain constraints are needed. Infrastructure providers should not be allowed to exercise their market power to generate revenues that provide more than a fair rate of return on their overall capital investment; prices in excess of the costs of providing rail services are justified only in so far as they help railways cover their overhead. In addition, the Panel believes a pricing limit must be set to prevent track owners from exploiting their potentially significant market power in relation to government-owned and -supported passenger and commuter services.

Passenger and commuter railways have very specific track access requirements that are often relatively costly to accommodate. Unlike guest operators carrying freight, passenger rail operators cannot readjust their schedules or reroute their cars to minimize congestion or give priority to any special needs the infrastructure owner might have. Track access agreements should include guarantees that passenger and commuter railways will receive the high quality of services they require. At the same time, contracts should ensure that the host is fully compensated for all incremental costs incurred — including potentially high congestion and delay costs, or the cost of the investment needed to reduce or avoid them — and receives a reasonable rate of return on the book value of the assets used by the passenger or commuter railway.18

Recommendation 5.19
The Panel recommends that the following considerations be used as a guide in determining compensation for track access without traffic solicitation rights:
  • access fees should cover all incremental costs the host incurs as a result of the guest railway's operations;
  • access fees that differentiate among users on the basis of the value they place on rail access should be permitted;
  • access fees based on differential pricing should not be allowed to help infrastructure owners generate more revenue than they need in total to cover costs, including a reasonable return on their investment; and
  • access fees for government-owned or -directed passenger and commuter rail services should be limited to an amount that compensates infrastructure owners for the additional costs they incur, including congestion and delay costs, and provides a reasonable after-tax return on the book value of the capital assets used by the guest.

Safety and Liability
Class I railways' significant investments have resulted in their being among the safest in the world. Granting running rights as a means of enhancing competition cannot be allowed to jeopardize that impressive safety record.

Co-ordinating two (or more) railway operations on a single line raises safety concerns that do not exist on a line with a single operator. The rail industry seems to have managed these issues successfully where running rights are consensual, but if running rights were imposed by regulation, the challenges to safe rail operation could be different. Where two railway companies operate over the same track, a considerable amount of co-ordination must take place to ensure safe operations — including communication in day-to-day operations between operations planners, rail traffic controllers, track maintenance and mechanical forces, field transportation staff, and operating crews. As well, planning and management of conflicting priorities must take place daily.

An important element of safe operation is the training and certification of personnel. In its submission to the Panel, the Brotherhood of Locomotive Engineers noted the need for a proper qualification and certification program that provides quality control and consistency in important safety skills of locomotive engineers and rail traffic controllers.

The trend in railway safety is away from prescriptive regulatory requirements toward a regime where railway management is responsible for ensuring that appropriate safety systems are in place. Recently Transport Canada has required that railways implement and maintain a safety management system, and all federal railway companies must submit specified information about their systems to Transport Canada. The need for greater federal/provincial regulatory harmonization in the area of railway safety is also recognized.

Consequently, receiving authority from the Agency to operate over the infrastructure of another railway is not the end of the matter. An applicant's running rights proposal must adequately address safety concerns. Although the Panel's mandate does not include railway safety issues, our proposal on running rights has safety implications that will need to be addressed. Transport Canada should review the situation to ensure that the provisions of the Railway Safety Act are adequate to address the situation.

A note on the cost of safety: as set out in the Panel's rail access pricing proposals, to the extent that an additional cost is associated with the safety burden on the infrastructure owner flowing from running rights, those costs must be borne by the guest railway. This matter is covered in the Panel's recommendations on compensation for rail access.

Constitutional Implications
Under the Panel's proposals, any railway operator, whether under federal or provincial jurisdiction, could apply for a running rights order. The Panel's interim report identified a possible unintended consequence of such a change. Under the constitutional division of powers, works or undertakings of a provincial character whose operations are sufficiently integrated with those of a federal work or undertaking may lose their provincial character. The Panel's concern was that a provincial short line railway operating to a significant degree on the lines of a federal railway might find that its operations were integrated with those of the federal line to the extent that, from a constitutional point of view, the railway would lose its provincial status and be deemed a federal railway.

A legal opinion prepared for the Panel clarified this issue.19 First, Parliament can grant running rights to a provincially regulated railway and require such a railway to meet any applicable federal insurance, licensing, safety or other statutory requirement. This is important if Parliament is to have a say in how provincial railways operate while using federally regulated track.

Second, the provincial railway would be subject to full federal jurisdiction only if its operations were integrated with those of the federal railway. Mere physical connection between a provincial and a federal undertaking would not be sufficient to establish exclusive federal jurisdiction over the provincial undertaking. Where running rights were sought by a provincial railway in order to compete with the federal railway, it is likely that the operations of the provincial railway would remain separate and distinct from those of the federal railway, avoiding any suggestion of integration from a constitutional point of view. While all traffic running over the federal line would be subject to federal regulation, the other activities and operations of the provincial railway would remain subject to provincial jurisdiction.20

Internal and International Trade
It has been suggested that provisions to permit enhanced access without full cost recovery could be regarded as a disguised subsidy to shippers and as an expropriation, thus making the measure vulnerable to challenge under international trade treaties to which Canada is a party. Throughout this report, the Panel has taken care to ensure that the recommended compensation formula is fair and compensates an infrastructure owner adequately for use of its track. Thus it should not be vulnerable to a successful trade challenge on this ground. CN also raised the issue of national treatment with respect to internal trade commitments.

Recommendation 5.20
The Panel recommends that the Minister of Transport ensure that implementation of the access proposals recommended in this report comply with all applicable requirements of international and internal trade law.

Other Competitive Access Proposals

Regional Railways
The regional railway concept has engendered much debate in the Prairie provinces. Numerous interveners told the Panel there is a need to foster greater competition among the Class I railways, to retain potentially viable branch lines, to protect deteriorating Prairie roads, and to save rural communities from extinction. Many interveners, including Prairie provincial governments, see the regional railway concept as addressing these problems. Two visions of the regional railway concept have been elaborated:

Brotherhood of Maintenance of Way Employees Approach
The BMWE sees the need for a regional railway as part of an overall approach to improving grain handling and transportation. It proposes an integrated regional grain system, operated as a not-for-profit service and intended to lower overall costs by making better use of existing elevator, rail and road infrastructure. The union maintains that under its approach, it can secure a supply of grain for the branch lines.

The union intends to work collaboratively with the Class I railways. On January 25, 2001, the BMWE and CN signed a Memorandum of Understanding whereby CN would initiate a commercial long-term lease of specific rail lines with a Co-op regional railway operated by BMWE. (The BMWE intends to seek a similar agreement with CPR.) CN would retain ownership of the lines (about 1,636 kilometres of track), but the Co-op would have exclusive control of the lines and be responsible for operation and maintenance. At the end of May 2001, the parties were finalizing the details of the commercial agreement.

The OmniTRAX Proposal
OmniTRAX has proposed that its subsidiary, CanRail West Inc. (launched on September 15, 2000), become a regional railway using 'managed access' over designated lines. OmniTRAX is seeking regulatory changes to give CanRail West guaranteed access to designated CN and CPR rail lines (some 6,200 kilometres of branch lines and secondary lines owned and operated by CN or CPR). Access would include traffic solicitation rights, unrestricted rights to deliver traffic to designated competitive interchange locations (or to final destination if necessary), and rights to serve captive shippers on the mainline, if requested by the shipper. Under the proposal, there would be no reciprocal access.21

OmniTRAX defines managed access as

the right for a selected railway operator to serve customers on designated lines owned by CN or CPR with the same rights and obligations as the owning carrier while providing a return to the owner.

OmniTRAX proposes that the access fee be determined through commercial negotiations. Failing this, the company anticipates that the Canadian Transportation Agency would be empowered to set rates, terms and other conditions of access.22

Under the proposed managed access scheme, the number of operators would be limited to ensure the viability of services provided. Operators would have to be established railways under the Act and regulated by the Agency. OmniTRAX believes that its regional railway concept can be successful only if the guest operator has adequate access to the national grain hopper car fleet and to support services (terminals, yards, maintenance areas, etc.), has the ability to set commercial rates, and has access to quick and effective dispute resolution mechanisms. A smoother process for acquiring branch lines abandoned by the Class I operators would also be needed.23

The Panel's Assessment
The potential impact of the OmniTRAX proposal on the degree of competition is not at all clear. If the selected carrier purchased track from CN or CPR, it would become the sole operator on those lines, since there would be no reciprocal access. On the other hand, where the selected carrier operated through running rights over CN or CPR lines, more direct competition might result.

The impact on system efficiency is also unclear. To the extent that the selected carrier's operations perpetuated the retention of non-viable Prairie branch lines, commercialization of the grain handling and transportation system could be slowed, effectively raising costs. The existence of a regional railway might, however, stimulate the mainline carriers to become more efficient.

Would the proposal add to the Agency's regulatory load? The OmniTRAX proposal is unlikely to add anything to the existing load imposed by operators asking the Agency to grant running rights. Likewise, the impact on host carrier profitability is not likely to be any greater or less than that imposed by operators requesting running rights; it will depend on the compensation formula used to calculate the access fee. However, because OmniTRAX has asked that CN and CPR not be permitted to continue abandoning branch lines, the access fee would have to include the additional costs associated with line retention.

One objective of the OmniTRAX proposal is more extensive use of Prairie branch lines and secondary lines. Nevertheless, it is possible that farmers may still continue to truck their grain past grain elevators on local branch lines to take advantage of incentives offered by high throughput elevators. Hence, the branch line network may not be used much more than at present.

The regional railway concept has been accepted with enthusiasm in parts of western Canada, with the participation of Class I railways in some cases. It is encouraging to note that the concept is developing in the existing regulatory environment. The Panel believes that commercially sound regional railways could provide tangible benefits to regions where they operate. Further, the Panel's proposals to transform running rights into a competitive access tool may provide further incentives to create commercially sound regional railways.

The Panel notes that the OmniTRAX proposal relies on legislative changes giving a designated regional railway operator special legislated privileges. The Panel cannot endorse a system where one operator is treated differently from others by statute or regulation. It is clear that a regional railway system could emerge on the Prairies, or elsewhere in the country, without regulatory change or government interference. The Panel therefore recommends no legislative changes specifically in respect of regional railways.

Vertical Separation

Vertical separation in transport means that
the operators of transport services work at arm's length from the provider of the fixed facilities. In railways separation can begin with merely keeping the accounts for infrastructure and operations separate, but it can extend to having different entities to own, provide, and control the infrastructure, and an entirely independent set of operators.24

As this definition shows, vertical separation encompasses a range of possibilities but usually involves a separate entity owning the infrastructure and selling track access to providers of rail transportation services.

Views on Vertical Separation
Significantly, the Panel heard virtually no calls for vertical separation from interveners. Among all the representations made to the Panel, only one, the PROLOG Canada Inc. submission, suggested a form of vertical separation. Many submissions contained proposals for increasing competition between railways; they often referred to experience with 'open access' overseas (including jurisdictions where vertical separation has been implemented), but none went so far as to propose vertical separation in Canada.

The submission from OmniTRAX, for example, pointed out that reforms

adopted in countries like Australia and Europe cannot be replicated in this country. Primarily private companies own railway infrastructure in this country, and the process of creating separate track authorities would be a form of expropriation.25

Similarly, Agricore's submission stated that

While in theory, a public rail bed would provide the environment for full competition, it is unlikely that the resources or the political will to take the necessary action, including expropriation of property, to create a public rail bed exists.26

The Panel's Assessment
The Panel continues to believe that vertical separation involving either government purchase of the infrastructure or a compulsory change in the ownership of private railway assets would be a major reversal of Canadian transportation policy and problematic in an integrated North American rail industry. In addition, vertical separation would mean trading off the efficiencies of the present business model where rail operators own the infrastructure. For these reasons vertical separation is not worth considering unless the evidence of its benefits is incontrovertible.

Vertical separation could promote equal access, mitigate carriers' market power, and reform (but not eliminate) differential pricing. However, vertical separation would not necessarily reduce overall costs, generate more money for infrastructure investment or reduce regulation, since infrastructure itself would be a monopoly. It is not clear what the impact would be on rates and costs. There would be issues in determining ownership of the infrastructure, setting and regulating terms of access, and determining the sharing of the costs.27

Integration of Canadian and U.S. markets adds further complications. If Canada opted for vertical separation but the U.S. did not, Canadian operators that did not own track in the U.S. would be restricted to Canada, whereas U.S. operators could operate freely in both countries. Canadian operators would face difficult competition for transborder traffic or traffic subject to diversion from one country to the other. For purely domestic traffic, there might be several carriers competing, Canadian and U.S. The question of how to structure access charges would also arise. Different formulas encourage different types of operations. Depending on the formula, the flow of traffic at the border could be seriously impeded.

What is clear is that vertical separation is no panacea.

The Panel's position does not preclude the railways, on their own, from implementing some form of vertical separation if they find it appropriate. At the same time, the Panel recognizes that this is unlikely under the present rail industry structure. The railways' business strategy has been — and continues to be — to operate as vertically integrated enterprises. CPR's submission is explicit on this, arguing strongly that vertical integration is the most efficient way for railways to operate in North America.28

While not likely at present, various scenarios for railway-initiated vertical separation can be envisaged, for example:

Railway Line Transfer and Discontinuance

The Act's line transfer and discontinuance provisions, as introduced in 1996, had as their premise the notion that decisions about continuing to operate a line or selling it are business decisions best left to the owner or operator, a proposition the Panel supports. These provisions significantly reduced the regulatory burden on federal railways and allowed them to rationalize their networks much more easily than before. The provisions require only that the operator give notice of impeding discontinuance, an opportunity to negotiate a commercial sale of the line, and where no commercial sale is feasible, to offer the line at its net salvage value to different levels of government. Several changes were introduced in 2000, including changes designed to make it easier for community-based interests to acquire grain-dependent branch lines. The Panel believes that a commercial approach to line sales is the one that will, in the long run, serve the best interests of communities, shippers and railways.

Nevertheless some interveners, principally in western Canada, suggested that the Agency's oversight powers be enhanced to deal with ability of railway companies to segment track (decide which portions will be offered for sale) and to establish paper barriers (set contractual terms governing a sale transaction). The Panel's view is that such steps would interfere with the business decisions of the track owner.

Others have suggested that the Agency be directed to take specific factors into account in determining net salvage value. Such an approach is possible under the existing legislation by way of policy direction, but the Panel believes that the Agency is generally in the best position to consider arguments about the factors that should or should not be taken into account in determining net salvage value case by case. (See also Chapter 13.)

Others asked for the ability to force a railway company to discontinue a line if adequate service levels are not maintained, thus making it available for others to purchase. This change was introduced in 2000 with respect to grain-dependent branch lines.

Some requested greater Agency control over discontinuance of rail sidings. Rail sidings are not subject to the Act's transfer and discontinuance provisions. In the past complaints about removal of rail sidings have been dealt with under the Act's level of service provisions. These complaints stem in part from shippers' lack of knowledge about which sidings are currently in operation, a situation that arises because railways are not obliged to inform interested parties which sidings are in service. The Panel believes this inadequacy should be rectified.

Recommendation 5.21
The Panel recommends that railways be required to identify and publish a list of rail sidings in operation on their network and available for producer car loading. We recommend further that railways be required to give 60 days' public notice before removing a siding from operation.

Other concerns were raised with the Panel about the $10,000 a mile payment that a railway discontinuing a grain-dependent branch line must make to affected municipalities, a provision added to the Act in 2000. The concerns relate to perceived shortcomings in the government's policy direction in this matter. More experience with the new provision would be needed, with evidence that it has had unintended consequences, before the Panel could comfortably recommend amending this provision. The Panel understands that Transport Canada is monitoring all aspects of the recent amendments with respect to grain. Any significant problems would be noted in that monitoring process.

Requests for harmonization of provincial legislation with federal line transfer and discontinuance provisions must be addressed to provincial authorities. The Panel notes, however, that considerations applicable at the federal level may not apply at the provincial level and that harmonization could in fact discourage the creation of short lines.

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Notes

1 Andrew Shea, "Assessment of Open Access Policies in Other Industries and Jurisdictions: A Literature Review", paper prepared for the Canada Transportation Act Review (CTAR), Ottawa, The Conference Board of Canada, April 2001.

2 For a summary of the CAR proposal, see The Canadian Shippers' Summit, "Enhancing Rail Competition in Canada", submission to CTAR, October 2000.

3 Currently, the Agency must first attempt to calculate the CLR using revenue for similar traffic moving over similar distances. If there is no such traffic, the Agency calculates the CLR based on the system average revenue per tonne-kilometre. If it is unable to calculate the CLR using that method, the Agency may establish an alternative method of determining the CLR. The CAR proposal eliminates the first and third methods of determining the rate.

4 75th percentile: 75% of the movements of the commodity in question generate lower revenue per tonne-kilometre for the railway and 25% generate higher unit revenues. Similarly, the 90th percentile means that 90% of the movements of the commodity in question generate lower revenue per tonne-kilometre for the railway and 10% generate higher unit revenues.

5 In general, the two most costly components of any rail movement, on a per tonne-kilometre basis, are picking up traffic from a shipper's siding and delivering it to the consignee's siding or an interchange with a connecting carrier. By contrast, the line haul costs, on a per tonne-kilometre basis, are much lower. Because origin and destination switching costs are spread over more kilometres for longer movements, cost (and revenue) per tonne-kilometre decline as the length of movement increases. The above provides an illustration of rate taper.

6 Section 27(2) applies to any relief under the Act. For example, the test applies to a complaint about air cargo rates.

7 This provision does not apply to the simpler process for matters under $750,000.

8 Railway Act 1888, section 102.

9 6 Canadian Railway Cases, p. 138

10 Canadian Shippers' Summit, submission to CTAR, October 2000.

11 Western Canadian Shippers' Coalition, supplementary submission to CTAR.

12 William J. Baumol, "Public Interest Standards for Canadian Rail Rate Regulation: Differential Prices, Access and Price Ceilings", statement to CTAR, October 6, 2000.

13 Kieran Management Advisory Services Ltd., "Methods and Practices in Pricing Railway Track Access", paper prepared for CTAR, January 2001.

14 See, for example, U.S. Surface Transportation Board Finance Docket 33388 (Sub-No. 69), Decision No. 123, Decided May 18, 1999.

15 ECPR pricing is not necessary to ensure efficiency, however. Under almost any pricing scheme, the most efficient firm will prevail as long as there is price competition in the market.

16 In most circumstances, the commodity-based charge for new traffic can be based on line-specific data provided by the incumbent carrier, but a different reference point is needed where the host is pursuing commodities not being carried currently on the line. In these circumstances, the Agency could base its access price calculations on the incumbent's system-wide revenue and variable costs for the particular commodity.

17 Discussed in the submission by the Railway Association of Canada, October 31, 2000.

18 After the book value of the line is established, its value would be apportioned among the host and the passenger and commuter guests, using available indicators of relative track usage.

19 The opinion was prepared by constitutional expert Professor Patrick Monahan of Osgoode Hall Law School.

20 The conclusions reached in this opinion are similar to those reached by the transportation law group Aikins, MacAulay & Thorvaldson, which prepared a supplemental presentation on this point at the request of the Panel.

21 OmniTRAX Inc., "A Proposal to Enhance Competition in the Canadian Railway Marketplace" submission to CTAR, October 3, 2000, p. 14.

22 OmniTRAX, submission, pp. 19-20.

23 OmniTRAX Inc., "A Regional Railway: An Exciting Prospect for Canada's Shippers and Small Communities", September 15, 2000, p. 4.

24 Louis S. Thompson, "The Benefits of Separating Rail Infrastructure from Operations", Public Policy for the Private Sector, note no. 135, December 1997, The World Bank Group.

25 OmniTRAX, submission, p.13.

26 Agricore Co-operative Limited, "Competition in Grain Transportation, A Submission to the Canada Transportation Act Review Panel", October 2000, p. 3.

27 Louis S. Thompson, CTAR Symposium on Rail Access, Winnipeg, February 2001.

28 Canadian Pacific Railway, "Railway Infrastructure, Access and Competition", submission to CTAR, November 2000, pp. 36-38.

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