BNSF Railway Co. v. Surface Transportation Board

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued February 5, 2008 Decided May 20, 2008

No. 06-1372

BNSF RAILWAY COMPANY,

PETITIONER

v.

SURFACE TRANSPORTATION BOARD AND

UNITED STATES OF AMERICA,

RESPONDENTS

WESTERN COAL TRAFFIC LEAGUE, ET AL.,

INTERVENORS

Consolidated with

06-1373, 06-1374, 06-1398, 06-1399, 06-1401, 06-1404,

06-1409, 06-1421

On Petitions for Review of an Order of the

Surface Transportation Board

John H. LeSeur argued the cause for Shipper Petitioners.

With him on the briefs were Christopher A. Mills, William L.

Slover, Kelvin J. Dowd, C. Michael Loftus, Andrew B.

Kolesar III, and Peter A. Pfohl.

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Samuel M. Sipe, Jr. and Michael L. Rosenthal argued the

cause for Railroad Petitioners. With them on the briefs were

Richard E. Weicher, Anthony J. LaRocca, Peter J. Shudtz,

Paul R. Hitchcock, George A. Aspatore, John M. Hemmer,

Louise A. Rinn, Terence M. Hynes, G. Paul Moates, and Paul

A. Hemmersbaugh.

Raymond A. Atkins, Associate General Counsel, Surface

Transportation Board, argued the cause for respondents. With

him on the brief were Robert B. Nicholson and John P. Fonte,

Attorneys, U.S. Department of Justice, and Ellen D. Hanson,

General Counsel.

Richard E. Weicher, Samuel M. Sipe, Jr., and Anthony J.

LaRocca were on the brief for intervenor BNSF Railway

Company.

C. Michael Loftus, Andrew B. Kolesar III, and Peter A.

Pfohl were on the brief for intervenor Western Coal Traffic

League.

Before: GINSBURG, ROGERS, and KAVANAUGH, Circuit

Judges.

Opinion for the Court filed by Circuit Judge

KAVANAUGH.

KAVANAUGH, Circuit Judge: In a recent rulemaking, the

Surface Transportation Board changed aspects of its rail rate-

setting methodology. Railroads and shippers both petition for

review – railroads arguing that certain changes improperly

benefit shippers and shippers arguing that certain changes

improperly benefit railroads. We conclude that the Board’s

3

changes are reasonable and reasonably explained. We

therefore deny the petitions.

I

Since Congress enacted the Interstate Commerce Act in

1887, the Federal Government has regulated the rates of

interstate railroads. Until 1995, the Interstate Commerce

Commission regulated the rates; since then, the Surface

Transportation Board has done so. See ICC Termination Act

of 1995, Pub. L. No. 104-88, §§ 101, 201, 109 Stat. 803, 804,

933-34.

Under federal law, a party may file a complaint with the

Board challenging a railroad’s rate. See 49 U.S.C.

§ 10704(b). After receiving a complaint, the Board first must

determine whether it has jurisdiction over the challenged rate.

The Board’s jurisdiction covers only those railroads that

possess “market dominance.” See §§ 10701(d)(1), 10707(b)-

(c). To have market dominance, a railroad must have revenue

that meets or exceeds 180 percent of its variable costs for the

traffic to which the rate applies. See §10707(d)(1)(A).

(Variable costs are those costs that increase as traffic over the

railroad increases – for example, the cost of fuel.)

After the Board determines that it has jurisdiction over a

challenged rate, the Board must decide whether the rate is

reasonable. See § 10701(d)(1). If the Board finds the rate

unreasonable, it sets the maximum rate the railroad may

charge. See §10704(a)(1). In setting that rate, the Board must

permit the railroad to cover its costs “plus a reasonable and

economic profit or return (or both) on capital employed in the

business.” §10704(a)(2).

Part of what makes railroad rate regulation complex is

that a railroad incurs many costs that cannot be attributed to

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any one shipper – costs that the Board has appropriately

termed “unattributable costs.” See Rate Guidelines – Non-

Coal Proceedings, 1 S.T.B. 1004, at 2-5 (1996) (Non-Coal

Guidelines). For example, how does the railroad allocate the

cost of a railroad terminal shared by multiple shippers?

Allocation is difficult, moreover, because railroads serve a

mix of “competitive” shippers and “captive” shippers –

competitive shippers can secure alternative transportation

relatively cheaply but captive shippers cannot. See id.

Therefore, a railroad cannot simply charge each shipper a pro

rata share of the unattributable costs without the risk of losing

competitive shippers to other carriers. See id.

In 1985, the Board promulgated guidelines to calculate

rates for shipping coal. See Coal Rate Guidelines,

Nationwide, 1 I.C.C.2d 520 (1985) (Guidelines). The

Guidelines approach, which has since been extended to non-

coal rates, established certain principles to resolve rate

disputes. Those principles sought to approximate “Ramsey

pricing,” which sets rates for individual shippers in inverse

proportion to those shippers’ demand elasticities. See Non-

Coal Guidelines, at 2-5. Ramsey pricing enables a railroad to

collect a higher share of unattributable costs from captive

shippers than from competitive shippers. Because captive

shippers have inelastic demand, the railroads can charge them

higher rates with a lower risk of losing their business.

Recently, however, the Board decided that the Guidelines

approach had become increasingly complex and costly, and in

some respects contrary to congressional intent. To address

those problems, it began a rulemaking proceeding in early

2006. The Board completed the rulemaking later that year,

changing how to determine its jurisdiction and how to

evaluate rate reasonableness. Both railroads and shippers

5

filed timely petitions for review challenging various aspects

of those changes.

We review Board decisions under the deferential

standards of the Administrative Procedure Act. As relevant

here, we will set aside a Board decision if it is “arbitrary,

capricious, an abuse of discretion, or otherwise not in

accordance with law.” 5 U.S.C. § 706(2)(A). The Board may

depart from its own precedent, moreover, so long as it

provides a reasoned explanation. PPL Mont., LLC v. STB,

437 F.3d 1240, 1246 (D.C. Cir. 2006). In the rate-making

area, our review is particularly deferential, as the Board is the

expert body Congress has designated to weigh the many

factors at issue when assessing whether a rate is just and

reasonable.

II

We first consider the Board’s new method for

determining whether it possesses jurisdiction over a

challenged rate.

As a general matter, the Board has jurisdiction over a rate

if the railroad’s ratio of revenue to variable costs (R/VC) for

the traffic to which that rate applies is at least 180 percent.

Therefore, to determine whether it has jurisdiction, the Board

must have a method to calculate variable costs. The statute

requires that the Board use a method called the Uniform Rail

Costing System, referred to as URCS, or an adequate

substitute. See 49 U.S.C. § 10707(d)(1)(B); Adoption of the

Uniform R.R. Costing Sys., 5 I.C.C.2d 894 (1989). The

railroad submits various data to the Board, and the Board, via

a computer program, plugs the data into URCS to produce a

figure for system-wide average variable costs. See generally

Surface Transp. Bd., Industry Data – Economic Data: URCS,

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http://www.stb.dot.gov. The amount of revenue from the

relevant traffic is then divided by a figure incorporating the

system-wide average variable costs and a number of operating

characteristics of the shipment to arrive at the R/VC ratio. If

the R/VC ratio is less than 180 percent, the Board has no

jurisdiction.

In the past, the Board has permitted parties to propose

“movement-specific adjustments” to the average variable

costs figure produced by URCS. In other words, parties could

argue that a higher or lower figure better reflected the variable

costs of a particular movement. Shippers, of course, propose

adjustments that would lower the variable-costs figure,

because that would result in higher R/VC ratios and thus

make Board review more likely. Railroads favor adjustments

that would raise the variable-costs figure, thereby lowering

R/VC ratios and making Board review less likely.

In the rulemaking at issue here, the Board eliminated the

ability of parties to suggest movement-specific adjustments.

Both the railroads and the shippers challenge that change as

an unreasonable departure from agency precedent. The Board

acknowledged that permitting movement-specific adjustments

has been its “longstanding practice,” but nevertheless

concluded that “these adjustments may not serve a useful

public purpose.” Major Issues in Rail Rate Cases, STB Ex

Parte No. 657, at 48 (Oct. 30, 2006). The Board gave seven

interrelated reasons for the change:

First, the analysis of proposals for movement-

specific adjustments is complex, expensive, and time

consuming. Second, the Board believed that

Congress intended, in adopting the 180% R/VC

limitation on Board rate review, to create an

administratively quick and easy-to-determine

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regulatory safe harbor for the railroads. Third, the

URCS program already tailors the variable cost

calculation to the movement at issue. Fourth,

disallowing movement-specific variable cost

adjustments would eliminate substantial uncertainty

in the current rail rate adjudication process. Fifth,

railroads do not consistently keep certain types of

information that shippers have relied on for

favorable movement-specific adjustments. Sixth,

adjustments to URCS may not provide more reliable

results than using the system-average expenses.

Finally, piecemeal or incomplete adjustments to

URCS are suspect.

Id. (emphases added). The Board ultimately concluded that it

“must balance the costly burden and complexity created by

movement-specific adjustments against any improvements in

the resulting variable cost,” and it found that “notwithstanding

[its] past allowance of these adjustments, such expense and

complexity are not justified.” Id. at 50.

The railroads, except BNSF, challenge the Board’s

decision on statutory grounds. Section 10707 of Title 49

directs that “variable costs for a rail carrier shall be

determined only by using such carrier’s unadjusted costs,

calculated using the Uniform Rail Costing System cost

finding methodology . . . with adjustments specified by the

Board.” 49 U.S.C. § 10707(d)(1)(B). The railroads claim

that the last phrase – “with adjustments specified by the

Board” – means that the Board may not eliminate all

movement-specific adjustments. We disagree. To begin

with, the railroads did not raise this argument before the

Board, so it is forfeited. See Univ. of D.C. Faculty Ass’n v.

D.C. Fin. Responsibility & Management Assistance Auth.,

163 F.3d 616, 625 (D.C. Cir. 1998). In any event, it is

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meritless. The statute does nothing more than broadly

delegate to the Board the authority to make reasonable

adjustments to the variable-costs figures produced by URCS.

It does not require the Board to adopt any adjustments. The

Board’s interpretation is therefore consistent with the

statutory text.

The railroads also claim that the Board did not give

adequate consideration to alternative proposals that would

allow the Board to take into account certain categories of

adjustments. We reject that argument as well. The Board

explained that it had considered the alternatives and found

none of them preferable in light of the seven considerations

listed above. The Board said that the elimination of

movement-specific adjustments would save up to $1 million

per party, per case. Moreover, the Board cited its years of

experience in dealing with those adjustments as the basis for

concluding that they are not especially accurate. In short, the

Board made a policy judgment that the cost savings and

increase in predictability of the Board’s jurisdiction, among

other factors, outweigh any gains in accuracy from the

railroads’ or shippers’ adjustment proposals. That kind of

judgment call, which balances inherently incommensurable

costs and benefits, falls within the expertise of the agency,

and we will not disturb it. Cf. Central & Southern Motor

Freight Tariff Ass’n v. United States, 757 F.2d 301, 321-22

(D.C. Cir. 1985) (“Deference is particularly appropriate when

– as here – the delegation of . . . power is very broad and

necessarily involves the administrative weighing of the costs

and benefits of regulation.”).

For the same reason, we reject the shippers’ arguments

that the Board’s decision to eliminate movement-specific

adjustments was unjustified. The shippers contend that the

Board placed too much emphasis on the expense of litigating

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movement-specific adjustments and that the Board

underestimated the increase in accuracy effected by those

adjustments. Again, the Board possesses the responsibility to

balance those kinds of competing considerations. The

shippers have not demonstrated that the Board’s decision was

unreasonable or unsupported by substantial evidence.

The fact that both the railroads and shippers contest the

Board’s elimination of movement-specific adjustments is not

enough to persuade us that the Board’s decision was arbitrary

and capricious. The Board has an institutional interest in

reducing the cost for parties litigating rate cases. And the

Board has discretion to consider the interests of the railroads

and shippers that could not afford to participate in the

rulemaking proceeding.

III

We turn now to petitioners’ challenges to the changes in

the Board’s rate-evaluation methodology. To provide

necessary context for our discussion, we begin with a brief

overview of how the Board evaluates railroad rates.

As we have said, railroads serve a mix of competitive and

captive traffic. Because of the varying demand elasticities of

the different shippers, a railroad has no interest in

apportioning costs evenly among the shippers for facilities or

services that the shippers share. If it imposes a pro rata share

of unattributable costs on each shipper, competitive shippers

with lower-cost transportation alternatives may opt for those

alternatives, and the railroad would lose revenue. Despite that

problem, the railroads cannot go too far in the other direction

and overload captive shippers with excessively high rates.

Even though captive shippers do not have practical access to

alternative carriers, they do have access to Board review, and

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the Board has a statutory duty to ensure that their rates are

reasonable.

The Board’s solution to the railroads’ problem, adopted

in Guidelines, has been the principle of Constrained Market

Pricing. See Coal Rate Guidelines, Nationwide, 1 I.C.C.2d

520 (1985) (Guidelines). Constrained Market Pricing sets

three constraints on a railroad’s rates, including the Stand-

Alone-Cost constraint, which ensures that a captive shipper

does not pay for services that provide it no benefits – in other

words, that it does not cross-subsidize other shippers. See

BNSF Ry. Co. v. STB, 453 F.3d 473, 476-77 (D.C. Cir. 2006);

Guidelines, 1 I.C.C.2d at 523-24.

To determine whether a complaining captive shipper is

paying for only those services that benefit it, the Board uses

an approach called the Stand-Alone-Cost test. The Stand-

Alone-Cost test posits a hypothetical railroad that serves a

subset of the movements in the railroad’s network, including

the route used by the complaining shipper. That hypothetical

railroad is called a Stand-Alone Railroad, known as a SARR,

and it is designed to be optimally efficient. The Stand-Alone-

Cost test determines the rate that the shippers using the SARR

(the “traffic group”) would be charged by taking into account

the costs of running the SARR, including a reasonable return

on investment, (the “Stand-Alone Costs”). See PPL Mont.,

LLC v. STB, 437 F.3d 1240, 1242 (D.C. Cir. 2006). The

amount of those costs becomes the maximum amount that the

railroad may collect from the traffic group. See id.

The underlying logic is that there are cost savings when

the portion of the railroad that constitutes the SARR is

combined with the rest of the real railroad; therefore, the costs

of that segment as part of the real railroad could never exceed

the costs of that segment if it stood alone. With a Stand-

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Alone-Cost ceiling, “no shipper (or shipper group) subsidizes

others, at least in a strict sense of the term: though some bear

a higher share of fixed costs than others, they still pay no

more than what they would for a facility designed to serve

only them.” Burlington Northern R.R. Co. v. ICC, 985 F.2d

589, 596 (D.C. Cir. 1993).

The Board’s rulemaking changed various aspects of the

Stand-Alone-Cost test. Petitioners challenge three of those

changes: (i) the method the Board uses to determine

maximum reasonable rates; (ii) the degree to which

productivity gains are taken into account when forecasting the

SARR’s operating expenses; and (iii) the allocation of

revenue to the SARR from shippers that use both the SARR

and other, off-SARR facilities. Shippers also challenge the

Board’s application of its new revenue-allocation rule to a

case that was pending when the Board issued its notice for

proposed rulemaking.

A

We first address the Board’s change to its method of

determining a complaining shipper’s maximum reasonable

rate.

Under the Stand-Alone-Cost test, if the hypothetical

SARR’s total revenue from the Stand-Alone-Cost traffic

group exceeds the Stand-Alone Cost, then the traffic group in

real life is covering more of the costs of the real railroad than

are attributable to it, and the rates of the shippers in the traffic

group are reduced. Once the Board decides to reduce the

rates of the traffic group (for purposes of the test), it then

must determine how to allocate that reduction among various

members of the traffic group to set maximum reasonable

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rates. In the rulemaking, the Board changed the way that it

performs that allocation.

In the past, the Board reduced the excessive rates in a

relatively straightforward way. Using the Percent Reduction

Method, the Board would reduce the rate of each shipper in

the traffic group by the same percentage: the percentage by

which the revenue from the traffic group exceeded the Stand-

Alone Costs. Thus, if revenue exceeded the Stand-Alone

Costs by 20 percent, the Board lowered the rate of each

shipper, including the complaining shipper, by 20 percent.

The rationale for that approach was that it maintained the

same proportion of rates among members of the traffic group.

For example, if one shipper initially paid twice the rate of

another shipper, that would continue to be true after the

reduction. The underlying assumption was that the existing

rate structure reflected the varying demand elasticities among

members of the traffic group. Under the Ramsey pricing

principle discussed above, which sets shippers’ rates in

inverse proportion to their demand elasticities, the Board

thought it important to maintain that rate structure – even

though the rates are entirely within the control of the railroad.

The railroads, of course, favor that assumption: In their view,

the Board should assume that the rates they set adequately

reflect differences in demand between the complaining

captive shipper and the other shippers.

In recent Stand-Alone-Cost cases, however, the Board

realized that railroads can easily manipulate the Percent

Reduction Method. In particular, a railroad can game the

system by initially setting an exceedingly high rate for a

captive shipper. If the shipper then challenges the rate and the

Board uses the Percent Reduction Method to reduce it, the

new rate will still be a function of the initial rate; the higher

the initial rate, the higher the final rate.

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To prevent “gaming,” the Board adopted a new method

to correct excessive rates: the Maximum Markup

Methodology. Rather than requiring an across-the-board cut

for every shipper, this new methodology lowers only the rates

of those shippers that make excessive revenue contributions

relative to the variable costs that they impose on the railroad.

And it requires that those shippers’ ratios of revenue to

variable cost be the same. The railroads cannot manipulate

this methodology because the higher they set the initial rate of

a captive shipper, the higher that shipper’s revenue

contribution relative to the variable costs it imposes on the

railroad – and the bigger the percentage cut for that shipper.

The railroads argue that the Board failed to sufficiently

explain what it meant by “gaming.” We, however, have no

trouble understanding the Board’s concern: A railroad could

charge any rate, including an inefficient monopoly rate,

simply by setting the rate incrementally higher than the rate it

wanted prior to the SAC proceeding.

The railroads further argue that the Board’s decision is

arbitrary and capricious because there is no evidence of

gaming by railroads. They cite our decision in National Fuel

Gas Supply Corp. v. FERC, which vacated a prophylactic rule

aimed at preventing market manipulation. See 468 F.3d 831

(D.C. Cir. 2006). In that case, FERC had specifically relied

on a supposed record of abuse to justify a rule, yet FERC had

not produced any evidence of abuse. See id. at 841. The

Court’s order instructed FERC to either compile the record of

abuse or “try to support [its rule] by setting out its best case

for relying solely on a theoretical threat of abuse.” Id. at 844.

In this case, the Board reasonably explained that the

undetectable nature of the problem plainly justifies the

Board’s reliance on the theoretical threat. To discern whether

an initial rate is set because it reflects a railroad’s perception

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of relative demand or a railroad’s effort to game the system

would require the Board to either divine the motives of the

railroad in setting the challenged rate or undertake the costly

task of estimating the railroad’s marginal costs and the

complaining shipper’s demand elasticity. The Board

reasonably concluded that either endeavor would be utterly

impracticable.

In addition to the anti-gaming rationale, the Board

offered another justification for adopting the Maximum

Markup Methodology: By statute, railroads must maximize

revenue from competitive shippers before increasing captive

shippers’ rates. See 49 U.S.C. § 10701(d)(2)(B); Guidelines,

1 I.C.C.2d at 539 (Under Constrained Market Pricing, “a

carrier must charge its competitive traffic as much of the

unattributable costs as the demand will permit.”). According

to the Board, this “reflects a Congressional directive” that

captive shippers “not bear a differentially larger share of the

joint and common expenses” until the railroad has charged its

competitive shippers “as much of the unattributable costs as

demand will permit.” STB Ex Parte No. 657, at 18. The

Board determined that the Maximum Markup Methodology

better implemented that statutory directive: Unlike the

Percent Reduction Method, it allows captive shippers, which

tend to contribute more revenue relative to the variable costs

they impose on railroads, to receive a disproportionately

higher share of a rate reduction.

The railroads counter that giving a disproportionately

higher share of a rate reduction to captive traffic runs directly

counter to the Ramsey pricing principle that the Guidelines

approach adopted. Those principles instruct that rates should

be set in inverse proportion to shippers’ demand elasticities.

The railroads argue that once the rate structure has been

established in that way, it should be maintained. The Percent

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Reduction Method preserved the rate structure because the

Board would reduce the rates of all shippers in the traffic

group by the same percentage when it would conclude that a

railroad was receiving excessive revenue.

The Board’s Maximum Markup Methodology is not a

departure from Ramsey pricing principles as reflected in

Guidelines unless one assumes that railroads set the initial

rate structure in inverse proportion to the shippers’ demand

elasticities. The Board’s conclusion that rate structures are

susceptible to gaming rejects that assumption. Moreover, the

Maximum Markup Methodology preserves demand-based

differential pricing to a significant degree: Shippers that pay

low rates relative to the variable costs attributable to them will

still bear considerably less of the railroad’s unattributable

costs than shippers that pay high rates relative to the variable

costs attributable to them.

There is therefore no contradiction between the

Maximum Markup Methodology and the Board’s goal under

Guidelines: Under both approaches, the objective is for

railroads to “ensure that competitive traffic contributes as

much as possible toward [unattributable] costs,” which

includes ensuring that competitive traffic does not leave the

railroad for transportation alternatives. 1 I.C.C.2d at 524. As

the Board put it, “Congress envisioned that captive shippers

would be the residual suppliers of capital, but only where the

competitive traffic cannot provide a sufficient share of the

contribution needed to support the rail infrastructure that it

uses.” STB Ex Parte No. 657, at 18. The Board has simply

changed its mind about how best to achieve that goal. It no

longer assumes that whenever it finds a railroad to be

receiving excessive revenue in a Stand-Alone-Cost case,

every shipper’s rate is too high and the railroad must lower all

of its shippers’ rates by the same percentage to maximize

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revenue from competitive traffic. Now the Board believes

that it makes the most sense to lower the rates of only those

shippers that are paying a high rate relative to the variable

costs attributable to them. The Board has license to change

how it implements its statutory duties, “either with or without

a change in circumstances,” so long as it supplies “a reasoned

analysis.” Motor Vehicle Mfrs. Ass’n v. State Farm Mut.

Auto. Ins. Co., 463 U.S. 29, 57 (1983) (internal quotation

marks omitted). The Board has met that requirement here,

and we find no reason to overturn its decision.

Finally, the railroads argue that the Maximum Markup

Methodology violates this Court’s decision in Burlington

Northern Railroad Co. v. ICC, 985 F.2d 589 (D.C. Cir. 1993).

But that decision addressed a substitute for the entire Stand-

Alone-Cost analysis, not a different method of reducing rates

after performing the Stand-Alone-Cost test. We found

multiple defects in the approach at issue in Burlington,

including a flaw that deprived the ICC’s approach of “any

glimmer of supporting principle or intellectual coherence.”

Id. at 597. By contrast, the Board here responded to a flaw in

its existing Percent Reduction Method, and adopted the

Maximum Markup Methodology to correct the problem. This

new methodology, as explained above, furthers the Board’s

goals under Guidelines and § 10701(d)(2)(B). Therefore, we

are satisfied that the Board’s decision is consistent with

Burlington.

B

We next address the Board’s change to its method for

forecasting the SARR’s future operating expenses.

To calculate the costs that the hypothetical SARR would

likely incur over the 10-year Stand-Alone-Cost analysis

17

period, the Board must estimate the operating expenses that

the SARR would face. Since 1980, the Board has used some

form of the “Rail Cost Adjustment Factor,” established by

statute, as an index to track changes in railroad costs. Before

this rulemaking, the Board’s operating-expense forecasts did

not take into account the possibility that the SARR could

experience productivity gains – gains in efficiency that would

reduce operating expenses. The Board figured that, because

“the SARR is designed to be an efficient replacement for the

railroad, it would not be able to realize the same productivity

gains as the rest of the industry, particularly in the early

years.” STB Ex Parte No. 657, at 40. In its Stand-Alone-Cost

tests, the Board thus had used the Rail Cost Adjustment

Factor-U index, which measures “the change in the prices of

inputs, such as labor and fuel, used to produce railroad

services,” but does not factor in anticipated industry-wide

productivity gains. Id. at 39. A separate index, the Rail Cost

Adjustment Factor-A index, takes into account the industry’s

productivity gains. Shippers have urged the Board to adopt

that index because, if there are productivity gains, then

operating expenses will be lower. And the lower the

forecasted operating expenses of the SARR, the lower the

revenue needed to cover the SARR’s costs, and the lower the

maximum permissible rate for shippers. The railroads, by the

same logic, have favored the status quo.

In the rulemaking, the Board settled on a hybrid

approach. Based on its special expertise in rail regulation, the

Board posited that a new hypothetical railroad would not

immediately experience the same level of productivity growth

as the anticipated industry average: “[A] SARR is presumed

to begin the analysis period at a higher productivity level than

the industry as a whole,” and as a result, in the early years, it

would not have as much room to increase productivity in

certain areas. Id. at 43. For example, “railroads realize

18

productivity gains in locomotives as they replace old

locomotives with newer technologies. The SARR would not

experience those same productivity gains in the short term,

because it would begin its operations with all new

locomotives.” Id. at 40. The Board, however, concluded that

a SARR would experience some productivity increases

“where gains derive from more efficient use of existing assets

such as improved management techniques, more flexible

work rules and learning by doing.” Id. at 43. Also, the SARR

could experience productivity gains for “short-lived assets”

whose replacement would “introduce the latest available

technology.” Id.

The Board posited that, within 20 years, the SARR’s

productivity growth rate would match that of the industry

because at that time the SARR would have about the same

mix of old and new assets as the industry generally. “[A]s the

SARR approaches the industry’s vintage of technology over

time, both the productivity level and the rate of growth for the

industry and the SARR would converge.” Id. at 44.

Therefore, the Board decided to phase in the Rail Cost

Adjustment Factor-A index – the measure of costs that takes

into account productivity gains – into its operating-expense

forecast gradually over a 20-year span. To accomplish this,

the Board calculates operating expenses based solely on the

Rail Cost Adjustment Factor-U index (no productivity gain)

for year 1 and factors in the Rail Cost Adjustment Factor-A

index (full productivity gain) at a rate of 5 percent per year

until it is fully phased in at year 20.

Unsurprisingly, both the shippers and the railroads object

to the Board’s hybrid approach, with each favoring an

opposite end of the spectrum. The shippers argue that the

Board ignored “substantial evidence of record before the STB

demonstrating the rapid rate at which the railroad industry

19

renews its assets and its technology.” Shippers’ Br. 36. The

shippers note that the average age of rail assets in 2002 was

only seven years. For their part, the railroads argue that

“there was no evidence that any [productivity] improvements

would occur in equal amounts over a 20-year period.”

Railroads’ Br. 34. The railroads believe that most

productivity gains would not be realized until many years in

the future. As a result, the railroads argue, even if the Board

is correct that the SARR would converge with the industry in

20 years, because the Stand-Alone-Cost analysis period

covers only the first 10 years, underestimating productivity

gains in years 11 through 20 will not balance out the

inaccuracy created by overestimating productivity gains in

years 1 through 10.

We decline to enter this hyper-technical fray. “It is well

established that an agency’s predictive judgments about areas

that are within the agency’s field of discretion and expertise

are entitled to particularly deferential review, so long as they

are reasonable.” Wis. Pub. Power, Inc. v. FERC, 493 F.3d

239, 260 (D.C. Cir. 2007) (internal quotation marks omitted);

see also Nuvio Corp. v. FCC, 473 F.3d 302, 306 (D.C. Cir.

2007) (We owe “substantial deference [to an agency’s]

predictive judgments.”). That maxim is especially true here,

where we are reviewing the Board’s predictive judgment

about hypothetical railroads. The agency has adopted a

straight-line, phase-in approach that is routinely used to

estimate the depreciation of assets, and we cannot conclude

that the approach is unreasonable. Although the parties have

submitted evidence that they claim supports their conflicting

views on how a SARR would experience productivity gains,

“[p]articularly where, as here, an agency issues a regulation

reflecting reasoned predictions about technical issues, logic

suggests that the record may well contain evidence sufficient

to support more than one possible outcome.” Ass’n of Pub.-

20

Safety Communications Officials-Int’l Inc. v. FCC, 76 F.3d

395, 398 (D.C. Cir. 1996). And as for the railroads’ claim

that imperfections in the 20-year phase in may inure to the

benefit of the shippers, at some point simplicity outweighs

accuracy, and the Board “is free to make reasonable trade-offs

between the quality and cost of possible regulatory

approaches.” Burlington Northern, 985 F.2d at 597.

C

We now consider the Board’s change to its method of

allocating to the SARR the revenue from shippers that use

both the SARR and other, off-SARR parts of the railroad.

As we have said, the Stand-Alone-Cost analysis posits a

hypothetical railroad – the SARR – that would serve the route

that the complaining shipper uses. The Stand-Alone-Cost

analysis then determines the total costs that the SARR would

incur – the Stand-Alone Costs – and what percentage of those

costs is attributable to the complaining shipper. If the total

revenue that the railroad collects from the SARR’s services

(calculated based on the real-world rates that the railroad

charges the traffic group that uses the SARR) exceeds the

Stand-Alone Costs, then the rate of the complaining shipper

may be lowered in accordance with the Maximum Markup

Methodology discussed above.

In determining the total revenue that a SARR generates, a

problem arises: Unlike the complaining shipper, the other

shippers do not necessarily use only the SARR. In the real

world, other shippers may use both on-SARR and off-SARR

parts of the railroad. For those shippers, the Board must

allocate to the SARR only a portion of the revenue that they

contribute in the real world. If the Board attributed all of their

revenue contribution to the SARR, it would overestimate the

21

SARR’s revenue because some of those shippers’ revenue

contributions go to covering off-SARR costs. The Board has

termed the traffic that uses both on-SARR and off-SARR

facilities “cross-over traffic.”

In this rulemaking, the Board changed the way that it

allocates the revenue of cross-over traffic between on-SARR

and off-SARR facilities. The Board previously allocated

revenue based essentially on the percentage of miles the

shipper used the SARR. Thus, if 60 percent of a shipper’s

route was on-SARR and 40 percent was off-SARR, roughly

60 percent of its revenue contribution would be allocated to

the SARR.

Although the old approach had the virtue of simplicity, it

had a critical flaw, which we identified in BNSF Railway Co.

v. STB, 453 F.3d 473 (D.C. Cir. 2006). The mileage-based

approach did not take into account “economies of density” –

the principle that the more traffic on a given stretch of rail, the

lower the average cost (and hence the lower the cross-over-

traffic revenue that should be attributed to it).

To take an example, imagine a toll road that five drivers

use. If the annual upkeep for the road costs $100, each driver

would need to contribute $20 annually. If those drivers pay

$40 per year in taxes, then 50 percent of their tax contribution

is attributable to the road. Now imagine that 50 drivers use

the road – that is, that its density has increased tenfold. Each

driver would need to contribute only $2 annually. Of their

$40 tax liability, only five percent would be attributable to the

road. The same logic applies here. For cross-over traffic, the

higher the density of the on-SARR facilities, the smaller the

proportion of their overall revenue contribution should be

attributed to the SARR. In other words, more of their revenue

22

contribution must be going to cover costs for off-SARR

facilities.

In BNSF, the complaining railroad proposed a method of

allocating revenue from cross-over traffic that would have

taken into account economies of density. We concluded,

however, that the Board had reasonably declined to adopt that

alternative because the proposal ignored the diminishing

nature of economies of density – that is, the fact that at some

point, higher density no longer results in lower average costs.

See id. at 483-84. As the Board summarized the principle,

“the railroad industry is characterized by economies of

density, meaning the average total cost for a network of a

given size initially decreases with increases in output. But

economies of density also diminish with higher output and at

some point are exhausted.” STB Ex Parte No. 657, at 26.

Although we were not convinced in BNSF that the Board

had acted unreasonably in rejecting the incomplete alternative

proposed by the railroad, we stated that “[w]ere the Board

presented with a model that took account both of the

economies of density and of the diminishing returns thereto, a

decision to adhere to [the old] model would be on shaky

ground indeed. But that day is yet to come.” BNSF Ry., 453

F.3d at 484.

In this rulemaking, the Board determined that the day had

arrived. It adopted an approach that takes into account both

economies of density and their diminishing nature. The

Board’s new approach – called the Average-Total-Cost

method – allocates revenues based partly on the average total

cost of a segment rather than just on mileage. Because

average total cost for a given segment of rail decreases as

density increases (up to a point), basing the revenue allocation

in part on average total costs solves the problem that we

23

identified in BNSF. As the Board recognizes, our decision in

BNSF strongly suggested that the Board would be required to

adopt an appropriate density-based approach if one were

presented to it. The Average-Total-Cost method “takes

account of both economies of density and diminishing

returns.” STB Ex Parte No. 657, at 34. The Board thus

concluded that continued use of the mileage-based approach

“would be on shaky ground.” Id.

The shippers nonetheless claim that the Board’s new

revenue-allocation formula arbitrarily departs from

Guidelines. Their argument can be summarized in the

following syllogism: Guidelines does not permit the Board,

when setting rates, to allocate a percentage of fixed costs to a

given shipper, but rather requires the Board to set rates on the

basis of shipper demand. The new revenue-allocation

formula for cross-over traffic, which is a fundamental

component of the Stand-Alone-Cost analysis, is based on the

average total costs of the on-SARR and off-SARR segments,

not shipper demand. Therefore, the cost-based, revenue-

allocation formula violates Guidelines.

We do not agree that the Board’s change to the Average-

Total-Cost method was unreasonable or contrary to precedent.

We have already held that the Board may allocate revenue

between on-SARR and off-SARR facilities without taking

into account shipper demand. In BNSF, we upheld the

mileage-based approach because the Board had reasonably

assumed that “average costs are a continuous function of

distance.” BNSF Ry., 453 F.3d at 483 (internal quotation

marks omitted). The new method simply refines that

approach by taking into account economies of density.

Although Guidelines may favor a demand-based approach

generally for setting rail rates, the Board has acted reasonably

in using a cost-based approach, for the Stand-Alone-Cost test,

24

to estimate the costs that cross-over traffic imposes on the

SARR. “The pursuit of precision in rate proceedings, as in

most things in life, must at some point give way to the

constraints of time and expense, and it is the agency’s

responsibility to mark that point. Our role is limited to

determining whether the balance it struck is arbitrary.” Id. at

482. In this case, it follows from our decision in BNSF that

the Board’s action was reasonable.

D

The shippers contend that the Board’s application of the

Average-Total-Cost method to a case that was pending when

the Board issued its notice for proposed rulemaking was

impermissibly retroactive and otherwise arbitrary and

capricious. See Western Fuels Ass’n, Inc. v. BNSF Ry. Co.,

2007 WL 2590251 (STB Sept. 7, 2007). The shippers argue

that the Board should not have applied its new Average-Total-

Cost revenue-allocation formula because they had relied on

the mileage-based approach in incurring significant costs to

design and defend a SARR for the Stand-Alone-Cost analysis.

We reject the shippers’ argument. “A new rule may be

applied retroactively to the parties in an ongoing adjudication,

so long as the parties before the agency are given notice and

an opportunity to offer evidence bearing on the new standard,

and the affected parties have not detrimentally relied on the

established legal regime.” Consol. Edison Co. v. FERC, 315

F.3d 316, 323 (D.C. Cir. 2003) (internal citations omitted).

Here, there was no established legal regime on which the

parties litigating before the Board could have reasonably

relied: They were on notice that the Board had not settled on

any one method for allocating the revenue contribution of

cross-over traffic. As we said in BNSF, “[t]he appropriate

allocation of revenue from cross-over traffic is a perennial

25

issue in [Stand-Alone-Cost] proceedings and one the Board

even now [in 2006] has not resolved definitively.” 453 F.3d

at 483; see also, e.g., Duke Energy Corp. v. Norfolk Southern

Ry. Co., 2003 WL 22673026, at *10 (STB Nov. 5, 2003)

(“The Board has long recognized, however, that this

methodology may not work in all cases, and it has been open

to suggestions for other methods to allocate cross-over

revenues.”). The shippers do not respond to the Board’s

argument that, before adopting the Average-Total-Cost

method, the Board had repeatedly warned that it sought to

adopt a methodology that would take density into account.

As the Board made clear both in the rulemaking and in

Western Fuels, the shippers had no basis for relying on the

prior revenue-allocation formula. See STB Ex Parte No. 657,

at 75; Western Fuels, 2007 WL 2590251, at *20.

Nevertheless, the Board gave the shippers an opportunity to

redesign or defend their SARR using the new formula. See

Western Fuels, 2007 WL 2590251, at *20.

Moreover, given that the new methodology was

“designed in large part to improve the reliability of [the

Stand-Alone-Cost] analysis, and given the possibility of rate

prescriptions of nearly 20 years,” it was reasonable for the

Board to immediately discard the flawed procedure and apply

its new rule to pending cases when the parties were on notice

of the potential change. STB Ex Parte No. 657, at 76.

***

For the reasons stated above, we deny the petitions for

review.

So ordered.