The Railway Association of Canada

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February 7, 2008

Canadian Transportation Agency
Ottawa, Ontario
K1A ON9

Attention: Mr. Michel Maisonneuve

Review of the Interswitching Regulations

Sir,

The Railway Association of Canada is pleased to participate in the consultation undertaking by the Agency regarding the Review of the Interswitching Regulations. The RAC represents virtually all federally-regulated freight railways in Canada. Comments made or opinions expressed hereafter are the results of discussions with RAC Short line railway members. Some Short lines transfer more traffic to other railways than they accept, while others do exactly the opposite. The RAC has attempted to balance their comments. In light of the inherent problem posed by this difference in their operations, some members have decided to comment independently. Please also note that the two main Canada Class 1 railways, CN and CP, will do the same.

In 1997, the Agency determined that a 7.5% contribution over the variable cost was a reasonable compensation for the fixed costs involved in the provision of interswitching services. A rate review conducted in 2002 lead to a general reduction of the rate structure in 2004. The current rates have been in force since then and neither the 1997 nor the 2002 reviews included short line railway information.

In its consultation material, the Agency states that in its recent development of interswitching costs, it adjusted interchange-specific interswitching costs for inflation and estimated changes in railway productivity between 2005 and 2007. These lead to a reduction of rates in Zone 4 for the interchange of less than 60 cars and for a neutral or negative variation for all interchange of blocks of 60 cars or more.

The RAC does not question the calculation made by the Agency, but submits that the proposed rates are not reflective of the Canadian Short line railways' costs, and even less of their cost variations in recent years. Moreover, Short line railways have not seen a positive change in their productivity levels. Short line railways have a unique cost structure and might have a lower labour cost structure than larger railways, but with lower traffic volumes they cannot benefit from economies of scale. An example of the difference in their costs is the recent drastic increase in fuel prices, which had a serious negative impact on the Short lines. Short line railways cannot afford to use the most fuel efficient locomotives available on the market, and don't have the contractual flexibility to pass on to their customer such a fuel increase.

The proportion of operating expenses over operating revenues is significantly higher for Short line railways. The relation between operating expenses and operating revenues is known as the operating ratio. Such a ratio is used in general to demonstrate a company's ability to operate profitably. A ratio above 100 % means that the company suffered a loss: the lower the ratio, the greater the company's operating profit margin. On average, Short line ratios exceed 90 percent with some being above 100%. That ratio has been increasing regularly over the last 10 years. By comparison, the Class Is have seen their average operating ratio, now at approximately 74%, go down steadily over the same period.

The fact that Short lines' operating ratios are rising indicates that their productivity has fallen down during this period. Consequently, applying the proposed interswitching costs outlined in the CTA publication/methodology to the Short line sector is certainly not reflective of their actual interswitching costs.

Class 1 and Short line railways have different cost structures and productivity levels. The proposed interswitching rates do not reflect the commercial realities of both the Class 1 railways and Short line railways, and cannot be commercially fair to them. Only rates negotiated freely could meet this objective of the Act. In addition, proposed rates could be a form of subsidization to the railway paying such rates, if they are below the costs of the railway accepting the transfer of cars. Moreover, not factoring in capital cost recovery or profit could also constitute a barrier to entry for Short line operators looking to compete with Class I railways for local switching and, as such, may not be commercially fair to specific Short line operators. This might eventually price some Short lines out of the interchange market.

This being said, RAC Short line members are pleased to see a positive variation for the interswitching of less than 60 cars, which is generally the type of transfers they receive. However the decrease in the rates applicable to zone 4 will be negative to Short lines since their cost to provide that type of transfer did not go down in general. Short lines generally interchange traffic at only one or two locations, and don't have the ability to average their costs or balance losses and benefits over many interchanges spread across the country. They will be severely impacted by this proposed decrease.

As mentioned in the past, a 7.5% contribution to the railway variable costs is insufficient for Short lines and below what a reasonable compensation for their fixed costs should be. In the absence of a specific study on Short line railways' interchange costs, the RAC suggests that the Agency considers using the former grain transportation costs approach as a proxy measure. This would result in a 20% contribution to the variable costs being used for interswitching costs.

In the early 1980s, the Western Grain Transportation Act increased grain rates to compensatory levels and provided for a regulated contribution of 20%. While interswitching rates do not have to be compensatory anymore, it is difficult to understand how, years later, with a productivity level for this sector declining, that a 7.5% contribution could be adequate compensation to the cost of providing interchange services.

Short line railways believe that an increase in the contribution to variable costs of at least 20% would be a step in the right direction.

The RAC invites the CTA to review the proposed rates accordingly.

Yours truly

J.C. (Cliff) Mackay
President & C.E.O.

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