Determination No. R-2017-37

April 28, 2017
DETERMINATION by the Canadian Transportation Agency (Agency) of the 2017-2018 Volume-Related Composite Price Index (VRCPI) required for the Maximum Revenue Entitlement (MRE) program pursuant to Part III, Division VI of the Canada Transportation Act, S.C., 1996, c. 10, as amended (CTA).
Case number: 
16-00227

SUMMARY

[1] The Agency has determined the VRCPI for the 2017-2018 crop year to be 1.3817, an increase of 4.1 percent from the 2016-2017 crop year.

[2] The Agency will use the VRCPI of 1.3817 in determining the Canadian National Railway Company (CN) and the Canadian Pacific Railway Company (CP) MREs for the 2017-2018 crop year, which the Agency must issue by December 31, 2018.

BACKGROUND

[3] The MRE is a statutory limit on the overall revenue that can be earned by a prescribed railway company for the movement of western grain over a railway line from any point west of Thunder Bay or Armstrong, Ontario, to:

  1. Thunder Bay or Armstrong;
  2. Churchill, Manitoba; or,
  3. a port in British Columbia for export, but does not include the carriage of grain to a port in British Columbia for export to the United States of America for consumption in that country.

[4] If a prescribed railway company’s revenue exceeds its MRE, the company must pay out the excess amount plus a penalty to the Western Grains Research Foundation, a farmer-financed and directed organization set up to fund research that benefits Prairie farmers.

[5] Subsection 151(1) of the CTA provides the formula that the Agency is to use in determining the MREs. One of the inputs to the formula is the VRCPI, an inflation index that reflects forecasted price changes for CN and CP with regard to labour, fuel, material and other capital items.

[6] The Agency is required to determine the VRCPI on or before April 30, prior to the beginning of the crop year.

[7] There are currently two prescribed railway companies: CN and CP. This determination is in respect of CN and CP for the 2017-2018 crop year.

[8] The determination of the VRCPI includes detailed submissions from CN and CP on their historical price information for railway inputs involving labour, fuel, material and other capital items. Agency staff reviewed and verified the submitted information. In addition, Agency staff developed forecasts for future changes in the price of railway inputs.

PROPOSALS FOR METHODOLOGICAL OR INTERPRETIVE CHANGES

[9] In accordance with the established process for managing proposals for methodological or interpretive changes related to the VRCPI, Agency staff, by letter dated January 22, 2016, reminded;CN and CP that the deadline for submitting any such proposals was August 15, 2016. No new proposals for methodological or interpretive changes were submitted by industry participants for consideration by the Agency for the 2017-2018 VRCPI.

[10] In last year’s determination (Decision No. 131-R-2016), the Agency directed staff to:

  1. review the current approach for determining the material price index with a view to establishing a new approach that includes other fuels (i.e. in addition to diesel locomotive fuel that is already included); and,
  2. review the methodology used for the establishment of CN’s and CP’s capital structures, an element used to calculate their cost of capital.

[11] On the first direction, Agency staff worked with CN and CP to review the methodology used to calculate the historical material price index to incorporate a new component to reflect changes in prices for fuels not captured as diesel locomotive fuel. This revised methodology was used in developing the 2017-2018 VRCPI.

[12] On the second direction, Agency staff consulted with industry stakeholders with the goal of instituting clear guidelines for the establishment of an appropriate capital structure to be used for the determination of CN’s and CP’s cost of capital. The outcome of that consultation process and the Agency’s final determinations will be issued in the coming weeks.

[13] In addition, Agency staff identified that CP, as part of its cost of capital submission, introduced two changes to the way it calculates its cost of capital: i) the inclusion of an amount for intangible assets; and, ii) the deduction of intercompany balances from its long term debt. The Agency considered CP’s new approach and, for the reasons provided in Decision No. LET-R-17-2017, ruled that neither change was appropriate for the purpose of calculating CP’s cost of capital.

THE LAW

[14] Subsection 151(4) of the CTA states that:

The following rules are applicable to the volume-related composite price index:

  1. in the crop year 2000-2001, the index is deemed to be 1.0;
  2. the index applies in respect of all of the prescribed railway companies; and
  3. the Agency shall make adjustments to the index to reflect the costs incurred by the prescribed railway companies for the purpose of obtaining cars as a result of the sale, lease or other disposal or withdrawal from service of government hopper cars and the costs incurred by the prescribed railway companies for the maintenance of cars that have been so obtained.

ANALYSIS AND DETERMINATIONS

[15] The Agency has determined the VRCPI for the 2017-2018 crop year to be 1.3817, an increase of 4.1 percent from the 2016-2017 crop year.

[16] The 4.1 percent increase in the VRCPI stems from:

  1. a 0.6 percent increase attributable to the effect of replacing last year’s forecasts of price changes for railway inputs for 2016 with actual (preliminary) data and incorporating revised forecasts for 2017 (from this year’s exercise); and,
  2. a 3.5 percent increase in forecasted price changes for railway inputs for the 2017-2018 crop year.

[17] The table below provides a summary of the changes that make up the 2017-2018 VRCPI.

Major component Effective weight (%) % change
Labour 35 +1.3
Fuel 17 +11.4
Material 34 +1.6
Other capital itemsFootnote 1 14 +3.7
Total weighted price changes within 2017-2018 100 +3.5
Revision to the 2016-2017 VRCPI weighted price changes based on actual and forecasted data +0.6
Total 2017-2018 increase in the VRCPI from 2016-2017 +4.1

Labour

[18] The labour price index captures price changes in wages, wage-related items (such as bonuses and stock-based compensation) and fringe benefits (such as government and railway company pensions, and employment insurance).

[19] The Agency, consistent with its practice in previous years, considered established labour contracts that extend into the future (if available) and relied on projections of historical trends for the remaining subcomponents.

[20] The Agency forecasts a 1.3 percent increase in labour for the 2017-2018 crop year, with projected increases in general wages partially offset by projected declines for some of the wage-related and fringe benefits components.

Fuel

[21] The railway fuel price index reflects changes in the average annual price per litre of diesel fuel.

[22] The Agency uses a long-established model based on the relationship of railway fuel prices and the price of crude oil (based on the common benchmark West Texas Intermediate) to arrive at the fuel index. The model also accounts for any known hedging practices, federal fuel excise tax and provincial fuel sales taxes. The Agency relies on forecasts of international crude oil prices and on the Canada/U.S. exchange rates from a number of expert third-party forecasters as inputs to the Agency’s fuel forecasting model.

[23] The average of the third-party forecasts for the price of crude oil used in the development of the 2017-2018 railway fuel price index is 53.70 USD/bbl for 2017 and 56.10 USD/bbl for 2018. This represents a year-over-year increase of 24.0 percent (2017 over 2016 which averaged 43.30 USD/bbl) and 4.5 percent (2018 over 2017), respectively. An important element in the development of forecasts for the railway fuel price index is the Canada/U.S. exchange rate, as crude oil is purchased in USD. The average of the third-party forecasts for the exchange rate is 0.736 USD for 2017 and 0.752 USD for 2018.

[24] The Agency forecasts an 11.4 percent increase in fuel prices for the 2017-2018 crop year, with larger increases projected in the price of crude oil in 2017 mitigated somewhat by more moderate increases in 2018.

Material

[25] The material price index reflects changes in the average annual price of a basket of railway materials, similar to the consumer price index.

[26] The Agency’s long established methodology involves a series of regressions based on the major railway material components to forecast (based on third-party data) the average material price change. The model also incorporates forecasts for the Canada/U.S. exchange rate, as an estimated 75 to 80 percent of materials purchased are affected by the exchange rate.

[27] The Agency forecasts a 1.6 percent increase in the material price index for the 2017-2018 crop year, with significantly higher 2017 prices for steel and petroleum-based materials partially mitigated by more moderate increases in 2018.

Other capital-related components

[28] Other capital-related components include items such as: the cost of capital and amortization of investments; leased hopper car rates; the net impact of replacing 1992 hopper car maintenance costs with more recent actual costs (Decision No. 67-R-2008); and adjustments made pursuant to paragraph 151(4)(c) of the CTA to reflect the cost changes incurred by CN and CP related to the replacement of withdrawn or leased back government-owned hopper cars.

[29] One of the components used in calculating the cost of capital component of the VRCPI is the cost of capital rate. This item has been dealt with separately in Decision No. LET-R-16-2017 for CN and Decision No. LET-R-17-2017 for CP.

[30] The Agency forecasts a 3.7 percent increase in the other components of the price index for the 2017-2018 crop year. The largest contributors to the increase are increases in the cost of capital, amortization and leased car price changes. This year’s projected cost of capital rate is slightly higher than last year’s while an overall lower Canadian dollar continues to contribute to upwards pressure on leased car costs (which are generally negotiated in USD).

Evolution of the VRCPI

[31] The graph below illustrates the annual percent increases in the VRCPI since the program was established.

% change in the VRCPI


  • % change in the VRCPI
    Crop Year VRCPI Annual % change Average annual rate 1.9%
    (includes forecasts for 2017-2018)
    2001-2002 1.0352 3.5% 1.9%
    2002-2003 1.0442 0.9% 1.9%
    2003-2004 1.0195 -2.4% 1.9%
    2004-2005 1.0108 -0.9% 1.9%
    2005-2006 1.0553 4.4% 1.9%
    2006-2007 1.1252 6.6% 1.9%
    2007-2008 1.0639 -5.4% 1.9%
    2008-2009 1.1493 8.0% 1.9%
    2009-2010 1.0638 -7.4% 1.9%
    2010-2011 1.1384 7.0% 1.8%
    2011-2012 1.1777 3.5% 1.9%
    2012-2013 1.2919 9.7% 1.9%
    2013-2014 1.2691 -1.8% 1.9%
    2014-2015 1.3322 5.0% 1.9%
    2015-2016 1.2668 -4.9% 1.9%
    2016-2017 1.3275 4.8% 1.9%
    2017-2018 1.3817 4.1% 1.9%

[32] Exceptional fluctuations in past years were a result of volatility in the price of fuel, the hopper car adjustment in 2007-2008, and changes in the methodology to better recognize the cost of capital and the effect on the labour price index of the substantial payments made by CN and CP to their pension funds, as outlined in Decision No. 149-R-2012.

[33] The VRCPI has, since the inception of the MRE program, grown at an average annual compounded growth rate of 1.9 percent.

Member(s)

P. Paul Fitzgerald
Sam Barone
Scott Streiner
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