# Determination No. R-2019-68

April 30, 2019

DETERMINATION by the Canadian Transportation Agency (Agency) of the 2019–2020 Volume-Related Composite Price Indices (VRCPIs) for the Canadian National Railway Company (CN) and the Canadian Pacific Railway Company (CP) as 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:
18-00109

### SUMMARY

[1] The Agency has determined:

1. CN's VRCPI for the 2019–2020 crop year to be 1.4371, an increase of 1.82 percent from the 2018–2019 crop year.
2. CP's VRCPI for the 2019–2020 crop year to be 1.5148, an increase of 3.70 percent from the 2018–2019 crop year.

[2] The Agency will use these values in determining CN and CP's MREs for the 2019–2020 crop year, which the Agency must issue by December 31, 2020.

### 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:

(a) Thunder Bay or Armstrong, Ontario,
(b) Churchill, Manitoba for export,
(c) a port in British Columbia for export, other than export to the United States for consumption in that country, or
(d) a point west of Thunder Bay or Armstrong, Ontario, if the grain is to be carried to a port in British Columbia for export, other than export to the United States 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.

[5] There are currently two prescribed railway companies: CN and CP.

[6] Subsection 151(1) of the CTA provides the formula that the Agency is to use in determining a railway company's MRE. 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.

[7] The determination of the VRCPIs is based on 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.

[8] The Agency is required to determine the VRCPIs on or before April 30, prior to the beginning of the crop year that they relate to. This determination is in respect of the 2019–2020 crop year.

### PROPOSALS FOR METHODOLOGICAL OR INTERPRETIVE CHANGES

[9] In accordance with the established process for managing proposals for methodological or interpretive changes related to the VRCPIs, Agency staff, by letter dated January 19, 2018, reminded CN and CP that the deadline for submitting any such proposals was August 15, 2018. No new proposals for methodological or interpretive changes were submitted by industry participants for consideration by the Agency for the 2019–2020 VRCPIs.

### THE LAW

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

The following rules are applicable to a volume-related composite price index:
(a) in the crop year 2016–2017, each prescribed railway company's index is 1.3275;
(b) an index shall be determined in respect of each of the prescribed railway companies; and
(c) the Agency shall make adjustments to each prescribed railway company's index to reflect the costs incurred by the prescribed railway company to obtain hopper cars for the movement of grain and the costs incurred by the prescribed railway company for the maintenance of those hopper cars.

### ANALYSIS AND DETERMINATIONS

#### CN

[11] The Agency has determined CN's VRCPI for the 2019–2020 crop year to be 1.4371, an increase of 1.82 percent from the 2018–2019 crop year.

[12] The 1.82 percent increase in CN's VRCPI stems from:

1. a 1.01 percent increase attributable to updating previous Agency forecasted price changes for 2018 with actual price changes and incorporating revised forecasts for 2019; and,
2. a 0.81 percent increase in forecasted price changes for the 2019–2020 crop year.

[13] The following table summarizes the changes that make up CN's 2019–2020 VRCPI:

Table 1: CN
CN 2019-2020 VRCPI Weight % A % Change B % Weighted Change C= A x B
Price Component: Labour 32.19 0.06 0.02
Price Component: Fuel 16.03 2.25 0.36
Price Component: Material 34.64 1.19 0.41
Price Component: Investment (leased cars, amortization, cost of capital) 17.14 -1.76 -0.30
Total price components 100   0.49
Total cost components     0.32
Total price changes for 2018-2019 (price components and cost components)     0.81
Revisions to the 2018-2019 VRCPI to reflect actual and updated - forecasted price and cost changes     1.01
Total increase to the 2019-2020 VRCPI     1.82

#### CP

[14] The Agency has determined CP's VRCPI for the 2019–2020 crop year to be 1.5148, an increase of 3.70 percent from the 2018–2019 crop year.

[15] The 3.70 percent increase in CP's VRCPI stems from:

1. a 1.38 percent increase attributable to updating previous Agency forecasted price changes for 2018 with actual price changes and incorporating revised forecasts for 2019; and,
2. a 2.32 percent increase in forecasted price changes for the 2019–2020 crop year.

[16] The following table summarizes the changes that make up CP's 2019–2020 VRCPI:

Table 2: CP
CP 2019-2020 VRCPI Weight % A % Change B % Weighted Change C= A x B
Price Component: Labour 33.07 -1.28 -0.42
Price Component: Fuel 15.03 2.79 0.42
Price Component: Material 31.90 1.08 0.34
Price Component: Investment (leased cars, amortization, cost of capital) 20.00 0.55 0.11
Total price components 100   0.45
Total cost components     1.87
Total price changes for 2018-2019 (price components and cost components)     2.32
Revisions to the 2018-2019 VRCPI to reflect actual and updated - forecasted price and cost changes     1.38
Total increase to the 2019-2020 VRCPI     3.70

#### 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 pension, and employment insurance contributions).

[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] For CN, the Agency forecasts a 0.06 percent increase in labour for the 2019–2020 crop year, and for CP a 1.28 percent decline. In both cases, projected increases in general wages were offset by projected declines for some of the wage related and fringe benefits (pension) 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 model based on the relationship of railway fuel prices and the price of crude oil (using the common benchmark West Texas Intermediate) to arrive at the projected fuel index. The model also accounts for any known hedging practices, federal fuel excise tax, provincial fuel sales taxes and carbon 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 is US$58.39/bbl for 2019 (a decline of 9.9 percent from 2018) and is forecasted to increase by 1.8 percent to US$59.47/bbl for 2020. 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 US dollars. The average of the third party forecasts for the exchange rate is US$0.754 for 2019 and US$0.764 for 2020.

[24] The Agency forecasts a 2.25 percent increase for CN and a 2.79 percent increase for CP in fuel prices for the 2019–2020 crop year, after taking into account increases in fuel-related taxes and a projected decline in the price of crude oil in 2019 which is partially offset by a small projected increase in 2020.

#### Material

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

[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 approximately 70 to 85 percent of materials purchased are affected by the exchange rate.

[27] The Agency forecasts a 1.19 percent increase for CN and a 1.08 percent increase for CP in their respective material price index for the 2019–2020 crop year, primarily attributable to moderate increases for fabricated metals products, refined petroleum and coal products.

#### Investment components

[28] Investment components include cost of capital and amortization of investments, as well as leased hopper car costs.

[29] One of the elements used in calculating the cost of capital component of the VRCPIs is the cost of capital rate. This item has been dealt with separately in Decision No. LET-R-41-2019 for CN and Decision No. LET-R-40-2019 for CP.

[30] The Agency forecasts a 1.76 percent decrease for CN and a 0.55 percent increase for CP in the investment components index for the 2019–2020 crop year. This year, CN's cost of capital rate (an important element in the overall investment components) fell, compared to last year, as outlined in Decision No. LET-R-41-2019. A projected moderate weakening of the Canadian dollar will lead to slightly higher costs for leased cars (which are generally negotiated in US dollars).

#### Cost Components

[31] Cost components include adjustments made to CN and CP's VRCPIs pursuant to paragraph 151(4)(c) of the CTA to reflect costs incurred by CN and CP in obtaining hopper cars for the movement of grain as well as the net impact of replacing 1992 hopper car maintenance costs with actual costs (Decision No. 67-R-2008). The Agency forecasts a 0.32 percent increase for CN and a 1.87 percent increase for CP primarily attributable to the acquisition of hopper cars for the movement of grain.

[32] On April 5, 2019, CP submitted, pursuant to paragraph 151(4)(c) of the CTA, amounts it expects to incur for the maintenance of hopper cars obtained for the movement of grain. The Agency finds that there is insufficient time to make an informed determination on this matter given the statutory deadline of April 30, 2019 and, as such, consistent with its authorities pursuant to subsection 151(6) of the CTA, the Agency will make any required adjustments it considers appropriate to CP's 2019–2020 VRCPI, at a later date.

## Member(s)

Scott Streiner
Elizabeth C. Barker
J. Mark MacKeigan
Date modified: