# Determination No. R-2018-254

November 30, 2018

DETERMINATION by the Canadian Transportation Agency (Agency) of the 2019 regulated interswitching rates pursuant to Part III, Division IV of the Canada Transportation Act, S.C., 1996, c. 10, as amended (CTA).

Case number:
18-04838

### SUMMARY

[1] This is the Agency’s determination of the 2019 regulated interswitching rates pursuant to Part III, Division IV of the CTA.

[2] Subsection 127.1(1) of the CTA requires that, no later than December 1 of every year, the Agency determine the rate per car to be charged for interswitching traffic for the following calendar year.

[3] Subsection 127.1(2) of the CTA requires that, in determining an interswitching rate, the Agency take into consideration

1. any reduction in costs that, in the opinion of the Agency, results from moving a greater number of cars or from transferring several cars at the same time; and
2. any long-term investment needed in the railways.

[4] Subsection 127.1(3) of the CTA requires that, in determining an interswitching rate, the Agency consider the average variable costs of all movements of traffic that are subject to the rate and the rate shall not be less than the variable costs of moving the traffic, as determined by the Agency.

[5] The Agency determines the regulated interswitching rates for 2019 as follows, according to the interswitching distance zones as defined in the Railway Interswitching Regulations, SOR/88‑41, as amended (Interswitching Regulations):

Interswitching distance zone Rate per car for interswitching traffic to or from a siding
(single car)
Rate per car for interswitching a car block
(60 cars or more)
Zone 1 $340$50
Zone 2 $435$80
Zone 3 $280$70
Zone 4 $275$55
Additional rate per kilometre per car $7.20$1.10

### BACKGROUND

[6] Regulated in Canada since 1904, interswitching is a practice that gives some shippers access to the services of railway companies that do not directly serve their facilities or sidings, by requiring that a railway company that does provide such direct service transfer cars with a shipper’s traffic at an interchange to a different railway company with which the shipper has made transportation arrangements.

[7] On May 23, 2018, the Transportation Modernization Act, S.C., 2018, c. 10, which included a number of interswitching-related amendments, received royal assent.

[8] Subsection 127.1(1) and paragraph 127.1(2)(b) were added to the CTA, requiring the Agency to determine the interswitching rates no later than December 1 of every year and to take into consideration any long-term investment needed in the railways, respectively.

[9] Subsection 127.1(4) was added to the CTA, requiring the Agency to publish the method that it followed for determining the rate.

[10] Subsection 127.1(5) was added to the CTA, requiring the Agency to publish the interswitching rate in the Canada Gazette no later than December 31 before the beginning of the calendar year for which the rate applies.

[11] These new provisions will help ensure that interswitching rates are established and communicated in a timely and transparent fashion. The present determination represents an important first step in implementing an updated approach to setting interswitching rates.

[12] This is the first revision of the interswitching rates since 2013. It necessarily relies on available data, and uses well-established costing methodologies, some elements of which are used in other Agency determinations. It also reflects relevant methodological determinations, for example, Decision No. 425-R-2011 (2011 cost of capital decision), Decision No. 97-R-2012 (pension decision), Decision No. 2015-R-91 (variability decision) and Determination No. R‑2017‑198 (determination of the methodology to determine the working capital amounts and capital structure for regulatory purposes).

[13] The Agency intends to launch consultations in early 2019 to examine the methodology used to set interswitching rates. These consultations will examine a broad range of methodological questions and factors, including car block categories, regional rates, rates developed for federally‑regulated short-line railway companies, and the Agency’s cost of capital methodology.

### RATE CONSIDERATIONS

[14] In calculating the 2019 regulated interswitching rates, the Agency used the methodology presented in Appendix A. This approach reflects the considerations referred to in subsections 127.1(2) and 127.1(3) of the CTA.

### REDUCTION IN COSTS RESULTING FROM MOVING A GREATER NUMBER OF CARS

[15] As provided for in paragraph 127.1(2)(a) of the CTA, the Agency has taken into consideration the resultant reduction in costs from the movement of a greater number of cars in the calculation of the car block rates.

[16] The current threshold for car block rates is set at 60 cars or more, which was established by the Agency in 1988 following a public consultation on its Interswitching Regulations. The Agency reviewed the threshold again in December 2007, and confirmed the 60-car limit at that time.

### LONG-TERM INVESTMENT NEEDED IN THE RAILWAYS

[17] The Transportation Modernization Act added a requirement, in paragraph 127.1(2)(b) of the CTA, which directs the Agency to also take into consideration “any long-term investment needed in the railways.” Below is an explanation of the approach used by the Agency to reflect this provision in the rate-setting exercise for 2019.

[18] The Agency’s interswitching methodology follows the standard Agency costing model, which captures the economic costs of providing interswitching service. This serves to capture both the accounting costs and the implicit costs of a railway, including labour costs, fuel costs, material and other costs, and capital costs, which include depreciation of assets, and the returns on investment in those assets.

[19] By comparison, accounting costs only capture the explicit costs of a firm. Accounting costs are the actual cash outlays of a company that is providing a service or good such as labour, fuel and materials. Compensating railway companies with the full economic costs of their operations supports their long-term economic viability in the market. The Agency captures the implicit costs of the Canadian National Railway Company (CN) and the Canadian Pacific Railway Company (CP) through the cost of capital allowance and a depreciation allowance in its costing methodology.

[20] The cost of capital is defined as an estimate of the total return on net investment required by debt holders (cost of debt) and shareholders (cost of common equity) such that debt costs can be paid and shareholders can be provided with a return on investment consistent with the risks assumed for the period under consideration.

[21] The cost of debt portion of the cost of capital is measured by the Agency using the coupon rate method, which represents the actual interest paid to financial institutions or bond holders for loans made to the railway companies, as recorded in the most recent financial statements of the railway companies. If the allowance for the cost of debt was less than the actual cost of debt paid, the businesses would have difficulty meeting their debt obligations and securing additional debt to fund future long-term investments. On the other hand, if the allowance for the cost of debt was more than the actual cost of debt, this would result in an unjustifiable windfall and not be in keeping with section 112 of the CTA, which states that a rate established by the Agency must be commercially fair and reasonable to all parties.

[22] The cost of the common equity portion of the cost of capital is calculated using the traditional Capital Asset Pricing Model (CAPM) as presented in the 2011 cost of capital decision. From 2009‑2011, the Agency conducted a comprehensive public review of different cost of common equity models including the Discounted Cash Flow (DCF) Model, the Equity Risk Premium Model, and combinations of different models including the averaging of the CAPM and the multi‑stage DCF Model. After reviewing the merits of all models, as well as considering stakeholder views, the Agency concluded that the traditional CAPM best met requirements.

[23] An allowance for depreciation costs uses the remaining life technique of the Group Plan method. In the remaining life technique, the depreciation rate for a group of assets, such as locomotives, divides the cost of locomotives (gross investment less net salvage value) by the number of years in its whole life calculation to determine a yearly depreciation value. Any imbalances in total annual depreciation (due to early or later retirements) are adjusted over the remaining life of all the locomotives.

[24] The whole life and remaining life of each asset are estimated by CN and CP and verified by the Agency through the analysis of historical data, comparisons between CN and CP, and with public data of other railway companies.

[25] This method of calculating the depreciation ensures that the costs of employing the assets used in providing rail service can be fairly apportioned between the railway companies and shippers.

### VARIABLE COSTS

[26] The Agency is responding to the requirements of subsection 127.1(3) of the CTA through its use of system average unit costs and by obtaining actual service units for regulated interswitching movements on site.

[27] By using actual costs incurred by the railway companies for each service unit (unit costs) and by applying actual service units utilized in providing regulated interswitching services, the Agency calculates the true variable cost of providing regulated interswitching services.

[28] This process is described in further detail in Appendix A.

### 2019 REGULATED INTERSWITCHING RATES

[29] The data used in the development of the interswitching rates are as follow (Appendix A describes these components in greater detail):

1. Interswitching service units (obtained through conducting annual Agency staff site visits);
2. 2014 unit cost for eachservice unit, including overheads (approved by the Agency on November 27, 2018);
3. 2017 volumes of interswitched cars (submitted by CN on April 12, 2018 and by CP on March 27, 2018);
4. 2014 contribution to fixed costs (the data required for this calculation was obtained by the Agency through Transport Canada on February 4, 2016).

[30] The current approach to determining interswitching rates is based on actual service units within each zone. Costs are affected by a range of factors that can include train length, customer siding characteristics, and train yard activities, any of which can vary considerably from one situation to another. As a result of taking these service unit factors into account, regulated interswitching costs do not simply increase in direct proportion to distance.

[31] In Order No. 2015-R-91, the Agency found that confidential railway company information, including the railway companies’ costing manuals, was not to be shared in the context of any proceeding.

[32] The Agency finds that the financial and operating data received from CN and CP and used as part of this determination process are commercially sensitive and that their public disclosure could reasonably be expected to prejudice the competitive position of CN and CP. Therefore, pursuant to section 25 of the CTA, the Agency will keep this information confidential. As such, no reference is made to this data, or to the Agency’s calculations relating to it, in this public Determination.

[33] The Agency determines that the regulated interswitching rates for 2019 for each of the interswitching distance zones defined in the Interswitching Regulations are to be as follows:

Interswitching distance zone Rate per car for interswitching traffic to or from a siding
(single car)
Rate per car for interswitching a car block
(60 cars or more)
Zone 1 $340$50
Zone 2 $435$80
Zone 3 $280$70
Zone 4 $275$55
Additional rate per kilometre per car $7.20$1.10

## Appendix A to Determination No. R-2018-254

### The Canadian Transportation Agency’s (Agency) Methodology for Calculating Regulated Interswitching Rates

The 2019 interswitching rates calculated by the Canadian Transportation Agency are based on a methodology that captures the economic costs of providing interswitching services. These economic costs include explicit costs such as operating costs, including the depreciation of assets, as well as the implicit costs associated with the returns on investment in those assets. The returns on investment are a weighted average of the returns on debt and the returns on equity, and are determined by the Agency according to its cost of capital methodology, which was reviewed in a comprehensive consultation and culminated in the 2011 cost of capital decision. It is important to note that the current interswitching rates setting methodology is based on determining actual costs of the activity, as described below, rather than employing techniques that enhance the relationship between rates and distance, as was done in the past.

For explanatory purpses, the Agency has calculated interswitching rates based on the following simplified formula:

Interswitching rates = (A x B) x C/D

Where:

• A is interswitching variable costs
• B is contribution to fixed costs
• C is a factor to account for price inflation, and
• D is a productivity adjustment factor

Interswitching variable costs are expressed as:

Interswitching variable costs(A) = (E/F x G) x H

Where:

• E is system costs
• F is system service units
• G is variability of costs, and
• H is interswitching service units

The expression (E/F X G) is referred to below as the unit cost for each service unit, including overheads.

A more detailed derivation can be found in Appendix B. In the following sections each of these variables is described in further detail.

### 1.0 Interswitching Service Units

Every year, Agency staff visit interchange locations across Canada to meet with CN and CP yard supervisors to review interswitching operations at each location. For each interchange location, all of the steps required to provide interswitching services for the major interswitching shippers in each zone and to estimate the service units involved in each step are verified . The Agency visits interchanges of different sizes, volumes and characteristics to capture the unique operations of interchanges across Canada.

The service unit estimates for single-car rates and block train rates are described in further detail in sections 1.1 and 1.2 respectively.

#### 1.1 Single-car service units

There are two different types of interswitching operations for single-car movements (interswitching 59 cars or less):

• Yard switching; and,

Under yard switching, a yard crew will pick up the interchange cars at the interchange and will bring them back to the yard for classification (sorting) and marshalling (placing cars in order for delivery). Cars are then delivered to the customer. On the return trip, the cars return to the yard where they are classified and marshalled again before returning to the interchange.

Road switching occurs in locations where switching in a yard is not possible, or in situations where only minimal classification or marshalling is required. Road switching involves either a line-haul train or a road crew picking up cars at the interchange. The cars may or may not be classified or marshalled at the interchange before being delivered to the customer. On the return trip, the cars are brought back to the interchange with little or no classification or marshalling.

Service unit estimates for road switching include:

• Gross ton-miles, which drive costs, such as track maintenance;
• Car-miles, which drive costs, such as car inspection;
• Train-miles, which drive costs, such as signals maintenance;
• Carloads, which drive costs, such as marketing and sales.
• Fuel consumed;
• Crew wages; and
• Diesel unit miles, which drive costs such as those for locomotive maintenance and investment.

Yard switching is more complex in terms of classification and marshalling. In most major yards, there would be a dedicated yard assignment with crews classifying or marshalling hundreds of cars. Since tracking specific cars and mileage at the yard is not possible in all circumstances, mileage at the yard is simplified as yard switching minutes.

Yard switching minutes captures the amount of time that it takes to service a customer, including the process of classification and marshalling. The associated unit cost for this service unit captures all of the expenses incurred for yard switching, including crew wages, locomotive fuel expenses, locomotive maintenance expenses, and track and roadway maintenance.

#### 1.2 Block train service units

Service unit estimates for block trains for the development of rates includes:

• Gross ton-miles;
• Car-miles;
• Train-miles;
• Fuel consumed;
• Crew wages; and
• Diesel unit miles.

Block movements involve a “hook and haul” operation where blocks of cars are hooked on at the interchange and delivered directly to the customer. On the return trip, cars are hooked and delivered directly to the customer. However, additional handling either at the interchange or at the shipper siding may be required. If, for example, the siding or the interchange is not long enough to handle the block, the railway must perform one or multiple cuts to the block in order to complete the movement. Where additional handling is identified during site visits, the costs are reflected in the final interswitching rate.

To calculate the extra kilometre rate for block trains, the movement for the average service units (average cars on a train, average number and type of locomotives used) of all of zone 4 block customers is assessed over one kilometre. To estimate the costs of moving one extra kilometre, the average train speed (obtained from CN’s and CP’s annual reports) is used. Unlike the extra kilometre rate for single-cars, where the costs of actual movements are captured, there are currently no movements in the extra kilometre zone for block trains so an estimation of costs is required.

### 2.0 Unit cost for each service unit, including overheads

Derived service units are multiplied by their corresponding unit cost to obtain a cost per car for each shipper in each zone. CN and CP submit their detailed financial and operating data to the Agency each year based on the Agency’s Uniform Classification of Accounts And Related Railway Records (2014) [UCA]. The UCA defines the method of accounting for railway companies subject to regulation by the Agency. It provides accounting instructions and the framework of accounts for the rail operations of suchrailway companies. It also provides instructions for the recording of operating statistics and defines the categories for such data.

The Agency approves each railway company’s cost to produce a unit of defined railway activities such as: track and roadway maintenance, signals investment, etc., based on system expenses on each activity and the system service units produced.

The costing model developed by the Agency then determines the total variable cost, including direct activities as well as indirect supervisory, management, and administration activities, to produce a unit cost for each service unit. These indirect costs are referred to as overheads because they do not relate to service units directly, but instead relate to the direct costs of those service units. (e.g. When a train moves one gross ton mile it will incur track maintenance labour costs directly, as well as indirect costs or overheads for the management of, and equipment used by track maintenance labourers).

For the 2019 interswitching rates, the Agency has used the 2014 CN and CP unit costs. An index factor (using indices from the volume-related composite price index) and productivity factor is applied (based on the Agency’s current productivity model) in order to estimate costs in 2019Footnote 1. The Agency applied an average productivity value of 98.23% to account for productivity gains between 2014 and 2019. This is based on the Agency’s calculation of the average total factor productivity growth of each railway company over this period.

The table in Appendix C lists all of the variable cost accounts (as defined by the UCA) that factor into the 2019 interswitching rates.

### 3.0 Volumes of interswitched cars

The volumes of interswitched cars are required to calculate a weighted system average of costs starting at each interchange, then for each zone, and finally CN and CP have to come up with the aggregated weighted system average interswitching costs. The example below illustrates the weighting that is applied:

1. For each interchange, the costs per car for each shipper within a zone are weighted by the carloads interswitched to produce an average cost per interchange.

#### Table 1:  Calculating costs for Vancouver zone 1 interswitching for railway ABC

Vancouver zone 1 for railway ABC 2017 carloads % weight
(share of traffic)
Variable cost per car Weighted zone 1 cost
Shipper A 800 80% $100.00$80.00
Shipper B 200 20% $80.00$16.00
Vancouver zone 1 cost per car for railway ABC 1,000 100%   $96.00 2. For each zone, the average costs for each interchange are then weighted by the traffic interswitched to produce an average cost per car for each zone. For example, the results from Table 1, are found in the first row below. #### Table 2: Calculating zone 1 Interswitching costs for railway ABC Zone 1 for railway ABC 2017 carloads % weight (share of traffic) Variable cost per car Weighted zone 1 cost Vancouver 1,000 62.50%$96.00 $60.00 Toronto 600 37.50%$150.00 $56.25 Zone 1 cost per car for railway ABC 1,600 100%$116.25

3. The costs for each railway in each zone are then averaged, based on the interswitching traffic of each railway company in that particular zone, to generate a system average variable cost measure per car for each of the four distance zones. For example, the results from Table 2, are found in the first row of Table 3.

#### Table 3: Calculating zone 1 Interswitching costs

Zone 1 2017 carloads % weight
(share of traffic)
Variable cost per car Weighted zone 1 cost
Railway ABC 1,600 44.44% $116.25$51.66
Railway XYZ 2,000 55.56% $125.00$69.45
Zone 1 cost per car 3,600 100%   $121.11 The zone 1 variable cost per car in this example is$121.11.

### 4.0 Contribution to fixed costs

Finally, a system average contribution to fixed costs is added to the variable costs for each zone to arrive at the interswitching rate for the zone. Fixed costs include items which are completely non‑variable such as the maintenance of bridges and snow removal. The costs related to the maintenance of bridges and snow removal do not vary with railway traffic volumes, but are caused by weather and age.

The Agency calculates the system average contribution to fixed costs separately for eachrailway company. The amount of fixed costs is calculated as the total system cost (which is derived from financial reports provided to the Agency) less the system variable cost (calculated by the Agency costing model). The system contribution to fixed costs is the amount of fixed costs expressed as a proportion of the system variable costs.

For 2019, the average contribution to fixed costs is 60.17%, compared to the 2013 value of 20.4% as set out in Decision No. LET-R-66-2010. There are two main reasons for this variation. First, in the pension decision, the Agency adjusted its methodology for railway pension accounting. This included the use of a regulatory cost assessment in place of GAAP principles and the creation of a pension asset account. These changes resulted in higher levels of both fixed and variable costs.
Second, in June 2015, the Agency issued the variability decision, which assessed the portion of railway expenses that could be directly linked to changes in railway operations. The variability decision, which was the result of the first major review of railway cost variabilities in over a decade, resulted in significant adjustments. The Agency will continue to monitor cost variabilities and the contribution to fixed costs.

## Appendix C to Determination No. R-2018-254

### Uniform Classification of Accounts (UCA) that factor into the 2019 Interswitching Rates

Cost complex UCA account number Description of account
103 Rail
105 Ties
106 Paved Concrete Trackbed (PACT System)
107 Other Track Material
109 Ballast
111 Track Laying and Surfacing
123 Public Improvements
125 Other Right-of-Way Property
141 Roadway Building Machines and Moveable Equipment
131cx 131 Office and Common Buildings
133 Office and Common Buildings Moveable Equipment and Machinery
143 143 Equipment Repair Shops
145 145 Shop Machinery and Moveable Equipment
149 149 Signals
151 151 Rail Communication Systems
163 163 Fuel Stations
171 171 Locomotives
187cx 187 Work Equipment
189 Other Non-Revenue Rolling Stock
195 195 Miscellaneous Equipment
463 Injuries to Railway Employees: Maintenance of Way and Structures
479 Other Way and Structure Expense
401cx 401 Track and Roadway Maintenance
403 Rails – Maintenance
405 Ties - Maintenance
406 Paved Concrete Trackbed - Maintenance
407 Other Track Material - Maintenance
409 Ballast - Maintenance
419 Tools and Supplies
423 Crossing Maintenance
461 Vehicles
431 431 Office and Common Buildings - Maintenance
437 437 Equipment Repair Shops - Maintenance
441cx 441 Track Signals - Maintenance
442 Hump Yard Devices - Maintenance
443 Crossing Protection - Maintenance
444 Other Signal Devices - Maintenance
671 Dispatching
673 Line Operators and Signal Operation
445cx 445 Rail Communication Systems - Maintenance
701 Rail Communication System Operation
457 457 Fuel Stations - Maintenance
571 Injuries to Railway Employees: Equipment Maintenance
579 Other Equipment Expense
501 501 Locomotive Maintenance
503 503 Locomotive Servicing
517 517 Lubrication, Inspection and Coupling Hose - Freight Cars
537 537 Work Equipment - Maintenance
539 539 Roadway machines - Maintenance
563cx 563 Work Equipment and Roadway Machine Rents - Dr.
564 Work Equipment and Roadway Machine Rents - Cr.
573 573 Shop Machinery - Maintenance
709 Building Operating Expenses
711 Other Rail Operations
743 Injuries to Railway Employees: Rail Operations (Yard and Train)
745 Clearing Wrecks
747 Third Party Injuries and Damage to Property (excluding Freight)
751 Miscellaneous Operating Expense
607 Train Crews - Freight
619 619 Train Locomotive Diesel Fuel - Freight
631 631 Train Other Expenses - Freight
641cx 641 Controlling Yard Operations
643 Yard and Terminal Clerical
645cx 645 Yard Engine Crews
647 Yard Train Crews
649 Operating Yard Devices
655 Yard Other Expense
651 651 Yard Locomotive Diesel Fuel
681cx 681 Freight Customer Service Centres
703 Weighing, Inspection and Demurrage Bureaus
741 741 Loss and Damage: Freight Train Accidents
749 749 Loss and Damage - Other Accidents
801 Management Services
809 Accounting and Finance
811 Personnel and Public Relations
861 Injuries to Railway Employees: General (and unallocated)
803 803 Marketing and Sales - Carload Freight
813 813 Environmental Remediation Expense
819 819 Employee Incentive Compensation
821 821 Pension Costs
823cx 823 Health and Welfare
827 Quebec Pension Plan
829 Employment Insurance
831 831 Other Employee Benefits
835 835 Labour Restructuring Expense
843 843 Provincial Sales Taxes
845cx 845 Municipal Property Taxes
849 Other Taxes
851 851 Insurance
903 Rail - Amortization
905 Ties - Amortization
906 Paved Concrete Trackbed - Amortization
907 Other Track Material - Amortization
909 Ballast - Amortization
911 Track Laying and Surfacing - Amortization
923 Public Improvements - Amortization
925 Other Right-of-Way Property - Amortization
941 Roadway Building Machines and Moveable Equipment - Amortization
931cx 931 Office and Common Buildings - Amortization
933 Office and Common Buildings Moveable Equipment and Machinery - Amortization
943 943 Equipment Repair Shops - Amortization
945 945 Shop Machinery and Moveable Equipment - Amortization
949 949 Signals - Amortization
951 951 Rail Communication Systems - Amortization
963 963 Fuel Stations - Amortization
971 971 Locomotives - Amortization
983 983 Roadway Machines - Amortization
987cx 987 Work Equipment - Amortization
989 Other Non-Revenue Rolling Stock - Amortization
995 995 Miscellaneous Equipment - Amortization

## Member(s)

Scott Streiner
Elizabeth C. Barker
Lenore Duff
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