Decision No. 120-R-2015

INTRODUCTION

[1] The Canadian Transportation Agency (Agency) is required to determine, by April 30, 2015, the Volume-Related Composite Price Index (VRCPI) for crop year 2015-2016 commencing August 1, 2015 and ending July 31, 2016.

[2] In this Decision, references to 2015-2016 mean the crop year from August 1, 2015 to July 31, 2016.

BACKGROUND

[3] The Maximum Revenue Entitlement (MRE) program, established August 1, 2000 for the movement of western grain by prescribed railway companies, requires the Agency to annually determine an MRE, commonly referred to as a “revenue cap” for each railway company and to subsequently determine whether each railway company has exceeded its MRE.

[4] Subsection 151(1) of the Canada Transportation Act (CTA) provides the formula that the Agency is to use in determining the MREs. One of the inputs to the formula is the VRCPI.

[5] 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.

[6] The development of the 2015-2016 VRCPI involved detailed submissions of historical price information of railway inputs (labour, fuel, material and capital) from the prescribed railway companies, currently the Canadian National Railway Company (CN) and the Canadian Pacific Railway Company (CP). The submitted information was reviewed and verified by Agency staff. In addition, Agency staff developed forecasts for future changes in the price of railway inputs.

ISSUES CONSIDERED BY THE AGENCY

[7] In keeping with the established process for managing proposals for methodological or interpretive changes related to the VRCPI, Agency staff, by letter dated January 14, 2014 reminded CN and CP that the deadline for submitting any such proposals was August 15, 2014. No new proposals for methodological or interpretive changes were submitted for consideration by the Agency for the 2015-2016 crop year. An issue relating to adjustments under paragraph 151(4)(c) of the CTA that may potentially affect the 2015-2016 VRCPI is being dealt with separately as detailed in Decision No. LET-R-17-2015 and the reasons for that Decision.

MAJOR COMPONENTS OF THE VRCPI

Labour

[8] The development of 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).

[9] In developing its forecasts for labour for the 2015-2016 crop year, the Agency considered forecasted price changes for each of the major price index components, including wages, wage-related items and fringe benefits. Employing the same practice as in previous years, i.e., considering established labour contracts that extend into the future (if available) and relying on projections of historical trends for the remaining sub-components, the labour component of the 2015-2016 VRCPI is forecasted to increase by 1.6 percent.

Fuel

[10] The railway fuel price index reflects changes in the average annual price per litre of diesel fuel. 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). The model also accounts for any known hedging practices, federal fuel excise tax and provincial fuel sales taxes.

[11] The Agency relies heavily on international crude oil price forecasts and forecasts for the Canada/U.S. exchange rates from a number of expert third-party forecasters as inputs to the Agency’s fuel forecasting model.

[12] The average of the third-party forecasters for the price of crude oil used in the development of the 2015-2016 railway fuel price index is 52.30 USD/bbl for 2015 and 65.30 USD/bbl for 2016. 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 third-party forecasts for the exchange rate is 0.783 USD for 2015 and 0.798 USD for 2016.

[13] The Agency fuel forecast model predicts an overall 8.3 percent decline in fuel prices for 2015-2016 as compared to 2014-2015.

Material

[14] Railway companies purchase thousands of different material items each year, far too numerous to track individually. Therefore, the material price index reflects changes in the average annual price of a basket of railway materials, similar to the consumer price index. 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 25 percent of materials purchased are affected by the exchange rate. For crop year 2015-2016, the Agency is forecasting a 1.6 percent increase in the material price index.

Other components

[15] One of the components in this group is the cost of capital rate which is applied to the capital indices. This item has been dealt with separately in Decision No. LET-R-22-2015 and Decision No. LET-R-23-2015. Other components in this group include leased hopper car rates, amortization of investments, and the net impact of replacing 1992 hopper car maintenance costs with more recent actual costs, as determined and implemented in 67-R-2008">Decision No. 67-R-2008 pursuant to Clause 57 of Bill C-11, which passed in June 2007.

[16] This component also includes 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. The most recent paragraph 151(4)(c) adjustment, as detailed in Decision No. LET-R-17-2015 and the reasons for that Decision, involved the withdrawal of CN-operated federal government-owned hopper cars and resulted in a 0.3 percent increase in the 2014-2015 VRCPI.

[17] The Agency has applied the same methodologies and cost basis as last year for each of these other components. The combined impact of changes for other components is a price decrease of 6.7 percent for 2015-2016. This change is partially attributable to a forecasted decline in the combined CN and CP cost of capital rate for 2015-2016 which dropped to 6.5 percent from 6.9 percent last year.

OVERVIEW OF VRCPI CHANGES FOR THE NEXT CROP YEAR

[18] As indicated in the table below, the 2015-2016 VRCPI is 5.6 percent lower than the 2014-2015 VRCPI determined by the Agency in Decision No. LET-R-17-2015. The 5.6 percent decline stems from two main sources:

1. a 4.1 percent decrease attributable to the effect of replacing last year’s forecasts of price changes for railway inputs for 2014 with actual (preliminary) data and incorporating revised forecasts for 2015 (from this year’s exercise); and,
2. a further 1.5 percent decrease due to forecasted price changes for railway inputs for the 2015-2016 crop year.

[19] The 4.1 percent decrease is largely attributable to the Agency having over forecasted the change in railway fuel prices for the 2014-2015 crop year. The Agency’s forecasting models for railway fuel prices rely heavily on third-party forecasts for the price of crude oil and the Canada/U.S. exchange rate. The 2014 third-party forecasts used by the Agency for the price of crude oil last year were higher than the actual 2014 price and the 2014 forecasts for the CAD were lower than actually experienced; a lower dollar makes the cost of crude oil more expensive as it is purchased in USD. As well, last year’s 2015 forecast for the price of crude oil was much higher than this year’s (90.2 USD/bbl v. 52.3 USD/bbl) and the 2015 forecast for the exchange rate was higher (0.898 USD v. 0.783 USD) which works to partially offset the forecasted decline in the crude oil price. In CAD terms, the Agency had forecasted 100.45 CAD/bbl (90.2 USD/bbl / 0.898 USD) for 2015 last year and is now forecasting 66.79 CAD/bbl (52.3 USD/bbl / 0.783 USD) this year.

[20] The Agency notes that in several instances in the past, year over year, fluctuations in the VRCPI have been largely attributable to the volatility inherent in fuel prices. The volatility present in each of the two main components used in the Agency’s fuel forecasting models, i.e., the price of crude oil and the exchange rate, renders these items, and therefore the price of fuel, very difficult to predict with a high level of accuracy, even by the expert forecasters on which the Agency relies.

[21] The table below provides a summary of the changes for the 2015-2016 VRCPI.

Major Component	Effective Weight (%)	% Change
Labour	35	+1.6
Fuel	23	-8.3
Material	32	+1.6
OtherNote 1	10	-6.7
Total weighted price changes within 2015-2016	100	-1.5
Downward revision to 2014-2015 VRCPI weighted price changes based on actual and updated forecasted data	-	-4.1Note 2
Total weighted price changes since the 2014-2015 VRCPI determination	-	-5.6

EVOLUTION OF THE VRCPI

[22] The graph below illustrates the impact of the current VRCPI determination in the context of the evolution of the VRCPI since 2001-2002.

[23] The VRCPI has tracked up and down since the beginning of the MRE program. In recent years, exceptional fluctuations have reflected the volatility of fuel prices, the hopper car adjustment in 2007-2008 and, as outlined in 149-R-2012">Decision No. 149-R-2012, the methodologies 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. The VRCPI is expected to grow at an average annual compounded growth rate of 1.5 percent over the 2000-2001 to 2015-2016 period.

Chart Details

VRCPI and VRCPI Annual % Change from 2000-2001 to 2015-2016

Crop Year	VRCPI	Annual % change	Average annual rate (includes forecasts for 2015-2016)
2001-02	1.0352	3.5%	1.5%
2002-03	1.0442	0.9%	1.5%
2003-04	1.0195	-2.4%	1.5%
2004-05	1.0108	-0.9%	1.5%
2005-06	1.0553	4.4%	1.5%
2006-07	1.1252	6.6%	1.5%
2007-08	1.0639	-5.4%	1.5%
2008-09	1.1493	8.0%	1.5%
2009-10	1.0638	-7.4%	1.5%
2010-11	1.1384	7.0%	1.5%
2011-12	1.1777	3.5%	1.5%
2012-13	1.2919	9.7%	1.5%
2013-14	1.2691	-1.8%	1.5%
2014-15	1.3257	4.5%	1.5%
2015-16	1.2517	-5.6%	1.5%

AGENCY DECISION

[24] The Agency’s determination of the VRCPI for 2015-2016 is 1.2517, a decrease of 5.6 percent from 2014-2015.

[25] The VRCPI of 1.2517 will be applied in the legislative formula under section 151 of the CTA when the Agency makes its MRE determinations by December 31, 2016 for the 2015-2016 crop year.