Decision No. 251-R-2005

File No. T6650-2

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INTRODUCTION

[1] The Canadian Transportation Agency (hereinafter the Agency) is required to determine the volume-related composite price index for crop year 2005-2006. A crop year begins on August 1 of one year and ends on July 31 of the following year.

BACKGROUND

[2] Effective August 1, 2000, a new "revenue cap" regime for the movement of western grain by a prescribed railway company replaced the former rate scale regime for such movements. The Canada Transportation Act (hereinafter the CTA) requires the Agency to determine each railway company's revenue cap annually and to determine whether each cap has been exceeded by the railway company.

[3] Subsection 151(1) of the CTA provides the formula that the Agency is to use in determining the revenue caps. One of the inputs to the formula is the volume-related composite price index. This index is to be determined by the Agency in advance of the crop year on or before April 30. Hence, by April 30, 2005, the Agency must determine the value for the volume-related composite price index for crop year 2005-2006.

[4] 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 incremental 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.

[5] The development of the volume-related composite price index for 2005-2006 required 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 (hereinafter CN) and the Canadian Pacific Railway Company (hereinafter CP). The submitted information was audited and verified by Agency staff. In addition, the railway companies and Agency staff developed forecasts for future changes in the price of railway inputs. The historical and forecasted information was summarized in an Agency report and shared with grain industry participants prior to a consultation session held in Winnipeg on March 31, 2005. This session included participants from producer organizations, the Canadian Wheat Board, shipper organizations, grain companies, railway companies, and federal, provincial and municipal governments.

ISSUE OF WHETHER TO UPDATE WEIGHTS

Background

[6] Since the 1994-1995 crop year, the volume-related composite price index has measured price changes, for CN and CP combined, based on a 1992 basket of input cost components and using 1992-based price indices for each input component. [There are currently six input cost components; labour, fuel, material, leased cars, depreciation and cost of capital.] 1992 basket "weights", derived for each input component as the ratio of its cost to the total basket cost, are used along with each component's price index to derive a single, composite measure of overall price change.

[7] Because component price indices assume different values over time, the "effective" weights for the components for a given year will differ from those in the 1992 base year. For example, the weight for labour increased from about 33percent in 1992 to an effective weight of about 40percent in 2004. If base year weights (and the corresponding rebasing of component price indices) are not periodically updated, the resulting composite price index will likely be upward-biassed, and consequently, will not provide an accurate measure of price change.

[8] As part of its mandate to determine the volume-related composite price index for crop year 2005-2006, the Agency addressed this issue and solicited comments from participants as to whether weights should be updated. Participants were given until March 8, 2005 to respond.

[9] In its annual volume-related composite price index report sent to industry participants for consultation purposes, the Agency summarized the feedback received on the question of whether it should update the weights. It also provided a brief assessment as to the impact of using 1992 weights versus more recent weights and proposed a methodology for updating the weights to determine the volume-related composite price index for 2005-2006. A round-table discussion of the various factors relating to the development of the composite price index for 2005-2006, including a discussion pertaining to the possible updating of the weights, was held in Winnipeg on March 31, 2005. Participants were given until April 8, 2005 to provide final written comments following the Winnipeg consultation.

Position of industry participants

[10] The opinions of the non-railway company participants differed from the opinions of the two railway company participants (i.e. CN and CP).

[11] The non-railway company participants showed support from the beginning for updating the weights. The main reasons were that, in theory, it provides a better measure of price change and, given that the Agency has used a fixed-basket indexation method, periodic updates to the weights are an integral part of that process. Once participants were provided with the March 18, 2005 consultation document that contained a brief assessment of the impact of using revised weights (the impact being a drop in the 2005-2006 composite index of about one-half percent which potentially translates to a savings of about $4 million per year on a volume of about 26 million tonnes), the shippers made it very clear that the Agency must not delay this process, or it would result in a potential $4 million overpayment by shippers for moving western grain. They also noted that based on additional information provided at the March 31, 2005 Winnipeg consultation, the upward bias in the composite price index (arising from the use of old, 1992 weights) appears to have begun several years ago and is widening at an increasing rate. Hence, it must be corrected immediately, to avoid further overstatement and overpayment by shippers.

[12] The railway companies were initially opposed to the Agency updating the weights as part of its mandate to determine the volume-related composite price index. Both railway companies noted that, aside from paragraph 151(4)(c), the CTA indicates that the Revenue Caps are to be indexed for "price" changes and not "cost" changes and that any changes to the indexation procedure that effectively converts the index from a price index to a cost index must be categorically rejected as contrary to legislation. CN suggested that the current approach of using 1992 weights is consistent with the fact that cost-based regulation and costing reviews were eliminated with the repeal of the Western Grain Transportation Act, R.S.C., 1985, c. W-8 (hereinafter the WGTA), and is also consistent with and supported by the work and consensus reached by Working Group #1 in the [1999] Kroeger review process which stated that the railway companies should continue to be compensated for inflation and that the Agency should continue to calculate the composite price index in advance of each crop year using the "current methods" [i.e., 1992 weights].

[13] Following the March 31, 2005 consultation in Winnipeg, it appears that the railway companies have acknowledged that it is within the mandate of the Agency to update the weights in its determination of the volume-related composite price index. Rather than focussing on the scope of the mandate of the Agency, the railway companies object to the Agency's consideration of updating the weights for crop year 2005-2006. Both railway companies indicate that the shortcomings with the current weights have not been demonstrated and that they have been given insufficient time to perform a comprehensive review. CP states that claims by participants that the current weights are "outdated" do not by themselves provide sufficient ground for a change in the current procedure in the absence of supporting evidence of any harm that may exist. CP also questions whether the use of weights derived from system-wide data and applied to western grain is appropriate, as weights derived from grain-specific data may differ. Both railway companies also question whether 2002 - the year for which information was gathered in support of the proposed updated weights - is an appropriate year given the drought conditions. Finally, CP listed a number of issues related to specific accounts, operations or costing techniques that might cause system-wide weights to vary from grain-specific weights.

Analysis and findings

[14] Although the railway companies now appear to recognize the authority of the Agency to update the weights as part of its determination of the volume-related composite price index, the Agency will nevertheless address this question. The core of the railway companies' argument appears to focus on the notion that the mandate of the Agency is to index the volume-related composite price index for price changes and not cost changes. In this respect, the railway companies argued that any changes to the indexation procedure that effectively convert the index from a price index to a cost index must categorically be rejected as contrary to legislation. The Agency agrees with the railway companies. However, the updating of the weights is not a cost exercise but rather is an exercise that is aimed at improving the accuracy of the measurement of price change. This is not only clearly within the mandate of the Agency in determining the volume-related composite price index but it is an exercise that must be done given the inherent weakness in the use of a fixed-basket price indexation procedure. It is indeed well known that the use of a fixed-based indexation procedure to measure a composite price change works well if the time interval is relatively short. But as the time interval lengthens, an upward bias is likely to result in the composite price index, which will overstate the index.

[15] In order to correct, at least partially, the inherent bias that may result from the use of a fixed based indexation procedure on a longer interval, it is the duty and the obligation of the Agency, as part of its determination of the volume-related composite price index, to amend the weights, if warranted.

[16] CN expressed the view that the current approach of using 1992 weights is consistent with the fact that cost-based regulation and costing reviews were eliminated with the repeal of the WGTA, and is consistent with a recommendation by Working Group #1 in the Kroeger review process that the railway companies should continue to be compensated for inflation and that the Agency should continue to calculate the composite price index in advance of each crop year using "current methods". In this regard, the Agency is of the opinion that the updating of weights used to determine the volume-related composite price index is consistent in both regards. First, no western grain costing review has been conducted, nor is considered to be necessary, in order to derive updated weights for the 2005-2006 crop year. The updated weights proposed by the Agency do not stem from a WGTA-based grain costing review. Furthermore, CN, in recent years, has updated "secondary" weights used to establish labour, fuel and material price indices and this was done without any requirement for information stemming from a WGTA-style costing review; it was done using recent years' accounting information. On the second point, although the Agency is not bound in any way by the recommendations of a 1999 Working Group's recommendation under the Kroeger review, the Agency is of the opinion that by periodically updating the weights, it is acting in a manner consistent with the Working Group's recommendation to use "current [1999] methods". During the interval from 1984 to 1999, original 1984 weights were first updated based on 1988 costing review information and then, based on 1992 costing review information. Following the repeal of the WGTA in 1995, updating the weights was still considered, annually, when developing the volume-related composite price index, but it was not implemented as the impact of such - at that time - was considered to be minor.

[17] There is no doubt that there is a need to update the weights. Notwithstanding the fact that the weights used to determine the volume-related composite price index have not been adjusted since crop year 1994-1995, the consultation document shared with industry participants clearly notes that an overstatement has resulted from the application of outdated weights. This overstatement, if ignored by the Agency, will not only result in an upward-biassed price index for crop year 2005-2006 but, in all likelihood, to an even greater extent for future crop years.

[18] In their submissions filed following the consultation held in Winnipeg, the railway companies claimed to have had insufficient time to analyze and look into the issue of updating weights. The Agency acknowledges that the time frame for the annual establishment of the volume-related composite price index is inherently short, given the April 30 statutory deadline set out in subsection 151(5) of the CTA and given that certain railway information for the previous year is not available until the end of January.

[19] Because of the time constraints within which the Agency and industry participants must operate to meet the annual April 30 statutory deadline, the time provided to industry participants to address a specific issue such as the updating of the weights will always be short in nature. In fact, most important issues raised and/or dealt with by the Agency since the coming into force of the revenue cap regime in 2000 have been dealt with within this narrow time frame. In this case, the Agency, in the early stages of the volume-related composite price index determination for crop year 2005-2006, formally and informally raised the issue of updating the weights.

[20] In addition, a proposed methodology for updating the weights using information formerly filed by the railway companies was circulated to the railway companies as part of the Agency's process prior to the Winnipeg consultation meeting. Not only were industry participants, including the railway companies, invited to attend and provide Agency staff with their comments at the Winnipeg consultation but they were also invited to submit final written submission following the consultation. While the time lines for the examination of an issue such as this one may have been longer outside the context of a volume-related composite price index determination, the Agency and/or industry participants must work and comply with the limitation imposed by the CTA.

[21] Notwithstanding the above, the Agency notes that the railway companies would have liked to have been provided with more time to perform a comprehensive review of the proposed updated Agency weights. However, the Agency cannot ignore the overstatement resulting from the application of outdated weights and nor should it postpone this exercise until next year given that the Agency is of the opinion that its proposed weights are fair and reasonable. Furthermore, there is nothing to prevent the railway companies from reviewing the updated weights used by the Agency for the purposes of determining the volume-related composite price index for crop year 2005-2006 and file submissions as to their views as to how the weights might be amended or improved, as part of next year's exercise of determining the volume-related composite price index for crop year 2006-2007.

[22] As part of their final written submission filed following the Winnipeg consultation, the railway companies raised a number of issues concerning the Agency's development of updated weights. Concerning the use of system-wide data to arrive at a set of weights applicable to grain, the Agency conducted a comparison of the 1992 weights (derived based on the volume-related costs for the movement of western grain) to weights based on 1992 system-wide regulatory costs. The comparison showed that the weights based on 1992 system-wide regulatory costs were similar to the 1992 weights; leading to the conclusion that updated weights derived based on Agency-derived system-wide regulatory costs for 2002 can reasonably be expected to be similar to weights derived based only on the movement of western grain for 2002. This similarity is supported from a regulatory costing perspective, as very few differences now exist between unit costs established for grain versus non-grain movements. In addition, differences in the price of grain inputs versus system-wide inputs has essentially been eliminated in recent years. Component price indices used to establish the volume-related composite price index for western grain are all derived based on system-wide information, including the cost of capital rate.

[23] The railway companies also questioned the appropriateness of using 2002 as the year supporting the proposed updated weights - given drought conditions that lowered grain volumes. Had proposed weights been derived based on grain data only, this might have been a concern - though there is no evidence to suggest that weights developed based on low versus high grain volumes would differ. Also, while 2002 drought conditions may have affected grain volume, it appears to have had a minor impact upon system-wide freight volume as 2002 system-wide volume for CN and CP combined was only marginally lower than that for 2001, and slightly higher than the volume for 2000. Hence, combined system-wide volume does not appear to have been impaired, or at least not significantly impaired, by the drought conditions.

[24] As for a number of issues related to specific accounts, operations or costing techniques that CP indicated might cause system-wide weights to vary from grain-specific weights, the Agency finds that it is more important to establish a "reasonably-accurate" set of updated weights in order to derive the crop year 2005-2006 volume-related composite price index than to use old, out-of-date, 1992 weights which, analysis suggests, overstate the composite price index.

AGENCY DECISION

[25] The Agency's determination of the volume-related composite price index for crop year 2005-2006 is: 1.0553, or 4.4 percent higher than for crop year 2004-2005.

[26] This determination is in compliance with subsection 151(4) of the CTA in that:

1. the crop year 2005-2006 index is determined on the basis that the crop year 2000-2001 index was deemed to be 1.0;
2. the index applies in respect of all of the prescribed railway companies; and
3. the volume-related composite price index has not been adjusted to reflect the incremental 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 as the sale, lease or other disposal or withdrawal from service of government hopper cars has not taken place.

[27] In making this determination, the Agency considered the views of the grain industry participants with which it consulted in March of this year. The Agency also took into account the most recent economic conditions and forecasts.

[28] This volume-related composite price index will be applied in the legislative formula under section 151 of the CTA when the Agency is required to make its revenue cap determinations for the crop year 2005-2006, which is legislated to be rendered by December 31, 2006.