Decision No. 253-R-2006

April 28, 2006

File No. T6650-2

---

INTRODUCTION

[1] The Canadian Transportation Agency (hereinafter the Agency) is required to determine the volume-related composite price index for crop year 2006-2007. 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, 2006, the Agency must determine the value for the volume-related composite price index for crop year 2006-2007.

[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 2006-2007 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 reviewed 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 for consultation purposes. Consultation included participants from producer organizations, the Canadian Wheat Board, shipper organizations, grain companies, railway companies, and federal, provincial and municipal governments.

THE LABOUR PRICE COMPONENT

Background

[6] The volume-related composite price index measures price changes for CN and CP combined, based on a basket of input cost components. In recent years, the basket has consisted of six input cost components, which are as follows: labour, fuel, material, leased cars, depreciation and cost of capital, each having its own price index.

[7] The labour price index has been developed based on information for

1. regular Wage Items (regular pay, overtime pay, vacation pay, etc.) and
2. Wage-Related Items (management bonuses, signing bonuses, training costs, share purchase plans and gain sharing plans), but it excluded
3. Fringe Benefit Items (CPP, QPP and Company pension amounts, Employment Insurance, Health & Welfare).

[8] During this year's exercise, it was proposed that the development of the labour price index be expanded to include Stock-Based Compensation plans as a Wage-Related Item, and to include all of the Fringe Benefit Items.

Positions of participants

[9] During the Agency's annual consultation on the volume-related composite price index, different opinions were given (in addition to various other items) as to whether the development of the labour price index should be expanded to i) include Stock-Based Compensation plans as a Wage-Related Item, and ii) to include all of the Fringe Benefit Items.

[10] On the topic of Stock-Based Compensation, the non-railway company respondents argued that it should not be taken into account when developing the labour price index. A concern was expressed that these benefits may not be based on merit, or on competition in the labour market, and that excessive compensation may be given for various reasons and it may be inappropriate to reflect this in the labour index, which contributes to the development of the volume-related composite price index. A second concern was that Stock-Based Compensation may not be related to the movement of western grain under the Revenue Cap Regime. The third concern was that it was inappropriate to inflate the labour price index for rewards related to efficiency gains as

1. that ensures that the rewards will be paid for, in part, by grain shippers who receive no benefit from railway efficiency gains, and
2. some of the railway efficiency gains have been achieved by downloading costs to the shippers.

[11] On the topic of Fringe Benefit items, one respondent repeated the concern that these benefits may not be based on merit, or on competition in the labour market, and that excessive compensation may be given for various reasons and it may be inappropriate to reflect this in the labour index, which contributes to the development of the volume-related composite price index.

[12] The Agency also dealt with the following methodological issue: how to forecast values for Wage-Related Items and Fringe Benefit Items. The railway companies generally favoured the Agency using railway-supplied forecasts or forecasts based on a moving average of information based on the most recently available two or three years. The only non-railway company respondent to comment on this issue supported the use of multi-year moving averages to forecast Wage-Related and Fringe Benefit Items.

ANALYSIS AND FINDINGS

[13] Stock-Based Compensation is an inducement to attract and to keep quality management. In this regard, it is similar to other Wage-Related Items which are included in the development of the labour price index. As for the reasonableness of the Stock-Based Compensation amounts or rewards, such a review extends beyond the scope of the Agency's mandate. The Agency's Uniform Classification of Accounts indicates that Stock-Based Compensation is a legitimate labour expense and no restrictions are put upon the amount. It follows that for price indices' development, the level of compensation is also not a relevant factor. With respect to the possibility that Stock-Based Compensation may not be related to the movement of western grain, there is no evidence to suggest that this might be the case. Furthermore, all price indices (labour, and other) are based on system-wide inputs and, consequently, are not based solely on grain inputs.

[14] On the issue of shippers not receiving any benefit for productivity gains and concerns that railway companies are downloading costs to shippers, this is a common theme within the grain industry as it relates to the Revenue Cap Regime. The Agency, however, is bound by the provisions of the CTA which direct the Agency to make adjustments only for price changes and not for productivity.

[15] As for Fringe Benefits Items, the concern about possible excessive management compensation has been addressed above.

[16] With respect to the methodological issue of how to forecast values for Wage-Related and Fringe Benefit Items, the difficulty with forecasting arises from the volatility of amounts related to these items. In the case of investments, where volatility is encountered, a common practice – for both unit cost purposes and price index development purposes – has been to normalize the data. This is typically done using five-year moving average techniques. It is the Agency's opinion that a five-year moving average methodology should be used to forecast amounts for all Wage-Related Items and Fringe Benefit Items, with the exception of railway company pension amounts, where a longer period (of ten years or more) may be warranted. Consistent with the above approach, and beginning with the year 2005, price indices and unit costs for Wage-Related and Fringe Benefit items should also be developed using five-year moving averages.

Paragraph 151(4)(c) of the CTA – Adjustment to the volume-related composite price index

[17] The Agency, in its Decision No. LET-R-113-2006 dated April 27, 2006, determined that the volume-related composite price index for crop year 2006-2007 would be adjusted to take into account the withdrawal from service by the Canadian Wheat Board (hereinafter CWB) of a number of hopper cars, followed by the subsequent lease of these cars to CN and CP.

[18] The 2006-2007 volume-related composite price index was adjusted pursuant to paragraph 151(4)(c) of the CTA by adding a seventh item ("Lease Costs for CWB Cars") to the basket of components used to develop the index, with a 2006-2007 value of unity and a weight of 1.24 percent. Consequently, the volume-related composite price is approximately 1.24 percent higher than what would have resulted had the CWB hopper cars not been withdrawn from service and subsequently leased to CN and CP. In developing the 1.24 percent weight, the Agency assumed a 2006-2007 western grain tonnage of 28.0 million tonnes, a western grain usage of about 71 percent, and added 2 percent to the lease costs for contribution to railway company constant costs.

AGENCY DECISION

[19] The Agency's determination of the volume-related composite price index for crop year 2006-2007 is: 1.1252, reflecting an increase of 6.6 percent from crop year 2005-2006.

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

1. the crop year 2006-2007 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 been adjusted to reflect the incremental costs incurred by the prescribed railway companies for the purpose of obtaining cars from the CWB as a result of the sale, lease or other disposal or withdrawal from service of government hopper cars.

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

[22] 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 2006-2007, which is legislated to be rendered by December 31, 2007.