Determination No. R-2022-50

SUMMARY

[1] The Agency has determined:

1. CN’s VRCPI for the 2022–2023 crop year to be 1.6319, an increase of 11.99 percent from the 2021–2022 crop year.
2. CP’s VRCPI for the 2022–2023 crop year to be 1.6709, an increase of 12.70 percent from the 2021–2022 crop year.

[2] The Agency will use these values in determining CN’s and CP’s MREs for the 2022–2023 crop year, which the Agency must issue by December 31, 2023.

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] The Agency applies the formula set out in subsection 151(1) of the CTA to determine 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. The Agency has verified the submitted information and forecasted 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 to which they relate. This determination is in respect of the 2022–2023 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 8, 2021, reminded CN and CP that the deadline for submitting any such proposals was August 13, 2021. No material proposals for methodological or interpretive changes were submitted by industry participants for consideration by the Agency for the 2022–2023 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

[11] As detailed further below, the Agency has determined 11.99% and 12.70% increases in the 2022-2023 VRCPI’s for CN and CP respectively. Over half of these increases are attributable to replacing previous Agency forecasted price changes for 2021 with actual price changes and incorporating revised forecasts for 2022. Much of this price change is linked to recent world events. For example, crude oil costs have increased steadily over the course of 2021 and have experienced even sharper increases following the start of the conflict in Ukraine. As well, global supply chain challenges and supply/demand imbalances in 2021 have contributed in part to higher than expected price changes for railway material inputs such as steel, fabricated metals and petroleum-related products.

CN

[12] The Agency has determined CN’s VRCPI for the 2022–2023 crop year to be 1.6319, an increase of 11.99 percent from the 2021–2022 crop year.

[13] The 11.99% increase in CN’s VRCPI stems from:

i. a 7.44% increase attributable to updating previous Agency forecasted price changes for 2021 with actual price changes and incorporating revised forecasts for 2022; and,

ii. a 4.55% increase in forecasted price changes for the 2022–2023 crop year.

[14] The following table summarizes the changes that make up CN’s 2022–2023 VRCPI:

Table 1: CN

CN's 2022-2023 VRCPI	Weight % A	% Change B	% Weighted Change C= A x B
Price Component: Labour	32.18	0.82	0.26
Price Component: Fuel	16.07	6.72	1.08
Price Component: Material	34.64	0.38	0.13
Price Component: Investment (leased cars, amortization, cost of capital)	17.11	15.69	2.68
Total of price components	100.00		4.16
Total of cost componentsFootnote 1			0.39
Total price changes for 2022-2023 (price components and cost components)			4.55
Revisions to the 2021-2022 VRCPI to reflect actual and updated forecasted price and cost changes			7.44
Total Weighted Price Changes for 2022-2023			11.99

CP

[15] The Agency has determined CP’s VRCPI for the 2022–2023 crop year to be 1.6709, an increase of 12.70 percent from the 2021–2022 crop year.

[16] The 12.70% increase in CP’s VRCPI stems from:

i. a 6.61% increase attributable to updating previous Agency forecasted price changes for 2021 with actual price changes and incorporating revised forecasts for 2022; and

ii. a 6.09% increase in forecasted price changes for the 2022–2023 crop year.

[17] The following table summarizes the changes that make up CP’s 2022–2023 VRCPI:

Table 2: CP

CP's 2022-2023 VRCPI	Weigh % A	% Change B	% Weighted Change C= A x B
Price Component: Labour	33.16	2.38	0.79
Price Component: Fuel	15.09	6.61	1.00
Price Component: Material	31.72	0.56	0.18
Price Component: Investment (leased cars, amortization, cost of capital)	20.03	8.87	1.78
Total of price components	100.00		3.74
Total of cost componentsFootnote 1			2.35
Total Price changes for 2022-2023 (Price Components and Cost Components)			6.09
Revisions to the 2021-2022 VRCPI to reflect actual and updated forecasted Price and Cost changes			6.61
Total Weighted Price Changes for 2022-2023			12.70

[18] The following provides further information on the individual price components used in developing the 2022–2023 VRCPIs.

Labour

[19] 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).

[20] The Agency, consistent with its practice in previous years, considered established labour contracts that extend into the future and relied on projections of historical trends for the remaining subcomponents.

[21] For CN, the Agency forecasts a 0.82% increase in labour for the 2022–2023 crop year. Projected increases in general wages were mostly offset by projected declines in wage‑related items, such as bonuses and stock-based compensation, and a decline in fringe benefits as expenses related to a series of substantial pension contribution payments made by CN beginning in 2012 are winding down.

[22] For CP, the Agency forecasts a 2.38% increase in labour for the 2022–2023 crop year. Projected increases in general wages and wage-related items such as bonuses and stock-based compensation were slightly offset by projected declines in fringe benefits.

Fuel

[23] The railway fuel price index reflects changes in the average annual price per litre of diesel fuel.

[24] 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 rate from a number of expert third-party forecasters as inputs to the Agency’s fuel forecasting model.

[25] The average of the third-party forecasts for the price of crude oil is USD 92.20/bbl for 2022 (an increase of 35.6% from 2021), which is forecasted to decrease by 14.4% to USD 78.90/bbl for 2023. 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 U.S. dollars. The average of the third-party forecasts for the exchange rate is USD 0.7970 for 2022 (a decline of 0.1% from 2021) which is forecast to decline to USD 0.7940 for 2023.

[26] The Agency forecasts a 6.72% increase for CN and a 6.61% increase for CP in fuel prices for the 2022–2023 crop year, after taking into account the projected increase in the price of crude oil in 2022 as compared to 2021, the associated fluctuations in the Canada/U.S. exchange rate, the projected decline in crude prices in 2023 and increases in fuel-related taxes in the Canadian jurisdictions where the respective railways purchase their fuel.

Material

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

[28] 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 Canadian/U.S. exchange rate, as approximately 70 to 85 percent of materials purchased are affected by the exchange rate.

[29] The Agency forecasts a 0.38% increase for CN and a 0.56% increase for CP in their respective material price indices for the 2022–2023 crop year. The significant increases experienced in key railway material inputs (primary steel, fabricated metals and petroleum-related products) in 2021 are projected to return to more normal levels throughout the 2022-2023 crop year, tempering the projected increases in the material price index. A projected slight decline in the Canada/U.S. exchange rate will affect material prices. As railway companies purchase a large percentage of materials in U.S. dollars, a weakening Canadian dollar provides less buying power and increases the railway companies’ overall material prices.

Investment components

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

[31] One of the elements used in calculating the cost of capital component of the VRCPIs is the cost of capital rate. The Agency completed its consultations on various aspects of the calculation of the cost of capital rate for the railway companies and issued its determination on February 11, 2022. In keeping with the newly established methodology, the Agency determined the Western Grain cost of capital rates for CN and CP in Determination R-2022-49 and Determination R-2022-47, respectively. This crop year the projected cost of capital rate for CN is 5.30% up from 4.33% last year and CP’s projected cost of capital rate is 6.33% up from 5.57% a year ago.

[32] For the 2022–2023 crop year, the Agency forecasts a 15.69% increase for CN and a 8.87% increase for CP in their respective overall investment component indices. These increases are largely attributable to increasing infrastructure and equipment investment and as well, to increases in the cost of equity rates for both CN and CP, resulting in higher overall cost of capital rates as compared to 2021-2022.

Cost components

For the cost component portion of the VRCPI, the Agency forecasts a 0.39% increase for CN and a 2.35% increase for CP primarily attributable to the acquisition of hopper cars for the movement of grain in 2022-2023.