Burlington Northern, Inc.-Construction and Oper., 348 I.C.C. 388 (1976). Since evidence in that proceeding indicates that traffic moving over the new trackage could exceed 100 million tons per year by 1980 and eventually reach a level of 300 million tons annually, protestant argues that the track being constructed to the Jacobs Ranch Mine will be moving a tremendous volume of traffic for a great number of shippers. Since HL&P will ship less than 13 million tons of coal from this origin, it is contended that the proposed capital investment does not have a sufficiently close relationship to the proposed new schedule to warrant treatment under section 15(19).

In reply, respondents state that they are required to purchase 69 locomotives and an additional number of cabooses because of the new HL&P movement, for a total capital investment of over $30 million for BN and over $9 million for Santa Fe. Respondents observe that HL&P specifically acknowledged locomotive purchases in its computation of variable costs (albeit at a figure of 65 rather than 69 locomotives). Respondents contend that there is no requirement that equipment be exclusively dedicated to a particular shipper or service in order to qualify for treatment under section 15(19). They argue that the Commission has recognized that new unit-train coal service requires the purchase of new locomotives in San Antonio, Tex. v. Burlington Northern, Inc., 355 I.C.C. 405 (1976), affirmed Burlington Northern v. United States, 555 F. 2d 637 (1977), wherein we included the cost of additional locomotives and cabooses, required because of coal traffic to San Antonio, when we calculated the variable cost of providing that service.

Although respondents make no reply to protestant's contention that increased maintenance is properly an expense rather than capital investment, they contend that plant upgrading and expansion attributable to the HL&P movement exceeds $1 million and itself satisfies section 15(19). Respondents argue that the capital investment funds in this category are not for the purpose of restoration (which, according to our interpretation of section 15(19), could not ordinarily serve as the basis for a capital incentive rate)," but rather will substantially upgrade and improve the line to handle the new volume coal traffic. While respondents concede that

In its reply, protestant claims that it was not conceding that 65 new locomotives would actually be used in its coal service, but only that the railroads` locomotive pool should be credited with 65 locomotives for costing purposes

"See Ex Parte No. 327, supra, at 764.

other volume coal movements also contribute to their need to upgrade main-line track (e.g., use of new heavier rail and new communications systems), that fact does not preclude the capital investment attributable to HL&P's traffic from being considered under section 15(19). Respondents again point to the San Antonio case, supra, where we attributed the cost of plant expansion to the specific coal traffic under consideration there.

(b) Market dominance.'-Protestant maintains that respondents clearly have market dominance over the traffic subject to their proposed schedules. Three presumptions set forth in 49 CFR 1109.1(g) are cited as applicable to the instant movement:

(1) Where the proponent carrier has handled 70 percent or more of the involved traffic or movement during the preceding year ***.

(2) Where the rate in issue exceeds the variable cost of providing the service by 60 percent or more; and

(3) Where affected shippers or consignees have made a substantial investment in rail-related equipment or facilities which prevents or makes impractical the use of another carrier or mode.

With respect to the market share presumption, protestant observes that while there has been no traffic moving between the named origin and destination to date, BN is the only carrier able to provide rail service at the mine from which HL&P's coal will be moving and the Santa Fe is the only carrier serving HL&P's new plantsite. The presumption relating to variable cost of the service is also applicable according to the variable cost calculations submitted by protestant. The substantial investment presumption is made applicable by HL&P's investment in cars to haul the coal and investment in its generating plant at Smithers Lake.

Respondents deny that they have market dominance over HL&P's coal traffic under criteria established by the Commission. Respondents argue that the first presumption of market dominance cited by protestant cannot apply since there has been no traffic at all moving between the named origin and destination. On the basis of cost evidence submitted by respondents, the second presumption

In respondents' cost calculations, only a portion of these costs are allocated to the HL&P

traffic.

"Section 202(b) of the 4R Act (section_1(5)(b) of the Interstate Commerce Act) requires a finding of market dominance as a prerequisite to a Commission finding that a rate exceeds a just or reasonable maximum for the service rendered.

"In Ex Parte No. 320. Special Procedures for Making Findings of Market Dominance as Required by the Railroad Revitalization and Regulatory Reform Act of 1976, final report served October 1. 1977. we promulgated rules for determining market dominance.

relating to the variable cost of service is not applicable either. Respondents concede that HL&P has made a substantial investment in rail-related equipment facilities and has entered into a long-term contract for coal at the point of origin, but contend that the presumption of market dominance created by these investments is irrational and inconsistent with section 1(5)(b) of the act. Moreover, respondents contend that any presumption of market dominance is rebutted by HL&P's careful consideration of competitive coal sources and originating and terminating carriers before deciding on its coal supplier and the location of its plant. Respondents contend that the proposed capital incentive rates (escalated to reflect cost increases) are the same as those offered to HL&P in that competitive environment. Moreover, respondents assert that the fact that Southern Pacific also serves Houston rebuts any presumption of market dominance.

In reply, protestant reiterates that the amounts expended by HL&P for trackage and unloading facilities at its Smithers Lake plant, in addition to freight cars which it has already acquired, clearly establish the applicability of the substantial investment presumption of market dominance. The rational of the presumption is that if a shipper has made substantial investment in rail-related equipment which cannot easily be disposed of, it will be committed to rail transportation and defenseless against predatory pricing. Protestant maintains that this case is a perfect example of the type of situation to which this presumption was intended to apply.

Protestant disputes the contention that its prior negotiations for other sources of coal supply indicate a present competitive transportation market. It notes that this issue was fully considered in Ex Parte No. 320, supra, when the Commission' rejected respondent's broad view of the relevant market and focused on present competitive circumstances.

(c) Lawfulness of the proposed rate-cost of service, revenue need, and cost of capital.-Protestant has analyzed the cost to the respondent railroads of hauling HL&P's coal. 10 Protestant made field surveys of the terminal and line-haul facilities over the route and analyzed the operating characteristics of the movement. Using costing techniques approved by the Commission in Rules to Govern Assembling & Presenting Cost Evidence, 337 I.C.C. 298 (1970), and the Rail Form A" formula (with some adjustments) protestant determined the variable cost of providing the service to be $8.61 per

"The parties' cost evidence is set out and discussed more fully in appendix B. "I.C.C. Statement No. IFI-73, "Formula for Use in Determining Rail Freight Service Costs."

or

net ton or $904.41 per carload. At a variable cost of $8.61 per ton, protestant observes that H&P's contribution over variable cost would amount to $6.99 per net ton at the proposed rate of $15.60, almost $35 million per year. Protestant concludes that level of contribution over variable costs is unconscionably high.

As detailed more fully in appendix B, protestant made several assumptions in its calculation of variable costs that have proved particularly controversial. In calculating the operating factors of the HL&P movement, protestant used a figure of 65 locomotives (4 less than respondents' assertion). Secondly, the cost of locomotives and certain fixed plant investment is not allocated directly to HL&P. Instead, system average costs are adjusted (as to locomotive and waycars only) and the cost of serving HL&P then recomputed using the adjusted system averages. Thirdly, and most significantly, protestant's analysis applied cost of capital rates of approximately 5.5 percent for BN and 6.1 percent for Santa Fe. Those rates reflect the embedded cost of debt only, and give no weight to the current higher cost of equity capital.

Respondents' defense of the proposed rates is premised on the new standards for railroad rate making set forth in the 4R Act. Respondents cite congressional recognition of the inadequate financial condition of the railroads and state that the principal purpose and effect of the 4R Act is to allow the railroads greater flexibility in setting rates which produce an adequate return and permit the raising of capital. Respondents place particular emphasis on section 205 of the 4R Act which directs that the railroads be permitted to earn “a fair, reasonable, and economic profit or return (or both) on capital employed in the business **** and that revenue levels should "permit the raising of needed equity capital." Respondents claim that unless these statutory provisions are fully implemented, the railroads will be unable to make the investments in plant and equipment which are necessary to implement the President's National Energy Plan which calls for the ready availability of huge volumes of coal and railroad facilities to haul that coal. Respondents argue that the railroads must raise billion of dollars for new capital investments over the next decade for plant and railroad equipment and a significant portion of that capital is required by the increasing use of coal as an energy source. Respondents state that they will make in excess of $70 million in capital expenditures attributable to the movement of coal to Houston involved in this case.

to

Respondents offer voluminous testimony on the financial condition of the railroad industry in general and the Santa Fe and BN in particular to show that there is need for additional revenues attract capital so that adequate and efficient railway transportation service will be available in the future. Proffered testimony indicates that the cost of capital to the railroads is far greater than it was 10 or 20 years ago because of inflation, higher interest rates, and increased demand for capital by the Government and other borrowers. In addition, low profitability and consequent risk to investors has so increased the cost of capital that certain markets are vitually forclosed to the railroads. Numerous recent decisions wherein we have recognized the weak financial position of the industry are cited.

Respondents contend that their roads, during the period 19701976, experienced little or no gains in net income, totally inadequate earnings margins, and increasing shortfalls between cash flows from operations and capital expenditures. Evidence introduced by respondents indicates that the BN's ratio of Net Railroad Operating Income (NROI) in 1976 relative to investment was 2.6 percent and the Santa Fe's 3.5 percent-lower than in any of the 5 preceding years.

Under these circumstances, respondents contend, a cost of capital rate of 5.5-6.1 percent (the embedded cost of debt used by protestant in its cost evidence) would condemn the railroads to a future in which they would be unable to attract needed capital as contemplated by the 4R Act. In support of the claim testimony was presented by respondents on the current cost of capital. Respondents' witnesses determined the cost of capital separately for debt and equity and adjusted the components to produce a weighted cost. Using debt cost in the range of 5.5-8.52 percent and equity in the range of 14-16 percent, respondents conclude that their total cost of capital exceeds 11 percent. By contrast, respondents assert that HL&P's use of 5.5-6.1 percent is directly contrary to financial fact and would be confiscatory.

In order to demonstrate what respondents refer to as the obvious inequity of HL&P's position with respect to cost of capital, respondents have introduced into evidence excerpts from the transcript of a hearing held by the city of Houston on an application by HL&P for an increase in its own electric rates. Respondents note

"Embedded debt costs and current debt cost, including the current rate on equipment trust certificates, were considered in respondents evidence.