Canpotex Submission to the Canadian Transportation Agency with respect to the Review of the Railway Interswitching Regulations

Canadian Transportation Agency Ottawa K1A ON9 Attention: John Corey

Fax: 819-953-5564 Email: [email protected]

1.0 INTRODUCTION

Canpotex Limited (“Canpotex”) is pleased to have the opportunity to present its comments and recommendations with respect to the Canadian Transportation Agency (“Agency”) review of regulated Interswitching, in response to the Agency’s letter and request for comments dated April 21, 2010.

Canpotex, a -based international marketing and distribution company wholly owned by the producers: Agrium Inc., The Mosaic Company, and Potash Corporation of Saskatchewan Inc. All potash mined in Saskatchewan and sold offshore from is marketed and distributed by Canpotex, which is the world’s largest exporter of potash and charged with responsibility for selling and distributing Saskatchewan-produced potash in all markets except Canada and the United States.

Potash is the largest fertilizer by volume and sales produced in Canada. It accounts for two thirds of all fertilizer materials shipped within Canada, to the U.S. and to offshore destinations. There are eleven operating potash mines in Canada of which ten are concentrated in the Province of Saskatchewan. The Saskatchewan mines employ more than 4,925 workers, paying CDN $554 million in wages and benefits annually. Canada’s potash capacity accounts for over 35% of the world’s total capacity and Canada is the world’s largest exporter of potash.

As a competitive world supplier, Canpotex markets and distributes Saskatchewan potash to customers overseas, principally to markets in Australia, Brazil, China, India, Indonesia, Japan, Korea, and Malaysia. Operating since 1972, Canpotex has corporate offices in Singapore, Hong Kong, Tokyo, Saskatoon, and Vancouver.

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Canpotex Potash Mines and Rail Shipments The Company's sales are normally in the range of 8-9 million metric tons a year, most of which is exported through the potash handling terminal at Neptune Bulk Terminals (Canada) Ltd. (“NBTL”) at North Vancouver, B.C.1. A smaller volume is currently moved through Portland Bulk Terminals, L.L.C2 near Portland, OR. Canpotex arranges the rail transportation to all terminals.

All potash destined offshore currently moves exclusively by (“CP”) in unit trains of 142 railcars to North Vancouver carrying approximately 15,000 metric tons per train. Canpotex is also moving to 170 railcar unit trains in the future. Potash is also exported out of but in very small amounts (less than 100,000 tonnes/ annum). Canpotex currently has plans to develop a new terminal at the Port of Prince Rupert, B.C. and at North Vancouver, B.C.

Nine of the ten potash mines in Saskatchewan are served directly by both Canadian National Railway (“CN”) and CP. A single mine, at Patience Lake , is served exclusively by CP but accessed by CN through regulated interswitching. Notwithstanding the availability of competitive rail services at all of the Saskatchewan mine sites from both CN and CP, all of the potash moved from Saskatchewan to NBTL at North Vancouver is captive to CN at destination. This is because all of the port terminals located on the north shore of the Burrard Inlet are captive to the lines of CN only. Competition between CP and CN in rail service is therefore limited in this respect.

1 Canpotex owns over 50% of NBTL. NBTL is a joint venture of bulk commodity handlers including Canpotex Bulk Terminals Limited. The terminal also receives coal delivered in unit coal trains from western Canada as well as smaller amounts of vegetable oil and other products for export. NBTL has modern, state-of-the- art equipment and handling processes, and Canpotex continues to ship the majority of its potash through this facility.

2 Portland Bulk Terminals, L.L.C. (“PBT”) is wholly owned by Canpotex and operated by Kinder Morgan Bulk Terminals, Inc. Operating since 1997, this terminal is a potash bulk-handling facility located on the Columbia River system near Portland, Oregon. Portland Terminals facilitates efficient handling of specialty potash products (particularly white potash), and provides another load port alternative for Canpotex potash shipments worldwide.

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Agency Determination In its letter of April 12th, the Agency states that it has determined that its methodology for the development of the interswitching service costs requires review to ensure that the resulting rates accurately reflect current interswitching costs incurred by the railways companies.

The Agency further states that, based on the current review, it has determined that a number of changes to the methodology used by the Agency to determine costs as well as specific cost factors should be changed. These include:

• an increase in the level of contribution towards railway constant costs • changes in the methodology for the determination of interswitching variable costs, and; • a reaffirmation of how movements made under co-production agreements and irregular operating practices are treated.

Applying these changes will increase interswitching rates in all zones except zone 4. The rates will also decrease for all zones for movements of blocks of 60 railcars or more.

Canpotex’s comments and recommendations with respect to the setting of the interswitching regulations are herein restricted to the following five issues:

1. The importance of regulated interswitching to Canpotex 2. National Transportation Policy considerations in the setting of interswitching rates 3. Interswitching rates levels of contributions 4. The impact of co-production agreements on interswitching 5. Interswitching of blocks of cars

1. The Importance of Regulated Interswitching to Canpotex Because of the heavy density of the product, the long distances over which the product must move to port facilities (over 1,600 km), and the value of the product relative to its density, rail plays an essential role in the inland portion of the logistics chain. Reliable and competitive transportation services are a key component in the value chain of potash production and the overall supply chain. Regulated interswitching plays an integral role in our efforts to maintain competitive rail services.

We view regulated interswitching as a critical competitive access tool. It creates the opportunity for competitive service in situations where natural monopolies occur. The real strength of the regulated interswitching provision in our view is its absence of regulatory application. Aside from the annual establishment of the interswitching rate scale by the Agency, there is virtually no regulatory intervention in the system. The interswitching rate structure, once set, encourages and allows both shippers and the railways to operate in harmony with the marketplace.

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Where competition exists, as it does at most of our mine sites, interswitching rates take a back seat to the competitive factors which influence our carriers when tendering services to us. In places where these factors are not present in the marketplace, regulated interswitching continues to provide us with competitive modal options. In the absence of modal competition, there would be no controls to protect us from potential rate or service abuse at the hands of a single railway.

2. Regulated Interswitching and National Transportation Policy

Regulated interswitching was designed at the turn of the last century to allow shippers who were located captive to the lines of a single railway to have physical access to the rates and services of a second, competing railway without the threat of rate or service abuse from the monopoly rail carrier to which they are otherwise captive.

The interswitching rates benefit shippers by extending their access to the lines of competing railways at rates that are reasonably close to the cost of moving the traffic to or from the interchange point, thus ensuring that shippers derive the benefits of price competition, improved service levels and varying routing options.

Regulated interswitching is a corner stone of the basket of pro-competitive shipper protections contained in the Canada Transportation Act (“CTA”), which also include competitive line rates (“CLRs”) final offer arbitration and confidential contracts. Interswitching rates are required by law to be set by the Agency on the basis of the average variable costs associated with the movement of interswitching traffic plus a mark up that results in a rate that is "commercially fair and reasonable3” to all parties. It is imperative that the policy objectives contained in the CTA remain paramount when addressing the continued establishment of rates at "commercially fair and reasonable” levels. Any changes to the rate-setting methodology that focuses primarily on the revenue needs of railways, without also equally considering the competitive market pressures faced by shippers, could have a negative impact on Canadian shippers.

3. Interswitching Rates Levels of Contribution Towards Railway Constant Costs

The law distinguishes interswitching rates from the other rate provisions under the CTA in the sense that subsection 128(3) of the CTA specifies that interswitching rates must be cost-based but not less than the variable costs of moving the traffic. As noted previously, the rates must also be “commercially fair and reasonable” to all parties.

3 S. 112, CTA 5

Since 1997, the Agency has consistently established interswitching rates at a level of 7.5% above the estimated long run variable costs of interswitching movements. This level has been determined by the Agency to be “commercially fair and reasonable” to all parties. On each occasion that the Agency has reviewed the rate structure since 1997 it has concluded that a contribution of 7.5 percent over variable costs represented an appropriate compensation towards the railway’s fixed costs. The Agency found that the resulting rate levels reflected an appropriate balance of providing an effective access to competitive alternatives through interswitching on the one hand, while compensating the rail carriers for the costs incurred in providing the services as an imposed public duty on the other hand.

Canpotex supports the Agency's 1997 determination that a contribution of 7.5% over variable costs represents appropriate compensation for the rail fixed costs and constitutes a balance that ensures the maintenance of effective competitive access through interswitching while providing rail carriers with fair and reasonable compensation for services provided as an imposed public duty. We strongly submit that this contribution level should continue to apply to the development of interswitching rates

It is useful to note that, prior to 1997, regulated interswitching rates were set by the Agency at a much lower level above cost; in fact the rates were simply rounded up to the nearest cent over the costs. The decision to set the rates at 7.5% over cost was made in recognition of the fact that regulated interswitching forms an important component of the basket of competitive access provisions under the CTA.

It is crucial to recognize that regulated interswitching rates are a pro-competitive provision intended to encourage and foster effective rail-to-rail competition in an otherwise captive transportation market. Transportation economics dictates that, in a truly competitive market place, rates will move increasingly closer to cost. Setting these rates at a level of 20.3% over long run variable costs, as the Agency now proposes to do, is not, in our view, reflective of effective intra-modal rail competition.

Canpotex believes railway interswitching rates should be established at or near the level of variable cost associated with providing rail service, to prevent cost disadvantages for railways that use interswitching to access customers. The interswitching provision requires the Agency to "consider the average variable costs of all movements of traffic". In addition, interswitching rates set by the Agency need to be "commercially fair and reasonable to all parties". Canpotex believes the "commercially fair and reasonable" level of interswitching rates should be the price that would exist under effective competition. 6

The justification for the proposed change to increase these rates from a level of 7.5% to a level of 20.3% over cost is, in our opinion, highly questionable. It is stated in the consultation document (File No 7360-6) that was circulated April 21st that “The Agency, through its mandate as an economic regulator, performs various economic determinations which incorporate a contribution towards railway constant costs…In its review of this issue, the Agency is of the opinion that it must be consistent in applying contribution towards railway constant costs for all its relevant cost and rate determinations…..The Agency does not see any convincing rational for continuing to apply a different, lower contribution towards constant costs for interswitching rate determination. Therefore, to standardize the contribution towards railway constant costs, the Agency considers it appropriate to treat the compensation of interswitching services as it would other regulated activities.”

We are unaware of any other areas of rate determination under the CTA where the Agency has set rates at a level of 20+% over long run variable costs. In fact, there are only four areas where the Agency can exercise its regulatory authority to set or influence line-haul rail rates under the CTA; they are:

• The setting of joint rates under s. 121. (1) of the CTA; • The setting of CLRs under s. 132. (1) of the CTA; • The fixing of compensation payable by a railway company to another railway company where the Agency has granted running rights under s. 138. (3) of the CTA, and; • The setting of the revenue ‘cap’ on export grain under s. of the CTA

There has not been a CLR established by the Agency in almost twenty years and the single CLR that was set by the Agency in 1991 was based on a published tariff rate offered by a competing railway for movement beyond the interchange where the traffic was received off of the lines of CP. That CLR rate had no bearing whatsoever to a 20% contribution to constant cost. Likewise, to our knowledge, the Agency has never established a joint rate at a level of 20% over variable cost or established running rights compensation payable by a railway exercising running rights at a level of 20% over variable cost. We, in fact, are not aware of any case where the Agency has recently established either a joint rate or running rights compensation.

With respect to setting of export grain rates, we are aware that between 1983 and 2000 the Agency set rates on export grain at a level of 20% above the long run variable costs associated with the movement of the grain to designated ports in Canada for export offshore. In actual practice, however, these rates - over the four years immediately following their establishment - provided the railways with an average of 25-30% contribution to constant costs. 7

Export grain rates have not been set by the Agency since 2000. In their place the Agency, since 2000, has established a maximum revenue cap in advance of each crop year. The statutory formula for establishing this cap is set out in the CTA and is both intricate and complex and, most significantly, contains no reference to a mark up of 20% over variable costs.

“Under the 1992 Costing Review, the 20% level of contribution to constant costs was defined by legislation. However, under the current Revenue Cap Regime, there is no legislation that defines the level of contribution to constant costs.”

It is also noteworthy that the rates flowing from the revenue cap formula are set by the railways themselves, not by the Agency. The Agency has recently recognized that commercially set export grain rates, in fact, provide the railways with much greater contributions than 20%. In the “Hopper Car Consultation Document” issued by the Agency October 15, 2007 the Agency stated

“Under the 1992 Costing Review, the 20% level of contribution was applied to the total amount of variable costs in order to ensure that 100% of the variable and constant costs, associated with the movement of Western grain, would be captured [and not less]. However, under the current exercise, the amount of revenue generated for crop year 2007-08 under the Revenue Cap Regime will be considerably more than 100% of the variable and constant costs. Agency staff currently estimate that, for crop year 2007-08 ..… the level of contribution to constant costs - based on the projected Revenue Caps and estimates of underlying costs - will exceed 60%” (Source: Hopper Car Consultation Document, October 15, 2007, Discussion Item #7, par. 4)

Canpotex understands a "commercially fair and reasonable" rate to be a rate that reimburses the provider of a service for the actual work performed in carrying out the service. Such rates should, of necessity, cover the out-of-pocket costs. The addition of the word "commercially" also implies some level of contribution. A "fair and reasonable" rate by definition is a rate that allows the traffic to move without being constrained. It also provides a return to the shareholders of the carrier. Canpotex respectfully submits that these criteria are being met through the present system of Agency rate determination.

4. The impact of Co-Production Agreements on Interswitching

Co-production agreements and other commercial arrangements between CN and CP have increased the interchange of traffic at points located outside the four interswitching zones, where regulated interswitching rates are not available.

Under co-production agreements, such as is the case in the Fraser Canyon, traffic that could be interswitched between the lines of CP and CN at Vancouver for delivery to the North Shore, has, since 2006, been handled under a cooperative ‘co-production’ directional agreement. The 8 agreement has increased operating efficiencies in the movement of potash and other bulk products such as coal and grain to Vancouver without the need for capital investment. This has assisted in the optimization of both CN’s and CP’s railway infrastructure in the lower mainland of .

Under the arrangement, CN operates the trains of both railways moving goods from the Prairies to Vancouver using CN crews from Boston Bar, B.C. (131 rail miles east of Vancouver), to the terminals on the north shore of the Burrard Inlet including NBTL, while CP operates all trains of both railways using its crews from Boston Bar to the terminals on the south shore of Burrard Inlet. CN and CP route empty railcars back from the north shore and south shore respectively to North Bend, B.C. where they are again interchanged for delivery back to the loading points.

The CN-CP co-production arrangement is an improvement over regulated interswitching at Vancouver, however, our preferred recommendation would be for the Agency to direct CN to allow CP to operate its trains and crews across the Second Narrows Bridge directly into North Vancouver. The Second Narrows Bridge is the vital rail link between the North and South Shore Vancouver Trade Areas. It is, however, controlled solely by CN and is not open to CP for the movement of traffic to the North Shore. While Canpotex moves potash exclusively over the lines of CP from the Prairie potash mine sites to Vancouver, we must rely on CN to ultimately deliver the trains across the bridge and spot them at our facility at NBTL. In 2006, CN Engineers went on strike and CP was refused permission to exercise running rights over the bridge in order to deliver the trains into NBTL. Our potash trains had to be held back in the Fraser Canyon.

5. Interswitching Rates for Blocks of 60 or More Railcars Canpotex notes that there are considerable differences between the proposed interswitching rates for movements of single railcars and for movements of railcar blocks of 60 railcars or more; for single railcars the proposed new rates will range from $229 per railcar in Zone 1 to $251 per railcar in Zone 4. This represents an increase of 24% in Zone 1 and a decrease of 20% in Zone 4. Obviously, the cost differences associated with interswitching single railcars within the four zones have narrowed dramatically since the last interswitching review. The proposed new rates for movements of a 60 railcar or greater block will range from $46 (Zone 1) to $74 (Zone 4) per railcar representing decreases of 8% to 18% from current rates. These cost differences have similarly narrowed dramatically.

As noted previously, Canpotex regularly ships unit trains of 142 railcars each to North Vancouver. We would accordingly urge the Agency to investigate the feasibility of establishing interswitching rates for railcar blocks of 80, 100 and greater railcar lots to determine if the cost differences warrant separate interswitching rates for blocks of these sizes. 9

Concluding Remarks Canpotex believes that this review is an important initiative and the results will have a significant impact on the competitiveness of our organization and members, as well as other important Canadian industries. We appreciate the opportunity to submit these comments and recommendations and are available to meet and discuss this submission with the Agency.

June 18, 2010