Canadian National Railway Company (CN) and Canadian Pacific Kansas City Limited (CPKC) - Determination of the 2024–2025 Volume-Related Composite Price Indices as required for[...]

April 29, 2024

Determination by the Canadian Transportation Agency (Agency) of the 2024-2025 Volume-Related Composite Price Indices (VRCPIs) for the Canadian National Railway Company (CN) and Canadian Pacific Kansas City Limited (CPKC) as required for the Maximum Revenue Entitlement (MRE) program pursuant to Part III, Division VI of the Canada Transportation Act, SC 1996, c 10 (CTA)

Summary

[1] The Agency has determined:

1. CN's VRCPI for the 2024-2025 crop year to be 1.9281, an increase of 5.39% from the 2023-2024 crop year.
2. CPKC's VRCPI for the 2024-2025 crop year to be 1.8760, an increase of 6.49% from the 2023-2024 crop year.

[2] The Agency will use these values in determining CN's and CPKC's MREs for the 2024-2025 crop year, which the Agency must issue by December 31, 2025.

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 CPKC.

[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 CPKC with regard to labour, fuel, material, and other capital items.

[7] The determination of the VRCPIs is based on detailed submissions from CN and CPKC 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 2024-2025 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 9, 2023, reminded CN and CP (as CPKC was then known) that the deadline for submitting any such proposals was August 15, 2023. No material proposals for methodological or interpretive changes were submitted by industry participants for consideration by the Agency for the 2024-2025 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] In determining the annual VRCPI for CN and CPKC, the Agency calculates the following:

i. actual historical price increases experienced by the railways in the past year (in this case 2023); and,

ii. forecasted price increases for the upcoming two calendar years (2024 and 2025).

CN

[12] The Agency has determined CN's VRCPI for the 2024-2025 crop year to be 1.9281, an increase of 5.39% from the 2023-2024 crop year.

[13] The 5.39% increase in CN's VRCPI stems from:

i. a 3.28% increase attributable to updating previous Agency forecasted price changes for 2023 with actual price changes and incorporating revised forecasts for 2024; and,

ii. a 2.11% increase in forecasted price changes for the 2024-2025 crop year as detailed in the table below.

[14] The following table summarizes the changes that make up CN's 2024-2025 VRCPI:

Table 1: CN

CN's 2023-2024 VRCPI	Weight % A	% Change B	% Weighted Change C = A x B
Price Component: Labour	32.18	2.95	0.95
Price Component: Fuel	16.07	1.43	0.23
Price Component: Material	34.64	-0.56	-0.19
Price Component: Investment (leased cars, amortization, cost of capital)	17.11	3.89	0.67
Total of price components	100.00		1.65
Total of cost components Footnote 1			0.46
Total Price changes for 2023-2024 (price components and cost components)			2.11
Revisions to the 2022-2023 VRCPI to reflect actual and updated - forecasted price and cost changes			3.28
Total increase of CN's 2023-2024 VRCPI			5.39

CPKC

[15] The Agency has determined CPKC's VRCPI for the 2024-2025 crop year to be 1.8760, an increase of 6.49% from the 2023-2024 crop year.

[16] The 6.49% increase in CPKC's VRCPI stems from:

i. a 3.19% increase attributable to updating previous Agency forecasted price changes for 2023 with actual price changes and incorporating revised forecasts for 2024; and

ii. a 3.30% increase in forecasted price changes for the 2024-2025 crop year.

[17] The following table summarizes the changes that make up CPKC's 2024-2025 VRCPI:

Table 2: CPKC

CP's 2023-2024 VRCPI	Weight % A	% Change B	% Weighted change C = A x B
Price Component: Labour	33.16	2.81	0.93
Price Component: Fuel	15.09	1.91	0.29
Price Component: Material	31.72	0.08	0.03
Price Component: Investment (leased cars, amortization, cost of capital)	20.03	7.36	1.47
Total of price components	100.00		2.72
Total of cost components Footnote 1			0.58
Total Price changes for 2023-2024 (price components and cost components)			3.30
Revisions to the 2022-2023 VRCPI to reflect actual and updated - forecasted price and cost changes			3.19
Total increase of CP's 2023-2024 VRCPI			6.49

[18] The following provides further information on the individual price components used in developing the 2024-2025 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 2.95% increase in labour for the 2024-2025 crop year. Projected increases in general wages and wage-related items, such as bonuses and stock-based compensation, were slightly offset by projected modest declines in fringe benefits which includes benefit plans and pensions.

[22] For CPKC, the Agency forecasts a 2.81% increase in labour for the 2024-2025 crop year. Projected increases in general wages and in wage-related items such as bonuses and stock-based compensation were slightly offset by a projected modest decline 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 79.80/bbl for 2024 (an increase of 2.8% from 2023), which is forecasted to decrease by 3.0% to USD 77.40/bbl for 2025. 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 0.736 for 2024 (a decline of 0.7% from 2023) which is forecasted to increase by 3.0% to USD 0.758 for 2025.

[26] The Agency forecasts a 1.43% increase for CN and a 1.91% increase for CPKC in fuel prices for the 2024-2025 crop year, after taking into account the projected increase in the price of crude oil in 2024 and the projected decline in 2025 compared to 2023 and 2024 respectively, the associated fluctuations in the Canada/U.S. exchange rate, 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% of materials purchased are affected by the exchange rate.

[29] The Agency forecasts a modest decline of 0.56% for CN and a relatively flat 0.08% increase for CPKC in their respective material price indices for the 2024-2025 crop year. These relatively flat crop year projections are a result of projected declines in the price of primary steel, fabricated metals and petroleum and coal products that were partially offset by projected increases in the Industrial Products Price Index (IPPI) and the Consumer Price Index (CPI) indicators as well as a projected increase in the Canada/U.S. exchange rate in 2025.

[30] Since railway companies purchase a large percentage of materials in U.S. dollars, a stronger Canadian dollar provides more buying power and decreases the railway companies' overall material prices and the opposite is true when the strength of the dollar declines.

Investment components

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

[32] One of the elements used in calculating the cost of capital component of the VRCPIs is the cost of capital rate. The Agency determined the Western Grain cost of capital rates for CN and CPKC in Determination R-2024-52 and Determination R-2024-53, respectively. This crop year, the projected cost of capital rate for CN is 6.05%, up slightly from 5.98% last year, and CPKC's projected cost of capital rate is 8.00%, up from 7.46% a year ago.

[33] For the 2024-2025 crop year, the Agency forecasts an 3.89% increase for CN and a 7.36% increase for CPKC in their respective overall investment component indices. These increases are largely attributable to increasing infrastructure and equipment investment, and to increases in the cost of capital rates for both CN and CPKC.

Cost components

[34] For the cost component portion of the VRCPI, the Agency forecasts a 0.46% increase for CN, primarily attributable to the increase in lease prices, and a 0.58% increase for CPKC, due to an increase in the usage of U.S. subsidiary cars in moving western grain in the 2024-2025 crop year as compared to last crop year and an increase in lease prices for Canadian leases.

Footnotes

Footnote 1

Cost components include adjustments made to CN's and CPKC's VRCPIs pursuant to paragraph 151(4)(c) of the CTA to reflect costs incurred by CN and CPKC in obtaining hopper cars for the movement of grain and the net impact of replacing 1992 hopper car maintenance costs with actual costs (Decision 67-R-2008).

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