Cost escalations subsequent to Ex Parte Nos. 310 and 313. (Annual amounts, in millions, applicable to freight service. Bused on levels of traffic and employment experienced in 12 months ended Sept. 30, 1975.)—Continued

Respondents contend that exclusion of the SP's share of cost escalations would reduce the total cost figures in the western districts of $668 million by $124 million, or approximately 18.5 percent. Respondents submit that the rates of cost escalations to freight revenues for the remaining western roads would remain at 8.1 percent, nevertheless. As a result, the total cost escalations nationally, with this reduction, amount to $1,058 million.

Our evaluation of the claimed cost increases of the respondents is contained in appendix C. A summary of these costs is shown in the following table.

We also agree that exclusion of the SP Lines would reduce total cost escalation in the western district by approximately 18.5 percent. As a result, under these premises, we find the total cost escalations, nationally, with this reduction, amount to approximately $1.033 million.

As mentioned previously, since the initial submissions by respondents, circumstances have changed; the Long Island has become a party to the increases, and after flagging out entirely, a portion of the West not competitive with the SP Lines was made subject to the Ex Parte No. 318 tariff.

As a result, the foregoing figures regarding cost escalations are not completely accurate. The petitioners did not submit a revised set of figures to reflect these changes. Our summary of the cost escalations, including these changes, is shown below.

The specific cost revisions are shown in appendix C. Only four of the nine eastern district cost items increased from the inclusion of the Long Island. This occurs because the Long Island represents such a small percentage of the total freight operating expenses of the eastern district. With all the above changes, we find the total cost escalations amount to approximately $1,036 million.

In addition to the cost escalation items set forth in the preceding tables, respondents state that they also need at least another $1 billion to close the widening gap between depreciation allowances and replacement costs, and to restore working capital. The railroads submit that much of this need results from persisting inflation. For instance, respondents note that freight cars purchased in 1974 cost $920 million, while the freight car depreciation charges for retired cars in 1974 came to only $397 million, leaving $523 million of replacement cost to be covered in some other way. The railroads submit that when similar data become available for 1975, they will show a worsening of this problem. They argue that the gap can be closed only by substantially increased net earnings which will generate capital funds and make railroad securities more acceptable to investors.

Although protestants contest the extent of several of the respondents' claimed cost escalations, they do not question the fact that the railroads have been subjected to cost increases. However, protestants insist that it is evident, where specific, commodities are concerned, that the railroads have made no effort to establish that such commodities are equally responsible for added expenses. These contentions are considered later. Further, numerous protestants have claimed that respondents' proposal should not be granted until the problems generated by Ex Parte No. 305, Nationwide Increase of Ten Percent in Freight Rates and Charges, 1974, are resolved.

In Ex Parte No. 305 we authorized for 1 year, subject to possible extension, a 10-percent freight rate increase. Our orders in that proceeding impose certain requirements designed to insure that the additional freight revenues realized from that increase shall be utilized for the purposes intended. The basic requirements in Ex Parte No. 305 are: (1) that up to 3 percentage points of the 10percent authorization may be applied to increased material and supply costs, excluding fuel, provided such costs have been incurred, and (2) that the remaining amount, less increased income tax paid as a result of the increase, shall be applied to deferred maintenance and delayed capital improvements.

Protestants complain that an analysis of quarterly reports filed by the railroads reveals no significant inroads have been made on deferred maintenance and capital improvements. They point out that numerous lines, especially, The Chesapeake and Ohio Railway Company (Chessie System), have won relief from the Ex Parte No. 305 conditions and have, in effect, received a 7-percent increase which was not cost justified. Based on this, protestants assert that if the Commission decides to allow the railroads to continue to apply the Ex Parte No. 305 increase without restriction on how the funds must be spent, then the Ex Parte No. 318 rate increase should be denied.

The history of Ex Parte No. 305 is complex, but important points need to be summarized here. Following the establishment of the Ex Parte No. 305 increase, by further order dated October 3, 1974, we permitted railroads in reorganization to use the Ex Parte No. 305 funds as necessary to meet cash requirements for continued operation, subject to reporting requirements. In addition, we permitted any railroad not in reorganization, which finds it imperative to expend the funds generated by the Ex Parte No. 305 increase for operating purposes to avoid curtailment of transportation service or to avoid the filing of a petition in reorganization, to make an application for other use of such funds, subject to the submission of supporting documentation. Many of these applications have been granted. By order of the Commission dated June 6, 1975, the expiration date of the Ex Parte No. 305 increase and the attached conditions was extended to April 30, 1976; by further order dated April 28, 1976, the expiration date and conditions were extended to January 1, 1977.

Shortly after the establishment of the Ex Parte No. 305 increase, the Chessie System brought suit challenging the Commission's authority to condition the use to which the revenues derived from this increase might be applied. By reason of the decision of the U.S. District Court in Chesapeake and Ohio Railway Company, et al., v. United States of America, et al., 392 F. Supp. 358 (E.D. Va. 1975), the Commission was enjoined from enforcing against the Chessie System those portions of the challenged orders that required revenues derived from the Ex Parte No. 305 increase to be spent for specified purposes, on the ground that "Congress has not authorized the Commission to control a carrier's expenditure of funds as a condition to withholding the suspension of rates," 392 F. Supp., at 367. On appeal, the Supreme Court reversed the judgment of the district court No. 75-420, United States et al. v.

Chesapeake & Ohio Railway Co. et al., decided June 17, 1976, 426 U. S. 500 (1976). The Court held that the Commission may, as a condition for not suspending and subsequently investigating the lawfulness of the proposed tariff, require the railroads to devote the additional Ex Parte No. 305 revenues for the purposes the carriers invoked in support of the increase. The case was remanded to the district court for further proceedings consistent with the Court's opinion.

Based on the above, the Commission feels that protestants' concerns regarding the Ex Parte No. 305 increase, in the context of the Ex Parte No. 318 general increase proceeding, are not warranted. As noted in our April 28, 1976, order, we have found that the railroads have not shown sufficient cause for elimination of the existing Ex Parte No. 305 conditions imposed in regard to the use of funds. We have, and will continue, to closely monitor the carriers' efforts with regard to use of these funds to improve their deferred maintenance and delayed capital improvement situation. Further, in our judgment, the various orders granting relief from the segregation of the Ex Parte No. 305 funds do not have the effect of undercutting the revenue increase justification submitted by the respondents in this proceeding. Each relief order reflects the evaluation of special circumstances applicable to each respective applicant railroad. These orders, in our judgment, do not have the effect of eroding the basic Ex Parte No. 305 structure. Based on all the above, we find no serious problems with Ex Parte No. 305 in regard to the proposed increase in this proceeding.

Upon review of the evidence, we are satisfied that the annual cost increases depicted in table 4, with the adjustments discussed in appendix C and summarized in tables 5 and 6, are substantially correct, and that the increased expenses experienced by the railroads amount to approximately $1,036 million. Based on these cost figures, it is apparent that respondents' proposal will have a short-fall of more than $550 million. This evidence of increased costs balanced with the estimated revenue yield, together with other financial data discussed in the following section of the report, provides an adequate basis for approval of the Ex Parte No. 318 increase to the extent previously authorized.

GENERAL REVENUE NEEDS

In Ex Parte No. 281, supra, we expressed an intent to institute a rulemaking proceeding looking toward prescription of minimum