Railway Infrastructure: Pricing and Investment

This paper analyses the requirements for rail infrastructure charging, laid down in directive 2001/14/EC. It calls for marginal cost pricing and allows for mark-ups. Four standard pricing principles are analyzed on their suitability for track charging. It is found that no charging system proves superior and that the EC legislation is in line with economic theory. Scrutinizing the tariff systems of the EU member states, information are gained for the development of tariff systems. Infrastructure pricing is a long established and controversial issue of European transport politics. The different approaches, that the European Commission has chosen over the years, reflects the heterogeneity of opinions across the member states, within the scientific community and among practitioners. The current trend towards marginal cost pricing for transport infrastructure for instance does not meet the suggestions of cost recovery aims as recognized in the Green Paper “Towards Fair and Efficient Pricing in Transport”. The recent policy in the pricing of railway infrastructure is ambiguous in this respect. In directive 2001/14/EC, the general claim is the establishing of marginal cost pricing. But deviations are allowed for in the form of mark-ups on these costs. The aim of this paper is threefold. The requirements for the charging the track use, laid down in the above mentioned directive, are analyzed. This is done by comparing them with standard tariff systems, which are usually deployed for transport infrastructure. In order to come to a conclusion, these standard tariff systems are evaluated, considering their effect on efficiency. The European Union member states were required to turn the claims of directive 2001/14/EC into national law by March 15, 2003. A second objective of this paper is therefore, to see if the charges in the member states are in line with this requirement and then suggestions of economic theory. Furthermore, they are scrutinized to find useful elements to improve existing tariff systems and create new ones. This is the third objective of this article. This paper concentrates on the access to the main facilities and their charges. The pricing for the use of the so-called service facilities in Annex II of directive 2001/14/EC is not considered. Hylen provides an insight into the access and charges of these facilities in five European countries (Hylen, 2001). The structure of the article is as follows: The background is described in chapter two by describing the cost components of the rail infrastructure and different principles of setting prices. These principles are then evaluated. In chapter three, the existing rail track charges of European Union member states are analyzed on the basis of the previous chapter. In the fourth chapter, recommendations for the creation and the amending of tariff systems are given, the last chapter concludes. 2 Rail Infrastructure Charging Rail infrastructure has long been a regulated sector. The public influence on the rail network is usually of a severe kind, leading to a public ownership of the infrastructure in nearly all European countries. The legislation of the European Commission refuses with good reasons to require a specific a organisational structure and ownership of the infrastructure 1 Infrastructure charging in Switzerland is considered, although the country is no member state of the European Union. This exemption is made because Switzerland obtains a crucial geographical position in the European rail network. Railway Infrastructure: Pricing and Investment Benedikt Peter Workgroup for Infrastructure Policy (WIP) 2 manager (IM). However, some conditions concerning open access, the price setting and slot allocation procedures have been laid down, but leave plenty of freedom for the national governments and the respective IMs. As this paper examines the directive 2001/14/EC and its accomplishment across the EU15, it follows the framework of this directive. It abstracts from the organisation of the IM, focussing solely on the system of charges. The existing price systems are judged and recommendations are given without considering any regulatory framework. This limits the possibilities of evaluation, as the aim of welfare maximization does not only depend on the price system. The individual situation in each country, e.g. an integrated incumbent, requires further analyzes, which is beyond the scope of this paper. The directive 2001/14/EC requires in Articles 7 and 8 for the charging of rail infrastructure the following: • Charges are to be set at the cost directly incurred as a result of operating the train service. • Cost that reflect scarcity of capacity during periods of congestion are allowed. • Charges to cover environmental costs are allowed. However, if they increase the revenue of the IM, they may only be charged, if competing modes of transport apply these charges on a comparable level • Mark-ups on the basis of efficient, transparent, and non-discriminatory principles can be applied to recover the total costs, if the market can bear this. For market segments, that are not able to pay these mark-ups, the charge should only cover the costs that are directly incurred by the train run. • Higher charges can be set to cover the costs of investment projects on the basis of the long-run costs, if they increase the efficiency and/or cost-effectiveness. • To prevent discrimination, the charges for equivalent uses have to be comparable and comparable services in the same market segments are subject to the same charges. • Discounts are only allowed to give savings in administrative costs to the customers or to encourage the use of a specific infrastructure section for a limited time. In the latter case, the discount schemes have to be available for all users of this section. This chapter describes in a general form the cost components of the rail infrastructure (section 2.1)and turns then to standard pricing principles. They are analyzed (section 2.3) with respect to their ability to ensure allocative efficiency and further aims, described in section 2.2. The outcome of section 2.3 is a pricing principle which should be preferred for rail infrastructure. Finally, it is concluded, whether the requirements of directive 2001/14/EC match the features of this “best standard pricing principle”. 2.1 Cost Components of Rail Infrastructure Railway infrastructure is used as an input for different services. Freight trains and passenger trains operate on it and further differentiations can be made within these market segments, as for instance single wagon load transport incurs costs and attracts demand different from trainload transport. These services – whether they are provided inside an integrated company or over the borders of two enterprises partly share the same infrastructure, e.g. the trackbed. Certain features of the infrastructure might be shared by one or more, but not all, services, thus generating blockwise variable costs. E.g. only electric trains make use of the power supply facilities, diesel trains don’t account for the costs generated by the wires etc. Indeed, the enforcement of the trackbed for an axle-load above 22.5 t could be assigned to specific operators. These costs, once identified, are common only for the operators which transport heavy weights. Other costs, which are entirely common to all operators, cannot be traced to any particular service or group of services. Thus, the costs of the slot provision depend not only on the traffic volume (q), but also on the characteristics of the infrastructure Railway Infrastructure: Pricing and Investment Benedikt Peter Workgroup for Infrastructure Policy (WIP) 3 (z) and the suprastructure (v). The cost function can be described as (Rothengatter, 2003, 126) C (z,q,v) = F1 (z) + F2 (z,v) +c(z,q,v) The function is based on the assumption, that the costs are additively separable. C denotes the total costs, F1 the blockwise variable costs, F2 the common fixed costs and c the variable costs. The proportions of F1 and F2 change over time. The difficulties of charging systems result from allocating the common costs and the blockwise variable costs to the operators, as their nature prevents them from being distributed in an impartial way. Once the blockwise variable costs are identified, the problem is reduced, as they are to be distributed only between the member of the user group at stake, which is still difficult. The problem is aggravated by the high proportion of these costs – they account for up to 80 90 % of the total social costs of the rail infrastructure (Hylén, 2000, 2). This proportion applies if a short planning horizon is chosen, as is required by EU legislation. The remaining short run marginal costs (SRMC) change with every further movement and can be attributed directly to a particular operator. Their determination requires detailed cost studies, which can comprise a variety of elements: Operating costs, that can be traced to a particular train movement, e.g. for personnel and signalling, Wear and tear costs for maintenance and renewal of the infrastructure, Costs for energy consumption (electricity or diesel), and Additional timetable planning and administration costs. If SRMC consider ecological costs, impacts on congestion, on the noise level and accident costs of other parties, they are referred to as short run marginal social costs (SRMSC). An additional externality, which currently attracts attention, is the influence of rail transport on global warming. The specification of the relevant cost curves, which are necessary to establish equilibrium prices, is problematic. Although there is no European IM deploying a perfect SRMSC-pricing scheme, remarkable examples exist, notably in Scandinavian countries, covering some of the above mentioned components (see Thomas, 2002). Marginal cost studies were also carried out in Austria and the UK. Most of these studies cover at least the wear and tear costs. Other components are of a less relevant proportion, like accident costs, which are moreover likely to be covered by insurance costs. Further marginal costs are rather easy to identify, e.g. the energy consumption costs, although meters on the traction vehicles are required. Scientific attention is now being paid to the capacity costs. These are usually considered to be composed of (Nash, 2003, 6): • Congestion costs, and • Scarcity Costs: opportunity costs of train operator B, which cannot run a train as they wish, because the slot has been given to operator A. The expected congestion costs only occur on track sections with dense traffic, where it is more difficult for the IM to manage reactionary delays. They consist of the costs of time and energy imposed on other users of the network. If the infrastructure investment is done optimally, the revenues from an optimal congestion charge will cover the deficit that is otherwise incurred (Mohring & Harwitz, 1962). This finding only holds if there are constant returns to scale, which is usually not found to be the case for railway infrastructure. Operators should consider these congestion costs in the process of timetabling. They are likely to influence the track choice if relatively high. The congestion costs can be estimated ex ante by means of models (on the basis of historic data) and assigned to the operators (Nash, 2003, 3). Congestion costs have to be considered separately from the disruption costs, which are incurred by vehicle breakdowns etc. The latter should be treated ex post, as it is done in the UK and the Netherlands, on the basis of costs imposed to other operators. Railway Infrastructure: Pricing and Investment Benedikt Peter Workgroup for Infrastructure Policy (WIP) 4 Scarcity costs are external marginal costs and as such not to be confounded with opportunity costs. Pricing of scarcity ensures that the service with the highest value gets the slot and is therefore most important for the timetabling and the slot allocation during operation. It has to be answered as well for the adjustment of schedules in long-term franchises. The basic problem is that scarcity generally only appears on particular sections of the network, where a number of trains want to pass at particular times, serving different relations. Even if the capacity is only scarce for the particular section, the value of the complete train runs at stake have to be considered in allocating the slot. The problem is independent of the organisation structure as integrated railways have to decide as well, how to distribute capacities (freight trains, local trains, ...) in bottlenecks. If there is a possibility to charge for scarcity on the tracks, it has to be ensured, that the revenue generated is invested in infrastructure enhancement. To date, this question is solved in all EU15 countries by priority rules, which are likely to be accompanied by mediation in practice. As these priorities do not guarantee a welfare maximizing capacity allocation, new approaches are currently examined, e.g. second-hand trading (see Nash, 2002, 5), auctions (see Cox, 2002), prices on the basis of long-term marginal costs (see Hylen, 1998) and definition of standard paths for each bottleneck if capacity has already been assigned (see Nash et al, 2003). 2.2 Economic Objectives of Rail Infrastructure Charges In neo-classical markets, the price mechanism clears supply and demand of scarce resources. However likely a perfect competition in general may be, it certainly does not exist in the case of the rail infrastructure supply. The main obstacles for competition is the nature of the rail infrastructure as a natural monopoly. Together with a high proportion of fixed costs and a lack of intermodal competition in wide parts of the market, this leads to the need of regulation. In all of the EU-member states governments influence the prices of the rail infrastructure slots, either in form of internal regulation or (direct or indirect) price regulation. In doing so, two economic aims of prices are to be considered: Allocative Efficiency (static) A price is allocative efficient, if it maximizes the social welfare. This is the case, if the price of a slot equals the marginal social costs respectively. It leads in a static perspective to the right number and the right quality of slots that the operators require to meet the demand of the final customers. Allocative Efficiency (dynamic) In order to maximize social welfare in a dynamic perspective, the prices for slots have to deliver signals for investment and disinvestment. Capacities and services should be increased, where they create benefits greater than the costs. This refers to both the supplyand the demand side. The IM should have the incentives to build new lines, close the ones which generate too little revenue, or to deploy a new technology. The operators have to rely on the price system to adjust their fleet to use the capacity in an optimal way. This might for example lead to the replacement of cost-intensive high speed trains by slower vehicles. In order to create incentives for (dis)investment, it is crucial that a pricing systems reflects the variable costs and the blockwise variable costs and links them to the respective user groups (Rothengatter, 2003, 126). A pricing system has to take account not only of the volume of transport and the infrastructure characteristics, but also of the suprastructure characteristics. Further conditions should be considered in the setting up of a pricing system. Transparency ensures that the RU know what they pay for and allows them to calculate different alternatives a vital element of each commercial undertaking. Moreover, it helps the mutual understanding of the parties. If they know the elements of the price and what drives them, they have the ground to predict future changes. Moreover, the prices should ensure a high degree of equivalence between the ones who benefit from the slots and the ones who bear the costs of their provision. This claim, which leads to cost-recovery considerations, is not Railway Infrastructure: Pricing and Investment Benedikt Peter Workgroup for Infrastructure Policy (WIP) 5 based on welfare economics, but on democratic principles. It can be ruled out by economic reasons. Finally, transactions costs should be considered while defining the prices for the slots, the allocation procedures and the funding of the IM. This includes the way in which the costs are covered and the transaction costs entailed. A good price system should not only incentivise the IM to provide the right amount of slots in the right quality. It should also lead to a minimal use of inputs in the production process and to choose the cost minimizing technology. Unlike in perfectly competitive markets, technical efficiency is not achieved automatically in the rail sector. A regulation regime that sets the prices exactly according to a proportion of the costs, will lead the IM to technical inefficiency, as he has no incentive for cost-reductions. The degree of technical efficiency, that the IM realizes, cannot be predicted without the respective regulatory framework, therefore it is not considered in this paper. The same applies for quality. A monopolist will not offer its products in the optimal quality. It needs to be adjusted by the overall regulatory framework for the IM. The price (for punctuality, rolling stock condition, ...) provides certainly a good incentive. There are good reasons to adjust quality outside the tariff system. Therefore, this issue is not considered in this paper either. Because of the exceptional cost curves of the rail infrastructure, price setting has always to face trade offs between two or all of the above mentioned objectives. This is highlighted in the next chapter, where the most common pricing principles for rail infrastructure charging are described briefly. 2.3 Pricing Principles Short Run Marginal Cost Pricing Marginal costs are the costs which are incurred by an additional train run. They include the above mentioned components. Applying this pricing principle, it is ensured, that every train operator, whose willingness to pay covers or exceeds the marginal costs, can run their train. Each slot allocation will lead to a net benefit. As external costs are substantial (Nash, 2003, 5), they should be included in the infrastructure charge. SRMC-pricing minimises the exclusion of RU from the network and leads to allocative efficiency in a static perspective. A number of examples shows that the implementation is, at least in a rough way, possible, although the definition of the components of marginal costs may differ from country to country. Moreover, it finds acceptance among operators, due to the low costs it generates. These strong favourable arguments face serious caveats. If marginal costs are considered only in the short perspective, they don’t cover the costs of upgrading and new investments in infrastructure, leaving this as a serious problem for the development of the rail industry as a whole. The IM will not have the necessary funds for investments, nor will he have the incentives, as new lines would only increase the deficit in the regime of SRMC-pricing. The problem is enforced by the lack of incentives for the IM to develop new cost-saving technologies, if he is regulated on the basis of marginal costs. He has no means to adjust prices to the demand of the operators, as the prices are set irrespective of this demand. He cannot gain information for investment decisions through price variations. In setting prices according to SRMC, little information about the vehicle characteristics is considered, as the block wise variable costs are fixed in this term. However, the SRMC vary with the vehicle characteristics and this should be considered in the charges, as it provides the operators with information for investment in rolling stock. As the proportion of marginal costs low, dynamic allocative efficiency is hardly achieved by marginal cost pricing. SRMC-pricing results in a deficit because of scale economies and a high proportion of fixed costs. This deficit will be partly covered, if externalities are considered in the pricing system. 2 The notion incremental costs is used as well, the difference being the way the costs are measured. Railway Infrastructure: Pricing and Investment Benedikt Peter Workgroup for Infrastructure Policy (WIP) 6 However, the charging for externalities should not be a financing instrument in order to guarantee allocative efficiency. It will in general not cover the deficit. It is not apparent to claim the charges for externalities to remain with the IM, one reason being that this would antagonize the IMs’ incentives to reduce some of the externalities, namely for accidents, congestion and noise. The deficit is in European countries usually covered by the government with general taxes. This raises concerns about the equivalence in this system, as the tax payers not necessarily will benefit from the spending of their money for rail infrastructure. The possibility of subsidized train operators benefiting more from the subsidies than tax-payers lose, is very theoretical (Rothengatter, 2003, 125). This holds particularly because of distortions that taxes other than poll-taxes usually entail. If for instance the deficit of the IM is covered by income-taxes, this procedure drives the labour-costs of the very IM away from marginal cost pricing (Baumol & Bradford, 1970, 265). The processes of tax collecting and distribution are to be considered. Complex structures may be cost-intensive and compensate a great deal of the tax income. Apart from the costs of levying taxes, the central investment decision, which is usually linked to the deficit coverage by the government, leads to high information requirements of the investment decisions. If users are only charged at the level of their marginal costs, it is not revealed whether their valuation of the tracks is as such that it justifies the total costs. This makes an appraisal of the project necessary, which faces serious information problems (Laffont & Tirole, 1994, 25). Caveats of tax financing of the deficit generated by SRMC-pricing leaves the possibilities of crosssubsidization and financing by charges for opportunity costs, which have chances and problems of their own.