ORR: Multiple objectives
The ORR finds itself (as do many sector regulators) in a slightly difficult position between regulated service delivery at the network and franchise level on the one hand, and competition on the other hand.
As the economic and safety regulator for the railways it must consider and achieve an appropriate balance between its 24 different statutory objectives (contrast, for example, Ofwat’s five primary statutory duties). While one of these duties is the promotion of competition for the benefit of users of railway services, another is factoring in the funds available to the Secretary of State for the purposes of his functions in relation to railways or railway services. When it comes to open access operators, these clearly have the potential to pull in different directions (see Panel 1).
There is also something of a contrast between ORR’s role as the regulator of Network Rail on the one hand, and on the other hand as decision-maker regarding open access operations. One of these roles is about maintaining a regulated monopoly and having it operate to specified standards within specified funding constraints. The other may be characterised as assessing whether potentially dynamic and innovative competition from non-traditional downstream service providers is likely to be beneficial to the network.
This may (to some degree) account for the way in which ORR applies the ‘not primarily abstractive’ test in relation to open access applications. Some raise criticisms that the methodology used in applying the test is outdated and does not take account of up-to-date economic information (particularly the growth of passengers on the East Coast Main Line), and may have some inherent inbuilt weights in favour of franchise operators over open access applicants.
It is interesting that despite being a concurrent regulator under the Competition Act 1998 in relation to railways, the ORR has brought no cases in relation to passenger rail services. Contrast this to the market for freight railway services, where the ORR has successfully brought a number of cases. This emphasises the low level of competition currently taking place on passenger rail services.
CMA discussion document
The CMA, while being alive to the other issues, has a much simpler perspective. Its relevant statutory duty is to promote competition for the benefit of consumers.
The CMA is particularly looking at:
- Securing better value for money for passengers (lower fares) and taxpayers (efficiencies leading to lower operating costs).
- Enhancing service quality and encouraging innovation.
- Unlocking network efficiencies, potentially by focusing on Network Rail’s incentives for capacity utilisation and cost controls.
However, the CMA recognises that changes should:
- Not disrupt current and forthcoming rounds of franchising.
- Maintain the provision of socially valuable services which may not be commercially viable.
- Not jeopardise current and future network investment.
- Not have any adverse operational impact.
The CMA’s discussion document raises concerns about the effectiveness of franchise competition in the rail industry context. From a pure economics perspective, the franchise competitions run by DfT meet only two of the four relevant conditions to be perfectly efficient. In particular, competition does not begin afresh for each new contract and customer, and entry is not ‘easy’ given that the franchise application process is expensive and time-consuming.
The CMA’s thesis is that examples from the rail freight sector, open access operators, overlapping franchises and Europe indicate that greater on-rail competition in Great Britain could generate benefits in terms of innovation, service quality improvements and lower prices.
While the CMA appreciates that the examples it refers to are not precise analogies, it believes that taken together they are “richly suggestive” that significant benefits could be gained from introducing greater on-rail competition alongside competition for the market in terms of franchises.
It also identifies various increases in available capacity on the network that it expects over the coming years (due to the introduction of new technology), which it believes will provide additional space on the network for new entrants.
One of the key arguments against additional open access operations has been the belief that they will reduce the funds available to the Government from rail franchising.
Some would argue that the economic evidence from other industries and from the East Coast Main Line would show this has not been the case. In particular, revenues on the ECML have increased considerably during the period that Grand Central and Hull Trains have been operating in competition with the East Coast franchise, noting the massive premium growth in percentage terms since 2008.
Proponents of open access would argue that these operators have grown the market for rail passenger travel as a result of the additional services they have provided and the destinations they have served, and that these growth effects have substantially outweighed any detriment to the franchise operation and the cross-subsidies available to unprofitable services. However, others would query whether this evidence is really conclusive, and in particular whether this growth would have occurred in the absence of open access in any event, given prevailing economic conditions.
An argument often used against the current open acess operations is an assertion that they do not pay a ‘fair’ contribution towards track maintenance costs, given that they only pay the Variable Track Access Charge and not the Fixed Track Access Charge payable by franchisees. While the High Court did not see this as an issue in 2006 (and there are contra-arguments), the CMA has picked up this proposition - all of its options that include open access operations also include revised track access charge proposals.
Four options for change
The options put forward should all be considered against the backdrop of the current system as the base case scenario. Interestingly two of the options for change rule out open access competition where they would apply (Options 2 and 3), while the other two options for change envisage a significant expansion in the role of open access operations. The options therefore cover a range of different approaches, even though they all fundamentally share the goal of achieving ‘on track’ competition for routes that are profitable.
Clearly, there are also a number of variants possible on these four options. One variation of Option 4 that has been added to the mix by one stakeholder group is that the licensing should apply only to profitable inter-city services, and that regional and commuter services should continue to be operated on a franchise basis as presently.
The two tricky parts for each of the four options are: how to fund and maintain socially desirable but in themselves unprofitable services; and how to manage track access given the practicalities of limited capacity.
