On the slow track: performance contracts and access regimes

Across Europe, liberalisation of passenger rail services has made slow progress. The UK was an early adopter of a regime designed to encourage entrants into passenger services with its franchise regime introduced in the 1990s. The EU has introduced a series of reforms aimed at liberalisation, with the “Third Package” in 2007 encouraging entry into the international rail market and the Fourth Package (2015) seeking to address domestic passenger services.

While before the pandemic the UK’s approach to liberalisation focussed on competitive franchising organised around either regions or major routes, the continental emphasis has tended to be on open access regimes for long-distance/high-speed services and public service delegations with extensive contracting (i.e. public authorities paying operators) for regional services.

Progress on this project has been mixed:

Outside of the UK, Germany has historically seen most evidence of an increasingly competitive market for passenger rail services, most notably on regional services where market shares for the historic incumbent Deutsche Bahn have been steadily decreasing to around 64% of total traffic in 2019.

Italy has also seen competition on high speed rail with NTV competing with Tenitalia connecting 25 Italian cities with a market share of 35% on these routes.

More generally incumbents still very much dominate European rail markets – in particular for long-distance and high-speed rail services. As shown in IRG-rail’s Ninth Annual Market Monitoring Report, incumbents across 27 European countries (including the UK) still represent a remarkably stable 75% of total passenger-kilometres in 2018 and 2019. For long-distance services, this share is likely much closer to 100%.

And such progress as has been achieved has been thrown into reverse by the effects of the COVID-19 pandemic and the collapse in rail passenger numbers. And returning to a pre-pandemic system is likely to prove extremely problematic, largely because of the difficulty, verging on impossibility of making meaningful passenger forecasts for the foreseeable future. Other developments include:

The UK has abandoned its franchising model and, somewhat ironically under the banner of “Great British Railways”, announced a reversion to a model more akin to the continental European approach to contracting for rail services.

In France, Thello (owned by Italian incumbent Trenitalia), SNCF Voyageurs’ most important competitor to date with services to various Italian cities had to suspend a large share of its offer during 2020 and while still planning to enter against SNCF on French domestic high-speed links (e.g. Lyon-Marseille) has repeatedly delayed the launch of these services in light of the Coronavirus crisis. As a result, SNCF has not been facing any competition on domestic high-speed services to date.

In Spain, Ouigo (SNCF’s low-cost high-speed brand) was originally due to launch services competing with Spanish incumbent Renfe between Madrid and Barcelona in late December 2020 but had to delay the launch due to the pandemic.

How to revive competition in the wake of Covid-19?

The problem rail authorities around Europe now face is: how to reinvigorate a liberalised rail sector in the wake of the pandemic? In particular, how to do so when faced not so much with uncertainty, but rather with genuine unknowability as to the level of passenger traffic in the months, even years, to come. For instance, the uncertain future of commuter traffic as we know it is a major contributor to this.

And this problem will impact on both contracted regional services and open access regimes, although in somewhat different ways.

Public service delegations for regional services

Even before Covid contracts for the operation of regional rail services were complex performance-driven agreements, with detailed specification of performance standards and penalties to the operator for failure to achieve minimum performance standards. Performance assessment is particularly difficult with independent companies, track and service operators, interacting with each other in ways that affects both their own and others’ performance.

Adding huge demand uncertainty to these contracts only makes the problem of inducing good quality behaviour even harder.

Under a franchise model it is possible, up to a point, to align operator and public interests by placing revenue risk on the operator: the incentive to grow traffic aligns with the incentive to run a reliable high-quality service. Public service delegations can also, in principle, share some of the revenue risk with the operator to achieve the same end. But this will be difficult or impossible for the immediate future while traffic figures are so uncertain.

It is unclear how successful this approach is likely to be. A report published by the International Transport Forum in 2018 questioned the efficacy of the contractual approach (specifically PPP) because the lack of commercial interest on the part of the operator in driving usage combined with the difficulties of defining complete performance contracts can be an expensive method of procurement.

All this places greater emphasis on the “quality of service” elements of these contracts to deliver value for money and on the public authorities’ ability to monitor performance. We note that the UK has optimistically implied that its new arrangements – that are based on performance contracts – will provide simplified and streamlined management of the rail network. But with continued interaction of multiple players it remains to be seen if this will be the case. It is easy to see the next few years being good for lawyers and experts in contract design. Even before the new regime was introduced the UK had experience of contracts without revenue risk because traffic was considered either too difficult to forecast or outside the operator’s control (e.g. relating to the Thameslink upgrade). The performance elements of these contracts are far from simple.

Undoubtedly across the UK and the EU these arrangements can continue to encourage private participation in provision of services. But it’s hard to see the immediate future as being “liberalised” in the sense of market-led and driven by competition to drive the shape of the regional passenger market.

Open access regimes

Open access regimes present quite a different challenge to those of contracted regional services. But the prospect for further progress on liberalisation through open access operators seems to also be pushed back by the uncertainty of the pandemic. This is in spite of mild encouragement from some European governments prohibiting short haul flights for environmental reasons where rail is a viable alternative.

Clearly new private operators will be extremely wary of the investment in rolling stock, staffing and marketing required to establish these services when the scale of the overall market within which they would be operating is highly open to question.

This seems inevitable and it is unclear what policy levers authorities can pull to change this. However, we note one area of contention for these operators which, in our view, should notform part of the solution. This would be to encourage open access operators by allowing more favourable terms of track access. These terms, set by EC regulation, already determine access charges relative to the current cost of wear and tear on the network, and make it hard for the network operator to recover the historic costs of investment.

Under existing EU rules, rail operators are permitted to levy mark-ups over current costs to recover past investment provided that the market is able to bear these. Even before the pandemic this test has proved contentious and subjective and raises questions about why any rational commercial operator would invest in track infrastructure if those costs are immediately to be treated as sunk. But given the wording of this legislation there is an open invitation for authorities to waive significant parts of track access charges to encourage the continued participation of independent open access operators.

This would not seem to be a particularly constructive approach and certainly not a “market-led” one. To do so would present a danger of creating a simulacrum of competition to the incumbent public operators, based on distorted price signals with the costs borne by the incumbents or the public purse for no clear benefit.

There is more to be said on open access regimes, which we will return to in another piece, but, for the present, open access may find itself on the “slow track”.

Conclusion

Rail liberalisation may have taken a step back as a result of the pandemic but this only serves to accentuate the need to find ways to promote better performance from the railways in the absence of competition. This applies to public service delegations but also to incumbent operators seeing less competitive pressure from open access entrants.

Moreover, paying for the railways will become more challenging as sources of funds from operators willing to take revenue risk (whether through franchises or open access) dry up.

These are the immediate challenges facing the rail sector during recovery from the pandemic.

Railway reform

Railway reform

Read the first article in the series discussing the effects of the shake-up to the UK rail network announced in May.

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