Rail 686: Another momentous year on the tracks – and mystic Wolmar

At the beginning of 2011 I wrote that it would be a momentous year. I’m not sure that it has actually quite lived up to that billing. Although there’s been no shortage of drama and excitement, the weakness of the McNulty report, hijacked by a minister who delved deep into the detail of what interested him – and railway finances certainly did – means that in essence it is ‘steady as she goes’ rather than ‘let’s change direction’. Moreover, Philip Hammond’s tendency to focus only on what interested him, and kick the rest into the long grass, has left a wealth of issues foownerr his successor, Justine Greening, to deal with, and not surprisingly she has given herself more time before publishing key documents such as the franchise reform paper and the responses to the HS2 consultation process.

The fundamentals of the malaise on the railway have simply not been addressed. A lot of lip service has been paid to the issue of costs, and we have a plethora of new committees, but there seems to be no clear road map on how to get to the nirvana of a cheaper railway. The McNulty investigation started off with the notion that £1bn could be cut from the costs of the railway, and not surprisingly, after much huffing and puffing, concurred with its original premise. However, McNulty’s failure to address the implications of the fragmentation of the industry, let alone to try to remedy the problems it causes, means the report will be seen as a lost opportunity.

The extent of the continued handwringing and thrashing about for solutions in the industry is neatly highlighted by the Office of Rail Regulation’s latest efforts to examine the relationship between the various players in the industry and crucially the incentives which determine their behaviour. The document, Periodic Review 2013 Consultation on incentives (available on the ORR website) is yet another example of how difficult it is to address the problems of the industry in a coherent way.

The ORR is, understandably, struggling to address the problem of perverse incentives in the industry which is created by the separation of infrastructure from operations. These were probably best highlighted by the fact that when GNER threw in the towel on its East Coast franchise, one of the reasons given was that Network Rail’s performance had improved so much that it was not getting as much money in compensation as expected!

Currently, train operators pay a set amount for track access charges, determined by the ORR, but which is effectively fed through the franchise. In other words, if track access charges go up, then their subsidy or premium will be adjusted accordingly. Therefore, from the train operator point of view, the level of track charges is irrelevant.

The ORR is proposing to change this. In order to incentivise operators and Network Rail to work more closely together, the idea is that the operators should share some of the costs of providing the infrastructure. So, if Network Rail managed to spend less on a particular route, some of that benefit would accrue to the operator. It sounds simple, but as the detail of the document shows, it is horrifyingly complex. The fundamental problem is the peculiarity of the railway industry which, in essence, remains little affected by genuine market forces because of its role at the heart of the nation’s infrastructure. The document admits as much: ‘In a normal competitive market, when a company reduces its costs its customers benefit as a result of the lower prices they receive. There are therefore natural incentives in place for customers to work together with the company to help reduce its costs and for the company to encourage them to do so. In the rail industry these natural incentives are not effective.’

Attempting to create these ‘market mechanisms’ seem doomed to fail. First, the reason why infrastructure costs may rise or fall on a particular route could be entirely arbitrary: a bridge may deteriorate, rails wear out quicker than expected or whatever. The document recognises that, but it leads to a conundrum – if the amount of risk exposure is minimal, that will not affect the operator’s behaviour, and it if is high, then there will be a heavy price to pay for it. Secondly, the private sector, quite understandably since it has obligation to its shareholders, either resists taking on risk or prices it at a very high rate. This would surely be reflected in franchise bids. Trying to get train operators to share this risk is simply what I have called many times ‘pretend capitalism’.

Just to add to the complexity, most routes have more than one operator especially as freight users are taken into account. So any savings would have to be shared between various operators which means there would not be much in it for each individual company.

The ORR has a stab at trying to ‘model’ the effects of this measure, and comes up with lots of interesting looking tables, but in practice it is educated guesswork, especially as the extra costs of franchise bids have not been taken into account. Ultimately by putting forward this clever mechanism, the ORR risks getting yet another perverse outcome, putting up the cost of the franchises to the taxpayer. ORR’s efforts are, therefore, yet another demonstration of how the solution to dealing with an already complex railway always seems to load the poor industry up with yet more layers of regulation, rules, contractual arrangements and general clutter whose ultimate effect will only be to create cost and fail to resolve the initial issue.

I cite this example in some detail partly because I want to save my readers having to actually go through such a document, but also because it shows how we end up with complex analyses that merely highlight that the only cure for the high costs of the industry is to simplify the structure, and in particular bring together operators and infrastructure as one business.

Interestingly, I was talking to Guillaume Pepy, the charismatic boss of SNCF the other day, and he reckons that the tide is moving in that direction in Europe, after years of the Commission trying to enforce rigid separation. It was a European requirement that gave the Tories the excuse to break up the industry into infrastructure and operations, though the British model goes far beyond anything required by European legislation. Consequently, throughout Europe, reluctant railways have had to split themselves up even if in most countries the ownership of both parts has remained in state hands.

Well the winds of change are blowing through Europe. Pepy has long, off the record, complained about the enforced separation of the railways, arguing it is expensive and wasteful. Now, though, he has being going public on it, and he is not a man to whistle in the wind but, rather, clearly expects potential movement in Europe. Pepy suggests that the failings of the current system are being recognised. Speaking in his near perfect English, he told me: ‘The commission consists of what we called technocrats. They just operate on a theoretical basis, regulating electricity or water, and think that railways are the same. The politicians, however, understand that it does not work for the railways. The state of mind is changing all over Europe’.

Pepy said that in France the regulator, a relatively new organisation, is expected to pronounce on the structure of the industry in the New Year. Pepy is confident that he will be allowed to bring SNCF closer together with RFF, the equivalent of Network Rail.  And guess what? Pepy cited the McNulty report in support, pointing out that it recommends integrating services with infrastructure as an experiment. Pepy argues that for too long the emphasis has been on theoretical structures rather than what railways need: ‘You need to organise for the best model, the point is not the structure of the organisation, but the best business model’. This sounds precisely like the ‘what works’ notion favoured by Tony Blair and it is one that McNulty should have followed. It will not, though, please Britain’s freight operators, who have long fought against vertical operation.

The winds of change, therefore, are blowing through Europe. That will add to the excitement. While this year has been an interesting one, next year threatens to be a very interesting one. With franchise reform in the offing, the continued fall-out of McNulty, controversy mounting on HS2, numerous franchises up for grabs, the fate of the British based rolling stock industry in the balance, the prospect of transport difficulties at the Olympics (though see Mystic Wolmar), the dip in the economy and progress on several exciting projects, 2012 will, I promise, really be a momentous year.

Mystic Wolmar’s six for 2012

So, having had a good year again, it’s time for Mystic Wolmar’s crystal ball to come out of the cupboard. Here’s half a dozen for 2012:

1. Justine Greening will come out of the shadows and proved to be an effective minister, asking difficult questions of the industry, and will remain in post.

2. Rail passenger numbers will actually decline as a result of the downturn in the economy but no more franchises will throw the towel in.

3. The Bombardier factory in Derby will get an order for some new trains.

4. Predictions of transport chaos at the Olympics will not be realised and apart from the odd crush after events, people will wonder what the fuss was about.

5. The performance of Network Rail will continue to decline as it has to cut back on maintenance spending because of the financial pressure of the current Control Period (2009-14).

6. There will be no general election despite increasing splits within the coalition.

Oh, and my indulgence – QPR will stay up comfortably.

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