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Russell PittmanNew Economic School and Antitrust Division,
U.S. Department of JusticeLeontief Centre
27 September 2013
The views expressed are not purported to reflect the views of the U.S. Department of Justice.
What Next for Russian Railways Restructuring?
How to handle “natural monopolies”: The restructuring debate
SECTOR Electricity Natural gas Telecoms Railways
NETWORK: MONOPOLY?
Long distance transmission lines, local distribution lines
Long distance pipelines
Local “loop” – fixed wire service to households and businesses
Track and signalling
COMPETITIVE? Generation: natural gas, coal, hydro, nuclear
Exploration and production
Long distance, mobile, internet
Trains
But competitive elements cohabit uneasily with monopoly networks…How restructure the overall sector?US telecommunications sectorFirst, 3rd party access
MCI competed with AT&T for long distance, while AT&T maintained local service monopoly
AT&T discriminated against MCI in order to favor its own long distance service
Then U.S. v. AT&T: Vertical separationAT&T forced to give up local service in order
to insure fair competition in long distance
The optionsVertical separation
Favorite of the World Bank, EU3rd party access
(Grudging) favorite of incumbents“Horizontal separation”: competition
among vertically integrated firmsCompetition where networks intersect
The old status quo: Regulation of vertically integrated monopolyWas it really so bad, compared to the costs
of restructuring?
How to restructure a vertically integrated monopoly railway?Economists’ (and EU) favorite: Vertical
SeparationOne track owner, many “train operating
companies” (TOC’s)UK, Sweden, Netherlands, Poland, Romania, parts
of AustraliaRemoves incentives to discriminate in providing
access to infrastructureRailways’ (grudging) favorite: 3rd Party
AccessTrack owner is one of the many TOC’sGermany, Austria, Italy, Chile, parts of AustraliaMaintains economies of vertical integration:
“where steel meets steel”Can be imposed gradually (to a fault)
Other options? “Horizontal separation” preserves vertical economies, requires less regulatory oversight
This is the model of North and South America
USA, Canada, Mexico, Brazil
Parallel competition where possible
Chicago to Los Angeles? BNSF or UP
Montreal to Vancouver? CN or CP
“Geographic competition” otherwise
Export grain from Chicago? Pacific NW competes with the Gulf Coast
Mexico, where “horizontal separation” relies on “geographic competition” only• Imported steel to Mexico City? KCSM from Monterrey (or Laredo), Ferromex from Manzanillo (or El Paso), Ferrosur from Veracruz• Exported auto parts from Mexico City? Same, in opposite directions.
How to decide?Vertical separation removes incentives to
discriminate but loses economies of scope (operations/infrastructure) and risks double marginalization
3rd party access maintains economies of scope but creates incentives to discriminate
Horizontal separation removes incentives to discriminate but loses economies of scale (in this case, system size) and risks preserving local monopoly power
How to decide (II)? Facts and constraintsSmall system or large? Passenger-based or
freight-based?Lessons from a small, passenger-based
system (UK) may translate poorly for a large, freight-based system (RF)
What are you trying to accomplish?Improve efficiency? Usually for rich countriesAttract private investment? Usually for poor
and middle-income countriesIn years past: Satisfy World Bank conditionality
Improve political and economic integration?Reduce political power of giant firms?
What can economics contribute?Economies of scope (i.e. vertical economies)
Presence not much in dispute, though estimates varyEarly econometric estimates of 20-40% likely too highMost recent results: more important in a) densely
operated and b) freight-dominant systemsEconomies of scale: density
Probably exhausted for most densely operated systems
Economies of scale: system sizeCertainly exhausted for largest systems
One takeaway from this combination: For largest systems, horizontal separation may dominate vertical separation (Savignat and Nash, 1999)
Access pricing issuesEspecially, potential welfare advantages of
discrimination
RZhD reform program 2001-2010, later extended to 2015 OBJECTIVES
Improve sustainability, accessibility, safety and quality of the rail transport service to help create the country’s common economic space and ensure the national economy’s development
Establish a single harmonised national transport system Lower rail transport costs Meet the increasing demand for rail transport services
PRINCIPLES Phased-in reforms and minimisation of irreversible action Separation of government regulation and operations Separation of the core and non-core operations Migration from monopoly to competition Function-based organisational structure Government’s regulation of and control over the monopoly
(infrastructure) Partial infrastructure integration with freight transport during the first
stages of the reform to be phased out to ensure rolling stock privatisation
(from a 2011 RZhD slide presentation)
How to achieve “migration from monopoly to competition”?From the original reform plan:Third Stage: 2006-2010
Partial or complete privatization of subsidiary companies
“Develop competition in the freight traffic sphere”“Estimate the opportunities of setting up several railway
companies, competing and vertically integrated”This last point has faded from the discussion
What competition has been created so far?Rolling stock, repair facilities“Daughter” operating companiesBut INDEPENDENT train operating companies?
Current state of reformsIn RF there are plenty of independent “operators”
(companies that arrange transportation for shippers and may own rolling stock) but not yet any “carriers” (companies that operate their own trains with their own locomotives on the RZhD infrastructure)
Barriers/complications to “carriers”Continued cross-subsidy requirements for RZhD
trains“Common carrier” requirements – other countries
do not impose theseVery high track access charges
Thus RF pioneered its own form of vertical separation: “infrastructure” includes locomotivesKazakhstan, Ukraine have followed
What next? “Target Model of the Cargo Railway Transportation
Market till 2015”“Continuing integration of rail transport infrastructure and
transport activities until at least 2015”“Pilot projects aimed at creating private carriers based on
the principle ‘for route’ and ‘en route’ competition” – though RZhD resisting “en route” pilot
After 2015: Vertical separation?Sale of majority shares of Freight One to ITCEncouraging “further consolitation of rolling stock
operators and, in the future, the formation of three or four companies operating across the whole rail network in Russia.”
Note the careful language!“Operators”, not “carriers” It appears that RZhD has not committed to exiting the
locomotive business. Thus...
RZhD’s secret weapon: The Institute of Natural Monopolies Study 1. Detailed engineering/accounting cost analysis of a)
vertical separation and b) creation of 3 competing vertically integrated firms
Conclusions:A. Vertical separation would increase railways transports
costs by RUB 223 billion – about 1/3 – with small and uncertain benefits “Occurrence of the positive consequences has probabilistic
nature. Occurrence of the negative consequences is inevitable.”B. In fact, given these costs as well as additional
complexities of operation, vertical separation is “not feasible”.
C. Regarding vertically integrated firms, parallel competition is “impossible ... as there is only one shortest distance between two stations.”
D. For vertically integrated firms, geographic competition is feasible, but would increase costs by RUB 105 billion – over 15 percent – with small benefits
RZhD’s secret weapon: The Institute of Natural Monopolies Study (II) 2. Extensive review of the international economics literature on
vertical separation in railways – 25 “foreign studies” (Full disclosure: I was the author of 2 of the foreign studies and
the co-author of a 3rd.) Conclusions:
A. “There is no practical evidence that vertical separation increases the internal competition and the rail’s modal share in freight or passenger transport or enhances the productivity and efficiency of the rail transport.”
B. “The authors of the majority of studies assert that the efficiency of each structural model depends on conditions ... in each country.”
C. A large number of the studies focus on Western Europe. Russian railways are very different from Western European railways.
D. “For rail networks with high traffic density and a large share of freight trains [like the RF] the preferable solution is not to perform vertical separation.” Footnote: The authors do not seem to have noticed that the study they
rely on for this point uses an unusual measure of traffic density, under which density in the RF is below average: 48 train-km per route-km per day, in contrast to the sample average of 61.
Large railway networks
Country KM TrackFreight
ton-KM(M)
Passenger-
KM(M)
(Freight + Passenger)/
Track
KM Track/ Land Km2
(US lower 48)
Population (2010)/ Land
Km2 (US lower 48)
China 60,8092,511,80
4772,834 54,015,656 0.0063 139
India 63,327 521,371 769,956 20,391,413 0.01926 357
Russian Federation
84,1582,400,00
0175,800 30,606,716
0.0049(European
Russia .0138)18
USA 227,0582,788,23
09,935 12,323,569 0.0296 40
Sources: US Census, CIA World Factbook, World Bank
Responses to the Study 1. Literature review is accurate.
Vertical separation has not been shown to be important for competition or efficiency.
In any case, it is difficult to apply the experience of UK or Sweden to Russia. 2. But RZhD’s conclusion – “competition does not have a direct impact
on improving the efficiency of railways and should not be an end in itself” – does not follow.
3. The report underestimates the benefits of competition. Companies with different costs can compete quite fiercely.
Parallel railways in the US and Canada TSR with the all-water route from East Asia to Europe
The benefits of competition are not limited to shaving a few rubles off costs – competitors improve quality and come up with new products and services to capture business. US airline deregulation US rail deregulation
Also, competition may reduce, not increase, the requirements for regulation. The report is correct: Vertical separation creates increased complexity and
requirements of regulation. But competition among vertically integrated railways greatly reduces the need for
regulation. This is certainly the US experience.
So: Competition among vertically integrated railways in the RF? Why not? 3 is a good number (as in Mexico). One possibility is plan: “Geographic competition among 3
vertically integrated railways”, all moving in different directions from the Kuzbass
An alternative possibility: parallel competition based on the TSR and the BAM through the Kuzbass to Moscow, with geographic competition from a 3rd railway between Moscow and the Baltic Sea
Facts and figures: RF Railway Strategy 2030 calls for doubling capacity and tripling
traffic on the BAM, including plan for “strategically important” extension to Magadan. Why not direct, parallel competition between TSR and BAM?
Traffic density on the Russian railways much greater than US (in fact 2nd in the world to China). So economies of density likely exhausted.
86,000/3 = 29,000 km average track length. Not as big as BNSF or UP in US, but in the same range as NS, CSX, and CN, and larger than CP. (Average length of 7 US Class I railways is 33,000 km.) So economies of system size likely exhausted, or nearly so.
2121
Analysis of the Feasibility to Divide the Single Business Entity (Russian Railways JSC) into Several Vertically Integrated Companies (VICs) Competing among Themselves
Focused on the Kuzbass — Northwest flow, participates in forming and advancing the North — South flow in its service range. Competes with the Southern VIC when relocating the Centre — Volga Region — Ural Mountains flow, and probably competes for part of the Kuzbass — Centre flow.
Focused on the Kuzbass — Azov-Black Sea Traffic Centre and North — South flows, maintains the Centre — West flow, competes with the Northern VIC when relocating the Centre — Volga Region flows, and also probably for part of the Kuzbass — Centre flow.
Work distribution among VICs:
Southern VIC
Northern VIC
Focused on the work with the Kuzbass — Far East Traffic Centre cargo flow, forms and sends the Kuzbass — Northwest and Kuzbass — Azov-Black Sea Traffic Centre flows to the Northern and Southern VICs.
Each VIC services customers located in its region of activity and performs the domestic and international freight transportation with the use of its infrastructure.
Northern VIC
Northern VIC
Eastern VIC
Eastern VIC
An alternative plan, combining parallel competition with geographic competition