Open access rail operators: change ahead?

by Dentons
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Open access still has a low market share

ORR has calculated that open access operators run just 1% of passenger rail miles in the United Kingdom, the rest being worked under passenger rail franchises. No open access operator would target an unprofitable route, and it remains the case that many franchised services rely on government subsidy under a franchise agreement. But why isn't there more competition from open access operators for profitable routes, and might this change?

The current regulatory position

Entrusted as they are with statutory duties to approve access to rail infrastructure and set rail access charges, there are two key parts to ORR's existing regulatory approach to open access operators.

The first is that while the post privatization policy of protecting franchisees from competition (so called "moderation of competition") has long been abandoned, ORR still upholds a softer barrier to new open access. It applies a revenue generation test (the "not primarily abstractive test") in deciding whether to approve any new open access service. To pass the test, a new service must provide added passenger benefits on top of the benefits provided by those franchised services with which it will compete. The open access service must therefore grow overall revenue on the route, rather than merely abstracting the revenue of the incumbent franchisee. A benchmark ratio of 0.3:1 is applied, so the open access service must be found likely to produce new revenue of a least £0.30 for every £1 of franchisee revenue that it will abstract.

The impeding effect of this test is increased by the fact it is necessarily forward looking, and therefore bureaucratic to apply.

The second key part of ORR's approach to open access operators is to mandate a charging policy that only requires them to pay Network Rail's variable charges for short run costs. To that extent, they have a cost advantage over franchised operators who also pay Network Rail's fixed track access charge on top of the variable charges. The fixed charge is set at a level related to their forecast traffic levels at the start of their franchise agreement.

Possibilities for change have been looked at for some time

Against this background, market authorities have for some time been considering making open access operators pay more for access in return for easier access.

In its June 2013 consultation, for example, ORR stated that competition for passengers has several valuable effects. It drives lower fares, creates passenger growth and brings quality benefits. It also highlighted that open access operators score highly in Passenger Focus' National Passenger Survey, and sought opinions on ways to relax the not primarily abstractive test in return for a contribution to fixed costs.

Likewise, in their 2016 project on competition in passenger rail services in Great Britain, the Competition and Markets Authority ("CMA") looked at possible alternatives for increasing open access (although alongside other options for increasing competition). Their report stated that this would need to be accompanied by a more level playing field for all operators in terms of charges they pay towards network costs and socially valuable services.

Current ORR proposals

Thinking has continued to develop, and work is underway on formulating new approaches to open access operators.

Firstly, ORR is conducting a major review of track access charges as part of the PR18 consultation. Industry engagement is taking place, and a charges and incentives consultation document is due to be published in July 2017. In its preparatory paper on the matter in December 2016, ORR stated that its preferred alternatives for open access operators would include:

  • Making open access operators pay a contribution to long run or fixed costs as well as the variable charge;
  • Developing the approach to recovery of fixed costs from all passenger operators, including franchisee and open access operator. ORR would take advantage of the facility under the Railways (Access, Management and Licensing of Railway Undertakings) Regulations 2016 to:
    • introduce a "market can bear" test under which the fixed costs element of charges would not exceed of the ability of the operator to pay;
    • develop the approach to market segmentation allowing differing charges for different market segments, with the potential, for example, to distinguish between intercity and rural services or between peak and off-peak services;
  • Improving transparency of the patterns of long-run cost causation to improve the objectivity and transparency of fixed costs allocation; and
  • Reviewing whether it is still right to apply the not primarily abstractive test in approving or rejecting open access.

DfT consulting on a public service obligation levy

At the same time DfT is consulting on a new public service obligation levy. Pending Brexit this is permitted under Article 12 of Directive 2012/34/EU on "establishing a single European railway area". The levy is for helping to finance public service obligations in public service contracts (in this case, rail franchise agreements). The consultation says that introduction of the levy is likely to reduce government opposition to open access applications in future. It also states that the levy is intended to complement the track access charge changes that ORR intends to introduce. Although a government levy, ORR would be responsible for its calculation.

It is not DfT's plan to apply the levy where to do so would make a service uneconomic. Their consultation says that if ORR's proposed "market can bear" test were to judge that the operator concerned should not pay fixed track access costs, the operator would also not have to pay the levy.

The aim of the levy will be to ensure that where the open access operator can, it will make a contribution to socially and economically important, but unprofitable services. In the government's view, it would not be right to apply the levy to franchised operators as their franchises are competed, and it would render their services uneconomic. In addition, they already share profits under the franchise agreement. It also won't apply to international services.

The total value of the levy to government will be limited to the net cost it incurs in subsidising passenger services, whether those services are delivered under a premium paying franchise agreement or a subsidy receiving franchise agreement.

DfT have not decided how to configure the levy but the consultation mentions the following non-exhaustive list of possibilities:

  • A levy per passenger kilometre;
  • A levy in profit above a fair rate of return;
  • A percentage of profit above a fair rate of return; and
  • A percentage off revenue.

How the future looks

The gradually emerging picture is therefore of an adjusted market structure for passenger rail services. Track access charges for all operators will be determined by the market segment in which they work rather than whether they are open access or franchised. In return for this more level playing field, open access operators are likely to face lower regulatory hurdles to gaining access rights. But it will be far from a free wheeling market that emerges because ORR will remain obliged to approve new open access services, and be mindful of franchised services in balancing its statutory duties. Even if the not primarily abstractive test is altered, it seems likely that some measure of favoring access rights for franchised services will continue. It is notable that DfT state that even after the changes, the "stability" of the franchised market should be preserved and that open access should not be "simply replicating services already provided by franchises…".

Market appetite would need to be considered

It's notable that open access operators responding to the CMA's consultation on competition in the rail passenger market said they would be happy to pay a levy in return for greater access to the network. The potential impact on the franchising market would, on the other hand, also need to be considered. The CMA have highlighted it may increase doubt for those bidding for franchises. This might have an impact on franchise bids or even willingness to bid.

Conclusion

There is still much to play for, with further consultations expected from both ORR and DfT later this year before any final decisions are made. Watch this space.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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