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Time to be realistic about railway privatisation

01 Sep 2006

To keep up with increasing competition from road and air transport, and to remain a relevant mode, most railways need to improve efficiency and substantially increase their capital investment. Privatisation is often proposed as the solution, but David Burns suggests that it is not that simple

OVER THE PAST 15 to 20 years, the world has seen a wave of railway restructuring, concessioning and privatisation. Sometimes it has been politically-inspired for reasons of dogma or economic necessity.

Privatisation is often hailed as the best way in which railways can be 'freed' from the constraints of state ownership, to harness the investment, innovation and entrepreneurial spirit which the private sector can inject into what is often seen as a dying organisation.

The results of these transformations have been mixed, to put it mildly. Some railways have indeed seen entrepreneurial talent keen to make a go of even the most unpromising opportunities. Elsewhere, new entrants have launched on-rail competition, winning traffic from other modes but undercutting existing operators and reducing the overall profitability of the rail sector. Operations, maintenance and renewals costs have trended up, rather than down, and many commitments to boost investment have either been scaled back or have not materialised at all.

So what lessons can we draw from this experience, and how can we apply them? Why does privatisation work in some cases and not in others?

Transport economics

Good transport is an economic necessity for any country. But from the perspective of capital investment by the government, modes such as road and air are much more cost-effective than a state-owned railway, because the taxpayer only has to supply a limited part of the total investment. So governments usually build and maintain roads and airports, leaving private enterprise to invest in and operate the lorries, buses, and planes.

When a mismanaged trucking company or airline goes out of business, there are usually several other companies ready to take its place, because they think they can do a better job. In reality, this may not be the case. If all the profits and losses reported by US airlines since the beginning of commercial aviation are added together, overall this 'private' industry has lost money, but the skies are still full of planes.

In an era when railways were the primary mode of mechanised transport, many lines were promoted and built by venture capitalists and many were very profitable - although others were not, and the investors lost their money. With the advent of road competition, railway profitability declined and so did the condition of the assets. Most private railways were nationalised in the 20th century for political reasons or to save them from eventual extinction.

Despite the repeated arguments about energy use, environmental impact and external costs, the reality is that main line railways throughout the world have to contend with steadily increasing competition. Lorries are getting larger and more energy-efficient, whilst passenger trains must face up to ever-increasing numbers of private cars and now the low-cost budget airlines.

As the other modes have developed, the railways have lost market share. Today few of the world's railways handle a significant proportion of their nation's traffic. In fewer than 30% of the countries with railways do they handle more than 20% of freight tonne-km, while only in 10% of the countries do the railways have more than a 10% share of the inter-city passenger travel market.

Part of the reason for this decline is that governments have effectively failed to regulate and tax the other modes on an equitable basis. Now it is probably too late - it is especially difficult to regulate retroactively, and much of the global economy has been shaped over the past 40 to 50 years by this imbalanced pricing of transport.

Take Japan as an example. The Japanese railways are envied for their 28% market share in terms of passenger-km. But this is achieved partly by the imposition of very high fuel taxes, very expensive toll roads, a vehicle inspection programme that essentially scraps any car more than 12 years old, and a requirement that every car registered in an urban area must have an off-street parking space. Try introducing such legislation in London, New York or Paris: Mission Impossible!

Maintenance and renewal costs

Railways are expensive to maintain. At typical revenue rates for road-competitive transport, an annual traffic of at least 1·5 million net tonnes per route-km is required just to keep an existing line open and maintained for the long term. If the line has deferred maintenance or needs upgrading, the annual traffic level would have to be greater, perhaps as much as the 5million to 10million tonnes per km needed to justify and support the construction of a new line.

On many railways, improved technology and changing travel and freight patterns have left the business with excess staff and surplus infrastructure. For publicly-owned railways it is very difficult to grasp the problem of labour and route reductions, and often it is only when the subsidy requirements start making a significant impact on the national budget that governments face up to the need for restructuring.

A large proportion of the world's railways have failed to keep up with the developing technology of their competitors. A recent study (p529) concluded that for a railway to have a long-term future it needs to have at least one of the following characteristics:

  • be part of a large network offering very long hauls;
  • be capable of handling heavy axle loads, to reduce the unit cost of transport; or
  • be capable of highway-competitive speeds.



Without substantial government support, the long-term survival of a railway that does not meet these criteria must be considered doubtful. In short, many railways today need an operating subsidy, restructuring, and substantial capital investment if they are to offer a viable transport mode in the future.

In some circles the current thinking is that privatisation is the answer, either for generating the investment or in removing the drain on public finances. One Balkan government official was probably closer to this second view when he commented recently 'the railway is a cancer on the government, privatisation will give the health issue to somebody else!'

The privatisation process

Forms of privatisation tried in the past two decades range from small-scale involvement to complex types of concessions for large railway businesses. At the simple end are the outsourcing of maintenance of track and rolling stock, or secondary services, such as catering or telecommunications, and the provision of locomotives and rolling stock through operating or capital leases.

The next step might be to permit third-party operators to supply complete trains for the railway to crew, or even to allow the third-party company to run their train for a track usage charge.

Alternatively, the government could sell off or concession all of the train operations whilst retaining control of the infrastructure and in some cases the signalling and train regulation functions.

A more drastic approach is for the entire railway operations and infrastructure to be concessioned or leased, either for a minimum level of subsidy or for the payment of a premium to the government by the concessionaire for the right to operate the network. There have even been a few cases where there has been an outright sale of the entire railway, but even then, in many cases, the government has retained partial ownership.

The government usually arranges for expensive consultants and lawyers, none of whom have much, if any, railway experience to draw up the privatisation documentation. The consultants' terms of reference are limited to the rail mode, and usually fail to consider the railway's role in current and future national transport requirements. The whole 19th century railway network is considered to be a valuable asset and becomes part of the concession.

Sometimes the concession terms include a requirement for capital investment, especially if low-interest development bank money is available. For political reasons, or because they think the answer is to make the railway operate like a road, some governments demand open access for other companies.

The railway is usually concessioned, occasionally leased, but seldom sold outright. Some governments even choose to retain ownership of all rolling stock, irrespective of its age and condition. There are agreements that require the return of locomotives that are already 30 years old and 40-year old wagons at the end of a 30-year concession!

In general terms, however, it is usually up to the government to confront the worst of the over-staffing issues since no private bidder could consider the cost implications of taking over a labour force that may be 80% higher than necessary. However, because of the political ramifications, governments tend to be reluctant to reduce the staffing levels right down to the optimum level.

Built-in problems

Unfortunately, the majority of railway privatisations undertaken so far have been fraught with difficulties. Even some of the simplest concepts, such as outsourcing, can bring major problems. The industry has seen many examples of maintenance having been outsourced and then brought back in-house, usually because of quality issues. On one railway, the outsourced catering service was so bad that it was affecting ridership, so the operator had to cancel the contract.

As mentioned earlier, the railway's role in the wider transport spectrum is hardly ever considered. Seldom is the rail mode considered as part of a national or international transport network. In fact, very few countries have effective state co-ordination of the different modes.

The bidding documents are usually designed to solve the immediate 'problem' of getting the railway off the government's books, requiring a commitment to improving services and a list of planned investments to be made by the concessionaire or buyer.

The bidders are asked to make a financial commitment based on a long-term (sometimes up to 30 years) forecast of revenue which can be, at best, an educated guess. In addition, the true condition of the railway assets is very difficult to determine. On one Brazilian concession, a team of 11 engineers spent a month looking at the railway in detail, but in the auction they were outbid by a venture capitalist who spent just one day looking at the actual railway! He, of course, had other objectives which became apparent later.

In many cases the assets are obsolete or aging, and there is a lack of traffic. Whilst few railways still rely on steam traction, how can a railway with 10 to 15 tonne axleloads realistically compete in the long term with lorries weighing up to 56 tonnes, or interchange effectively with another railway that has upgraded to 25 tonne axleloads? On the passenger side, how can one or two trains a day compete with a bus service that runs every 30 min?

Generally speaking, the provision of adequate funding for the railway is never a government priority. If privatisation is being considered, there is even the prospect that annual funding can be eliminated. So the concessionaire or buyer is likely to be acquiring a railway, at best, that is out-of-date, under-funded and, at worst, is marginally usable or even closed.

Much has been written about the UK railway privatisation fiasco. British Rail was essentially privatised for political reasons by people who had little knowledge about the practical aspects of owning and operating a railway. To make matters worse, in the years leading up to privatisation there had been a run-down in investment which resulted in a decline in infrastructure condition, whilst the hiatus in rolling stock orders triggered the demise of much of the domestic railway supply industry.

Commitments revisited

Once they have been selected, or even better when they are operating, the private companies have leverage to re-open negotiations on their concession agreements. With few exceptions, concessioned railways have all re-opened negotiations with their governments. Some concessions were cancelled, and, in at least one case, the situation was such that the government itself insisted on re-opening negotiations.

To have access to significant private-sector capital, a privatised railway must have sufficient value to be leveraged against. A quick survey suggests that almost none of the concessionaires are companies with substantial capital resources, and those that do have the money usually do not use it to invest in the railway.

All private companies entering the railway business are interested in making a profit, and usually the quicker the better. This is most easily done by buying, creating an impression of 'value' and selling on - look at the successful management buy-outs in the British privatisation, or that venture capitalist in Brazil. Another approach is to earn contracting profits from rebuilding the railway - using other people's money if possible!

As a result, a large proportion of the concessions have changed hands within a few years. A slower approach to earning 'profits' is by using up any residual value of the railway assets and then 'handing' the depleted business back to the government.

Just occasionally the government concessions or sells a railway that turns out to be a real moneyspinner, and there is the temptation to try and get it back. The government changes and so can the law. One of the most successful privatisations has been Estonian Railways, but the owners are now facing problems because the current regime is trying to renationalise their revitalised business.

In theory, any failure in a free market environment results in a company going out of business. But in the case of a railway it is seldom that a government can afford to let it happen. Shippers usually are slow to complain and passengers do not put pressure on the government until the situation is very bad. We saw this in the USA back in the 1970s when Penn Central failed and was rescued by the government-funded Conrail. More recently we have seen franchises rescued in the UK, or the infrastructure bought back in New Zealand.

Complex accounting

Railway accounting is very complex. By manipulating various accounts and expenditures in the short term, the railway can show almost any financial result it chooses. To make matters worse, unless there is a government requirement, traffic and financial data do not have to be published - especially if the concessionaire is not a publicly-traded company or is part of a conglomerate. Even where the data are published, it requires extensive knowledge of railways to really understand what the balance sheet and income statement are indicating.

Within a railway there are many opportunities to make one department's budget look good at the expense of another. This can be a major problem for a vertically-separated railway. As an example, the train operator has no incentive to maintain wheel profiles or prevent overloading, other than within safety limits. If the wagon wheels and excess axleloads wear out the track faster, it is the infrastructure manager that picks up the cost. Such issues can distort significantly what is happening within the railway as a system.

For some privatisations, the governments have committed to make grants, provide subsidies, or pay for a public service obligation contract. Given that money is fungible, it is very difficult to trace whether these sums have been used for the purpose intended. One of the financial manoeuvrings that led to the downfall of Railtrack in the UK was its need to borrow large amounts of money on the commercial markets. To obtain low interest rates, the company needed to show it was profitable. So government subsidy that should have gone into infrastructure renewals was used to pay shareholder dividends.

Another problem is that the government grant or subsidy, if there is one, is usually a budget allocation, and as such can easily be reduced, delayed or even eliminated.

Concession or premium payments to government often show no relation to logic other than the amount that the bidder considers necessary to win the contest. Some concessionaires are paying millions of dollars to the government for the rights to run railways where the replacement of a single bridge, or even a locomotive, would require more than the entire annual revenue.

Elsewhere, concessionaires are required to pay annual charges of 5% to 10% of their gross revenue, which is almost certainly more than their profit margin. On a busy line, this can reach a significant amount; many years ago the Illinois Central even built a parallel route to get out of a similar obligation.

One of the fundamental problems is how to invest in the railway, and who should do it? In most cases the governments seem to think that after privatisation the private company will invest heavily, using its own money. But there have been few, if any, instances of this. When questioned about capital investments made after taking over a railway, one South American concessionaire indicated that it had purchased a few desktop computers, some hand-held radios, and a few thousand sleepers!

One of the best assets to leverage investment funding is property, but an outright sale of a railway is unusual if land is involved. Few governments are willing to give up what many consider a national asset, especially where the fixed property value is greater than the value of the railway as a going concern. In the UK, 'surplus' railway property was retained by the government through the residual BR Property Board, and an early priority for Railtrack was to identify more 'non-operational' land that it could use for investment.

Another key to the success of privatisation of any utility, and especially a railway, is that there has to be an informed and honest regulator. Some privatisations have taken place without even the creation of such a position. Elsewhere there have been regulators appointed who know nothing about railways - perhaps the relative of a politician, or even worse of a senior railway official.

Taking a realistic approach

Any government considering the transfer of its railway into the private sector needs to have a comprehensive long-term strategy, which defines the expected role of all modes of freight and passenger transport.

It should not be that difficult to develop, as there is sufficient comparative data available to make a long-term forecast of the expected future freight and passenger traffic in all but the most unusual circumstances. From this it can be determined what the role of the railway should be. The plan should consider environmental issues and the government's ability to tax and regulate so that all modes are treated equally.

Based on this vision of the railway's role, an investment plan can be developed that determines what is needed to catch up on deferred maintenance and what will be required to develop the railway to meet the needs of the future.

It is unlikely that the railway's revenue will come close to generating funds for this development work - at least not in the short term. So the question becomes can the government fund the difference? If it cannot, then it must be recognised that privatisation can only be a delaying tactic that postpones the railway's inevitable demise, or transfers responsibility away from the politicians.

In almost all cases, some form of subsidy mechanism is a necessity. With the possible exception of few heavy-haul railways or major inter-city passenger routes, all railways have to be subsidised. The much-vaunted North American private railways already receive various subsidies; several of their recent infrastructure capital investment projects are receiving up to 80% in federal support. Even the most profitable Japanese railways have to depend on local and central government grants to support their infrastructure investments.

Keeping the track under state ownership and charging private operators a usage fee may sound simple to apply, but it raises many complex problems. If on-rail competition is considered a necessity, then the most efficient way to integrate track and train is for the majority user to control the network and for other companies to negotiate operating rights, backed up by an independent negotiator if necessary.

Governments need to recognise that in almost all cases the privatised railways will still require state funding, either through general support, specific investment grants, or some form of public service contract payment for performing a specific obligation. This funding will need to come from a form of taxation that is not subject to an annual budget allocation.

Unfortunately, there is no easy way to ensure that the process can be fair and transparent, and that the money will go for the intended proposes. The key is to put in place a supervisory body that has practical railway knowledge, authority and a high degree of honesty. For this to be the case the regulator's team must be very well-paid, and they have to be as smart as or smarter than the railway's management.

Secure foundations

In summary, any railway, be it state-owned or private, needs to invest in keeping its assets in good condition and up to date. This is essential if it is to be competitive with other modes, attracting secure traffic flows that can generate enough income to fund future investment cycles. Without those basics in place, no railway can be secure.

Privatisation is by no means the panacea that many governments and various lobbying organisations seem to think it will be. Simply transferring ownership without addressing the fundamentals cannot be expected to succeed.

A national transport strategy that defines the role of the railway is vital. And in most cases the government is going to have to continue investing in or subsidising the railway. The privatisation process will be complex, especially if the railway is broken up into separate entities. It will require people with extensive railway expertise, a few transport economists, and the fewer lawyers the better.

And even with all these elements in place, the chance of a successful privatisation is still only a resounding 'maybe!'

Il est temps d'être réaliste à propos de la privatisation du chemin de fer

Pour faire face à la concurrence croissante de la route et du transport aérien, beaucoup de chemins de fer ont besoin d'améliorer leur efficacité et d'augmenter leur investissement en capital. La privatisation est souvent proposée comme la solution, mais David Burns affirme que ce n'est pas aussi simple. L'expérience a montré que la méthode de privatisation choisie s'est souvent révélée irréalisable, avec des co–ts croissants et des concessions renégociées. N'importe quel chemin de fer, qu'il soit propriété d'état ou privé, a besoin d'engranger suffisamment de recettes pour financer le renouvellement régulier de ses actifs, et, on ne peut pas s'attendre au succès en réalisant simplement un transfer de propriété sans examiner les éléments fondamentaux


Zeit, um über Bahnprivatisierungen realistisch zu werden

Um gegenüber der zunehmenden Konkurrenz durch Strasse und Luftfahrt zu bestehen müssen viele Bahnen ihre Effizienz verbessern und ihren Kapitaleinsatz steigern. Privatisierung ist eine häufig vorgebrachte Lösungsmöglichkeit, aber David Burns zeigt, dass es nicht ganz so einfach ist. Erfahrung hat gezeigt, dass die gewählte Privatisierungsmethode oft nicht funktioniert hat, und die Kosten gestiegen sind und die Konzessionen neu verhandelt werden mussten. Jede Bahn, egal ob staatlich oder privat, muss ausreichend Einnahmen generieren, um die regelmässige Erneuerung ihrer Aktiven zu finanzieren. Ein simples Umlagern der Besitzverhältnisse ohne Berücksichtigung dieser fundamentalen Belange wird nicht zum Erfolg führen


Hora de ser realistas sobre las privatizaciones ferroviarias

Para poder enfrentarse a una mayor competencia del transporte por carretera y avión, muchas redes ferroviarias necesitan mejorar su eficiencia e incrementar su inversión en capital. A menudo se propone la privatización como la solución, pero David Burns sugiere que esta solución no es tan sencilla. La experiencia demuestra que el método de privatización elegido no suele ser el m s idóneo y que al no funcionar como se esperaba, se ha incurrido con frecuencia en un incremento de los costes y en una renegociación de las concesiones. Cualquier ferrocarril debe ganar lo suficiente como para financiar la renovación regular de sus activos. No se puede esperar que la simple transferencia de propiedad sin resolver los hechos fundamentales sea la panacea


References



1. Bullock R. Results of Railway Privatisation in Africa. World Bank report, September 2005

2. Williams R, Greig D and Wallis I. Results of Railway Privatisation in Australia and New Zealand. World Bank report, September 2005

3. Sharp R. Results of Railway Privatisation in Latin America. World Bank report, September 2005

4. Best practices for private-sector investment in railways. TERA International Group report for the Asian Development Bank, March 2006

5. Van der Meulen R D and Möller L C. Leveraging insight from developed into developing regions. World Congress on Railway Research, Montréal, June 2006.

Picture caption: TOP: Privatisation has already started to revitalise the Nacala corridor between Malawi and Mozambique, and the prospect of heavy-haul export coal traffic may secure the line's long-term future Photo:Henry Posner III

Picture caption: Although the Slovakian government had started the process of privatising state-owned freight operator ZSSK Cargo and shortlisted potential purchasers,the process was abandoned earlier this year following a change of administration after a general election
Photo: Quintus Vosman

Picture caption: On certain French inter-city corridors the train has 35% of the overall passenger business, but rail's share of the national passenger market is only about 9·6%. This means that on many routes the train has only 2% or 3% of the market. Under such conditions it is not possible to provide road-competitive services without some form of subsidy Photo:SNCF

Picture caption: Yield management is making the low-cost airlines and inter-city coach operators into formidable competitors for the passenger railway, and these will have a significant impact on the money-making inter-city services that are still cross-subsidising rural routes

Picture caption: As roads are improved isolated railways with run-down infrastructure will not be able to compete unless there is 5 to 10 tonnes of traffic per km or major investment from the government to fund rehabilitation work

Picture caption: Bidders for a railway concession do not always find it easy to determine the true condition of the assets, particularly if there has been a long period of neglect before the start of the sale Photo: Henry Posner III

Picture caption: Splitting a railway to leave the infrastructure in state ownership and privatise the train operations sounds simple, but raises many issues of complexity which are currently being debated in Germany (p539)

Picture caption: West Japan Railway is currently developing a major office and shopping complex over its principal station at Osaka, and other Japanese railways have completed similar projects to increase their non-railway revenues. But in many cases, the government strips out assets such as real estate in order to finance the privatisation process