Transcript Slide 1

What Next for Russian Railways
Restructuring?
Russell Pittman
New Economic School and Antitrust Division, U.S.
Department of Justice
Leontief Centre
27 September 2013
The views expressed are not purported to reflect the views of the U.S. Department of Justice.
How to handle “natural monopolies”: The
restructuring debate
SECTOR
Electricity
NETWORK:
MONOPOLY?
Long
Long
distance
distance
transmission pipelines
lines, local
distribution
lines
COMPETITIVE? Generation:
natural gas,
coal, hydro,
nuclear
Natural gas Telecoms
Local “loop”
– fixed wire
service to
households
and
businesses
Exploration Long
and
distance,
production mobile,
internet
Railways
Track
and
signalling
Trains
But competitive elements cohabit
uneasily with monopoly networks…
 How restructure the overall sector?
 US telecommunications sector
 First, 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 separation
 AT&T forced to give up local service in order to insure fair
competition in long distance
The options
 Vertical separation
 Favorite of the World Bank, EU
 3rd party access
 (Grudging) favorite of incumbents
 “Horizontal separation”: competition among vertically
integrated firms
 Competition where networks intersect
 The old status quo: Regulation of vertically integrated
monopoly
 Was it really so bad, compared to the costs of restructuring?
How to restructure a vertically
integrated monopoly railway?
 Economists’ (and EU) favorite: Vertical Separation
 One track owner, many “train operating companies” (TOC’s)
 UK, Sweden, Netherlands, Poland, Romania, parts of Australia
 Removes incentives to discriminate in providing access to
infrastructure
 Railways’ (grudging) favorite: 3rd Party Access
 Track owner is one of the many TOC’s
 Germany, Austria, Italy, Chile, parts of Australia
 Maintains 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
constraints
 Small 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 countries
 Attract private investment? Usually for poor and middle-
income countries
 In 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 vary
 Early econometric estimates of 20-40% likely too high
 Most recent results: more important in a) densely operated and b) freight-
dominant systems
 Economies of scale: density
 Probably exhausted for most densely operated systems
 Economies of scale: system size
 Certainly exhausted for largest systems
 One takeaway from this combination: For largest systems, horizontal
separation may dominate vertical separation (Savignat and Nash, 1999)
 Access pricing issues
 Especially, 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 companies
 But INDEPENDENT train operating companies?
Current state of reforms
 In 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
these
 Very high track access charges
 Thus RF pioneered its own form of vertical separation:
“infrastructure” includes locomotives
 Kazakhstan, 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 ITC
 Encouraging “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 routekm per day, in contrast to the sample average of 61.
Large railway networks
Freight Passengerton-KM(M) KM(M)
(Freight +
Passenger)/
Track
KM Track/ Population
Land Km2 (2010)/ Land
(US lower
Km2 (US
48)
lower 48)
Country
KM Track
China
60,809
2,511,804
772,834
54,015,656
0.0063
139
India
63,327
521,371
769,956
20,391,413
0.01926
357
18
40
Russian
Federation
84,158
2,400,000
175,800
30,606,716
0.0049
(European
Russia .0138)
USA
227,058
2,788,230
9,935
12,323,569
0.0296
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.
Analysis of the Feasibility to Divide the Single Business Entity (Russian Railways JSC) into Several Vertically
Integrated Companies (VICs) Competing among Themselves
Work distribution among VICs:
Northern VIC
Northern VIC
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.
Northern VIC
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.
Southern VIC
Eastern VIC
Focused on the work with the Kuzbass — Far East Traffic Centre cargo
flow, forms and sends the Kuzbass — Northwest and Kuzbass — AzovBlack Sea Traffic Centre flows to the Northern and Southern VICs.
Eastern VIC
Each
21 VIC services customers located in its region of activity and performs the domestic and international freight
transportation with the use of its infrastructure.
21
An alternative plan, combining parallel
competition with geographic competition