Railway concessions - Heading down the right track in Argentina

Privatesector P U B L I C P O L I C Y F O R T H E The World Bank Group September 1996 Note No. 88 Railway Concessions—Heading Down the Right Track in Argentina José Carbajo and Argentina privatized many of its railway services by concession contract during the early 1990s. Antonio Estache The reforms have been remarkable for their speed and innovation—despite the complexity of the issues and the lack of “off-the-shelf” models to follow at the time. The overall result has been positive. Many services have improved. Traffic has grown—up about 180 million passenger trips a year. Subsidies have been cut dramatically—down from US$2 billion or so a year to a little more than US$100 million. But as with any complex reform, there is an unfinished agenda. And with the Argentine approach becoming a model for other countries in Latin America, this review of the lessons starting to emerge from the reform experience is a timely one. Strategy for reform RAIL CONCESSIONS—EARLY IMPACT When the Menem administration set the rail- way reform in motion in 1990, Ferrocarriles (percentage increase) Argentinos, the largest operator, ran a national network of about 35,000 kilometers, employed Freight volume, major lines, 1990–95 92,000 people, and was losing about US$1.4 bil- lion a year (1992 dollars). These losses were a Nuevo Central Argentino 40% big drain on the Treasury and the main motiva- Ferrocarril Mesopotámico 50% tion for reform. On top of this, the fixed assets Buenos Aires al Pacífico 92% were in poor shape—in 1990, 54 percent of the Ferroexpreso Pampeano 130% track network was in fair or bad condition, and Ferrosur Roca 160% only half the locomotives were available for service. As a result, the operator was losing traffic and market share. Passengers carried, 1993–95 The reform strategy the government adopted SUBTE (subway) 28% was to break up the network into monopoly Urquiza 36% franchises that combine track and service op- San Martin 64% erations—identifying the profitable and unprof- Belgrano Sur 69% itable segments in the freight and passenger Mitre 74% markets, awarding concessions to the private sector through competitive bidding, and trans- Roca 83% ferring a sizable network to the provinces. This Belgrano Norte 408% single-operator strategy means that competi- tion will arise not from several operators using Source: Comisión Nacional de Transporte Ferroviario. the same track but from several potential op- Private Sector Development Department ▪ Vice Presidency for Finance and Private Sector Development Railway Concessions—Heading Down the Right Track in Argentina erators bidding for the exclusive right to pro- faced a complicated set of weights attached to vide a service during the life of a concession. the criteria used to select the winning bid— experience, investment plan, employment The freight network pledge, local investor participation, fees and rent, the access toll. The method for the com- The freight network was partitioned into six muter concessions was more transparent, and vertically integrated concessions, each for thirty probably induced more rational bidding be- years with an optional ten-year extension. Con- havior from potential concessionaires (see be- cessionaires are responsible for all operations low). In the end, the subsidy requested by the and maintenance and for the investment pro- winning consortiums amounted to slightly more gram proposed in their bidding documents. than US$1 billion (1992 dollars), spread over Each concessionaire is free to introduce new twelve years—most of it for capital investment working rules and practices. Because the fixed and system upgrading, not operations. assets remain the property of the government, private operators must pay the state a fee for The intercity passenger services the use of the rail infrastructure and rent for the use of the rolling stock. Operators can of- Viability studies of the intercity passenger ser- fer intercity passenger service, but must allow vices concluded that only one corridor, Buenos other passenger operators access to the track Aires–Mar del Plata, was commercially profit- in exchange for a toll. Freight tariffs have been able. Low traffic levels prompted the govern- deregulated, but operators must file maximum ment to decide not to subsidize any of them. rates with the regulator for approval. Instead, the government offered the provinces the option to continue providing the services at The commuter network their own expense. Most provinces rejected this offer, so the routes were closed. Provinces that The government identified seven suburban rail- accepted the offer entered into concession agree- way services for privatization. The concession ments with the state, which transferred to them terms were set for ten years (twenty for the the rolling stock and other equipment neces- metro, or SUBTE, of Buenos Aires), and the sary to run the services. The provinces agreed model of concessioning was similar to that for to subsidize the services and run them over the the freight network, though it differed in two network concessioned to the freight and com- important respects. First, while freight conces- muter rail operators, paying a fee to these op- sionaires were expected to make a profit, it erators for access to and use of the track. was accepted that suburban rail might need public subsidies for operation, rehabilitation, Impact and investment. The government identified for each line the type and amount of investments With only about three years having elapsed needed, which the private operator was ex- since the awarding of concessions, it is still pected to undertake. The regulator would set too early to tell how much more successful the the maximum fares—with automatic increases new operators have been. And concessionaires for rising quality of service. Concessionaires have been hampered by the unexpectedly poor would also pay a nominal fee to the govern- state of the assets on transfer—maintenance ment for the use of the rail infrastructure. and inventory seem to have been neglected during the final months of public ownership. Second, concessions were awarded on the ba- But some preliminary conclusions can be sis of a single criterion: the lowest subsidy re- reached. Excluding SUBTE, the commuter rail- quired to operate the line and undertake the way concessions show on average a healthy specified investment and rehabilitation pro- 75 percent increase in passenger traffic. Car gram. Bidders for the freight concessions had kilometers increased only 25 percent, pointing to more effective use of capacity. The SUBTE Competition for the market has experienced 28 percent passenger growth— perhaps in part because of worsening road con- How well has competition for the market worked? gestion, but also in response to improved It is difficult to tell with precision. There were so customer service, security, and safety, particu- few bids for the freight concession, for example, larly at stations. Growth in revenue-passengers that it is reasonable to wonder whether the full carried also has been impressive, in large part benefits of competition have been realized. The because of the measures against fare evasion answer is obscured in part by the flawed scoring that all private operators adopted. system in this early bidding process. Neverthe- less, government subsidies for railways have been Traffic has also grown in freight services, but significantly reduced, through increased labor the private operators are reaching on average productivity and cutting services. The reduction only 60 to 70 percent of their projected traffic. in employment on the services previously oper- Some estimates put revenues as low as 50 to ated by Ferrocarriles Argentinos is particularly 60 percent of projections. Part of the expla- dramatic—from 92,500 in 1989 to about 17,000 nation for this is stronger-than-expected com- now. (The government went to considerable ef- petition from trucks. But another part is fort to ensure that severance pay would ease the overoptimistic demand projections—the bid- layoffs.) No more than half the labor savings were ding process prompted concessionaires to make achieved by cutting services. The most signifi- unrealistic projections and investment prom- cant cuts were in intercity passenger services, ises to help them win concessions. The conse- where the number of train kilometers operated quence is that freight concessionaires have not fell by about three-quarters and the number of been fulfilling their investment promises, which passengers by perhaps two-thirds. amount to about US$1.2 billion over fifteen years. For now, the regulatory agency that over- Flexible contracts sees the freight concessions is filing the requi- site penalties, but has problems enforcing both The many freight concessionaires reportedly not the payment of the penalties and the invest- meeting their investment promises are essentially ments. Most suburban rail operators also are disinvesting in the network, failing to maintain falling short of projected demand—by about lightly used lines. This presents the government 30 percent—again in part because of overly with the following dilemma: If it enforces the optimistic demand projections but also because letter of the contracts, making the concession- of competition from bus services. aires undertake the promised investments, they may go out of business, ceasing service. If in- Lessons stead the government does not enforce the con- tracts, it loses credibility, sets a precedent, and One objective for privatization was to mini- incurs a reputation cost. And even if the conces- mize or eliminate the fiscal drain from the rail- sionaires could afford to comply with their con- way deficits, reducing subsidies to the minimum tracts, making them undertake investments that possible level by inducing the private sector to might be commercially unnecessary is question- take over the profitable segments of the freight able from an economic perspective. What is market and to take over the commuter railway needed is a mechanism for flexible yet fair rene- lines in exchange for the lowest minimum sub- gotiation of concession contracts. sidy. Enough bidders competing for the right to operate the monopoly concessions would Challenges ahead ensure that any subsidies would be kept to a minimum. Private sector control of operations As can be expected from a complex and chal- and maintenance was expected to improve ef- lenging exercise, the railway privatization still ficiency and service quality. has an unfinished agenda. An overall regula-  Railway Concessions—Heading Down the Right Track in Argentina tory structure must be put in place, and a con- If revisions are to be considered, they must be tractual strategy needs to be devised for deal- based on clear, agreed, preestablished criteria. ing with concessionaires’ noncompliance with Such criteria could include: How would over- their concession agreements. all efficiency be affected? Would investor and consumer interests be protected? To adjudicate The single-operator strategy shifts the burden disputes, one procedural option is to rely on of preserving effective competition to the con- normal commercial contract law and the in- tract and to the regulator. Once the concession- centives and opportunities it creates for the vol- aire is selected, a specialized regulatory agency untary renegotiation of contracts that no longer becomes responsible for any final contract ne- serve the interests of either party. But courts gotiations, for contract enforcement, and in some tend to be better at enforcement than at rene- cases for other regulatory functions. This sys- gotiation. Another option is to establish a spe- tem appears to work reasonably well, with three cial commission to arbitrate contract disputes qualifications. The first, and most easily cor- using clear and fair rules. The challenge is to rected, is that broad grants of discretionary regu- find such rules. One possibility is a rule that, latory authority to guard against monopoly in the event of a negotiating impasse, requires abuse, such as that enjoyed by the freight rail the arbitrator to choose one of the two parties’ regulator, are probably unnecessary and unwise. best and final offers, without modifications. Al- The regulatory commissions should focus on en- lowing no modifications would give both par- The Note series is an forcing and monitoring contracts and not be ties (the government and the concessionaire) open forum intended to encourage dissemina- distracted by issues of monopoly. Most of the strong incentives to be reasonable and to rec- tion of and debate on modes already face strong competition. The ognize each other’s legitimate interests. This ideas, innovations, and freight railroads, for example, compete fiercely system has been used successfully with labor best practices for expanding the private with trucks and with one another. contracts in the United States. sector. The views published are those of The second problem, at least as important but A final, related concern is the proliferation of the authors and should not be attributed to the far more difficult to solve, is how to cope with regulatory commissions. There is now one for World Bank or any of its the need to periodically renegotiate or modify each transport concession program. If arbitra- affiliated organizations. the concession contracts. Renegotiation or modi- tion commissions are to be used in addition, Nor do any of the con- clusions represent fication may seem antithetical to the whole idea they should be independent from the enforce- official policy of the of concession contracting: the contract system ment commissions; otherwise, the arbitrator World Bank or of its is meant to protect both the public and the con- would also be one of the disputing parties to Executive Directors or the countries they cessionaire by specifying all the terms of the the contract. But some of these commissions represent. concession in advance. The prospect of rene- could handle several sectors. Argentina does gotiation could undermine potential concession- not need a large number of enforcement or To order additional copies please call the aires’ incentives to bid honestly and open the arbitration commissions. FPD Note line to leave a door to political interference. But Argentina’s message (202-458-1111) transport concessions showed that it is prob- or contact Suzanne For more on this topic, see Ron Kopicki and Louis Thompson, “Best Smith, editor, Room ably impossible to specify all the conditions in Methods of Railway Restructuring and Privatization,” CFS Discussion G8105, The World Bank, advance, especially in an economic environment Paper 111, World Bank, Washington, D.C., 1995; Antonio Estache, F. 1818 H Street, NW, Helou, and Martin Rodriguez-Pardina, “A Portable Description of changing as rapidly as Argentina’s. So the con- Argentina’s Transport Privatization and Regulation,” World Bank, Latin Washington, D.C. 20433, or Internet address tracts must be seen as living documents. Even America and the Caribbean, Country Department I, Washington, D.C., ssmith7@worldbank.org. carefully drawn contracts may become obso- 1995; and World Bank, “Argentina, Transport Privatization and Regu- Previous issues are also lation: The Next Wave of Challenges,” Report 14469-AR, Washington, lete because the world changes quickly and in D.C., 1996. available on-line (http:// www.worldbank.org/ unexpected ways. Part of the problem may be html/fpd/notes/ that the rail concession contracts were poorly notelist.html). José Carbajo, Private Consultant, and Antonio drawn. But in many ways the obsolescence of Estache, Latin America and the Caribbean, 9 Printed on recycled the contracts stems from the success of the eco- Country Department I (aestache@worldbank.org) paper. nomic reforms in Argentina.