Argentina - Transport privatization and regulation : the next wave of challenges

Report No. 14469-AR Argentina Transport Privatization and Regulation: The Next Wave of Challenges June 6, 1996 Infrastructure Division C-ountrv Department I Latin America and the Caribbean Regional Office Document of the World Bank  FISCAL YEAR January I to December 31 WEIGHTS AND MEASURES The Metric System is used throughout this report CURRENCY EQUIVALENTS Currency Unit - Argentine Peso (A$) US$ = A$1 ACRONYMS AGP = Administration General de Puertos ATAM = Autoridad de Transporte del Area Metropolitana BA = Buenos Aires BOT = Build Operate and Transfer CVF = Consejo Vial Federal DNCPVN = Direcci6n Nacional de Construcciones Portuarias y Vias Navegables DNV = Departamento Nacional de Vialidad DPV = Direcci6n Provincial de Vialidad FA = Ferrocarriles Argentinos FEMESA = Ferrocarriles Metropolitanos S. A. FONAVI = Fondo Nacional de Vivienda FONDOVIAL Fondo Nacional de Vialidad FP = Ferroexpreso Pampeno GOA = Government of Argentina JNG = Junta Nacional de Granos NRT Net Registered Tons OECD = Organization for Economic Cooperation and Development SAP = Sociedad de Administraci6n Portuaria SAR = Staff Appraisal Report SBASE = Subterraneos de Buenos Aires S. E. SUBTE = The Metropolitan Suburban Rail Services of Buenos Aires  PREFACE This report has been prepared by a team led by Antonio Estache (LA1IN) based on the findings of two missions that visited Argentina in January 9-17, 1995 and January 29-February 11, 1995. The first mission included Jose Carbajo (TWUTD), Jose G6mez- Ibanez (Harvard University) and John Meyers (Harvard University). The second included Antonio Estache (LAIN), Marianne Fay (Young Professional), Walter Garcia-Fontes (Univesitat Pompeu Fabra, Barcelona), Frannie Humplick (PRDEI), and Thomas-Olivier Nasser (MIT and Institut d'Economie Industrielle, Toulouse). The report benefited from background papers by Javier Cardozo (Consultant), Xavier Freixas (Universitat Pompeu Fabra, Barcelona), Felix Helou (Consultant), Martin Rodriguez-Pardina (Consultant), and Jeff Ruster (PSD). The mission would also like to thank key members of Argentina's transport sector, Mr. Corcuera Ibanez, Mr. Conejero and Mr. Kohon for their help in the preparation of this report. The Peer Reviewers for this report were Messrs. Z. Shalizi (TWUTD), and I. Kessides (PSD).   Background Papers Supporting the Report Carbajo, J., J. G6mez-Ibanez and J. Meyers (1995), "An Assessment of Argentina Transport Reform", mimeo, The World Bank, LA1IN Cardozo, J., (1994), "Estado de Situaci6n del Transporte en el Area Metropolitana de Buenos Aires", mimeo, The World Bank, LAIIN Fay, M. (1994), "Infrastructure and Growth in Argentina", mimeo, the World Bank, LAIIN Fay, M. and A. Estache (1995), "Regional Growth in Argentina: Determinants and Policy Options", mimeo, The World Bank, LAlIN Freixas, X and W. Garcia-Fontes (1995), "Infrastructure Financing for Argentina's Provinces: Issues and Options", mimeo, The World Bank, LAIIN Humplick, F. (1995), "Infrastructure Performance in the Provinces of Argentina", mimeo, The World Bank, LAI IN Hlumplick, F. and T. 0. Nasser (1995), "Risk in Provincial Infrastructure Provision: An Investor's Perspective", mimeo, The World Bank, LA1IN Rodriguez-Pardina, M. and F. Helou (1995), "Comparaci6n de Marcos Regulatorios en Argentina", mimeo, The World Bank, LAIIN Ruster, J., (1995), "Infrastructure Financing: Options for Brazil's States and Argentina's Provinces", mimeo, The World Bank, LAIIN In addition the paper has benefited from two documents prepared in parallel by our colleagues of the Government of Argentina. Kohon, Jorge: "Argentina Railways Case Study" in Kopicki, Ronald & Louis S. Thompson (eds.), Draft report on "Institutional Change and Private Sector Development in Railways". World Bank (forthcoming) "Diagn6stico del Sector Transportes" Draft report produced for the Government (December 1994) (mimeo)   ARGENTINA TRANSPORT PRIVATIZATION AND REGULATION: THE NEXT WAVE OF CHALLENGES Table of Contents' Page No. Executive Summary .......................................................i Chapter 1: Introduction and Policy Summary .....................................1 Reform Needs in the Provinces .......................... .............................. 2 Learning from the National Privatization Experience ........................................3 Railways and Subways ........................................................4 Highways ........................................................5 Ports and Waterways ........................................................5 Some Key Issues with Implications for the Provinces ................... ..................6 The Role of Subsidies ........................................................6 Fine-tuning Regulation ......................... ..............................7 The Need for an Integrated Transport Policy Approach .................... 10 Chapter 2: Intercity and Metropolitan Railways ...................................................... 12 The Background Before the Reform ....................................................... 12 The Strategy of Railway Reform ..................................... .................. 13 How was the Freight Network Unbundled and Privatized? ................ 14 How was the Metropolitan Commuter Network Unbundled? ............ 16 How were the Intercity Passenger Services Addressed? .......... .......... 18 The First Effects of Rail Privatization ....................................................... 19 Impact on Freight Services ................................................. ...... 19 Impact on Metropolitan Railways ..................................................... 21 Impact on Intercity Passenger Services ............................................. 23 Overall Impacts of Rail Privatization ................................................. 24 Lessons and Challenges Ahead ....................................................... 25 Lessons learned ....................................................... 25 Challenges Ahead ....................................................... 26 Chapter 3: Intercity and Buenos Aires Access Roads .............................................. 30 The Background Before the Reform ....................................................... 30 The Reform Strategy for Roads ....................................................... 31 First Wave of Concessions: Intercity Roads .................... .................. 32 lThis report was produced under the supervision of Mr. Gobind Nankani, Director, Mr. Asif Faiz, Division Chief, Infrastructure and Urban Development, and Mr. Danny Leipziger, Lead Economist, Country Department I, Latin America and the Caribbean Regional Office. The Peer Reviewers for this report were Messrs. Z. Shalizi (TWUTD), and I. Kessides (PSD).  Second Wave of Concessions: Access Roads to Buenos Aires .......... 34 The Impacts of the Road Concession Program ............................................. 35 Lessons and Challenges ................................................ 38 Lessons Learned ................................................ 38 Challenges ahead? ................................................ 38 Chapter 4: Ports and Waterways ...................................................... 41 The Situation Before the Reform ...................................................... 41 The Strategy of Reform in the Port Sector ................................................... 42 D eregulation ...................................................... 43 D ecentralization ...................................................... 43 Privatization ...................................................... 43 The Strategy of Reform in Waterways ...................................................... 45 The Impacts of the Regulatory Reform of the Ports Sector .......... . ............................................ 46 Lessons learned ....................................................... 47 C hallenges A head ...................................................... 48 Chapter 5: Reform Options for Provincial Roads .................................................... 50 What is the Demand for Road Services in the Provinces? .............. ............... 50 What is the State of the Provincial Supply of Road Services? . ...... I 52 How Relevant is the National Experience for the Provinces? ............... A Strategy for the Reform of Provincial Road Management . ........................ 57 Tables 2.1 Summary Features of the Freight Railway Concessions 2.2 Bidding Criteria Used in the Railway Freight Concessions 2.3 Winning Bids for the Railway Freight Concessions 2.4 Summary Features of the Metropolitan Railway Concessions 2.5 Winning Bids for the Metropolitan Railway Concessions 2.6 Projected vs. Actual Railway Freight Volumes 2.7 Metropolitan Railway Performance Shortly After Privatization 2.8 Most Recent Performance of Metropolitan Railway Concessions 3.1 Summary Features of the Original Intercity Road Concessions 3.2 Intercity Road Concessions 3.3 Summary Features of the Buenos Aires Access Road Concessions 3.4 Buenos Aires Access Road Concessions 3.5 Aggregate Traffic Flows for the Intercity Road Concessions 3.6 Toll Revenue in the Intercity Road Concessions 3.7 Final Price Evolution of Gasoline and Diesel Fuels 4.1 Summary Features of the Port Terminal Concessions of Puerto Nuevo, Buenos Aires 4.2 Buenos Aires Port Terminals Concessions 4.3 Perfornance Indicators of Labor Productivity in the Port Sub-Sector 4.4 Argentine External Trade after Port Privatization  5.1 Explaining Deviations From Regional Productivity, 1990 5.2 Rating Provincial Risk for the Road Sector Boxes 5.1 How much do Roads Matter to the Private Sector of Santa Fe? 5.2 Long-term Options to Attract Private Interest in the Provincial Road Sector Graphs 5.1 A Comparison of New Road Construction Costs Across Provinces 5.2 Unit Costs of Maintenance Contracted out in Selected Provinces   ARGENTINA - TRANSPORT PRIVATIZATION AND REGULATION: THE NEXT WAVE OF CHALLENGES EXECUTIVE SUMMARY OBJECTIVES OF THE REPORT The report identifies the main issues the provinces face and options they have in carrying out their new expanded responsibilities in the transport sector. In the process, the report draws some lessons from the national reforms in railways, roads, ports and waterways and identifies in these reforms some issues that could not be anticipated at the time the reforms were originally implemented in view of their novelty. MAIN GENERAL CONCLUSIONS The transport sector reforms initiated in 1989 have generally improved efficiency, quality and prices of the major services, but to ensure the sustainability of the successes achieved, the following changes would help: 1. Reform provincial road management andfinancing 2. Reassess the role of subsidies in the sector 3. Spell out renegotiation rules for contracts 4. Streamline the oversight of concessionaires 5. Design and explicit integrated transport strategy o Reform road management in the provinces - For most provinces, the reform should aim at commercializing the management and operation of provincial road agencies to cut costs and improve accountability of managers and workers by relying on multi-year management contracts between the road agencies and the provincial government with specific performance goals and built in minimum levels of service contracts with the private sector; * In the few cases where it is possible, consider concession contracts with the private sector based on minimum subsidy required when traffic levels are too low to allow profitable private operations; * Bids for all contracts in the provinces may require revisions of procurement rules; * Consider innovative financing options for the few high traffic provincial roads to reduce risks faced by private investors in provincial projects (i.e., the concessioning of "road packages" covering road networks across provinces to reduce commercial risks); and  ii * There may be a market for a "Transport Investment Fund" to finance roads likely to benefit from increased trade due to MERCOSUR. * Reassess the role of subsidies to reduce misallocation of traffic between modes: * To reduce urban congestion and air pollution costs, reduce the implicit subsidy to urban motorists by charging them; otherwise, subsidize explicitly commuter rail; * Review the apparent implicit subsidy to heavy trucks (i.e., they pay lower fuels taxes) and charge them for road damage, pollution and congestion they cause; and * Suppress subsidies to waterway dredging (as in the Parana River) since competing modes or ports are not subsidized, unless the positive externalities of this subsidy can been demonstrated. 3 Spell out rules for contract renegotiation: * Introduce a flexible, fair and transparent mechanism for the renegotiation and modification of concession contracts, this should facilitate needed contract revisions in freight railroads, subway and commuter rail; and * Consider the option of a special arbitration commission independent of the regulators and faster than the court system to settle renegotiations. * Reduce the number of monitoring agencies and focus their role: * Concentrate the focus of regulatory authorities on supervision and enforcement, rather than the monitoring of possible monopoly practices; and * Maintain only one enforcement commission and one arbitration commission to settle contract disputes between regulator and regulated for the entire sector. * Design an integrated transport strategy * a National integrated strategy needed to internalize the impacts of transport on the environment and on health (to cut the current high rate of traffic accidents) and to better identify sectoral investment needs; * The instruments of this strategy should include demand management (including a more explicit recognition of the role of subsidies) and explicit assessments of the environmental impact of project and program design; and * An integrated approach would also take better advantage of multimodal options even if much of the initiative is left to t he private sector and of any new needs resulting from the creation of MERCOSUR.  iii SECTOR SPECIFIC ISSUES * Railways * Spell out the rules being considered for the revision of the concession contracts and the conditions that justify the changes. * Roads * Make road user charges more consistent with costs attributable to different types of uses and vehicles; and * Clarify the institutional aspect of decentralization and the rules and conditions of assistance to the provinces. * Ports and Waterways 3 Finalize quickly the creation of the regulator and of the transfer of ports; - Accept renegotiation of subsidies and/or fees in demand estimates built in contracts are found to have been overoptimistic after private operators take over operations; and - Adjust road user charges because containers traffic and the development of Puerto Madero and of the Retiro Station are all likely to increase traffic and congestion downtown.   Chapter 1: INTRODUCTION AND POLICY SUMMARY 1.1 Objective of the Report. The report analyzes the reform agenda facing provincial governments in the transport sector.' Argentina's provinces inherited many new responsibilities as a result of the transport reforms started in 1989. To cope with this new role, many are trying to rely more systematically on the private sector. The lessons of the recent experience of transport privatization at the national level are thus very relevant to any assessment of the provincial options. While drawing these lessons, the report identifies some issues emerging in these early stages of the reform process as both government and private operators are learning more about their respective new roles in the sector. 1.2 Main Conclusions. First, the report endorses the decision of many provinces to close most of the ports and railways they inherited from the national government in view of the modest demand for these services. Whenever demand is sufficient, however, and when the provinces decide to keep some of the ports and railways operating, the private sector is often likely to provide the most cost- effective service, a conclusion suggested by national experience. The situation is different for roads, however, where the provinces are slower in adjusting to their new role and the private sector is not showing much interest due to low traffic. Consequendy, since concessions to private operators are likely to be the exception rather than the rule, the provinces need to focus on other options. The report suggests that in most provinces, cost reductions and improved accountability in road management could be achieved through management and service contracts-altough the government will have to continue to finance operations, maintenance and investment in most cases. Indeed, where contracting-out is feasible, the concession experience at the national level has demonstrated that most users often stand to gainL 1.3 From a more general perspective, the review of the national experience suggests that while the reforms, generally, have been very effective so far at improving services and cutting costs and prices, four issues merit the attention of not only the provincial authorities but also the national authorities, namely: - The importance of implicit subsidies in the sector. * The need to spell out the renegotiation rules for concession contracts. * The importance of a streamlined oversight of the concessionaires. * The potential benefits from an integrated transport poiicy approach. 1.4 Road Map. The remainder of this chapter provides a policy summary of the report and includes a cross-sectoral view of the issues. Chapters 2 through 4 draw lessons from the national reforms of railway, port and waterway and highways, respectively, focusing on the issues most relevant to the provincial govemments. Chapter 5 addresses the reform needs of the provinces in the management, operation and financing options in the road sector, where the provinces are likely to face their most difficult challenges. T Ihe focus is on surface Imnsportation modes: railroads, highways, ports, and waterways. The privatizatico of Argeina's national airline and the status of Argentinars airports are not consideed, neither are buses or other forns of public urban tlm sritation.  -2- REFORM NEEDS IN THE PROVINCES 1.5 A crucial aspect of the transport reform in Argentina is the devolution of many responsibilities in railways, roads and ports from the national to the provincial governments. Issues are complex as the provinces vary enormously in both needs and resources. The provinces have been able to take quick decisions in railways and ports, but are still struggling with the adjustment needs in the road sector. 1.6 Most provinces will not have a railways or port problem. Because most intercity rail passenger services offered to the provinces are very lightly used, they have been or are likely to be abandoned without much social cost. All but a handful of the communities apparently can be reached by road and have bus service. The principal loss may be that travelers now must pay higher fares since intercity rail service is heavily subsidized while intercity bus service is not Similarly, many of the ports devolved to the provinces apparently handled no traffic for years and most of those that did have traffic are likely to be viable as concessions. There is an excess of small ports on the Parana River, for example, and the consolidation of traffic at several financialy self-supporting ports probably will cause little hardship. There are a number of fishing ports on the Atlantic Coast south of Buenos Aires, and the most important of these are probably financially viable. 1.7 It is taking the provinces much longer to adjust to their new role in roads. The provinces' adjustment to their expanded responsibilities in the road sector has been much slower than im ports or railways, a clear symptom of problems in the provincial management of the sector. The main issues every provincial road secretary is likely to face are: * the operation, maintenance and construction of provincial roads cost on average twice what they should cost and the local managers are not accountable, and * the commercial, fiscal and political risks are all too high to attract much private interest in the provincial road sector 1.8 Road costs are too high and provincial managers are not accountable. A snapshot of the current state of roads in Argentina's provinces reveals an alarming picture. Only 70 percent of provincial roads are regularly maintained and ,on average, maintenance expenditure represents only about 37 percent of total public road expenditure. The most serious issue, however, is the high unit cost of activities in the sector. New road construction, for instance, costs on average about twice as much as what might be considered a best practice. Similar observations could be made for patching, graveling, sealing or overlaying. Most often, this reflects a fair amount of cost padding and regulatory restrictions to entry in the bidding of services as well as poor incentives in the overall management of the sector. In a sample of eight provinces (Buenos Aires, C6rdoba, Santa Fe, La Pampa, Neuquen, Corrientes Misiones and Chaco), the World Bank estimates that about $125 million are wasted every year as a result of these inefficiencies. Many provincial governments are now aware of the situation and are trying to change the operation of the sector. 1.9 Risks faced by potential private investors are too high in most provinces. The main risk pertains to commercial viability. Only a few roads in the wealthier provinces are likely to be able to rely on some forrn of private financing. Santa Fe has already granted a concession to toll, maintain, and improve an existing intercity expressway and C6rdoba, Mendoza, and Santa Fe are in the process of granting toll-based concessions for the high-volume roads that access their main cities.  -3- Santa Fe also has plans to grant concessions to toll and maintain some intercity roads that carry relatively modest volumes (between 1,000 and 2,000 vehicles per day) and to contact with municipalities to maintain the provincial and local network of low-volume, earth roads. But for the majority of roads and provinces, the traffic levels simply do not justify much private interest. This is obvious in the less densely populated and poorer provinces. Moreover, the report shows that in many of these, policy and political risk levels for potential private investors are often much higher than in the richest provinces. For instance, the fiscal situation in many provinces is so poor that any contract requiring public sector payment is likely to be a source of concem. 1.10 A solution: contracts to minimize costs and subsidies and rely on benchmark pricing. In the short to medium run, for most provinces, the best option for reform is probably one in which the provincial government introduces some type of performance or management contract in the road agencies, with specific targets on pricing of services (based on best practice benchmarks when possible), on share of services subcontracted to the private sector and on minimum levels and shares of resources to be allocated to maintenance, as a way of avoiding overinvestment in new roads at the cost of a deterioration of the existing network. In a few cases, the road amin ions should be able to bid out to the private operators demanding the lowest subsidy at least some share of the network. The Province of Buenos Aires, for instance, is planning to bid out at minimum subsidy cost its roads with light traffic; however, this is likely to be an exception rather than the rule when provinces- specific risks are accounted for. Whatever type of contract is adopted, mary of the provinces may encounter difficulties; then, it will be important for the national government to mnaintain technical assistance to the provinces. Technical assistance, however, is currently much too weak to be able to have any major impact and will need to be strengthened. 1.11 Increasing the odds of getting private financing in the longer run. Even if roads will have to be financed mainly by the public sector in the foreseeable future, as provinces improve their fiscal status, private financing may become available for specific projects. For example, candidates are commercial projects such as roads from Brazil to Chile which would allow some Brazilian and Argentinean products to be exported through Chile to the West Coast of North America or to East Asia. The report proposes various options to increase the odds of getting access to private capital. These options essentially try to create funds that reduce transaction costs for investors, ease diversification of investments in infrastructure, provide small projects with easier access to capital markets, and contribute to the development of capital market financing of infastructure. LEARNING FROM THE NATIONAL PRIVATIZATION EXPERIENCE 1.12 Management and service contracts with the pnrvate sector are likely to be the mnain instrument by which to involve the private sector in provincial transport activities. Concession contracts were the main instrument used at the national level. Even if these contracts are not exacy of the same type, the lessons learned from the experience with concession contracts in transport at the national level is relevant since they show a preference for contract-based regulation in Argentina. Moreover, the national experience, initiated in 1989, is at the forefront of recent efforts to privatize and deregulate in Latin America Argentina was the first Latin American country to privaize its intercity railroad, for example. It is the only country outside Japan that has private urban conmnuter railways. And it is the only country in the world to grant a private concession to operate its subway. Argentina (along with Mexico and Chile) was also among the first in the developing world to grant private concessions to build and maintain roads, and is also a leader in efforts to privatize ports and  -4- waterways. It is thus vital to ensure that the lessons gained from this experience are disseminated within the country as much as outside, since Argentina's reforms are rapidly becoming a model for many other reforms elsewhere. The experience of the three main subsectors are reviewed next Emphasis is on the design of the reform process (i.e., unbundling, bidding process, and contract coverage) since it was key to maximizing the gains from the introduction of competition; this is what may be most relevant to the provinces--or any other administration attracted to the national reform model. Railways and Subways 1.13 The reform. Ferrocamles Argentinos (FA) was divided into three separate businesses- freight, intercity passenger, and commuter rail--which were privatized or transferred to the provinces in that order. The viable freight network was divided into six separate concessions. The first 20- year concession was offered in early 1990, and by October 1993 five of the six were in private operation. All intercity passenger services were offered to the provinces, but most were ultimately abandoned (as mentioned earlier). FA's urban commuter railroad services, centered around Buenos Aires, were divided into seven separate lines and offered in concession to the private sector. The municipally-owned subway system was also placed in a concession jointly with one of the seven commuter lines. Private operations began on the first concession on January 1, 1994 and by June 1995, all the commuter lines had been transferred to the concession winners. 1.14 The outcomes. The outcomes in terms of cost and traffic level and reliability have so far been very positive. First; the sector cost much less to the national govenmment since the reforrns and the need for govemment subsidy has been cut significantly. Throughout the 1 980s, FA required an average subsidy of about 0.6 percent of GDP per year--the budgetary transfers to FA was about US$1.5 billion per year in the years immediately preceding concessioning. The intercity freight concessionaires now receive no subsidies from the national government, while the urban commnuter railroads and the subway concessionaires are expected to receive a subsidy averaging less than $100 million per year over the life of their 12-year concessions, most of which is for capital imnprovements. These changes had a direct impact on the province, since several provinces provide some modest subsidies for intercity passenger services. Moreover, while the national govemment continues to subsidize the only "unsold" intercity freight line (Belgrano), one of the options to reduce the burden of this subsidy is to devolve the line to the provinces and let them decide if they want to continue operations. 1.15 Second, except for intercity passengers, rail usage is stable or increasing. This suggests that rail users as a whole are no worse off or are better off under privatization. In many cases, service quality improved quickly. By 1994, in the case of freight, the concessionaires were carrying about the same tonnage as in the late 1980s. In 1994, the first year in which some urban rail services were operated by concessionaires, reported ridership increased 45 percent on urban commuter rail services and 18 percent on the subway compared to 1993. Half or more of the reported increase on the commuter railroads is thought to be due simply to dramatic reductions in the theft of fare receipts by train staff; the remainder and most of the reported gain on the subway is thought to be real. The increases in freight traffic are due to both increased service reliability and tariff reductions, while urban passenger growth is largely attributed to additional trains, cleanliness, and security.  -5- Highways 1.16 The reform. The Government concessioned about a third of the intercity highway system-- with average daily traffic volumes of at least 2,000 to 2,500 vehicles--considered most suitable for concessions. The concessionaires were allowed to collect tolls, but in return were required to undertake a program of maintenance, rehabilitation, and capacity improvements. Twelve separate 12-year concessions were offered in 1989 and awarded in early 1990. Next; in 1992, the government organized a system of concessions for improvements to the major access roads of Buenos Aires. It awarded (in 1994) three 22-year-and-8-month concessions to toll and substantially increase the capacity of the expressways approaching from the north, west, and southeast. In addition, the governnent negotiated with the firm that won the concession for the Buenos Aires-Mar del Plata intercity road to upgrade substantially the expressway approaching from the south.. 1.17 The outcomes. The improvements in intercity highways have been significant although less dramatic and more debatable than in the other two subsectors. On the one hand, according to information provided by DNV, the maintenance of the intercity highway system, including the portions concessioned, has improved significantly. In 1989, the proportion of paved roads in bad condition reached about 30 percent. In 1993, it fell to 25 percent and DNV expects it to fall to about 10 percent by 1997. Moreover, road usage has apparently increased, while the cost of maintenance on the concessioned network is no longer a drain on government budgets. On the other hand, there is no direct evidence that the private sector is maintaining the roads at lower cost than the public sector did, or even that it is doing better at the same cost. The users now must pay tolls, and the continued traffic growth is undoubtedly due in part to the economic recovery and to long-term trends dtat favor highway modes. The concessions for urban access roads are too recent to offer any firm evidence, but they promise to provide some badly needed increases in urban highway capacity that the government might not have built otherwise. Ports and Waterways. 1.18 The reform. The Government abolished many of the restrictive regulations governing working practices at ports and on vessels between 1990 and 1993. The seven largest ports operated by the Administraci6n General de Puertos (AGP) were put in the hands of new port authorities- three in the province of Buenos Aires and two in Santa Fe. These new authorities are govemed by representatives of provincial and local govenmments and shippers and are required to lease the terminals in the ports as concessions. The remaining 60 old AGP ports, which were small, half of which had not served as ports for many years, were transferred to the provinces, which could continue to operate them, lease them to private firms, or abandon operatiorL By 1995, the new authority for the Puerto Nuevo at Buenos Aires, Argentina's main container port; had awarded and turned over its five terminals to five different concessionaires, and a similar process of concessioning was underway at the other major ports. Argentina's port approaches and navigable river channels had been maintained by another public agency, Direcci6n Nacional de Construcciones Portuarias y Vias Navegables (DNCPVN). In 1994, the govemment awarded a concession for dredging and maintaiing the 750km navigation channel from the Atlantic Ocean up the Parana River as far as Santa Fe, including the approaches to the ports of Buenos Aires and Rosario. The concessionaire is expected to collect a third of the dredging and maintenance costs from tolls.  -6- 1.19 The outcomes. The combination of deregulation and privatization led to dramatic reductions in port charges and in barge and ocean-shipping tariffs. Charges for shipping containers between Argentina and Northern Europe declined between 30 and 70 percent between 1991 and 1993; the savings for grain and other bulk shipments were around 10 percent. Much of the savings come from improved labor productivity. At the ports of BA, which handles most of the containers bound to or from Argentina, employment fell from around 8,000 immediately before the reforms to 2,500 in 1994. Some of the minor unprofitable ports transferred to the provinces probably will be abandoned; however, these are so lightly used that the benefits lost should be minor relative to the costs saved. 1.20 Although the Atlantic Ocean-Santa Fe waterway concession has only recently been awarded, the Argentine Government expects that it will generate similar savings. The public agency had been maintaining the channel at a cost of about $70 million per year. The winning concession bid to maintain it is at $60 rmillion per year, $20 million of which the concessionaire hopes to collect in tolls and $40 million in subsidy from the national government. The savings is greater than these figures suggest because the concessionaire is obliged to maintain the channel to a depth greater than before north of Buenos Aires. At the Parana River port of Rosario, one of Argentina's main graim ports, bulk grain ships of the Panama design, the standard for world trade, now can load only partially fill and must go to the deeper ocean ports of Bahia Blanca (in Argentina) or Santos (in Brazil) to be topped up. The deeper channel will allow Panama ships to leave Rosario fully loaded SOME KEY ISSUES WITH IMPLICATIONS FOR THE PROVINCES 1.21 In any reformn, there are usually areas in which fine-tuning is necessary. There are three such broad areas in which the Government of Argentina may wish to consider some fine-tuning and on which the provincial, and occasionally municipal governments, may wish to :pay particular attention as they cany out their own transport sector reforms: * Revisiting the cost and benefits of subsidies; * Supervising, coordinating, and streamlining contract-based regulation; and * Integrahtng policies in the sector. The Role of Subsidies 1.22 Argentina's basic transport strategy since 1989 has been to reduce government subsidies and privatize wherever possible to allow market forces to be the primary determinant of the services provided. As long as the markets are reasonably competitive, the privatized and unsubsidized firms will have strong incentives to control their costs, improve their productivity, and tailor their services to customer needs. But it is difficult to eliminate subsidies and privatize comprehensively, however; thus, in practice transportation activities will be provided by a mix of subsidized and unsubsidized public and private agencies. 1.23 Explicit versus implicit subsidies to urban commuters. Privatization is compatible with subsidy, as Argentina's urban rail concessions demonstrate. Moreover, some subsidies may be desirable because they are needed to offset others, often implicit, that have not been removed. Consider an example relevant to many of Argentina's largest cities, including most provincial capitals. Urban road use is subsidized in the sense that motorists do not pay for the congestion or  -7- pollution they impose on others. The best solution would be to charge directly urban motorists for these costs; the policy of allowing concessionaires to build and toll urban expressways is a step in this direction. Absent a comprehensive system of urban road charges, however, it may be sensible-- as a second best solution--to subsidize urban commuter rail if doing so significantly reduces motor vehicle congestion and pollution. 1.24 No need to subsidize heavy trucks. Continued subsidies to heavy trucks, by contrast seem less defensible--and results in unfair competition for railways--and may have to be removed gradually. Heavy trucks are almost surely not paying for the road damage, pollution, and congestion they cause since diesel fuels are comparatively only lightly taxed while gasoline is heavily taxed. Rail traffic might increase significantly if trucks were forced to pay their way (and this can be easily done at tolls for instance), which may lead some provinces to reassess the potential they see im railways. If so, subsidizing heavy trucks and not subsidizing rail may be causing a senrous misallocation of traffic between the two modes. 1.25 No need to subsidize waterway dredging. In the Atlantic Ocean-Santa Fe waterway concession, it is unclear why the dredging of the Parana River channel should be subsidized since the competing modes or ports are not. Without the subsidies, it is conceivable that bulk commodities might move by rail to the deep-water ports on the Atlantic at Bahia Blanca and Quequen. The Government apparently regards the subsidies as temporary, and hopes eventually to move to a system that is completely toll financed. The claim, moreover, is that studies show that dredging the Parana to 32 feet is the cheapest shipping option. In that event, however, shippers should be willing to finance the dredging thrugh tolls. In short, the waterway subsidies are inconsistent with the overall transportation policy, in that they further depart from more market- oriented traffic pattems. Fine-tuning Regulation 1.26 The national approach to transport regulation is to rely on a combination of concession contracts and specialized commissions charged, with contract enforcement and residual regulatory powers. Contract-based regulation seems to be a reasonable model for the provinces as well because the system appears to work. However, there are three exceptions or qualifications that were difficult to anticipate at the beginning of the reform process but could now be corrected with the benefit of expenrence: * the need for a mechanism for contract modification; * the need to improve contract enforcement; and * the need to reduce the number of regulatorn commissions 1.27 Contract modifications. Concession contracts, especialy when they are used as a regulatory instrument, can, to some extent, be seen as living documents, because unifreseen and enforceable circumstances often make the concession contract unworkable from the perspective of either the govemment, the contractor, or both. Under these circumstances, contract flexibility is good pub!..L: policy RB.- I.? ensure that the contract is a credible regulatory instrument, the contract modifatawl-s sho.:'.- bc t;sed . scmne .air aj'd wiordiJe ienegotiation rles base(d on clearly spelled out jolicy ciwnaa sLu belev. .'lus .sscin has aiready been mtemalized by some of the national authorities. The Govemment had to renegotiate the intercity road contracts in 1991 because  -8- of unexpectedly vehement complaints from users that tolls were being collected in advance of improvements, and because the Government's emergency decree to peg the new peso to the dollar made the contracts' tariff-escalation clauses illegal. The solution was to lower allowable tolls and to compensate concessionaires with both a subsidy and reduced investment requirements. By 1995, even these contracts are seen as inadequate because rapid traffic growth, stimulated by the economic recovery, has heightened the need for the capacity improvements deleted in the 1991 renegotiations. Similar problems are arising in the case of the freight railroads and in subway and commuter rail. 1.28 But such ad-hoc solutions are not always in the interest of all the parties involved What is needed is a mechanism forflexibly yet fairly renegotiating concession contracts. With the current level of technical expertise on regulation and of information, and in view of the current tradition of commercial law, the best option is to establish a special commission to arbitrate or adjudicate concession contract disputes using clear but fair rules. The key is to find such rules--otherwise, the arbitration commission confronts the same problems as the standard rate-of-return regulatory commission Final offer arbitration is a possibility that might work in this context. Under this scenario, in the event of a negotiating impasse, the arbitrator must chose between the two parties' best and final offers, without modifications. Since no further modifications are possible, both parties (the Government and the concessionaire) would have strong incentives to be reasonable and to recognize each other's legitimate interests. This system has been used successfully with some labor contracts in the United States, but further research is needed to understand whether it would work with transport concession contracts in Argentina 1.29 Public Policy Criteria to Test if a Contract Revision is Needed. The contractual rigidities built into the privatization agreements are necessary to close deals and to create binding commitments among the participants. However, they make it difficult to adapt when there is a need to resolve emerging problems because many of the actors find adaptation threatening to the privatization commitments that protect their interests and the whole fabric of reform. Moreover, clearly each franchisee is likely to attempt to interpret most of the contractual ambiguities to its own advantage. This is why there is a need to continuously monitor the privatization agreements and to assess any need to adjust them. The option of contract flexibility is a normal feature of a successful long-term contract, provided that public policy concerns predominate the revision decisions. The assessment of any modification requirements, however, needs to be based on a good sense of what went wrong and on a clear set of public policy criteria 1.30 The sense of what went wrong is necessary for any arbitrator to be able to decide on the distribution of the costs that may result from the contract change. This starts with a clear sense of the performance achieved. It may very well be that the short-run performance is much better in terms of service quality and price but that the concessionaires do not meet some of their obligations. Why would these problems arise: * How realistic were the govenmment requests? Where all the objectives consistent with each other? Were there trade-off not well identified at the initial stage by either the government or the private bidders who could have asked then for a revision of the specification of the needs as is taking place in the pnrvatization of the Santa Fe water company for instance. * Was the demand overestimated? This is common. A recent survey of all U. S. urban transport contracts shows that the estimates of capital and operating costs as well as  -9- demand built in contracts were systematically too optimistic. But is this due to the formula used in the awarding of a concession or was is due to a mistake by the pnrvate operator? * Did the state of the assets deteriorate between the time the bids were made and the time they were actually transferred? If not, was this due to the weather or to the fact that the public operators stopped maintaining these assets? If it is due to the weather, the responsibility may be shared. In the second case, the private sector may have a fair claim on a request to revise the contract to allow a revision of some of the terms since additional rehabilitation needs are arising due to a poor protection of his property rights dunng the transition period. 1.31 But before proceeding with ary change, the policy criteria need to be spelled out They are required to ensure a transparent basis for contractual dispute resolution and related policy decisions, as well as to avoid excessively subjective decisions on the need for or nature of contractual changes. These criteria ease the judgment as to whether the maintenance of existing provisions is suboptimal to all parties in view of a fundamental change in external circumstances (e.g., a permanent demand shift), a change in policy priority (e.g., the relative importance of services to the poor increases) or an ex-post assessment that the contract is unviable and needs to be restructured. Possible criteria include: * Is the protection of the interests of investors at the baseline levels established in the original terms of privatization guaranteed? Should it be? * How would the efficiency of the overall operation (flexibility, variety, responsiveness of operators, quality of maintenance and of investment strategies) be affected by the change? - Would the composition of the financing of the activity be altered? Would it reduce the public share in this financing? * Would the consumer interests be protected? * What is the nature and source of change in scale of operations in response to demand? 1.32 Discretionary regulatory authority for monopoly control. The second and most easily corrected issue is that the broad discretionary regulatory authority to guard against monopoly abuse, such as that enjoyed by the rail freight regulator, is probably unnecessary and unwise because most of the modes already face strong competition. The freight railroads compete fiercely with trucks because of the relatively short haul lengths in Argentina, for example, and with one another since the six rail lines overlap or are within easy trucking distance of each other. Ports compete against one another and, within the larger ports, the individual termnials are required to be granted as separate concessions to further increase competitive pressures. The urban railways face competition from buses, taxis, and private automobiles, while the urban toll road concessionaires are required to build parallel and untolled collector roads. Those modes where competition is weaker also have toll rates and service quality regulated by contract, so that further protection against monopoly abuse seems unnecessary. The urban toll road concessions were awarded to the bidder who offered the lowest toll rate, for example, while the urban railroad concessions were granted to the bidder who requested the lowest subsidy to provide, at the existing fare, a specified level of train service and program of capital improvements.  -10- 1.33 All this suggests that the regulatory authorities should focus on contract enforcement and monitoring and not be distracted by issues of monopoly. Experience shows that broad grants of regulatory authority, potential or actual, may be risky as well as unneeded in that they provide an opportunity for the politicization of concession oversight. For example, if the definition of 'just" tariffs is left ambiguous, the regulatory commission may be confused or pressured to substitute its own judgment for normal commercial considerations. Therefore, it is important to make sure that the tariff principles spelled out in the contract are as clear as possible to avoid the temptation of interference by the regulatory authority in the details of the tariff structure. These should be left to the private operator to decide. 1.34 The number of regulatory commissions. A final concem in the area of concession oversight is the proliferation of regulatory commissions, one for each transport concession program (7 in total). If arbitration commissions are to be used, then they should be independent of the enforcement commissions; otherwise the arbitrator would also be, in effect, one of the two disputing parties to the contract. It seems unlikely, moreover, that Argentina needs a large number of either enforcing or arbitrating commissions. 1.35 The case for establishing just one arbitration commission is persuasive. Little specialized industry knowledge would be required, since the arbitration rule must be simple and clear. A single commission might make it easier to pay more and attract commissioners with the extensive business and govemment experience needed for judging the competing claims. A single commission might also better resist capture by industries. There may be gains from a consolidation of enforcement conmmissions as well. Many of the advantages of attracting higher-quality commissioners and staff and resisting specialized interest groups obviously apply to enforcement commissions. Separate commissions might be required where specialized local concessions were predominant, since provincial or local governments would probably want a strong say in naming commission members. The Need for An Integrated Transport Policy Approach 1.36 An integrated policy approach in transport is needed for two main reasons: (i) to internalize efficiently the externalities derived from a rapid increase in motorization; and (ii) to reap the economies of scale inherent in multimodal transport. This is just as true at the national as at the provincial level. 1.37 Coping with increased motorization. The changes brought about by deregulation and privatization across sectors of the economy, coupled with changes in the structure of the Argentine economy, have had a substantial impact on the consumption of transport services. Roads continue to take the lion's share of transport activity, and vehicle fleets are experiencing a very high rate of growth. These developments are bound to have significant impacts on the environment, including the public health threat posed by the current disproportionate rate of traffic accidents. An integrated approach is required to intemalize the extemalities through demand management and explicit assessment of the environmental impacts both in project and program design. At the center of the issue is the need to set efficient road user charges that try to cope with the environmental, congestion and road damage extemalities.  -11- 1.38 An obvious illustration of this point is the metropolitan transport system in Buenos Aires. It is controlled by different jurisdictions. The national Government is responsible for the main access highways, the regulation of all railways, including the underground metro, and two-thirds of bus services; the Government of the province of Buenos Aires is responsible for many primary network roads and the regulation of 20 percent of bus services; the municipality of Buenos Aires is responsible for traffic engineering and traffic and street management of the city's most important area in terms of economic activity and congestion; and the other 36 municipalities of the Province of Buenos Aires are responsible for municipal streets and the regulation of 13 percent of bus services. This dispersion of responsibility makes it very difficult to formulate and coordinate an integrated urban transport strategy. A law under consideration in the National Congress would establish the Autoridad de Transporte del Area Metropolitaha (ATAM), which is expected to coordinate, plan, and regulate urban transport in metropolitan Buenos Aires. This authornty would be effective to the extent that its mandate does not focus primarily on the oversight of the metropolitan railway concessions, but rather on planning and coordinating effectively the implementation of major policies and investments--such as transport-related air quality and traffic safety strategies. 1.39 An integrated approach is also necessary to address the financing of investment needs. For instance, the concession agreements with the metropolitan railway operators stipulate substantial government investments to modernize the outdated rail infrastructure. This is more evident in the underground system, where the rehabilitation of line A alone is estimated to cost of US$80 million. If the Government is unable to comply with its investment commitments, the metropolitan railway privatization exercise would be seriously undermined. To do so, the Government cannot simply rely on extemal borrowing. It should develop instead an integrated urban transport strategy, including pricing and regulatory policies to improve cost recovery and the financial sustainability of all urban transport operators involved 1.40 Takdng advantage of multimodal transport In a likely scenario of increased extemal trade with the other MERCOSUR countines, Argentina can reap the economies of scale and other advantages of multimodal transport if the infrastructure needs of the key export corridors are adequately identified and addressed. The private sector is likely to take much of the initiative in developing integrated multimodal transport--especially now that the regulatory barriers and distorfing subsidies are being reduced. But there may be some worthwhile intermodal facilities, as well as other large infrastructure investments, which may not be attractive to the private sector in their first phase of development. Here again is where an integrated approach is necessary to define the real needs of various transport modes and to raise sufficient financing. The Government has a role to play by planning the allocation of public expenditures destined to capital infrastructure in a way that recognizes the advantages of mutlimodal transport Increased participation from transport users and providers is a prerequisite within an integrated policy approach.  -12- Chapter 2: INTERCITY AND METROPOLITAN RAILWAYS2 2.1 In 1989 Argentina did not have a well defined policy to re-structure its railways, but could not afford the fiscal drain created by the railway deficits. A series of policy decisions adopted between 1989 and 1992 ultimately shaped the railway reform strategy, including the approval in 1991 of a railway restructuring program in collaboration with the World Bank. The pattem of reform used in the railways would also be followed in the highway and port sectors. In essence, the reform has consisted of re-defining the network, identifying the profitable segmnents in each market, through a process of competitive bidding awarding concessions to the private sector, and transferring a sizable network to the provinces. 2.2 This chapter describes briefly the background and market conditions that existed before the railway reform. It explains the process of reform, the concessioning of freight and metropolitan railway services to private operators, and gives an indication of the performance of private rail operators to date. Finally, the chapter discusses what remains to be done in the railway privatization agenda and the issues to be address in the wider context of a multi-sectoral transport policy. THE BACKGROUND BEFORE THE REFORM 2.3 When the Menem administration set in motion the reform of the railways in 1990, Ferrocarriles Argentinos (FA) operated a national network of about 35,000 kilometers, employed 92,000 people and was losing about US$1,400 million annually (1992 dollar values). Of these losses, approximately $585 million were incurred by the freight services, $350 million by the intercity passenger services, and $465 million by the metropolitan commuter services. These losses represented a major drain to the national Treasury and were the main motivation for the re- structuring of the railways. 2.4 Lack of commercial orientation. Many of the problems experienced by FA were typical of large national railway companies. FA did not have a clear commercial policy. Managers were concemed more with production targets than with satisfying user needs. They were also heavily influenced by the interests of labor unions and equipment suppliers. FA had too many employees for the amount of traffic canred; operating practices were outdated, and the maintenance of railway track and rolling stock was deficient. 2.5 The lack of commercially-oriented pricing and investment policies explains many of the difficulties faced by the Argentinean railways. FA did not have an explicit rates policy, but freight rates were set at about 70 percent the level of the rates offered by truckers. This policy satisfied a demand for low-quality services which was highly costly and conducive to unremunerative behavior. Likewise, FA's investment policy had no commercial rationale. Uneconomic lines were maintained to accommodate labor unions' requests and provincial political interests. Locomotives were allocated to uneconomic services which did not generate sufficient funds for maintenance and investments. 2 This chapter owes a lot to Kohon (1994).  -13- 2.6 Lack of own resources. As a result of the lack of commercially-oriented policies, FA could not generate sufficient internal funds to maintain and improve the network adequately, further contributing to the deterioration of track and equipment. By 1990, for example, 54 percent of the total network had its track either in bad or fair condition, and only 49 percent of a total fleet of 992 locomotives were available for service. 2.7 Loss of market share. These conditions lead FA to lose traffic and market shares over the years and the financial performance of the company deteriorated. Between 1965 and 1990, total traffic units (passenger-kilometers and ton-kilometers) declined by 39 percent from 29.6 billion to 18.2 billion. Intercity passenger services, an even less profitable business line, experienced the smallest reduction in traffic with a decline of only 26 percent. Freight services were more adversely affected with a drop of 50 percent in traffic during the sarne period, while suburban commuter rail traffic fell by 34 percent. Between 1970 and 1989, the railway share in both the freight and intercity passenger markets fell to about 8 percent from levels of 14 and 11 percent, respectively. 2.8 High deficits. FA's financial performance continued to deteriorate in the years before 1989. For more than 15 years prior to privatization, FA's wage bill alone exceeded its total revenue. During the period 1980-88, the estimated gap between FA's operating revenues and operating and capital expenditures amounted to an average of US$1,652 million per year (1992 US dollars). THE STRATEGY OF RAILWAY REFORM 2.9 In 1989, the Menem administration decided to embark on one of the most ambitious programs of railway reform and privatization. The first results from privatization are described in the next section. The main objective of the reforms was to reduce the railway's financial burden. The previous administration of Raul Alfonsin had already considered various strategies to re- structure and privatize the railways. It was particularly interested in separating infrastructure from operations (the Swedish model), where freight, intercity passenger and metropolitan commuter services were to be run by independent operators of mixed public-private ownership. This attempt at re-structuring FA did not succeed because it lacked political support and there were difficulties in setting up the rules of operation for a horizontally integrated railway. Another option, at least in theory, was to offer the whole of FA's operations in a single concession This option was never pursued because the large amount of finance required and the difficulties inherent in operating a concession of such a large scale made the chances of finding a willing taker very improbable. 2.10 A two step strategy. A series of policy decisions adopted between 1989 and 1992 ultimately conformed a railway reform strategy consisting of two steps. The first step was to unbundle the fully integrated and centralized network by dividing the company into separate businesses: freight services, intercity passengers and metropolitan commuter rail. Freight services were partitioned into sub-networks, mainly, but not exclusively, according to geographical (old private railways) and track (gauge width) criteria. To run the suburban passenger services a new state-owned company Ferrocarriles Metropolitanos S A. (FEMESA), was created, but later authorities decided to split its services into seven lines, also according to the old existing private railway lines. The Buenos Aires metro (SBASE or more colloquially "Subte') would be included in one of the suburban rail lines. The second step was to offer the operations of the railways to private consortia through concessions. As a result of this strategy, most intercity passenger services were  -14- transferred to the Provinces because they were not commercially attractive. Provincial authorities were given the choice between running the passenger service and closing it down. How Was the Freight Network Unbundled and Privatized? 2.11 The freight network was partitioned into six sub-networks with a total track of 27,000 km. Each of the sub-network was then concessioned to private consortia Freight concessions remained vertically integrated: each concessionaire had to undertake all of the activities involved in railroad operations, from the improvement and maintenance of fixed facilities such as stations and rail track to the dispatching and mnovement of trains as well as marketing and financial control. Concessionaires were given the freedom to introduce new working rules and practices. 2.12 Freight concessions followed the single operator model and granted the concessionaire a monopoly to run the services during the life of the concession. FA would not be allowed to compete with the concessionaire, while concessionaires were not required to run passenger services. This single operator strategy meant that competition would not arise from several operators using the same track but from several potential operators bidding for the right to provide the service in isolation during the life of the concession. This unbundling strategy was chosen because of the complexity found in establishing the rules of operation in the previous attempt to unbundle the railways along horizontal lines. It was not the recommendation of any elaborate and comprehensive study of options but the result of historic inertia and political consensus. The political expediency required to carry out the reform was another factor that favored the choice of the vertically integrated option. 2.13 The main features of the freight concessions are summanzed in Table 2.1. Freight concessionaires are responsible for all operations and maintenance and for undertaking an investment program proposed by them in the bidding documents. Private operators must pay the State a 'fee" for the use of the rail infrastructure as well as a 'tent" for the use of the rolling stock. Operators have the option to run intercity passenger, but must allow access to the track to other passenger operators in exchange for a toll. This separation between freight and passenger services was decided because the freight business was not profitable enough to continue cross-subsidizing passenger operations. 2.14 Bids selection. The process of selecting bids for the freight concession followed a two- envelope system: Envelope 1 contained technical and financial qualification documents. Envelope 2 contained information on a set of criteria that would deterrnmine the concession winner among the technically and financially qualified bidders. Table 2.2 shows the criteria, and the weights attached to each criterion, that were used to select the wrining bids in the freight concessions. The Rosario- Bahia Blanca concession, the first freight concession awarded, used slightly different weights with the same criteria. It served as a test of the remaining concessions that followed. The largest valuation weight was assigned to the basic investment plan submitted by each bidder, followed by  -15- Table 2.1: Summary Features of the Freight Railway Concessions Length 30 years plus an optional 10-year extension Ownership The State remains the owner of the fixed facilities, including tracks and stations, and of the rolling stock. The concessionaires have to pay a 'See" for the use of the fixed infrastructure and a 'tent" for the use of the rolling stock received from FA Labor Concessionaires must hire FA employees but only those considered necessary; labor redundancy would be financed by the government Operations and All commercial operations are performed by the concessionaire, who is maintenance also responsible for the maintenance of track and rolling stock Pricing Although freight tariffs are deregulated, operators still need to file maximum rates for each commodity for approval by the Secretary of Transport Capital investments The concessionaire would undertake project-specific annual investments as proposed by them in the terms of the concession Financial performance The government will not subsidize the freight operators irrespective of their financial performance the projected quality of operations and the number of FA staff to be hired by the private concessionaire in its new operation. The points awarded for employment of FA personnel reflect a political compromise and the limited amount of money available for redundancy payments. The rationale for the last criterion is not straightforward. The emphasis placed on investments raises the nsk of non-compliance with the terms of the concession if the operator is not commercially successful. Table 2.3 summarizes the winning bids in each freight sub-network. Table 2.2: Bidding Criteria Used in the Railway Freight Concessions Criteria Points Weight Organization: Bidder's experience as railway operator; Key personnel; Business plan and profitability I to 10 23 Basic investment plan: money and quality of the investment plan I to 10 33 Additional investments: proposed by the concessionaire I to 10 5 Fee: to be paid to the government and rent for the use of rolling stock I to 10 10 Access pricing: Toll level required to allow passenger operations I to 10 5 Employment: Number of former FA personnel to be hired I to 10 15 Argentine presence: Total interest held by Argentine companies and their I to 10 9 decision-naking share in the concessionaire I I Source: Kohon (1994); annex E-l; page 83) Note the weights applied to the Rosario-Bahia Blanca concession were different (see Kohon (1994) Table E-l; page 30)  -16- Table 2.3: Winning Bids for the Railway Freight Concessions Bid Proposed Offers Canon Investments Demand Projections Personnel Sub-network Private US$ mill in Year 1 Year 15 (% hired Concessionaire No. US$ mill. first 15 years mill. tons mill. tons from FA) Rosario- Ferroexpreso Bahia Blanca Pampeano (FEPSA) 2 48.4 234 3.4 6.1 1,500 (5,163 km) (1-Nov-1991) (85___) Mitre Nuevo Central 2 33.5 386 4.2 7.9 2,322 (4,520 km) Argentino (NCA) (78%) (23-Dec-1992) San Martin Buenos Aires 2 36.4 369 2.9 4.7 2,271 (5,493 kin) al Pacifico (BAP) (83%) (26-Aug-1993) Urquiza Ferrocarril 1 2.8 64 0.9 1.9 1,255 (2,751 kIn) Mesopotamico (76%) (22-Oct-1993) Roca Ferrosur 1 18.0 173 2.7 6.4 1,133 (4,791 kim) Roca (86%) (12-Mar-1993) TOTAL 139.1 1,226 14.1 27.2 6,912 (22,781 km) (82%_ Source: Kohon (1994) Data are from winning bids when concessions were awarded. Takeover dates appear in parentheses under concessionaire's name. How Was the Metropolitan Commuter Network Unbundled? 2.15 The metropolitan suburban rail services and Metro (SUBTE) of Buenos Aires followed a model of unbundling and concessioning similar to the freight concessions. Seven suburban railway services were identified according to the different rail networks that existed in the 1940s befbre the creation of FA: Mitre, Sarmiento, Urquiza, Roca, San Martin, Belgrano Norte and Belgrano Sur. The urban rail service provided by the metro company was placed in a bidding package with the Urquiza line, whose end of line station is physically integrated with the terminal station of the B line of the underground. These services were then concessioned to the private sector. 2.16 The exercise of concessioning the underground metro service has unique features. There is no precedent in the world of using the concession approach for a loss-making underground mass transit system. The metro network has an extension of 37 km, and the premetro of 7 kms. The metro was owned by Subterraneos de Buenos Aires S E. (SBASE), a municipal company. The system is old and obsolete. Operations first started in 1913 and by 1950 most of the present network was already operating. It has been serving the Buenos Aires urban population which has grown from 6.7 million people in 1960 to over 12 million today. Although it steadily lost patronage since the early and rnid-1980s, it carried 143 million revenue passengers in 1993, which was the last year of public operations. When the decision to concession the metro was made, its system was in need of a complete infrastructure rehabilitation, including tracks, communication, signaling systems, escalators and cars. The investment needs were estimated to be around US$400 million.  -17- 2.17 What pnivatization model? The metropolitan railway concessions differ from the freight concessions in two aspects. First, while freight concessionaires were expected to make a profit and pay their fees and rents to the State, it was accepted from the start that suburban rail operations might need public financial support to operate the services, but most importantly, to undertake the much needed rehabilitation and investments in track and rolling stock. The Govemment identified for each line the amount and type of investments needed and the private operator was expected to undertake such program. Concessionaires would obtain much of their revenue from charging users an authorized fare and would pay a nominal fee to the Government for the use of the rail infrastructure. Table 2.4 summarizes the main features of the metropolitan railway concessions. 2.18 The second distinctive aspect was the criteria used to award metropolitan railway concessions. A three envelope model was used. Envelope 1 contained information about the technical and operating experience of the bidder, and was common to all bidders. Envelope 2A contained a detailed business and operating plan for the railway line in contention. Envelope 2B, also specific to each line, contained the financial proposal for the concession offered by the bidder, in particular the subsidy required from the Government to run the service. Concessions were then awarded on the basis of a single parameter: the lowest subsidy requested by the concessionaire to operate the line and undertake the specified investment and rehabilitation program. The lowest subsidy is measured as the first ten-year present value of the annual subsidy flow required to operate the line and undertake the investment plans, net of the annual flow of the fee (or 'banon') offered to be paid for the use of fixed assets such as track and stations. This method of awarding the concessions was more transparent, and probably induced a more rational behavior from potential concessionaires, than the method used for the railway freight concessions. Table 2.4: Summary Features of the Metropolitan Railway Concessions Length 10 years (20 years for the metro) plus optional 10-year extensions indefinitely; Ownership The State remains the owner of the fixed facilities, including track stations, and rolling stock. Labor Concessionaires will introduce whatever labor practices considered necessary to increase productivity. Labor redundancy would be financed by the government; Operations and All commercial operations are performed by the concessionaire, who is also maintenance responsible for the maintenance of track and rolling stock. The concessionaire pays a 'fee" for the use of the infrastructure. The government sets service levels (minimum frequency of service) and service quality for each concession. Pricing The government sets maximum fares which are subject to automatic increases according to the service quality achieved. Non-achievement of quality levels results in financial penalties; Capital investments The concessionaire would undertake project-specific annual investments as specified in the terms of the concession but financed by the government; Financial performance Each concessionaire bid on the basis of a business plan and annual financial results. The concessionaires pay a 'fee" to the government and receive a subsidy from the government, or not, depending on the financial outcome of their operations, which included a rate of return. Irrespective of the outcome from operations the concessionaire would quote the amount of money required to execute the investment plan defined by the government. 2.19 The bidding outcome. The characteristics of the successful bids for each sub-urban railway line are summarized in Table 2.5. Seven consortia subrmitted bids for each line and various  -18- packages combining two or more lines. The calls for bids were staggered; first, the Mitre, Sarmiento and Urquiza & SUBTE; second, the Roca and San Martin lines; and finally the Belgrano None and Belgrano Sur lines. The Metrovias consortia led by a construction company won the concessions to run the Mitre, Sarmiento, and Urquiza & SUIBTE concessions. The Trainmnet consortia composed of construction and railway equipment supplier companies, as well as 64 bus companies won the Roca, San Martin and Belgrano Sur concessions. The Ferrovias consortia, the winner of the Belgrano Norte concession represents several construction and rail equipment repair companies. The total amount of subsidy requested by the winning consortia amounts to slightly over US$1,000 million (June 1992 dollar value). Most of this amount is intended for capital investment an system upgrading as opposed to the subsidies received before privatization which tended to finance operational deficits mostly. How Were the Intercity Passenger Services Addressed? 2.20 In mid-1989, FA was operating intercity passenger trains with an aggregate level of service of approximately 15 million train-km per yeai. A 1991 study that examined the economic viability of these intercity passenger services concluded that the only corridor which was commercially profitable was Buenos Aires-Mar del Plata. Although the remaining services were not profitable, the study recommended to maintain services that had small losses but a high social justification. Table 2.5: Winning Bids for the Metropolitan Railway Concessions Canon (- or No. of Subsidy Proposed Expected bids Investments Demand Personnel US$ million Year I number of Line Concessionaire USS mill. in first 15 million people =_______ years passenger Mitre METROVIAS 3 84.1 221.2 57.8 1660 (182.1 Iam) Sarniento METROVIAS 3 (177.9) 193.2 93.6 1528 (166.6 krn) Urquiza METROVLAS 3 101.7 37.8 24.8 697 (25.6 km) (takeover 1-Jan-94) SUBTE METROVIAS 3 (438.4) 399.2 151.5 2129 (44.1 km) (takeover 1 -Jan-94) Roca TRAINMET 4 (70.0) 136.0 120.2 2062 (252.4 km.) (takeover l-Jan-95) _ San Martin TRAINET 4 (44.7) 62.7 54.9 867 (55.4 km) (takeover 1-Apr-94) Belgano Sur TRAINMET 3 166.1 43.8 13.5 788 (58.4 kin) (takeover 1-May-94) Belgrano Norte FERROVIAS 2 196.7 58.7 18.1 830 (51.9km) (takeover 1-Apr-94) TOTAL (182.4) 1,152.6 534.4 10561 (836.5 km) I _I I _ _ _ _ _ _ Source: Kogan & Thompson (1994) Data are from winning bids when concessions were awarded Note: the canon is the Argentinean label for the fee for the rental of infrastructure owned by the public sector  -19- 2.21 Given that the vast majority of intercity passenger services were not commercially attractive to the private sector, the Government finally decided in 1992 not to subsidize them any longer and offered the Provinces the option to continue providing the services but at their own expense. Most provinces rejected the Government's invitation. Provinces that agreed to the transfer were Buenos Aires, La Pampa, Tucumcin, C6rdoba, Salta, Rio Negro and Chubut. The transfers were done with concession agreements between the State and the Provinces whereby the State transferred the rolling stock and complementary equipment necessaiy to run the services. The Provinces agreed to subsidize these operation and run the services over the network concessioned to the freight and metropolitan private operators, and to pay a fee to these operators THE FIRST EFFECUS OF RAIL PRIVATIZATION 2.22 It is still early to tell if the private rail operators are more successful than the public operators were since it is orny possible to observe their performnance during the first year of operations. Some preliminary conclusions can be reached however Impact on Freight Services 2.23 Freight concessions in operation for more than a year, Ferroexpreso Painpeano and Nuevo Central Argentino, have been able to reach the level of tonnage carried by FA in 1990. This traffic recovery has also been achieved by two of the three other private concessionaires that have been in operation for only a year: Buenos Aires al Pacifico and Ferrocarril Mesopotamico (see Table 2.6). Only Ferrosur Roca has not been able to reach FA's 1990 level. Despite this traffic recovery, the level of traffic realized is considerably below the level of traffic projected with the only exception of Ferrocarril Mesopotamico. In addition, the oldest concession, Ferroexpreso Pampeano has not been able to improve much and has been finding difficulties associated with floodings and adverse market conditions. As a whole, the private operators are reaching an average 70 percent of the projected traffic and according to some estimates, actual revenues may be between 50 and 60 percent of expected levels. 2.24 What caused under-performance? The under-performance of freight operators is partly due to the strong competition from trucks. FA foUlowed the practice of setting the rates at 70 percent of the trucking rates. Private freight rail operators assumed that their improved service would allow higher rates without fully anticipating the likely response from truckers and the possibility that the demand would not materialize as expected. Ferroexpreso Pampeno (Rosario-Bahia Blanca concession), for example, has had losses during its first three years of operation due, among other reasons, to increased competition from trucks, delays in the privatization of the port of Bahia Blanca, and a drop in the international pnrce of grains. Even though the resurgence of the Argentinean economy is said to be changing substantially the pattem of production, the type of products carried by private rail operators does not seem to differ substantially from that carried before privatization. 2.25 The optimism in projecting demand levels, possibly induced by the bidding cnrteria used to award the concessions, may bear some responsibility for the gap between realized and expected traffic levels. For the freight concessions, the private consortia did not have to accept a pre-specified program of investments, unlike in the bid for the metropolitan railways. Instead, they had to identify investment needs and propose an investment program for the first 5 years. This would be  -20- compulsory to fulfill, but could be modified from the sixth year of operations if demand conditions warranted it. Nevertheless, the size of the net present value of the investment flow during the first 15 years of the concession had a weight of 0.35 in the bid evaluation criteria This criterion of selection undoubtedly may have induced the concessionaires to make demand projections and associated investment promises that were unrealistic but helped them obtain the concession. Table 2.6: Projected vs. Actual Railway Freight Volumes (in thousand tons) Ferrocarriles Argentinos Private concessionaire Railway (ach al) (Projected vs. actual) 1990 1991 Year 1 Year 2 Year 3 Ferroexpreso Pampeano 2,143 1,263 3,410 3,601 3,793 (takeover I -Nov-1 991) 1,804 2,351 2,479 (52.9%) (65.2%) (65.3o%) Nuevo Central Argentbno 3,310 2,533 4,214 4,542 4,870 (takeover 23-Dec-1992) 2,832 3,435 (67.2