The supply of ferry services: a policy assessment

Prepared for States of Jersey

June 2009

Oxera i Draft for Comment: Strictly Confidential

Oxera Consulting Ltd is registered in England No. 2589629 and in Belgium No. 0883.432.547. Registered offices at Park Central, 40/41 Park End Street, Oxford, OX1 1JD, UK, and Stephanie Square Centre, Avenue Louise 65, Box 11, 1050 Brussels, Belgium. Although every effort has been made to ensure the accuracy of the material and the integrity of the analysis presented herein, the Company accepts no liability for any actions taken on the basis of its contents. Oxera Consulting Ltd is not licensed in the conduct of investment business as defined in the Financial Services and Markets Act 2000. Anyone considering a specific investment should consult their own broker or other investment adviser. The Company accepts no liability for any specific investment decision, which must be at the investor’s own risk. © Oxera, 2010. All rights reserved. Except for the quotation of short passages for the purposes of criticism or review, no part may be used or reproduced without permission.

Executive summary

The States of Jersey commissioned Oxera to provide advice on the options available to ensure that the ferry services market can function in the best overall interests of the Island. This report sets out an analysis of the ferry services market, along with a set of policy recommendations for consideration by the States. During the course of this study, Oxera has benefited from discussion and information provided by Condor Ltd, which operates roll-on, roll-off services to the Island, as well as with the Economic Development Department of the States of Jersey, the Jersey Competition and Regulatory Authority, and the Jersey Harbours Authority. Oxera wishes to thank all those who have provided data and valuable comments during the course of the study. Objectives and approach to the study

The terms of reference for this report included the assessment of a number of policy options in relation to their ability to meet a set of objectives for the market identified by the States, which included:

– security of supply in the provision of passenger and freight services; – scope for competition in the market; – the net welfare impact on consumers; – the impact on the States of Jersey’s budget; – practical implementation.

The main options assessed are described in further detail below, and address the approach to licensing of operators, the scope for competition in the market, and options for preserving the winter service. Oxera has sought to estimate the likely cost of a ‘universal service obligation’ to provide a winter passenger service in the event that competition in the summer were to reduce the scope for covering the costs from summer profits.

In carrying out this assignment, Oxera has examined the main characteristics of the ferry services market (including passenger and freight) on both the northern and southern routes. In each case, a framework of analysis has been applied which seeks to identify whether competition in the market may be sustainable and desirable. This market analysis has been informed by a profitability assessment, the objective of which has been to identify to what extent the services currently provided cover their costs, in both the winter and summer operating seasons.

This study builds on work undertaken by Oxera in a review of the market in 2004. At that time, the main market characteristics were identified as the considerable fixed cost associated with ferry operations; low demand in winter relative to summer, and significant logistical constraints at the harbour. These and related features of the market led Oxera to conclude at that time that ‘open seas’ competition may have a destabilising impact, leading to significant price fluctuations and patterns of repeated entry and exit, and would raise concerns about the sustainability of the winter service. Recent developments in the market for ferry services

Since Oxera’s review in 2004, there have been a number of developments. In particular, the southern route has alternated between monopoly and competitive provision due to a pattern of entry and exit of operators on the route, most recently with HD Ferries announcing its (permanent) departure from the route in January 2009. These developments are largely

Oxera i The supply of ferry services: a policy assessment consistent with the projections made at the time of the Oxera report in 2004. Entry on the southern route has tended to lead to a pattern of lower prices, but this has not proved to be financially sustainable, and the market has reverted to a single supplier. No entry has materialised on the northern route. Market analysis

Revenue and cost data, where available, has been obtained for this study in order to review the profitability of ferry services.

On the northern route, Oxera’s modelling has identified that the expected market outcome would be a year-round monopoly, including both passenger and freight services. This reflects a set of market features, including the low level of winter demand and physical constraints to entry in the freight market owing to the capacity of the harbour and logistical issues. A further issue concerns the close interaction between the freight and passenger markets, given the need for back-up capacity for fast vessels which may not be able to run reliably during winter due to wave height limitations. These features imply the need for two daily services (of which one comprises largely empty containers) as a minimum level of service that an entrant would need to offer, and suggests that coordination would be required across firms were they both to split the existing services.

The modelling of the profitability of the route indicates that, while both the fast ferries and the conventional vessel cover their operating costs (in both winter and summer), once ownership costs associated with depreciation and the cost of financing the ferry vessels are taken into account, this is no longer the case for the winter period. Demand is higher in summer, and hence the profitability of the summer season is sufficient to cover ownership costs.

Looking at the year as a whole, the passenger and freight services appear to cover costs, with the summer surplus exceeding the winter loss.

If entry were to be feasible on the northern route, it is unclear what the outcome might be. The average pricing level might fall, and could therefore risk undermining the ability of the summer operation to cover the winter costs. In any event, the evidence on the route, where no new operators have requested licences despite the absence of any legal barriers to entry, is consistent with the findings that a monopoly outcome is the most likely sustainable market structure.

On the southern route from Jersey to St Malo, France, the results are somewhat less clear- cut, at least for the summer operation. Attempts at entry have been made, although these have not managed to establish a sustainable competitive outcome. According to the modelling exercise undertaken (using 2008 revenue levels), the profitability of the summer operation does not appear to be sufficient to cover ownership costs, let alone the costs of the winter service. The magnitude of these results depends on the treatment of the allocation of fixed costs to the different routes, and whether the market is examined on a ‘Channel Islands’ basis or is focused just on Jersey—although similar broad findings emerge, irrespective of these considerations.

In itself, this does not imply that a year-round monopoly on the southern route would be unsustainable, since fare levels and/or capacity utilisation under such an outcome would be expected to be higher. Indeed, there have been periods in the recent past when such an outcome has been realised. The evidence is therefore consistent with the perspective that the impact of entry may be to increase costs, while potentially reducing revenue per operator. Therefore, on balance, it is considered that the most likely long-term sustainable market structure for roll-on, roll-off services on the southern route is also a year-round monopoly provision. As is currently the case, passenger-only ferries will offer a degree of competition for those not travelling by car.

Oxera ii The supply of ferry services: a policy assessment

In summary, the following conclusions emerge from the market analysis.

– Winter competition does not appear likely to be financially viable in the longer term due to the limited demand for services during this period.

– Summer competition also appears unlikely to be viable due to the costs of additional capacity and the price reductions that are likely to arise as operators attempt to fill capacity. However, given the higher underlying demand, summer competition cannot be fully discounted as a possible market outcome, particularly on the southern route.

– The available evidence suggests that the northern route can cover costs on a year- round basis. This route is served by two fast ferries as well as a conventional boat primarily carrying freight, but also providing back-up passenger capacity. The evidence on the southern route is less clear (based on 2008 data), but this might be affected by yields having been depressed by competition. Earlier data indicates that the route could be sustainable if operated as a monopoly.

– There are important interactions between the freight and passenger markets. In particular, fast passenger vessels can carry some light freight, while the conventional ferry used to carry freight on the northern route provides back-up capacity for the passenger services. These interactions should be taken into account when considering the application of policy options.

– Although a formal assessment of the wider market for passenger and freight services has not been carried out as part of this exercise, it would appear that the ability of passenger ferry operators to increase prices might, to some extent, be constrained by the potential for consumers to switch to flights or fly-drive. While this may be seen as a viable substitute for a proportion of ferry users, it is unclear whether this would necessarily ensure that prices are kept to a competitive level.

– A similar issue applies in relation to constraints on freight pricing. Although detailed freight yields were not available for analysis for this study, it is likely that, for some types of freight (particularly lower-value and non-time-sensitive materials), alternatives to roll- on, roll-off services would act to constrain prices to some extent. It is less clear, however, to what extent this applies across other freight categories.

Policy options

In view of the above findings on the market, some options that might be adopted for the ferry services market are considered in the report, as follows.

– Option 1: non-exclusive licences, subject to universal service obligations (USOs). All operators wishing to provide ferry services to Jersey would be required to obtain licences. Licences would not be exclusive—in principle, the number of licences for each route would be driven by market considerations. Their critical function would be to ensure that any operators providing ferry services to the Island met minimum standards. These might include features designed to ensure a level playing field, either requiring minimum winter service backed by a performance bond, or a payment to cover a proportion of winter services.

– Option 2: licensed monopoly, with USO. The main distinction between this option and Option 1 is that the licence terms would specify either a monopoly service or, if this is deemed not to be compliant with States of Jersey policy, the standards for issuing licences could be set at a high threshold. In particular, this would seek to ensure that licences are awarded only where the impact on the winter service would be mitigated. In practice, therefore, this might converge closely with Option 1.

Oxera iii The supply of ferry services: a policy assessment

– Option 3: maintain status quo. All operators would be required to obtain car ferry licences in order to provide ferry services to and from Jersey, and these would be non- exclusive. Licences would continue to be awarded on the basis of demonstration of financial and operational capability to operate a year-round timetable with a predefined level of frequency on each route. This is similar to option 1, although in that case more specific mechanisms would be adopted to ensure that the winter service is sustainable.

– Option 4: licensed tendered monopoly. In this option, the contract to operate the two routes would be awarded to the chosen bidder through a competitive tender. While this process could take several forms, it would appear most likely that potential service operators would bid against the costs of operating a minimum set of standards, which would be clearly identified—including minimum services, quality, back-up capacity, fares policy, and financial resources. The States of Jersey could then ask bidders to bid the maximum price they would be willing to pay to operate the service. (Alternatively, if the net costs of the operation are negative, the bids may be assessed in terms of the lowest required subsidy.) The contract would have a specified duration (eg, 10–15 years) and would need to address aspects such as risk allocation between the operator, consumers and the States.

The tendered monopoly could include roll-on, roll-off services, both passenger and freight, given the interaction between them. This would allow separate services to provide some competition at the margin in both passenger (via passenger-only ferries) and freight (via load-on, load-off services).

– Option 5: separate licensed monopolies for the northern and southern routes. A variant of Option 2 would be to issue two separate exclusive licences—one in respect of each of the northern and southern routes—and to insist that these are held by different companies. This might be considered, for example, if there appeared to be few benefits to having a joint operator across the two routes and if separating the routes might enhance the prospects for competition.

Economic regulation

An important issue for consideration is what form of oversight, if any, the regulatory authorities should adopt. Options might include light-touch regimes, which would focus on ensuring compliance with licence conditions, and which could set out clear information requirements to allow for oversight or approval of pricing changes, through to more detailed options, which would require bottom-up analysis of costs and established price levels consistent with these. Any implementation of economic regulation would need to take into account several factors, including the degree of market power the operator is likely to have, the costs imposed by the regulations (which will ultimately be borne by consumers), and the capability of the existing authorities to carry out the role. Recommendations and conclusions

It is recommended that Option 1—non-exclusive licence with USO obligations—be pursued. This reflects the priority for securing the stable provision of ferry services, and recognises that selective competition could undermine the profitability of the year-round service. The licence could include features that increase the commitment to the winter service, such as a requirement to post performance bonds which would be forfeited if year-round obligations are not fulfilled, or requirements to contribute to the cost of the USO.

The States of Jersey may not wish formally to exclude the prospect of future applications for services which may be in the public interest; for this reason, Option 2—exclusive licences—is not recommended. It should be recognised that the choice of whether to issue exclusive

Oxera iv The supply of ferry services: a policy assessment licences would have some bearing on the approach taken to economic regulation, since the case for detailed price regulation is less strong in the presence of potential competition.

While there may be a case for tendering of services in order to introduce some competition ‘for the market’, there are two important practical features which limit the viability of this approach, at least for the next few years. Under the existing licence agreements, the notice period requirement limits the possibility of tendering the services until at least 2012/13. The second critical issue associated with the tendering option relates to the inter-Island nature of the routes. A tender cannot be issued for the existing services without the agreement of Guernsey to issue a joint tender. The States may therefore wish to consider holding the right to tender the services in reserve as a means of ensuring that licensed operators provide value for money.

There does not appear to be a strong case for Option 5, which would involve separate licensed monopolies on the northern and southern routes. While the market could be segmented in this way, there do not appear to be any strong competition or security of supply benefits in doing so. Furthermore, as noted above, the States of Jersey does not wish to formally exclude applications for new services, which would be implied by this option.

The case for increased regulatory oversight depends on the decision taken with respect to the market structure. If non-exclusive licences are retained, there is a weaker case for detailed regulation including setting of price caps based on forecast cost and demand data and this may risk undermining operators’ ability to cover costs over the life of the assets. If exclusive licences are granted, the case for increased regulatory oversight becomes stronger.

The precise structure of the regulatory oversight will need to reflect the fact that the costs of regulation to both the company and to the authorities will ultimately be borne by users and taxpayers. Oxera has presented the merits of a number of approaches, which range from those that are lighter-touch (eg, price monitoring) to more detailed, cost-reflective price caps. Given the size of the market, the case for imposing a significant regulatory burden is not strong since these costs would be likely to outweigh any potential welfare savings. At the same time, there is a case for more detailed information provision than currently exists in order to aid price monitoring.

It will nevertheless be important to ensure that the operator maintains some degree of operational and pricing flexibility to deal with changes in the market environment. Such changes could include developments in the competitive environment (particularly air services) as well as costs such as fuel costs.

The options which best meet the various requirements include price monitoring supplemented with enhanced information powers, price approval, or indexation. Each of these may be designed to provide some flexibility in terms of pricing structure for the operator, while providing the regulatory authorities with a means of action should the operator be considered to be engaging in excessive pricing.

Several features associated with a licence would need to be developed in detail, including the scope and frequency of services offered, licence duration and information provision. It is recommended that the States of Jersey develop a work programme to consider detailed options for each of these, informed by the market analysis and policy options identified in this report.

Oxera v The supply of ferry services: a policy assessment

Contents

1 Introduction 1

2 Market developments since Oxera’s 2004 report 3 2.1 Summary of Oxera 2004 recommendations 3 2.2 Recent developments in the routes to and from Jersey 4

3 What are the States of Jersey policy objectives for the ferry services market? 7

4 Framework for assessing the likely market outcomes and policy options available to the States of Jersey 9 4.1 Framework for the market analysis 9 4.2 Market modelling 11

5 Assessment of market outcomes and policy options 13 5.1 Northern route 13 5.2 Southern route 19 5.3 Conclusions on market structure 25

6 Assessment of policy options 27 6.1 Option 1: non-exclusive licences subject to USOs 27 6.2 Option 2: licensed monopoly, with USO 30 6.3 Option 3: maintain the status quo 32 6.4 Option 4: licensed tendered monopoly 33 6.5 Option 5: separate licensed monopolies for northern/southern routes 35 6.6 Regulatory options 36 6.7 Summary of policy and regulatory options 40

7 Conclusions and recommendations 43

A1 Description of modelling approach and results 45 A1.1 Methodology 45 A1.2 Southern route 50 A1.3 Northern route 54 A1.4 Findings 57

A2 Policy tools 59

Oxera The supply of ferry services: a policy assessment

List of tables Table 2.1 Chronology of entry and exit since 2004 5 Table 5.1 Profitability (£’000s)—northern route Jersey, per boat 16 Table 5.2 Southern route profitability (£’000s) 22 Table 5.3 Indicative southern route profitability (£’000s, 2006 revenue) 22 Table A1.1 Data sources 49 Table A1.2 Southern route profitability: small fast ferry (Channel Islands) (£’000s) 50 Table A1.3 Southern route profitability: large fast ferry (Channel Islands) (£’000s) 51 Table A1.4 Southern route profitability: large fast ferry (Jersey) (£’000s) 52 Table A1.5 Southern route profitability: small fast ferry (Jersey) (£’000s) 53 Table A1.6 Fast ferries (northern route) (Channel Islands) (£’000s) 54 Table A1.7 Fast ferries (northern route) (Jersey) (£’000s) 55 Table A1.8 Conventional vessel (Channel Islands) (£’000s) 56 Table A1.9 Conventional vessel (Jersey) (£’000s) 57

List of figures Figure 4.1 Winter assessment 10 Figure 4.2 Summer assessment 11 Figure 5.1 Three-month moving average of year-on-year percentage changes in demand for freight, passenger and car ferry services 13 Figure 5.2 Import and export volumes, 2008 (tonnes) 14 Figure 5.3 Passenger volumes—northern route 15 Figure 5.4 Winter assessment—northern route 17 Figure 5.5 Summer assessment—northern route 19 Figure 5.6 Foot passenger volumes on the southern route, 2008 20 Figure 5.7 Car volumes on the southern route, 2008 21 Figure 5.8 Winter assessment 23 Figure 5.9 Summer assessment 24 Figure A1.1 Model structure 46 Figure A1.2 Route map 47

Oxera The supply of ferry services: a policy assessment

1 Introduction

Oxera is pleased to submit this report to the States of Jersey Economic Development Department. The report presents the findings of a study commissioned by the Department to investigate the market structure of ferry services to and from Jersey, and to provide advice on regulatory structures that the States of Jersey may wish to set up to meet its policy objectives. The study achieves this as comprehensively as possible given the data constraints, particularly in relation to the freight market on the northern route to Portsmouth.

The study has considered the market structure and the likely dynamics of any entry into the ferry services market in light of the States of Jersey’s policy objectives, which are:

– to ensure security of supply;

– to promote competition, if possible;

– that any solution should:

– have a limited impact on the States’ budget; – be immediately practical; – have a positive net welfare impact.

Of these objectives, it is understood that the security of supply is of paramount importance, reflecting the status of the ferry services as providing a ‘lifeline’ to the Island in terms of both passenger and freight services.

The report is structured as follows.

– Section 2 summarises the findings from a 2004 Oxera report on the Jersey ferry services market and the main developments in the market since then.1 Accordingly, this section provides a setting for the rest of the report.

– Section 3 reviews the States of Jersey’s policy objectives as they relate to the ferry services market, in order to provide an understanding of the issues that need to be considered.

– Section 4 provides a conceptual framework for analysing how the characteristics of the various routes may require different policy options to achieve the States of Jersey’s policy objectives. It also describes the modelling approach adopted for this study in order to assess the market structure for ferry services on the northern and southern routes.

– Section 5 applies the conceptual framework to the northern and southern routes and discusses the likely market outcomes in the absence of any policy action. It also provides illustrative evidence on the cost of the ‘universal service obligation’—that is, to serve the Island with a year-round schedule, based on the modelling undertaken to identify the nature and extent of the costs of providing ferry services.

– Section 6 discusses the options available to the States of Jersey to achieve its policy objectives. This section includes a discussion of the costs and benefits of price

1 Oxera (2004), ‘Viability of Ferry Services to and from the Island of Jersey’, July.

Oxera 1 The supply of ferry services: a policy assessment

regulation more generally, as well as a discussion of some of the practical considerations which may be relevant in assessing any particular regulatory options.

– Section 7 draws conclusions on the likely market outcomes and the dynamics of entry, and presents recommendations on policies that will assist the States of Jersey in meeting its policy objectives.

– The modelling assumptions, approach and results are presented in Appendix 1, while Appendix 2 provides further detail on the nature of some of the policy tools available to the States of Jersey to ensure a secure ferry service.

Oxera 2 The supply of ferry services: a policy assessment

2 Market developments since Oxera’s 2004 report

This section summarises the market structure in 2004 and Oxera’s recommendations at that time, before describing the developments in the market structure of the northern, southern and inter-island routes since the 2004 report.

2.1 Summary of Oxera 2004 recommendations

In 2004 the States of Jersey Harbours and Airport Committee commissioned Oxera to review the ferry services market and to assess policy options available to the Committee. A number of recommendations were made in relation to how the Committee might best preserve a secure service. 2 The principal reason for commissioning the study was that the ramp permits for ferry operators (which set the main obligations on the providers of ferry services to Jersey) were due to expire.

The demand for passenger and car ferry services was found to be driven largely by tourists (including tourists visiting Jersey and Jersey residents going on holiday) and was therefore highly seasonal—at its peak in August, with an estimated ten times more foot passengers and cars than in winter. The ferry services market had substantial sunk costs in purchasing vessels, high fixed costs in running services, and low marginal costs per passenger.3

When the 2004 report was drafted, Condor Ferries was a monopoly provider on the northern route. There was already competition between Condor Ferries and Emeraude Jersey Ferries on the inter-island route, and Condor had just enhanced its services on the southern route to include the transport of private vehicles.

Operators had to obtain ramp permits in order to provide services in the market. These permits fixed certain standards through a service-level agreement (SLA), which included clauses such as the minimum number of required trips per week in winter. The permits were restricted to the control of vehicular use of the ramps up until the change in law in 2007, when the Harbour Master gained the power to require any commercial port or shipping services to have a permit.4

Given the market characteristics, structure and legal requirements in 2004, Oxera examined the implications of a number of ferry services market structure options to inform the States of Jersey and its various committees, enabling the policy-makers to come to a decision on how to set the new ramp permits, while ensuring viable ferry services. These options included:

– non-tendered monopoly for the northern and southern routes; – open seas without quality regulation or with SLA; – tendering exclusive rights for a route, for the whole year or part thereof, including an SLA; – shared provision of services in winter with competition in summer.

Of these, Oxera put forward recommendations for those that would help ensure the policy objectives, identified by the study through consultations with stakeholders. The main conclusion was that some form of licensing was required to ensure that a year-round service

2 ‘With the retirement of the Harbours and Airport Committee in December 2005, the newly appointed Economic Development Minister will be politically and legally accountable for Jersey Harbours.’ Jersey Harbours (2006), ‘Business Plan 2006–2008’, p. 7. 3 Oxera (2004), ‘Viability of Ferry Services to and from the Island of Jersey’, July. 4 Ramp Permit Legislation—Amendment (MD-E-2007-0012).

Oxera 3 The supply of ferry services: a policy assessment

was sustainable and to reduce regulatory, political and viability risks for the States of Jersey and the providers.

The conclusion that a licence was necessary in this market was informed by the finding that a policy of open seas without an SLA would be likely to lead to disruptive entry and exit in the market. In principle, an effective open seas policy would lead to entry and result in competition between the operators, leading to reduced prices. However, given the high fixed costs of entry and service, the decrease in price would in turn be likely to result in the exit of some of these providers, risking supply disruption and price volatility.

The report found that, in addition to the cost structure and demand patterns noted above, constraints on access to the harbour, driven by tidal patterns and port capacity, could constitute a barrier to effective entry. This is because the scope for entrants to devise optimised timetables would be limited, further constraining the demand levels that entrants could sustain over time.

Finally, the report identified that competition on ferry routes had rarely been sustainable in the past and, therefore, a policy option that would lead to competition with no restrictions would not be the optimal policy. Consequently, two methods of implementing licences that would allow for a sustainable market structure were suggested.

– Through an auction process, in which prospective operators bid for exclusive licences for a number of years on either the northern or the southern route, or on the route network with the price to consumers being used as the main decision criterion. The auction would need to include some form of SLA and would be open to the possibility of having a period of open seas in summer on the southern route if demand were to be greater than capacity, since one of the objectives was that capacity should meet demand.

– With a non-exclusive licence, which would:

– define the SLA required from each provider and would need to include mechanisms to allocate ramp capacity to new entrants;

– deal with potential monopoly pricing if effective competition failed to emerge or remain sustainable; and

– enable efficient cooperation between providers in order to satisfy winter capacity/service requirements.

Oxera also recommended removing the requirement for ferry companies to have a back-up ferry in case of problems and to change the supervision of ferry services market licensing from the Harbours and Airport Committee to the Jersey Competition Regulatory Authority (JCRA).

2.2 Recent developments in the routes to and from Jersey

Since 2004 there have been changes in both the legal environment and the market structure for ferry services to and from Jersey, particularly on the southern route.

The ramp permits, which constitute the legal framework for ferry operators to offer services, have been modified several times. In 2006, they included an SLA for the northern route only.5 In 2007, the permits were amended to address the problem that the legislation was ‘too limited for the purpose of controlling market access to passenger services’, that it was ‘restricted solely to control of vehicular use of the ramps’ and that SLAs were not ‘legally

5 Boleat, M. (2006), ‘Jersey Ferry Services—Report for the Jersey Consumer Council’, September, section 3.

Oxera 4 The supply of ferry services: a policy assessment enforceable as part of the ramp permit permission process’.6 There were further changes in 2008: the latest permit, which has been active since May 6th 2008,7 includes SLAs for both northern and southern routes.8

The 2008 permit is now called a ‘car ferry permit’, although it is ‘in effect, identical to previous Ramp Permits’.9 This is a ‘broader-based ferry permit that is issued to an operator for the use of certain facilities or for the provision of services.’10

The current services provided by the operators under the car ferry permit are subject to States of Jersey policy, as defined in the Notice under Regulation 5(6)(a) of the Harbours Regulations 1962 and MD-E-2008-0088. This regulation establishes certain objectives for the Harbour Master, such as setting the SLA and the standards under which providers can operate. The standards stipulate that the operators should have year-round, long-term and robust passenger car ferry services.11

There have been no relevant changes in the market characteristics for either of the routes (discussed in section 5), and no important changes in the market structure for the northern route. However, there have been changes in the way competition between providers has developed on the southern route since 2004, as summarised in Table 2.1.

Table 2.1 Chronology of entry and exit since 2004

Market Date Entry/exit structure Ferry operators 2005 None Competition Emeraude Ferries and Condor Ferries Emeraude Ferries suspends December 2005 services Monopoly Condor Ferries 2006 None Monopoly Condor Ferries March 2007 HD Ferries enters Competition Condor Ferries and HD Ferries October 2007 HD Ferries suspends services Monopoly Condor Ferries March 2008 HD Ferries restarts services Competition Condor Ferries and HD Ferries September 2009 HD Ferries suspends services Monopoly Condor Ferries January 2009 HD Ferries exits Monopoly Condor Ferries

Source: Drewry Shipping Consultants (2008), ‘Investigation into the Availability and Supply of Shipping Services’, September; and HD Ferries website.

Emeraude Ferries exited the market in December 2005 (initially for a few months),12 before confirming its complete exit from the market in May 2006.13 This put Condor Ferries into a monopoly position on both the northern and southern routes during most of 2006 and part of 2007.

6 Ramp Permit Legislation—Amendment1, MD-E-2007-0012. 7 Economic Development Department (2008), ‘Ministerial Decision MD-E-2008-0088’, Decision Summary, April 30th, p. 1. 8 Jersey Harbours (Administration) (Jersey) Law 1961 as amended (2008), ‘Combined Car and Passenger Ferry Permit Applications’ (‘Car Ferry Permits’). 9 The legislation was amended in 2007: Ramp Permit Legislation—Amendment (MD-E-2007-0012). 10 Economic Development Department: Strategic Development (2008), ‘Response to Oxera Information Request’, November, p. 1. 11 Economic Development Department (2008), ‘Notice under Regulation 5(6)(a) of the Harbours (Jersey) Regulations 1962’, combined passenger and private vehicle car ferry services, paragraph 1. 12 Jersey Consumer Council (2006), ‘Ferry Services to and from the Channel Islands—A brief review’, October, p. 9. 13 Drewry Shipping Consultants (2008), ‘Investigation into the Availability and Supply of Shipping Services’, September, p. 5.

Oxera 5 The supply of ferry services: a policy assessment

However, in March 2007 HD Ferries entered the southern route.14 This period of competition did not last long; HD Ferries did not operate a year-round service on the southern route, despite the clause in the ramp permits requiring it to provide services in both the summer and winter. In winter 2007/08 its ferry had technical problems and could not operate; in the following winter it cancelled its operations again (at short notice), although this time it gave the reason that ‘the general economic slowdown coupled with high fuel costs [had made] the continued operation of services through the Autumn and Winter seasons economically unsustainable.’15 On January 16th 2009 HD Ferries announced that it would not resume services, leaving Condor as the sole operator on the southern route, citing the following reasons:

the simple truth is that not enough people are able to travel as often as would be necessary to make the service viable. HD Ferries is privately funded and does not enjoy any special privileges such as those from which our competitor benefits and so, with little prospect of generating a reasonable return on investment in the foreseeable future, we have taken the difficult decision not to resume services.16

The statement that certain providers benefit from special privileges has been denied by Jersey’s Economic Development Department.

This pattern of entry and exit is largely consistent with the findings of the Oxera 2004 report. The report identified that the fixed-cost nature of the ferry business suggested that, were entry to occur, the likely outcome would be a period of reduced fares, but that these would be unlikely to cover the overall costs of operation.

The evolution in this market indicates that, consistent with the conclusions of the 2004 report, a number of important risks would be associated with an open seas policy—in particular, the risk of disruptive entry and exit in the market. While competition has occurred during some periods of time on the southern route since 2004, this does not appear to have led to a sustainable outcome. Furthermore, the entry which has occurred focused on summer operation, which could raise further concerns about the sustainability of the year-round service (ie, the services in winter, when there is little demand).

14 See HD Ferries’ website: http://www.hd.ferries.org/?gclid=CKW3vJW5iZgCFQ5YQgod6SidJg. 15 HD Ferries (2008), ‘HD Ferries Ends Summer 2008 Service Early Owing to High Fuel Costs and General Economic Slowdown: Plans to Resume in Spring 2009’, press release, September 3rd. 16 HD Ferries (2009), ‘HD Ferries Announces it Will Not Resume Services in 2009’, press release, February 16th.

Oxera 6 The supply of ferry services: a policy assessment

3 What are the States of Jersey policy objectives for the ferry services market?

This section identifies the desired and feasible objectives for the ferry services market in Jersey. These objectives form the basis for the criteria against which any potential policy options may be assessed.

– Security and continuity of supply—this objective is of vital importance for Jersey. In a policy statement, Jersey and Guernsey expressed their common aspiration to ‘maintain and develop year-round, long-term, reliable, robust and reasonably priced passenger car ferry services’.17 Jersey considers that the minimum frequency of services provided during the winter period should be three rotations per week, as is currently stated in the ramp permits.18 Throughout the study, and consistent with discussions with the States of Jersey, Oxera considers this to be the critical policy requirement to take into account.

– Competition (if feasible)—to the extent of being feasible, a competitive outcome would be preferred over one that requires detailed regulation: ‘The islands will maintain the option to further develop local competition law or increase the use of regulatory authorities rather than direct government intervention should this prove necessary.’19

– Limited budget impact—Oxera understands from discussions with the States of Jersey that the preferred policy option would be one that has the least impact on its budget.

– Immediate practicality—the States of Jersey would like to be able to implement the appropriate policy option relatively quickly in order to provide policy certainty, given the market outcome. For example, one option which might be considered—such as tendering of services—would be subject to timing constraints given the existing contract terms and policy commitments.

– Positive net welfare impact—the combination of the market outcome and the policy options should result in a positive net welfare impact.

From the above set of objectives, it appears that a range of trade-offs may need to be taken into account, and that the range of policy options that may be considered desirable depends on the underlying market characteristics. In particular, the objectives of competition and security of supply may conflict with each other. This has been recognised by both the States of Jersey and Guernsey, and is explained by the fact that the current winter provision of passenger and car ferry services does not appear to break even on a stand-alone basis:

Policy aims can conflict with each other: A low priced fare may be bought with a consequently lower quality or less reliable service. The guarantee of a robust service (such as an all-weather conventional ship available at the same time as a fast ferry) comes at a price. Unrealistically low fares, high capacity and frequency may result from

17 States of Jersey and States of Guernsey (2008), ‘Channel Island Passenger Car Ferry Sea Transport Policy Statement’, January 17th. 18 Economic Development Department: Strategic Development (2008), ‘Response to Oxera Information Request’, November, p. 7. 19 States of Jersey and States of Guernsey (2008), ‘Channel Island Passenger Car Ferry Sea Transport Policy Statement’, January 17th.

Oxera 7 The supply of ferry services: a policy assessment

competition but be impossible to sustain in the long term. Both islands recognise this inevitable, and to some extent insoluble, dilemma.20

Section 4 presents a conceptual framework for assessing the likely market outcomes on each route to and from Jersey. The analysis of these outcomes is supported by a quantitative analysis per route.

20 States of Jersey and States of Guernsey (2008), ‘Channel Island Passenger Car Ferry Sea Transport Policy Statement’, January 17th.

Oxera 8 The supply of ferry services: a policy assessment

4 Framework for assessing the likely market outcomes and policy options available to the States of Jersey

In addition to presenting a conceptual framework for analysing the likely market outcomes, this section describes the market modelling undertaken to identify the extent to which the winter ferry services may impose a net cost which must be supported by alternative means. 4.1 Framework for the market analysis

The aim of the framework is to understand the drivers of the market outcomes that may arise in Jersey. Oxera has analysed whether there are differences in the market conditions between the summer and winter periods that may affect the number of operators that can profitably operate in the market. Furthermore, different market conditions may exist on the northern and southern routes and in the passenger, car and freight markets. All these elements must be taken into account to infer what the market structure is likely to be.

The framework developed consists of four steps, which are analysed independently for the northern and southern routes, and account for the difference in freight traffic on those routes.

Step 1 Analyse whether competition is viable and desirable during winter. Step 2 Analyse whether, given the outcome of step 1, summer competition is viable. Step 3 Identify the likely market outcomes which would be expected to arise on each route. Step 4 Assess the policy options available to Jersey for supporting the market outcome and analyse which provide the closest match to Jersey’s policy objectives.

Steps 1 and 2 are illustrated in Figures 4.1 and 4.2 below and are further analysed in section 5. The reason for starting the analysis by asking what the likely outcome is for the winter season is as follows: if winter competition were viable on a stand-alone basis, there would be no need to be concerned about entry and competition in the summer because no cross- subsidy would be required from the summer to the winter season.

There are two main questions, analysed in both step 1 and step 2, which need to be answered when considering the likely outcomes in the market: is a particular market structure viable, and, if so, is it desirable?

The term ‘viable’ refers to the financial sustainability of the ferry operators under either competition or monopoly market structures—ie, whether the outcome of the market would enable the operator to cover its full costs over time. However, even though a competitive outcome may be sustainable for a period of time, it may be that it is not deemed ‘desirable’ for other reasons—for example, if competition led to increased costs (due to the requirement to cover the additional fixed costs of ferries used in the provision of services).

Oxera 9 The supply of ferry services: a policy assessment

Figure 4.1 Winter assessment

1 yes 2 yes Competition Competition Winter competition viable? Can more than two firms desirable? operate profitably during the winter season? For example, because the market For example, because of is a natural no no the ‘impact on the monopoly and/or long-term cost base’ margins are unattractive for competitors

3 no No winter services Is winter provided monopoly For example, (non-desirable outcome) viable? because services are not profitable, even for a monopoly yes

Winter Winter monopoly monopoly (subsidised)

Decision Outcome What happens in the summer?

Source: Oxera.

The assessment in Figure 4.1 suggests three different market outcomes: winter competition, financially sustainable winter monopoly, and subsidised winter monopoly. Only in the last case is the outcome of the summer period relevant because, without taxpayer subsidy, a continued service throughout the year would require a transfer from the summer to the winter period or from the freight operation to the passenger operation. To gain a clearer understanding of the range of options to support the winter service in such a scenario, the second step in the framework requires an assessment of the market for each route in the summer period (see Figure 4.2).

Oxera 10 The supply of ferry services: a policy assessment

Figure 4.2 Summer assessment

For example, because prices are stable and driven by competition, there is scope for service innovation, benefit of summer competition is higher than 4 yes 5 cost of funding, etc Step Competition Competition Summer competition 1 viable? desirable? yes Winter monopoly

For example, because the If competition in market is a natural summer is strong, monopoly and/or there are no no service in the winter barriers to entry could be compromised (eg, high price, volume risk)

no 6 No provision of Is summer summer services monopoly viable?

yes

Joint summer–winter monopoly Decision Outcome

Source: Oxera.

The summer analysis also suggests three market outcomes: summer competition and winter monopoly, no provision of services (without further financial support), and joint summer–winter monopoly. Given that the analysis of the summer is relevant only when the winter monopoly is not viable on its own, it is logical that all outcomes in summer are considered alongside a subsidised monopoly in winter.

The analysis is applied in section 5 to both of the northern and southern routes.

4.2 Market modelling

A modelling exercise has been undertaken to help understand the sustainability of ferry services to and from the States of Jersey. This has assessed the profitability of ferry services at different times of the year on the northern and southern routes, based on an assumption that the existing level of service is continued. The purpose of the modelling is to inform both the assessment of the potentially viable market structures, as well as to understand whether it is likely that policy intervention may be required to support the continued provision of services.

For example, in the event that the financial viability of the winter operation is in question, the model could broadly illustrate the level of support from cross-subsidies (eg, from the operators’ freight activities, summer operations, or profits on other routes to Jersey) that may be required to support a given operation. Alternatively, it might provide an indication as to the contributions that prospective entrants would need to make in order to engage in summer operations.

It is important to understand the potential implications of such a conclusion: if the winter services require some support to continue operation, and this is not provided either explicitly or implicitly, the service may cease—thereby endangering the security of supply to the Island during the winter.

Oxera 11 The supply of ferry services: a policy assessment

The approach of the modelling exercise was as follows.21

– The cost of running the services for the existing timetable operated by Condor Ferries was estimated (costs included in this phase of the modelling are: staff costs, fuel costs, harbour dues, other operating costs including maintenance, spares, lubricants, etc). – Revenue was then estimated on the basis of demand and yield data provided by Jersey Harbours and Condor Ferries for foot passengers, car passengers, light freight (such as trade cars), and heavy freight. – An indication of the extent to which the operations covered running costs was identified as the difference between the estimated revenue and operating cost. – A contribution to the onshore fixed costs and the marketing of the services, depreciation of the vessels and the cost of capital are taken from this operational profit to estimate the ownership profit.

The route structures and vessels used are assumed to be similar to those in operation during 2008—ie, the southern route between the Channel Islands and St Malo uses one small, fast ferry, while there are two large fast ferries and a conventional vessel in operation on the northern route—ie, between the south coast of the UK and the Channel Islands. The operation of one the large fast ferries on a route that runs from the UK to St Malo via the Channel Islands is also modelled, as is the use of one of the large fast ferries on a route between the UK and Cherbourg. The operation of the freight-only vessel is not considered here (due to the lack of data on the vessel). The conventional vessel in operation is modelled; however, due to the lack of freight data to which Oxera has had access, the profitability of this vessel is dependent on the assumptions that have been made, and so any conclusions drawn should be treated with caution. Following consultation with Condor Ferries, it is assumed that no passengers travel on the conventional vessel due to the long journey times and inconvenient time of arrival and departure.

Ownership costs (such as marketing and contribution to fixed costs) are allocated on the basis of the number of journeys scheduled to be made on a particular route in 2009. This results in a substantial proportion of the costs being allocated to the southern route, due to the high-frequency nature of the service on that route. Operational costs are allocated to the vessel which runs the route; where that route spans both the northern and southern routes, the costs are allocated equally between the two routes in order to obtain separate profitability figures for the northern and southern parts.

Oxera does not have access to the number of passengers or quantities of freight on any specific vessel and so has had to make assumptions about how to allocate the revenue between the vessels. This allocation does not affect the total amount of revenue on either route, but does affect the profitability of individual vessels. The assumptions are given in more detail in Appendix 1, and are as follows: 50% of passengers on the northern route travel on each of the fast vessels, with no freight and 6,000 lane metres of light freight travelling on each fast vessel; and 40% of freight travels on the conventional ferry, with the remaining 60% travelling on the freight-only vessel.

The profitability analysis conducted for this report provides only an indication of the actual profitability. While every effort has been made to ensure that the analysis is accurate, there is insufficient data to reach definitive conclusions, particularly in relation to the freight aspect of the market. As such, the figures provided here should be regarded as illustrative, until a full profitability analysis can be conducted.

A more detailed description of the modelling approach, assumptions and results is contained in Appendix 1.

21 The main sources of data for the modelling were the Drewry Shipping Consultants report; data provided by Jersey Harbours; yield data from Condor for passengers; and publicly available data on the cost of shipping freight. Drewry Shipping Consultants (2008), ‘Investigation into the Availability and Supply of Shipping Services’, September.

Oxera 12 The supply of ferry services: a policy assessment

5 Assessment of market outcomes and policy options

This section analyses the main trends in the overall market for ferry services before examining the northern and southern routes in detail. Some aspects of the market are common to both these routes, as discussed below.

Figure 5.1 presents a three-month moving average of year-on-year growth in total passenger and freight demand. This indicates large year-on-year changes, particularly in the passenger market.

Figure 5.1 Three-month moving average of year-on-year percentage changes in demand for freight, passenger and car ferry services

50

40

30

20

10

0

-10

-20 % % changeon a year 3-monthearlier, movingaverage -30

-40 January 2002 January 2003 January 2004 January 2005 January 2006 January 2007

Freight Passengers Cars

Source: Jersey Harbours.

This graphical analysis has been supplemented by a more formal statistical analysis, where the seasonality is removed from the data and the remaining trend is examined. While the trend in freight and cars over time is broadly stable, the number of passengers has tended to decline on average through the period. 5.1 Northern route

5.1.1 Route assessment The northern route provides a ‘lifeline’ service to the States of Jersey through the provision of freight services to and from the Island. The security and continuity of these services is of paramount importance to the States of Jersey.

As noted in Oxera’s 2004 report, the passenger market is determined primarily by leisure travel and is highly seasonal, whereas freight traffic is more stable throughout the year. However, the level of imports throughout the year is significantly greater than that of exports,

Oxera 13 The supply of ferry services: a policy assessment as shown in Figure 5.2. This leads to a pattern of operation in which there are substantial movements of empty containers between Jersey and Portsmouth.

Figure 5.2 Import and export volumes, 2008 (tonnes)

35,000

30,000

25,000

20,000 Tonnes 15,000

10,000

5,000

- January February March April May June July August September October November December

Import Export

Source: Jersey Harbours.

Freight on the northern route is carried on two types of vessel: roll-on, roll-off (ro/ro) and load-on, load-off (lo/lo) ferries. The two types of service are distinguished by a number of features.

– Ro/ro services are more frequent (twice per day, rather than three times per week).

– Lo/lo services require goods to be packed into containers, which adds significant time to the logistics chain.

– The two types of service use different parts of the port due to the various facilities required for the different types of vessel.

– The two types of vessel are used for different types of freight, with ro/ro services being used for time-critical or refrigerated services, while lo/lo services are used for building materials and other bulky freight.22

In 2007, 67% of freight (by weight) travelled by ro/ro, a proportion that has not changed substantially over time.23 In a 2006 report on the merger between Ferryspeed/Channel Express, the JCRA noted that ‘despite the lower prices for lo/lo compared to ro/ro, evidence of customers switching from ro/ro to lo/lo appears to be limited.’24 This finding reflects the fact that the two types of freight service have substantially different characteristics in terms of

22 Jersey Competition Regulatory Authority (2006), ‘Decision M 005/05 Ferryspeed (C.I.) Limited/Channel Express (C.I.) Limited’, p. 10. 23 Data provided by Jersey Harbours. 24 Jersey Competition Regulatory Authority (2006), ‘Decision M 005/05 Ferryspeed (C.I.) Limited/Channel Express (C.I.) Limited’, p. 11.

Oxera 14 The supply of ferry services: a policy assessment loading times, transport speed, and refrigeration. This tends to suggest that there are some limits to the ability of the lo/lo services to constrain any market power that may exist in the ro/ro market.

A comparison of Figure 5.2 with Figure 5.3, which presents passenger volumes, shows that the freight business is much less cyclical than the passenger business. This makes cherry-picking any of the freight business less feasible.

Figure 5.3 Passenger volumes—northern route

45,000

40,000

35,000

30,000

25,000

20,000

15,000 Number of passengers/cars

10,000

5,000

- January February March April May June July August September October November December

Passengers Cars

Source: Jersey Harbours.

There are a number of important factors that need to be taken into account when considering the appropriate structure for the northern route to Jersey. These include the fact that many services from the UK also stop at Guernsey. This implies that any analysis of route profitability needs to reflect revenues from (or allocate costs to) services for Guernsey passengers.

A second issue relates to the interaction between the different types of vessel that operate on the route, namely fast passenger vessels (which can carry some light freight) and the conventional vessel (which primarily carries freight but can take passengers if required). Any requirement that the operator of the passenger/car service has the option to operate services in conditions when the fast ferries cannot operate (eg, beyond their wave height and wind speed restrictions) means that there are economies of scope between the operation of the freight service and the passenger/car service. Alternatively, the requirement for back-up capacity could be dealt with through a contract with the owner of the conventional vessel.

In addition to the scope economies identified above, the market for freight on the northern route and physical elements that are unique to Jersey provide a number of barriers to entry into the market. This corresponds to the JCRA’s finding that entry into the market for freight is unlikely.25 These barriers include the relatively small size of the Jersey economy; the

25 Jersey Competition Regulatory Authority (2006), ‘Decision M 005/05 Ferryspeed (C.I.) Limited/Channel Express (C.I.) Limited’.

Oxera 15 The supply of ferry services: a policy assessment

limited physical space available for storage of containers within the port at St Helier; and the time-limiting aspect of the tides, which affect the number of vessels that can use the harbour at St Helier.

The relatively small amount of space available to store containers and trailers in Jersey implies that an entrant would need to coordinate its timetable with an incumbent to avoid a build-up of trailers, and/or offer two services per day to remove the empty containers. Offering two freight services per day is unlikely to be possible without having two boats available that are capable of carrying heavy freight. In combination with the relatively small size of the Jersey economy, the introduction of such a large amount of extra capacity is likely to result in fierce price competition, which would in turn eventually result in the exit of one company from the market and the return of higher prices.

This cyclical effect, when combined with the vertical integration of the incumbent operator— which means that there is an element of the market that would not be contestable by an entrant—implies that the incumbent operator is well placed to retain its position. The requirement to have a back-up vessel (in case of technical problems with the fast ferries) adds to the entry barriers, in requiring more capital to be invested before an operator will be granted a ferry permit. This reduces the likelihood that a competitor will enter the market, as this investment increases the risk of entry. These barriers to entry suggest that sustainable competition between operators for the northern route, from Jersey to the south coast of England, is unlikely to occur. On the other hand, they do not imply that the incumbent operator is abusing any market power that it may have.

5.1.2 Route modelling The outcome of the market modelling approach (as described in section 4.2) is summarised in Table 5.1. Further details on key assumptions, the approach, and outcomes are provided in Appendix 1. Note that the results presented are purely illustrative, given that a number of assumptions have been required in the absence of access to some commercially sensitive data, particularly with regard to freight yields.

Table 5.1 Profitability (£’000s)—northern route Jersey, per boat

Operational profit Ownership profit1 Ownership profit2 Winter (5 months) Conventional vessel 1,334 435 –859 Fast vessels 600 60 –660 Summer (7 months) Conventional vessel 3,218 1,960 147 Fast vessels 3,481 2,725 1,716

Note: 1 Includes depreciation of the cost of the vessel on a straight-line basis over 20 years for the fast vessels and 25 years for the conventional vessel. 2 Includes depreciation and the cost of capital, which has been calculated by annualising the cost of the vessel over its lifetime, including an assumed 10% required rate of return. Source: Oxera analysis.

The fast vessels do not operate for substantial periods during the winter season, possibly because of the weather or insufficient demand. However, the operating profits are positive and, hence, running these vessels covers their average variable costs and makes a contribution towards the fixed costs. However, when the depreciation and cost of capital of the vessels is taken into account, the fast ferries make a loss over the winter period. In the summer, the fast vessels make a profit, even after allowing for depreciation and the cost of capital, which implies that the current service levels during the summer months are sustainable. However, this does not necessarily imply that entry into the market in the summer only would be profitable since it is uncertain to what degree the entrant would generate new revenue compared with abstracting revenue from the incumbent operator. This

Oxera 16 The supply of ferry services: a policy assessment

split of revenue would depend on the pricing of the entrant, and how passengers respond to changing prices.

Over the course of a year, the profit in the summer appears to cover the losses in the winter, even when an allowance is made for the cost of capital, with a margin of around £1–£2m when allowing for the use of the two fast vessels. This suggests that a northern route passenger monopoly is sustainable. However, the degree of this margin may be sensitive to changes in parameters such as average yields and fuel costs. Furthermore, the costs do not include any payments which a passenger operator may need to make in relation to the provision of back-up capacity, should this be required.

While the modelling does not demonstrate that the conventional vessel covers ownership costs on a year-round basis, this may reflect uncertainty about freight yields owing to data limitations. Furthermore, the modelling does suggest that the combined operation of the passenger and freight service on the northern route is likely to be profitable at current pricing levels and volumes on a year-round basis. However, the winter operation would be at risk if it were required to operate as a stand-alone business.

5.1.3 Summary of likely market structure

Winter Based on the above analysis, the most likely outcome during the winter on the northern route is a single monopoly supplier of ro/ro ferry services for both passengers and freight. This is consistent with the conclusions reached by other analyses—for example, the JCRA noted that the entry barriers are sufficiently high to make entry into the market unlikely.26 Figure 5.4 applies the conceptual framework developed above to the northern route.

Figure 5.4 Winter assessment—northern route

1 2 This outcome requires less yes yes Winter competition Competition Competition policy action but is highly (unlikely outcome) viable? Can more than two firms desirable? unlikely operate profitably during the winter season? For example, For example, because the Requires funding to sustain no no because of market is a winter (monopoly) ‘destructive natural operations competition’ monopoly Funding options required to and/or margins analyse what are the are unattractive outcomes in summer for competitors season Options include 3 No winter services no - government transfer Is winter provided (non- from taxpayers monopoly For example, desirable outcome) viable? - funding from summer because services are operations (eg, cross- Desirable as no need not profitable even subsidy by same operator, for government subsidy for a monopoly compensation fund, pay or and/or funding from yes play, negotiation between summer operations entrant in summer) However, unlikely to be Winter monopoly Winter monopoly - non-funding policies—eg, profitable on a stand- (unlikely outcome) (subsidised) differentiated harbour alone basis (viable) charges—are unlikely to Policies might still be be enough to grant winter needed: price operations but could help surveillance, SLA, What happens in the summer? winter price regulation

Decision Outcome Bold arrow suggests most likely outcomes

Source: Oxera.

26 JCRA (2006), ‘Decision M 005/05 Ferryspeed (C.I.) Limited/Channel Express (C.I.) Limited’, p. 13.

Oxera 17 The supply of ferry services: a policy assessment

Given the characteristics of the market—relatively stable demand for freight services, the comparatively small size of the Jersey economy, the imbalance between imports and exports, and restrictions on the size of vessel that can use the harbour—sustainable entry into the freight market appears unlikely in winter (and, indeed, in summer).

This conclusion may be reached by considering the two entry options for the market for freight services:

– an entrant wins some market share, with the existing level of service split across the two operators; – an entrant provides an extra two services per day from Jersey using an additional ferry.

The case of an entrant winning market share by splitting the existing level of services with the incumbent would require detailed assessment of the likely outcome. However, the likely conclusion is that this scenario would require a high degree of coordination between the entrant and the incumbent for the entry to be sustainable. Such a degree of coordination will give rise to doubts as to the extent of competition between the two companies, given the requirement to return empty trailers to Portsmouth. This option would appear to have little benefit and could give rise to the possibility of endangering the security of supply, particularly if the conventional vessel that can also carry passengers and cars is removed under this option.

In the second case, in which an entrant doubles the effective number of services from Jersey, the entrant would have to recoup substantial costs that would ultimately have to be paid by the consumers of Jersey. Given the physical constraints for vessels entering the harbour at St Helier caused by tides and the scale of the infrastructure, this option appears unlikely to be feasible in any event.

This assessment answers the first stage of Oxera’s conceptual framework (set out in section 4.1) as to whether competition in winter is viable. The next question is whether a stand-alone winter monopoly is viable for freight and passengers.

The modelling undertaken suggests that, while both fast passenger services and the freight services by conventional ferry cover operating costs during the winter, the contributions made are not sufficient to cover long-term ownership costs. Together, the shortfall appears to be of the order of just under £0.5m per year, although, as noted above, the figures— particularly for the freight revenues—are illustrative.

Summer The conceptual framework and the likely outcome for the northern route in summer is presented in Figure 5.5 below.

Oxera 18 The supply of ferry services: a policy assessment

Figure 5.5 Summer assessment—northern route

For example, because prices are stable and driven by competition, there is scope for service innovation, benefit of summer competition is higher than cost of f unding, 4 5 etc Step yes Summer competition Competition Competition 1 Winter monopoly viable? desirable? yes

For example, because If competition in the market is a natural summer is strong, monopoly and/or there no no service in the winter are barriers to entry could be compromised (eg, high price, volume risk)

6 No provision of no Is summer summer services monopoly (unlikely outcome) viable?

yes Internal cross-subsidy is possible. Reduce the need for government subsidy Would require some sort of price regulation for summer/winter operation Monopoly operation could be granted through tender process (competition Joint summer–winter f or the market) monopoly Additional measure required to sustain monopoly rights (exclusive operation licence) and SLA If summer gains are less than winter losses, then government subsidy is required for joint summer–winter monopoly

Decision Outcome Bold arrows suggests most likely outcomes

Source: Oxera.

The summer market is characterised by much higher passenger demand than in the winter, and hence a greater opportunity for profit (see Figure 5.3). However, the barriers to entry and market characteristics that were present in the winter market remain during the summer. This implies that competition on the northern route during the summer is not viable, and the conclusion is supported by observation of the route over time—although there is no current legal barrier to a competitor entering on the northern route, none has done so.

Based on quantitative modelling and a qualitative assessment of barriers to entry, the most likely outcome on the northern route is a continuation of the status quo, with one company providing year-round passenger and freight services.

In summary, the passenger aspect of the service, assuming the use of the fast ferries only, can cover year-round costs (including ownership costs). However, revenues would not be sufficient to cover the costs of a back-up conventional vessel unless the freight revenues are also taken into account. This leads to the conclusion that a stand-alone winter passenger monopoly on the northern route may not be sustainable at current prices and with the back- up requirement; that a joint passenger/freight operation is likely to be sustainable, at least based on the current services and cost and revenue estimates; and that entry into the northern route is unlikely. 5.2 Southern route

5.2.1 Route assessment The southern route is a return ferry route from Jersey to St Malo, France. Since the bulk of freight to Jersey comes from the UK, there is little freight traffic on this route, and hence it is used mainly by passengers and cars. This section therefore focuses on foot passenger and car transport, but does include some light freight.

Oxera 19 The supply of ferry services: a policy assessment

As noted in section 2, there have been a number of changes to ferry operators on this route since 2004, with Condor Ferries currently the sole provider of services. These services are provided mainly on fast ferries, which take around an hour and primarily carry passengers and cars. The vessels are not designed to carry heavy freight, but can carry some light freight. In addition, a conventional ferry travels between Jersey and France once per week to transport freight.

Oxera’s 2004 report described the main characteristics of the southern route, which, for the reasons cited above, also focused on foot passengers and cars.27 These include the following:

– the demand for both foot passengers and car volumes is highly seasonal; – foot passenger volumes are more volatile than car volumes; – the highest demand occurs on Saturdays; – the seasonal pattern of yields is not as clear as that of volumes.

The data provided to Oxera by Jersey Harbours shows that the seasonal trend in demand, for both foot passengers and cars, continues to reflect these characteristics. The major peak in demand can be found in August, while the lowest level is still in January. Furthermore, the foot passenger volumes continue to be more volatile than the car volumes, as shown in Figures 5.6 and 5.7.

Figure 5.6 Foot passenger volumes on the southern route, 2008

100,000

90,000

80,000

70,000

60,000

50,000

40,000

30,000

20,000

10,000

- January February March April May June July August September October November December

Source: Jersey Harbours.

27 Oxera (2004), ‘Viability of Ferry Services to and from the Island of Jersey’, July, pp. 14–19.

Oxera 20 The supply of ferry services: a policy assessment

Figure 5.7 Car volumes on the southern route, 2008

12,000

10,000

8,000

6,000

4,000

2,000

0 January February March April May June July August September October November December

Source: Jersey Harbours.

The frequencies during winter for the fast ferries are much lower than in summer. In general, the ferries in winter are not run every day and on those days when there are services, there tend to be 1–2 round trips per day. However, in summer, services are provided daily, with a frequency that ranges between two and four round trips per day. These changes in frequency reflect the seasonal pattern of demand, as shown in Figures 5.6 and 5.7.28 This is explained by the demand being driven mainly by leisure travel. These changes in demand have an important impact on the ferry operator’s viability.

The busiest period of the week is the weekend. As Condor Ferries confirmed, Tuesdays, Wednesdays and Thursdays are always quieter than the rest of the week. Since 2004, there have been no major changes in either the demand pattern throughout the year or the demand throughout the week.

Discussion with Condor on yield patterns supports the proposition that these are also seasonal, although to a lesser extent than the pattern of passenger numbers.

In addition to the effects of the different levels of demand on the ferry operators, an entrant has to deal with the high sunk costs of entering the market—ie, purchasing the vessel—and the high costs of running the services. Furthermore, access to the harbour is limited by tidal patterns, which may increase the logistical challenges associated with running additional capacity than is currently the case.

The above discussion suggests that, although there have been temporary periods of competition, the sustainability of entry on the southern route over the longer term is at best unclear. As is shown in the next section, the level of demand on the route does not appear to be sufficient to enable multiple operators to cover operating plus financial costs.

28 According to Oxera’s 2004 report, the peak of demand in August is approximately ten times the lowest demand in winter.

Oxera 21 The supply of ferry services: a policy assessment

5.2.2 Route modelling The modelling methodology is set out in section 5.3 below, with more detailed discussion, including the assumptions made and data sources used (presented in Appendix 1). The outcome from the modelling, using 2008 data (which may have been affected by the presence of competition in the market) is presented in Table 5.2.

Table 5.2 Southern route profitability (£’000s)

Operational profit Ownership profit 1 Ownership profit 2 Winter (5 months) Large fast ferry (infrequent service) –206 –280 –324 Small fast ferry (regular service) –654 –1,262 –1,702 Summer (7 months) Large fast ferry (infrequent service) –202 –285 –347 Small fast ferry (regular service) 432 –305 –922

Note: 1 Includes depreciation of the cost of the vessel on a straight-line basis over 20 years for the fast vessels and 25 years for the conventional vessel. 2 Includes depreciation and the cost of capital, which has been calculated by annuitising the cost of the vessel over the lifetime of the vessel, including an assumed 10% required rate of return. Source: Oxera analysis.

The conclusions from this analysis are as follows.

– It is clearly unprofitable to run services in the winter at current yields and volumes, even before ownership costs are taken into account. The case for summer is less clear, although even here the modelled costs exceed revenues earned. However, a relatively low revenue assumption has been made for light freight (as per fixed costs, light freight has been allocated to vessels according to the number of trips) which may not capture the actual amount of freight on the southern route.

– At current yields, and when ownership costs are taken into account, it is not profitable to run the services in either summer or winter.

– Yields may change with market structure, and in a monopoly fares may increase from the levels seen in 2008, which are those used in the modelling. In addition, in a monopoly environment, total capacity provided may be expected to fall, which could lead to an increase in load factors. These factors suggest that the southern route, if operated as a monopoly, could potentially cover the costs of a year-round service. Table 5.3 sets out an indicative analysis for 2006 (when the southern route was operated as a monopoly), which suggests that this route is viable when operated in this way.

Table 5.3 Indicative southern route profitability (£’000s, 2006 revenue)

Operational profit Ownership profit 1 Ownership profit 2 Winter Large fast ferry (infrequent service) –118 –162 –206 Small fast ferry (regular service) –169 –612 –1,052 Summer Large fast ferry (infrequent service) 302 240 178 Small fast ferry (regular service) 3,206 2,586 1,970

Note: 1 Includes depreciation of the cost of the vessel on a straight-line basis over 20 years for the fast vessels and 25 years for the conventional vessel. 2 Includes depreciation and the cost of capital, which has been

Oxera 22 The supply of ferry services: a policy assessment

calculated by annuitising the cost of the vessel over the lifetime of the vessel: 20 years for the fast vessel and 25 years for the conventional vessel. Source: Oxera analysis.

5.2.3 Summary of likely market structure An assessment of the likely sustainable market structure for the southern route may be derived from a range of sources of evidence, including:

– analysis of the underlying features of the market (see section 5.2.1); – an assessment of the profitability of the existing operation (see section 5.2.2 and Appendix 1); – evidence on actual market developments (see section 2).

The market structure which is likely to be sustainable is considered separately for winter and summer. Figure 5.8 presents the summary assessment for the winter case.

Figure 5.8 Winter assessment

1 2 This outcome requires less yes yes Winter competition Competition Competition policy action but is highly (unlikely outcome) viable? Can more than two firms desirable? unlikely operate profitably during the winter season? For example, because the For example, market is a natural no no because of monopoly and/or ‘destructive Requires funding to sustain margins competition’ winter (monopoly) operations are unattractive Funding options required to for competitors analyse what are the outcomes in summer season Options include

3 - government transfer No winter services from taxpayers Is winter no provided monopoly (non-desirable - funding from summer For example, operations (eg, cross- viable? because services are outcome) subsidy by same operator, Desirable as no need not profitable even compensation fund, pay or for government subsidy for a monopoly play, negotiation between and/or funding from yes entrant in summer) summer operations - non-funding policies—eg, However, unlikely to be Winter monopoly differentiated harbour profitable on a stand- Winter monopoly charges—are unlikely to be (subsidised) alone basis (viable) (unlikely outcome) enough to grant winter operations but could help Policies might still be needed: price surveillance, SLA, What happens in the summer? winter price regulation

Decision Outcome Bold arrows suggest most likely outcomes

Source: Oxera.

Competition is unlikely to be viable during winter due to the low level of demand. As noted in section 5.2.2, even the existing winter monopoly is not estimated to cover ownership costs.

The likely implications of entry during winter, were it to occur, would be increased losses on the route, driven by the addition of further operating (and ownership) costs, as well as a possible reduction in total revenue due to price wars, given that operators would be likely to face excess capacity and relatively low marginal costs. The conclusion emerging from this is that the most efficient means of providing the winter operation is a monopoly service.

It also appears from the modelling to be highly probable that some form of support is required for the costs of the winter operation to sustain the southern winter service at its current level and at current prices. This could be from summer profits (if these are earned from the southern route), or cross-subsidies from the northern route, including the possibility of a subsidy from freight revenues.

Oxera 23 The supply of ferry services: a policy assessment

While the costs of providing the winter service could be lowered to some extent by a reduction in frequency (assuming that the remaining services would be sufficient to meet the States’ security of supply requirement), there may be associated revenue losses with such a change. While the extent of operating losses could be reduced somewhat, the operation is still unlikely to be profitable, both at an operating level and once ownership costs are taken into account.

A summary assessment of the market structure that may be sustainable in summer is presented in Figure 5.9.

Figure 5.9 Summer assessment

For example, because prices are stable and driven by competition, there is scope for service innovation, and benefit of summer competition is higher than cost of 4 5 funding, etc Step yes Summer competition Competition Competition 1 Winter monopoly viable? desirable? yes

Summer competition reduces incumbent operators’ For example, because If competition in abilities to cross-subsidise winter operations. Policies the market is a natural summer is strong, for sustaining winter monopoly while allowing monopoly and/or there no no service in the winter summer competition include: are barriers to entry could be compromised – levy charges for summer operators (eg, high price, volume risk) – pay or play for summer However, these policies reduce entry/competition likelihood in summer No provision of – alternative policy is government subsidy no 6 summer services Is summer – additional measures are required to sustain (unlikely monopoly monopoly rights in winter (exclusive operation outcome) viable? licence) and SLA

yes Internal cross-subsidy is possible. Reduce the need for government subsidy Would require some sort of price regulation for summer/winter operation Monopoly operation could be granted through tender process (competition Joint summer–winter for the market) monopoly Additional measure required to sustain monopoly rights (exclusive operation licence) and SLA If summer gains are less than winter losses, government subsidy is required for joint summer–winter monopoly

Decision Outcome Bold arrows suggest most likely outcomes

Source: Oxera.

As demand on the southern route is much greater in summer than in winter, the potential for competition in the summer to be viable in the longer term cannot be fully discounted (as was the case for winter). Nevertheless, the modelling of the route based on current service levels and current average yields does not suggest that this is likely to be sustainable.

Even if the figures presented here were to understate the profitability of the southern route— for example, due to the somewhat arbitrary way in which fixed ‘onshore’ costs are allocated across the routes—there remains an important question with regard to the long-term sustainability of entry on the route, even if only for the duration of the summer months. Entry would increase the total costs associated with service provision. Furthermore, average fares might be expected to fall due to the presence of excess capacity during certain periods within the summer season. The net effect of these two features would be expected to make the financial prospects for ferry companies operating under competitive conditions significantly worse than is the case under monopoly conditions. Given the findings noted above—that it is not clear even whether the monopoly covers fixed costs—competition would not appear to be sustainable.

Oxera 24 The supply of ferry services: a policy assessment

A more optimistic perspective on the prospects for a competitive market might be taken if it were anticipated that significant market expansion would occur as a result of service frequency or fares reductions. However, this scenario does not appear particularly viable; if the expansion effects were indeed likely to be significant, they would be internalised within the pricing policy of the existing operator. Moreover, if the market expansion effect is small (relative to the potential for price competition to cut revenues), the financial consequences for both operators could be significant.

The above analysis leads to the conclusion that the long-term profitability of the southern route during the summer season is unlikely to be sufficient to cover entry costs. This does not discount the possibility that a new operator could gain a foothold in the market by winning sufficient market share and ultimately force the incumbent to exit. However, this does not change the underlying conclusion that the most likely sustainable market structure on the route, even in summer, is a monopoly operator.

This is consistent with the recent developments on the southern route explained in section 2. While there have been attempts at entry on the route, these have led to the subsequent exit of one of the two operators and the return to a monopoly service.

Even if the above analysis were unduly pessimistic with regard to the prospects for sustainable summer operation, it is not clear that such an outcome would be the preferred one in the market. This is because the profits that an individual operator would obtain from the summer market would be unlikely to sustain a winter service. Therefore, a range of additional policy options would probably be necessary to sustain the winter operation. These are described in more detail in section 6.

The above conclusions are broadly consistent with both the 2004 Oxera report, and a report produced in 2006 for the Jersey Consumer Council, which noted the following:

A requirement to provide a year round frequent service to St Malo which might not be economic would have to be balanced by some protection for the operator in the peak season.29

A further important question, relevant in the policy analysis, is whether the summer service is itself viable in terms of covering ownership costs, and whether it may also provide sufficient scope for profits to enable the winter service to be cross-subsidised.

The ability to cover year-round costs with summer profits at current (2008) prices is at best questionable under a competitive environment. Monopoly operation appears to be more sustainable, and would be consistent with the longer historical pattern of services; but the year-round operation is likely to be sustainable only at prices higher than those experienced in 2008. 5.3 Conclusions on market structure

Oxera’s assessment of the northern and southern route suggests that the expected market outcome for the northern route will be a year-round monopoly, including both passenger and freight services—due in particular to the low profitability of the winter passenger service at current pricing levels—and the costs of, and physical constraints to, entry in the freight market owing to the capacity of the harbour and logistical issues which imply the need for two daily services (of which one comprises largely empty containers as a minimum level of service that an entrant would need to offer). This is consistent with the observation that, although there are no legal barriers to entry, attempts at entry on the northern route have not been made.

29 Boleat, M. (2006), ‘Jersey Ferry Services—Report for the Jersey Consumer Council’, executive summary, September. This report was commissioned to assist the Council in informing the public debate and provide input into government policy.

Oxera 25 The supply of ferry services: a policy assessment

On the southern route, in respect of the summer operation, the results are somewhat less clear cut ,. Attempts at entry have been made, although these have been unsuccessful and have led to the restoration of a monopoly service. The profitability of the summer operation does not appear to be sufficient—according to the modelling exercise undertaken using 2008 revenue levels (and noting the uncertainty around fuel costs and the monopoly level of fares)—to cover ownership costs, let alone the costs of the winter services. The long-term effects of entry would be to increase overall costs of provision, and potentially reduce revenues per operator. Therefore, on balance, it is considered that the most likely long-term sustainable market structure is also a year-round monopoly provision on the southern route.

Oxera 26 The supply of ferry services: a policy assessment

6 Assessment of policy options

The analysis presented thus far leads to a number of important conclusions regarding the likely sustainable market for ferries services. These are as follows.

– On the northern route, the passenger ferry service is profitable as currently operated. Although not modelled (and not a sensible way of operating a service), a passenger- and cars-only service with a requirement for a back-up conventional ferry may not be viable. Thus, notwithstanding the economic viability of current operations, these are likely to need to be run in conjunction with the freight services to exploit the economies of scope between the back-up requirement and the requirements of the freight service.

– The combination of the economies of scope and other barriers to entry suggest that additional entry (or passenger- and car-only entry) would not appear to be viable on the northern route, particularly given the need for operators to run multiple ferries and the harbour constraints. The absence of entry on the route in recent years is consistent with this assessment.

– On the southern route, the winter operation is loss-making given the relatively low levels of demand. The summer operation does not currently appear to be profitable when ownership costs are allowed for, although the level of fares assumed reflects the market state of competition during the period for which data has been collected. When operated as a monopoly (eg, 2006), the indications are that the route is profitable on a year-round basis, and this is consistent with the longer-term historical experience.

– Entry on the southern route does not appear to be sustainable, with several recent entry attempts having led relatively quickly to a return to a single main operator. Competition in the market, even if only in the summer, does not appear to be stable, and would threaten the operation of the service in the winter which, even under monopoly operation (2006), suggests that operating costs are not covered.

In view of the above findings on the market, a number of potential policies which might be adopted for the ferry services market are considered here.

– Option 1: non-exclusive licences, subject to universal service obligations (USOs).

– Option 2: licensed monopoly, with USO.

– Option 3: maintain status quo.

– Option 4: licensed tendered monopoly.

– Option 5: separate licensed monopolies for northern and southern route.

Each of the policy options are described below, together with an assessment of their likely impacts on the main policy objectives set out in section 3. 6.1 Option 1: non-exclusive licences subject to USOs

6.1.1 Description of Option 1 Under this option, all operators wishing to provide ferry services to Jersey would be required to obtain licences. Licences would not be exclusive—in principle, the number of licences which could be issued on each route would be driven by market considerations.

Oxera 27 The supply of ferry services: a policy assessment

The critical function of licences would be to ensure that minimum standards would be met by any operators providing ferry services to the Island. While there are a variety of terms which could be considered in relation to these, the primary features would include the following.

– Safety compliance requirements—licences would be contingent on meeting required safety standards for passengers and employees.

– Financial standing—minimum standards of financial backing would be required for all operators, so as to ensure that the services would not be disrupted owing to financial constraints.

– Specification of minimum services—most critically from the perspective of the security of service supply, the licence would specify minimum frequencies on routes, potentially by season. Existing ramp permits already have this feature.

– Back-up capacity—operators may be required to identify back-up capacity, although this would lead to higher costs of provision (unless combined with an existing ro/ro freight operation).

A key issue regarding the provision of minimum services relates to the means available to the States to enforce the requirement. To the extent that winter services are unprofitable, in the absence of some means of enforcement, there is a risk that operators would pull out of the winter operation.

Options to address this issue are described below.

– Performance bond—each licensed entity could be required to put up a cash bond, valued at approximately the net cost of the USO winter operation. This performance bond could be forfeited in the event that the operator does not fulfil its obligations. In the context of multiple operators, however, it may be unduly costly to require all operators to provide a winter operation; rather, the performance requirement in this case could be considered to be fulfilled by proxy if a summer-only operator makes a proportionate contribution to the fulfilment of the winter service through a compensating payment to the winter service operator.

– State compensation—the cost of meeting the winter operation could be estimated, and a payment made to each operator which fulfils these obligations. The USO net cost could be estimated as the net losses suffered by the passenger operation during the winter season. Indicative modelling summarised in the previous section, and detailed in Appendix 1, suggests that on the northern route no compensation would be required so long as the operation of the back-up vessel is seen as part of the freight activities, while on the southern route the USO cost could be around £0.5–£1m (on 2008 results) to cover the operational expenditure for the winter period (although the indicative analysis of 2006 suggests that the subsidy could be lower under different operating conditions). The obvious shortcoming of this approach is that the value of the USO would need to be made available from States’ tax revenues each year. As indicated above, there is little benefit in having multiple operators providing winter services when these are not viable (even for a monopolist). Thus, rather than making the USO payment available to all winter operators, a single operator could be selected to take responsibility for winter services (and receive the winter payment).

– Entrant compensation—rather than the USO cost being paid to all operators from the States’ resources, prospective summer-only entrants could be required to pay some compensation to the provider of winter services. The objective of this payment would be to ensure that a ‘level playing field’ is created in the market, with no firms being in a worse position as a result. This would require a process by which the USO provider would be selected (this could be the incumbent, or an agreement could be reached among prospective operators as to which one is best placed to undertake this role). Only

Oxera 28 The supply of ferry services: a policy assessment

a proportion of the total USO cost would be covered by the summer-only entrant—for example, in line with the extent of its summer service provision as a proportion of total summer capacity.

6.1.2 Assessment An assessment of Option 1 in relation to each of the main policy objectives is set out below.

Security of supply Under some circumstances, this option could satisfy the security of supply requirement, by setting clear obligations for operators to ensure that the winter service is provided. However, there would nevertheless be two issues which raise questions regarding the consistency of non-exclusive licences with the year-round service. One risk is that a party may not comply with the full terms of the licence (as has been the case in recent years, with operators deciding not to pursue winter operations), while undermining the profitability of the summer operation. This concern could be addressed by requiring binding, up-front commitments to the USO from all parties (including a performance bond that is at least equal to the net cost of operating a winter schedule). A second concern would be that the pattern of destructive entry (as described in the 2004 Oxera report as well as this report) would lead to periods of volatile fares, with entry and exit leading to service disruptions.

Competition if feasible This option has the potential advantage of not ruling out competition. However, given the significant doubts regarding the sustainability of competition on both the northern and southern routes, it may be that the costs associated with maintaining this option (eg, in terms of greater uncertainty of market outcomes; risk of an increased cost base to provide services overall; and need to avoid price regulation in order to avoid risks of market distortions) are greater than the value to consumers associated with it. Recent market evidence suggests that the main scope for competition lies in the operation of the southern route during summer periods. As previously noted, it would be important to ensure that any such entry would not undermine the financing of the winter operation unless other steps are taken to cover the costs of the USO.

Minimisation of impact on States’ budget Under Option 1, the year-round service would be expected to be covered by the operators’ overall revenues. In practice, this may require the winter service for either route to be supported by contributions from other parts of the market, including peak season or contributions from the freight business. Under some circumstances, there is a risk that Option 1 as described above could lead to an impact on the budget of the States. This could occur, for example, if entrants were to be permitted to operate selectively (such as only during the summer peaks), leading to a situation in which neither operator generates sufficient funds from its summer operations to sustain the winter service. However, the risk of such a situation could be mitigated by imposing conditions for entry which would ensure that funds are available to cover the winter services.

Practical implementation The scope for implementing Option 1 is relatively straightforward. Licences could be developed, using existing ramp permits as a template. Choices would need to be made regarding the specific terms, with particular emphasis on whether performance bonds are used, and how the USO cost is measured in detail and responsibility for covering its costs is allocated. Negotiations would need to take place with Condor, as the incumbent operator, to address these issues. New applications from potential operators could be received—subject to equivalent conditions—so as to ensure the continued operation of the winter service.

Given the assumption that the threat (or actual) competition would induce operators to price at a competitive level, then relatively little institutional change would need to take place. However, the authorities may need to become involved at short notice to ensure that steps are in place (in the event of market disruption) to deliver continued services . Some up-front

Oxera 29 The supply of ferry services: a policy assessment

costs would also be imposed due to the need to set out the specific USO costs which would be imposed on licensees.

Impact on customer welfare This option would protect customer interests by ensuring that the year-round service is preserved as a condition of the licence. The possibility of entry, should an application meet the required standards (including those relating to ensuring that entry would not undermine the winter service), could provide some potential for further benefits in future—although the conditions for this do not appear to be likely to hold—and entry may actually lead to higher costs of service due to the additional capacity used to serve the Island. To the extent that competition is unlikely to be forthcoming on a sustainable basis, some limited regulatory oversight may be required to ensure that the interests of consumers are protected in terms of pricing and quality of service.

Should this option be adopted, it is critical that measures to mitigate the risks of unsustainable entry (leading to both detriment to the winter services as well as excessive disruption in the market) are included. In particular, it would be important to ensure a level playing field for all operators. Given the significant limitations to the feasibility of entry on the northern route, and the questions regarding the sustainability (and desirability) of entry on the southern route, it seems likely that any measures designed to promote a level playing field would, in fact, lead to an outcome where competition in the market does not evolve. In such a situation, Option 1 can still be designed to promote the wider interests of customers—by clarifying the conditions under which the incumbent operates, and how the States would treat future applications. The conditions would also include setting out measures designed to emphasise the importance of the year-round service, while making the continued right of summer and freight operations contingent on running specified winter services. 6.2 Option 2: licensed monopoly, with USO

6.2.1 Description of Option 2 The second option would be to develop an exclusive licence offer, which builds in USO provisions to help ensure that the security of supply condition is met. The licence terms would be negotiated with the existing incumbent, and would confer exclusive rights to operate both the northern and southern routes, with minimum frequencies for the winter timetable. In order to reflect the absence of competitive pressures within this model, some form of economic regulation would be required.

The licence terms would include many of the features described under Option 1—namely, licences would be issued subject to financial and safety standards, and would contain various frequency, reliability and quality of service requirements.

To ensure that incentives are preserved for fulfilling the specified commitments, a number of options could be considered.

– Threat of licence revocation—in order to encourage delivery of the specified service levels and quality, the threat of licence revocation in situations of material failure to meet the terms of the licence would be necessary. However, the conditions under which revocation might be exercised would need to be clearly stated and subject to stringent materiality tests. While it would be unduly costly to maintain a ‘reserve operator’ on standby in case of revocation, ensuring that the legal ability to transfer the licence effectively would be critical to preserve security of supply.

– Performance bond—as described in Option 1, enforcing the levy of a performance bond up front would provide some incentive to continue with the mandated winter services.

A second key issue within Option 2 is the form of economic regulation that might be appropriate if a licensed monopoly were issued. On the assumption that the services are not

Oxera 30 The supply of ferry services: a policy assessment

tendered (this is addressed separately in Option 4), the use of some form of regulation (which could include light-touch regulation, such as requirements to provide information, through to more formal pricing restrictions) would need to be considered. A further discussion of the regulatory options associated with the market is set out in section 6.6 below.

6.2.2 Assessment

Security of supply Option 2 addresses the concerns regarding security of supply by ensuring that the winter services can be operated within the scope of a wider year-round freight plus passenger service (assumed to be profitable overall). By restricting the scope for entry, and hence eliminating risks of disruptive competition, the exclusive nature of the licence in this case provides greater certainty to the operator and policy-makers alike. It also avoids difficult questions about how back-up capacity can be funded in a competitive market. The commitments to a year-round service would need to be made binding, with the threat of loss of licence and performance bonds both being helpful means of establishing this (although the latter would entail some cost to the service provider and would effectively need to be recovered). A possible risk associated with the exclusive licence option is that it would potentially leave the States exposed should the licensed operator fail financially. However, the extent of this disadvantage may be limited in practice if (even under non-exclusive licence options) alternative operators may not be in the market.

Competition if feasible This option would not provide for the scope for entry—at least over a defined period consistent with the duration of the licence. However, if the prospect of sustainable entry to occur without otherwise imposing risks to security of supply is unlikely (as discussed in this report), relatively little would be ‘lost’ by adopting an exclusive licence.

Impact on States’ budget Given the assumption of a profitable overall service, Option 2 can preserve security of supply without any contribution from the budget. Some incremental monitoring costs may need to be reflected, however, depending on the approach to regulatory oversight selected among the options described in this section.

Practical implementation While there are few barriers to the practical implementation of this option, there may be reasons why the States may not wish to limit its ability to review potential applications for services from potential future providers. Alternatively, there may be legal reasons which may constrain the ability of the States to explicitly incorporate exclusivity into a ferry services licence, even if it felt that there would be advantages in doing so.

To address this issue, the States would need to identify alternative means of establishing a ‘quasi-exclusive’ licence. This could include setting out clear terms for accepting future licences, such as provision of up-front cash contributions (in the form of performance bonds) at a sufficient level to dissuade entrants from attempting to enter the market using a ‘selective’ (and potentially disruptive) model of targeting summer-only operations. This would potentially lead to an outcome similar to that described in Option 1. In order to implement this option, the main requirements would include development of the detailed licence terms and conditions, as well as work to establish (and subsequently carry out) the appropriate regulatory model. The JCRA would be the body best suited to carry out this role, given its existing knowledge of the market and powers as a regulatory and competition authority. Further discussion on the potential institutional arrangements under regulation is provided in section 6.6.

Impact on consumer welfare This option would provide certainty and stability, while avoiding inefficient costs associated with significant increases in capacity (which may not be necessary to address the level of demand on the Island). The main risk to consumer welfare of the exclusive licence—that the

Oxera 31 The supply of ferry services: a policy assessment

monopolist is able to abuse its position through excessive pricing—would need to be addressed through a form of regulatory oversight, as noted above. While standard economic thinking suggests that competition often leads to a preferable outcome compared with regulatory oversight this, in practice, depends on the characteristics of the market. The analysis in this report highlights significant limits to the benefits that competition is able to bring on a sustainable basis. Nevertheless, there may be a risk that the adoption of an exclusive licence would require somewhat more detailed regulatory oversight—the costs of which would need to be borne either by consumers or taxpayers. 6.3 Option 3: maintain the status quo

6.3.1 Description of Option 3 This option would reflect the continuation of the status quo. In particular, it would retain the following features.

– All operators would be required to obtain car ferry licences in order to provide ferry services to and from Jersey.

– The licences are not exclusive, and new applications would be considered on their merits.

– In theory, multiple operators could satisfy the requirements to obtain licences, so long as they are able to demonstrate that they had the financial and operational capability to operate a year-round reliable service considered to involve operating a fast and conventional passenger and car ferry service on the northern route, or a reasonable year-round passenger and car ferry service with a minimum of three return services per week on the southern route.

Approvals for licences would be tested against the above criteria and the car ferry licences would require the provision of a year-round service. However, should the year-round service not be delivered the licences would be revoked. In addition, the ferry provider’s track record would be taken into account should it reapply in a subsequent season, which could lead to the permit being denied.

6.3.2 Assessment of Option 3

Security of supply This option does not provide a strong basis for ensuring security of supply. Although it enables factors such as financial resources and availability of back-up capacity to be taken into account when granting licences, the current model potentially leaves open the risk that summer-only entry undermines the scope for sufficient profitability to cover winter operating costs. While, under the current model, the main sanction available to the States would be to remove rights of operation in future seasons, further measures to enhance the protection of the year-round service, such as the performance bond approach described in Option 1, could be adopted.

Competition if feasible This option would enable scope for entry where this is commercially viable. To the extent that the current ramp permits do not specifically include requirements to contribute towards the USO, entry may be more likely than under Option 1. However, as noted in the discussion under Option 1, the benefits of entry, which may be targeted at a summer-only operation, are far from clear, and could potentially undermine the achievement of a stable, year-round service.

Impact on States’ budget Continuation of the status quo would be expected to have the least impact on the budget of all the options. This is because no further formal structure of regulatory oversight would need to be created, and no specific commitment to support the USO with States’ funding would be

Oxera 32 The supply of ferry services: a policy assessment

required. However, to the extent that the risk of summer-only entry leads to a loss of ability to cover the costs of the winter operation, the States may face the risk that it will be called on by the winter operator to provide direct compensation for the costs of the winter service.

Practical implementation By definition, the status quo would not impose any immediate practical set-up costs, although the States would need to be ready to assess any potential requests for licences. This could be a challenging exercise—for example, if prospective entrants were to suggest areas of business which might create risks to the lifeline status of the year-round operation.

Impact on consumer welfare The current approach is unlikely to optimise consumer welfare, in that it leaves open the range of risks to ongoing supply described above. It may be that consumers could benefit from periods of lower fares, driven by intense price competition due to the cost structure of the business. However, to the extent that entry also requires a higher overall cost base to be covered in the long run by users of the services, little weight should be placed on this outcome on a sustained basis.

6.4 Option 4: licensed tendered monopoly

6.4.1 Description of Option 4 This option is similar to Option 2, in that an exclusive licence would be made available to a single operator of ferry services to the Island. The main difference from Option 2 is that, rather than negotiating the outcome with the incumbent operator (with a regulatory framework overlaid to ensure that pricing outcomes are reasonable), a competitive tender would take place and the contract to operate the two routes would be awarded to the chosen bidder.

While a number of options could be considered in terms of how the bidding process would operate, it would appear most likely that bidders would bid against the costs of operating a minimum set of standards, which would be clearly identified, although essentially covering the licence requirements as described in Options 1 and 2: minimum services, quality, back- up capacity and financial resources. The States could then ask bidders to bid the maximum price they would be willing to pay to operate the service (or, if the net costs of the operation are negative, the bids may be assessed in terms of the lowest required subsidy). In this case, bidders may also have a framework for pricing against which they would assess prospects for revenues: either retaining flexibility for setting all fares, or having the tender process identify a number of pricing constraints that bidders would need to take into account.

Alternatively, bids could be assessed in terms of the minimum price which would be charged to consumers—the focus here being on maximising consumer welfare, rather than maximising the value of the exclusive contract to the States.

The contract would have a specified duration (eg, 10–15 years), and would need to address aspects such as risk allocation between the operator, consumers and the States.

A number of associated requirements to enable the States to monitor the performance of the operator under the terms of the contract would also need to be specified.

A key issue to consider is whether a tender would be for passenger services or for freight and passengers services. One factor to take into account in reaching a decision on this issue is whether the two services can be efficiently separated. Clearly, it would be inefficient to prevent the passenger services from carrying freight, so a ‘passenger-only’ operation is likely to be ruled out on efficiency grounds. More importantly, the requirement for the conventional ferry back-up capability on the northern route would be expensive and inefficient to supply solely as part of the passenger and car service. However, there may be a cost to a freight- only operation to retain this capability (ie, it may be more efficient to use two freight-only conventional vessels without a capacity to take passengers and cars in order to satisfy the

Oxera 33 The supply of ferry services: a policy assessment

freight demand). One approach would be to allow an independent passenger and car operator to purchase the back-up capability from the freight operator, rather than requiring the back-up service to be directly provided. Thus, separating out the services could require a slightly more complex set of arrangements to maintain the back-up service compared with a joint operation.

Given these factors, a first working assumption would be that a tendered monopoly would include both the passenger and freight services, at least as an option. However, as noted previously, the lo/lo services use different vessels and facilities, wholly unrelated to the passenger market, and would not need to be included in the tendering process. They would continue to provide limited competition at the margin to the tender winners’ ro/ro services.

6.4.2 Assessment of Option 4

Security of supply This option would be expected to have a similar impact on security of supply as described under Option 2. The exclusive nature of the licence which would be conferred on the winning bidder would remove the risk of opportunistic entry, which might otherwise undermine the ability to finance the USO. The assumption which underpins this assessment in the context of a bidding outcome is that the overall market can be profitable (and hence, bidders will be willing to bid for the market), which would appear to be a reasonable assumption based on evidence reviewed in this report, particularly for the northern route.

Competition if feasible This provides for competition for the exclusive right to operate the ferry services, rather than competition within the market itself. Under some circumstances this may be expected to provide a significant degree of competitive pressure on bidders. In theory, even if the underlying market is not likely to be profitable, competitive pressure in terms of bidding to minimise subsidy could occur. The main constraint on the competitive bidding outcome would be expected to be information-related. Given the incumbent’s long track record of operating in the market, and the limitations on data, other parties may not consider themselves to be in as strong a bidding position. Under such an outcome, there would be a risk that few alternative bidders would come forward, or few alternative bids made at a very competitive level. In these situations the incumbent could emerge from the bidding process with an attractive contract without much protection for consumers. This suggests that care will need to be taken to encourage a range of bidders, while also incorporating a number of features in the contract to ensure that pricing for consumers is reasonable.

Impact on States’ budget The impact of the tendering option on the budget will depend fundamentally on the approach to the tender. A minimum price tender would have no impact on the budget (but would lead to uncertain outcomes for consumer prices); a maximum premium/minimum subsidy bidding process could lead to a positive or negative impact on the budget, depending on bidders’ expectations of the profitability of the contract. On the basis that the overall market (including freight services) is currently estimated to be profitable, it would be expected that a positive premium would be paid for the contract so long as the pricing constraints are not too onerous.

Practical implementation The primary issues with the tendering option relate to the practical implementation of the approach. In particular, it is not an option which can be immediately pursued, given the notice period requirement under the existing licence agreements, which would limit the possibility of tendering the services until at least 2012/13. The second critical issue associated with the tendering option relates to the inter-Island nature of the routes. A tender cannot be issued for the existing services without the agreement of Guernsey to issue a joint tender. The alternative of tendering for direct routes between the UK and Jersey would be inefficient in that the contributions from additional passengers to and from Guernsey would not be taken into account in the bidding process, leading to a materially worse outcome for

Oxera 34 The supply of ferry services: a policy assessment

the States of Jersey (or, if the bid is in prices, the consumers in Jersey). Finally, developing the tendering approach would involve a number of important steps, from design of the terms of the tender, to running the various rounds of the tender which are likely to be necessary (pre-qualification, best and final offer, negotiation with the preferred bidder). This will require significant resources, although to the extent that the States has prior experience in similar tendering exercises, such an experience would be transferable.

Impact on consumer welfare Under the tendering option, the impact on consumer welfare will depend on two factors: first, the way in which the tender is designed; and second, the degree of competition within the tendering process. In relation to the first point on tender design, the consumer welfare impact could depend on the extent to which the States specifies the pricing arrangements which are to apply during the course of the contract, as opposed to the alternative approach of having a tender in lowest consumer prices. The degree of competitiveness could also have an important impact. 6.5 Option 5: separate licensed monopolies for northern/southern routes

6.5.1 Description of Option 5 The models described above have not specifically distinguished between the northern route and the southern route; rather, they have assumed that, where monopoly licences are issued, this applies in respect of both the northern and southern routes. A variant of Option 2 would be to issue two separate exclusive licences, one in respect of each of the northern and southern routes, and to insist that different companies hold each licence.

Many of the characteristics of this option would mirror those of Option 2: rather than repeating them here, the assessment below considers how the issuance of two separate licences would affect the main policy criteria relative to a joint licence.

6.5.2 Assessment of Option 5

Security of supply Option 5 would address the security of supply concerns in a similar way to Options 2 and 4; namely by limiting the scope for destructive or cherry-picking entry. Other implications associated with having two separate licences may be as follows.

Enhance scope for back-up provision If there are two nominated operators, should one encounter financial difficulty, the other could have a contractual basis to act as the ‘supplier of last resort’ until such time as the failed contract can be retendered.

However, unless the contracts specified the continued use of the assets owned by the individual operators in the event of financial failure, it would not be possible to rely on the other party to continue the operation, since it would not necessarily have the assets required to fulfil the obligation (and carrying reserve capacity to be able to do so would be prohibitively expensive). Incorporating requirements for the transfer of assets would represent an important consideration, given the limits that such clauses would impose on the ability of the owners (and creditors) to recover value for the assets through divestment. While such provisions are common in the utilities sector as a means of protecting consumers in the event of financial failure, the application of such an approach to ferry assets may be more complex.

A risk to security of supply could arise where the smaller scale (and hence financial resources) of the two separately licensed businesses would reduce the ability of the licensees to deal with economic shocks (eg, fuel prices and demand fluctuations). Even if a number of these shocks might be correlated across the two routes, they may be imperfectly so due to the different demand and trip distances on the two routes.

Oxera 35 The supply of ferry services: a policy assessment

To the extent that either of the route’s overall viability is questionable, separation of the monopoly licences may raise a further security of supply issue. For example, if the southern route (which relies much more heavily on passenger demand relative to freight) does not cover its costs across the winter and summer periods, parties may not be able to sustainably operate the southern licence without external support. The modelling undertaken by Oxera suggests that financial returns on the southern route may indeed be insufficient to cover costs, at least at 2008 fare and demand levels.

Competition if feasible The extent to which issuance of two separate licensed monopolies would enhance the basis of competition is not clear. While there would certainly be no direct competition within the market, the degree of competitive intensity associated with the acquisition (or tendering) of the separate licences could differ under the separate licensing approach. On the one hand, if the separate licences are both tendered out, the number of bidders for each route might be smaller (or greater) than the number for a single licence. If the smaller scale of the separate licences gives rise to the opportunity for smaller organisations to become involved, competitive intensity could increase. However, if the underlying attractiveness of the routes on their own is reduced in the likelihood of profitability being low (for example, as noted above on the southern route), few bidders may wish to come forward.

Impact on States’ budget Relative to a single licence tender, it would appear likely that, if two separate licences are operated, the risk of an impact on the budget could be greater. If the profitability of the two routes differs (for example, due to the stronger contributions from the freight activity on the northern route), the States may be required to contribute external funding to ensure the continued operation of the weaker route. While this requirement could potentially be offset by the recovery of a premium in respect of an exclusive licence to run the more profitable route, this would clearly be dependent on the approach taken to issuing the licences.

Practical implementation There would appear to be few practical advantages to separating the licences, relative to Option 2. First, separate licences would require one of the routes to be taken from the existing incumbent, which would require a notification period and may require some form of settlement in relation to termination of existing services. Second, the States would need to increase resources to deal with two separate concessions, even if having two separate operators would not be expected to double the workload for the States’ regulatory and administrative authorities.

Impact on consumer welfare Relative to Option 2, it is not clear that many advantages from a consumer welfare perspective would arise if licences were split between the northern and southern route. The main outcomes in the market relevant to consumers, including frequency, reliability, and pricing, would not appear to be directly affected by the choice of whether or not to split the licence. As noted above, if the financial viability of one of the routes was particularly challenging, the outcome of splitting the licence could be to reduce service levels on that route, since the scope for effectively cross-subsidising from earnings on the other route would be made more difficult. 6.6 Regulatory options

6.6.1 Regulatory options To ensure that a monopoly structure—which may provide the least-cost structure to deliver the States’ required level of security of supply—does not lead to an outcome whereby consumers are harmed by high prices or poor service, the States could implement some form of economic regulation. The case for ex ante regulation (which specifies certain rules or conditions in advance with which the operator must comply) is strongest where the degree of market power is greatest (ie, where a formal restriction on entry is imposed, while the

Oxera 36 The supply of ferry services: a policy assessment prospect of future entry would tend to impose some constraints on the degree of market power). Another factor affecting the market power of the operator may be the presence of substitutes (eg, by air transport, or in the case of freight by lo/lo services). Both types of service would be expected to limit the ability of an operator to raise prices; however, identifying the extent of this in a precise way would require a more formal product market competition assessment, beyond the scope of this report. Nevertheless, when selecting from the various regulatory options, the States should bear in mind the wider market conditions within which the operator may be active.

A brief description of some of the regulatory options available to the States is set out below, beginning with more ‘light-touch’ approaches, and moving on to those involving closer intervention in the market.

Price monitoring The key features of a price monitoring approach to regulation are as follows.

– The regulatory authorities could monitor pricing levels for a basket of services (potentially including both freight and passenger services).

– Minimum service levels would be identified in the licence to ensure security of supply, but, subject to this constraint, operators would be free to adjust actual services and fare levels to meet market conditions.

– In circumstances where any price changes were to raise concerns on the part of consumer groups or the authorities more directly, the authorities could undertake a more detailed review of the proposed basis for amendments to charges. Should the outcome of such a review (which could be undertaken by a nominated authority, such as the JCRA) identify that there is no sound basis for the proposals, the operator could be required to come up with an alternative, more acceptable, set of proposals.

This light-touch approach to regulation requires little upfront analysis by the regulatory authorities, and would impose relatively few restrictions on the operator—other than to provide information relating to the pricing of various aspects of the ferry service (except in cases where the authorities request more detailed information to justify changes in price which may be considered excessive). This model would not typically require detailed cost information to be provided so long as the broad pattern of prices is not considered to be contrary to user interests. An advantage of this model is that it would allow the operator to ‘get on with’ delivery of the service with limited government intervention, while providing flexibility to respond to changing conditions—such as increasing fuel costs, seasonal peaks in demand, or competitive pressures from air transport services.

The main concern with this regulatory option is that it may not be considered to offer a sufficient basis for the authorities to ensure that overall consumer interests are fulfilled: while price monitoring could provide a reasonable basis for assessing the pattern of pricing over time, it would rely on an assumption that the current price level provides a reasonable starting point. While Oxera’s indicative modelling does provide an indication that the costs of the northern route operation are covered at the current price level, this does not appear to be the case on the southern route.

Price approval The key features of a price approval approach to regulation are as follows.

– The ferry service operator would be required to propose fare changes—eg, on an annual basis—with the regulatory authority having the right to approve the proposals, or to refer the matter back to the operator for revision.

Oxera 37 The supply of ferry services: a policy assessment

– Once approved, charges could not be increased until the next period (say one year), although the pricing commitments could apply at an aggregate level in order to provide the operator with some flexibility in relation to the structure of charges.

– It may be the case that extraordinary circumstances may lead to a need to review charges within the proposed period: the model would need to identify whether such a provision should be allowed, and under what conditions it could be operated. In general, the longer the period between price proposals, the greater the case for including a degree of flexibility with regard to revision of charges in the interim period.

A key issue for consideration under this regulatory approach would be under what conditions the authorities would approve, or require revisions to, proposals put forward by the operator. A competition-type assessment (such as an abuse of dominance test for excessive pricing) could be one way of proceeding, although this would be relatively burdensome in terms of information and resources. An alternative approach would be to review whether the proposed changes may be justified by changes in costs.

The regulatory authorities would require some powers to request information from the operator in order to enable them to carry out the approval process. Such information requirements would, at a minimum, include pricing information (including maximum as well as average fares across essential service categories). Furthermore, cost-based information could also form part of the information process, albeit at some cost to both the operator and the nominated authority in collation and analysis.

Price indexation The key features of a price indexation form of regulation are as follows.

– A price index would be created to reflect the cost of a basket of services.

– The average price charged by the operator for services included within the basket could change in light of movements in an external index, which would be intended to broadly reflect trends in the cost of inputs.

– Options for which index to use could include a consumer price index, a fuel index, or an index designed to reflect more specifically the cost structure of the operator.

– The basket could in principle be disaggregated, with a separate index applied, for example, to passenger and freight services.

In theory, the price index approach could also include an agreed ‘efficiency assumption’ (or alternatively, if investment pressures are significant, an uplift over the index). Evidence supporting the case for adopting such an approach would need to be developed.

While this approach would initially entail some up-front regulatory costs (in order to design the indexation rule), the regulatory burden on both the company and the authorities would be relatively limited, consisting only of tracking the index in question and demonstrating compliance.

In addition to this relatively limited ongoing oversight, there may be a case for a periodic reconsideration of the index, should it fail to represent trends in the market. This could, for example, be carried out every five or ten years.

Ex ante price cap The key features of a fourth model for price regulation (ex ante price limits) are as follows.

– Maximum prices for a basket of goods, for example, would be established for a duration of three to five years.

Oxera 38 The supply of ferry services: a policy assessment

– The price limits could be informed by an assessment of the forecast costs likely to be incurred by the operator in providing the nominated services.

– The cost forecasting could in theory adopt the standard ‘utility’ model, requiring an assessment of the value of the assets used in providing the services, operating costs, financing costs, and new investment.

– The operator would be able to outperform the price limits by operating more efficiently than anticipated by the regulatory authorities, either in terms of the costs incurred or the revenue earned. However, it would also face risks associated with underperformance under such a model.

– In order to undertake the above analysis, detailed cost information would need to be provided, including forecast data for the period in question. The regulator would also need to undertake robust analysis in order to determine key financial parameters, such as the cost of capital and an appropriate asset value.

Such a model could help ensure that prices to consumers broadly match the costs incurred by the operator. However, the model (as described above) suffers from two important disadvantages when applied to the ferry services market.

– First, it would require substantially greater amounts of information to be collated by the authorities when compared with the status quo. The analytical resources of the authorities would also need to reflect the nature of work likely to be required. While in theory price limits could be set using less intensive methods, these would tend to converge with the ‘price indexation’ approach previously identified.

– Second, while such a model may be appropriate where a monopoly exists (for example, in the case of water or energy networks), it does not provide a great deal of flexibility for operators in more competitive markets to adjust for changing market conditions. In the ferry services market, some competitive pressures may arise from the fact that a significant proportion of ferry users consider air transport options as a viable alternative.30

6.6.2 Summary assessment on regulatory approach The regulatory options differ in terms of the costs imposed on the firm and the regulatory authorities, the amount of information that needs to be collected, and the degree to which detailed bottom-up analysis is required in order to set prices.

Given that the size of the passenger market is limited, and noting that the regulatory costs will need to be recovered from ferry users (or from general taxation), it is important to strike the right balance between the regulatory costs imposed and the benefits that may arise from regulation.

While this report does not set out to provide a full cost–benefit analysis of individual regulatory options, some general remarks on the appropriate balance can be made.

The two disadvantages identified with a detailed bottom-up price cap imply that, for this approach to have merit, the potential size of welfare gains from its adoption would need to be very significant. Given the fact that this type of model is typically adopted for network utilities, and applied by regulatory authorities that are reasonably well resourced—with the necessary economic, accounting and industry expertise to develop detailed models of costs and forecasts of how the market will develop—it is not recommended that this option is pursued.

30 For example, over one-third of people who responded that they had not travelled by ferry during the preceding year claimed that they preferred to travel by plane and hire a car. States of Jersey Statistics Unit (2008), ‘Jersey Annual Social Survey 2008’.

Oxera 39 The supply of ferry services: a policy assessment

Any of the other three models could, potentially, strike the right balance. A price-monitoring approach would largely imply retaining the status quo, although the role could be passed from government ministers to the JCRA to enhance the focus on economic considerations and market developments. In particular, formalising this role within the JCRA could help ensure that information required to fulfil the role can be subject to the formal information- raising powers of the JCRA.

There should be some recognition of the degree of the firm’s market power when deciding on the appropriate form of regulation. Assuming a licensing approach that includes provisions to ensure that any entrants would not undermine the year-round service, the analysis in section 5 suggests that sustained entry would be unlikely. However, the prospect of future entry, along with features of the market such as relatively low levels of demand, potential for substitution to air transport, or smaller passenger-only services (operating on the southern route) and lo-lo services (in the case of freight) may impose some limits on the degree of market power. This might suggest that imposing detailed regulatory structures (even without going so far as ex ante price caps) could feed through to higher, rather than lower, consumer prices. In light of this, the States may wish to start with a monitoring or approval process, subject to greater clarification of the information required and the process the authorities would follow. Should future concerns emerge regarding value for money of the ferry service, the option of imposing a more detailed regulatory structure would remain.

6.6.3 Practical considerations A number of practical considerations will need to be addressed in the event of any of the above regulatory options being pursued. These include the following.

Which party should be responsible for regulatory oversight? The approach recommended in this report is that the JCRA take on the formal oversight of the sector (including the price monitoring, approval, and/or determination of the basis for any indexation formulae). This reflects the types of skills that would be required to effectively carry out such a role, which include regulatory and competition analysis, as well as a degree of understanding of the sector in question. This is more likely to fit with the role of the JCRA than with Ministers. This approach may also be more likely to generate independent assessments over time. The JCRA currently has formal powers to request information of the type relevant to this oversight role, which is not available to other parties.

What resources would be required by regulatory authorities? It will be for the JCRA to determine the precise requirement anticipated to fulfil a role as outlined above. It is anticipated that the level of work implied would be rather greater at the outset, when the precise form of the regulation is developed: once in place, the oversight role could then, for example, be performed by a case officer reporting to the JCRA board. Once the initial structure of the regulatory oversight has been established (including any licensing terms), the role of the JCRA staff may include identification of information requirements, review of compliance with licence terms, and calculation of USO contributions to be made by potential entrants (where appropriate). Further discussion with the JCRA would, however, be necessary to identify the detailed requirements for undertaking this role. 6.7 Summary of policy and regulatory options

Given the market environment described in section 5, and the discussion on the merits of the various policy alternatives above, the following assessment may be made.

At a minimum, there is a case for some policy intervention to promote the primary objective of securing the stable provision of ferry services. This might include features of licences that increase the commitment to the winter service, which is likely to be unprofitable on a stand- alone basis on both the northern and southern routes. Within the licence, this could include a number of obligations (however defined), with an optional requirement for licensees to post performance bonds which would be forfeited if such obligations are not fulfilled.

Oxera 40 The supply of ferry services: a policy assessment

In respect of licence exclusivity, the analysis suggests that the States will not be able to rely on sustainable competition to protect the interests of users while meeting the minimum service requirements. Nevertheless, the States may not wish to formally exclude the prospect of future applications for services which may be in the public interest.

In particular, it will be important to ensure that any future entry to the market does not undermine the year-round service by, for example, targeting more profitable summer operations. The States would therefore need to identify the appropriate balance of access rights and contributions to the USO, which would address these trade-offs. However, requiring all parties to physically provide the year-round service (as opposed to contributing financially to the USO) is likely to impose significant and unnecessary costs to the Island. Oxera considers that the scope for sustainable entry—given these licence requirements, observations of recent market developments, and assessment of the market characteristics—would suggest that the prospect of sustainable entry in the market is limited.

While both options of separating the licence or issuing licences for both the northern and southern routes are possible, splitting the licence would appear to generate a number of potential disadvantages in terms of security of supply and impact on the States’ budget, with little gain in terms of increased competition.

The case for increased regulatory oversight depends on the decision taken with respect to the market structure. If non-exclusive licences are retained, the case for detailed regulation (including setting of price caps based on forecast cost and demand data) is weaker and may risk undermining the ability of operators to cover costs over the life of the assets. If exclusive licences are granted, the case for increased regulatory oversight becomes stronger.

The precise structure of the regulatory oversight will need to reflect the fact that the costs of regulation to both the company and to the authorities will ultimately be borne by users and taxpayers. Oxera has presented the merits of a number of options, which range from lighter- touch approaches, such as price monitoring, to more detailed cost-reflective price caps. Given the size of the market, the case for imposing a significant regulatory burden is not strong, since these costs would be likely to outweigh the welfare savings which might be generated. At the same time, there is a case for more detailed information provision than currently exists to aid price monitoring.

It will nevertheless be important to ensure that the operator maintains some degree of operational and pricing flexibility to deal with changes in the market environment. Such changes could include developments in the competitive environment (particularly air services) as well as those affecting fuel costs.

The options which best meet the various requirements include price monitoring supplemented with enhanced information powers, price approval, or indexation. Each of these may be designed to provide some flexibility in terms of pricing structure for the operator, while presenting the regulatory authorities with a means of action should the operator engage in excessive pricing.

A number of features associated with a licence would need to be developed in detail. Among the issues to address are the following.

– Defining the minimum services—these can, for example, be based on the current schedule of services, or on the minimum requirements, as set out within existing ramp permits.

– Duration of licence—the notice period for the licence should be made clear. The States may also wish to define terms for licence revocation if contract terms are breached.

– Information requirements—if an exclusive licence is issued, the States may wish to monitor performance under the terms of the contract. The obligation to provide such

Oxera 41 The supply of ferry services: a policy assessment

information that might be necessary to oversee performance should be a condition of the contract, and could include pricing and volume data as well as indications of service performance. It could also include some cost data to assist with calibration of pricing.

– Scope of services included—given the close interaction identified between the freight services and the passenger services—reflecting the fact that fast passenger services do carry light freight, while the conventional ferry services carry significant amounts of freight and provide back-up support to the passenger service—it is recommended that the licence refers to the minimum services schedule, which must be provided to fulfil both passenger and freight services. However, there is a case for excluding separate services, currently provided by independent operators, which may provide some useful competitive checks on the licence holder, such as lo/lo freight or independent (foot) passenger-only services, provided that these do not undermine the year-round service.

Oxera 42 The supply of ferry services: a policy assessment

7 Conclusions and recommendations

This report has analysed the security of supply of the northern and southern ferry routes to and from Jersey under a range of market structures. It is clear that it is not possible to meet all of the States’ policy objectives simultaneously. This difficulty has previously been recognised by the States,31 and this report concludes that it is not easy to reconcile the need for security of supply in the form of sustainable winter services with open competition. There is therefore a requirement to prioritise which policy objectives are more important. Oxera understands that security of supply is the most important objective and has focused the analysis on understanding the implications of different market structures for security of supply. Having analysed these, the other policy objectives are considered.

In considering the security of supply objective, the profitability of the different routes was assessed and the following conclusions reached.

– On the southern route, the winter service does not appear to cover operating costs for the year 2008 (and probably for earlier years) even when operating in a monopoly market. The summer service also does not appear to cover ownership costs in 2008, although this more surprising result may reflect assumptions made to reflect limits in freight and passenger yield data.

– The fast ferry service on the northern route appears to be profitable on a year-round basis, with summer profits exceeding losses on the winter service by around £1.5m (once ownership costs are taken into account).

– While there is considerable uncertainty regarding freight yields due to the commercial sensitivity of this figure, it is estimated that the heavy freight service on the northern route is profitable.

Several policy options have been identified which address the concerns. This analysis suggests that there is a case for policy intervention to ensure security of supply within the ferry services market. The detailed design of the policy will need to be considered alongside the existing powers and duties of regulatory authorities within Jersey. Nevertheless, a number of steps may be recommended: licences should be established which address the need for the provision of lifeline services. Steps should be taken to ensure that operators are incentivised to operate lifeline services which may otherwise be unprofitable. This may include performance bonds, and clarifying the basis of licence revocation in the event of non-compliance.

It is recommended that the States review the conditions under which any future applications from prospective entrants may be considered. This should include a means to ensure a proportionate contribution to the USO—if not through physical provision of services, then through a financial contribution to the operator of the expected winter losses.

Options for regulation, described in section 6, range from light-touch price monitoring to detailed price regulation. It is recommended that, at a minimum, a process of price monitoring be established, enhanced by a requirement to provide such information as is necessary for the concessioning party to review the performance of the operator under the terms of the licence. It is further proposed that, given the importance of scope economies between the freight and passenger service—in particular, owing to the need for conventional

31 States of Jersey and States of Guernsey (2008), ‘Channel Island Passenger Car Ferry Sea Transport Policy Statement’, January 17th.

Oxera 43 The supply of ferry services: a policy assessment ferry services for winter and the back-up service—the operator be allowed to retain flexibility of tariff structures to ensure the costs can be most efficiently covered.

There may be a case for setting out an indexation of pricing to ensure that overall prices are broadly cost-reflective. However, the most formal approach to regulation—including detailed cost efficiency studies, tests of allowed returns, and price limits established over specific review periods—would entail significant costs to the Island and the existing operator of the services. Rather, the ability to introduce a more formal process should be maintained as an option to be considered at a regular review point in the licence, on the basis that if there is evidence or concern that the operator is abusing its dominant position in the market, more direct control of pricing policy would be required.

The party likely to be best placed to carry out this oversight role is the JCRA, in view of its existing knowledge of the sector, and its wider remit for economic regulation in Jersey. Precise duties, as well as resourcing requirements, would need to be identified and discussed with the JCRA, but these are likely to include initial work to define the proposed licensing model in more detail, and a relatively limited ongoing monitoring role to ensure compliance with licence conditions.

Oxera 44 The supply of ferry services: a policy assessment

A1 Description of modelling approach and results

As part of the security of supply exercise, Oxera has modelled the profitability of the northern and southern ferry routes from Jersey in both summer and winter. The underlying rationale is that a commercial operator is less likely to cease operations on a profitable route than an unprofitable one. Hence the profitability of each route is an important consideration in the analysis of the security of supply.

Separate models have been created for the northern and southern routes because of the different characteristics of each route (see section 5). The models provide an estimate of the profitability of each route for both seasons as far as possible, on the basis of current vessels, timetables and demand. Therefore if the vessels or routes change substantially, Oxera’s analysis may no longer provide an accurate representation of reality.

This exercise does not consider the profitability of the freight-only vessel, as entry into the freight market appears unlikely, and Oxera does not have sufficient data to undertake this analysis.

The modelling methodology, the data sources to which Oxera has had access during this study, and the assumptions made, are outlined below. Section A1.2 then examines the outcomes of the modelling for the southern route; section A1.3 investigates the northern route, focusing on the interaction of passengers and freight; and section A1.4 concludes. A1.1 Methodology

A1.1.1 Method As stated above, although separate models have been created for each route, the model structure is essentially the same for both routes, and uses cost data from the Drewry Shipping Consultants report,32 passenger data from Jersey Harbours, timetable data from Condor Ferries’ website and the States of Jersey, and data on average yields provided by Condor Ferries to calculate the profitability in winter and summer. This can then be used to estimate the level of subsidy that an operator may require.

The Drewry Shipping Consultants report does not contain information on conventional ferries; therefore, data on conventional ferries has been taken from previous projects to provide a robust estimate of the costs of this type of vessel. The models have been reviewed by Condor Ferries to help ensure that the results are reflective of current conditions in the market.

32 Drewry Shipping Consultants (2008), ‘Investigation into the Availability and Supply of Shipping Services: France—Channel Islands’, September.

Oxera 45 The supply of ferry services: a policy assessment

Figure A1.1 Model structure

Ownership profit = Operating profit – (depreciation+ cost of capital + contribution to fixed costs + marketing costs)

− depreciation − cost of capital − contribution to fixed costs Operating profit − marketing costs = revenue – cost

Revenue Cost = demand × yield

Demand Yield

– data from Jersey – data from Condor – number of trips/day Harbours – harbour dues – assumptions to – fuel price allocate demand – other operating costs between vessels

Source: Oxera.

Revenue is calculated from Jersey Harbours’ data on passenger numbers (and for the northern route, freight numbers), data on passenger yields from Condor, and publicly available information on the cost of shipping freight.

Although the northern route is more complex because of the interaction between freight and passengers, the model is conceptually similar. It allows both passengers and freight to travel on the conventional vessel; an assumption is made (detailed below) about the split of passengers and freight between vessels. The revenue allocations are dependent on this split.

Oxera is aware that there is currently a service that runs between the UK and St Malo. This has been split by assuming that there are two separate journeys contained within that voyage: one from the UK to the Channel Islands (the northern route) and the second from the Channel Islands to St Malo (the southern route). Figure A1.2 below shows the routes and how they have been split.

Oxera 46 The supply of ferry services: a policy assessment

Figure A1.2 Route map

Poole/ Weymouth Portsmouth

freight/conventional vessel large fast vessel

Guernsey large fast vessel

Jersey Cherbourg

large fast vessel small fast vessel

St Malo

Source: Oxera.

A separate analysis has been conducted for the Channel Islands (taken to be Jersey and Guernsey) and Jersey separately. In the analysis of Jersey, costs are allocated according to the number of journeys calling at the island as a proportion of the whole, whereas in the analysis for the Channel Islands as a whole, estimates of revenue earned on routes including Guernsey using the vessels in question are incorporated into the model.

A1.1.2 Assumptions Assumptions used in the modelling are as follows.

– A fast ferry is used with a capacity of 800 passengers and 200 cars. It travels at 40 knots and consumes six tonnes of marine gas oil per single journey between St Helier and St Malo, as per the Drewry Shipping Consultants report. Oxera is aware that both the Condor Vitesse and the Condor Express are close to this; the Condor 10 is roughly half the size (carrying 90 cars and 570 passengers) and so adjustments were made to fuel consumption, depreciation and cost of capital requirements for this vessel. These adjustments are detailed below. The speed assumed above is slightly greater than the actual operational speed of the ferries currently used in services from the Channel Islands, which typically travel at 30–35 knots. However, Oxera has no data with which to assess the effect of this difference on profitability. The impact would be expected to be limited, however, since it takes existing schedules as fixed, rather than attempting to model the maximum number of services which could feasibly be run per day.

– Some costs are incurred by the operator regardless of whether the ferry is used; these costs amount to £341 per day and are taken from Table 1 of the appendix to the Drewry Shipping Consultants report.

– The cost of running a vessel does not change with the volume of passengers or freight using it.

– The fuel consumption of the small vessel is assumed to be equal to 70% of the consumption of a large vessel, based on data from Condor Ferries.

Oxera 47 The supply of ferry services: a policy assessment

– The price of fuel is assumed to be $475 per tonne (the price charged in Rotterdam on January 8th 2009),33 which is a more recent figure than the $905 per tonne quoted in the Drewry report. The exchange rate used to convert the cost of fuel is 0.6566 (£1:$0.6566).34

– The number of journeys is taken from Condor’s 2008 timetable.

– On the northern route, 50% of passengers are assumed to travel on each of the fast vessels, with the conventional ferry being used solely for freight; 60% of freight by weight is assumed to be transported on the freight-only vessel, with the remaining 40% travelling on the conventional vessel.

– Oxera has made assumptions, based on information provided by the Economic Development Department of the States of Jersey, that 88% of passengers are adults and that 65% of adults purchase goods from the duty-free shops on board the vessels. Data received from Condor Ferries suggests that the average value of the goods purchased is £12. Furthermore, Oxera has assumed a margin of 50% on these sales to obtain an estimate of the profit stream from onboard sales.

– Guernsey is assumed to provide two-thirds of the revenue from Jersey, adjusted for the proportion of trips to Guernsey compared with Jersey. This assumption is made because of the relative population sizes and because the fares on Condor’s website appear to be the same between Jersey and Portsmouth and Guernsey and Portsmouth.

– Costs are allocated between Jersey and Guernsey on the basis of the proportion of journeys where the vessels call at each port. Where the vessel calls at both Jersey and Guernsey, the cost is allocated equally. Depreciation is calculated on a straight-line basis, using data from Oxera’s previous work. The assumptions are as follows: for the large fast ferries, an initial cost of £29.8m, a terminal value of £4.5m and an asset life of 20 years, which results in depreciation (on a straight-line basis) of £1.27m per year. For the small fast ferry, an initial cost of £25m, a terminal value of £3.75m and an asset life of 20 years, which results in depreciation (on a straight-line basis) of £1.06m per year. For the conventional vessel, an initial cost of £40m, a terminal value of £6m, and an asset life of 25 years, which results in depreciation (on a straight-line basis) of £1.36m per year.

– The cost of capital is calculated on the basis of an annuity, using the same assumptions as those presented above for the depreciation calculation, and an interest rate of 10%.

– In the absence of information covering maintenance requirements, it has been assumed that the conventional vessel is in use every day of the year except Sundays, as per Condor Ferries’ website.

– Overhead costs are allocated according to the number of journeys made by each vessel.

– Total passengers are allocated between the large and small fast ferries on the southern route according to the number of trips made. In reality, this is likely to be unrealistic, with some services on each type of vessel being more heavily loaded than others. However, without more detailed data on loadings, Oxera is unable to assess this further.

33 Source: http://www.bunkerworld.com/markets/prices/nl/rtm/, accessed January 9th 2009. 34 Conversion rate as at January 9th 2009.

Oxera 48 The supply of ferry services: a policy assessment

Table A1.1 Data sources

Source Description Drewry Shipping Consultants report Data on cost for a fast ferry Jersey Harbours Data on passenger and freight volumes Condor Ferries Data on actual average yields for car and foot passengers Data on the relative costs of a 74m (small) vessel compared with an 86m vessel (large) Data on overheads, marketing and port/other direct costs Data on on-board sales Bunkerworld.com Data on the price of marine gas oil Freightferries.co.uk Data on cost of shipping freight from Portsmouth to Jersey Oxera project experience Data on cost for the conventional ferry States of Jersey Economic Development Data on on-board sales Department Data on number of vessels travelling on each route

Source: Oxera analysis.

Oxera 49 The supply of ferry services: a policy assessment

A1.2 Southern route

A1.2.1 Southern route: Channel Islands This section presents a high-level analysis of the profitability of the southern route in both summer and winter.

Table A1.2 Southern route profitability: small fast ferry (Channel Islands) (£’000s)

Winter Summer Staff costs 431 847 Fuel costs 730 2,356 Other operational costs 246 482 Non-operational costs 44 62 Other port costs (not harbour dues) 393 1,270 Total estimated cost 1,844 5,017 Revenue Jersey pax 233 1,430 Revenue Jersey vehicles 397 2,276 Revenue Jersey duty-free 77 473 Revenue Jersey light freight 32 45 Revenue from Jersey 739 4,224 Revenue from Guernsey 82 467 Total revenue 821 4,690 Operating profit –1,023 –327 Contribution to fixed costs and marketing 218 156 Depreciation 443 620 Profit after depreciation & contribution to fixed costs and –1,684 –1,102 marketing Cost of capital 883 1,236 Profit after cost of capital, depreciation, contribution to –2,125 –1,719 fixed costs & marketing

Note: Component parts may not sum to the total due to rounding. Source: Oxera analysis.

Oxera 50 The supply of ferry services: a policy assessment

Table A1.3 Southern route profitability: large fast ferry (Channel Islands) (£’000s)

Winter Summer Staff costs 78 154 Fuel costs 247 799 Other operational costs 45 88 Non-operational costs 8 11 Other port costs (not harbour dues) 71 231 Total estimated cost 450 1,282 Revenue Jersey pax 42 260 Revenue Jersey vehicles 72 413 Revenue Jersey duty-free 14 86 Revenue Jersey light- freight 6 8 Revenue from Jersey 134 767 Revenue from Guernsey 61 346 Total revenue 195 1,113 Operating profit –255 –169 Contribution to fixed costs and marketing 40 28 Depreciation 73 102 Profit after depreciation & contribution to fixed costs and –368 –299 marketing Cost of capital 146 204 Profit after cost of capital, depreciation, contribution to –440 –401 fixed costs & marketing

Note: Component parts may not sum to the total due to rounding. Source: Oxera analysis.

The table above reflects the contribution of the southern route to the profitability of the large fast ferry.

The conclusions from this analysis are as follows.

– It is not profitable to run services in the winter, before ownership costs are taken into account.

– When ownership costs are taken into account, it is not profitable to run the services in either summer or winter.

Note that the conclusions are sensitive to the fuel price and the level of the other harbour costs. Fuel is the single largest operating cost and so will have a significant impact on profitability. They also reflect the yields during 2008, which may be affected by the period of competition on the southern route.

Oxera 51 The supply of ferry services: a policy assessment

A1.2.2 Southern route: Jersey This section presents a high-level analysis of the profitability of the southern route in both summer and winter for Jersey.

Table A1.4 Southern route profitability: large fast ferry (Jersey) (£’000s)

Winter Summer Staff costs 59 116 Fuel costs 187 604 Other operational costs 34 66 Non-operational costs 6 8 Other port costs (not harbour dues) 54 174 Total estimated cost 340 969 Revenue Jersey pax 42 260 Revenue Jersey vehicles 72 413 Revenue Jersey duty-free 14 86 Revenue Jersey light freight 6 8 Revenue from Jersey 134 767 Operating profit –206 –202 Contribution to fixed costs and marketing 30 21 Depreciation 44 62 Profit after depreciation & contribution to fixed costs –280 –285 and marketing Cost of capital 88 124 Profit after cost of capital, depreciation, contribution –324 –347 to fixed costs & marketing

Note: Component parts may not sum to the total due to rounding. Source: Oxera analysis.

Oxera 52 The supply of ferry services: a policy assessment

Table A1.5 Southern route profitability: small fast ferry (Jersey) (£’000s)

Winter Summer Staff costs 326 640 Fuel costs 551 1,780 Other operational costs 186 365 Non-operational costs 33 47 Other port costs (not harbour dues) 297 959 Total estimated cost 1,393 3,791 Revenue Jersey pax 233 1,430 Revenue Jersey vehicles 397 2,276 Revenue Jersey duty-free 77 473 Revenue Jersey light-freight 32 45 Revenue from Jersey 739 4,224 Operating profit –654 432 Contribution to fixed costs and marketing 165 118 Depreciation 443 620 Profit after depreciation & contribution to fixed costs and –1,262 –305 marketing Cost of capital 883 1,236 Profit after cost of capital, depreciation, contribution to –1,702 –922 fixed costs & marketing

Note: Component parts may not sum to the total due to rounding. Source: Oxera analysis.

The conclusions from this analysis are similar to those for the Channel Islands as a whole, with the exception that the small fast vessel appears to cover its operating costs in the summer at the yields and volumes for 2008. While it may be appropriate to consider the wider market for the Channel Islands, it is worth noting that this requires additional estimates, in terms of the revenues earned from the Guernsey leg of the route, and which may increase the uncertainty associated with the estimates.

Oxera 53 The supply of ferry services: a policy assessment

A1.3 Northern route

A1.3.1 Fast ferries The analysis for these vessels reflects that carried out for the fast vessel on the southern route, and is appropriately modified for the extra distance between Weymouth/Poole and St Helier, compared with St Malo and St Helier.

Table A1.6 Fast ferries (northern route) (Channel Islands) (£’000s)

Winter Summer Staff costs 68 412 Fuel costs 105 1,227 Other operational costs 53 405 Non-operational costs 51 73 Other port costs (not harbour dues) 42 494 Total estimated cost 319 2,611 Revenue Jersey pax 220 1,747 Revenue Jersey vehicles 174 1,149 Revenue Jersey duty-free 38 254 Revenue Jersey light freight 56 79 Revenue from Jersey 487 3,229 Revenue from Guernsey 432 2,863 Operating profit 600 3,481 Contribution to fixed costs and marketing 145 203 Depreciation 395 553 Profit after depreciation & contribution to fixed costs and 60 2,725 marketing Cost of capital 1,115 1,562 Profit after cost of capital, depreciation, contribution to –660 1,716 fixed costs & marketing

Note: Component parts may not sum to the total due to rounding. Source: Oxera analysis.

The conclusion in light of this analysis is that is not profitable to run the winter services once ownership costs (such as depreciation and the cost of capital) are taken into account. However, given that the operating profit is positive, it is likely that running the services during the winter covers average variable costs and makes a contribution to the fixed costs of the vessel. The operation appears to be profitable during the summer season, although, as previously noted, the revenues for the Guernsey leg are assumed rather than known.

Oxera 54 The supply of ferry services: a policy assessment

Table A1.7 Fast ferries (northern route) (Jersey) (£’000s)

Winter Summer Staff costs 34 208 Fuel costs 53 621 Other operational costs 27 205 Non-operational costs 26 37 Other port costs (not harbour dues) 21 250 Total estimated cost 162 1,322 Revenue Jersey pax 220 1,747 Revenue Jersey vehicles 174 1,149 Revenue Jersey duty-free 38 254 Revenue Jersey light freight 56 79 Revenue from Jersey 487 3,229 Revenue from Guernsey 0 0 Operating profit 326 1,907 Contribution to fixed costs and marketing 74 103 Depreciation 200 280 Profit after depreciation & contribution to fixed costs and 52 1,524 marketing Cost of capital 565 790 Profit after cost of capital, depreciation, contribution to –312 1,014 fixed costs & marketing

Note: Component parts may not sum to the total due to rounding. Source: Oxera analysis.

The conclusion of this analysis is similar to that presented above for the Channel Islands as a whole—ie, that the profitability of the fast vessel is negative in the winter period when depreciation, contribution to overheads and the cost of capital are allowed for, but that the vessel is profitable in the summer.

Oxera 55 The supply of ferry services: a policy assessment

A1.3.2 Conventional vessel The data for the conventional vessel is taken from a different source to the fast ferries, but the results are comparable.

Table A1.8 Conventional vessel (Channel Islands) (£’000s)

Winter Summer Staff costs 588 843 Fuel costs 1,832 2,628 Other operational costs 660 947 Non-operational costs 0 0 Other port costs (not harbour dues) 1,002 1,438 Total estimated cost 4,083 5,856 Revenue Jersey pax 0 0 Revenue Jersey vehicles 0 0 Revenue Jersey freight 2,871 4,809 Revenue Jersey duty-free 0 0 Revenue from Jersey 2,871 4,809 Revenue from Guernsey 2,546 4,265 Operating profit 1,334 3,218 Contribution to fixed costs and marketing 332 465 Depreciation 567 793 Profit after depreciation & contribution to fixed costs and 435 1,960 marketing Cost of capital 1,862 2,606 Profit after cost of capital, depreciation, contribution to –859 147 fixed costs & marketing

Note: Component parts may not sum to the total due to rounding. Source: Oxera analysis.

This analysis suggests that the conventional ferry does not cover the costs of the winter operation (once ownership costs, including the cost of capital, are accounted for), although it does make a contribution towards covering fixed costs. The summer operation appears to be profitable. Overall, the conventional service across the Channel Islands as a whole is estimated to make a small loss over the course of a year, although as previously noted this result may be sensitive to the freight yields assumed in the model.

Oxera 56 The supply of ferry services: a policy assessment

Table A1.9 Conventional vessel (Jersey) (£’000s)

Winter Summer Staff costs 294 422 Fuel costs 916 1,314 Other operational costs 330 474 Non-operational costs 0 0 Other port costs (not harbour dues) 501 719 Total estimated cost 2,042 2,928 Revenue Jersey pax 0 0 Revenue Jersey vehicles 0 0 Revenue Jersey freight 2,871 4,809 Revenue Jersey duty-free 0 0 Revenue from Jersey 2,871 4,809 Revenue from Guernsey 0 0 Operating profit 830 1,881 Contribution to fixed costs and marketing 166 233 Depreciation 283 397 Profit after depreciation & contribution to fixed costs and 380 1,252 marketing Cost of capital 931 1,303 Profit after cost of capital, depreciation, contribution to –267 346 fixed costs & marketing

Note: Component parts may not sum to the total due to rounding. Source: Oxera analysis.

The conclusions reached from the Jersey modelling are broadly similar to those reached through the Channel Islands as a whole—ie, that the conventional vessel does not cover winter costs (including the cost of capital) but does so in summer. The year-round service is estimated to cover costs, which reflects the fact that a somewhat greater proportion of revenues than costs for the Channel Islands is allocated to Jersey (given the modelling assumptions), although as noted above these outcomes will be sensitive to freight yields. A1.4 Findings

The main findings from the modelling indicate that the passenger element does not cover its costs in the winter months (defined as January, February, March, November and December) on either route at the volumes and yields achieved in 2008. On the northern route the summer profits are estimated to cover the winter losses, while this was not the case for the southern route. However, the yields during 2008 in particular will have been affected by a period of competition on the route, and an indicative analysis using 2006 data (when a monopoly was in operation) suggests that under such conditions the year-round service can potentially cover its costs.

An accurate calculation of the profitability of the routes would require a detailed analysis of cost and revenue data for the operations in question. In the absence of full access to this data, Oxera has made certain assumptions, which are reflected in the calculated profitability.

The security of supply on the northern route is of particular interest, given the vital importance of the freight services on this route. The modelling suggests that the freight

Oxera 57 The supply of ferry services: a policy assessment business covers its costs (including the cost of capital), at least during summer, and may also do so over the course of a year-round service.

Oxera 58 The supply of ferry services: a policy assessment

A2 Policy tools

Policy tools Assessment Differential harbour Implies higher harbour charges for summer and lower charges for winter charges Requires coordination with Jersey Harbours or legislative change Levy charges Implies imposing a charge on the summer operators that will be transferred by the government to the winter operator Requires non-exclusive licences Pay-or-play Implies that providers in summer can decide whether to operate (play) or avoid operating in winter (by paying the provider that is going to play) Requires designing a mechanism through which operators can coordinate (via a bargaining process), setting up a tender to allocate who plays in winter, or designating who will play Government transfer Implies a transfer from the States of Jersey to the winter provider Requires collecting the necessary transfer through taxation Minimum Implies setting a minimum number of frequencies for the winter period frequencies Requires a mechanism to enforce the required level of service (ie, a licence or a bond) Non-exclusive Implies establishing a legal document giving official non-exclusive permission to operate licence in the Jersey ferry services market Requires the legal document to be drafted, as well as a mechanism through which to provide those licences to be created Exclusive licence Implies establishing a legal document giving official exclusive permission to operate in the Jersey ferry services market Requires the legal document to be drafted, including clauses such as transfer rights in case the provider cannot operate, as well as a mechanism through which to provide those licences to be created Price regulation Implies introducing a price cap or a revenue cap on the prices/revenues that the operators can maintain in the Jersey ferry services market Requires a legislative change and the creation of an authority or designation—probably the JCRA—to control the price regulation Bond on the Implies a bond to be deposited by the operator, which would be forfeited if certain operator requirements are not met Requires a decision on the size of the bond required and on the list of requirements that need to be met Tender Implies a formal proposal to operate the Jersey ferry services at a specified price Requires the tender to be designed

Oxera 59 The supply of ferry services: a policy assessment

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