Victorian Intra-State Rail Access Regime: Application for Certification Victorian Government

July 2001 Table of Contents

Section Page

1. Application and prescribed information...... 1

1.1. Applicant State or Territory...... 1

1.2. Responsible Minister...... 1

1.3. Contact Officers...... 1

1.4. Address of Responsible Minister ...... 2

1.5. Description of access regime ...... 2

1.6. Description of the services...... 2

1.7. Grounds in support of application ...... 2

2. Introduction...... 3

2.1. Background ...... 4

3. Victorian Government policy perspective...... 7

3.1. Vertical integration ...... 8

3.2. The Victorian access regime ...... 9

3.2.1. Key policy objectives relevant to the access regime ...... 10

3.2.2. What were bidders told about the access regime? ...... 13

3.3. The Victorian Government’s ongoing commitment to investment and competition in rail ...... 14

3.4. Appropriate for State to retain regulatory control...... 15

July 2001 i Table of Contents

Section Page

4. The Victorian intra-State rail access regime...... 16

4.1. Declaration...... 16

4.2. Administration of the regime...... 17

4.2.1. Negotiations...... 18

4.3. Arbitration...... 18

4.4. Pricing principles ...... 20

4.4.1. Pricing principles for Freight Australia’s leased network ...... 20

4.4.2. Pricing principles for the Bayside network ...... 21

4.4.3. Access pricing principles relating to the Dynon Terminals ...... 22

5. The Victorian regime is effective...... 24

5.1. Appropriate coverage of services ...... 24

5.1.1. Are the facilities ‘significant’?...... 26

5.1.2. Is it economically feasible to duplicate the facilities? ...... 27

5.1.3. Is access to the service necessary in order to permit effective competition in a downstream or upstream market? ...... 30

5.1.4. Can the safe use of the facility by access seekers be ensured at an economically feasible cost? Do appropriate regulatory arrangements for safety exist?...... 32

5.1.5. Summary...... 33

5.2. Negotiation framework ...... 34

July 2001 ii Table of Contents

Section Page

5.2.1. The Victorian regime meets criteria (a) to (c) ...... 34

5.2.2. Competitive neutrality ...... 36

5.2.3. Service quality ...... 39

5.2.4. Timepath management ...... 41

5.2.5. Safety accreditation ...... 42

5.2.6. Pricing principles ...... 42

5.2.7. Dispute resolution mechanisms...... 43

5.3. Clause 6(4)(d) – Expiry date...... 43

5.4. Clause 6(4)(e) – Reasonable endeavours to negotiate...... 44

5.5. Clause 6(4)(f) – No requirement for identical terms and conditions..... 44

5.6. Clause 6(4)(g) – Dispute resolution...... 44

5.6.1. Power to issue Orders-in-Council ...... 45

5.6.2. Requirement to seek and consider submissions from the Director of Public Transport ...... 50

5.6.3. Possible conflict between pricing principles and the CPA principles 50

5.7. Clause 6(4)(h) – Appeal rights ...... 50

5.8. Clause 6(4)(i) and (j) – Matters to be taken into account...... 51

5.8.1. Treatment of sunk costs ...... 53

July 2001 iii Table of Contents

Section Page

5.8.2. Average cost pricing ...... 57

5.8.3. Recovering the costs of new investments ...... 60

5.8.4. Pricing issues raised in the NCC Issues Paper ...... 62

5.9. Clause 6(4)(k) – Material change in circumstances ...... 63

5.10. – Existing users ...... 63

5.10.1. Clause 6(4)(m) – Hindering access...... 63

5.11. Clauses 6(4)(n) and (o) – Ring fencing...... 64

5.12. Clause 6(4)(p) – Multiple jurisdictions...... 64

5.12.1. Consistency with other regimes...... 65

Appendix A: Relevant legislation

Appendix B: Orders in Council issued under Part 2A of the Rail Corporations Act 1996

Appendix C: Guidelines issued by the Office of the Regulator-General

Appendix D: Information provided to bidders regarding the rail access regime

July 2001 iv Victorian Intra-State Rail Access Regime: Application for Certification

1. Application and prescribed information

This application is made under section 44M(2) of the Trade Practices Act 1974. The following supporting information is submitted for the National Competition Council’s (NCC’s) consideration in accordance with Regulation 6B of the Trade Practices Regulations. It seeks a recommendation from the NCC to the Relevant Minister that the Victorian rail access regime is an effective access regime in relation to the service of providing railway infrastructure facilities necessary for the operation and use of a railway by a person for the purpose providing a service of carrying freight.

1.1. Applicant State or Territory

This application is made by the State of Victoria.

1.2. Responsible Minister

The Responsible Minister concerning this application is:

The Hon. Stephen Phillip Bracks, MP Premier of Victoria

1.3. Contact Officers

The relevant contact officer concerning this application is:

Ms Mary Potter Assistant Franchise Manager Office of the Director of Public Transport Department of Infrastructure Level 25, Nauru House 80 Collins St MELBOURNE VIC 3000 ph: (03) 9655 6418 fax: (03) 9655 6426 Email: [email protected]

July 2001 1 Victorian Intra-State Rail Access Regime: Application for Certification

1.4. Address of Responsible Minister

The Responsible Minister’s address for the delivery of documents, including the notification of any decision or recommendation of the Relevant Minister or the NCC relating to this application is:

The Hon. Stephen Bracks, MP Premier of Victoria Level 1, 1 Treasury Place MELBOURNE VIC 3002

1.5. Description of access regime

A description of the access regime is at Section 4 of this document. A copy of the relevant legislation, Orders-in-Council and Guidelines is attached at Appendices A, B and C.

1.6. Description of the services

As required under Regulation 6B(f), this application includes a description of the services covered by the access regime (see Section 4.1).

1.7. Grounds in support of application

As required under Regulation 6B(g), this application includes argument in support of the application (see Section 5 of this application).

July 2001 2 Victorian Intra-State Rail Access Regime: Application for Certification

2. Introduction

This application seeks certification of the access regime relating to Victoria’s intra-state rail freight network (Victorian rail access regime).

The Victorian rail access regime commenced on 1 July 2001. The regime enables operators to gain access to a number of services necessary for the provision of rail freight services.

The Victorian Government considers that the Victorian rail access regime meets all of the criteria for effectiveness contained in the Competition Principles Agreement (CPA).

The facilities covered by the regime are significant

The declared services under the regime involve the use of the country intra-state rail network, the metropolitan freight-only rail network, part of the metropolitan passenger rail network and two major rail freight terminals close to the Port of Melbourne. These facilities are significant to the Victorian economy and Victoria’s export performance.

The facilities ere uneconomic to duplicate

The large economies of scale and the strategic locations of these facilities make them uneconomic or infeasible to duplicate. Duplicating these facilities would be economically and socially costly with little or no compensating benefits.

Access to the services is necessary to permit effective competition in the freight transport market

The Victorian intra-state rail freight network primarily transports grain. Currently, purchasers of grain freight services have little or no choice of their provider. Access to these services will enable above-rail freight operators to offer competing services to users of freight transport services within Victoria.

The regime promotes efficient use and investment in intra-state rail facilities

An important feature of the regime is that it minimises unnecessary transaction costs to the parties. Nevertheless, the regime will promote efficient investment and the efficient use of the infrastructure. A key factor in promoting efficient outcomes is the pricing principles incorporated in the regime. These principles prevent the access provider from including the cost of Government rail

July 2001 3 Victorian Intra-State Rail Access Regime: Application for Certification investments in access charges, but enable the access provider to recover the costs of its own renewal expenditure and investments in expanding and improving the intra-state rail network.

A State-based regime will enable the Victorian Government to pursue legitimate policy objectives

The access regime is a key component of the Government’s reform of rail transport services in Victoria and part of its ongoing commitment to National Competition Policy. The regime permits effective competition in the transport freight market, while enabling the Government to achieve other policy objectives in the rail industry (such as passenger priority).

2.1. Background

The Victorian rail access regime applies to:

¾ the country intra-state rail network leased to Freight Australia;

¾ the independent freight lines into Melbourne leased to Freight Australia;

¾ that part of the metropolitan rail network that is leased to Bayside Trains;

¾ the South Dynon Terminal leased to National Rail; and

¾ the Dynon Terminal leased to Freight Australia.

The services of the Freight and Bayside networks have been declared in relation to freight services only. Details of the coverage of the declaration are provided at Appendix B.

Intra-state rail freight services are currently provided by Freight Australia (FA). FA purchased V/Line Freight (VLF) from the Victorian Government in May 1999. The purchase involved two major components. The first component was the above-rail V/Line Freight business. This comprised the rolling stock and a number of contracts relating to the provision of freight services (such as those with the Australian Wheat Board and the Australian Barley Board). The second component of the purchase was the infrastructure business. This involved the leasing of the intra-state track (an initial lease of 15 years, with two further 15 year options, which have since been taken up), the provision of access to rail passenger operators and the regime enabling access by rail freight operators.

July 2001 4 Victorian Intra-State Rail Access Regime: Application for Certification

The Bayside Trains passenger rail franchise was awarded to National Express in August 1999. Bayside Trains was franchised as a vertically integrated entity. The franchise contract, including the lease over the Bayside network, lasts for 15 years.

The South Dynon Terminal was leased to National Rail in 1999. The Dynon Terminal was leased to FA in 1999. These terminals are located close to the Port of Melbourne, and are an important element of the Victorian Government’s strategy of streamlining links between road, rail and sea transport.

The Victorian Government considers that the Victorian rail access regime meets all of the criteria for effectiveness contained in the Competition Principles Agreement (CPA). The regime was designed with these requirements in mind. Its design features reflect the Victorian Government’s ongoing commitment to National Competition Policy.

The Victorian Government interests in the intra-state network stem from three main factors.

1. The Victorian Government is still a major investor in rail in Victoria. The Victorian Government has committed significant funds to sponsor gauge standardisation and upgrades of track for the Regional Fast Rail Project and to reintroduce passenger services to Mildura, South Gippsland, Ararat and Bairnsdale.

2. Intra-state freight is of strategic importance to the Victorian economy. Rail is particularly important to bulk commodity freight activities, notably grain. Around 90 per cent of the grain shipped from the ports of Geelong and Portland is delivered by rail. The Government is committed to increasing rail’s share of the State’s freight activities.

3. Country passenger rail services represent an important part of the Government’s commitment to improving the quality of services to rural and regional Victorians.

The Victorian rail access regime has been designed to achieve the Victorian Government’s policy objectives in relation to this network, which are discussed in more detail in Section 3.2. Certification of the regime will protect these policy priorities, chief among which is the development of a sustainable and competitive rail freight industry. This goal has shaped certain elements of the regime, such as its relative simplicity and the non-recovery of the costs of the Government’s rail track infrastructure that were sunk at the time of privatisation. The latter will lead to lower access prices and more efficient use of the network overall.

July 2001 5 Victorian Intra-State Rail Access Regime: Application for Certification

This submission is structured as follows.

Section 3 places the Victorian rail access regime in a public policy context. The rail reform program is outlined briefly, and the policy objectives that shape the access regime explained.

Section 4 describes the key features of the Victorian regime. The regime is designed to promote rail-on-rail competition, protect the legitimate interests of the access provider, encourage the efficient use of existing infrastructure, promote efficient investment in network extensions and upgrades, and to be as simple and straightforward as possible.

Section 5 provides an assessment of the regime against the principles for effectiveness outlined in the CPA.

July 2001 6 Victorian Intra-State Rail Access Regime: Application for Certification

3. Victorian Government policy perspective

The Victorian Government privatised its intra-state rail freight business V/Line Freight (VLF) in May 1999. This sale was part of a broad package of rail reforms. The main features of the reform program are outlined briefly below.

The inter-state track (i.e. the standard gauge track from Serviceton to Melbourne to Albury) was leased to the Australian Rail Track Corporation (ARTC) to form part of its ‘one stop shop’ for access to the nominated ‘national’ track and encourage growth in rail’s share of inter-state freight movements. ARTC is not vertically integrated. It does not own an above-rail freight or passenger rail business. The ARTC structure was supported by the Productivity Commission (PC) in its report on rail reform.1 Access to this track is covered by the ARTC’s draft undertaking, which has been submitted to the Australian Competition and Consumer Commission (ACCC) for consideration.

In relation to intra-state rail activities, six separate operating companies were privatised in 1999 as part of Victoria’s rail reform process:

¾ VLF, purchased by FA, which operates a rail freight business and leases country intra-state rail lines and independent freight lines into Melbourne;

¾ V/Line Passenger (V/Line), franchised to National Express, which operates passenger services in rural and regional Victoria using trains purchased from the Government;

¾ two metropolitan train franchises, Bayside Trains and Hillside Trains (now Connex), franchised to National Express and MTE respectively; and

¾ two metropolitan tram franchises, Yarra Trams, franchised to Metrolink, and Swanston Trams, franchised to National Express.

In 1994, two individual rail services were also privatised – the Warrnambool services to West Coast Railway and the Shepparton services to Hoys Roadlines.

Track and associated infrastructure remains in Government ownership, and is leased to private rail operating companies. All businesses were sold as vertically integrated enterprises, with the exception of V/Line. V/Line operates mostly on

1 Productivity Commission 1999, Progress in Rail Reform, Inquiry report no. 6, AusInfo, Canberra, p. 113.

July 2001 7 Victorian Intra-State Rail Access Regime: Application for Certification track leased to FA and Bayside Trains, to which it currently pays pre-determined access fees.

Each company purchased existing rolling stock from the Government.

Bidders had significant flexibility over the financial structure of their bids. For example, bidders for VLF could allocate funds into categories including lease pre- payments, rolling stock payments or payments for other business assets. Bid structures varied significantly among bidders, representing differences in the tax position of each consortium, among other things. As far as the Government was concerned, the key financial criterion was the net present value (NPV) of all of these payments. One of the principal evaluation criteria applied by the Government in evaluating the bids for VLF was:

The net present value of proceeds (adjusted for expected redundancy costs) and lease payments over the 45 year period.2

For the passenger businesses, bidders competed on the basis of the lowest subsidy requirement in NPV terms. Quality of service criteria were also important in the evaluation.

Victoria has also been actively involved in progressing harmonisation of rail practices across Australia. The Government has committed $96 million to standardisation to encourage integration of the intra-state network into a seamless national freight and logistics network.

3.1. Vertical integration

Clause 4 of the CPA requires State Governments to conduct a structural review of a public entity prior to its sale.

After the decision was made to lease the inter-state track to the ARTC, the Victorian Government conducted a review of the remaining intra-state rail businesses in 1997. Following the review the Victorian Government decided not to structurally separate the rail freight business.3 The results of this review were

2 Department of Treasury and Finance Transport Reform Unit 1998, V/Line Freight Invitation to Tender, September, p.31.

3 This decision was made by the previous Government. The current Government may not have made the same decision.

July 2001 8 Victorian Intra-State Rail Access Regime: Application for Certification

presented to the NCC. In relation to the country freight business, the NCC concluded in its second tranche assessment report that:

The Government made these [structural] decisions after conducting a review of the structural reform options for the intra-state freight network. The review found that the gains in terms of competition from a vertically separated track and freight business would be outweighed by the technical inefficiencies that separation would introduce.

Assessment

The Council is satisfied that Victoria has met its clause 4 obligations in respect of the introduction of increased competition and privatisation of the intra-state freight network.4

The Productivity Commission in its report on Progress in Rail Reform also endorsed the Victorian Government’s approach. The PC concluded that vertical integration was the appropriate structural form for Victoria’s intra-state freight network, and recommended this structure for other regional networks with similar characteristics.5

3.2. The Victorian access regime

VLF was sold on the basis that an access regime would apply. The structure of the regime was communicated to bidders during the bid process, and has not changed significantly since. A copy of relevant information provided to bidders is provided at Appendix D.

The Victorian regime was designed to be effective according to the principles outlined in the CPA. The CPA criteria are not prescriptive regarding the detailed design features of an access regime. As the NCC notes in its submission to the PC’s review of the national access regime:

… a range of regulatory arrangements are capable of promoting competitive outcomes and efficient use of infrastructure.6

4 NCC 2000, Second Tranche Assessment of State and Territory Progress in Implementing National Competition Policy and Related Reforms, July, vol. 1, p. 82.

5 Productivity Commission 1999, Progress in Rail Reform, Inquiry report no. 6, AusInfo, Canberra, pp. 117-120.

6 NCC 2001, Legislation review of Clause 6 of the Competition Principles Agreement and Part IIIA of the Trade Practices Act 1974, Submission to the Productivity Commission, January, p. 97.

July 2001 9 Victorian Intra-State Rail Access Regime: Application for Certification

The particular design features chosen by the Victorian Government reflect a range of legitimate State Government policy considerations, as discussed below.

3.2.1. Key policy objectives relevant to the access regime

Three policy objectives that have a direct bearing on the access regime are discussed below.

Promoting the efficient use of the infrastructure

A key policy objective of the Victorian Government is to promote the efficient use of the existing rail infrastructure.

The Victorian intra-state network was built a long time ago. It is a relatively lightly used network. Even in a boom grain year the tonnes per kilometre is lower than that of Tasmania.7 Most of the assets involved have no alternative use – they are effectively sunk. Nevertheless, the Victorian Government had a choice regarding whether or not it should seek to recover the costs of these assets through the sale process.

The Government’s priority is to ensure that the assets are not inefficiently under utilised. This is encouraged by lower rather than higher access charges. Efficient use of existing infrastructure was considered more important than recouping past investments in the network.8 The Government made this decision on the basis that this would best promote the interests of businesses operating in rural and regional Victoria, and growth in the Victorian economy more generally.

This policy objective shaped two key privatisation parameters:

¾ third party access charges were not to recover network costs that were sunk at the time of privatisation. This largely eliminates the threat to allocative efficiency posed by the recovery of high fixed costs for services for which the willingness to pay is low; and

7 Mr. Marinus van Onselen, quoted in the Melbourne Age, Business Section, 23 July 200, p.5.

8 The consequences of recovering the sunk costs for the efficient use of existing rail infrastructure is likely to be more significant in Victoria than in, say, Queensland, NSW or Western Australia. In other jurisdictions, coal and minerals industries bear the bulk of fixed cost recovery, allowing other industries, such as grain, logs and other freight, to pay significantly lower prices. The Victorian rail freight task comprises only the latter – a group of industries that exhibit a comparatively low willingness to pay for rail freight services.

July 2001 10 Victorian Intra-State Rail Access Regime: Application for Certification

¾ lease payments were essentially driven by the financial structuring of bids – there is no reason to believe that they represent the value of the infrastructure that should be recouped through access charges.

The decision to disallow the recovery of costs that were sunk at the time of privatisation affected VLF’s sale price. Clearly, a higher price could have been achieved if sunk costs were included in the access price formula. The decision to accept a lower sale price is equivalent to granting an ongoing subsidy to all users of the tracks to encourage the efficient use of the infrastructure.

Simplicity, certainty and transparency

A high priority for the Victorian Government was to minimise the regulatory burden created by the access regime. This has been achieved by designing an access regime that is:

¾ simple to understand and administer. This minimises the compliance costs for all involved. Victorian intra-state freight is not a highly profitable business – it was loss-making under Government ownership – therefore, the Government did not want providers and access seekers incurring unnecessary costs complying with a complicated regime. To give a sense of scale, VLF sold for $163 million. By contrast, the Victorian gas transmission business sold for $1.025 billion, and the electricity transmission business sold for $2.55 billion. Within the rail sector, FA’s revenues are around $180 million per annum in a good grain year. FreightCorp’s revenues are around $700 million per annum, while Queensland Rail’s revenues are around $1 billion. It would be difficult to justify, on a cost-benefit basis, an access regime that is anywhere near as complex as those applying to these latter business for the Victorian intra- state freight business;

¾ certain with respect to arbitrated outcomes. A regime that permits a very broad scope for arbitrated outcomes does not provide access seekers and providers with a high degree of certainty. The Victorian regime limits the scope for regulatory discretion thus promoting certainty; and

¾ transparent. The formula to be applied to access charges is publicly known. The access regime itself underwent an extensive period of consultation prior to privatisation. Further, any Government directions to the regulator are made through gazetted Orders.

July 2001 11 Victorian Intra-State Rail Access Regime: Application for Certification

Protection of passenger interests

The Victorian Government franchised the delivery of services provided by V/Line, which supplies the majority of passenger services to rural and regional Victorians. These services are now provided by National Express, whose franchise contract runs until 29 August 2009. The Warrnambool and Shepparton contracts are currently being refranchised, together with contracts for new services to Mildura and South Gippsland.

The Victorian Government has a policy interest in passenger services primarily because:

¾ they are a key element of service delivery to rural and regional Victorians; and

¾ the subsidy requirement for such services is substantial.

As noted above, the country passenger services were not vertically integrated at sale. The Government needed to ensure that they were not disadvantaged by this fact.

Generally, the intra-state freight network in Victoria is not subject to congestion, unlike, say, the regional track in NSW. However, there is some scope for clashes of priority over train paths for passenger and freight trains, particularly in that part of the metropolitan network leased by Bayside Trains. In the event that this occurs, the Victorian Government wanted to maintain its existing policy embedded in section 10 of the Transport Act 1983 and section 38B(b) of the Rail Corporations Act 1996, of granting priority to passenger services in most circumstances. This is because:

¾ timely passenger rail transport services are an important part of the Government’s provision of services to rural and regional Victorians;

¾ demand for passenger services are generally much more time sensitive than rail freight services;

¾ if a freight train needs to wait until a passenger train passes, the delay is likely to be relatively short. This is because passenger trains travel at high speed, and because they have fewer carriages. The reverse is not true; and

¾ National Express’s contract includes penalties for poor punctuality. To manage the passenger service provider’s risk, the Government needed to provide for passenger priority over freight.

July 2001 12 Victorian Intra-State Rail Access Regime: Application for Certification

The general premise that passenger services are more time sensitive than freight may not hold in every instance. For this reason, the Government decided that passenger priority should not be absolute. This is reflected in the Victorian access regime. If passenger priority might cause ‘serious and unreasonable’ interference to a freight operator’s business, then passenger priority will not be applied. This arrangement strikes a reasonable balance between protecting the interests of rural and regional Victorians in maintaining timely passenger services, and promoting the timely delivery of freight where this would be seriously compromised by passenger priority.

Promotion of efficient new investment in the network

At the time of privatisation, the intra-state network was suffering the results of a long period of under-investment. The Victorian Government did not want to create any impediments to the new private owner investing in the network. The access regime provides incentives for both renewal expenditure and investments in the expansion of the network and improvements in quality.

To protect investment incentives, access charges incorporate the costs of new investment (including renewal expenditure). Assets that existed at the time of privatisation are considered sunk, and the costs of which are not recoverable through access charges.

Efficient renewal expenditure is recoverable through access charges as maintenance expenditure. The nature of rail maintenance is that at any point in time some section of the network (track, signalling systems, sleepers and so on) is being replaced – it is generally not the case that an entire line reaches the end of its useful life and is then entirely replaced. For this reason, the difference between maintenance and investment is rather blurred. Renewal expenditure is considered as maintenance under the access regime and is recoverable (including a margin) through access charges.

Consistent with the policy that Government provided assets be available to all users, the costs of new investment by Government will also not be recoverable through access charges.

3.2.2. What were bidders told about the access regime?

During the VLF sale process, all bidders were informed of:

¾ the fact that an access regime would apply;

¾ the categories of costs that could be recovered through access charges, which excluded any return on existing infrastructure;

July 2001 13 Victorian Intra-State Rail Access Regime: Application for Certification

¾ the pricing principles to be adopted by the regulator; and

¾ the administrative arrangements associated with the regime.

Information was initially provided to bidders in the Information Memorandum. Draft pricing principles were available in the VLF data room. Meetings were held with each bidder to discuss the draft pricing principles. Following these meetings the pricing principles were revised and the revised pricing principles were placed in the data room prior to sale. The pricing principles are presented at Appendix D.

3.3. The Victorian Government’s ongoing commitment to investment and competition in rail

The provision of an access regime is just one element in the Victorian Government’s active commitment to a competitive rail freight industry. The Government has made significant financial commitments to projects that will increase the scope for competition in the rail freight industry in a meaningful, practical way.

In its 2001 budget, the Victorian Government committed $96 million over five years to convert some 2000 km of broad gauge lines to standard gauge. This will contribute to the creation of a seamless national freight and logistics network and reduce entry costs for rail operators that already possess standard gauge rolling stock. It will help rail become a more robust competitor to road in the freight market.

The Government has committed $3.5 million to the Dock Link Road project, a dedicated road connecting the Dynon terminals to the Port of Melbourne. Again, this will improve rail’s competitiveness compared with road. Since the Dynon terminals have been declared under the Victorian access regime, interested competing rail operators will be able to take advantage of this investment.

Other important projects in the rail freight sector include:

¾ the Albury-Wodonga Rail by-pass ($30 million); and

¾ the standardisation of the grain loop at the Port of Geelong ($1.86 million committed by Government).

Projects such as these provide tangible evidence of the Victorian Government’s commitment to developing a competitive rail freight industry.

July 2001 14 Victorian Intra-State Rail Access Regime: Application for Certification

Passenger rail projects including upgrades of track to Geelong, Ballarat, Bendigo and the Latrobe Valley under the Regional Fast Rail Project ($550 of Government funds committed to the project), upgrades of track for the re-opening of passenger services to Mildura and South Gippsland ($33 million committed) and extensions from Ballarat to Ararat, and Sale to Bairnsdale, will also benefit freight.

Victoria is also working towards the harmonisation of safety standards, operating practices and engineering standards for the inter-state network in order to facilitate safe access by multiple operators. The InterGovernment Agreement of 1997 which agreed to the establishment of the Australia Rail Track Corporation (ARTC) also committed Governments to work towards the harmonisation of rail practices across Australia, including safety accreditation and mutual accreditation between the States. There has been significant progress in the harmonisation of safety accreditation.

The Commonwealth has established the Australian Rail Operations Unit to develop a common set of operating practices and engineering standards for the defined inter-state network. These have been published.

Victoria is working to introduce these practices and standards across the entire Victorian rail network to reduce the number of interfaces between different operating methods, thus facilitating safe access by multiple operators.

3.4. Appropriate for State to retain regulatory control

Given the Government’s role as a major investor in Victoria’s intra-state track and underwriter of passenger services, the Victorian Government believes it is appropriate that it be subject to a State-based access regime. This will enable legitimate State interests to be managed effectively, while fostering competition in the rail freight industry.

However, Victoria’s ultimate objective is to participate in the development of consistent access arrangements across all Australian rail networks. These would though have to take into account State issues such as the interests of passenger services.

July 2001 15 Victorian Intra-State Rail Access Regime: Application for Certification

4. The Victorian intra-State rail access regime

The Victorian access regime comprises:

¾ Part 2A of the Rail Corporations Act 1996;

¾ Orders-in-Council issued under Part 2A of the Rail Corporations Act 1996 (the Declaration Orders and Pricing Orders);

¾ section 10 of the Transport Act 1983; and

¾ the Office of the Regulator-General Act 1994.

It is also relevant to consider the Guidelines issued by the Regulator-General in relation to the rail access regime.

Copies of the relevant documents are provided at Appendices A,B and C.

There are three main elements to the Victorian access regime:

¾ first, relevant rail transport services must be declared by the Governor-in- Council. The statutory access regime only applies to declared services;

¾ second, access providers are required to negotiate with prospective access seekers. This is facilitated by a number of provisions in the regime; and

¾ third, if agreement cannot be reached, the Office of the Regulator General (ORG) can arbitrate disputes relating to all access terms and conditions. In resolving disputes, the ORG must take into account the matters in CPA clauses 6(4)(i) and (j). If Orders-in-Council have been issued in relation to the matter at hand, the ORG must apply them.

4.1. Declaration

The access regime in Part 2A applies only to rail transport services that have been declared by the Governor-in-Council to be ‘declared rail transport services’. A rail transport service is a service comprising access to or use of ‘rail infrastructure’ or ‘tram infrastructure’ for the purposes of providing passenger services or other transport services. Rail transport services can be declared only following a recommendation from the Minister. The Minister may make such a

July 2001 16 Victorian Intra-State Rail Access Regime: Application for Certification recommendation only if he or she is satisfied that it is necessary to do so to promote competition or increase efficiency or the level of services to the public.

The following services have been declared for freight purposes only:

¾ the country intra-state rail network leased to Freight Australia;

¾ the independent freight lines into Melbourne leased to Freight Australia;

¾ that part of the metropolitan rail network that is leased to Bayside Trains;

¾ the South Dynon Terminal leased to National Rail; and

¾ the Dynon Terminal leased to Freight Australia.

The Victorian access regime does not apply to Victoria’s inter-state track, which is leased to ARTC. As noted above, this is subject to separate arrangements.

4.2. Administration of the regime

Once declarations have been made, the body responsible for administering the Victorian rail access regime is the ORG. The ORG is an independent regulator established under the Office of the Regulator-General Act 1994. In administering the Victorian rail access regime, ORG’s objectives, which are set out in section 38B of the Rail Corporations Act 1996 are:

¾ to ensure users have fair and reasonable access to declared rail transport services; and

¾ to ensure that users requiring access to declared rail transport services to provide passenger services have priority over users that require access to provide services other than passenger services.

The ORG’s objectives under section 7 of the Office of the Regulator-General Act 1994 are also relevant.9 These are:

9 It is likely that the objectives will be varied when the Essential Services Commission is established in January 2002. See Essential Services Commission Legislation , Exposure Draft at www.reggen.vic.gov.au

July 2001 17 Victorian Intra-State Rail Access Regime: Application for Certification

(1) In performing its functions and exercising its powers the Office has the following objectives-- (a) to promote competitive market conduct;

(b) to prevent misuse of monopoly or market power;

(c) to facilitate entry into the relevant market;

(d) to facilitate efficiency in regulated industries;

(e) to ensure that users and consumers benefit from competition and efficiency.

(2) Without derogating from sub-section (1), the Office must also perform its functions and exercise its powers in such a manner as the Office considers best achieves any objectives specified in the relevant legislation under which a regulated industry operates.

4.2.1. Negotiations

The Victorian rail access regime contains a number of provisions designed to facilitate access negotiations.

The access provider must provide information to prospective access seekers. This information will help access seekers frame requests for access. The ORG can specify the content of the information provided by access providers. Draft notices have been issued by the ORG, upon which it has sought comment. Final notices will be issued shortly.

The access provider is required to respond to a request for access with a proposal within 14 days, or longer if the ORG allows.

Parties are free to negotiate an agreement that suits them. There are no rules restricting the commercial terms and conditions that can be agreed between the parties.

Section 38E(2) of the Rail Corporations Act 1996 provides that the terms and conditions of access may vary according to the actual and opportunity costs imposed on the access provider, but must not vary simply because of the identity of the person seeking access.

4.3. Arbitration

If the parties cannot reach agreement, either party may refer the matter to the ORG for a determination. It is expected that serious negotiations will take place

July 2001 18 Victorian Intra-State Rail Access Regime: Application for Certification

between access providers and access seekers before a party requests the ORG to arbitrate. Access providers are required by legislation to make an access offer within a specified timeframe. The ORG has stated that it may dismiss as vexatious a request for arbitration in circumstances where the access seeker has failed to provide the access provider with sufficient information.10

A determination by the ORG may deal with any matter relating to access (e.g. price, available train paths/time slots for access to the tracks, and service quality requirements). The ORG has powers to obtain the information necessary to determine a dispute.

Section 38J(1)(a) of the Rail Corporations Act 1996 requires the ORG to apply the principles set out in clauses 6(4)(i) and (j) of the Competition Principles Agreement in making a determination.

If the dispute is about price, the ORG is also required to apply the pricing principles set out in the relevant Orders-in-Council in determining the appropriate price for access.

The ORG’s determinations are binding on the access provider.

The ORG may recover its costs in determining a dispute from each party. Each party can be required to pay up to 50 per cent of the overall costs.

It is possible to appeal against the determinations of the ORG under certain circumstances, as provided under section 37 of the Office of the Regulator-General Act 1994.

If the ORG seeks to disclose information which a party providing that information considers confidential, the Rail Corporations Act 1996 contains an appeal mechanism.

FA’s Primary Infrastructure Lease provides added incentives to comply with access agreements and determinations. Clause 28.5(a) of the Lease allows the Director of Public Transport to refuse to renew the lease for the second or third 15 year period if:

(a) In the first five year period immediately preceding the expiration of the initial term or the first further term (as the case may be) the Lessee has been in repeated material breach of:

10 ORG 2001, Victorian Rail Access Regime: Guidelines, July, p. 6.

July 2001 19 Victorian Intra-State Rail Access Regime: Application for Certification

(i) its obligations under one or more access arrangements; or

(ii) its obligations under one or more access determinations.

4.4. Pricing principles

The Government has established pricing principles that will apply to each of the declared services. These principles are to be applied by the ORG in the event of an arbitration. Although the principles will most likely affect commercial outcomes, they pose no legal constraints on the terms and conditions that can be negotiated privately between access providers and access seekers.

The pricing principles aim to provide certainty to both access providers and access seekers. They are relatively simple. This minimises the transaction costs associated with arbitrations, and provides a more certain regulatory backdrop against which commercial negotiations can occur.

The pricing principles seek to strike a balance between the competing needs of the access provider and access seekers. On the one hand, an access seeker needs to be able to secure access at a competitive price and in a reasonable time frame. On the other hand, an access provider must be adequately compensated for the costs of providing access and achieve a commercial return on its new investments, and remain in a position where it is able to compete in its above-rail freight business.

The pricing principles vary between the declared services, reflecting their different circumstances.

4.4.1. Pricing principles for Freight Australia’s leased network

The pricing principles allow the access provider to recover:

¾ any incremental costs associated with any individual access seeker’s use of the network (e.g. increased Transport Accident Commission premiums paid by the access provider); and

¾ a share of the access provider’s cost base associated with the line(s) to be used by the access seeker.

The cost base of each line comprises:

¾ the costs of infrastructure operations and maintenance for that line in the relevant period;

July 2001 20 Victorian Intra-State Rail Access Regime: Application for Certification

¾ a capital charge relating to any new capital expenditure. The cost of capital must be at least as high as the 10 year Commonwealth bond rate plus 4 per cent; and

¾ an allowable margin on operations and maintenance costs of either 10 per cent, or any other such size as the ORG considers appropriate.

There is scope for the ORG to disallow some costs incurred by the access provider on the basis that they do not represent the costs of an efficient operator. This provides the access provider with added incentives to improve the efficiency of its operations.

For lines that do not carry passenger services, the costs are allocated between operators on the basis of gross tonne kilometres and train kilometres. Specifically, gross tonne kilometres and train kilometres are given equal weight.

Additional expenditure by FA required to keep passenger lines up to an appropriate standard (i.e. higher than the standard required for freight trains) is not recoverable from freight operators under the access regime. These costs, plus a share of the remaining costs, are currently recovered separately from rail passenger operators under contracts determined prior to privatisation. The remaining costs are allocated among freight operators on the basis of gross tonne kilometres and train kilometres.

Within these principles, details of the structure of access charges, indexation and the terms of payments, including mechanisms to reduce any risk of default, will be matters to be determined at the discretion of the ORG.

4.4.2. Pricing principles for the Bayside network

Off peak freight operators will pay for a share of any incremental costs that freight access imposes on the access provider (Bayside Trains). These costs might include, for example, employing signalling staff late at night. This reflects the fact that the primary purpose of the Bayside network is to provide passenger services. Providing access to freight trains is incremental to this business.

The incremental costs will be shared between off peak freight operators on the basis of forecast relative use measured on a gross tonne kilometre basis.

During peak periods, freight trains could potentially displace passenger trains. Therefore, it is considered appropriate that freight trains operating during the peak (a rare occurrence) should contribute to the wider cost base of the access provider. Peak freight operators will be allocated their share of the entire cost base of the network. The access charge a peak freight operator would pay will be

July 2001 21 Victorian Intra-State Rail Access Regime: Application for Certification calculated so as to allow the access provider to recover a share of the cost base allocated to passenger and peak freight operators. That share would be determined on the basis of forecast relative use measured on a train kilometre basis.

The cost base of the Bayside network is determined on an overall rather than a line by line basis. As with the FA network, the cost base will comprise:

¾ operations and maintenance costs;

¾ a return on capital enhancements; and

¾ an allowable margin.

Freight operators will also pay any costs directly attributable to seeking access and using the network. These costs are those that would not be incurred by the access provider if the particular freight operator did not seek access.

Again, within these principles, details of the structure of access charges, indexation and the terms of payments, including mechanisms to reduce any risk of default, will be matters to be determined at the discretion of the ORG.

4.4.3. Access pricing principles relating to the Dynon Terminals

The pricing principles relating to the Dynon Terminals differ from those for the FA and Bayside networks in that the access providers are permitted to earn a rate of return on capital assets that existed at the time of privatisation. Unlike the networks, there were assets at the South Dynon Terminal that were owned by the National Rail Corporation, rather than the Victorian Government. It would have been inappropriate for the Victorian Government to disallow the recovery of someone else’s sunk costs. For consistency, the Dynon Terminal was treated in the same way.

Access providers are permitted to recover a fair and reasonable amount with respect to:

¾ the access seeker’s use of plant and equipment;

¾ the access seeker’s use of capital, including existing capital;

¾ the access provider’s operations and maintenance costs; and

July 2001 22 Victorian Intra-State Rail Access Regime: Application for Certification

¾ an allowable margin.

July 2001 23 Victorian Intra-State Rail Access Regime: Application for Certification

5. The Victorian regime is effective

Section 44G(3) of the Trade Practices Act 1974 provides:

In deciding whether an access regime established by a State or Territory that is a party to the Competition Principles Agreement is an effective access regime, the Council:

(a) must apply the relevant principles set out in that agreement; and

(b) must, subject to section 44DA, not consider any other matters.

Section 44DA provides:

1. For the avoidance of doubt: …

c. the requirement, under subsection 44G(3), that the Council apply the relevant principles set out in the Agreement in deciding whether to recommend to the Commonwealth Minister that he or she should decide that an access regime is or is not, an effective regime; …

are obligations that the Council … must treat each individual relevant principle as having the status of a guideline rather than a binding rule.

2. An effective access regime may contain additional matters that are not inconsistent with the Competition Principles Agreement Principles.

In considering whether the Victorian regime is an effective access regime, the NCC must apply the principles in the CPA but must not consider any other matter. The CPA principles apply as guidelines rather than binding rules.

In particular industry arrangements are not required to be structured so as to maximise the ease with which access can be obtained (i.e. the regime is only required to be ‘effective’ in providing access).

5.1. Appropriate coverage of services

Clause 6(3) of the CPA relates to the appropriate coverage of services by the access regime. It states:

(3) For a State or Territory access regime to conform to the principles set out in this clause, it should:

(a) apply to services provided by means of significant infrastructure facilities where:

July 2001 24 Victorian Intra-State Rail Access Regime: Application for Certification

(i) it would not be economically feasible to duplicate the facility; (ii) access to the service is necessary in order to permit effective competition in a downstream or upstream market; and (iii) the safe use of the facility by the person seeking access can be ensured at an economically feasible cost and, if there is a safety requirement, appropriate regulatory arrangements exist; and (b) incorporate the principles referred to in subclause (4). The facilities covered by the Victorian access regime are:

¾ the rail network leased to FA, including all infrastructure situated upon the rail lines, but excluding any:

o buildings (including stations, platforms, sheds and shelters);

o car parks;

o terminals, storage and receival facilities;

o workshops, depots, yards and fuel points; and

o rail infrastructure on the line from Simms Street Junction and Appleton Dock-Footscray Road Junction (which is managed by ARTC);

¾ the Freight Victoria Dynon Terminal and the South Dynon Terminal; and

¾ the Bayside network excluding any:

o buildings (including stations, platforms, advertising hoardings, sheds and shelters);

o car parks;

o terminals, storage and receival facilities; and

o workshops, locomotive depots and fuel points.

July 2001 25 Victorian Intra-State Rail Access Regime: Application for Certification

5.1.1. Are the facilities ‘significant’?

FA and Bayside networks

The NCC’s Issues Paper in relation to FA’s application for declaration suggests that the intra-state rail network meets the criterion of ‘national significance’. This suggests that the facility easily meets the lesser criterion for certification of ‘significance’. The NCC states:

The rail lines cover Victoria from border to border and reach into southern NSW. They represent approximately 3,600 km of track over some 3,300 route kms. The rail lines allow the provision of rail transport services to centres of population and production significant to the Australian economy. As such, its size is likely to define a facility of national significance.

…

The importance of Victorian production, both agricultural and industrial, to the Australian economy and the central role the rail lines play in transporting Victoria’s and other states’ products indicates that the facility is of national significance for constitutional trade and commerce.11

The NCC has also considered the relevance to export markets as an important determinant of national significance. The bulk of Victorian export grain travels on the intra-state rail network. In 1997, rail freight delivered grain for export with a value of about $50 million. In this business, rail has cost advantages over road.

The Bayside network is a necessary part of the package of track services for freight. The network is an integral part of the intra-state network. The Bayside network has been declared so that access seekers are able to access all existing freight routes. In particular, Bayside tracks must be used to access Gippsland and the Mornington Peninsula.

Dynon Terminals

The Dynon terminals are also significant. Declaration of the South Dynon terminal is consistent with the objectives of the establishment of the National Rail Corporation, which included:

11 NCC 2001, Application for Declaration of Freight Australia Railway Network Services, Issues Paper, June, pp. 26 & 27.

July 2001 26 Victorian Intra-State Rail Access Regime: Application for Certification

to provide access on a commercial basis to the NRC [National Rail Corporation] network and to terminal facilities for private and public sector operators.12

The South Dynon rail terminal developed by National Rail covers a land area of approximately 18 hectares. All the key tracks in South Dynon terminal are standard gauge. The terminal has the following configuration:

o 4 x 750 under rail mounted gantries;

o 2 x 1300 pair of tracks worked by rubber tyred gantries; and

o 1x 1800 worked by fork lifts.

The Dynon terminal is a container terminal covering a land area of 6 hectares. There are both broad gauge and dual gauge tracks. The broad gauge tracks are 500 metres in length and the dual gauge tracks are 600 metres in length.

Both terminals are extremely important for freight destined for export through the Port of Melbourne. Around 6.5 million tonnes of freight is moved through the Dynon Terminal each year. This comprises a diverse range of goods, including Energy Brix, dried fruit, dairy products, meat, pet food and packaging paper. Around 3.8 million tonnes of freight is moved through the South Dynon Terminal each year.

5.1.2. Is it economically feasible to duplicate the facilities?

A facility is uneconomical to duplicate if one facility can provide the required level and quality of service at a lower economic cost than two or more similar facilities. If this is the case then duplicating the facility will increase costs without commensurate increases in economic benefits. This is wasteful from a social perspective.

The facilities covered by the Victorian rail access regime include rail lines (including sidings) and terminals. In most cases not only are these facilities uneconomic to duplicate, but just as importantly they are infeasible to duplicate.

12 National Rail Corporation Establishment Agreement 30 July 1991.

July 2001 27 Victorian Intra-State Rail Access Regime: Application for Certification

FA’s network and relevant sections of the Bayside network

Constructing rail lines involves significant up-front costs. The cost of land acquisition, site preparation and the construction of the rail line are significant and must be incurred independently of the use of the track. These costs are fixed in the sense they do not vary with the use of the rail line. In addition to the fixed costs there are operation and maintenance costs that vary to some extent with the use of the rail line.

As a result of the high fixed costs it is less costly, in the absence of congestion, for rail services to provided using one facility rather than more than one facility.13

Currently and for the foreseeable future FA’s network can provide the level and quality of services demanded by users. That is, the rail lines are not congested and there is sufficient available capacity to meet the demands of users for the foreseeable future. Duplicating the rail lines would significantly increase the fixed costs with no increase in the services provided. This would be wasteful.

Similarly, in many cases, sidings are uneconomic or infeasible to duplicate. Either access to the necessary land is not possible or, in the case of siding used for grain loading, access to the silos using a duplicate siding is infeasible.

The Bayside network is congested during periods of peak passenger use, but uncongested during off-peak periods. Freight traffic using the Bayside network is time insensitive. For the foreseeable future the available capacity during off-peak periods will be able to cater for freight traffic. Expansions of capacity of the Bayside network will be driven by demands for passenger services not freight services. Duplication of the Bayside network to cater for freight services would be extremely wasteful.

The conclusion that the facilities are uneconomical to duplicate is consistent with the NCC’s findings in relation to the Rail Access Corporation’s (RAC’s) network in NSW. It is also consistent with Freight Australia’s contention in relation to the services for which it seeks declaration.

13 An exception to this is if the variable costs of providing rail services using the existing facility are significantly higher than the variable costs of providing the same services using a duplicate facility. If the differences in costs are sufficient, then it may be less costly to invest in a duplicate facility. However, this is not the case in relation to the rail lines subject to the Victorian rail access regime.

July 2001 28 Victorian Intra-State Rail Access Regime: Application for Certification

Dynon Terminals

In general, the regime excludes terminals, including those which from part of FA’s lease. This reflects the fact that while there are some economies of scale associated with terminals, these are not of overwhelming significance. Duplication is generally feasible.

The only exceptions are the Dynon terminals. The Dynon terminals enjoy significant strategic advantages in being located close to the city and the Port of Melbourne. These strategic locational advantages cannot be feasibly duplicated.

The Dynon terminals occupy a considerable area of inner-city land. While other terminals on and off the FA network could feasibly be replicated elsewhere, this does not apply to the Dynon terminals. Duplication of these facilities with comparable locational advantages is in all likelihood impossible, because of the need to gain planning approvals. Planning approvals are unlikely to be forthcoming for a number of reasons.

First, freight terminals raise a range of environmental issues, most notably in relation to very high noise levels, and the potential for contamination. Freight terminals are also visually unappealing.

Second, local councils would be concerned at the burden on local roads created by the large numbers of trucks required to transport freight arriving at the terminal. Trucks in themselves raise a range of safety and environmental issues.

Third, a new facility would have to be located along an existing line, or else a new piece of track would need to be constructed linking the main line and the terminal. Gaining planning approval to build new track through inner-city suburbs is also highly unlikely.

Given high levels of residential and commercial development in comparable inner-city locations, the chances of overcoming these difficulties and gaining approval to build a new major terminal close to the Port of Melbourne are considered to be negligible. Therefore, duplication of the facilities is not considered feasible.

Declaration of the South Dynon terminal, which is leased to National Rail Corporation (NRC) is consistent with the objectives of the agreement establishing

July 2001 29 Victorian Intra-State Rail Access Regime: Application for Certification the NRC which includes to “provide access on a commercial basis to the NRC network and to terminal facilities for private and public sector operators.”14

5.1.3. Is access to the service necessary in order to permit effective competition in a downstream or upstream market?

FA and Bayside networks

Access to the rail line services subject to the Victorian regime is necessary in order to permit effective competition in the downstream freight transport market. In the Victorian Government’s view, the implications for competition are not dissimilar to the effects access to major rail line services in other states will have on competition.

In its decision to certify the NSW rail access regime, the NCC considered that the regime would promote competition in a market for rail freight services:

In its recommendations to declare the Sydney to Broken Hill and the Hunter Lines, the Council concluded that access to rail line services was necessary for the delivery of downstream rail freight services and that competition in this market would be promoted if these services were declared. While road transport can be an effective substitute for a range of rail freight services, for many bulk commodities and goods being transported over long distances, there is no economic substitute for rail freight.15

Similarly, in its decision regarding the AustralAsia Railway, the NCC concluded that access to the railway would promote competition in a broader freight transport market:

The Council considers that access is necessary to permit competition in the downstream markets for freight transport services. While not affecting all of these services, it will have an impact on several important aspects of those markets.

¾ For certain freight now carried by other modes, such as road, but most suited to rail transport, the introduction of rail will provide a new dimension to competition in existing freight services.

¾ For freights that cannot be transported economically by other modes, such as bulk minerals over long distances, the new railway will allow the development of projects dependent on rail transport for viability. The approaches now contained in the

14 National Rail Corporation Establishment Agreement, dated 30 July 1991.

15 NCC 1999, NSW Rail Access regime: Statement of Reasons for the National Competition Council’s recommendations under section 44M of the Trade Practices Act, p. 6.

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Regime should ensure that operators, other than the access provider’s operator, are able to compete to provide rail services to such projects.16

In the case of access to intra-state rail line services, the impact on competition is likely to be greater in those market segments for which road transport is currently an inferior substitute, such as the transport of grain, logs and other bulk commodities. The most important freight transported on the intra-state network is grain for export. Grain is a low value, high volume commodity that is best suited to transport by rail.

Dynon Terminals

The rationale for coverage of the Dynon terminals under the Victorian regime was also to promote competition in the downstream freight market. As discussed above, the terminals are strategically located in an inner-city location close to the Port of Melbourne. An operator that had to transfer freight to road vehicles well beyond the city would be disadvantaged, incurring higher costs. Cost advantages associated with rail haulage could be lost.

There is a significant cost differential associated with using any other terminals located in metropolitan Melbourne to handle containers prior to transfer onto road for delivery to the port. This is mainly related to distance between terminal location and port location.

The availability of rail terminal services at Dynon to additional operators should increase their ability to compete with FA and National Rail by giving them access to these strategically located facilities. As Toll Holdings discussed in its submission in response to the DOI Issues Paper on the access regime, these terminals are an integral part of the port/rail interface:

Toll is not aware of any other terminals that could fulfil the rail freight tasks in Melbourne nor is it aware of any suitable locations for alternative terminals.

The terminals are valuable to third party operators because of:

¾ their proximity to the Port of Melbourne;

¾ their capacity to handle economic (i.e. long) train configurations;

16 NCC 2000, AustralAsia Railway Access Regime: Final Recommendation, p. 20.

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¾ the opportunity to use state of the art terminal equipment and road truck resources at hours when they are currently not utilised; and

¾ in the case of South Dynon, the dedicated purpose-built road link between terminal and wharves to the Port of Melbourne. The government has committed $3.5 million to extend this road link to the Dynon Terminal.

By contributing to a reduction in rail costs, declaration of the Dynon terminals should also increase the competitiveness of rail against road to and from the Port of Melbourne.

5.1.4. Can the safe use of the facility by access seekers be ensured at an economically feasible cost? Do appropriate regulatory arrangements for safety exist?

The intra-state rail network is lightly used. Since all rail operators are required to meet safety requirements independently administered by the Victorian Government, there is no reason to suggest that providing access will cause safety concerns. FA in its application for declaration agrees.

Rail safety accreditation in Victoria

In Victoria, as in other States, the Government has introduced legislation governing accreditation of rail operators, rail infrastructure managers and rolling stock providers. The Victorian Transport (Rail Safety) Act 1996 was introduced for this purpose, and came into force on 1 January 1998. The Office of the Director of Public Transport, Safety and Technical Services Branch, located within the Department of Infrastructure, administers the regime. This involves, inter alia, managing rail, bus and tramway safety through the accreditation model provided for in the Act and the Rail Safety Regulations 1998 and the Public Transport Regulations 1999.

The purpose of accreditation is to:

¾ attest that the person accredited has the competence and capacity to safely provide the relevant services, to safely provide or operate rolling stock, or to safely conduct any other work affecting railway safety, to the degree required by the regulations;

¾ provide a scheme to facilitate the provision of an effective and efficient network of rail transport services within Victoria, and the observance of appropriate standards by rail infrastructure managers and providers and operators of rolling stock; and

July 2001 32 Victorian Intra-State Rail Access Regime: Application for Certification

¾ increase competition in the provision of rail-based transport by facilitating the market entry of competitive transport managers, providers and operators.

On 1 July 1996, an Inter-Governmental Agreement was signed by the Commonwealth and the States providing for mutual recognition of state safety accreditation regimes. Complementary legislation has been passed in each state, and it is now possible for national recognition of accreditation obtained in any one state. Legislative arrangements have been put in place in Victoria, NSW, Queensland, South Australia, Western Australia and Tasmania.

For the most part, it is not expected that individual access seekers will pose any safety risk that involves additional expenditure. Nonetheless, the regime is capable of dealing with such a situation. As discussed in Section 4.4, the access pricing principles for the declared services require that each access seeker must pay at least the costs that are directly attributable to its use of the network. Therefore, in the event that any additional costs are incurred to address safety concerns, they will be borne by the access seeker generating the costs. This party will then be in a position to decide whether the benefits of gaining access exceed the costs of doing so (i.e. whether it is economically feasible).

In the case of the Dynon terminal, National Rail did raise its submission to the DOI the issue of safety if other operators sought to operate terminal equipment. The declaration does not confer an automatic right to operate terminal equipment and the ORG is well placed to resolve safety issues associated with terminal access.

5.1.5. Summary

In summary, the Victorian regime satisfies the criteria set out in clause 6(3) of the CPA because:

¾ it is not economically feasible to duplicate the facilities covered by the Victorian rail access regime;

¾ access to these services is necessary in order to promote effective competition in the downstream freight transport market; and

¾ the safe use of the facility by access seekers can be ensured at an economically feasible cost. Appropriate independent regulatory arrangements for the rail industry exist.

July 2001 33 Victorian Intra-State Rail Access Regime: Application for Certification

5.2. Negotiation framework

Sub-clauses 6(4)(a),(b) and (c) of the CPA state:

A State or Territory access regime should incorporate the following principles:

(a) Wherever possible third party access to a service provided by means of a facility should be on the basis of terms and conditions agreed between the owner of the facility and the person seeking access.

(b) Where such agreement cannot be reached, Governments should establish a right for persons to negotiate access to a service provided by means of a facility.

(c) Any right to negotiate access should provide for an enforcement process.

5.2.1. The Victorian regime meets criteria (a) to (c)

The Victorian access regime is based on a negotiate/arbitrate model. Parties are free to agree to whatever access terms they wish – the ORG is only ever involved in the event of disputes and a failure to reach commercial resolution.

The Victorian rail access regime contains a number of features that are designed to promote commercial negotiations, and to minimise the need for arbitration.

Section 38E of the Rail Corporations Act 1996 requires an access provider to use all reasonable endeavours to meet the requirements of the person seeking access and to make a formal proposal of terms and conditions for access within 14 days after receiving a request.

The information asymmetries faced by access seekers are reduced by the package of information that the ORG can require access providers to make available to access seekers. The ORG’s Guidelines currently propose that this information include:

(i) Detailed network diagrammatic maps detailing track locations and current characteristics as well as any planned upgrades;

(ii) Indicative Services and Tariffs for services that are likely to be commonly required including a standard form contract setting out the standard commercial and operational terms and conditions for access proposed by the operator;

(iii) Operational requirements including all relevant operational rules and procedures for the operation of a rail transport service on the Network, including operational manuals maintained by the operator in respect of the Network;

July 2001 34 Victorian Intra-State Rail Access Regime: Application for Certification

(iv) Operational Information Requirements that the operator requires from the access seeker. The information required by the operator will be subject to approval by the Office … The Office recognises that the operator can only request the kinds of generic information that might relate to a standard service in a general access seeker information pack. This should not preclude the operator from requesting additional information during subsequent commercial negotiations, especially in the event of non-standard access requests; and

(v) Capacity information including indicative figures for the number of unutilised Train Paths for Standard Consists.

In respect of terminals the Office sees the following information as being required for an access seeker:

(i) Diagrammatic and other information about the terminal including information about the location of plant and equipment currently as well as information about planned upgrades;

(ii) Indicative services and tariffs for commonly required services including a standard form contract setting out the standard commercial and operational terms and conditions for access proposed by the operator;

(iii) Operational Requirements including all operational protocols for services offered within the terminal;

(iv) Operators Information Requirements setting out the information the operator requires from the access seeker. The information required by the operator will be subject to approval by the Office; and

(v) Capacity information.17

The potential for meaningful negotiations is increased by the provision of pricing principles. These principles narrow the boundaries of uncertainty associated with prices and other terms and conditions that are likely to be achieved under an ORG arbitration. Greater certainty over the regulatory alternative increases the scope for commercial negotiations that are at least as mutually beneficial as the regulatory alternative.

The combination of these factors means that not only is a right to negotiate satisfied, thereby satisfying criterion (b), but the regime actively increases the chances of successful commercial negotiation, which satisfies criterion (a).

17 ORG 2001, Victorian Rail Access Regime: Guidelines, July, pp.10-11.

July 2001 35 Victorian Intra-State Rail Access Regime: Application for Certification

Access seekers’ rights to negotiate are enforced by the ORG. Failure to comply with the requirements discussed above can entail a fine of 100 penalty units, or up to 2 years’ imprisonment.

In the event that terms of access cannot be agreed, Section 38F of the Rail Corporations Act 1996 provides that a dispute may be referred to the ORG for a determination. An ORG determination would bind FA.

Criterion (c) is therefore satisfied.

In summary, the Victorian regime creates a robust negotiation framework.

The NCC’s Issues Paper in relation to FA’s application for declaration raises a number of additional issues in relation to the negotiation framework. The Victorian Government submits that these issues do not detract from the effectiveness of the negotiation framework, for the reasons outlined below.

5.2.2. Competitive neutrality

Section 38E of the Rail Corporations Act 1996 states that access terms and conditions may vary according to costs, but are not permitted to vary because of the identity of the access seeker. There is no direct provision in the regime that prohibits the access provider from granting access on terms that differ from those it provides to its own above-rail operations. There is no requirement to disclose the implicit price charged to its own freight business.

There are two key points that can be made in this regard:

¾ such a provision might be difficult to enforce in practice. Access providers may be able to shift costs between different categories such that it appears to charge itself the same price as an access seeker, when actually it is able to undercut the access seeker. Therefore, commercial pressures to avoid such discrimination are more likely to be important than legal prohibitions, in practice; and

¾ commercial pressures to avoid such discrimination are created by the average cost pricing principles. If an access provider were to charge itself a track use charge of below average cost, it must recover the difference on some other segment of its business. However, this would create an incentive for an access seeker to cherry-pick the latter business. Just as free entry destroys the likelihood of cross-subsidisation in other markets, the Victorian access regime creates commercial pressures on an access provider to avoid charging itself any less than it charges access seekers. The incentive to adopt competitively neutral pricing between the vertically integrated

July 2001 36 Victorian Intra-State Rail Access Regime: Application for Certification

access provider and access seekers is much stronger under the Victorian regime than under alternative ‘floor and ceiling’ pricing approaches.

Section 38O requires an access provider to keep separate financial and business records for the declared services. The ORG is able to issue guidelines as to their preparation and maintenance. Draft ORG guidelines have been released, and are attached at Appendix C. The Victorian Government considers such guidelines to be an important element in the access regime. These Guidelines provide for consistency of information provided to access seekers, and the swift resolution of disputes that are arbitrated by the ORG. The ORG has stated that the Record Keeping Rules will require the access provider to maintain:

(a) the necessary information to be able to provide the required Access Seeker Information. The Access Seeker Information includes the standard terms and conditions of access, indicated services and tariffs, and operational and procedural guidelines and protocols;

(b) financial information and forecasts, in line with the relevant Pricing Orders for each of the Freight and Bayside Networks and the Dynon Terminals. This includes details as to operations and maintenance costs and historical capital costs (where relevant) and new capital expenditure; and

(c) capacity information, including details as to passenger, non-passenger and access seeker train kilometres (where relevant) as well as detailed information as to the existing and prospective usage of the Network or Terminals.18

Detailed information requirements are set out in the Guidelines. The information is required to be kept separately from any other information relating to any other business conducted by the access provider.

The potential for the vertically integrated access provider to misuse commercially sensitive information is limited by two main factors. Firstly, the absence of a ‘floor to ceiling’ pricing regime limits the amount of sensitive demand side information that access seekers need to provide. Information regarding distances, weights and wagon types is less likely to be exploited than information regarding potential prices, profits or revenues (the likely informational ingredients in a Ramsey pricing environment). Secondly, clause 33.4 of the Primary Infrastructure Lease between the Director of Public Transport and FA provides:

The lessee covenants with the Director that it will not misuse confidential information obtained by the Lessee in the course of its activities as an access provider.

18 ORG 2001, Victorian Rail Access Regime: Guidelines, July, pp. 13-14.

July 2001 37 Victorian Intra-State Rail Access Regime: Application for Certification

Stronger forms of ring-fencing, such as the creation of separate legal entities handling track and rolling stock operations, are not required by the CPA principles. Moreover, in accordance with Clause 4 of the CPA, the Victorian Government conducted a structural review of the intra-state freight business prior to privatisation. This review concluded that vertical integration was a preferable structural form over vertical separation. Although there is a risk that this makes the provision of access more problematic, this is outweighed by the significant economies of scope associated with vertical integration. As noted above, the Productivity Commission endorsed this view for the Victorian intra-state rail business, and recommended it as the preferred model for other regional rail networks that do not have significant market power. The PC states that:

The potential costs of structural separation in the rail sector have been discussed widely. It has been suggested that costs may arise from:

o a lack of coordination between separated rail entities, both in terms of above and below track businesses and between geographically separated entities. This may result in inappropriate investment decisions;

o ‘interface issues’, such as difficulties associated with a train operator traversing different networks with multiple owners and managers;

o complications associated with timetabling, train schedule allocation and capacity management;

o the loss of some economies of size, scope and density;

o added complexities in the administration of prices and services, such as ticketing;

o the high initial cost of separation;

o high transaction costs of acquiring full information necessary for train operators and track providers to undertake long term investment planning;

o the loss of the ability to price discriminate (to use Ramsey pricing) and therefore recover the cost of track infrastructure; and

o greater regulatory intervention.19

As also noted above, a report outlining the review’s conclusions was presented to the NCC in 2000. The NCC did not raise any objections to this structure.

19 Productivity Commission 1999, Progress in Rail Reform, Inquiry Report no.6, AusInfo, Canberra, pp. 107-108.

July 2001 38 Victorian Intra-State Rail Access Regime: Application for Certification

Requiring FA to create separate business units operating at arm’s length from one another would remove the benefits of vertical integration. Even if it were a requirement, effective enforcement of arms’ length transactions in a vertically integrated business is problematic. It is also likely to increase perceptions of regulatory risk. Accounting separation of the type required by the legislation and the ORG’s guidelines is sufficient both to meet the CPA requirements and to promote effective competition in downstream markets without destroying the efficiency benefits of vertical integration.

By way of comparison, no power to impose ring-fencing is included under Part IIIA. If the NCC has any concerns regarding the Victorian arrangements, these cannot be rectified through declaration.

5.2.3. Service quality

Access seekers can negotiate service quality requirements for inclusion in access agreements with the access provider. Either party may request the ORG to arbitrate in the event of a dispute regarding any terms and conditions of access, including service quality.

The NCC Issues Paper in relation to FA’s application for declaration raises the issue of passenger priority, and suggests that:

Enforcement of the passenger priority principle could affect the timeliness of freight services in an ad hoc and unpredictable way. The regime’s pricing approaches are based on specified formulas. The Victorian regime may not allow the ORG to determine prices that appropriately accommodate varying levels of certainty.20

Passenger services run to timetables that are altered infrequently. Passenger service providers’ contracts contain penalties for poor punctuality, and on-time performance is high. Any interference with freight services is unlikely to be ad hoc or unpredictable.

There are very few instances in which freight and passenger train paths clash on the FA network. In Victoria, unlike other States in Australia, country passenger trains only share the intra-state main line rail network infrastructure from key provincial centres on four rail corridors. With the exception of trains to and from eastern Victoria, freight trains share passenger lines only to the fringe of the Melbourne metropolitan area, where they are then segregated onto freight-only lines. The four country corridors where freight and passenger trains share lines are

20 NCC 2001, Application for Declaration of Freight Australia Railway Network Services, Issues Paper, June, p.32.

July 2001 39 Victorian Intra-State Rail Access Regime: Application for Certification

Geelong/Warrnambool, Bendigo/Swan Hill, Seymour/Shepparton/Albury and Traralgon. From provincial centres to the end of the line (e.g. Geelong to Warrnambool, Bendigo to Swan Hill, Seymour to Albury or Seymour to Shepparton), passenger trains are only competing with an average of one general/container type freight train per day, sometimes more in heavy grain seasons. On most occasions, the nature of the freight business is that freight trains (including grain trains) are at terminals being loaded/unloaded during daylight hours when most passenger trains are operating. Freight trains generally operate overnight during periods when passenger traffic is very light.

Once freight trains reach Newport or Sunshine, they are routed via the independent freight-only lines to the freight terminals at Tottenham, Dynon or South Dynon. This includes trains off the North East from Seymour, which are diverted onto freight only lines at Broadmeadows to Sunshine. Freight trains operating to Ballarat do not generally use the Sunshine-Bacchus Marsh country passenger train route and are routed via Newport to Geelong-Warrenhelp, which is not generally used for passenger traffic.

Freight trains from eastern Victoria use the Bayside network. These trains usually carry logs and paper and are infrequent. Specifically, they run twice three days per week and once on the other two week days.

In summary, the number of freight trains that are interfered with by passenger trains is likely to be minimal. This is not a major issue in Victoria.

Moreover, passenger priority is not absolute. If it might cause ‘serious and unreasonable’ interference to freight operations, priority can be reversed by the Director of Public Transport.

For these reasons, passenger priority is not an issue that weakens the effectiveness of the Victorian regime. In any case, it has to be recognised that rail infrastructure is used for two purposes, commercial freight services and heavily subsidised passenger services which would not exist without Government support. It is reasonable that the Government be able to allocate sufficient rail resources to operate these services in the community interest.

The NCC suggests in its Issues Paper in relation to the FA application for declaration that the pricing principles may give the ORG little flexibility to take varying levels of certainty into account in pricing determinations. However as the network is not congested, the benefits of allowing the ORG to do so are likely to be minor compared to the costs of complicating the approach to determining access prices. The Victorian Government submits that this is not an issue that weakens the effectiveness of the Victorian regime.

July 2001 40 Victorian Intra-State Rail Access Regime: Application for Certification

5.2.4. Timepath management

As noted in the NCC Issues Paper, the Victorian regime leaves timepath management to the general negotiate/arbitrate model. The ORG has the power to intervene in disputes over timepath management.

The ORG’s Guidelines contain provisions that are likely to increase the success of commercially negotiated outcomes in relation to timepath management. In particular, it is proposed that capacity information is to be provided to access seekers.

In the event of arbitration, the ORG has stated that it will take a number of pieces of information into account:

… [B]efore it can make a determination the Office will need to determine if there is spare capacity on the facility to which access is sought. In determining whether spare capacity exists for a service in relation to a facility, the Office may consider relevant information such as:

o the master timetable in operation at the time;

o protocols for amending the master and daily timetables, including the track occupation rules and procedures;

o the ‘Book of Rules and Operating Procedures’ governing industry railway operation;

o system operating protocols;

o network operating requirements;

o for terminals, standard industry practice in relation to efficient terminal management; and

o any other relevant information.

The Office will also have regard to strategic or ‘gaming’ behaviour by the operator that may serve to unreasonably reduce available spare capacity.21

21 ORG 2001, Victorian Rail Access Regime: Guidelines, July, pp. 22-23.

July 2001 41 Victorian Intra-State Rail Access Regime: Application for Certification

The absence of congestion on the Victorian country intra-state network significantly reduces the likelihood of disputes over timepath allocation. This is in distinct contrast to many other rail networks in Australia, where congestion is a significant problem and a failure to gain paths can effectively limit entry. In the case of access to the Bayside network timepath management is an issue. However, Bayside is not a freight operator and has no incentive to prevent access. Its timetable has to be approved by the Director of Public Transport and unequivocally has a passenger service focus.

Given the ORG has power to intervene in the event of a dispute over timepaths, this is not an issue that weakens the effectiveness of the regime.

5.2.5. Safety accreditation

The Victorian accreditation system is described in Section 5.1.4. The NCC has raised concerns in other jurisdictions where safety accreditation is controlled by the access provider, since this party may have incentives to inappropriately exclude access seekers on supposed safety grounds. In the Victorian regime, this is not an issue: safety accreditation is not administered by the access provider, but instead by the Victorian Government.

Day to day operational issues are determined by agreement. Disputes can be resolved by the ORG.

Information to be provided by both access providers and access seekers will help reduce the information asymmetries that can create safety risks. The ORG’s Guidelines state that the access provider must provide access seekers with all relevant rules, procedures and manuals. The access provider will be entitled to an assurance that the access seeker is not carrying hazardous freight, and can request information regarding the type of rolling stock to be used.22

5.2.6. Pricing principles

An assessment of the Victorian access regime’s pricing principles against the CPA criteria is provided at Section 5.8.

22 ORG 2001, Victorian Rail Access Regime: Guidelines, p.6.

July 2001 42 Victorian Intra-State Rail Access Regime: Application for Certification

5.2.7. Dispute resolution mechanisms

Dispute resolution arrangements under the Victorian regime are assessed against the CPA principles at Section 5.6.

The Victorian regime establishes a sound dispute resolution mechanism, administered by an independent arbitrator. Clear direction is given to the ORG in relation to the pricing principles to be applied in the event of a dispute, which is in distinct contrast to arbitrations under Part IIIA of the Trade Practices Act 1974. The ORG has appropriate powers to gather information required to make a decision. Time limits apply to arbitrations.

As noted in Section 4.2.1, the Victorian regime includes a number of features to promote successful commercial negotiation, which reduces the chances of disputes resulting in arbitration. These features include the provision of information to access seekers, the ability to require financial information to be held in a form useful for determining disputes, and time limits on the access provider to make an offer. The ORG has the power to refuse to hear vexatious disputes, which could include situations in which the access seeker has failed to provide sufficient information to the access provider to allow them to make an access offer.

Although in practice the ORG may informally seek to facilitate negotiations with a view to minimising formal disputes, there is no requirement under the CPA for such a procedure to be implemented. This does not appear to be a relevant matter to be considered by the NCC in relation to an assessment of the effectiveness of the Victorian access regime.

5.3. Clause 6(4)(d) – Expiry date

Clause 6(4)(d) of the CPA states that:

Any right to negotiate access should include a date after which the right would lapse unless reviewed and subsequently extended; however, existing contractual rights and obligations should not be automatically revoked.

Each declaration lapses on its fifth anniversary (i.e. on 1 July 2006). It is the Victorian Government’s intention to review the access regime arrangements before this date. Therefore, the Victorian regime meets this criterion.

A five year timeframe was considered to represent a reasonable balance, given competing considerations such as:

July 2001 43 Victorian Intra-State Rail Access Regime: Application for Certification

¾ the changing nature of the freight market generally, and rail freight in particular;

¾ the possibility of improved national rail access arrangements being put in place in the future;

¾ the need to give a reasonable period to bed down the regime, and allow participants to gain familiarity with it; and

¾ the fact that FA’s major contract with the Australian Wheat Board does not expire until 2004.

5.4. Clause 6(4)(e) – Reasonable endeavours to negotiate

Clause 6(4)(e) of the CPA states:

The owner of a facility that is used to provide a service should use all reasonable endeavours to meet the requirements of the person seeking access.

The exact wording of this requirement is replicated in Section 38E(1)(a) of the Rail Corporations Act 1996. Therefore, the Victorian regime meets this criterion.

5.5. Clause 6(4)(f) – No requirement for identical terms and conditions

Clause 6(4)(f) of the CPA states:

Access to a service for persons seeking access need not be on exactly the same terms and conditions.

Section 38E(2) of the Rail Corporations Act 1996 provides that the terms and conditions of access may vary according to the actual and opportunity costs imposed on the access provider, but must not vary simply because of the identity of the person seeking access.

This CPA sub-clause does not positively require that terms and conditions vary between access seekers – it simply implies that a regime is not ineffective because it allows terms and conditions to vary.

5.6. Clause 6(4)(g) – Dispute resolution

Clause 6(4)(g) of the CPA provides:

July 2001 44 Victorian Intra-State Rail Access Regime: Application for Certification

Where the owner and a person seeking access cannot agree on terms and conditions for access to the service, they should be required to appoint and fund an independent body to resolve the dispute, if they have not already done so.

Section 38F of the Rail Corporations Act 1996 states that if an access seeker has not received a formal offer of access as required by Section 38E, or cannot agree terms and conditions with the access provider, either party may apply in writing to the ORG for a determination.

Section 38K allows the ORG to make an order in relation to payment of its costs.

The NCC’s Issues Paper in relation to FA’s application for declaration suggests that the ORG’s independence may be compromised by:

¾ the ability of the Government to issue Orders-in-Council to which the ORG must have regard; and

¾ the requirement to seek and consider a submission from the Director of Public Transport in the event of an access dispute being arbitrated by the ORG.

In the Victorian Government’s view, neither of these elements limits the independence of the regulator.

5.6.1. Power to issue Orders-in-Council

The Victorian access regime includes six Orders in Council: the declarations of the FA network, the Bayside network and the Dynon Terminals and the pricing orders for the FA network, the Bayside network and the Dynon Terminals.

The level of detail does not detract from ORG’s independence

In its Issues Paper regarding FA’s application for declaration, the NCC draws attention to certain features of the pricing principles that limit ORG’s discretion. In particular, the ORG is required to:

¾ set the rate of return on capital expenditure enhancing the network (post privatisation/sale) at or above the Commonwealth bond rate plus 4 per cent;

¾ consider investment by government (and lease payments) as sunk in the case of the FA and Bayside networks;

July 2001 45 Victorian Intra-State Rail Access Regime: Application for Certification

¾ allocate costs across services in accordance with certain formulae contained in the pricing orders; and

¾ adopt an average cost pricing approach to setting access charges.

The degree of prescription in the pricing orders is desirable and does not detract from the ORG’s independence for three reasons.

First, like Part IIIA, the Victorian regime is a negotiate/arbitrate regime without the intermediate step of an access arrangement or reference tariffs as in the Gas Code and other access regimes. Without reasonably precise pricing rules, negotiations between an access provider and access seeker in a negotiate/arbitrate regime are unlikely to lead to an agreed outcome because of asymmetric information and uncertainty about the likely arbitrated outcome. Greater clarity in the pricing principles to be applied by the ORG also increases the likelihood that the ORG will meet the tight timeframes within which the ORG is expected to make a determination. As noted earlier, this is particularly important in an industry characterised by a high proportion of seasonal freight.

Second, the rules that have been prescribed are appropriate for the Victorian intra- state rail industry for the following reasons:

¾ the floor on the rate of return for new capital investment provides the level of assurance necessary to encourage new capital investment in the Victorian intra-state rail industry. Floors on the allowable rate of return are unusual in regulated industries;

¾ V/Line Freight was sold on the basis that investment by Government (and lease payments) would be considered as sunk and no return allowed on such investment to either purchaser of V/Line Freight or the Government (this issue is discussed in more detail in Section 5.8.1);

¾ allocation rules reflect well understood industry practice based on measures of gross tonne kilometres and train kilometres. Such data is objective and readily identifiable, which can help minimise transaction costs;

¾ an average pricing approach will simplify the regime and will facilitate effective negotiation. It also reduces the risk of cross subsidisation between the access provider’s above-rail business and other parties’ above- rail businesses (discussed in more detail in Section 5.11).

Third, and importantly, the pricing principles still leave scope for ORG discretion. For example, ORG is given broad discretion to determine:

July 2001 46 Victorian Intra-State Rail Access Regime: Application for Certification

¾ what operations and maintenance costs and new capital expenditure are efficient and therefore recoverable;

¾ what the allowable margin should be and what margin should be applied to new capital investment (subject to a floor in the case of new capital investment as discussed above);

¾ what directly attributable costs to allow to be recovered from a particular access seeker;

¾ the structure of the access charge including fixed and variable components and mechanisms to deal with risks of default; and

¾ what mechanisms to include in relation to adjustments for forecast errors, price inflation and expected efficiency gains.

In applying the discretions conferred on it the ORG must take into account the matters specified in CPA clauses 6(4)(i) and (j).

In summary, the pricing orders are designed to strike a balance between providing a simple, cost effective regime with sufficient certainty being given to access providers and access seekers to facilitate effective negotiation, while at the same time allowing the ORG sufficient discretion to tailor an appropriate access charge for a particular situation. That balance is appropriate to the intra-state infrastructure concerned and in no way undermines the independence of the ORG.

In this regard the Victorian Government notes that a power to issue pricing orders has not been an impediment to the NCC recommending certification of access regimes in the past. In Victoria’s case, a similar power to issue Orders-in-Council existed under section 50 of the Port Services Act 1995, which was relevant to the access regime relating to certain Victorian shipping channels. Section 50 of the Port Services Act provides that:

(1) The Governor in Council may by Order published in the Government Gazette regulate in such manner as the Governor in Council thinks fit--

(a) prescribed prices; and

(b) terms and conditions subject to which prescribed services are to be provided--

in any one or more of the ports of Melbourne, Geelong, Portland and Hastings, or in any part or parts of those ports.

July 2001 47 Victorian Intra-State Rail Access Regime: Application for Certification

(2) A Pricing Order may contain directions regarding the exercise by the Office of its powers under the Office of the Regulator-General Act 1994 in relation to the regulated industry.

(3) While a Pricing Order is in force, the Office must in relation to the regulated industry exercise its powers under the Office of the Regulator-General Act 1994 in accordance with the Pricing Order.

(4) Without limiting the generality of sub-section (1), the manner of regulating prescribed prices may include--

(a) fixing the price or the rate of increase or decrease in the price;

(b) fixing a maximum price or maximum rate of increase or minimum rate of decrease in the maximum price;

(c) fixing an average price for specified goods or services or an average rate of increase or decrease in the average price;

(d) specifying pricing policies or principles;

(e) specifying an amount determined by reference to a general price index, the cost of production, a rate of return on assets employed or any other specified factor;

(f) specifying an amount determined by reference to quantity, location, period or other specified factor relevant to the rate or supply of the goods or services;

(g) fixing a maximum average revenue or maximum rate of increase or minimum rate of decrease in the maximum average revenue in relation to specified goods or services;

(h) monitoring the price levels of specified goods and services.

(5) A Pricing Order--

(a) subject to section 51, has effect from the date specified in the Pricing Order, being a date after the Pricing Order has been published in the Government Gazette;

(b) has effect as if the Pricing Order were a determination under the Office of the Regulator-General Act 1994 except that sections 37 and 38 of that Act do not apply in respect of the Pricing Order;

(c) subject to section 52, ceases to have effect on the date specified in the Pricing Order but cannot be revoked before then;

(d) cannot be made, amended or varied--

July 2001 48 Victorian Intra-State Rail Access Regime: Application for Certification

(i) in the case of a Pricing Order applying to the port of Melbourne, Geelong or Portland or to any part or parts of that port, after the expiry of 12 months after this Act receives the Royal Assent;

(ii) in the case of a Pricing Order applying to the port of Hastings or to any part or parts of that port, on or after 28 November 1998.

The NCC recommended certification of this access regime in 1997. The Commonwealth Minister accepted this recommendation, and the regime was certified for a period of five years.

A Pricing Order relating to the channels was in place when the NCC undertook its examination of the access regime. In making its recommendation, the NCC acknowledged the existence of the Order – which constrained the discretion of the ORG much more tightly than under the Pricing Orders in the Victorain rail access regime – but did not raise any issues in relation to the independence of the regulator.

Ability to make further Orders in Council.

It is possible, of course, that the Orders in Council could be changed, or that the new Orders in Council could be made.

As noted above, the Orders in Council form a key part of the Victorian access regime that the NCC is asked to recommend be certified. As the NCC will be aware it is common for access regimes to include both legislation and subordinate instruments made by the executive under that legislation. For example, the National Third Party Access Code for Natural Gas Pipeline Systems is a form of subordinate instrument made under legislation and can be amended by the executive (rather than legislature) of the participating jurisdictions. Subordinate instruments are used, particularly in relation to such matters as pricing, because they can contain a level of detail that is inappropriate for legislation.

The Victorian Government recognises that modifying the existing Orders in Council or introducing new Orders in Council may well amount to a substantial modification of the Victorian access regime for which certification is being sought. If the Victorian regime were certified, the Victorian Government would wish to consult with the NCC in relation to any such amendments or new Orders in Council that are ever made to ensure that regime was not adversely affected by such amendments or new Orders in Council.

However, the existing Orders in Council, and the power to make new Orders in Council, are consistent with clause 6(4)(g) of the CPA.

July 2001 49 Victorian Intra-State Rail Access Regime: Application for Certification

5.6.2. Requirement to seek and consider submissions from the Director of Public Transport

The requirement to seek and consider submissions from the Director of Public Transport in no way interferes with the independence of the ORG. It is usual for regulatory bodies, or quasi-regulatory bodies such as the NCC, to receive submissions from Government. These submissions are quite different from Orders, in that they are considered, but not necessarily followed. The suggestion that the receipt and consideration of Government submissions interferes with a regulator’s independence conflicts with a good deal of practical experience.

The ORG actually has no power to comply with a Government submission that is inconsistent with its statutory duties created under the Rail Corporations Act 1996 and the Office of the Regulator-General Act 1994.

The requirement to seek such a submission merely ensures that the Director of Public Transport is informed of access disputes, and is given the chance to comment. For example, this power ensures that the ORG is informed of any Government plans or projects or other issues that would have a material bearing on the determination. This provision also reflects Victorian Government’s natural interest in the rail freight industry and its importance to the Victorian economy.

5.6.3. Possible conflict between pricing principles and the CPA principles

The NCC’s Issues Paper raises the possibility that there may be clashes between the CPA principles and the pricing principles issued by Order-in-Council. The Victorian Government submits the pricing principles are entirely consistent with the CPA principles. These principles are quite broad, and could apply to a variety of pricing arrangements. In particular as discussed in Section 4.4, there is no conflict between the pricing principles (particularly the valuation of assets in existence at the time of the sale at zero) and the requirement to take into account the owner’s legitimate business interests. As discussed above, the Government undertakes to consult with the NCC regarding any new Orders, in order to ensure that the regime remains effective. An assessment of the pricing principles against the CPA criteria is provided at Section 5.8.

5.7. Clause 6(4)(h) – Appeal rights

Clause 6(4)(h) states:

July 2001 50 Victorian Intra-State Rail Access Regime: Application for Certification

The decision of the dispute resolution body should bind the parties; however, rights of appeal under existing legislative provision should be preserved.

Section 27 of the Office of the Regulator-General Act 1994 makes a determination of the ORG binding. Existing rights of appeal under this legislation provided by section 37 have not been altered. This right of appeal is as follows:

(1) A person who is aggrieved by a determination of the Office may appeal against the determination. In accordance with this section.

(2) The ground for an appeal under this section is that –

(a) there has been bias; or

(b) the determination is based wholly or partly on an error of fact in a material respect.

(3) Notice of the appeal must be lodged with the Office within 7 working days after the determination is published.

Therefore, criterion 6(4)(h) is met.23

5.8. Clause 6(4)(i) and (j) – Matters to be taken into account

Clauses 6(4)(i) and (j) state:

(i) In deciding on the terms and conditions for access, the dispute resolution body should take into account:

(i) the owner’s legitimate business interest and investment in the facility;

(ii) the costs to the owner of providing access, including any costs of extending the facility but not costs associated with losses arising from increased competition in upstream or downstream markets;

(iii) the economic value to the owner of any additional investment that the person seeking access or the owner has agreed to undertake;

23 The appeal rights may change when the Essential Services Commission is established in January 2002. For example, the time to lodge an appeal may be extended. See Essential Services Commission Legislation , Exposure Draft at www.reggen.vic.gov.au

July 2001 51 Victorian Intra-State Rail Access Regime: Application for Certification

(iv) the interests of all persons holding contracts for use of the facility;

(v) firm and binding contractual obligations of the owner or other persons (or both) already using the facility;

(vi) the operational and technical requirements necessary for the safe and reliable operation of the facility;

(vii) the economically efficient operation of the facility; and

(viii) the benefits to the public from having competitive markets.

(j) The owner may be required to extend, or permit extension of, the facility that is used to provide a service if necessary this would be subject to:

(i) such extension being technically and economically feasible and consistent with the safe and reliable operation of the facility;

(ii) the owner’s legitimate business interests in the facility being protected; and

(iii) the terms of access for the third party taking into account the costs borne by the parties for the extension and the economic benefits to the parties resulting from the extension.

Section 38J(1)(a) of the Rail Corporations Act 1996 requires the ORG to take these criteria into account when making a determination.

The pricing principles included in the Victorian access regime conform with the CPA principles listed above. The main features of the pricing approach to be followed in the event of an arbitration are:

¾ costs that were sunk at the time of sale are not to be recovered through access charges;

¾ operations and maintenance costs, plus a margin, can be recovered from access seekers, on an average cost basis;

¾ any incremental costs imposed by any particular access seeker are paid by that access seeker;

¾ the costs of new investment in the network can be recovered through access charges, on an average cost basis; and

¾ the ORG has scope to disallow costs that it considers were inefficiently incurred.

July 2001 52 Victorian Intra-State Rail Access Regime: Application for Certification

5.8.1. Treatment of sunk costs

Freight Australia has argued that failure to allow recovery of capital costs associated with infrastructure that was in existence at the time of sale means that the regime fails to take into account the legitimate business interests and investment of the provider. This assertion is unsubstantiated, and should be rejected.

If FA had made these past investments themselves, rather than the Government, and the access regime did not allow the recovery of their investments, then FA would have a legitimate point. Similarly, if FA were told during the bidding process that sunk costs would be recoverable, and then the Victorian Government changed its mind, again FA’s argument would be convincing. However, neither of these arguments applies.

All bidders were informed that the costs of infrastructure existing at the time of sale would not be recoverable through access charges. Information provided to bidders is included at Appendix D. The fact that these sunk costs were not recoverable through access prices should have been reflected in bid prices.

Since bidders were informed that this pricing principle would be applied before they made their bids, applying that principle can hardly constitute a failure to take into account the legitimate business interests or investment of the provider.

This situation is conceptually identical to the asset write-downs that occurred in the Victorian country gas and electricity networks prior to their sale. The Government considered that distribution prices to rural and regional Victoria would be too high if they were based on the full value of the distribution assets. Prior to sale, the Government adjusted the value of these assets downwards. Bidders were told that these lower values were those that would apply for regulatory purposes. This was taken into account by bidders in their bid prices – i.e. bidders expected a lower revenue stream over time as a result of the smaller regulatory asset base. (Actual sale prices were much higher than the regulated asset bases.) The same approach was taken to the intra-state rail network, with the exception that the regulatory asset base was reduced to zero in relation to assets that were sunk at the time of sale. Asset write-downs were no bar to the NCC’s recommendation that the Victorian gas access regime was effective.

The access regime applying to the Victorian Channels Authority also takes the approach that existing sunk costs should not be taken into account in setting access fees. Access fees cover the operations and maintenance costs only, not the original capital costs associated with dredging that occurred many decades ago. The Pricing Order in force at the time stated:

July 2001 53 Victorian Intra-State Rail Access Regime: Application for Certification

The Office should also take account of the Government’s policy that the cost or value of channels existing at the time the Victorian Channels Authority commenced operations should not be taken into account in determining prices for Regulated Services.24

Under the new Pricing Orders relating to the channels, this continues to be the case. This regime has also been certified as effective, on the recommendation of the NCC.

Adjusting the regulatory value of existing assets prior to sale is the functional equivalent of providing ongoing subsidies for the use of the facility. In industries characterised by high fixed costs and low marginal costs and low utilisation, this can be efficiency enhancing.

Pre-paid lease payments

FA has argued that its pre-paid lease payment of $90 million should be recoverable through access charges. The lease payment is part of the total sale price of $163 million paid by FA. In sale processes, such as the one for VLF, it is expected that bids would be made on the basis of the net present value of the profit stream that bidders expected to earn from the lease of the assets. This profit could be derived from three main revenue streams:

¾ rail freight services;

¾ rail line services to passenger rail operators; and

¾ rail line services to rail freight operators.

The V/line Freight transaction involved the purchase of the above-rail freight business (including existing contracts), together with the infrastructure lease and passenger access arrangements. As discussed in Section 3, no particular significance should be attached to the lease payment. Bidders had almost complete flexibility over the structure of their payments to Government being advised that the financial evaluation would be based on the net present value and the proposed cash flows to and from the State. Large lease pre-payments reflect tax advantages, and not necessarily the lease’s value to the bidder compared with other business components. They could just as easily have been named rolling stock payments, payments for business good-will, or payments for the value of

24 Clause 1.1, Pricing Order for the Channels in the Ports of Melbourne and Geelong, 29 October 1996, published in Victorian Government Gazette, 6 November 1996.

July 2001 54 Victorian Intra-State Rail Access Regime: Application for Certification existing contracts. It makes no sense to set regulated prices on the basis of lease payments under these circumstances.

This situation can be compared with the Victorian energy utilities, which argued post-privatisation that regulated prices should reflect actual prices paid, not the regulatory asset bases that all bidders were told would apply. The ORG rejected this argument, and applied the asset bases against which bids were made. To do otherwise would introduce a perverse element into all bidding processes. If regulated prices reflect actual sale prices, bid price would reflect the rents from monopoly pricing. This would also undermine one of the key objectives of reform – lower prices for consumers.

Non-recovery of sunk costs and incentives for investment

As a general rule, it would be poor public policy to allow a firm to invest in a piece of infrastructure and then take advantage of these sunk costs by setting access prices at a level at which those costs can never be recovered. As Professor Gans has rightly argued:

Almost all investments infrastructure represent sunk costs, ex post. Basically, the assets are dedicated to particular activities and often have little scrap value. While it is consistent with economic efficiency to neglect these sunk expenditures in determining the optimal use of an asset, regulatory authorities cannot neglect them when it comes to the potential for future investment. No firm would invest if it thought that, after the fact, they would be deemed sunk and no return would be required. No financier would lend to a firm that believed this All investment takes place with a view to future return and the potential irreversibility of investment decisions is a constraint that requires potential investors to be even more secure in their expectations of generating a return. So far from not requiring a return, the requirements are in fact more stringent than for investments that were reversible and whose expenditures were not sunk.25

This is correct as a statement of general principle. However, this description does not fit the facts in this case. This is not a case of a regulator acting opportunistically, and taking advantage of costs sunk by an unsuspecting investor. The costs of building the rail network were sunk by the Government. It is the Governments’ decision not to recover the costs it has sunk. As owner, the Government elected not to try to recover these sunk costs through the sale price. It was prepared to accept a lower price for the assets on the basis that the new lessor would not seek to recover those sunk costs from other access seekers.

25 Gans, J. 2000, An Evaluation of the Draft Access Pricing Principles for Access to the Victorian Rail Network (Freight): A Report Prepared on Behalf of Freight Australia Ltd, 28 June, pp. 14-15.

July 2001 55 Victorian Intra-State Rail Access Regime: Application for Certification

Therefore, the Victorian access regime protects the legitimate business interests of the provider, as well as the public interest generally in protecting incentives for new investment.

Effects on competition

Failing to exclude the sunk costs at the time of privatisation from the price of access is likely to undermine the key objective of the access regime - that is, to promote competition in the provision of freight services.

In order for the maximum benefits of the access regime to be realised, the pricing of access to rail line services should not unnecessarily discourage more efficient providers from entering and providing rail freight services and not artificially encourage less efficient providers to enter. Including the sunk costs at the time of privatisation in the price of access will unnecessarily discourage more efficient providers from entering and providing rail freight services in competition with FA.

To see this consider any contribution made by access seekers to the sunk cost at the time of privatisation as an entry fee to provide rail freight services using FA’s rail lines. Even if another provider was more efficient than FA in providing rail freight services, this entry fee may nevertheless prevent that provider from entering and competing.

In the normal course of events the entry fee is necessary to ensure that the access provider gains a sufficient return on its investments in those assets. Without such a return the access provider is likely to be inefficiently discouraged from investing in similar assets in the future.

However, in this case, as it was known at the time of the sale that the access regime would not allow a return on those sunk costs, a rational investor would not have included a return to those assets in its bid price. A contribution to these sunk costs are therefore not necessary to preserve efficient investment incentives.

As a result, including the sunk costs in the access price will unnecessarily deter entry in the provision of rail freight services, with the likelihood of deterring efficient entry. It will simply result in a windfall gain to FA.

In addition, the inclusion of sunk costs would add considerably to the uncertainty surrounding the outcomes of an arbitration process and the cost of achieving it. These impacts may also deter competition.

July 2001 56 Victorian Intra-State Rail Access Regime: Application for Certification

5.8.2. Average cost pricing

To achieve allocative efficiency, a user should be granted access so long as its willingness to pay is at least as high as the incremental cost associated with providing access to that user. The average cost pricing methodology may prevent the regime from promoting the efficient use of the infrastructure. A more flexible pricing approach may allow the access provider (and the arbitrator) to take the relative willingness to pay of different access seekers into account when setting prices.

As an empirical matter, the difference between average costs and incremental costs is likely to be much smaller under the Victorian access regime than under rail access regimes in other jurisdictions. This is because access charges are not seeking to recover the sunk costs of the existing network – by far the largest element of access costs under other access regimes.

Ramsey pricing (efficient price discrimination) is not as simple to achieve in practice as average cost pricing. The information requirements on an arbitrator are much higher. In practice, perfect price discrimination is impossible to achieve, and so inefficient exclusion of some users is still likely. In its decision to certify the NSW rail access regime until 31 December 2000, the NCC noted the practical difficulties associated with Ramsey pricing.

An additional concern associated with flexible pricing approaches, is that it may be easier for a vertically integrated firm to misuse this flexibility to favour its own downstream business.

In its Draft Report on Telecommunications Competition Regulation, the Productivity Commission noted:

…[I]t may be difficult to distinguish the efficient application of these forms of discrimination from the anti-competitive use of them. As well, the informational requirements on the regulator are large. The regulator may need, for example, to scrutinise the demand conditions for rivals, as well as their costs. These forms of discrimination are probably more workable under a global price cap – since this weakens incentives for foreclosure – and thereby reduces the requirement that the regulator oversees pricing at the disaggregated level. But there are other practical limitations in imposing such a cap.26

26 Productivity Commission 2001, Telecommunications Competition Regulation, Draft report, Canberra, March, p. 10.16.

July 2001 57 Victorian Intra-State Rail Access Regime: Application for Certification

While the Productivity Commission supports the inclusion of scope for price discrimination where this will aid efficiency, it notes in its Review of the National Access Regime:

While there is a large literature on the attributes of specific rules for setting access prices for individual services, debate about the appropriate rule is not as important as it may first appear. In practice, pricing rules have tended to merge into variations of average cost. To take examples from telecommunications pricing, despite different titles, rules such as Directly Attributable Incremental Cost or Total Service Long-Run Incremental Cost, in practice, are all essentially versions of average cost.27

Despite the practical limitations with Ramsey pricing, it may be worth attempting to price in this manner when fixed costs are a very high proportion of total costs. In this case, there is greater potential for harm created by simpler pricing approaches, such as average cost pricing. Therefore, it is probably appropriate to allow greater flexibility in pricing on networks that need to recover the full fixed costs – i.e. in any other network than Victoria’s. The increased complexity and uncertainty is more likely to be justified in these cases.

In the case of FA’s network in Victoria, however, there is no need to recover the high fixed costs associated with the existing infrastructure. These have been paid for by Government, which does not seek a return on its investment. Therefore, the basic impetus to attempt Ramsey pricing – to allow for the efficient recovery of high fixed costs, which is otherwise highly problematic – is significantly weakened.

Finally, in Western Australia, Queensland and NSW, the range of willingness to pay between different classes of access seekers is likely to be much wider than in Victoria. In these other States, rail freight companies are able to extract high prices from carrying black coal and other minerals. For example, in its decision to certify the NSW rail access regime, the NCC stated:

Although NSW pays substantial subsidies to RAC to cover unprofitable services, RAC’s 1996-97 Annual Report indicates that without revenues from coal freight usage, it would have incurred losses.28 By comparison, the willingness to pay of other types of freight carriers (including grain carriers) is much lower. Victoria has no black coal or significant minerals industries. Victorian rail freight consists primarily of grain, with some logs and other agricultural products, and some containerised freight.

27 Productivity Commission 2001, Review of the National Access Regime, Position paper, Canberra, March, p. 208.

28 NCC 1999, NSW Rail Access Regime: Statement of Reasons for the National Competition Council’s Recommendation Under Section 44M of the Trade Practices Act, p. 6.

July 2001 58 Victorian Intra-State Rail Access Regime: Application for Certification

The simplicity of the Victorian regime is of itself important for efficiency. The transaction costs associated with complying with the regime, and achieving access through it, are likely to be significantly lower than under a regime that allows a very broad range of pricing outcomes. Regimes with a very wide gap between floor and ceiling access revenues (such as in Western Australia, with a floor close to zero and a ceiling based on the full replacement cost of the network) offer little in the way of useful guidance to the arbitrator or the parties. Under the Victorian regime disputes requiring arbitrated outcomes are likely to be less information- intensive and time consuming. They will require less, if any, confidential information about the willingness to pay of the access seeker.

High costs of negotiation and arbitration could be seen as a barrier to entry. To promote competitive entry, the Victorian Government sought to contain the costs associated with seeking access, through the creation of a simple access regime. There is much less scope for argument about basic pricing parameters under this regime than in other regimes in Australia. Where the bulk of freight is low value commodities (e.g. grain), the arguments for minimising transaction costs and specifying pricing principles in more detail are more forceful.

Low transactions costs associated with gaining access are likely to promote competition. Victorian intra-state rail freight is not a highly profitable industry. Potential access seekers could include quite small companies. Lucrative coal and mineral contracts do not exist in Victoria as they do in other jurisdictions, such as NSW, Western Australia or Queensland. The Victorian intra-state freight market cannot afford a complicated access regime, which might be more easily justified in some other jurisdictions.

Basis of average cost

The allocation of costs to freight users under the Victorian regime is determined 50/50 on the basis of each users’ total train kilometres and gross tonne kilometres. Freight users who use more of the rail line services are allocated more of the costs as are freight users who run heavier rolling stock and carry heavier freight.

In order to encourage the efficient use of the rail line services, users should be signalled the additional costs resulting from their usage. As previously noted, any costs directly attributable to the use of the rail lines by individual access seekers will be recovered directly from that user.

Efficient use of rail line services is also promoted by allocating more of the fixed costs of the network to users who are less sensitive to higher charges. The allocation mechanism under the Victorian regime is not designed to allocate the fixed costs in this manner. Rather the aim is to have a transparent and administratively simple approach to allocating these costs that is agreeable to the

July 2001 59 Victorian Intra-State Rail Access Regime: Application for Certification access provider and users. Gross tonne kilometres is industry practice in this area. Further, given the non-recovery of sunk costs, the efficiency losses are likely to be relatively minor.

5.8.3. Recovering the costs of new investments

One way of encouraging efficient investment decisions by FA is to ensure that FA, acting efficiently, has the scope to achieve a commercial return on new investment. There are two key issues in this regard. First is to ensure that efficient new investment is included in the regulated asset base. The second is to ensure that the rate of return on that investment is commensurate with the required commercial returns commensurate with the risks involved.

Regulated asset base

As discussed in Section 3.2, the Victorian regime does allow the cost of extending the facilities, or improving their quality in a verifiable manner, to be recovered through access charges.

The Pricing Orders allow network service providers to recover the efficient costs of investments that will:

(i) enable trains to operate at a higher speed; or

(ii) enable heavier trains to operate; or

(iii) enable more trains to operate; or

(iv) otherwise improve the performance, or enable the safer operation, of trains operating; or

(v) enable operating and maintenance costs to be reduced.

In this respect, the pricing principles are consistent with the criteria in (i) and (j) in the CPA.

FA has publicly argued that the failure to allow for depreciation of and a return on the existing capital base means that it will not be able to fund infrastructure maintenance and replacement at the end of its economic life.29 This is incorrect.

29 Van Onselen, M. 2001, Rail Access in Victoria: the Private Access Provider’s View, presentation at Victorian Rail Summit: Victoria at the Cross Roads, 23-24 July.

July 2001 60 Victorian Intra-State Rail Access Regime: Application for Certification

All maintenance and renewal expenditure incurred by FA is recoverable through access charges (assuming the ORG considers it to have been efficiently incurred). This includes expenditure on replacing assets at the end of their useful lives, such as worn pieces of track, old signalling systems, sleepers and so on. The nature of rail maintenance is that at any point in time, some section of the network is being replaced – it is generally not the case that an entire line reaches the end of its useful life and is then entirely replaced. For this reason, the difference between maintenance and investment is rather blurred. Bidders were informed that renewal expenditure would be considered as maintenance, which was to be recoverable (including a margin). Any investment that goes beyond mere replacement and actually adds to the quality or capacity of the track is counted as new investment, for which a rate of return is allowed.

Rate of return

The rate of return on new investment that underpins access prices is to be determined by the ORG in a manner consistent with the clause 6(4)(i) and (j) and subject to the Pricing Order stating:

… a rate of return which will be set as the prevailing Australian 10 year Commonwealth bond rate at the date of completion of the capital asset plus a margin of not less than 4 per cent determined by the Office having regard to the risk involved in incurring the New Capital Expenditure.

The Pricing Order sets a floor to the rate of return on new investment made by FA. The Pricing Order does not set a ceiling on the rate of return. The original purpose of doing so was to introduce some certainty into the access regime prior to sale. In itself the floor on the rate of return is unlikely to inhibit the ORG in setting access prices that are consistent with 6(4)(i) and (j).

A floor on the rate of return does not prevent the ORG from providing FA with a rate sufficient to encourage efficient new investment. Nor does it undermine the owners legitimate interests in its investment in that facility. To the extent it has an effect, it specifically reduces the possibility that the ORG may in the future set an unreasonably low rate of return. This is more likely to encourage efficient investment than deter such investments.

The only major issue with setting this floor is if it is set above the level required to encourage efficient investment. Such a circumstance will unnecessarily inflate access prices which may result in the inefficient under use of new rail investment. However, as noted by the PC:

July 2001 61 Victorian Intra-State Rail Access Regime: Application for Certification

Excessively low access pricing is more insidious because its adverse effects are only felt in the long run, and because its welfare implications are likely to be worse than where access prices are high.30

5.8.4. Pricing issues raised in the NCC Issues Paper

The NCC’s Issues Paper in relation to FA’s application for declaration raised two additional matters in relation to the pricing principles:

An issue with the Victorian regime’s pricing approach is that it may not allow the ORG a regulatory role to independently establish the efficient supply costs and the coincident efficient prices for the range of services the access provider supplies. Additionally, the Victorian regime does not establish a revenue boundary to ensure that total revenues only recover efficient supply costs.31

The pricing principles do allow the ORG a regulatory role in estimating the efficient supply costs. The Pricing Declarations state:

The Office may exclude any:

(a) operations and maintenance costs from the calculation of the Operations and Maintenance Costs …; and

(b) New Capital Expenditure from the calculation of the Capital Charge …

if the Office is of the view that an Access Provider acting efficiently, having regard to the nature and state of the Freight Network, would not incur those costs or make that New Capital Expenditure.

Assuming that any regulator in possession of an estimate of efficient costs can therefore establish the ‘coincident efficient prices’ is ambitious. The pricing principles offer a solution that minimises transaction costs with little risk to allocative efficiency, due to the exclusion of existing sunk costs.

In relation to a revenue boundary, note that the average cost formulae for access charges are unlikely to deliver super-normal returns. This is only likely to be possible if traffic forecasts used to determine access prices proved to be much

30 Productivity Commission 2001, Telecommunications Competition Regulation, Draft report, Canberra, March, p. xxx.

31 NCC 2001, Application for Declaration of Freight Australia Railway Network Services, Issues Paper, June, p. 34.

July 2001 62 Victorian Intra-State Rail Access Regime: Application for Certification lower than actual traffic. The Pricing Orders contain provisions allowing the ORG to insert provisions to vary access charges in certain circumstances:

The Office may, if it considers it appropriate, include in its determination a mechanism to change the amount to be paid for access which the Office has set pursuant to paragraph 3 to reflect any or all of:

o price inflation or expected efficiency gains or both; and

o differences arising between forecasts made by the Office pursuant to this Schedule and actual results in relation to the matter forecast for each line.

In essence, this provides a mechanism to deal with significant ‘unders and overs’, which is means that the average cost methodology can be equivalent to a revenue cap.

5.9. Clause 6(4)(k) – Material change in circumstances

Clause 6(4)(k) states:

If there has been a material change in circumstances, the parties should be able to apply for a revocation or modification of the access arrangement which was made at the conclusion of the dispute resolution process.

Clause 38L of the Rail Corporations Ac 1996 exactly mirrors this requirement. Therefore, this criterion is met.

5.10. – Existing users

Clause 6(4)(l) states:

The dispute resolution body should only impede the existing right of a person to use a facility where the dispute resolution body has considered whether there is a case for compensation of tat person and, if appropriate, determined such compensation.

Section 38L of the Rail Corporations Act 1996 replicates this criterion.

5.10.1.Clause 6(4)(m) – Hindering access

Clause 6(4)(m) states:

The owner or user of a service shall not engage in conduct for the purpose of hindering access to that service by another person.

July 2001 63 Victorian Intra-State Rail Access Regime: Application for Certification

Section 38N of the Rail Corporations Act 1996 replicates this criterion.

5.11. Clauses 6(4)(n) and (o) – Ring fencing

Clauses 6(4)(n) and (o) of the CPA state:

Separate accounting arrangements should be required for the elements of a business which are covered by the access regime.

The dispute resolution body, or relevant authority where provided for under specific legislation, should have access to financial statements and other accounting information pertaining to a service.

The ring-fencing requirements under the Victorian regime were discussed under Section 5.2.2. These requirements meet the CPA criteria, since separate accounting arrangements are applied, and the ORG has access to any financial or accounting information relating to declared services that it may require. The ORG’s proposed arrangements in this regard were also discussed in Section 5.2.2.

5.12. Clause 6(4)(p) – Multiple jurisdictions

Clause 6(4)(p) of the CPA states:

Where more than one State or Territory access regime applies to a service, those regimes should be consistent and, by means of vested jurisdiction or other cooperative legislative schemes, provide for a single process for persons to seek access to the service, a single body to resolve disputes about any aspect of access and a single forum for enforcement of access arrangements.

Clause 6(2) of the CPA provides that:

The regime to be established by the Commonwealth legislation is not intended to cover a service provided by means of a facility where the State or Territory Party in whose jurisdiction the facility is situated has in place an access regime which covers the facility and conforms to the principles set out in this clause unless:

(a) the Council determines that the regime is ineffective having regard to the influence of the facility beyond the jurisdictional boundary of the State or Territory; or

(b) substantial difficulties arise from the facility being situated in more than one jurisdiction.

The services for which the Victorian regime applies include some services provided by infrastructure located in NSW. However, these services are subject

July 2001 64 Victorian Intra-State Rail Access Regime: Application for Certification solely to the Victorian access regime. Therefore, only one access regime applies to the services in question. Therefore, criterion 6(4)(p) is met.

The regime does not cover Victorian track currently managed by ARTC. In particular, a length of track at South Dynon between Simms Street Junction and Appleton Dock, which FA has sub-leased to ARTC, is excluded.

By leasing its interstate track to ARTC and requiring ARTC to submit an access undertaking to the ACCC as a condition of the lease, Victoria has ensured consistency of access arrangements with other track managed by ARTC.

5.12.1.Consistency with other regimes

Since only one access regime applies to the relevant services, the CPA does not require consistency with other access regimes applying to rail. Nonetheless, some comments in this regard are offered here.

Even if the Victorian Government tried to develop a regime that was consistent with some national standard, this would be a difficult feat. The only rail access regime that is currently certified relates to a railway line that has yet to be built. No rail services anywhere in Australia have been declared. An access undertaking submitted by the ARTC in relation to part of its network (including Victoria’s interstate track) has yet to be accepted.

The Victorian regime could be made more similar to other, non-certified regimes, the benefits may be limited however, as:

¾ an access seeker would still be required to negotiate with each individual access provider. No one-stop-shop exists;

¾ each rail network differs according to the degree of utilisation, the costs associated with maintenance and renewal, the need for new investment, the degree of congestion, and the types of services (including passenger services) operated. Separate negotiations or arbitrations would need to take these factors into account, which would result in different and possibly inconsistent pricing outcomes for each network, even if carried out by a single arbitrator applying a consistent set of principles; and

¾ the arbitrator is not the same under each regime. Each arbitrator is free to interpret similar principles in different ways:

o IPART is the arbitrator under the NSW access regime;

July 2001 65 Victorian Intra-State Rail Access Regime: Application for Certification

o the proposed arbitrator under ARTC’s proposed access undertaking is the President of the Institute of Commercial Arbitrators;

o the Queensland Competition Authority is the proposed arbitrator under Queensland Rail’s proposed access arrangements;

o in Western Australia, the arbitrator is selected from a panel of names recommended by the Chairman of the WA Chapter of the Institute of Arbitrators and Mediators; and

o a regulator appointed jointly by the relevant Ministers from the Northern Territory and South Australia will be the arbitrator under the access regime applying to the AustralAsia railway.

A key difference with access regimes in other jurisdictions relates to the pricing principles. In other jurisdictions, a floor/ceiling pricing approach applies (although there are some differences in detail), while an average cost methodology is applied in Victoria. As discussed in Section 5.8, there are fundamental differences in the set of costs that each regime sets out to recover. Victoria is the only jurisdiction in which the costs of the existing network (at the time of sale) are not to be recovered through access pricing. Note that these costs represent the bulk of the costs associated with providing access. A simple average cost methodology may not be an appropriate way of recovering total network costs. In Victoria, however, a much smaller set of costs is to be recovered, which greatly reduces the risk of allocative inefficiencies being caused by average cost pricing. Given this fact, the transaction costs associated with a Ramsey pricing approach are not considered justified in this case.

Victoria has made the most significant contribution of all the States to the development of national rail network, having leased its interstate track to the ARTC, to be part of its ‘one-stop shop’. Progress towards harmonisation of standards and operating procedures are of greater practical importance in generating competition than consistency of pricing. As noted in Section 3.3 considerable progress has been made in this regard. The Government is also committed to standardisation of key parts of the freight network.

July 2001 66