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Implementation of Marginal Cost Pricing in Transport Integrated Conceptual and Applied Model Analysis

Marginal cost pricing implementation paths to setting rail, air and water transport charges
MC-ICAM Deliverable 5 28 November, 2002 Authors: Nicole Adler, Yossi Berechman, Patrizia Fagiani, Gyula Farkas, Dirk Henstra, Bryan Matthews, Chris Nash, Jan-Eric Nilsson, Esko Niskanen, Katalin Tanczos and Kostas Zografos Contract No: GRD1/2000/25475-SI2.316057 Project Coordinator: Esko Niskanen Funded by the European Commission Contract No. GRD1/2000/25475-SI2.316057 MC-ICAM Partner Organisations: UNIVLEEDS, FUA, KUL, TNO, TOI, ADPC, TAU, RC/AUEB, TUD, VTI, ISIS, UFSIA, BUTE, MEAP, HUJI, STRAFICA Website: http://www.mcicam.net Status: Distribution: Availability: Quality assurance: Coordinator's review: Signed: Date: Draft European Commission, partners Public (only once status above is "Accepted") MC-ICAM Steering Committee

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Table of Contents
Table of Contents ................................................................................................................... 2 Table of Figures ..................................................................................................................... 3 Executive Summary ................................................................................................................ 4

1. 2.
2.1 2.2 2.3 2.4 2.5 2.6

Introduction ................................................................................................................. 8 Rail ........................................................................................................................... 11 Types and Drivers of Externalities ................................................................................ 11 Recent Reforms in Railway Industry ............................................................................. 12 Initial Pricing Reforms ................................................................................................. 15 Subsequent Reforms and Propositions for Alternative Pricing Measures .......................... 17 Barriers to Implementation .......................................................................................... 20 Implementation of Pricing Measures ............................................................................. 21

3. Air Transport .................................................................................................................... 25 3.1 Types and Drivers of Externalities at Airports ................................................................ 25 3.2 Current Pricing Mechanisms at Airports......................................................................... 27 3.3 Proposed New Pricing Mechanism for Airports ............................................................... 29 3.4 Schiphol Case Study .................................................................................................... 30 3.5 Barriers and Constraints to Implementation of Proposed Pricing Mechanisms .................. 32 3.6 Implementation Paths to Marginal Cost Pricing at Airports ............................................. 35

4.

Water ........................................................................................................................ 38 4.1 Short Sea Shipping Case Study Description............................................................... 38 4.1.1 Types and Drivers of Externalities .......................................................................... 40 4.1.2 Current Pricing Mechanisms ................................................................................... 41 4.1.3 Implementation Barriers of Marginal Cost Pricing in Short Sea Shipping.................... 42 4.1.4 Implementation Paths in Short Sea Shipping........................................................... 45 4.2 Inland Shipping Case Study Description.................................................................... 47 4.2.1 Institutional Issues ................................................................................................ 47 4.2.2 Types and Drivers of External Effects of Inland Shipping ......................................... 47 4.2.3 Proposed Pricing Mechanisms in Inland Waterways ................................................. 48 4.2.4 Barrier Removal, Potential Solutions and Constraints in Inland Waterways ................ 48 4.2.5 Implementation Paths in Inland Waterways ............................................................ 50 Acceptability Issues in Rail, Air and Water Transport .................................................... 52 5.1 Methodological Framework .......................................................................................... 52 5.2 Acceptability Issues in Rail Transport............................................................................ 53 5.3 Acceptability Issues in Air Transport ............................................................................. 55 5.4 Acceptability Issues in Water Transport ........................................................................ 58 5.4.1 Acceptability Issues in Short Sea Shipping .............................................................. 58 5.4.2 Acceptability Issues in Inland Waterways................................................................ 60 Concluding Comments ................................................................................................ 64

5.

6.

Bibliography ......................................................................................................................... 66

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Table of Figures
Table 1: Barriers to implementation of marginal cost based pricing............................................... 6 Table 2: Short, medium and long term MCP policies for rail, air and water transport...................... 7 Table Table Table Table 2.1: 2.2: 2.3: 2.4: Types and drivers of externalities over rail infrastructure............................................ 12 Charges for using Swedish tracks, January 2000........................................................ 18 Barriers and solutions in marginal cost pricing of rail infrastructure ............................. 20 Potential implementation paths to pricing rail infrastructure ....................................... 23

Graph 3.1: Annual passenger volume in 2001 by time of day at Schiphol airport ......................... 26 Table 3.1: Types and drivers of externalities at airports ............................................................. 27 Table 3.2: Results of Schiphol case study .................................................................................. 31 Table 3.3: Barriers and solutions to marginal cost pricing at airports........................................... 33 Table 3.4: Potential implementation paths to pricing airports...................................................... 37 Table Table Table Table Table Table 4.1: 4.2: 4.3: 4.4: 4.5: 4.6: Types and drivers of externalities in short sea shipping (Piraeus Port)......................... 40 Barriers and solutions to marginal cost pricing in short sea shipping ........................... 44 Potential implementation paths to pricing short sea shipping ports ............................. 46 Externalities and their drivers in inland shipping ........................................................ 47 Barriers and solutions in inland shipping.................................................................... 49 Potential implementation paths to pricing inland shipping........................................... 51

Figure 5.1: Methodological framework for assessing acceptability barriers to pricing strategies for rail, air and water transport ............................................................................................... 52 Table 5.2: Acceptability barriers to marginal cost based pricing strategies for railways ................. 54 Table 5.3: Summary of stakeholder groups and barriers to acceptability in air transport .............. 57 Table 5.4: Acceptability barriers for port pricing strategy of short sea shipping ........................... 59 Table 5.5: Acceptability barriers to marginal cost based pricing strategies for inland waterways ... 62 Table 6.1: Short, medium and long term MCP policies for rail, air and water ............................... 65

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Executive Summary
Project MC-ICAM investigates the implementation of marginal cost pricing (MCP) in transport. The aim of this report is to discuss MCP approaches to setting charges in different modes of transport, specifically rail, air and water. Each mode is described in detail, including the size of the system, its geographical properties and industry profile. The market structure and stakeholders involved are identified in general and specifically with respect to the case studies analysed. Institutional, organizational, technological, legal, political, financial and competitive issues are discussed in detail and barriers and constraints to MCP are identified. In separate sections on each mode, types and drivers of externalities are subsequently identified. Current pricing mechanism characteristics are described and classified followed by the proposed second-best pricing measures modelled or developed through case studies. Finally, for each mode, we discuss barriers to implementation of the proposed pricing schemes and potential paths of implementation with respect to constraint removal and acceptability issues over the short, medium and long term. An additional section, prior to the conclusions, discusses acceptability issues in each mode utilizing SWOT (strengths, weaknesses, opportunities and threats) and compatibility analyses. The principal goals of this report are as follows: i) To provide detailed practical information on current pricing instruments and policies of member states, from a specific mode perspective. ii) On the basis of this review, (a) to make suggestions for the optimal transition path or phasing of marginal-cost based pricing, and (b) to provide recommendations for the design of policy packages that enhance the efficiency gains from pricing and contribute to overcoming acceptability and other barriers to the implementation of marginal-cost based pricing. iii) To provide a lead in to, and guidance for, the multi-modal modelling of subsequent MC-ICAM work packages. Consequently, presented in this report are suggestions for the implementation of MCP in the fields of rail, air and water transport, including short sea shipping and inland waterways. Whilst all these modes of transport are similar in the sense that they work through networks with stations or ports and generally a hub-and-spoke system, it has become clear that they are at different stages of MCP implementation. Rail would appear to be the most advanced and four case studies are detailed specifying the current pricing schemes in the United Kingdom, Germany and Sweden, with a slightly less advanced scheme to date in Hungary. In this historical analysis, it becomes clear that frequently watered-down versions of MCP have been implemented, due to political, legal, market structure (institutional) and acceptability barriers. It is however very important to ensure that each new step improves overall social welfare and is not perceived as moving backwards, otherwise the entire MCP notion in transport may be abandoned, as would appear to be the case in Germany. Hence, this report aims to provide clear identification of potential, future steps towards optimal pricing.

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The air transport mode is discussed and a modelling exercise is undertaken for Schiphol Amsterdam airport. For the water mode, Greek short sea shipping is used as a case study, with a specific analysis of the Port of Piraeus, and inland waterways are analysed, with a specific application to inter-modal transport on the river Rhine. In rail, descriptions of the successes and failures of the introduction of MCP provide knowledge for the other modes. Air transport is dealt with as a modelling exercise, since a large number of tariffs already exist, but need to be adapted to meet the current level of demand. Some airports however have already begun changes in the pricing process, hence the modelling approach was deemed appropriate. Water transport is the furthest from potential implementation hence a discussion of current practices and suggestions of how to move forward provide a first basis for change. The barriers to implementation of MC based pricing policies have been summarized for all three modes of transport in table 1. Much greater detail can be found under each mode of transports specific chapter with background documentation available for each mode. Based on this report, it would appear to be true that the issues affecting implementation exist across all modes and are reasonably similar in nature. Lack of data on scarcity, congestion, noise and air pollution and accident externalities all lead to problems of computation of optimal or second-best optimal MC prices for all modes discussed. Therefore, this is the first or short-run step required to remove political and general acceptability, and to some extent technological, barriers. The proposed implementation paths for second-best to optimal MCP for the individual modes in the short, medium and long term appear in table 2. The major drivers behind the pricing policies are the market characteristics required to enable implementation. There are roughly two ways to achieve MCP, the first is to accomplish a competitive equilibrium given constant returns to scale and the second is to rely on state ownership and control or regulation given a natural monopoly. However, perfect competition and natural monopoly are simply two extremes on a continuum. Technology can exhibit increasing returns to scale over a range of output that falls short of total industry output, which results in an oligopoly. Furthermore, regardless of the technology and nature of returns to scale, it is always possible for governments to implement MCP. The competitive equilibrium model is most applicable to freight operators and end users of all three modes of transport, namely rail, air and water. This may also be true for airports that appear to work under constant returns-to-scale. Alternatively the airports could be viewed as natural monopolies and therefore be either state-owned or at least regulated. For the case of infrastructure pricing and of short-to-medium distance public transport, the state owned and/or regulated approach would appear to be preferable, in part due to the Mohring effect (Mohring (1972)). More specifically, appropriate policy steps for rail transport would be (i) to achieve separate track authorities with independent regulators charged with achieving efficient pricing policies, and (ii) to franchise in order to permit control of end user fares. For air and water transport, appropriate policy steps would appear to be (i) pure competition for end users, and (ii) privatisation of ports and airports with price capping or regulation setting infrastructure charges and imposition of taxes to reflect other externalities.

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Clearly there are many possibilities for implementation paths, all with the ultimate aim of harmonizing charging policies to account for externalities on an equal basis across modes.
Table 1: Barriers to implementation of marginal cost based pricing
Categories Institutional: Organizational Political Legal Rail Inappropriate pricing in competing modes. No charging of environmental costs in other modes. Air Monopolistic hub airport power. Monopolistic flag carrier power. Lack of harmonisation across EU countries and across smaller and hub airports. Short Sea Shipping Lack of political will to change both infrastructure pricing and end-user equilibrium, requiring much legislation in certain EU countries e.g. Greece. Market distortions due to liners lobby group. Oligopolistic practices. Inland Waterways Mannheim convention prohibits levying taxes. Different judicial systems: EU and CCR (plus Danube commission) govern inland waterways. EU policy and policy of national and regional governments currently promote use of inland waterway transport via a variety of investments grants and subsidies, differing per country. Low priority of pricing inland shipping at government level due to modal shift policy (priority given to road pricing). Price increases will be fought by operators and their customers (shippers). Relatively low externalities and scepticism about the effectiveness of pricing. Fear of an unwanted modal shift to other modes.

Acceptability

Inappropriate pricing in competing modes. No charging of environmental costs in other modes.

Status quo strongly preferred by powerful airline lobby groups. Not acceptable to charge environmental costs until other modes charged.

Technological

Problems with measuring congestion and scarcity.

Data collection of delays and their causes. Current questions as to noise measurement and data collection. Lack of information on scarcity and its estimation.

Passengers inertia due to established travel patterns / inelastic demand. Non-acceptance of new congestion fees will cause powerful shipping lines to fight introduction. Not acceptable to charge environmental externalities before other modes contribute. Lacking research on practical port capacity, delay and scarcity definitions. Lack of data collection with respect to particular cost elements (real costs for providing services).

MC calculation problems and problems of how to allocate costs such as infrastructure maintenance to inland shipping, water management and recreational/sea shipping.

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MC-ICAM D5 Table 2: Short, medium and long term MCP policies for rail, air and water transport
Current State Rail Generally consists of a MCbased, two part (or multipart) tariff with fixed element based on unavoidable costs and an allocation of joint costs and a variable element based on wear and tear and electric traction costs. In some cases, schemes include penalty payments/bonuses based on performance criteria, accident charges, congestion charges and information charges Agree amongst EU countries on removal of organisational constraints. No changes currently to allow other modes to reach MCP schemes already in place for rail transport. Introduce MCP of wear and tear. Introduce MCP of environmental costs. Airports Airport pricing includes landing fees according to maximum take-off weight of aircraft, transfer and nontransfer passenger departing fees, air traffic control tariffs, parking fees, freight loading/unloading charges, security and control charges for passengers and freight and at certain airports, night charges, noise fees and peak fees. Separate concessions and gate fees are collected for landside operations. Harmonise state legislation according to EU legislation, define delay legally and setup EU-wide database for all airports. Initiate use of peak-off peak, congestion and noise pricing mechanisms at large, hub airports Initiate use of peak-off peak, congestion and noise pricing mechanism at all airports, in a neutral manner. Introduce fuel taxes to account for NOx and CO2 emissions, on at least an E.U. wide basis. Encourage discussion on a worldwide basis to prevent airlines from refuelling at tax-free refuges. Short Sea Shipping Port fee based on vessel type and destination, location of operations in the port, total processing time at port and season.

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Inland Waterways Harbour and lock dues.

Short Term

Medium Term

Introduce route or distance based charge with differentiation according to vessel type and emission factor to account for marginal infrastructure costs and emissions of local pollutants. Introduce peak, congestion port pricing at major, hub ports (sub-optimal fee to ensure acceptability). Inform stakeholders on the rationale and benefits of moving from the ability-to-pay to the congestionbased pricing.

Long Term

Full MCP including congestion, scarcity and environmental costs. Introduce accident charges,.

Use MCP mechanism without constraints. Introduce scarcity charges through market-based slot allocation mechanism. Introduce accident charges.

Introduce peak, congestion port pricing at all ports, moving towards firstbest MC-based schemes, including environmental, scarcity and accident charges.

Modify Mannheim convention. Implement engine emission standards. Start reducing promotional measures such as investment grants and subsidies. Introduce fuel tax to internalise climate change effects and part of air pollution costs. Introduce vessel registration fees differentiated according to emission factors. Remove all promotional measures such as investment grants and subsidies. Introduce route or distance based charge with differentiation according to vessel type and emission factor. Introduce insurance system to account for accidents (expanded liability).

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1.

Introduction

Project MC-ICAM investigates the implementation of marginal cost pricing (MCP) in transport. Its goal is to provide clear policy conclusions on this topic, based on strong theoretical analysis, in-depth case studies and analyses of current situations in transport markets in different modes and countries with a large number of modelling case studies covering many different situations. The project covers intramodal, inter-modal and inter-sectoral aspects. It focuses on a phased approach to implementation of pricing measures. The purpose of this report is to provide MC-based policy packages and transition paths or steps of the phased approach for rail, air and water transport. This summary report is based on a number of background reports listed at the end of this section. Each mode is described in detail, including the geographical properties and industry profile. The market structure and stakeholders involved are identified in general and specifically with respect to the case studies analysed. Institutional, organizational, technological, legal, political, financial and competitive issues are discussed in detail and barriers and constraints to MCP are identified. For each mode, types and drivers of externalities are identified. Current pricing mechanism characteristics are described and classified followed by the proposed second-best pricing measures modelled or developed through case studies. Finally for each mode, we discuss barriers to implementation of the proposed pricing schemes and potential paths of implementation with respect to constraint removal and acceptability issues over the short, medium and long term. More specifically, this report is organised as follows: Section 2 analyses the requirements and prospects for institutional change, defining and discussing future directions in rail transport pricing. We discuss an overall package of measures to implement MCP for rail transport and tentatively suggest the necessary or second-best optimal implementation steps from the rail transport perspective. Different instruments are considered and selected case studies look in depth at systems implemented in a selection of member states and accession countries to understand how they came about, the issues involved in implementing them and the lessons for future implementation that can be learned. The section reports on four case studies, including Britain, Germany, Sweden and Hungary. They include a review of the existing rail infrastructure charging regimes and development of alternatives. It explores how the existing pattern of charges came into existence in each country, what alternatives were considered, why they were rejected and how the objections to MCP could be overcome. It leads to recommendations on how to move closer to MCP and on the phasing and packaging of such moves. Section 3 analyses the need for institutional change, defines future directions in airport pricing and discusses barriers to the implementation of MCP in air transport. It develops an overall package of measures to implement MCP at airports and tentatively suggests the necessary or second-best optimal implementation steps from the air transport perspective. Schiphol Amsterdam airport is examined in detail. The case study concerns airport charges for passenger airline carriers. Inter-sectoral issues include employment, residence, government, passengers and airlines. It
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considers first-best versus second-best implementation and phasing issues, EU policy harmonisation and the barriers to MCP that are likely to arise from airlines, labour unions and state governments. MCP will impact both airfares and specific airport usage whilst the revenues can be used to mitigate congestion and adverse externalities. Section 4 analyses the needs and prospects for institutional change and future directions in water transport pricing. It develops an overall package of measures to implement MCP for both short sea shipping and inland waterways and tentatively suggests the necessary or second-best optimal implementation steps from water transport perspectives. It reports on two case studies, namely short sea shipping in Greece and inland waterway transport on the river Rhine. The case studies look at costs, prices, market imperfections, ways in which external costs can be priced and implementation barriers for pricing policy. Section 5 assesses the packages of measures and the necessary and second-best optimal implementation steps suggested in sections 2 to 4 for rail, air and water transport, from the viewpoint of acceptability constraints and issues. Assessment of the measures and implementation steps will be made considering public, political and business acceptability using both SWOT (strengths, weaknesses, opportunities, threats) and compatibility analyses. The section explores ways of overcoming the identified barriers. Finally, section 6 concludes, drawing comparisons between the different modes and the identified paths towards implementation of marginal cost pricing. This report is based the background documents listed below. At the end of each chapter, references are given to these documents. The background documents are available from the MC-ICAM web site. Matthews B., Nash C., Nilsson J-E. and Farkas G. (2002). Institutional and Technological Barriers to Implementation - Rail Transport, MC-ICAM Task 5.2 part 1. Matthews B. and Nash C., (2002). Railway Infrastructure Charging in Britain - the Process of Re-organisation and Reform, MC-ICAM Task 5.2 part 2. Adler N. and Berechman Y. (2002). Marginal Cost Pricing Approach to Setting Airport Charges, MC-ICAM Task 5.3. Nilsson E. (2002). The Case for Using a Market Mechanism for Slot Pricing, MCICAM Task 5.3 Part 2. Zografos K. (2002). Institutional and Technological Barriers to Implementation Water Transport, MC-ICAM Task 5.4 part 1. Henstra D. (2002). Institutional and Technological Barriers to Implementation in Inland Waterways a case study of the river Rhine, MC-ICAM Task 5.4 part 2.

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Zografos K. (2002). Acceptability Barriers of Pricing Strategies for Rail, Air & Water, MC-ICAM Task 5.5.

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2.

Rail

There has been much interest at the EU level in reforming the railway industry, stemming from a strong desire to limit subsidies to the industry and enhance its market share. The aim of this section is to review the current situation in rail transport with respect to pricing mechanisms, identify the important barriers to pricing reform and provide tentative suggestions for implementation paths. Rail is by far the most advanced of the three modes studied in this report, with various types of MCP schemes applied at different levels in the diverse EU countries over the past decade. Hence, case studies with historical analysis are the most appropriate form of analysis for rail infrastructure and can provide a rich picture of potential implementation paths from which the other modes can learn. This section is a summary of case studies that review experiences of railway infrastructure charging reforms in four European countries: Britain, Germany, Hungary and Sweden. The case studies are used to provide an analysis of the key issues in relation to implementing pricing reform in rail transport. The four analyses draw on detailed literature reviews, supplemented where appropriate by expert interviews with those who have been, or are, closely involved in the reforms. The case studies provide information as to appropriate implementation paths with respect to MCP schemes, taking the successes and failures of the past into account. The first subsection will discuss the types and drivers of externalities specific to rail that cause the pricing issue to be of specific interest. A broad discussion of the case studies is then presented, followed by sections on the current pricing regime and appropriate new pricing mechanisms. The next section discusses barriers to the suggested pricing schemes, followed by a final section discussing possible implementation paths. 2.1 Types and Drivers of Externalities The additional costs generated when an additional train uses the infrastructure can be divided into five main types: use-related infrastructure wear and tear costs, congestion costs, scarcity costs, external accident costs and environmental costs. Each type of externality will be discussed individually below. Wear and tear of railway track is caused by a combination of usage-related and environmental-related damage. This results in the need to inspect, maintain and renew the track which gives rise to costs. Use-related wear and tear costs are that proportion of these inspection, maintenance and renewal costs which result from trains using, and hence causing damage to, the track. Congestion represents the expected delays resulting from the transmission of delays from one train to another. The introduction of an additional rail service onto the network reduces the infrastructure managers ability to recover from an incident and increases the probability of delays. This becomes worse at high levels of capacity utilisation, since there is a lack of spare capacity to recover from any delays. Congestion costs are the costs associated with these expected delays. In this way, the consumption of additional capacity and the resulting congestion on the network imposes delay costs on train operators and, ultimately, rail customers.
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Scarcity represents the inability for an operator to obtain the path they want, in terms of departure time, stopping pattern or speed. Therefore, in the presence of a capacity constraint, the value of any train that could not run due to insufficient capacity would be added to the costs of track damage and of expected delays. The High Level Group on Transport Infrastructure Pricing identified scarcity, rather than congestion, as the dominant consequence of existing capacity constraints on the existing rail network (European Commission, 1999). When travellers use a rail service, they expose themselves to accident risk on that service. At the same time, their use of that service may affect the accident risk for all other rail users and for users of other transport modes. Moreover, part of the costs of accidents may be imposed on third parties (such as the National Health Service) and not recovered from the rail company or its insurers. The economic value of these consequences of additional rail use form the marginal accident cost. Whilst the users internalise their valuation of the risk to which they are exposed, the marginal external cost consists of the expected accident cost to the rest of society (e.g., medical and hospital costs) and the willingness-to-pay of the household, relatives and friends and the rest of society with respect to the change in accident risk for other transport users. However, the exact nature of the relationship between the use of rail infrastructure and the number and severity of accidents is not clearly understood. Environmental costs arise out of the impacts of local and regional air pollution, global warming and noise emitted by railways. Several methods have been developed for valuing these impacts and extensive national and international research has been conducted over the past decade to derive actual values (Friedrich et al, 1998).
Table 2.1: Types and drivers of externalities over rail infrastructure Type of Externality Operational Externality Wear and tear costs. Congestion and delays. Scarcity. Accidents. Congestion and delays. Driver Usage related damage. High level of capacity utilization. Capacity constraints. Exact connection between rail infrastructure use and number & severity of accidents is unknown. Train fuel use. Population living near tracks. Demand profile & volume.

Safety

Environmental

Noise and air pollution.

2.2 Recent Reforms in Railway Industry The European Commissions policy of separating railway infrastructure from operations and opening up operations to new entry has given rise to the need for explicit methods of charging for the use of rail infrastructure. The Commission sees this as an important way of improving the efficiency and marketing of rail transport and, hence, of increasing the role of the railways in the European Common
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Transport Policy (CEC, 1996). They are keen to see comparable approaches to infrastructure charging being used in all member states, to avoid the distortions that exist when neighbouring countries charge for the use of infrastructure on a very different basis, and to base these charges on marginal social cost as the most efficient approach to transport pricing (CEC, 1998). However, deriving and implementing an appropriate pricing system poses extreme difficulties. These difficulties are reflected in the amount of progress the Commission and the member states have made to date, both on implementation of pricing proposals and on reform and liberalisation of the rail industry. Very few countries have seen radical change. However, the most radical changes have taken place in Germany, Sweden and Britain. In addition, Hungary has made considerable progress with implementing railway reform and a system of railway infrastructure charges, as part of its preparation for accession to the European Union. The case study countries generally span the extremes of the current situation in Europe. Other countries either follow the pure marginal cost approach of Sweden, with most infrastructure costs paid by the state (the Netherlands being an extreme case with zero infrastructure charges until recently), or some form of cost allocation with budgetary contributions from the state, more like that of Germany (France is a good example as the relative charges for different parts of the network reflect both differing levels of congestion and abilities to pay). Britain is unique so far in having attempted to operate a system with a privately owned infrastructure company receiving no government finance other than from access charges, but that attempt has now been abandoned as noted below. In Britain, during the mid-1990s, the rail system was broken up into around a hundred different companies and privatised. The industrial structure that emerged is unique to Europe and comprised a privately owned infrastructure authority, Railtrack Plc; privately owned passenger franchises, whereby all passenger services are operated on contracts for a fixed number of years; privately owned freight operations; extensive sub-contracting; an independent regulator, responsible for determining the rules for rail infrastructure charges, licensing all rail companies and approving all access agreements; and a strategic rail authority, responsible for the long term planning of the passenger network. However, in September 2001, Railtrack was declared bankrupt and placed in the hands of administrators. It is proposed that its functions will be taken over by a not-for-profit company, Network Rail. In the meantime, substantial direct government funding is being paid to Railtrack to supplement funding via track access charges. During the mid 1990s, Germany embarked on a programme of railway reforms, a number of elements of which are relevant here. The previously separate Deutsche Bundesbahn (DB) in the former German Federal Republic and Deutsche Reichsbahn (DR) in the former German Democratic Republic were merged into DBAG, a public limited company with share capital, owned wholly by the Federal Government. DBAG was established as a holding company, with a number of separate subsidiaries responsible for infrastructure, stations, long distance passenger services, regional passenger services and freight. At the same time, a Federal Railway Office was created as a government body and responsibility for funding regional services
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was transferred from the federal Government to the States, enabling them to contract with DBAG to run the services, to provide them themselves or to contract with a third party. Thus an element of contracting out for the provision of services was provided for, and open access to the German rail network was provided for both passenger and freight operators. Throughout the 1990s, Hungarys railway industry underwent a series of reforms and restructurings. Some of these reforms were driven by a desire to revitalise the Hungarian railway sector following substantial changes in the market demand for rail services in the wake of the political and economic changes. In addition, the desire to move towards compliance with EU regulations and policies, as a precursor to accession to the European Union, was also a driver for change. The first reforms, in the early 1990s, involved breaking up the former Hungarian State Railways organisation into approximately 100 separate companies, including Hungarian State Railways Plc. (MAV) and a series of infrastructure maintenance and construction companies. In the mid 1990s, the Hungarian government and MAV formalised arrangements for financing MAVs public service obligations and agreed on the separation of infrastructure organisation and accounting from commercial rail operations. In 1999, it was decided to separate the state owned infrastructure company from the commercial railway company. The infrastructure company will be responsible for the development, maintenance and operation of the track and belongings, whilst the railway company will be responsible for passenger and freight services, will own the rolling stock and will pay track user fee to the infrastructure company. The track user fee is designed to cover the cost of maintenance and operation, but funding for the development of the infrastructure will be provided by the state. At time of writing, two companies specialized in passenger transport and two companies specialized in freight transport operate train services on the Hungarian railway network and there is no open access to railway infrastructure. In 1988, Sweden was the first country in the world to vertically separate its railway sector.1 The government was seeking a radical transformation of the industry, following two decades of escalating state subsidies and the failure of a major financial reconstruction package in 1985. The state owned monopolist was broken up into two parts; Banverket the Swedish National Rail Administration with responsibility for infrastructure, and Statens Jrnvgar (SJ) running railway services, under a monopoly franchise. By organisationally separating infrastructure from service operations, the 1988 reform put railways on an equal footing with roads. The reforms also involved continued financial support to rail, in recognition of its safety and environmental benefits and transferred the responsibility for commercially unviable traffic over secondary, low-density lines to regional transport authorities, enabling rail support to form part of regional policy (Nilsson, 1995).

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The first move towards market entry came in 1989, when the first competitive procurement of regional train services resulted in a four-year contract being awarded to a private operator, BK Tg (at that time an operator of coach services), who began operations in 1990. The first years of the 1990s also saw the establishment of several small-scale freight operators. Most of these are subcontractors to SJ on peripheral parts of the network. From July 1996, anyone fit, willing and able can run freight services over the network, competing with SJ for contracts with consignors. At time of writing, only long-distance passenger services run by SJ on a commercial basis, operate on a monopoly franchise. From 1988 to 2001 SJ was run as a public sector state business administration, administering assets on behalf of the government, but doing so based on commercial principles. From 2001, three independent limited liability corporations have been formed, one running passenger services (SJ AB), one in charge of freight transport (SJ Green Cargo AB) and the third AB Swedecarrier a holding company for real estate assets, heavy maintenance, etc. All stock is still owned by the government, but the new organisation can now be sold to other investors, wholly or partially. The new organisational format inter alia means that the previous monopolist has been turned into two separate claimants for track capacity that in 2001/02 has to compete for track access with another 20 firms. 2.3 Initial Pricing Reforms In Britain, the initial pricing reform resulted in a system of infrastructure charges implemented for passenger franchises, which relied on a two-part tariff: (i) allocated access rights, a MC based solely on wear and tear and where appropriate electric traction costs (ii) a large fixed element based on avoidable costs and an allocation of joint costs (Office of the Rail Regulator, 1995). In addition, the franchise agreements contain 'performance regimes' which specify penalty payments or bonuses according to specified performance criteria, such as punctuality and cancellations. Given the arbitrariness of the allocation of joint costs, the pricing system does not necessarily provide good information on the relative profitability of different services. Moreover, the system has been criticised for the very low variable element in the charges, which give too great an incentive to fill scarce track capacity with lightly loaded trains. The variable charges include no element either to allow for congestion or the opportunity cost of slots or for externalities such as air pollution. Moreover, Railtrack has little incentive to enhance capacity to provide for extra services, indeed they argue that the variable element does not even cover wear and tear cost, resulting in a disincentive to expand capacity. From the point of view of efficiency, the result is that the system has no mechanism to ensure efficient use of scarce capacity. Adjustments in capacity or quality may be made by negotiation between Railtrack and the operators beyond the access rights held by operators, but these negotiations are complex, involving often several operators as well as the Strategic Rail Authority and the Regulator, and there is an obvious incentive for operators other than the main one affected to seek to 'free ride'.

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A similar difficulty in ensuring fair and efficient charges exists in the case of freight operators, which are the subject of individual negotiations but again subject to the approval of the Regulator. The major operator here has also negotiated a two-part tariff, which it may be argued favours it above rival operators. From the start, charges for use of the infrastructure in Germany were a highly contentious issue (Link (1997)). The initial structure of charges provided a detailed differentiated tariff, which recovered the total cost of the infrastructure, excluding capital charges, from users on essentially a fully allocated cost basis as a charge per train kilometre. However, there were major quantity discounts, which of course benefited the train operating divisions of DBAG relative to any entrant. Moreover, the relatively high charge per train kilometre also made new entry relatively unattractive; for instance, rail freight operators through the Channel Tunnel had previously expected through traffic to Germany to be a major market, but in the event they ran no through services to Germany, which was served by road from railheads in neighbouring countries. The United States, in particular, objected to the level of charges they would have to pay if any operator other than DBAG provided them services. The first reform in the face of this protest was to provide a discount for regional services, but soon the entire tariff structure was changed (see below). In Sweden, the first version of the pricing regime was constructed as a multi-part tariff. A fixed annual charge was levied per vehicle, different for different vehicles, and in addition, several variable components of the tariff generated revenue relative to gross ton km or train km run, etc. An accident charge was included within this original charging regime, based on a cost allocation principle, that the total (external) accident cost2 being averaged over total number of train kilometres driven. In addition, diesel trains which account for about 10% of total train kilometres driven were required to pay SKr 0.31 per litre of fuel used, as a means to internalise otherwise external environmental costs; cf. Hansson & Nilsson (1991) for more detail. The projection was that revenue and infrastructure costs would add up to SKR 890 and 1,854 million, respectively, the difference being the projected need for subsidies. In addition, a promise was made to invest massively in infrastructure, and to finance these costs over the public budget. Thus, the charging and investment regimes were initially set to mirror those for the use of roads. Cost recovery was of secondary importance in the 1988 organisational separation. Policy-makers realised that substantial parts of the network would have to be abandoned if the industry was forced to cover its own cost. This sentiment, although implicit, still permeates the political attitude towards charges for railway use. In this context, a simplistic version of the short-run, MCP paradigm, whereby efficiency enhancing charges for using existing infrastructure are set below average costs in recognition of increasing returns to scale (assuming no shortage of capacity and no need to levy Pigouvian charges to handle externalities), legitimises financial deficits as a means to ascertain efficient use of existing infrastructure.

Total cost is computed by multiplying the social cost per average accident, including a willingness-to-pay component for reducing accident risks, with the number of injuries and casualties over a year. 16/16

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2.4 Subsequent Reforms and Propositions for Alternative Pricing Measures The first regulatory review of access charges in Britain concluded that the initial structure was in need of substantial revision to improve the incentives to Railtrack. As part of this review, Railtrack has brought forward evidence for a higher variable element in the charges. This is based on a number of factors: engineering evidence that the wear and tear element of the charges does not fully recover these costs, evidence on the impact on delays to other trains of adding additional services to the system. an argument that Railtrack needs an incentive payment to encourage increased use of the system, and that such an incentive payment will give it reason to undertake small capacity enhancing investments without costly negotiations over who will pay for them. The regulator accepted the broad arguments put forward by Railtrack, whilst differing with them on many specific points regarding how the new system would be implemented. The eventual conclusion of the Regulatory Review was published in October 2000 and the new charging regime took effect as of May 2002. The new system retains the two-part tariff, but with the variable element increased to some 20% of total charges. Rather strangely, the new variable element includes the revised marginal wear and tear cost but only 50% of the estimated congestion cost. In other words, it is being deliberately held below marginal social cost to give an incentive to expand services. There is also a new incentive payment to Railtrack based on increases in traffic, but this is recovered through the fixed element of the two-part tariff rather than the variable element. (Office of the Rail Regulator, 2000). New entrants in the passenger sector will be treated relatively favourably, in that they must be offered the chance to operate paying only the variable element of the charge. However, the extent to which entrants are permitted to challenge franchisees head on is very limited. Thus, Britain will move to a system where the charge for using the infrastructure will consist broadly of a variable element reflecting wear and tear (and electric traction where relevant), a capacity charge reflecting the likely delays imposed on other services, and a fixed charge in the case of the franchisees based essentially on train kilometres. These charges will apply to most modest changes in services, although individual negotiation will still be needed for major projects affecting capacity or quality. In Germany, a move was made to a two-part tariff, with a fixed charge for using a particular stretch of track plus a charge per train kilometre run. This gave a greater incentive to expand services, and did not greatly disadvantage anyone running at a reasonably high frequency over that track, but it did of course mean that a new entrant running just once or twice a day would be at a disadvantage. However, such entrants were offered the choice of a single charge per train kilometre similar to the average paid by DBAG taking account of the fixed element in their charge. In other words, a new entrant would be required to make the same average contribution to fixed costs as that made by DBAG. This may seem a reasonable approximation to the efficient component pricing principle (Baumol, 1983) given the impossibility of a tariff taking account of the contribution made by each individual train. Yet again, the structure has had to be changed because of a ruling by the German competition
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authorities that the two-part tariff was anti-competitive and reversion to a single differentiated charge per train kilometre is now being made. In Hungary, the proposed charges are based on infrastructure expenditure excluding investments. That is, the amount of charges to be paid equals the sum of expenditures on track maintenance and renewal, signalling maintenance and renewal, train circulation (traffic control), depreciation, overhead, wear and tear and structures maintenance and renewal. The infrastructure charge to be paid applying a global method is calculated using Operation and Traction Statistics (OTS) data. This method of calculation is adequate at the moment since only the national transport company has to be taken into account. (The charges exclude charges for traction energy). Within the prime cost calculating system of MV Inc., infrastructure charges belong to domicilated costs costs are to be stated per statistical sections and stations. Therefore, according to the variable costs of specific lines, an IT accounting database is to be created. To achieve this, a new method should be implemented. The charging system makes it clear that the infrastructure charge is the offset of the maintenance costs of track and structures, telecommunication and signalling and depreciation, but bears no other content (neither performance, nor the parameters describing service quality are taken into consideration). That is, it does not provide information about the utilization or profitability of the lines. The drafted model is applicable to calculate the lump-sum charge of a single user, but is not applicable to: 1. Assessing the costs utilising market value and technical service quality of each line section (at MV Inc. satisfying prime-cost calculation needs). 2. Calculating a reasonable infrastructure charge on a given part of the network (line(s) sections). 3. The calculation of the infrastructure charge on a definite train path. In recognition of these limitations of the proposed system, the Ministry of Transport prescribes the introduction of a charging scheme that takes into account the quality of infrastructure and harmonizes with the EU Directives. A decree on the above issue is planned to be passed during 2002. In Sweden, the charging system was revised in February 1999. One part of the transformation was to abandon the fixed charges per vehicle. Table 2.2 provides an overview of the current structure of infrastructure charges.
Table 2.2: Charges for using Swedish tracks, January 2000.3 Type of charge Trackage fee, passenger Trackage fee, freight Information fee, passenger Accident charge, passenger Accident charge, freight Diesel charge
3

SKr 0,0086 per gross ton km 0,0028 per gross ton km 0,002 per gross ton km 1,10 per train km 0,55 per train km 0,31 per litre diesel

SFS 1998:1827 1 corresponds to about SKr 9. 18/18

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A trackage fee (spravgift) of 0.28 re per gross ton km is paid by freight trains. The charging level is based on detailed econometric analyses of the variability of track maintenance costs with respect to traffic, measured as gross ton, and a number of technical parameters (track length, number of switches, tunnels and bridges, etc). The data set does not include costs that are reported to be common for several track units; the district, region or main office costs are not expected to vary with track usage. Since it is not obvious how to measure traffic load in station areas, costs related to usage of this part of the network are not part of the analysis. Usage-related re-investment (or renewals) costs are also not included. The trackage fee for passenger trains is three times higher than for freight trains. The difference goes back to the Swedish-Danish deal over the resund Bridge. It was stipulated that train traffic was to pay an annual lump sum of 50 million SKr for using the bridge. When it was to be opened in 1999, SJ declared that its passenger services could not bear this cost and the incumbent refused to run commuter or long-distance services over the bridge. The government however, did not agree to foot the bill for passenger services. The solution was to charge freight services 2,325 SKr per train and passage over the bridge but to include the cost for passenger services within the trackage fee. Consequently, all passenger services in the country now contribute to the revenue generation required by the agreement. In addition, all passenger operations pay an information charge (trafikantinformationsavgift). This has nothing to do with MCs but is a way to recover costs for information services to passengers, an activity that was transferred from SJ to Banverket in 1999. Infrastructure charges also include a fee per car shunted at the major shunting yards. The logic behind this fee is MCs but the empirical substance behind the charging level is thought to be poor (Nilsson, 2002). The accident charge was substantially reduced in the late 1990s. This resulted from Banverket arguing that the costs for road/rail accidents were irrelevant for charging because a road vehicle is legally culpable in any incidents with railway vehicles and that accidents occurring because of people (illegally) walking on the tracks were also irrelevant to pricing accident externalities. The differentiation between freight and passenger vehicles is based on the argument that freight services conduct a larger proportion of their transports on those parts of the network that are more exposed to accidents. There are two problems related to the current level of the accident charge. The first is that the rate is based on average rather than MCs. There are indications that additional train traffic, controlling for the extent of safety installations, reduces accident risk (Lindberg (2002)). If this is correct, ceteris paribus, the current charge is too high. Secondly, and as described above, the current charge does not include certain classes of accidents. The legalistic motives given for this have poor relevance for calculating social MCs; irrespective of whether people have been culpable in a legal meaning, the presence of railway traffic does per se give rise to an accident. This would then motivate a charge increase, ceteris paribus. The net consequences of these offsetting aspects are not
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yet clear, but it is not probable that the optimal charge would be considerably higher than today. Despite arguments that it should be increased substantially, the current diesel charge has not been adjusted since it was first introduced in 1988. The main reason for this being regional policy concerns; much diesel traffic is operated in remote parts of the country and upward adjustments of the charging level might impact negatively on the possibility of retaining these services. 2.5 Barriers to Implementation Based on the discussions in the previous sections, the key barriers to the implementation of marginal social cost pricing in the rail sector appear to be: 1. Problems of measurement: estimation methods and, in most cases, estimated values exist for most cost components of marginal external costs, though the need for further research is especially acute for congestion and scarcity (see Nilsson (2002) for one method of treating scarcity). 2. Governments are unwilling or unable to provide necessary subsidies: under MCP with scale (and/or density and/or scope) economies, there is a need to subsidise (in the static perspective), but this may be unacceptable politically. It may be considered equitable to charge according to MCP but governments may fear Xinefficiency resulting from subsidization. 3. Anti-trust legal problems: currently there are legal problems with the implementation of two-part tariffs, which either require changes to the law or a different mechanism design achieving an uncommon tariff. 3. Failure to provide correct incentives for investment: There is a fear that the incorrect or diluted application of MCP may provide poor incentives for capacity expansion where needed, as well as causing X-inefficiency. The EC Directive on infrastructure charges (2001/14) recognises these issues by permitting nondiscriminatory mark-ups above MC for financial reasons and to recover the costs of specific investments. 4. Failure to encourage competition within the rail sector and across modes: the most likely second best policy involves two part tariffs and/or Ramsey pricing, but this may not be possible to do in a way that preserves terms of competition between operators. Furthermore, if other modes of transport charge less than MCP, for example road, this may cause rail to lose competitiveness. Only Sweden of our case studies, and as far as is known - more generally, explicitly includes environmental costs within its tariffs. No country other than Britain includes congestion costs in its tariffs, and no country includes pure scarcity costs. Scarcity costs remain a priority for further research. A summary of the barriers discussed can be found in table 2.3 alongside potential solutions.
Table 2.3: Barriers and solutions in marginal cost pricing of rail infrastructure
Categories Barrier Solutions

Institutional: Organizational Political Legal

1. The individual governments lack the power to implement MCP. 2. Governments are unwilling or unable to provide necessary subsidies.

1. Separate track authority with regulator charged with achieving MCP. 2. Open access for freight. 20/20

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Solutions

3. Anti-trust concerns with 2-part tariffs.

Acceptability

Technological

1. Inappropriate pricing in competing modes 2. No charging of environmental costs in other modes Problems with measuring congestion and scarcity.

3. Fare regulation for passengers as part of franchising. 4. 2-part tariff for infrastructure (by legislation) and Ramsey pricing by operators. 5. Appropriate treatment of cost of public funds and equity weighting. 6. Change of political philosophy e.g. change of government 1. Second best subsidies to rail until pricing in other modes are reformed. 2. Charge other modes. 1. Further research

The modelling constraints that draw on the barriers described in table 2.3 could be defined as follows: 1. No change in current prices in short term. Then separate track authority with regulator charged to achieve MCP. 2. Cap passenger fares as part of franchising in short to medium term. 3. No 2-part tariffs until anti-trust legislation changed. 4. Set budget constraints in form of total revenue greater than or equal to some proportion of costs, with proportion differing among countries. 5. No pricing of scarcity until measurement agreed upon through further research. 2.6 Implementation of Pricing Measures Currently, there is a diversity of approaches in terms of charging, institutional arrangements and competitive structures in the European rail industry. MCP is clearly much easier to implement where the infrastructure manager is a public body, funded largely from general taxation, as in Sweden. In both Britain and Germany there were strongly held fears that such a solution would lead to X-inefficiency and excessive investment at the time when the reform was discussed and designed. Therefore, in both countries, the infrastructure manager was to be a commercial body funded largely by payments from train operating companies. Moreover, in Britain the infrastructure manager was privatised. Even with a commercial infrastructure manager, there is a variety of ways of covering costs. In particular, direct funding from the state remains possible; in Germany, the state funds DB Netzs investment, whilst in Britain because of the crisis in Railtracks finances that led to its bankruptcy, the state now funds a substantial part of Railtracks maintenance and renewal costs directly. To the extent that train operating companies do pay the total costs of rail infrastructure, two part tariffs are a popular solution. The benefit of this approach is that it means that train operating companies make decisions, such as frequency of service, on the basis of true marginal costs and are free to exercise their power to implement Ramsey pricing in final markets in order to raise the revenues needed to pay the fixed part of the tariff. In general, train operating companies have much greater ability to
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discriminate between different types of traffic according to their price elasticity of demand than do infrastructure managers, as they are closer to the end consumer, and can differentiate between different types of customer using the same train, or identical trains. The principal objection to them is in terms of their potential impact on competition, and (as stated above) this has led to their abandonment in Germany. No country, except perhaps to a limited degree France, has attempted to implement Ramsey pricing for rail infrastructure. Ramsey pricing for infrastructure, which is an intermediate good, is problematic because the degree of differentiation that would be practicable is very limited and because it distorts train operating companies choice of frequency of service, although this is a solution that is often favoured in reports (NERA (1998)). Pricing rail services to the final consumer is generally seen as a matter for commercial train operating companies, though with a degree of regulation particularly of commuter fares. Thus, no country has attempted a policy of MC pricing for rail services, as opposed to rail infrastructure. Commuter fares are often held below MC, perhaps on justifiable second-best grounds; inter city fares show an increasing degree of differentiation perhaps on Ramsey pricing principles. Something approaching perfect price discrimination is practiced in freight markets, where negotiations with each individual customer are the norm. Where, either for budgetary reasons or because of fears of X inefficiency, governments are unwilling to provide the funding necessary to achieve full marginal social cost pricing for rail, we recommend that implementation paths concentrate on two part tariffs for rail infrastructure and on Ramsey pricing in final output markets, with the major unresolved issues being the treatment of small new entrants and charging for scarcity. Probably the best that can be done in terms of new entrants is to ensure that they can buy access to small parts of the network at a fixed charge that reflects their desired route coverage and to offer them a choice of the two part tariff or a single price, per train kilometre, reflecting the average charge paid by the incumbent. For scarcity, more research is certainly needed into auctioning systems, but until these can be shown to work an attempt to calculate the opportunity cost in the light of knowledge of competing demands may be made. However, precise paths towards implementation of marginal social cost pricing for infrastructure use will be dependent on national governments attitudes towards cost recovery and subsidy within their national rail industry and on their existing infrastructure charging framework. In addition, appropriate charges for both rail infrastructure and end usage will hang on the far more politically difficult issue of implementing corresponding charges for road users, most of whom fall a long way short of covering their external costs. The degree to which such an approach will actually cover fixed costs will vary according to the perceived constraints at the level of the individual countries. Until recently there was a constraint in Britain that, as a commercial organization, Railtrack had to cover all its costs from charges, although that constraint has now been breached. In Germany, the government is willing to provide DB Netz with assistance with capital but not operating cost. In both cases, the government offsets part of the inefficiency caused by charges that exceed marginal cost for infrastructure by the provision of subsidies for some or all services. What is important is that, in such a structure of charges, the fixed element of the
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infrastructure charge should be set so as have as little effect as possible on the decisions of train operating companies. Likewise in final consumer markets, if pure marginal social cost pricing is impossible, prices should be as differentiated as possible in order to minimize the extent to which users who are willing to pay marginal social cost are dissuaded from using rail. The solutions to potential barriers for implementation of MCP in rail, as summarised in table 2.3, implies that the main implementation path might be as follows. Existing EU proposals should remove the organizational constraints over the next few years, whilst further research will remove the technological barriers. The remaining key issues then are the relationships between prices on the different modes and the willingness of governments to provide subsidies. The current situation is very variable with many countries (such as Sweden and the Netherlands) charging below MC for infrastructure and some considerably above (such as Germany). After 5 years, it is envisioned that every country charges marginal cost of wear and tear including renewals as part of a two-part tariff where necessary. Second best subsidies to train operators should be in place to allow for incorrect pricing of competing modes and no environmental costs should be charged unless this is true in other modes. Open access for freight and franchising of passenger services should lead to efficient pricing of operations, with Ramsey pricing where necessary for financial reasons. After 10 years the problems of measuring congestion and scarcity should be overcome, hence full MCP still as part of a twopart tariff where needed, should be applied to infrastructure pricing. End users should be paying Ramsey priced tariffs and second best subsidies will be maintained only if other transport modes are not efficiently priced. Table 2.4 summarises the discussion on implementation paths in rail transport for the short, medium and long term. The paths are split according to a basic timeframe: short term (up to 5 years), medium term (5 to 10 years) and long term (10 years and beyond).
Table 2.4: Potential implementation paths to pricing rail infrastructure Rail infrastructure charging Short Term No changes currently. Medium Term All countries implement MCP of wear and tear. Introduce environmental charges, if charged on other modes. Introduce Ramsey pricing with second best adjustments for pricing of other modes. Establish agreed procedures for estimating or incorporating accident and environmental costs. Long Term Full MCP including congestion, scarcity and environmental costs. Introduce accident charges, if charged on other modes. Continue with Ramsey pricing, reflecting revised infrastructure charges too.

Charges to end users

No changes.

Technology

Establish agreed procedures for estimating or incorporating congestion and scarcity costs.

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25/08/2002 Short Term Medium Term Long Term Use cost-benefit Implement value for money investment to alleviate analysis to evaluate capacity constraints and assess the need for any targeted investments targeted line closures in the face of over capacity. to alleviate current capacity constraints. Complete the move towards separation of Determine appropriate infrastructure from operations and establish mix of open access independent regulator. versus franchised operations.

Market characteristics

We do not expect to see further significant changes in general to rail infrastructure charges in the short term, but within 5 years we expect all countries to implement a pattern based on a variable charge reflecting marginal wear and tear. Environmental charges at this stage will only be seen as acceptable if already imposed on other modes. Charges to end-users will by this stage be more explicitly based on Ramsey pricing principles. Within 10 years it should be possible to modify the variable element of the charge to reflect all the elements of marginal social cost, although again acceptability of this will depend on progress on other modes. This section is based on the background reports: Matthews B., Nash C., Nilsson J-E. and Farkas G. (2002). Institutional and Technological Barriers to Implementation - Rail Transport, MC-ICAM Task 5.2 part 1. Matthews B. and Nash C., (2002). Railway Infrastructure Charging in Britain - the Process of Re-organisation and Reform, MC-ICAM Task 5.2 part 2.

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3. Air Transport
The air transport industry consists of many players, including airlines, airports, ground transport authorities, local, state and EU governments, the travelling public, cargo and the general public. In general terms, airlines are the users of airports, with passengers and cargo representing derived demand. The airlines within Europe are owned by a variety of institutions. Some are fully privatised, such as British Airways, others are entirely government owned, such as Olympic, and some are a public-private partnership, such as Air France. In general, airlines aim to maximize profits and consequently desire to minimize charges paid to airports and EUROCONTROL (for en-route sector usage). Airports within Europe are generally publicly owned with one or two notable exceptions, for example the British Airport Authority (BAA) owns and runs the four London airports. Government interest also lies in the employment opportunities provided by the air transport industry, through which they collect both labour and transport taxes. The general public is affected by airports directly, through noise and congestion issues both from the air and on the ground and indirectly through house values. The aims of this section are to evaluate second best MCP mechanisms through a simple modelling approach and derive empirical results for Schiphol Amsterdam airport. Unlike rail, where MCP has been analysed and in some countries implemented, airport pricing is largely a secret, except for the London airports where the Civil Aviation Authority (CAA) publishes price caps for the privatised airports in an open manner. The current tariffs are known for all airports in Europe, but the economic rationale lying behind the prices is unclear, hence the aim of this exercise was to evaluate the appropriate levels of MCP and then compare them to current prices for the case study. Subsequently, the aim is to discuss barriers to the setting of MC-based tariffs and suggest implementation paths to move from current pricing to the proposed pricing at all airports in Europe. To this end, section 3.1 examines externalities of the airport system and sections 3.2 and 3.3 discusses the current and proposed MCP measures that could be applied at all airports. Section 3.4 presents a modelling approach in order to compute second-best MCP and specifically compute such a pricing scheme for Schiphol Amsterdam airport. The scheme suggested includes peak and off-peak pricing with charges for delays and noise pollution and is substantially different to the current pricing mechanism, which is weight rather than time based. Finally, section 3.6 discusses barriers and constraints to implementation of MCP and suggests potential implementation paths, describing how to reach the proposed solutions from the current situation in incremental steps over time. 3.1 Types and Drivers of Externalities at Airports Airport capacity that limits demand is a major driver of all the externalities, as described in table 3.1. In general, the capacity of an airport is defined as the volume of passengers and cargo that can be accommodated within a given time period (e.g., an hour). This capacity consists of several distinct components, as described in the following list.

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Runway capacity (maximum number of take offs and landings per hour that can be performed safely); Terminal capacity (number of passengers that can move about the terminal at an acceptable pace in a given time unit); Apron capacity (maximum number of aircraft per area that can be served per time unit) Air traffic control (ATC) capacity (maximum number of aircraft approaching or departing the airport in a given time frame) Gates (number of gates available in a time frame)

If capacity is insufficient to accommodate demand then delays will develop. However, runway capacity changes as a function of operational conditions such as aircraft spacing, proximity of runways one to the other, runway characteristics and airframe technology. It has been argued that head-up displays on aircraft, grooved, cement runways and a reduction in distance between aircraft movements together could expand existing capacity by at least one-third. This should be considered in conjunction with the pricing mechanisms proposed in the current study. The second major driver of externalities is the market structure and specifically the demand for air transportation, which is characterized by two main elements: 1. Traffic pattern (passengers origin-destination demand matrix), which in part reflects the configuration of airlines networks (e.g., hub-andspoke, multi hub, alliances linked networks, linear networks) 2. Peak and off-peak daily and seasonal demand patterns Demand fluctuations over a 24-hour period at major hub airports can be extreme. For example, daily demand at Schiphol airport has three major peak times: 9 a.m., 12-1 p.m., and 3 p.m., see graph 3.1 for details. Shoulder or off-peak periods show a substantial drop in demand.
Graph 3.1: Annual passenger volume in 2001 by time of day at Schiphol airport

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3,500,000

3,000,000

2,500,000

2,000,000

1,500,000

1,000,000

500,000

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Arrivals

Departures

Clearly the market structure and demand patterns affect other externalities, namely noise and air pollution and cause ground transportation congestion in the process.
Table 3.1: Types and drivers of externalities at airports Type of Externality Externality Driver Demand profile & volume Airport capacity (airside, grooved runways etc.) Technological infrastructure Airport operational characteristics (hub) Airframe characteristics & operating conditions (head-up displays etc.) Demand profile & volume Air traffic control behaviour (safe distance between ACM) Airport capacity (runways etc.) Technological infrastructure Airframe operating conditions Demand profile & volume Population area and density Aircraft characteristics (older, noisier etc.) Traffic patterns (ground transport access) Airport operational characteristics (hub) Technological infrastructure

Operational

Congestion and delays

Safety

Accidents, congestion and delays

Environmental

Noise, air and water pollution

3.2 Current Pricing Mechanisms at Airports Currently, airport activity related charges consist mainly of the following two services:

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i) Airport tariffs (landing and take-off charges, aircraft parking charges, passenger boarding charges, freight loading and unloading charges, security and control charges for passengers and freight); ii) Handling (administrative assistance and supervision, baggage assistance, freight and mail, runway operations assistance, cleaning and ramp services, fuel assistance, aircraft maintenance assistance, air operations and crew assistance, ground transport and catering). The price determination mechanisms differ substantially from one service to another and we will now discuss each in detail. The European Union is interested in uniform charging principles in the long run, based on the following criterion: airport differentiation according to traffic dimension e.g. size of market; differentiation within airports according to traffic intensity during a day; correlation with the quality and quantity of the supplied services; cost recovery considerations, including development and improvement; environmental protection goals.

These criteria are often not applied to date, and frequently the update of the level of tariffs would appear to be made by the local and state governments, mainly adjusting the level to the forecasted inflation rate given regional competition. The structure of the tariffs is mainly linked to the technical features of the aircraft such as weight, and the duration of infrastructure use. In particular, landing and take-off charges are determined as follows: Landing charges The charge applied to the aircraft is proportional to the maximum take-off weight (a price per tonne is fixed for the first 25 tonnes and a higher price for the following tonnes). The charge applied to the aircraft is proportional to the maximum take-off weight and is equal for internal and international flights

Parking fees for aircraft (Apron)

The result is a price structure that does not reflect management and operating costs, and does not differentiate according to changes in demand during the day. Moreover, the level of landing charges and parking charges increases for night flights (a 50% increase is applied to night flights to cover lighting expenses in Italy). In this case, a cost based logic drives the increase, but results in a further disincentive to flying during less congested periods such as night, at least at those airports where night flying is permitted. Clearly some airports have begun peak and off-peak pricing, such as BAA and Brussels, however the number of cases is diminutive and the additional peak charge is relatively small.

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The airport handling services market is in general privatised, consequently specialized companies handle both baggage and cargo. Within this market, tariffs are generally determined through contracts between the handling services operator and the customer, based on a multiplicity of factors such as cost, market power and medium and long-term objectives of the operators. The level of the tariffs is therefore extremely uneven, and generally negotiated on a one-to-one basis with the specific customer. A tax on aircraft noise emissions, if it exists, is normally added on top of landing charges paid by the airlines, and is proportional to noise emissions. The income from this tax, collected from airlines by the airport operators, is currently transferred directly to city, county or federal governments. The revenues are earmarked to finance schemes to reduce noise emissions from aircraft, complete and improve acoustic pollution monitoring systems, reduce noise pollution and pay compensation to residents living near the airport area. This charge is already in existence at certain airports, such as Schiphol Amsterdam and yet to be legalized in other countries, such as Italy. Fees to account for NOx and CO2 emissions are not yet considered in any form. Non-aeronautical fees collected from concessions amount to between 40 and 60% of all airport revenues. The question then arises as to whether these additional revenues should be used to expand existing infrastructure or whether airside operations alone should cover these costs. If an airport is government owned, it is also unclear as to what yield level could be considered acceptable with respect to airside operations and whether airport profitability ought to include non-aeronautical revenue. Clearly, if airport managers were to receive bonuses based on revenue achieved, all aspects of airport revenue would be promoted. However, landside concessions are entirely dependent on derived airside demand in general. Zhang and Zhang (2002) would appear to argue that consideration of both sets of revenue is important, dependent on whether the airport is privatised or not, whilst the CAA would appear to be moving towards a single till system for the three privatised airports in London. 3.3 Proposed New Pricing Mechanism for Airports The proposed pricing measures aim to correct inefficiencies including: (i) peak and off-peak charges, needed as a result of airline network choice and aimed at ensuring efficient use of current capacity limitations; (ii) congestion charges, in the face of limited and indivisible runway capacity, demand may exceed available capacity generating congestion and delay which may not be internalised in its entirety by all airlines (Brueckner (2002) argues that airlines at hub airports internalise their own congestion costs which suggests that such charges would consequently be relatively low. On the other hand, congestion can be substantially high at hub airports, suggesting perhaps the opposite, a subject for debate in the current literature e.g. Daniel (1995)); (iii) noise charges, due to environmental externalities, which if unpriced, will result in social costs exceeding users costs. Other externalities, including air pollution, accidents and ground traffic congestion, are not considered within the proposed, short-term pricing mechanism modelled in section 3.4. Air pollution has been modelled very little in the air transport industry
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(see for example Perl et al. (1997), Lu and Morrell (2001), Schipper (2001) and Oum and Tretheway (1988)) necessary data will need to be collected in the short to medium term, in order to lead to potential pricing schemes in the longer term. Air pollution needs to be considered both at airports, where the majority of fuel is spent (approximately 60%) and along flight paths, through EUROCONTROL intersectoral charges. Perl et al. (1997) suggest using economic calculations drawn from research in other ground transportation fields and multiplying these figures with the estimated yearly emission inventories emanating at airports. Using Lyon-Satolas as an example, they do not provide a single value, but rather a range of potential cost levels based on the following data: total number of aircraft movements, type of aircraft and engines employed and the average time that aircraft spend in taxi-idlequeue mode. The probability of accidents is very small, and much greater research needs to be undertaken in order to find valid methods for charging. Finally, ground traffic congestion needs to be considered in a multi-modal analysis. 3.4 Schiphol Case Study The aim of this section is to discuss the modelling approach subsequently applied to Schiphol airport in order to compute second-best MC prices. In order to undertake the analysis, the following information was collected (however, it should be noted that it has proven extremely difficult to attain useful information and as part of the MCP introduction, data collection will need to be improved and made publicly available): (i) airport charges including landing, passenger, noise-related and emissionrelated, parking, security, terminal navaid, lighting and cargo charges and taxes for various airports as well as fuel costs and ground handling charges (ii) airport operating costs and revenues from airside and landside operations (iii) capacity data including runway, terminal, apron and air-traffic control maximum capacities on an hourly, daily and weekly basis as well as number of gates and baggage handling capabilities (iv) origin-destination passenger and cargo matrix (v) delay data as an average number of minutes per peak and off-peak periods Having chosen a social welfare maximisation model with congestion and noise externalities and an airport minimum net revenue constraint, the following notation and assumptions are required to solve the model. Notation Decision Variables: P1 airport charge in peak period P2 airport charge off-peak Data: t={1,2} t Dt(Pt) at bt c(Dt(Pt) index for peak/off-peak periods percentage of time airport operates under peak/off-peak demand demand in the peak/off-peak period intersection of demand function in peak/off-peak period elasticity of price to demand in peak/off-peak period average/marginal cost per ACM in peak/off-peak period
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FC C N

fixed cost of providing capacity congestion costs per ACM noise costs per ACM level of profit that the airport must attain

Assumption (A1) specifies that the demand is linear in price. We also assume that there are no cross-elasticities between the two periods, mostly for reasons of data collection. Assumption (A2) specifies that the MC of maintaining the infrastructure of the airport increases linearly in aircraft movements (ACM). The assumption of linearity in turn means that we are assuming that average cost equals MC. This is subject to debate and needs to be analysed more accurately when relevant data can be collected. Morrison and Winston (1989) evaluate the marginal cost of airport maintenance at $40 (in 1989 terms) per landing, however both Pels et al. (2000) and Adler et al. (2002) find constant returns to scale to exist at airports. Assumption (A3) specifies that we are assuming an additional fixed cost with respect to the cost of providing current capacity. If we wish to consider the addition of new capacity, a step function is required, in order to consider the indivisibility of runway expansion. The model, taking account of assumptions A1 to A3, can be defined as in equations (1) and (2).
a1 max f = 1 b1 (a1 + b1 x )d (x ) + (P1 c1 )(a1 + b1 P1 ) P P 1 1 ,P2 a2 + 2 b2 (a 2 + b2 x )d (x ) + (P2 c 2 )(a 2 + b2 P2 ) P 2 FC C 1 D1 N ( 1 (a1 + b1 P1 ) + 2 (a 2 + b2 P2 ))

(1)

subject to:

1 [(a1 + b1 P1 )(P1 c1 )]+ 2 [(a2 + b2 P2 )(P2 c 2 )] FC

(2)

The objective function aims to maximize social welfare, as defined by consumer (airlines) and producer (airport) surplus less the cost of providing capacity, congestion and noise externalities. It is assumed that congestion charges only occur once full capacity has been utilized and noise charges are paid by all flights equally. Constraint (2) sets a minimum level of profitability for an airport at , where = 0 is a break-even constraint. Consequently, the model will compute the drop in social welfare corresponding to one additional unit of airport profitability (1). Solution to model for Schiphol airport: The current situation at Schiphol airport is that all landings pay the same fixed price, on average 3,170, and demand at the peak period is on average 42 landings and at off-peak 25. The maximum capacity for aircraft landings is approximately 35 per hour. One set of results is presented in table 3.2.
Table 3.2: Results of Schiphol case study

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Social Airport Peak Off-peak Number Number Welfare in profit in tariffs in tariffs of Number of Offs per s per s per in s per of Peak peak aircraft 1 hour hour landing landing landings landings Delayed 0 35,168 17,954 3,350 2,900 39.7 29.4 4.7 0 20,000 35,095 20,000 3,433 3,006 38.2 27.9 3.2 0.077 25,000 33,373 25,000 3,644 3,450 34.4 21.7 0 1.147

Under the requirement that the airport breaks-even, constraint (2) is redundant and the airport achieves 17,954 per hour profit, as compared to the approximately 60,000 profit it is achieving today. On the other hand, we are only considering airside revenue, whereas 50% of Schiphols revenue is drawn from landside concessions (The Civil Aviation Authority of Great Britain is discussing this issue today and planning to move to a dual till system, as presented here). The results of the model show that peak period prices should increase to 3,350 in order to reduce congestion slightly. Currently, demand in the peak period is 7 landings above the airport capacity of approximately 35 landings per hour. Under this pricing regime, delay would drop to just under 5 landings. Off-peak prices should be reduced to 2,900, in order to increase social welfare. This would enable the airport to be used more efficiently, encouraging a more uniform demand pattern and reducing delays due to congestion. As the net profit requirement increases, social welfare decreases, tariffs increase in both peak and off-peak periods and delays drop. However, given the fact that slot allocation is already limited so we are evaluating an already stunted demand curve, there is obvious room for expansion if the political issues can be resolved. The results of this model demonstrate the need to move towards MCP in order to improve the efficient use of monopolistic airports. It has also become clear in developing the model and collecting the data required that several barriers exist to computing MCP tariffs today and in resolving some of the disagreements that exist in the literature as to the most appropriate path over time. The barriers and implementation paths are discussed in the following sections. 3.5 Barriers and Constraints to Implementation of Proposed Pricing Mechanisms The barriers fall into three broad categories, namely institutional, acceptability and, to a smaller extent, technological. The biggest barrier today to changing the pricing formula would appear to be the lack of transparency involved in the entire chargesetting approach making suggestions for appropriate tariff setting very difficult. It is currently very difficult to ascertain the formula that lies behind the setting of airport charges, though the levels of charges themselves are fairly well known. It may in fact be true that no formulas are used to set charge levels, rather simple accounting rules may be followed in which last year's tariffs are increased by at least the level of inflation, considering also the competitors levels, namely other airports around Europe. Consequently, it could be argued that the first institutional and legal requirement necessary to begin the policy of first or second best MCP is to clearly specify the current formula, often set by local or state government. A clear and open explanation of the computation will aid in reducing lobby power that always prefers the status quo and improve acceptability of the entire scheme amongst politicians and the public alike.
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A second barrier is the lack of harmonization between the countries within the EU. An agreed pricing formula needs to be defined at EU level, ensuring minimum distortion amongst airports. Clearly, levels can be different across countries but the methods by which they are computed should be similar to ensure that all externalities are internalised and not simply passed from one country or region to another. There would also need to be an agreed upon administrative body, such as EUROCONTROL, that could ensure that if peak demand indeed changes with adjustment in tariffs, the airports are able to respond. Certainly newer aircraft with lower noise levels, for example, ought to be continually encouraged through appropriate tariffs. In this respect, technology is constantly in flux and needs to be managed. Another consideration is the natural tendency of airlines to push towards monopoly using hub airport market power. The trade off is airline profitability from the hubspoke network, through aggregation of demand hence lower costs versus competition, which ensures lower airfares in the long run. Thus, whilst it is not worthwhile preventing airlines from developing hub-spoke networks, a balance must be attained through some form of regulation. One alternative is to authorize lower airport fees for new entrants, thus warding off excess airline profits. The question here is whether international carriers should pay the same as regional, smaller airlines and whether discriminatory charges would break EU and state law. Another barrier to the introduction of MCP will likely come from the airports themselves, who have little interest in either annoying their customers, the airlines, or collecting additional data that will be required to accurately charge the new tariffs. Hence, the local and state governments will probably need to pass new legislation in order to implement the new pricing regime. It is clear that some legislation has already been passed, but this is not true in all countries and tends to be partial at best. Within the air transport industry today, charges are already levied and substantial data collected, consequently, technology is not a barrier to pricing. However, delay data is currently very difficult to compute and scarcity is not considered at all. Improvements in technology, based on research, should aid in the computation of both scarcity and delay on an on-line basis. Furthermore, expansion of airport infrastructure, namely the building of additional runways and terminals, as suggested in the results of the Schiphol case study presents political, acceptability and legal problems that will need to be overcome. The political problems lie in land use and environmental issues. Table 3.3 describes the key barriers to MCP that currently exist and have been identified, based on the discussion above.
Table 3.3: Barriers and solutions to marginal cost pricing at airports Categories Institutional: Organizational Political Legal Barrier 1. Monopolistic hub airport power. 2. Monopolistic flag carrier power. 3. Lack of harmonisation across EU countries and across smaller and hub airports. Solutions 1. Privatise airports with price cap regulation or regulate airport pricing using transparent mechanisms that are understandable. 2. Privatise all airlines and encourage 33/33

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25/08/2002 Solutions competition. 3. Artificially restrict aircraft movements, saving some slots for new entrants and/or introduce market mechanisms for slot allocation. 1. Through international negotiations and action at EU level, slowly introduce fuel taxes, thus ensuring refuelling at zero-tax countries is not possible. 2. Encourage all EU countries to introduce environmental charges both of noise and air pollution at all airports (not just hubs) and then across all modes of transport. 1. Invest in research on the question of scarcity estimation. 2. Legislate reporting of all delay information on a standardised EU-wide basis. 3. Based on noise mapping data (EU database expected by 2005), evaluate methods to translate data into noise charges.

Acceptability

1. Status quo strongly preferred by powerful airline lobby groups. 2. Not acceptable to charge environmental costs until other modes charged.

Technological

1. Data collection of delays and their causes. 2. Current questions as to noise measurement and data collection. 3. Lack of information on scarcity and its estimation.

Modelling constraints drawing on the barriers described in table 3.3 would include the following: 1. Restrict size of change from current tariff in short term, weaken constraints over medium term with no restrictions over long term. 2. Cap tariffs below MC at small airports in short term, relaxing regulation over medium term with no restrictions over long term. At large hub airports, tariffs equal to MC (i.e. not higher) in short, medium and long term. 3. Introduce slot charges to reflect issue of scarcity. Requires research in short term to analyse appropriate market mechanism. Introduce at large, hub airports in medium term and apply to all airports in long term. 4. Offer tariff reduction to airlines investing in technology to improve capacity usage in short-term. 5. Permit two tariffs (peak/off-peak), introducing continually changing charges (based on delay data) in longer-term. 6. Add additional charge to cover research and IT costs for data collection issues in short to medium term. 7. Permit price discrimination (different tariff levels) between international carriers and smaller, regional airlines, if not illegal. 8. Constrain size of changes until all airports around Europe are using MCP principles. 9. Include budget constraint, such that airports are not subsidized beyond a pre-specified level.

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3.6 Implementation Paths to Marginal Cost Pricing at Airports Having discussed the barriers to achieving MCP schemes, we will now attempt to address the issue of implementation. One of the important elements to implementation of MCP is the necessity to ensure that the schemes are implemented at all airports within the European Union. Clearly some airports have begun to implement peak and night charges. However, the additional peak charges are currently very low and are implemented only by BAA London and Schiphol Amsterdam and nominally by Dublin, Hamburg, Athens and Madrid. Furthermore, some airports charge additional night tariffs whilst others are cheaper over night and yet others shut down entirely over night. Schiphol Amsterdam has initiated noise charges to fund a noise abatement scheme but the rest of the airports in Europe have yet to initiate such charges. No congestion or delay charges have yet been implemented. In the short-term, the implementation path could consider the introduction of peak/off-peak, congestion and noise charges, first at all major, hub airports. The medium or long term should lead to a harmonisation amongst all airports. There is the question of whether small, spoke airports might be exempted from such pricing systems and this may in fact be preferable in order to encourage traffic to use secondary airports. Another question arises as to whether privatisation of airports and subsequent market driven pricing could in fact overcome some of the political barriers discussed in the previous section. Nilsson (2002) discusses the development of a market mechanism such as an auction to decide on issues of slot allocation, which are currently chosen according to grandfather principles. This principle specifies that an airline using its slots more than 80% of the time in the previous year have automatic rights to the same slot allocation in the coming year. Whilst open market mechanisms would probably encourage higher prices, drawing profits from airlines to airports, ensuring the availability and use of slots by new entrants needs to be considered too. These are thorny issues, which are a long way from being settled, and the monopoly powers of both hub based flag carriers and airports, in this instance, are likely to cause serious political barriers to implementation. In the shorter term, legislation is more likely to successfully implement social welfare maximization to the extent possible. Following the EU liberalization policies and open skies practices, both airlines and airports should eventually be privatised, encouraging market mechanisms to eventually solve the pricing issues, with some safeguards preventing extensive monopoly power. Alternatively, airports could remain government-owned and regulated, in which case it would appear to be important to regulate both airside and landside revenues together. Zhang and Zhang (2002) show that a profit-maximizing monopolist that controls both airside operations and concessions will discount the price charged for operations in order to boost travel through the airport and increase its revenue from concession profits. This is consistent with Starkies (2001) contention that allowing airports to retain monopoly profits from concessions encourages them to set lower prices for operations. Zhang and Zhang (2002) also compare the timing of airport capacity expansions under three administration regimes; (1) profit-maximizing, (2) welfaremaximizing subject to a long-run self-financing constraint, and (3) unconstrained
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welfare maximizing. They establish two results; expansion is delayed under constrained welfare maximisation compared to the unconstrained regime, and delayed under profit maximisation compared to constrained welfare maximisation. Furthermore, permitting a private airport to retain concession profits encourages it to expand sooner than it would otherwise. Clearly, high-speed trains are a serious competitor within Europe to the air transport industry, as well as autobahns to a lesser extent. Average air trip lengths within Europe are 750 kilometres, a distance over which high speed trains in countries such as France and Italy compete. If prices at airports increase dramatically and even if some of the increase is not rolled over to the end-consumer, clearly a modal change from air to rail is a possibility. Given that rail is subsidized and air is to a much lesser extent, this too should be a consideration. Airlines have developed hub-and-spoke networks, up until 1997 due to the bi-lateral agreements between each country. Since liberalization and the introduction of cabotage rights, the European airlines are now freer to develop their most preferable networks. Based on academic research (Adler and Berechman (2001), Button (2002)) and current practice in both the U.S. and Europe, it would appear that the hub-spoke system is efficient due in part to the aggregation of demand along fewer paths and the reduction in costs due to centralization. However, major congestion occurs at hub airports and is a direct result of demand patterns. Travellers flying via a hub prefer to minimize layover time and airlines therefore choose to fly in over an hour or two and then fly out over an hour or two in approximately two or three waves over a 24 hour period. Capacity needs to be sufficient to meet this peak need and slot allocations need to be organized to enable such network patterns. Without the ability to fly in waves, a more fully connected network will be developed with the resultant loss of efficiency and higher prices for passengers. Consequently a balance needs to be found, in which congestion and delays are minimized through sufficient infrastructure, namely runways, air traffic control, terminals and ground transport capabilities on the demand side with pricing measures used to balance supply. The problem of acceptability is a direct result of the market structure. In the majority of cases, airlines are still flag carriers in their respective countries, although this is slowly changing and the airlines are being privatised. The vast majority of airports in Europe are not yet privatised and in the case of major, hub airports, may behave as monopolists. Consequently, if the aim is to maximize social welfare, the results of the models are rather different to the existing situation. Furthermore, lobby power on the part of the directly interested parties and the political organization is such that it will not be simple to change the pricing mechanisms. Moving forward in stages may be more manageable and several paths are indeed available. The simpler and more immediate path will lead to peak/offpeak pricing and noise charges, which in some cases are slowly beginning to be adopted, such as the Netherlands, and in others are on the legislative agenda, such as Italy. The medium term measures call for pricing delays so as to ensure that airlines internalise all congestion, not just that which affects them alone. Charging policies at airports in the medium term also need to ensure that new entrants are given the
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chance to use all airports. Finally, privatisation issues will probably be decided in the middle to longer term, as will mechanisms for slot allocation. Table 3.4 suggests potential implementation paths, which are based on the previous discussion. The paths are split according to a basic timeframe: short term (up to 5 years), medium term (5 to 10 years) and long term (10 years and beyond). In the short term, the aim is to gain political acceptability and understanding by all stakeholders in the system. In the medium term, the aim is to achieve welfare gains from reduced externalities and in the long term, the aim is to achieve first best optimal pricing under sustainable growth.
Table 3.4: Potential implementation paths to pricing airports Airport pricing Short Term Harmonise state legislation according to EU legislation, define delay legally and set-up EU-wide database for all airports. Medium Term Initiate use of peak-off peak, congestion and noise pricing mechanism at all airports, such that total cost is not substantially different to current, total airport charges. Long Term Use MCP mechanism without constraints. Introduce fuel taxes to account for NOx and CO2 emissions.

Technology

Infrastructure

Use of revenues

Market characteristics

Encourage airlines to adopt head-up technology in Continue to invest in cockpit to improve productivity through tariff technological research breaks. to reduce noise and air Set up EU-wide noise, air and congestion database. pollution in new aircraft. Improve runways Increase runway capacity and remaining infrastructure and air traffic control to meet demand patterns, if necessary and possible. capabilities to increase runway productivity. Finance Cross-subsidise lower Finance increased infrastructure demand airports with hub infrastructure, including improvements at airports, thus ensuring ground transport airport and data service for all and some access. collation. diversion to secondary airport usage. Privatise airlines as per 1997 EU liberalization Free market legislation. mechanisms with some Consider privatisation of airports. protection for new entrants and price capping at privatised airports.

This section is based on the background report: Adler N. and Berechman Y. (2002). Marginal Cost Pricing Approach to Setting Airport Charges, MC-ICAM Task 5.3. Nilsson E. (2002). The Case for Using a Market Mechanism for Slot Pricing, MCICAM Task 5.3 Part 2.

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4.

Water

In recent years, there has been an increasing policy shift at both the national and EU level towards liberalising services and infrastructure in water transport, reforming pricing mechanisms and streamlining decision-making. The intent is to produce higher quality services and greater operational efficiency through the charging of externalities. Water transport provides an efficient means of transportation and is an important factor in the national economies of the Mediterranean countries that are active in short sea shipping, e.g. Greece, particularly with respect to passenger transport. Short sea shipping operates on a hub-and-spoke basis serving wide coastal networks, but suffers from severe congestion at nodal ports, is significantly underpriced, very centralised and is a highly regulated system. Inland waterways support intermodal freight transport across Central European countries. It is currently experiencing market decline and excess capacity, which generates considerable environmental externalities. This section reports results from an analysis of the alternative pricing schemes and barriers to the implementation of MCP, which was conducted on the basis of two major constituents of water transport: i) short sea shipping (Greece), and ii) inter-modal shipping corridors (specific emphasis has been put on the inland waterway barge transport from Basel to Antwerp over the river Rhine). The objective of these case studies was fourfold: i) to identify the major regulatory, organizational and operational aspects affecting or determining the implementation of particular pricing schemes in water transport ii) to review alternative pricing measures and current practices along with the rationale and the stated criteria governing the current pricing mechanisms and tariff structures iii) to explore the potential and perspective of MC-based pricing measures, either first-best or second-best policy packages and to examine alternative implementation paths iv) to elicit evidence and draw conclusions on the institutional, organizational and technological barriers in implementing the proposed pricing schemes, while simultaneously exploring the need for potential reform, review alternative ways to overcome the implementation barriers and examine anticipated benefits, acceptability and equity issues derived from implementing these pricing mechanisms in water transport. 4.1 Short Sea Shipping Case Study Description The Greek case study involves Short Sea Shipping (SSS) which is a major transport mode covering the wide Greek coastal network, as well as a principal structural factor of the Greek economy due to the peculiarities and morphological characteristics of the Greek transportation network. The Greek coastal transportation network consists of 31 main lines servicing 63 major ports, and 138 minor nodes [NTUA, 1993]. These lines operate on a strict hub-and-spoke basis connecting the port of Piraeus with the Greek islands, as well as other ports located in the mainland of Greece.
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The scope of the case study focused on the core node, Piraeus port, which accommodates the major bulk of SSS demand volumes, while simultaneously exhibiting the most severe congestion and delays problems. The port of Piraeus in the Athens greater metropolitan area is the major hub of the Greek coastal network. Each year, more than 12 million passengers are accommodated by the Piraeus port, which is by far the largest in Greece (Thessaloniki is a distant second). In addition to passenger traffic, the port of Piraeus handles a substantial volume of cargo traffic, [Psaraftis, 1998, NTUA, 1993]. Currently in Greek SSS, the prevailing pricing policy is far from adapting the concepts and principles dictated by the various MCbased approaches. The small number of service suppliers lead to oligopolistic tactics, which are detrimental to service quality. The few, but powerful, service providers operate in a strict regulatory environment, and capitalize on the short-term oligopolistic advantages stemming from the current maritime cabotage in Greece. The large number of customers of SSS services essentially signifies the heavy bargaining power of the supply side due to customer base fragmentation. The major competition lies between air transport and SSS (differences in fare levels and the introduction of the new high-speed ferries are the prime reasons) over a number of connections that are provided by both modes between the Greek islands and mainland. Finally, the externalities generated by the SSS system are concentrated at the nodal points (i.e., ports) of the network, due to severe congestion on both landside accessibility and waterside operations. As a member of the European Union, Greece is bound by the provisions of formal regulations issued by the Council of Ministers of the European Union. The most recent regulation pertaining directly to maritime transport and regulating its overall operational background is the Council Regulation [EEC, 1992] No 3577/92 "applying the principle of freedom to provide services to maritime transport within Member States (maritime cabotage)". For reasons of socio-economic cohesion within Greece, island cabotage and services by ships of less than 650 GRT (Gross Registered Tonnage), will only be introduced towards the end of 2002. Consequently, fares are administered and to a wide extent determined centrally by the Ministry of Mercantile Marine (through caps on passenger charges) and primary port users are not considered in the price determination process. Port authorities impose charges on the shipping lines that represent only a small portion (e.g., 15% 25%) of the total passenger fares, hence they do not significantly affect or communicate an efficient charging policy directly to passengers. The introduction of cabotage in Greece will enable new entrants that are active in the European or worldwide SSS market to offer services, potentially increasing the traffic volume as well as the demand profile that major ports will be called to accommodate after the full market deregulation at the end of 2002. For this purpose, large Greek ports (e.g., Piraeus, Thessaloniki and Patras) have been upgraded in terms of managerial and technological infrastructure, while more flexible, autonomous and efficient business structures have been adopted in order to cope with the spatial and temporal concentration of traffic around these ports. The Greek SSS does not gather systematic data on port capacity. It is however apparent that there are severe port capacity constraints (waterside), as well as environmental problems related to landside accessibility at a number of mainland
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ports (Piraeus and Patras). It is expected to further deteriorate under competition and the 2004 Olympic games in Greece. The current operational policy is based on administratively allocating slots on a first-come first-served basis without considering demand volumes and patterns or the congestion and delays experienced by busy ports. The three major mainland ports in the Greek SSS (Piraeus, Patras and Igoumenitsa) have clearly reached their capacity, while operating beyond capacity in many important aspects [Sturmey et al., 1994].
4.1.1 Types and Drivers of Externalities

On a theoretical basis, externalities signify indirect costs that generate changes in social welfare in terms of multi-side impacts and effects on stakeholders involved, which are not incorporated or reflected in current pricing [MC-ICAM, 2002, AFFORD, 1999]. With respect to SSS, the externalities can be grouped into three major types (Table 4.1).
Table 4.1: Types and drivers of externalities in short sea shipping (Piraeus Port) Type of Externality Externality Driver Demand profile & volume Vessel characteristics & operating condition Service requirements Port capacity (waterside) Technological infrastructure Personnel training & working experience Port operational characteristics (hub) Demand profile & volume (congestion/delays) Driving / manoeuvring behaviour Personnel training & working experience Port capacity (waterside) Vessel operating condition Technological infrastructure Demand profile & volume Traffic patterns (e.g., public transport use) Landside accessibility Port landside capacity Population area Port facilities (e.g. landside parking) Technological infrastructure Vessel characteristics (passenger/car capacity) Port operational characteristics (hub) Demand profile & volume Port capacity (waterside) Technological infrastructure Vessel characteristics (emission levels, use of environment-friendly technology) Vessel operating condition

Operational

Port congestion and delays

Safety

Accidents (probability, frequency, severity of accident)

Landside pollution (port vicinity, landside) Environmental

Waterside pollution (within port limits)

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Current pricing practices have been mainly based on empirical intuition and past trends, while private shipping companies exhibit limited participation in the process. Unfortunately, current pricing would appear to not sufficiently consider the cost structure and levels of both port operators and port users. The tariff structure at the Port of Piraeus differentiates according to the following main criteria: i) vessel types and destination, ii) location of operations in the port territory, iii) total time of service use (i.e., processing time), iv) season. The berthing fee for a 500-foot ferry in the Piraeus passenger port was approximately 16 per day in 1998 thus being roughly equivalent to that of parking a private car. These tariff levels do not reflect the actual costs levied by the port operations and they do not recover costs, thus creating severe inefficiencies (e.g., congestion) and sources of significant financial loss. By 1998, The Piraeus Port Authority had approved increases of up to 200% on ferry berthing rates despite protest from local ferry operators [Psaraftis, 1998]. In a theoretical context, the first-best pricing policy for seaports can be defined as the unconstrained welfare optimum, in which each port user is charged with the true marginal social cost of the use of port facilities, as given by the following externalities [MC-ICAM, 2002, AFFORD, 1999]: i) congestion and delays of terminal facilities, due to excess demand ii) environmental landside pollution, due to severe problems in landside accessibility iii) en route congestion, which is less important iv) accidents, mainly occurring en route and not at seaports. Although the consequences of sea accidents are severe especially in terms of human loss, the probability of occurrence is extremely low. Consequently, port congestion and delays and landside accessibility externalities are considered the most important external costs to be internalised and captured by a future pricing scheme. Congestion and peak port pricing constitute a pricing strategy that is expected to efficiently deal with the severe port capacity and delay problems and promote more effective usage and management of the port resources and infrastructure. Each port user should be charged the MC that is incurred by both the port and the port users resulting from the additional activities assigned to that user [Frankel, 1987, Pardali, 1997]. This pricing mechanism could be operationally achieved through charging higher user fees during peak-hours and lower fees during off-peak hours. Congestion and peak port pricing aim to also solve the landside accessibility problem of Piraeus port. Congestion fees levied on commercial port users e.g. shipping lines, will be partially or totally passed on to passengers as a means of potentially modifying their travel patterns, which in turn generates a peak smoothing in the traffic concentrated on the ports landside. Therefore, the congestion pricing measure will be used to deal with both the congestion phenomena and the external costs associated with the ports landside. The reasoning behind the MC-based pricing approach for European SSS lies in the identification and inclusion of the most important factors on which such an
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approach should be based, namely port and landside congestion, landside pollution and environmental deterioration, and accidents. To this extent, the inclusion of pollution from vessels when entering or leaving ports and whilst at berth in a pricing strategy based on marginal cost should be viewed in connection to the existence of congestion that would incur the cause of such externalities. Furthermore, peak port pricing could be used to alleviate the negative environmental effects that are incurred by waterside congestion at port terminals. Since pollution from vessels approaching port and at port increases with congestion, due to the increased amount of time that the vessels must spend in waiting outside the port limits and in entering the terminal, it is obvious that this external cost should somehow be incorporated in an MC-based pricing scheme. Peak port pricing could effectively deal with this problem, as smoothing of the traffic pattern and passing on a significant amount of traffic to either off-peak hours or reliever ports will reduce congestion and the consequent pollution from vessels. This, however, presupposes that the fees charged during peak hours will incorporate the additional external cost incurred and that there exists a mechanism for objectively estimating the cost of pollution that stems from congestion at port terminals.
4.1.3 Implementation Barriers of Marginal Cost Pricing in Short Sea Shipping

The barriers to the implementation of MC-based approaches can be classified according to the following taxonomy: Institutional Barriers: The regulatory framework in Greece fosters close state intervention in the determination of prices and charges by port authorities to the main port users. The Ministry of Mercantile Marine directly determines the fare structure for coastal shipping passengers, using methods that are far from the logic of MCP. It is obvious that the current policy cannot be coupled with a policy aiming at ensuring the most efficient usage of the ports scarce resources regardless of the actual level of the charge that will be levied to users. The intervention of political authorities in various sectors of the economic life in Greece poses a significant obstacle, since it directly affects the perceived or actual benefits of major stakeholders, while significantly distorting the free market mechanisms. Legal: One of the insurmountable barriers posing severe constraints and inflexibility in the overall system is the legal framework and the strictly regulated environment governing SSS in Greece. Clearly, there should be legal provisions towards changing the inherent inertia of liners to modify their slot requests either temporally or spatially, as well as to ensure that a part of the congestion fees will be passed on to passengers, who represent the direct and true source of port congestion and delays. However, the MC-based fees should be closely supervised by public authorities in order to avoid possible discriminatory practices against particular user groups e.g. light port users, or alternatively to amend them where necessary e.g. economic incentives, spatial traffic diversion with service priority and dedicated service facilities to particular satellite ports. Organisational Barriers: The establishment of a MCP policy in the field of seaports and SSS in particular will possibly result in a modal shift and a reduction in the competitiveness of this specific mode of transport. This is undesirable because it
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would favour air transport, which possibly poses more severe and extensive externalities as compared to SSS. It is advocated that MCP is most efficient when implemented in all economic sectors, but this is often difficult in the transport sector, as many authorities, stakeholders and regulatory institutions are involved. Moreover, the need for homogeneous and uniform implementation is even more imperative in the case of a coastal network since partial implementation at the Port of Piraeus alone may jeopardize the ports competitiveness. Practical Implementation Issues: Congestion pricing is theoretically grounded on the concept of the demand versus supply imbalance thus it is necessary to obtain insight into the real and practical port capacity throughput. Congestion pricing, as a MC-based pricing instrument, directly targets the issue of temporal and spatial concentration of demand. The congestion can be confronted either by diverting some traffic to other ports (e.g. Patras, Rafina and Lavrio) or by modifying the temporal demand profile. In other words, peak smoothing is low-cost and easily implemented in the short run provided there are available slots in off-peak periods. On the other hand, traffic diversion to reliever ports can be totally (or partially) achieved through the congestion pricing mechanism, but will require a sufficient time horizon to allow port users to adapt their demand. It also presupposes that there are satellite ports e.g. Lavrio and Rafina, willing and able to accommodate new demand. A similar constraint can be attributed to the inherent inertia and unwillingness of passengers to modify or adapt their travel patterns and behaviour. Furthermore, the spatial monopolistic power of ports and oligopolistic practices of shipping lines will constitute the basis for strong political resistance against any changes to the status quo. This resistance might jeopardize the applicability and implementation of the congestion pricing mechanism due to the operators unwillingness to shift schedules either spatially or temporarily. Another matter that should be clarified is whether a potential introduction of distance-based charges in a short-term perspective is linked to the reduction of en route congestion or acts as a means of recuperating the environmental burden imposed by the normal operation of vessels while en route. The application of distance-based charges as a means of reducing congestion (different charges during peak and off-peak hours) and smoothing the traffic pattern in European seaways will not have any significant effect on the above mentioned scope, as i) severe congestion of seaways is not as common a phenomenon for maritime transport as it is for road transport and ii) peak and off-peak periods in the use of seaways are not clearly identifiable. However, distance-based charging can be used as an effective measure for the recuperation of environmental costs, if it is linked to the vessel-generated emissions of potentially hazardous materials, under normal traffic conditions. Under this perspective, distance-based charges could be differentiated according to the levels of emissions generated by the each vessel, the vessels size, and could apply the polluter-pays principle by promoting environment-friendly vessels with lower fairway dues. To this extent, port dues could act as a proxy by offering rebates in their dues based on environmental measures regarding the emission levels of polluting substances
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from vessels wishing to make use of their facilities. Port dues could also act as an instrument through which distance-based charges can be collected at each port of call for the distance travelled between this specific port and the port of origin. Finally, when considering potential implementation paths, in the short to medium term it is important to ensure a homogeneous and uniform implementation of the MC-based approaches to ports located in the wider service area and competing for the same traffic. An optimal implementation sequence could involve at first the Piraeus Port as the core and hub port of the Greek coastal network, while including specific provisions to include in this pricing scheme the major metropolitan ports accommodating high demand figures and directly competing against Piraeus. At a more macroscopic level, the relevant policy authorities in the European context should actively pursue a harmonization of pricing mechanisms and a uniform practical implementation of MC-based schemes across all countries. On the other hand, harmonization should also consider the peculiarities and the wider environmental characteristics surrounding the operation of each harbour in Europe. In that respect, a situational analysis of relevant stakeholders, the internal structure, the anticipated imbalances and the acceptability issues should be conducted first. Hence, necessary refinements of the pricing mechanism will be properly identified and applied at each individual site. Technological Barriers: The major technological barriers concern the lack of the required infrastructure and equipment capable of accurately estimating and quantifying the real port congestion and delay figures in order to assign the appropriate MC-based fee to the port user. Similarly, port capacity analyses that provide insight into the real port capacity according to different demand profiles and volumes are singularly lacking currently. Finally, IT is still missing in order to ascertain the real costs of providing services.
Table 4.2: Barriers and solutions to marginal cost pricing in short sea shipping

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MC-ICAM D5 Categories Institutional Organizational Political Legal Barrier 1. Lack of political will to change both infrastructure pricing and enduser equilibrium, requiring much legislation in certain EU countries e.g. Greece. 2. Market distortions due to liners lobby group. 3. Oligopolistic practices. 1. Passengers inertia due to established travel patterns / inelastic demand. 2. Non-acceptance of new congestion fees will cause powerful shipping lines to fight introduction. 3. Not acceptable to charge environmental externalities before other modes contribute. 1. Lacking research on practical port capacity, delay and scarcity definitions. 2. Lack of data collection with respect to particular cost elements (real costs for providing services).

25/08/2002 Solutions 1. Encouragement at EU level for institutional reform in each individual country, towards a common goal. 2. Phased approach of MC infrastructure pricing e.g. busy metropolitan ports first. 3. Establishment of cap limits and direct passenger charges. 4. Adoption of uniform pricing schemes in competitive modes. 1. Support connectivity by establishing slot priorities. 2. Neutral pricing scheme with higher peak fees offsetting lower off-peak tariffs. 3. Communicate rationale of MCP mechanism. 4. Use fees to improve infrastructure.

Acceptability

Technological

1. Invest in IT infrastructure. 2. Introduce IT cost in the short term to finance data collection. 3. Finance research to develop accurate port capacity and scarcity analyses.

Modelling constraints, drawing on the barriers described in table 4.2, could be defined as follows: 1. Phased approach to MCP; in short to medium term introduce only at large, metropolitan ports and in the long term at all ports. 2. Introduce neutral, peak-off peak system in short term i.e. higher peak fees than currently and lower off-peak tariffs. In medium-term, move towards actual peak-off peak fees at large ports. In long term, introduce optimal MCP system at all ports. 3. Permit price discrimination (different tariff levels) between small (below true MC) and large ports (capped at MC) in short to medium term moving to true MCP with externality costs in long term. 4. Establishment of cap limits and/or direct passenger surcharges in short to medium term and free competition in long run, with taxes reflecting externalities. 5. Add short-term charges to cover research and IT costs for estimation and data collection.
4.1.4 Implementation Paths in Short Sea Shipping

It is clearly crucial to adopt an implementation path in the form of a transition period from current sub-optimal pricing schemes and practices to MC-based ones. This transition period will essentially signify a phased approach during which fees will be gradually upgraded to meet the relevant MC-based charges in the future, whilst the technological infrastructure and the organizational practices will be prepared to estimate, maintain, and impose MC-based fees (partially and gradually
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incorporating external costs) to port users. One important reason for this gradual implementation is that there will be adjustment costs, required institutional reforms and investments in infrastructure and technological upgrade. Finally, a gradual change will allow for adjustments to unforeseen changes in other variables, actors, and entities of the system that will be confronted proactively. The practical implementation issues and sequence, described in this section, are schematically illustrated in table 4.3. The paths are split according to a basic timeframe: short term (up to 5 years), medium term (5 to 10 years) and long term (10 years and beyond).
Table 4.3: Potential implementation paths to pricing short sea shipping ports Port pricing & Institutional issues Short Term Medium Term Introduce route or Introduce peak / distance based charge congestion port pricing at with differentiation large, hub ports (subaccording to vessel type optimal fee to ensure and emission factor to acceptability). account for marginal Inform stakeholders on the infrastructure costs and rationale and benefits of moving from the ability-toemissions of local pay to the congestionpollutants. based pricing principle. Use port dues as proxy and instrument for the Consider adopting similar pricing mechanisms for collection of such competing modes. charges. Develop IT infrastructure capable of estimating congestion costs and delays and assigning them to users. Obtain insight into real port costs. Estimate accurately port congestion costs and delays. Estimate waterside pollution costs. Perform port capacity Improve port analyses and examine infrastructure, processes, spatial redistribution and operational aspects to opportunities. increase capacity. Consider legislative /institutional reforms. Finance improvements / expansion of port infrastructure and IT equipment to support the implementation of the pricing scheme. Cross-subsidize spoke ports to accept and efficiently accommodate redirected traffic. Use revenues to restore negative environmental effects. Harmonisation with EU Establish flexible, regulation on maritime autonomous port business cabotage. entities. Promote competition and eliminate entry barriers at the local port level. Long Term Introduce peak / congestion port pricing, at least at metropolitan ports. Move gradually to firstbest MC-based schemes.

Technology

Infrastructure

Evaluate the implementability of market-based slot allocation schemes. Develop estimation principles for scarcity measurement. Conduct port capacity and landside expansion projects, where relevant.

Use of revenues

Finance port expansion projects. Ensure social mobility and welfare equity through the use of revenues Adopt similar pricing mechanisms to all transport modes. Establish monitoring / supervision mechanisms of competition and pricing. Remove legal restrictions on end user pricing. 46/46

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4.2 Inland Shipping Case Study Description The inland shipping case study involves inland waterway shipping on the river Rhine. Inter-modal inland shipping has been analysed as an example, in particular with respect to the market and cost structure. The case study draws on literature and interviews.
4.2.1 Institutional Issues

Inland waterway transport is almost fully liberalised. In the Mannheim agreement of 1868, it was decided that the river Rhine would be subject to technical, safetyoriented regulation only. The market is close to the definition of perfect competition and has been completely liberalized since 1/1/2000. The Central Commission for Navigation on the Rhine (CCR) is the main policy making body, drawing up the rules governing shipping on the Rhine and its tributaries. The inland waterway transport market in Europe is characterised by overcapacity. To bring demand closer to the supply of inland water transport after the abolition of chartering by rotation4, governments set up supporting measures, such as the vessel-scrapping initiative, the old-for-new measure (obligation to scrap "old" capacity if adding new capacity to the fleet) and an enterprise-termination arrangement (allowing operators to stop with an acceptable level of financial compensation). The European Union promotes the use of inland waterway transport. The Commissions Marco Polo programme aims to improve interoperability and intermodality by supporting commercial projects such as setting up new services. All European states, as well as regional governments, offer investment grants for inter-modal transport. Direct and indirect subsidisation of inter-modal transport includes building and upgrading of terminals, acquiring or renting inter-modal equipment and the exploitation of inter-modal transport. Finally, inland waterway barge services are fully privatised and both private and government run inland ports and harbours exist.
4.2.2 Types and Drivers of External Effects of Inland Shipping

Many studies have shown that air pollution and infrastructure costs are the major externalities within inland shipping, although the valuation of these effects differs per study. Accidents are generally considered negligible. Noise problems are not experienced and congestion is not a problem and will not become one in the near future. Table 4.4 discusses the drivers of the main external effects to be considered.
Table 4.4: Externalities and their drivers in inland shipping Externality Global emissions Driver Distance travelled Vessel characteristics (technology engine, type/size) Direction (upstream/downstream) Driving behaviour (speed) Fuel quality Load factor (draught) Distance travelled

Local emissions
4

a system in which freight charges are fixed by national authorities and barge operators take their turn in loading consignments, like taxis queue to pick up passengers. 47/47

MC-ICAM D5 Vessel characteristics (technology engine, type/size) Direction (upstream/downstream) Driving behaviour (speed) Fuel quality Location of residence, work and leisure activities Load factor (draught) Distance travelled Characteristics of the waterway (geometry/constructions) Vessel characteristics (type/size, engine) Direction (upstream/downstream) Driving behaviour (speed) Load factor (draught)

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Infrastructure use

4.2.3 Proposed Pricing Mechanisms in Inland Waterways

Inland shipping is currently not charged or taxed for any environmental costs. The only charges paid by inland vessels are harbour and lock dues, but these are far below the marginal infrastructure cost. Given the barriers described above, the regulator would need to resort to second-best pricing and the preferred schemes differ per externality: Emissions: CO2 is produced through fuel use, so a fuel tax seems the best instrument to charge for global emissions. The impact of local emissions is best accounted for via differentiated km charges, taking into account different impacts along different segments of the waterways (e.g. due to different population densities). Another, less suitable but easier instrument, would be fuel tax, but such a tax does not allow for a differentiation according to the emission characteristics of the vessel or place. Registration fees could be used to account for part of the emissions, differentiating according to emission factors of a vessel. Infrastructure use costs are best charged per kilometre. They can differ considerably between segments of the waterways; the maintenance cost (as well as the construction cost) of a natural waterway segment (river) is lower than an artificial waterway segment like a channel with locks. A geographically differentiated charging system could be implemented via harbour and lock fees. A more sophisticated system would be electronic pricing. There are two technical options: one using "beacons" along the waterway that communicate with a receiver in the passing vessel, the other using a GSM/GPS-based system. Another, less preferable, option would be the use of fuel taxes.
4.2.4 Barrier Removal, Potential Solutions and Constraints in Inland Waterways

For inland shipping, the introduction of a pricing system must be undertaken on an international level (CCR, EU) as transport is mainly cross border and different operators of different countries of registration (also non EU) can make use of the waterways. A pricing system would conflict with the Mannheim convention, one of its main principles being exemption from navigation duties. Historically the CCR makes the rules governing shipping on the Rhine and its tributaries. The EU has endeavoured to incorporate these rules in the Community legislation applicable to

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the entire inland waterway network. Nevertheless, the coexistence of these two judicial systems poses problems concerning regulation. The inland shipping lobby is reticent with respect to pricing issues, arguing that the external cost of inland shipping is relatively low. The lobbys position is that internalising external cost will ultimately be unavoidable but can only be done on an international level. The lobby stresses the importance of the accurate calculation and allocation of infrastructure costs amongst water management and recreational and sea shipping. There are a variety of investments grants and subsidies, differing per country, to promote inland shipping. In a fair pricing scheme, these subsidies should ultimately disappear and external cost should be internalised. This could conflict with EU policy and the policies of national and regional governments to promote the use of inland waterway transport. Furthermore, implementation of MCP will lead to higher costs for the barge operator and it is unclear if the operator can fully pass on the increase to the shippers. Two types of possible technical barriers may be distinguished: (1) the measurement, allocation and monetarisation of the externalities and (2) the implementation of pricing systems. There are several barriers to determining the MCs of a vessel sailing a piece of waterway. The main area of uncertainty is the infrastructure cost including the marginal effect, cost levels and allocation. Nevertheless, there are several technological options to differentiate charges according to place: port/lock fee based or electronic. This is not so much a technological barrier as a question as to whether the benefits of the implementation of such a system would exceed the associated costs. Table 4.5 gives an overview of the (hypothetical) possibilities to remove the barriers described above.
Table 4.5: Barriers and solutions in inland shipping

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MC-ICAM D5 Categories Institutional Barrier 1. Mannheim convention prohibits levying taxes. 2. Different judicial systems: EU and CCR (plus Danube commission) govern inland waterways. 3. EU policy and policy of national and regional governments currently promote use of inland waterway transport via a variety of investments grants and subsidies, differing per country. 4. Low priority of pricing inland shipping at government level due to modal shift policy (priority given to road pricing) 1. Price increases will be fought by operators and their customers (shippers). 2. Relatively low externalities and scepticism about the effectiveness of pricing. 3. Fear of an unwanted modal shift to other modes. 1. MC calculation problems and problems of how to allocate costs such as infrastructure maintenance to inland shipping, water management and recreational/sea shipping.

25/08/2002 Solutions 1. Investigate legal possibilities to pricing on the Rhine within the Mannheim convention (e.g. via harbour/lock dues) or amend the Mannheim convention. 2. Tune and ultimately integrate the judicial systems of the EU and the CCR. 3. Gradually decrease distortional subsidies and then introduce MCP charging scheme.

Acceptability

1. Use revenues for infrastructure improvements to gain acceptance. 2. Communicate with industry. 3. Co-ordinate the implementation of pricing systems for different modes.

Technological

1. Research: calculate marginal social cost (including cost and allocation rules for infrastructure cost).

Modelling constraints that draw on the barriers described in table 4.5 include: 1. Mannheim convention limits possibilities to implement MCP tariffs 2. Reduce distortional subsidies slowly over time e.g. reduce subsidies slowly in short to medium term and remove entirely in long term. 3. Introduce charges gradually i.e. cap below MCP in medium term and release in long term. 4. Permit different tariff levels for different users e.g. inland, recreational and short sea shipping over medium term. Regulate true MCP with externalities in the long term. 5. Introduce IT charge in short to medium term to cover research costs.
4.2.5 Implementation Paths in Inland Waterways

Please note that given the newness of the subject, the implementation path should be considered an impetus to start the discussion on pricing inland shipping. Given the objective of internalising social MC, ignoring other possible motivations for pricing such as raising revenues, or any difficulties in monetarising the precise external cost and consequently the charge level, a potential implementation path is presented in table 4.6. The path is split according to a basic timeframe; short term (up to 5 years), medium term (5 to 10 years) and long term (10 years and beyond).

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MC-ICAM D5 Table 4.6: Potential implementation paths to pricing inland shipping


Short term Medium term

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Long term

Pricing and institutional issues

Investigate legal possibilities to pricing given the Mannheim convention. Implement engine emission standards. Start harmonising promotional measures such as investment grants and subsidies for terminals, inter-modal equipment, and exploitation.

Technology

Obtain insight into the marginal infrastructure cost and accident cost and into the allocation of these costs to water management, recreational shipping, sea shipping and professional inland shipping. Set average emission cost.

Introduce a fuel tax to Introduce route or internalise climate distance based change effects and part charge with of air pollution costs. differentiation Introduce vessel according to vessel registration fees type and emission differentiated according factor to account for to emission factors. marginal Consider charging for infrastructure costs infrastructure use via and emissions of local port and lock fees on pollutants. main waterways, or Move gradually to alternatively (partially) optimal prices. via fuel tax. Gradually reduce promotional measures such as investment grants and subsidies for terminals, inter-modal equipment, and exploitation. Develop system for route or distance based charge via harbour/lock fees or electronic systems. Determine marginal emission cost taking into account locations of residence, work and leisure activities. Determine marginal infrastructure cost taking into account the characteristics of the waterways (geometry, constructions) per segment.

Use of revenues

Market characteristics

Finance infrastructure improvements, implementation of charging system and cost calculations. Adopt similar pricing mechanisms to all transport modes to avoid jeopardising mode competitiveness. Ensure that charges are at least partially passed on to shippers.

This section is based on the background reports: Zografos K. (2002). Institutional and Technological Barriers to Implementation Water Transport, MC-ICAM Task 5.4 part 1. Henstra D. (2002). Institutional and Technological Barriers to Implementation in Inland Waterways a case study of the river Rhine, MC-ICAM Task 5.4 part 2.

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5.

Acceptability Issues in Rail, Air and Water Transport

The objective of this section is to discuss acceptability issues in air, rail and water transport. The analysis is based on information presented in the previous sections. In order to perform this assessment, a methodological framework was developed with the aim of assessing the different stakeholding groups and providing suggestions as to how the identified acceptability barriers should be overcome. Consequently, we first provide a brief description of the methodological framework and then present the results of the acceptability assessment with respect to each mode of transport. 5.1 Methodological Framework The methodological framework, which was used to identify the acceptability barriers to MCP measures, is illustrated in figure 5.1. The framework consists of four steps. The first step involved an extensive literature review, whose objectives were the following: 1) Identification of methods and techniques used for assessing the acceptability of pricing strategies of the stakeholding groups affected by the operation of the transportation mode considered. 2) Identification of different categories of impacts of pricing strategies in relation to the objectives of the various stakeholding groups. 3) Identification of acceptability barriers, i.e. institutional, legal and market barriers that may exist when implementing pricing strategies. 4) Identification of the relative importance of different stakeholding groups in the decision making process. 5) Identification of alternative ways to overcome the acceptability barriers. The second step identified the relevant pricing strategies. Based on the information of the first two steps, the third step identified: i) the factors impacting the acceptability of rail, air and water transport pricing strategies by the stakeholding groups, ii) the degree of acceptability of pricing strategies by the stakeholding groups, and iii) the acceptability barriers to implementation. More specifically, within the third step, two types of analyses were performed: i) compatibility analysis and ii) SWOT analysis. Each pricing strategy exhibits certain strengths, weaknesses, opportunities and threats (SWOT) related to the scope and objectives of each stakeholding group. Comparisons were made between the results of the SWOT analysis and compatibility analysis performed for each alternative pricing strategy and the stakeholding group. The degree of acceptability of a pricing strategy by a stakeholding group is mainly subject to the balance of gains and losses imposed by the strategy (longitudinal equity). Therefore, the SWOT analysis takes into account the role and the relevant strength of each stakeholding group. The acceptability assessment, capitalizing on AFFORD (2000), considers the following dimensions: i) aims of the pricing measure, ii) effectiveness and efficiency, iii) equity and iv) revenue allocation. Finally, the fourth step made specific recommendations with respect to the removal of the identified barriers.
Figure 5.1: Methodological framework for assessing acceptability barriers to pricing strategies for rail, air and water transport 52/52

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Step 1 State-of-the Art & State of-Practice Review on Pricing Strategies Acceptability

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Identification of Pricing Strategies Impacts on StakeholdingGroups Tasks 5.2, 5.3, 5.4 Pricing Strategies for Rail Water & Air Step 2 Qualitative Assessment of Pricing Strategies Acceptability for the different Stakeholding Groups

Identification of Acceptability Assessment Techniques

Identification of Pricing Strategies Acceptability Barriers for different Stakeholding Groups

Step 3

Factors impacting the Acceptability for Rail, Water & Air Pricing Strategies Rough Assessment of the Degree of Acceptability of the Pricing Strategies by the Stakeholding Groups Barriers to Implement the Pricing strategies Step 4

Suggestions to Overcome Identified Barriers

5.2 Acceptability Issues in Rail Transport Two alternative pricing strategies were identified through a series of case studies reviewing experience in railway infrastructure charging reforms in four European countries (Britain, Germany, Hungary and Sweden). Five major stakeholders were identified: i) railway infrastructure managers, ii) train operators, iii) passengers, iv) policy makers and governmental bodies, and v) the business community e.g., freight forwarders and shippers. The institutional reform that is required will be implemented by the policy makers representing the infrastructure owners, who in most EU states are essentially the same stakeholding group. Based on the results of the SWOT and compatibility analyses, the main acceptability barrier for policy makers will be the political cost that such reform involves, as well as the extent of effectiveness, efficiency and applicability that the proposed pricing strategy will have. Past experience in the UK, Germany and Sweden has shown that it is very hard to set the level of both parts of the tariffs, i.e. fixed and variable, so as to reflect the actual operational and external costs respectively. In particular, policy makers should focus on the following two issues while reforming the regulatory framework of rail: (i) the definition of the variable part of the tariff including its level. It is important to ensure that it will be implementable and no further measures (i.e. subsidies) will be required in order for new entrants to be encouraged, (ii) the use of the revenues deriving from the implementation of the proposed pricing strategy. As identified in the literature [AFFORD 2000, TRANSPRICE 1999, Viegas 2001, Nash and Matthews 2002] and the case studies, the use of revenues is very important to all groups of stakeholders; therefore transparency and efficiency should be ensured in the identification and establishment of the process of using the revenues.

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As demonstrated within the case studies, the main objectives of the proposed strategy are to increase the effectiveness and efficiency of the rail transport system, to support the finance and development of infrastructure projects, to provide incentives for new entrants and to enhance services in order to increase the competitiveness of the mode i.e. high speed freight trains. Furthermore, incentives for new entrants to provide services are very important in order to improve competitiveness of the rail mode as compared to road and air transport. Train operators will be the most impacted by the proposed pricing strategy as they pay the charges. However, it is expected that they will gain substantial benefits in terms of operation, and will have the opportunity in collaboration with infrastructure operators and owners to support investment projects that will enhance the capacity of the railway system, whilst increasing the potential for providing new, advanced services. More specifically, the implementation of new infrastructure will enable train operators to provide a new range of services such as express delivery, and to enter new markets beyond the heavy manufacturing industry. However, in order for this to be possible, the proposed reform and implementation should be appropriate. For example, MCP failed in Germany because the tariff neither supported new entrants, especially small operators, nor provided incentives and investment capital for infrastructure and service enhancement. Table 5.2 summarises the acceptability barriers for all groups of stakeholders identified in the analysis.
Table 5.2: Acceptability barriers to marginal cost based pricing strategies for railways Stakeholding Group Infrastructure Operators Barriers to Acceptability Applicability of the pricing strategy. Effectiveness/efficiency of the pricing strategy. Risk of losing part of the market share of a specific truck or railroad terminal. Use of pricing strategy revenues. Political cost. Effectiveness/efficiency of the proposed pricing strategy. Applicability of the proposed pricing strategy. The extent of effectiveness/efficiency of the proposed pricing strategy. Risk of losing part of the market share due to the increase in competition. The level of charges imposed. The use of the revenues deriving from increased charges (e.g. possible redistribution in the form of railway investments/capacity and service expansion). Perception of equity of measures/discriminatory practices against particular user groups (e.g. small operators)

Policy Makers

Train Operators

The following considerations should be taken into account in order to overcome potential barriers: 1. Ensure that appropriate levels of subsidies will be provided to train operators, within the budget constraints of the state. 2. The proposed charges should not be overly complex.

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3. Ensure that the proposed pricing strategy involves no discriminatory practices, e.g. to smaller train operators. 4. The use of the pricing revenues should be transparent and well defined. 5. The increase in the operating cost of train operators should be at an appropriate level within the terms of reference of competition in the transport market. 6. Preserve equity related to the support provided by the state to all modes of transport. 7. Provide appropriate incentives to support the involvement of train operators in infrastructure and service enhancement. This fact may also act as a countermeasure to the high level of subsidies provided to rail as compared to other modes of transport. 5.3 Acceptability Issues in Air Transport The stakeholding groups considered in the analysis include airport operators, airlines, policy makers, passengers and the business community i.e. freight forwarders and shippers. According to the results of the analysis performed, airport operators gain the major share of benefits from the proposed MCP strategy. Although, the extent of the additional revenues is not yet clear, the implementation of the pricing strategy will likely smooth demand over the day increasing the efficiency and effectiveness of airport operations including the efficient use of the available infrastructure and personnel. In addition, these benefits may lead to an increase in airport throughput and therefore revenues. As was identified in the analysis, many of the weaknesses of the present pricing scheme seem to be alleviated by the proposed pricing scheme. However, a visible acceptability barrier lies with congestion pricing, which may lead not only to temporal but also to spatial redistribution of demand within the network of airports (i.e. on a country or European level), which in the case of private or public-private airports can be interpreted as a threat to market share. The proposed pricing strategy is likely to impact airlines negatively as their aim is to maximise profits and under MCP they are likely to pay more. However, the implementation of congestion pricing may reduce delays and their associated costs. Therefore, given that airport charges are not as important to airlines as delay costs (see Adler and Berechman (2001) and Morrison and Winston (1989)), it could be argued that MCP may lead to a reduction in airline operating costs. According to the results of the SWOT and compatibility analyses, the implementation of MCP involves issues related to: i) the operational cost of the airlines, ii) revenues and iii) market patronage. In particular, a small increase in operational costs caused by increased airport charges is not of major importance. However, the introduction of market mechanisms for slot allocation and of congestion pricing may lead to: i) the entry of new airlines in the market, i.e. low cost carriers, ii) changes in the flight schedules, iii) changes in the ticket prices and/or the level of the scheduled services. Any of these may cause lost sales, since those airlines that will fly off peak hours will have to reduce prices and/or increase the level of service in order to remain competitive, while the airlines that operate peak-hours will need to identify an optimum between prices and level of service in order to maintain their sales level. Furthermore, the implementation of the proposed
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pricing strategy eliminates discriminatory practices in slot allocation and provision of services at airports. Finally, congestion prices may lead to spatial changes in service provision as a result of the airlines attempting either to enter new, more profitable markets or to use cheaper, secondary airports. However, if the collected fees are invested in enhancing airport capacity, increasing the level of service and the safety of the air transport system, this may provide a trade-off to some of the increased operating cost. Last, but not least, is the impact of environmental charges and taxes related to noise and air pollution especially for those airlines that still operate older aircraft, which may have to update their fleet. In summary, the changes expected in the airline industry from the implementation of a MCP strategy are the following: Increase in charges at some airports, particularly hub airports Temporal and spatial shift of services Impact on the structure of the airline service network (i.e. changes in the hub and spoke structure) Changes in scheduled frequency Changes in competition between airlines and across modes Need for fleet renewal

However, despite the fact that both benefits and costs are expected for airlines from the implementation of the MCP scheme, substantial resistance is expected from the airline lobby, which is very powerful due to its substantial contribution to the socio-economic activities of the member states. The current airport pricing strategy exhibits several weaknesses for policy makers. In particular, air transport suffers from capacity shortages leading to delays and other related inefficiencies such as energy consumption, noise and air pollution, safety, disruption of the socio-economic activities of passengers and shippers, etc. At the same time, there is a powerful airline lobby that defends the market and sets the rules for competition. Considering the fact that MCP aims to increase the effectiveness and efficiency of airports, the impacts of the proposed pricing strategy are along the lines of the objectives of the policy makers. The main hesitation for policy makers stems from the expected unwillingness of the airline lobby to comply with the pricing measures and the distortion this may create to air transport and the economy in general, as well as the political cost this distortion may cause. For passengers, the acceptability of the proposed MCP scheme depends on the degree of manifestation of the following: Increase in tariffs Disruption of socio-economic activities either due to the reduction of available flights or due to changes in flight schedules offered The use and the transparency in use of the additional revenues

Finally, for shippers the impact of the proposed MCP strategy are of importance since it may jeopardize their ability to provide intended services (i.e. 24h delivery),
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as well as increase the cost of services. As a result, shippers may have to restructure their distribution network in order to provide a certain level of service, which in turn may lead to changes in the inbound and outbound logistics of the business entities they serve. On the other hand, support of new low-cost carriers in the airline industry by the proposed pricing scheme may increase the size of the market available for freight shippers and forwarders and therefore, their negotiation power. Table 5.3 presents the acceptability barriers identified for the different groups of stakeholders.
Table 5.3: Summary of stakeholder groups and barriers to acceptability in air transport Stakeholding Group Airlines Barriers to Acceptability Increased charges The market-based slot allocation process characteristics The use and the transparency in use of additional revenues The level of service and benefit provided to airlines operating off-peak hours The feasibility of the required changes in the provision of services by the airlines The risk of losing market share The risk of losing some market share, particularly if congestion pricing and new slot market mechanisms are not implemented at competing airports The degree of effectiveness and applicability of the proposed pricing strategy The risk of jeopardizing certain shipper services The use and the transparency in use of pricing strategy revenues Increase in fare prices Disruption of socio-economic activities either due to the reduction of available flights or due to changes in the provided flight schedules The use and the transparency in use of pricing strategy revenues Airline industry distortions Economic distortions Political costs

Airport Operators

Business Community Passengers

Policy Makers

Therefore, the reform of the institutional/regulatory framework that is required to introduce and implement MCP at airports should take into account the following issues: Equity, in the sense that only potentially positive discriminatory practices will be implemented affecting: i) smaller airlines to encourage competition, ii) regional airports to ensure essential air services are not dropped, iii) air transport competency with respect to other modes of transport. The importance of a well-defined and transparent process for collecting and using the revenues of the proposed pricing strategy. The introduction of a phased implementation approach to the market allocation of slots in order for all carriers to have time to adjust their operational practices. The provision of incentives to airlines to shift services spatially and temporally.
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5.4 Acceptability Issues in Water Transport


5.4.1 Acceptability Issues in Short Sea Shipping

Two alternative pricing strategies for port charges were identified for SSS. Five major categories of stakeholders were identified in order to explore and assess the degree of acceptability of MC-based pricing strategies, including port operators, shipping lines, policy makers, passengers and the business community. According to the results of the SWOT analysis, the proposed pricing scheme is expected to increase the strengths and opportunities of the port operators. In particular, the following benefits are expected for port operators: 1. Increase in port revenues, 2. Increase in the efficiency and effectiveness of port operations due to peak smoothing of demand for port operations during the day, resulting in a reduction in congestion, 3. Increase in demand that the port will be able to accommodate (port practical capacity), 4. Higher utilization of the available resources including equipment, infrastructure and human resources, 5. Increase of capital available for infrastructure enhancement. The main threat that the SSS system and consequently the ports will possibly face is competition from other modes of transport, specifically air transport or other ports, if congestion pricing is not applied uniformly across all transport sectors. The mechanism for setting, collecting and using the proposed port charges is very important to ensure the effectiveness, efficiency and applicability of the pricing strategy, hence the degree of acceptability of the proposed measures by the port operators. The reform of the port pricing scheme in Greece to a MC-based strategy involves substantial risk for policy makers. This is due to the fact that shipping line operators, the stakeholding group most impacted by the proposed reform, have substantial power due to the importance of SSS, particularly in the Greek economy. The expected resistance of the shipping line operators to implementation will directly lead to resistance from passengers and the business community in general. Therefore, the proposed reform should also ensure the increase in effectiveness and efficiency of the SSS transportation system, since this constitutes the main objective and competitive argument for policy makers both towards shipping lines operators and end users. Furthermore, the implementation of MCP will alleviate environmental and traffic congestion problems due to the smoothing of demand for port operations, which will satisfy the inhabitants of the area . Shipping line operators will probably present the most resistant stakeholding group to the proposed changes, as they will be the most impacted. Shipping line operators will have to pay more for port facility usage, adjust schedules and improve services in order to maintain market share. As peak hour port usage becomes more expensive, the operators will need to consider the following alternatives; i) adapt their schedule to off-peak hours, ii) continue to schedule during
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peak hours and pay more and iii) use an alternative port. In any case, such a redistribution of traffic might raise strong arguments for possible discriminatory practices (e.g., small port users). Moreover, the implementation of any of these alternatives requires information on competition and the institutional framework governing fare setting. Thus, shipping line operators are facing the following risks: Loss of sales due to passenger inertia Loss of sales due to changes in the port of call Increases in operational costs due to an increase in the level of service The degree of acceptability for passengers depends on the level of fare increases, and the degree that the changes imposed on the schedule and level of services of the shipping lines will impact their activities and mobility. However, the current institutional/regulatory framework does not allow an increase in the fare price due to an increase in port charges. Therefore, considering the fact that passengers tend to resist changes in their mobility patterns (i.e. passenger inertia), it is expected that acceptability barriers related to the proposed port pricing scheme are expected, if one of the following occurs: Increase in fare prices Decrease of service level Reduction/cut in lines served Disruption of socio-economic activities due to lack of available service Inefficient and non-transparent use of revenues Finally, for the business community, specifically freight forwarders and shippers, the implementation of the proposed port pricing scheme may create some logistical inefficiencies due to possible temporal and spatial shifts. Furthermore, an increase in the fare due to a reform in the institutional framework governing the fare setting will increase the cost of goods. However, the decrease in delays that will be achieved and consequently the increase in the efficiency of the transportation system may act as trade-off to the negative impacts, at least for a part of the business community, i.e. for goods very sensitive to time or high cost goods. Finally, the provision of information on the use of revenues and the transparency of the process may aid the acceptance of the port pricing scheme. Table 5.4 presents the acceptability barriers identified for the different stakeholding groups.
Table 5.4: Acceptability barriers for port pricing strategy of short sea shipping Stakeholding Group Port Operators Barriers to Acceptability Applicability of the port pricing strategy Effectiveness/efficiency of the port pricing strategy Risk of losing market share Use of port pricing strategy revenues Equity Effectiveness/efficiency of the proposed port pricing strategy Political cost Institutional/regulatory framework governing the identification of the level of fares The ability/flexibility of the shipping line to change the scheduled service 59/59

Policy Makers

Shipping Line Operators

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25/08/2002 The feasibility of the new schedule imposed by compliance with proposed scheme The level of port charges imposed The risk associated with the reduction of the market share of the line The use of revenues derived from the increase in port charges e.g. possible redistribution in the form of port investments and/or capacity expansion Perception of equity of measures/discriminatory practices against particular user groups (e.g., small users) Institutional/regulatory framework governing the fare level specification Decrease of the current level of service Reduction/cut in lines being served Disruption of logistical activities Increase in the transportation cost of goods Non-transparent use of revenues Increase in fare level Decrease of current level of service Risk of disruption to passengers socio-economic activities due to reduction in service

Business Community

Passengers

According to the identified barriers, there are two main institutional issues that should be addressed by the policy makers in order to ensure that the stakeholding groups impacted by the reform in port charges will raise no major acceptability barriers. The first issue concerns the institutional framework that will govern the calculation and implementation of the pricing strategy, as well as the use of the revenues. This framework should ensure the identification of the level of port charges and the implementation in an effective and efficient manner. Considering the conflicting objectives of the stakeholding groups involved, the institutional and regulatory reform needs to be a compromise. Furthermore, special emphasis should be placed on the use of port pricing strategy revenues, as well as on the transparency of the process, as was identified in the literature [AFFORD 2000, TRANSPRICE 1999, Viegas 2001]. The second important issue that has a major impact on the degree of acceptability of the proposed pricing strategy relates to the framework of the fare establishment process. The current framework should be reformed to allow shipping line operators to participate more actively in the decision making process related to establishment of SSS fares. The extent to which this reform will allow shipping line operators to pass on the extra charges to the passengers and shippers is also important both for the acceptability of the pricing strategy by the shipping lines and by the passengers and shippers.
5.4.2 Acceptability Issues in Inland Waterways

Three alternative pricing strategies have been identified for inland waterways, i.e., the baseline pricing strategy and two alternative MCP strategies (i.e. second best pricing strategies) with respect to different implementation horizons. Four categories of stakeholders were considered in the analysis; infrastructure operators, barge operators, policy makers and the business community (i.e. shippers and freight forwarders).

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According to the results of the SWOT analysis, barge operators are the most impacted from the implementation of MCP. Their operating costs will increase, and it is not clear if the costs will be passed on to shippers in their entirety. Therefore, they will resist the implementation of any of the proposed pricing schemes especially considering the threat of lost market share. The degree of acceptability is subject to the following conditions: i) the level of charges, ii) the degree that charges could be passed on to the shippers, iii) the use of revenues, iv) the prices of the competing modes, v) the effectiveness of the proposed measures. In particular, the level of charges is rather important with regard to the competition with the other transportation modes. If the charges increase the pricing of inland shipping substantially, i.e., such as to be comparable with the other competitive modes like train or road, then barge operators will either have to absorb this cost and reduce profits or increase prices and most probably service schedules at the risk of losing part of their market share, and therefore reducing revenues. In addition, according to previous studies [AFFORD 2000, TRANSPRICE 1999, Viegas 2001], the use of revenues is also of substantial importance for the acceptability of the pricing strategy. More specifically, if the revenues are used to enhance the available infrastructure and increase safety, then the level of services that can be provided by the barge operators automatically increases, an impact that helps them to counterbalance the increase in prices. It should also be noted that currently there is over-supply and no congestion problems in this mode of transport, hence some reduction may not necessarily hurt the industry. Policy makers must introduce and implement reform of the institutional and regulatory framework related to the charges of the inland waterway transportation system. It is expected that through the introduction of the institutional reform, funds required in order to: i) enhance the infrastructure, and therefore the level of service provided by inland waterway transport, ii) increase safety and iii) protect the environment, will become available. Furthermore, the introduction of charges in inland waterways will increase equity in the way that the state promotes alternative transport modes, and will increase competition between inland waterways, rail and road transport. However, this manipulation involves the risk of a modal shift (i.e. a shift to road transport), and therefore constitutes a major threat to the proposed pricing strategy. Infrastructure operators will view the proposed reforms positively as the revenues will be used for infrastructure enhancement. Finally, freight forwarders and shippers will be impacted by the implementation of the proposed pricing strategies since their operating costs will directly increase, i.e. the transportation cost. The extent of this impact is subject to the degree that operators will pass on the increased charges. Therefore, based on the results of the compatibility analysis, the impacts of the proposed pricing strategies are in the opposite direction to the major objective of the shippers, i.e. they will lead to increases in transportation costs and probably reductions in profits. However, the increase in safety that will result from the use of the expected revenues is along the lines of the objectives of the shippers. Therefore, an important factor for the acceptability of the measures by the shippers is the use of the revenues from the charges. Table 5.5 summarises the acceptability barriers identified from all stakeholding groups.
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Considering the above it is imperative that policy makers i.e. the Central Commission for Navigation on the Rhine, introduce reforms to the institutional and regulatory framework governing the inland waterway charges. The institutional reform issues become rather important since the proposed charges may lead to: i) an increase of the operating costs of barge operators and possibly shippers, and ii) a reduction in one of their competitive advantages (i.e., low cost) unless of course, such costs are introduced in all transportation modes equally. Therefore, the proposed pricing strategy should take into account the following considerations: 1. Stimulate barge operators to pass on part of the charge to the shippers. This should be well balanced as compared to the charge level internalised by the operators. 2. The competitive advantage, in terms of cost, of inland waterways in relation to the cost of other modes. 3. Use the revenues in a transparent manner.
Table 5.5: Acceptability barriers to marginal cost based pricing strategies for inland waterways Stakeholding Group Infrastructure Operators Barge Operators Barriers to Acceptability Use of revenues derived from charges The risk related to the reduction of the market share of the mode Effectiveness of the proposed scheme Ability to pass part of the charges on to the shippers The level of charges The use of the revenues derived from the charges The risk related to the reduction of the market share of the mode Effectiveness of the proposed scheme Expected effectiveness/applicability of the proposed measures Harmonization between international and national regulatory framework Two judicial systems / regulatory frameworks Political cost Level of charges Increase in the transportation cost of goods Degree of charges passed on to end users Use of revenues generated by the charges

Policy Makers

Business Community

Furthermore, according to the findings of the inland waterway case study, the introduction of an inland waterway pricing strategy should be done at an international level (i.e. by the Central Commission for Navigation on the Rhine (CCR) and EU) as transport is mainly cross border and different operators of different countries (also non EU) are using the inland waterways. Historically the CCR sets the rules governing shipping on the Rhine and its tributaries. The EU has endeavoured to incorporate these rules in the Community legislation applicable to the entire inland waterway network. The coexistence of these two judicial systems, i.e. CCR and EU, poses problems concerning regulation. Nevertheless, the ultimate barrier to the implementation of any pricing strategy is the Mannheim agreement (1868), according to which inland waterways would be subject to technical, safetyoriented regulation only.

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This section is based on the background reports: Zografos K. (2002). Acceptability Barriers of Pricing Strategies for Rail, Air & Water, MC-ICAM Task 5.5. Matthews B., Nash C., Nilsson J-E. and Farkas G. (2002). Institutional and Technological Barriers to Implementation - Rail Transport, MC-ICAM Task 5.2 part 1. Matthews B. and Nash C., (2002). Railway Infrastructure Charging in Britain - the Process of Re-organisation and Reform, MC-ICAM Task 5.2 part 2. Adler N. and Berechman Y. (2002). Marginal Cost Pricing Approach to Setting Airport Charges, MC-ICAM Task 5.3. Nilsson E. (2002). The Case for Using a Market Mechanism for Slot Pricing, MCICAM Task 5.3 Part 2. Zografos K. (2002). Institutional and Technological Barriers to Implementation Water Transport, MC-ICAM Task 5.4 part 1. Henstra D. (2002). Institutional and Technological Barriers to Implementation in Inland Waterways a case study of the river Rhine, MC-ICAM Task 5.4 part 2.

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6.

Concluding Comments

Presented in this report are suggestions as to the implementation of marginal cost based pricing (MCP) in the fields of rail, air and water transport, including short sea shipping and inland waterways. Whilst all these modes of transport are similar in the sense that they work through networks with stations or ports and generally a hub-and-spoke system, it has become clear that they are at various stages of MCP implementation. Rail would appear to be the most advanced in this respect and in Section 2, four case studies are detailed specifying the current pricing schemes in the United Kingdom, Germany and Sweden, with a slightly less advanced scheme to date in Hungary. In this historical analysis, it becomes clear that frequently watereddown versions of MCP schemes have been implemented, due to political, legal, market structure (institutional) and acceptability barriers. It is very important to ensure that each new step improves overall social welfare and is not perceived as moving backwards, otherwise the entire MCP notion in transport may be abandoned, as evidenced in Germany. Hence, clear identification of potential, future steps towards optimal pricing, as attempted in this report, is so important. It would also appear to be true that the issues affecting implementation are reasonably similar in nature across all modes. Lack of data on congestion, noise and air pollution and accident externalities all lead to problems of computation of optimal or second-best optimal MC prices. Therefore, a first or short-run step required by all modes is to remove technological and to some extent political and acceptability barriers. Suggested implementation paths for second-best MCP schemes for rail, air and water transport modes in the short, medium and long term appear in table 6.1. The major drivers behind the pricing policies are the market characteristics required to enable implementation. There are roughly two ways to achieve MCP, the first is to accomplish a competitive equilibrium given constant returns to scale, the second is to rely on state ownership and control or regulation given a natural monopoly. Clearly, these represent two ends of a spectrum with oligopolistic practices, as associated with short sea shipping for example, lying in-between. The competitive equilibrium model is most applicable to freight operators and end users of all three modes of transport, namely rail, air and water. This may also be true for airports that appear to work under constant returns-to-scale (Adler et al. (2002)). Alternatively the airports could be viewed as natural monopolies and therefore be either stateowned or at least regulated. For the case of infrastructure pricing and of short-tomedium distance public transport, the state owned and/or regulated approach would appear to be preferable, in part due to the Mohring effect (Mohring (1972)). Appropriate policy steps for rail transport would be (i) to establish separate track authorities with independent regulators charged with achieving efficient pricing policies, (ii) to franchise in order to permit control of end user fares. For air and water transport, appropriate policy steps would appear to be (i) pure competition for end users and (ii) privatisation of ports and airports with price capping or regulation setting infrastructure charges and imposition of taxes to reflect other externalities. Clearly there are many possibilities for implementation paths, all with the ultimate
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aim of harmonizing charging policies to account for externalities on an equal basis across modes.
Table 6.1: Short, medium and long term MCP policies for rail, air and water
Current State Rail Generally consists of a MCbased, two part (or multipart) tariff with fixed element based on unavoidable costs and an allocation of joint costs and a variable element based on wear and tear and electric traction costs. In some cases, schemes include penalty payments/bonuses based on performance criteria, accident charges, congestion charges and information charges Agree amongst EU countries on removal of organisational constraints. No changes currently to allow other modes to reach MCP schemes already in place for rail transport. Introduce MC of wear and tear. Introduce environmental costs. Airports Airport pricing includes landing fees according to maximum take-off weight of aircraft, transfer and nontransfer passenger departing fees, air traffic control tariffs, parking fees, freight loading/unloading charges, security and control charges for passengers and freight and at certain airports, night charges, noise fees and peak fees. Separate concessions and gate fees are collected for landside operations. Harmonise state legislation according to EU legislation, define delay legally and setup EU-wide database for all airports. Initiate use of peak-off peak, congestion and noise pricing mechanisms at large, hub airports Initiate use of peak-off peak, congestion and noise pricing mechanism at all airports, in a neutral manner. Introduce fuel taxes to account for NOx and CO2 emissions, on at least an E.U. wide basis. Encourage discussion on a worldwide basis to prevent airlines from refuelling at tax-free refuges. Short Sea Shipping Port fee based on vessel type and destination, location of operations in the port, total processing time at port and season. Inland Waterways Harbour and lock dues.

Short Term

Medium Term

Introduce route or distance based charge with differentiation according to vessel type and emission factor to account for marginal infrastructure costs and emissions of local pollutants. Introduce peak, congestion port pricing at major, hub ports (sub-optimal fee to ensure acceptability). Inform stakeholders on the rationale and benefits of moving from the ability-to-pay to the congestionbased pricing.

Long Term

Full MCP including congestion, scarcity and environmental costs. Introduce accident charges,.

Use MCP mechanism without constraints. Introduce scarcity charges through market-based slot allocation mechanism. Introduce accident charges.

Introduce peak, congestion port pricing at all ports, moving towards firstbest MC-based schemes, including environmental, scarcity and accident charges.

Modify Mannheim convention. Implement engine emission standards. Start reducing promotional measures such as investment grants and subsidies. Introduce fuel tax to internalise climate change effects and part of air pollution costs. Introduce vessel registration fees differentiated according to emission factors. Remove all promotional measures such as investment grants and subsidies. Introduce route or distance based charge with differentiation according to vessel type and emission factor. Introduce insurance system to account for accidents (expanded liability).

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