RAILFREIGHT is at the heart of European Union (EU) transport policy and competition, and the liberalisation of railfreight markets is seen as key to the EU's 2011 policy goal of transferring 30% of road freight over 300km from road to rail and barge by 2030, and 50% by 2050. The theory goes that unleashing intramodal competition fuels modal shift and promotes the efficiency and innovation the sector will need to win business back from road hauliers.

In many ways the market is still evolving as EU directives are gradually implemented at a national level and this process is at different stages of development in different member states. Likewise, regulation of the industry has evolved at varying speeds and some states have only recently established independent regulators. Implementation of the third and fourth railway packages means the role of regulators will continue to develop.

In December the Centre on Regulation in Europe (CERRE) published a report entitled Development of Rail Freight in Europe: What Regulation Can and Cannot Do, which is authored by Professor Yves Crozet of the Lyon University Institute of Policy Studies with contributions from other leading experts on the topic.

The report notes that railfreight liberalisation is evolving in very different ways to the opening of the road freight market 30 years ago, which led to the emergence of hundreds of small businesses operating just one or two vehicles. In this case, competition between small and large operators is a powerful factor in competition. By contrast, the railfreight market in many countries is concentrated relative to road with few active operators, one of which is likely to be a powerful incumbent.

Competition therefore has a cost for new entrants which fail to make a profit on their investments, and often leads to restructuring after a few years of operation. Lack of interoperability means there are many sunk costs and equipment cannot easily be transferred from one country to another. With high barriers to entry, the report suggests competition is only legitimate if it leads to an overall improvement in the efficiency of individual companies and the sector as a whole. This fuels competition with other modes, leading to collective gains for rail.

NA-Feb"Competition - more specifically imperfect competition - can only be applied to network industries if the natural monopoly can be abolished or contained, so as to remove certain barriers to entry," the report says. The breakdown of natural monopolies and the emergence of new entrants makes rail "capable of changing the cost and content of its offer," from the introduction of new technologies to operations and, most crucially of all, in the quality of service provided to shippers. But the report stresses that the latter will only be possible with a level playing field, which opens the door to new production processes better able to meet market demand.

Operational issues are highlighted as a barrier to growth in many countries, not least the level of access charges and the availability of quality paths. The report questions whether infrastructure charges are always an accurate reflection of costs incurred by the infrastructure manager. Under EU legislation access charges should be based on direct costs with mark-ups permitted when required for financial reasons. In practice, this means the level of charges essentially depends on how much the state is willing to cover the fixed costs of a rail network, as opposed to passing on costs to train operators through mark-ups.

However, the report notes that access charges are far from the only problem facing the industry and, indeed, the sensitivity of the market to infrastructure costs varies between countries. Indeed, it suggests that reducing charges might lead to little, if any, improvement in the competitiveness of railfreight: "Lowering access charges does not always lead to significant improvements if the railway companies have not been able to make profound changes to their internal organisation and to the services they offer to shippers."

Major operators play a key role at an international level and indeed, many "new entrants" at a local level are in fact established players in other countries. "This raises questions about how the sector is to be regulated," says the report. "Although liberalisation has allowed competition to develop, regulation must take into account companies' strategic behaviour and how it affects the overall efficiency of the sector."

Rail regulation is a relatively recent phenomenon in Europe and with further directives on their way this process is set to continue. The report argues that the implementation of the Fourth Railway Package will make the role of regulators more crucial but also more complex. It becomes more crucial because the existence of holding companies, where infrastructure manager (IM) and train operator exist under a shared parent company (as in Germany, Austria, and Italy) means a privileged relationship can continue to exist between the IM, the holding company and other subsidiaries. It will be more complex because more frequent and more detailed investigations may be required to reduce the risk of discrimination.

While price discrimination may be easy to identify, the report highlights two key areas where regulators may be tested. The first is the allocation of train paths. The Fourth Railway Package calls for "Chinese Walls" to prevent incumbent freight operators from obtaining information from the IM on train path requests submitted by rival operators, but this will require vigilance and regular checks by the regulator.

The second issue concerns financial transfers between the IM and the rest of the holding. For example, in Germany railway reform resulted in the federal government taking on long-term debts from German Rail (DB), which means IM DB Networks has little debt. DB Networks has also made significant productivity gains and makes "modest profits" on track access charges, which the report argues contributes to better operating results for DB. "This type of flow should be monitored closely to ensure incumbent operators do not gain any undue benefit in terms of cost and capital financing compared with its competitors," the report says.

Regulators will therefore need to consider national contexts, which are likely to remain very different, alongside broader strategic issues that will influence the long-term sustainability of the industry.

The relative fragility of railfreight economics means increases in access charges or energy costs can have a profound impact, and regulators will need to consider these factors when setting infrastructure fees. Public authorities will also need to find ways to ensure railfreight is not penalised for lack of investment in infrastructure or by giving "too much" priority to passenger traffic.

The strategies followed by operators will also be crucial to the development of the market, but the report warns that regulation will need to evolve if the consolidation predicted by many in the industry becomes a reality.

"If we are moving towards an oligopolistic structure, and this situation is considered favourable to the efficiency of the sector, a specific kind of regulation will have to emerge, closely following mergers and acquisitions, market shares, and the necessary survival of smaller operators, as they are important drivers of innovation," the report says.

The report concludes that the power of regulators needs to be strengthened in many countries to ensure that access to essential facilities such as terminals, train path allocation, and competition between operators takes

place on an equitable basis, which is currently far from the reality in many European countries. EU directives already provide the necessary legal basis for this, but the report stresses that regulators will need to work together as they will be confronted by the market power of major companies operating internationally.

The report can be downloaded in full at www.cerre.eu