Kpmg KPMG Corporate Finance Financing Regional Passenger Rail in Poland: Lessons from the UK Irene Walsh 31 March 2004

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KPMG Corporate Finance

Financing Regional Passenger Rail in Poland: Lessons from the UKIrene Walsh31 March 2004

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The economic dynamics of Polish rail

Poland’s transition to a market economy has led to:

Decline in passenger traffic

Collapse of the coal industry, the largest freight customer

Increase in PKP’s labor costs

In the last year before reform, financial losses exceeded USD 1 million per day


The Reform Program

The Law on Commercialisation, Restructuring and Privatization of Polish State Railways enacted September 2000

Commercialization = transformation into the joint stock company PKP SA (December 2000)

Restructuring = breakdown of PKP SA into subsidiaries

Privatization = Selected subsidiaries commencing with LHS, SKM, WKD and PKP Cargo. PLK SA to remain in state ownership

Subsidiaries

PLK SA (infrastructure and access)

PKP Cargo (freight operator)

LHS (iron ore freight operator)

SKM (Tri-cities metropolitan passenger network)

WKD (Warsaw metropolitan passenger network)

New inter-city express passenger operating company

New slow-speed inter-urban passenger operating company

New regional passenger operating companies contracted to the Voivodships


Conforming to EU Policy on Railways

Key principals:

Accounting (and institutional?) separation of infrastructure from operating functions

Independent regulator at national level

Access to infrastructure by railway enterprises of other member states on non-discriminatory terms

Cross subsidies from profitable services (freight and intercity passenger) to unprofitable services banned

Operating subsidies banned except for local passenger operations and infrastructure


The challenge for PKP

Redefining the State’s role from a direct provider of services to a strategic planner and regulator

Initiating competition

Facilitating decentralization to sub-national governments


Regional Passenger Operating Companies

The reform program

The State subsidy approach



Key elements of the reform program:

Debt funded labor restructuring to lower cost base

Decentralize operating subsidy regime by channelling payments through Voivodships

Privatize where possible, with SKM and WKD serving as test cases



Detail on State subsidy:

Voivodships to receive dedicated funds from State budget; aggregate amount determined annually

Individual Voivodship allocation determined by formula based on population, kilometres of active railway line, level of structural unemployment

Subsidy distributed by Voivodships to regional passenger operating companies as an offset to losses from unprofitable services


The UK experience

Overview of privatization program

Relevance to Poland’s Regional Passenger Operating Companies

Lessons learned


The UK experienceOverview of privatization program

Objectives: Access to private investment and an ongoing investment

program

A higher quality of service and better value for money for the public

Introduction of competition in the operating of services

Harnessing private sector management skills and entrepreneurial spirit



Steps in the process: Reorganization into infrastructure and operations

Sale of subsidiary businesses

Establishment of an independent regulator and a State body to act as strategic planner

For passenger rail: design of a franchise map, a track access regime, and a subsidy mechanism

Sale of the infrastructure company through IPO

Letting of operating franchises to private operators through a competition based on minimum subsidy requirement



Post - privatization industry structure

Network Rail Licence Regulation

Department for Transport

Network Rail

Freight Operating Companies

Strategic Rail Authority

Passenger Transport Executive

Rolling Stock Companies

Train Operating Companies

Funds

Franchise Payments

Sponsor/Liaison

Lease PaymentsTrack Access

Charges

OperatingLicence

Monitoring Performance/ConsultationFares

GrantsFreight Revenues

Direction &

Guidance

Funds

Private Finance

Rail Users Consultative Committee

Office of the Rail Regulator


The UK experienceRelevance to Poland

Like Poland, UK privatization required a complex model: market share of rail is small, and high level of service provision is for social purposes

Like Poland, UK privatization program had a strong decentralizing element

Many of the UK passenger franchises have characteristics of Poland’s regional passenger operating companies

size

commuter usage

profitability

Like Poland, UK Government subsidy is still necessary to maintain service on many franchises


The UK experienceLessons learned

Public subsidy

Infrastructure investment and track access charging

Franchise structure

Performance regime


The UK experienceLessons learned : public subsidy

Transparent vs. “Opaque” : A transparent subsidy regime is preferable. Tends to promote rational

policy making that balances fiscal alternatives such as investment in rural vs. urban services or investment in road vs. rail. The UK passenger rail subsidy remains opaque.

Open-ended vs. fixed: A fixed subsidy approach is a means of cost control and state fiscal

“protection”. Moving to a fixed appropriation for uneconomic services will eliminate reliance on emergency measures which have had broader fiscal consequences. In the UK, Government is still the ultimate guarantor for the system overall.


The UK experienceLessons learned : infrastructure investment and track access charging

Asset valuation: A robust asset valuation is the key to adequate track access charging.

In the UK, the initial infrastructure valuation did not result in a sufficient income stream for the infrastructure company to maintain the network appropriately.

Pre-privatization upgrading: Asset upgrading can improve the chances of attracting private interest

in an operating franchise.

Ongoing renewals and future improvements: An approach to financing future infrastructure investment must be

carefully considered before operating franchises are tendered. In the UK, state subsidy for infrastructure continues to be necessary and is now funded through a sovereign-backed credit structure.

The prime users’ willingness to pay is the ultimate constraint


The UK experienceLessons learned : franchise structure

Optimal length for private franchises:

Some of the original UK franchises now believed too short to have been economically viable. Cost containment could not be achieved in the time frame and franchisees required additional public subsidy for survival.

Transfer of risk to private operators:

Exposing private franchisees to passenger fare revenue risk is easier in a dynamic Government subsidy system than in the fixed subsidy regime planned in Poland.


The UK experienceLessons learned : performance regime

Regime should be no more complex than necessary for purposes of:

Incentivization

Accountability


The UK experienceLessons learned summary

Positives:

Market innovation and growth

Private investment

Invigorated financial and engineering markets

Preparatory spin-offs of non-core businesses

Overall:

Key parts of the process were hurried

It is difficult to create a “free market” in a natural monopoly

Negatives: TOCs not capitalised to bear

revenue risk

Too many interfaces and constraints, undermining efficiency

Insufficient understanding of costs and asset conditions (infrastructure)

100% privatised network operator

Insufficient recognition that the rail network is dynamic and there is an ongoing state role

Insufficient working practice reform


Questions for Poland

Has labor restructuring been successful in generating the required cost savings?

Is the anticipated State subsidy level sufficient to preserve current passenger services?

Can EU structural funds contribute to the necessary infrastructure upgrade?

Do the Voivodships have sufficient administrative capacity to manage the subsidy program?

Will the private sector come?


ISPA funding

TENS corridor projects

Modernisation of the Berlin-Warsaw-Moscow corridor (E-20) – Minsk Mazowiecki to Teraspol

– Rzepin to the German border

– Poznan rail interchange yard

Wroclaw to the German border (E-30)

Warsaw to Dzialdowo (E-65)

Documents

Kpmg KPMG Corporate Finance Financing Regional Passenger Rail in Poland: Lessons from the UK Irene Walsh 31 March 2004