Kyiv School of Economics invited to the Ukrainian capital of one of the world's leading specialists in the field of railway reform. During his visit, Russell Pittman participated in the competition for the best economic research as an expert, as well as a panel discussion on transformation of  State Railway Administration (Ukrzaliznytsia). Despite his tight schedule, he also devoted some time to correspondent of CFTS portal and told him about his vision for the railway reform in our country.

What model of railway reform do you consider to be the best for Ukraine?

My personal belief is that for a medium to large size country like Ukraine, for a system that is rather freight than passenger like Ukraine, the North American or Latin American model with multiple vertically integrated companies competing with each other is probably the best solution. It's the one I've suggested for Russia also and it will probably work well in Ukraine, better than the others. The models that had been more often tried in Europe were complete vertical separation or third party access model. The first of them did not get a big success…

Why?

For one thing, because there are costs of separation. It is what economists call vertical economies. There are some cost savings when the same company operates the tracks and the trains. You maintain the tracks better, you maintain the wheels better. According to the economic estimates sometimes costs go up as high as 20%, at least 10% if you separate tracks from trains. That is a big penalty to pay right off and you hope you will gain a lot from competition, efficiency etc. But so far the literature does not seem to suggest and the estimates do not seem to suggest that you gain very much from vertical separation.

Third party access they are having many success. Let us take countries like Poland and Romania for example. A lot of shippers are much happier now that they can either run their own trains or find a competing train company. But as far as I know it still has not been tried in countries as big as Ukraine. I am a big fan of this model that works so well in Mexico. It's worked for more than 100 years in the US and Canada: vertically integrated companies that compete with each other sometimes over parallel routes, sometimes to and from common points.

Is it difficult to coordinate the work of rolling stock of multiple competing carriers in this case?

I do not think the country the size of Ukraine will create so many competing companies. Even the country the size of Russia can mould three of four different carriers. But in the US for example different companies use each other's rolling stock all the time. There is a pool of rolling stock as well as a complicated system that calculates how much I owe you or you owe me for using those cars. And somehow it seems to work.  So I don't think that will make a big problem.

In Mexico there was a terrible state owned railway. They looked at vertical separation and third party access and decided that it was too complicated, probably too hard to regulate. They decided to use North American model. And they created three vertically integrated railways which all served Mexico City. The three railways plus the city itself jointly own all the tracks around the capital of the country. Any of the carriers can serve anyone in Mexico City. Then they go three different directions. But because the Mexican economy is so well centered on Mexico City these companies are competing to carry the freight to or from Mexico City. And any of them can transport them to the water for export very quickly and two of them go directly to the United States. It's worked very well and in addition to the fact that it created competition it also raised huge amount of money for the government.

But the model did not mean the full privatization of the railways. Each of the companies has got at least 30-year franchise. It gives it the rights to own the infrastructure and control it for 30 years. The government-run auctions for the franchise rights, the consortia of private companies bid over 100 000 dollars per track kilometer. and these auction proceeds went directly into the government treasury. And then the companies invested their own money in the track. And then, as in Mexico, the winning consortia will use their own money to upgrade the infrastructure.

Financially it's been a big success for the Mexican authorities. So I think Ukrainian government would be quite delighted to get these franchise fees from private companies. And then they can use the money to upgrade the infrastructure.

Unfortunately we often have such a problem as inefficient investor…

I think this will be politically challenging. And in my opinion Ukraine will need foreign strategic investment to be part of the bidders. In Mexico for example two of three operators had US Railways as a partner. And I would bet that Deutsche Bahn for example would love to be a joint venture partner bidding for a section of Ukrainian railways. If you have Deutsche Bahn as a partner in the West and another strategic partner in the East of Ukraine for example Warren Buffet it might work. The Mexican government insisted on majority domestic ownership in three consortia.

Do you support Ukrzaliznytsia's decision to postpone complete separation of passenger and freight services thus preserving cross-subsidization?

This is a problem in many countries around the world. When you look at Russia, China, India you see the same problem. All of them want to make railway service available to the poor. And if you want such people to have transportation one solution is to subsidize the tickets. Another solution is much cheaper offer: to have buses instead of trains. If you want to subsidize passengers,  get more efficient freight and have a competition in freight you must figure out the way to move the subsidies away from cargo. It's the standard good government prescription: if the government wants poor people to be able to ride trains the government should support that. It not only seems a kind of unfair, it's also kind of inefficient. The railways try to compete for their business. But they can not compete effectively if they have to use their profits to subsidize passengers instead of investing in the rolling stock or tracks.

And I would bet that Deutsche Bahn for example would love to be a joint venture partner bidding for a section of Ukrainian railways. If you have Deutsche Bahn as a partner in the West and another strategic partner in the East of Ukraine for example Warren Buffet it might work.

In Russia the central government is doing some of the subsidization but it forces most of the regional governments to subsidize because they are the ones who need this train service. And the national government says: "If you want this service find the way to pay for it". I think that's probably the future way for Ukraine. I understand the regional governments do not have money either. But there aren't any free goods or services in the world. If you want something to happen you have to find the money to pay for it. And in the long run it's not a good policy to continue cross-subsidization.

Do you see any ways to make passenger service more efficient itself and able to earn some money?

There are certainly ways to make passenger rail more efficient. And one of them is to make the tough choices and cancel the routes where there are only three people on the train. And that is a hard political decision. In the US we still have some passenger routes that are heavily subsidized. And we haven't  made tough political decisions either. One of the ways to address this problem without just saying: "Let's raise taxes and find tax money", is to figure out the ways to do that. And that may be in closing out some tracks that aren't used much, in canceling some trains that aren't used much, running shorter trains…

Another thing that is interesting in development passenger rail is that in many countries the first and the second class passengers are actually ready to pay full cost for really good service. And you may be able to get some extra profits from the first and second class passengers if you provide them good service. Such trains usually take passengers away from planes.

But in Ukraine they are not fast enough to compete with aircraft. So Ukrzaliznytsia has to build very expensive high speed tracks. Do you see any prospects of such project in our country?

That may not be Ukraine's future in time soon. Because it is really too expensive to build those tracks. That may not be a realistic prospect for your country.

Ukraine is currently losing transit cargoes due to the political situation and economic crisis. Do you see any opportunities to get them back or find any alternative goods to be delivered through the territory of our country?

I think there are some possibilities. Ukraine is a part of three different trans-European corridors. The hope is that with EU investment and with transit traffic from EU there will be more cargoes going both ways. I think all countries in the world are trying to improve their customs procedures, inspections etc. Especially on the railways trying to get the traffic from South Korea,  China and Japan from long water route which is cheap but slow. Many manufacturers are ready to pay more if the delivery goes faster. I think there is a chance and I know the people willing to improve the ways of delivery and get the traffic off the water.

What else can you recommend to Ukrzaliznytsia in order to improve its work?

From what I gather I see some bottlenecks in the Ukrainian system itself. And the railway cannot handle more traffic than shippers want to send because of the tracks and other reasons. It seems to me that one of the top priorities for the Ukrainian authorities is to figure out how to get more investment money into the system. Creation of joint stock company will open the doors to the European bank loans but the point I'm trying to make is that you will be more successful in raising money if you create that Mexican system with the companies having full control over their parts of the track.

And who owns the locomotives in Mexico?

The same company that owns the tracks runs the locomotives and controls the rolling stock. The advantage is that you do not break up between the trains and the tracks.

Some experts propose to abolish the division of Ukrzaliznytsia into six autonomous railways Currently, each of them has their own locomotives and operates it for its own commercial purposes. As a rule, none of these entities allows locomotives to get out of their territories. Therefore, if the current rules are preserved, the dual-powered locomotives that the State Railway Administration has spoken so much about will not be needed in Ukraine. And they could cross the territory of Ukraine without changing each other and save some time for shippers.

I think that is a perfectly reasonable logical first step. And I would say for the second step you could look into whether you could create two railways out of that that would compete with each other. For example you could have Western and Eastern railway that meet in Kiev and Odessa or they could meet in the Donbass . And they would compete for the traffic at those two points but they would each have their own exclusive territory in the East and the West.

Ukrainian railways have the same tracks both for freight and passenger trains. If separate companies control those tracks they will demand some money for the access to the rail from passenger operators. And that will make tickets more expensive.

In a system like Ukraine and like US where it is mostly a freight system it makes sense to allow passenger trains on the system at a fairly low access charge. In the US we used to have a system where freight operators were required to have passenger services as well. And they were losing so much money that railways were going bankrupt. They reorganized that, they created the company called Amtrak which is more or less a monopoly passenger service operator. And the freight railways are required to allow passenger trains on their tracks at basically low cost.

Ukrainian government had an idea to separate the directions and make some routes only for the freight trains and some for the passenger services. Do you support such an idea?

Passenger and cargo trains tend to operate at different speeds. Passenger trains are usually faster.  That's not the case if you have container trains. They usually go fast too. So if you try that separation then you should have passenger and container trains on the same track. And then you have cargo trains that go slow on a separate track. That seems to work very well when you can do it. But unfortunately there are times when you do not have two tracks. What for example Russian railways are planning to do in the nearby future. They are in the process of substantially upgrading the Baikal – Amur line. When they finish doing that they will essentially have two separate railways: Baikal – Amur and Trans-Siberian. And they are planning to run passenger and container trains on the Trans-Siberian and heavy freight on the Baikal – Amur. If it works that can be example for the rest of the world.

But I would argue that if the BAM and the Trans-Siberian can divide up freight like that, they could also compete with each other - as separate, vertically integrated railways, Mexican-style, competing over their long parallel routes from the Russian Far East to the Urals and into European Russia. Then they would look at lot like the Canadian National Railway and the Canadian Pacific Railway - or the Burlington Northern Railway and the Union Pacific Railway - vertically integrated railways, controlling their own infrastructure, making profits and competing to serve customers over parallel routes and at common points.