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It's a rail battle out there as competition heats up

Competition authorities in the UK seem to be keen on allowing multiple train companies to operate within the same region, which could be good for passengers but a complication for investors
May 17, 2016

The decision by a government quango to allow a train company to use track within another's franchise parameters might not seem controversial.

But the move by the Office of Rail and Road (ORR), an independent body whose board is appointed by government and which is funded by the rail industry, could spark changes in how train companies bid for franchises and impact the protection they perceive they have within franchise agreements.

The ORR has granted an application by FirstGroup (FGP) to run services on track within a franchise currently run by Virgin Trains East Coast (VTEC), in which Stagecoach (SGC) has a 90 per cent shareholding. This application has been granted under so-called 'open access' rules which have allowed FirstGroup to use the track as well.

The rules are not new, but they are only used on 1 per cent of UK passenger miles, according to the Competition and Markets Authority (CMA). There was a suggestion this could change back in March when the CMA reported on competition in passenger rail services, suggesting further open-access agreements as one possible route to improvement.

This latest agreement means FirstGroup will be able to run five trains a day each way from London King's Cross to Edinburgh via Stevenage, Newcastle and Morpeth from 2021 for a decade. Stagecoach said it did not believe these services should have been granted within a franchised system and questioned whether "without a level playing field [it] is in the best interests of passengers, taxpayers and communities".

It is expected that Stagecoach will lose roughly £24m a year in revenues as a result of this ruling once FirstGroup's trains are up and running. This amount is hardly a hammerblow to the £1bn it expects the franchise to be registering in turnover by 2021, but it is not an insignificant sum.

Gerald Khoo, transport analyst at Liberum, said the two things that make open-access work are "extraordinarily artificial" - these being the fact the open-access operator does not pay the same track access fee as the franchisee, meaning their costs are lower, and the incoming operator is automatically paid a percentage of ticket sales based on the capacity they are due to take. So if FirstGroup, for instance, was running one train on a track with capacity for five trains, it would instantly get a fifth of the revenues, which are collected by the franchisee, regardless of whether it actually carries any passengers.

While the decision could open up competition, some argue - usually the 'victims' - that it could be bad for us as taxpayers as it reduces the likelihood of an incumbent operator hitting the revenue threshold which sees them pay additional money to the government.

It also potentially makes the decision about which company to invest in more tricky. Arguably the transport company with the most rail franchises might look the most attractive due to its scale, but now it could be seen as the biggest target for open-access operators to come in and spoil the party.

Mr Khoo said he would "doubt" whether these would become commonplace given the fact that if revenue is taken away from franchisees this impacts the Department for Transport (DfT).

But Alliance Rail, an open-access operator that already runs services from London to Bradford as well as to Sunderland, said the reason it did not pay one of the charges levied on franchise operators was because it was restricted on where it could operate.

Chris Brandon, head of systems at Alliance Rail (part of Arriva UK Trains), said the DfT and franchisees would always argue that open-access impacts taxpayers, but "there is no evidence to back this suggestion up".

He added that open-access agreements made the railway more competitive and so brought more passengers to the geographic area they were operating in. This, he suggests, is likely to push premiums up for those who bid for franchises, which insulates the taxpayer, and more passengers are good for operators. But Shore Capital analyst Martin Brown questioned why operators would bid for franchises if they were unsure about the prospects of open access.