An economic pricing framework for land freight transport infrastructure

The Issue

The Transport and Infrastructure Council’s (the Council) Heavy Vehicle Road Reform initiative’s objective is to create a market mechanism that links heavy vehicle user needs with the level of services they receive, the charges they pay and the investment of those charges back into heavy vehicle road services.

Road and rail freight services are directly substitutable in the inter-city general and container freight market. For certain types of freight, road and rail are in direct competition. However, they are also subject to very different pricing frameworks and regulatory regimes.

Whereas rail access charges are determined on a transparent and cost-reflective basis under regulatory frameworks, the road pricing regime for heavy vehicles does not provide a clear and direct relationship with the costs of servicing heavy vehicles. As a result, the regime does not provide effective price signals necessary to promote the efficient allocation of resources and incentivise improvements in productivity. It also does not provide effective competition between road and rail resulting in economic efficiency benefits that are typically associated with effective competition, not being produced.

A key issue with the current road pricing regime is whether heavy vehicles operating on the key freight routes are bearing a less than proportionate share of the costs they impose on the road network (including where there are capacity constraints), resulting in cross subsidies between different road user classes and across transport modes (i.e. road and rail).

Maximising efficiency benefits from road freight charging and investment requires the design and implementation of a pricing framework that encourages more efficient decisions as to what mode of transport (road or rail) is used by heavy transport haulage suppliers and end customers, as well as when and where to further invest in the transport network infrastructure.

Methodology

Our advice on a pricing framework for land freight transport was based on a range of analyses, including:

• Defining the relevant market scope;
• Economic analysis of the existing PAYGO model;
• Identifying the key principles and objectives to be taken into account in a pricing framework;
• High level assessment of suitable economic pricing models and key challenges;
• Assessment of the feasibility of applying a uniform pricing framework across different transport modes;
• Assessment of key implementation issues; and
• Identification of the best approach to delivering the framework.

The Solution & Benefits

The solution is to apply a coordinated approach to pricing road and rail freight services, based on consistent pricing objectives and principles that align with principles applied in other regulated infrastructure sectors in Australia.

This would maximise efficiency benefits for the community and achieve competitive neutrality between transport modes. Competitive neutrality is important because it is only through the promotion of effective competition that optimal outcomes are achieved for consumers and incentives are created for improving productivity and innovation.

There are two main long term pricing frameworks that can be applied to pricing heavy vehicle access to road network infrastructure that would meet the Council’s objectives: Long Run Marginal Cost (LRMC) and the Building Blocks approach. The two are not necessarily mutually exclusive.

While LRMC is often seen as the theoretical benchmark or ‘ideal’, it is very difficult to correctly implement in its ‘pure’ form. As a result, the Building Blocks approach is the most common approach applied to infrastructure industries in Australia, where it is based on a ‘forward looking’ assessment of efficient costs.

This approach includes explicit recognition of sunk costs, which has been an inherent feature of all building block methodologies implemented to date. The key reason for this is that appropriate recognition of these costs is considered essential in preserving investment incentives for infrastructure providers through ensuring an appropriate return on (and of) capital invested.

For public sector infrastructure investments, this will help ensure a rigorous approach to investment expenditure and an appropriate return on taxpayers’ funds, which is essential given the ongoing pressure on Government budgets.

In terms of implementation, putting the appropriate institutional arrangements in place will be vital. These arrangements should ensure that there is a competitively neutral approach to the application of the pricing objectives and principles, which should be administrated under a single regulator or an effectively coordinated set of economic regulatory arrangements.

Key steps to developing and delivering a pricing framework include:

• Agreement of the pricing objectives and principles for both heavy vehicles using key freight routes and intermodal rail freight using the interstate network;
• Establishing a process, involving consultation with freight transport industry representatives, to consider in detail appropriate pricing options consistent with agreed objectives and principles;
• Establishing a process, involving consultation, to develop a pricing framework to best achieve these objectives and principles for both road and rail freight competing on their respective routes and networks; and
• Determining the appropriate land freight access pricing infrastructure arrangements, with the agreed economic regulator having appropriate oversight responsibilities. This should be determined at an early stage to ensure development of the detailed pricing framework is consistent with the agreed pricing objectives and principles.

In conclusion, the application of a single, consistent pricing framework for land transport infrastructure would optimise the achievement of the Council’s objectives; reduce the scope for differences in the regulatory treatment between road and rail (other than where necessary due to differences between each mode); and assist in minimising competitive distortions.