1. 1-May-15 1 Network Unbundling and the Cost of Misaligned Coordination: Lessons from Electricity and Railways paper to appear soon on: http://b-e-r.user.jacobs-university.de/index.php/publications Gert Brunekreeft Jacobs University Bremen g.brunekreeft@jacobs-university.de November 22, 2013 CRNI annual conference, Brussels http://www.germany.info/V ertretung/usa

2. Unbundling and Electricity GB 1-May-15 2 EU: First directive 1996/92/EC ► Unbundling: accounting separation  Non discriminatory network access  Prevention of cross-subsidies  Transparency EU: Second directive 2003/54/EC: ► Legal, functional and managerial unbundling  Legal unbundling  Managerial unbundling  Personnel split  Independent decision rights for network maintenance.  Firewalls EU: Third Directive 2009/72/EG ► Option out of three: 1.Ownership unbundling 2.Deep-ISO 3.Independent Transmission Operator (ITO) (“third way”)

3. Unbundling and Railways  Background: –4 th Railway Package 2013 EU-Commission, 2013, “The fourth railway package – completing the single European railway area to foster European competiveness and growth”, 31.01.2013, Brussels. –Impact Assessment 2013 EU-Commission, 2013, Impact Assessment, Brussels, 30.1.2013 SWD(2013) 12 final  Subgoal: “optimizing the governance of infrastructure management” –Two “challenges”: “Equal access challenge” “Efficient management challenge”: –Ensure better coordination/alignment between the infrastructure managers and rail operators ► Balancing between competition and coordination! GB 1-May-15 3

4. UK railways – McNulty-report  McNulty report 2011 for the UK-government on the UK railway system –UK railway system is a separation (unbundled) model  Two main conclusions: ► the UK railway system is significantly less efficient than comparable peers 40% inefficient! ► the main cause of the inefficiency is far-reaching fragmentation of the system leading to misaligned incentives GB 1-May-15 4

5. McNulty-report (cont’d)  “Barriers to efficiency” in more detail: –Fragmentation of structure and interfaces –Ineffective and misaligned incentives –Fares structures do not send efficient pricing signals –The industry’s legal and contractual framework is complex  One of the main recommendations: “Closer alignment of route-level infrastructure management with Train Operating Companies (TOCs), at one or other of the following levels: –minimum – cost and revenue sharing, and joint targets; or –intermediate – joint ventures or alliances; or –maximum – full vertical integration through a concession of infrastructure management and train operations combined.” GB 1-May-15 5

6. Cost of coordination: 3 sources 1.regulation versus unbundling dilemma –The combination of strict regulation and strict unbundling can quickly lead to inefficient outcomes; see next slide 2.difficulties with optimal network charging –Distributional effects –Legal constraints –Informational constraints –Unbundling itself: does the network charge reach the end-user? 3.strategic behavior resulting in misaligned incentives –Asymmetric information and incentive compatibility are real challenges –Classical: sunk investment and long life duration, which is different for infrastructure and users GB 1-May-15 6

7. regulation versus unbundling dilemma GB 1-May-15 7 ► Two numerical examples Source: Brunekreeft, 2013, BEWP-DP 15, p. 11 ► Either loosen regulation (revenue- and cost-sharing models) or loosen unbundling.

8. Conclusions  In the unbundling debate, we need to weigh the benefits against the cost more carefully  We need to balance better between competition and coordination  Policy recommendation: –Either loosen regulation (revenue- and cost-sharing models) or loosen unbundling –Find other innovative governance structures that strike a better balance GB 1-May-15 8

9. 1-May-15 9 Thank you! Gert Brunekreeft Jacobs University Bremen g.brunekreeft@jacobs-university.de http://www.germany.info/V ertretung/usa