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Abolish the Canadian rail monopoly
Published: June 24, 2008
Source: Francois Tougas, Financial Post
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Canadian National and Canadian Pacific operate monopolies on significant parts of their railway networks. They enjoy almost unlimited power over rates and service in uncontested or "captive" markets and at present there are no market-based solutions to counteract that power. Why should Canadians care? Because unfettered railway monopoly power is undermining the competitiveness of a number of important Canadian industries, including suppliers of steelmaking and thermal coal, base metal concentrate and industrial minerals, lumber and pulp.

The best way to regulate a natural monopoly is to introduce competition by allowing others (a "guest" railway, in this case) to access the track infrastructure of the incumbent (the "host" railway) to vie for the business. Modern economies already do this with other network industries like telecom, cable and electricity and gas distribution.

This solution is commonly called "running rights" and it is not a new idea. The Australians have forged ahead with running rights, realizing efficiencies on various state rail systems. Railways throughout Canada and the U. S. grant each other these rights regularly, by agreement. In Canada, the statutory ability to compel those rights has been in force for over a century.

The economic case justifies it. Not every Canadian shipper needs running rights, as some already have truck or marine alternatives for the shipment of their products. For others who are captive to a single railway, limited running rights -- subject to certain tests to ensure that the guest railway can demonstrate its fitness to operate a railway -- may be appropriate. Of course, the guest railway would have to pay the host railway for track access and there may be debates over the appropriate level of that compensation.

For years, Canada addressed the railway monopoly problem by regulating railways' rate-making ability and compelling them to provide service to the far reaches of Canada. High government subsidies were needed to make this possible. In 1988, regulatory reforms gave both railways control over pricing, among other things, while rail users (shippers) were granted three new remedies, to the extent they could use them.

For various reasons, none of these remedies intended to overcome railway pricing power. Competitive line rates, interswitching and final offer arbitration-- have proved useful or even available to most captive shippers.

Further reforms in 1996 continued the railways' steady ascent toward financial success. Today, they are earning well in excess of their cost of capital. However, that success has come by extracting high rates from resource industries and even some grain growers -- and often service has been inadequate.

Resource shippers are the most captive. Typically, their mines and mills are located in isolated areas on CP's or CN's rail lines. In these circumstances, a railway enjoys tremendous market power: Its ability to charge supra-competitive rates and to provide inadequate service is unfettered by market discipline because there is no other railway contesting those markets. Barriers to entry are tremendously high.

The result is an inefficient and inequitable transfer of wealth from producers/ shippers to carriers. Railways are able to conduct themselves free of the hallmarks of competition: low rates, rates coupled closely to costs, innovation and good service. Instead of worrying about the markets they serve, the railways focus on their customers' markets: If commodity prices go up, the railways expect and even project rate increases. When commodity prices are down, as many have been for most of the past several decades, the railways set themselves a floor of profitability.

To a large extent, Canada's rail carriers decide which major industries will participate in what downstream markets and whether these major industries survive or excel. In a way, they manage the businesses of their customers.

Those who say that railways are charging "what the market will bear" ignore the fact that there is no market. What is needed is effective competition to create a market. Limited running rights will permit resource industries to do what all companies seek to do -- namely, call for tenders from more than one supplier (in this case, for the transportation of their products).

All Canadian enterprises expect suppliers to compete to get their business; in the case of essential facilities like rail, it is critical. Easing access to railway infrastructure through limited running rights will improve Canada's international competitiveness and allow resource industries to take advantage of global value chains.

Despite increased fuel costs and a weakening economy, CN and CP are financially healthy. They are very viable enterprises, paying their capital expenditures and raising capital without difficulty. They are also incumbents on their own systems, in the same way the original telecom carriers are on theirs. New entrants have an inherent disadvantage. CN and CP should be able to compete against new entrants, and provide lower rates and better service to keep their customers.

It is simply in Canada's best interests for our resource industries to realize the benefits of competition generally. Equity dictates that rail carriers should not be preferred over those who are captive to rail. - Francois Tougas is a partner with Lang Michener LLP and an adjunct professor in competition policy at the University of British Columbia Faculty of Law.

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