This is the sixth article in our series on PR18, the Office of Rail and Road (ORR)'s periodic review of Network Rail.

The ORR have now published their conclusions on their review of charges and contractual incentives that they consulted on in December and which we reported on in our article PR18 Review of Charges and Incentives.

Headline points

• Fixed cost charges will be extended to all operators, including open access operators, subject to a "market can bear" test
• The capacity charge will no longer apply
• Variable charges can be capped

Fixed costs

The ORR will continue to work towards recovering fixed costs from ALL operators, subject to a market can bear test, and potentially based on Network Rail's updated cost allocation methodology. The two existing freight mark-ups – the freight specific charge (FSC) and freight only line charge (FOL) will be merged into one charge.

This is as proposed in the consultation but met with a mixed response. There was support for merging the FSC and FOL but not everyone supported changing the cost allocation and were concerned about how recovering fixed costs from all operators would work in practice.

Cost allocation

Network Rail's new cost allocation methodology will:

• disaggregate cost to sections of a route, rather than the route as a whole;
• allocate costs to all operators using a particular route, not just franchised passenger operators; and
• identify the costs associated with a basic network (low traffic, low speed but the same range of destinations) and the additional costs incurred to accommodate different types of traffic.

The ORR think there could be benefits in implementing this methodology, but before they do so, they will consider the responses to the consultation that Network Rail is issuing later this year (see Next Steps below).

Extending fixed cost charges to all operators

The consultation responses wanted to understand more about how the market can bear analysis would be undertaken and how the mark-ups would be applied.

The ORR stress that this will be the first time that they have carried out a market can bear test for passenger services and the analysis will be innovative and complex. They have appointed consultants and there will be a consultation in September that will set out which passenger market segments should be subject to mark-up charges (see Next Steps).

However, the ORR have not ruled out continuing with the existing fixed track access charges (FTAC) for franchised passenger operators in CP6 if they cannot develop a sufficiently robust market can bear test.

The ORR are still developing their new fixed cost charge and one option they put forward involves an annual recalculation of FTAC to reflect changes in timetabled traffic, rather than the charge being fixed for the entire control period. They are also considering how the new charge will affect the incentives faced by Network Rail and operators: if all operators paid fixed cost charges when adding new services, that would incentivise Network Rail to find ways of accommodating additional services on the network.

Capacity charge

The ORR have gone with Option 3 as set out in our previous update – removing the capacity charge and instead recovering the lost revenue through higher fixed cost charges. They considered its incentive effects to be relatively weak as the way it is calculated does not provide a strong link between the level of the charge and either congestion or the impact on end users. However they recognise some respondents' concerns about how it will affect Network Rail's incentives to add traffic and will take this into consideration in its November consultation on incentives (see Next Steps).

Capping variable charges

The Variable Use Charge (VUC) is levied on all operators and is designed to recover the track, civil engineering and signalling "wear and tear" costs that Network Rail incurs when it accommodates an additional train on the network. The way the VUC is calculated will remain broadly the same for CP6, but there had been concern that this would mean much higher rates for freight operators. This is because research between CP4 and CP5 found that heavy vehicles caused more "wear and tear" than previously thought and high speed vehicles caused less. This would have meant a big increase in freight VUC rates for CP5, but the ORR capped the increase at 10% and phased it in over the control period.

New EU legislation meant that the ORR felt it could not roll over the CP5 cap on the VUC for freight into CP6, but they have (as we suspected) reconsidered their view. They will therefore consider whether to cap or phase-in changes to the VUC at a later date, once they have a better idea of the likely level of the VUC and the impact of other charges and incentives. This is good news for freight operators, who should not be hit with higher charges at the outset of CP6.There will be no change to the Electrification Asset Use Charge or the Traction Electricity Charge; and the Coal Spillage Charge will be abolished.

Schedule 8

The Schedule 8 performance regime compensates train operators for unplanned service disruption caused by Network Rail and other train operators. Passenger train operators also have to pay compensation to passengers who are delayed, even if the delay was not the operator's fault. At the moment, the two regimes are not linked.

One option the ORR were looking at was to allow operators to recover from Network Rail the passenger compensation they have paid, to the extent that this is due to a Schedule 8 event caused by Network Rail. Network Rail would need additional funding for this, and the ORR will need to work closely with the funders to decide how best to use taxpayer money.

There will be no change to the approach for setting benchmarks (they will continue to be linked to past performance); and no change to the way TOC performance is measured – they had proposed moving from "TOC-on-self" (minutes of delay that a TOC causes itself) to "TOC-on-TOC" (minutes of delay caused to other TOCs) but this did not go down well. The ORR remain of the view that TOC-on-TOC is a better measure and will look to introduce it in CP23.

The ORR has decided to drop its proposal to restrict Sustained Poor Performance claims to costs only.

Schedule 4

The Schedule 4 possessions regime compensates train operators for planned service disruption (when Network Rail needs to restrict access to its network to carry out many of its maintenance and renewals activities). The compensation is reduced depending on how much notice Network Rail gives (the Notification Discount Factor, or NDF). The more notice, the lower the NDF, as rail users will have been able to plan ahead and disruption should be minimal. Now that people can get almost instant notification via their smart phone, there is an argument that the notice periods can be shorter.

Franchised passenger operators pay a pre-determined Access Charge Supplement (ACS) to cover the estimated cost to Network Rail of providing Schedule 4 compensation – like an insurance premium in return for getting Schedule 4 protection for planned disruption. The ORR are concerned that this is over-compensating Network Rail if they end up carrying out less engineering work than they had forecast (and therefore pay out less compensation under Schedule 4).

The ORR will consult on the NDF and the ACS in the September consultation; and on the bespoke compensation arrangements for large scale planned disruption in its November consultation.

Next steps

There will be two further ORR consultations on charges and incentives and a Network Rail consultation.

Summer/early Autumn 2017 (deadline Autumn, conclusions February 2018) – Network Rail's charges consultation covering the detailed recalibration of charges for CP6

September 2017 (deadline November, conclusions February 2018) – ORR consultation on fixed costs, Schedule 4 and (if required) Schedule 8

November 2017 – ORR consultation on aligning incentives and Volume Incentive

June 2018 – draft determination: ORR consultation on final proposals on which market segments can bear infrastructure cost charges, and the level of those charges; plus final proposal on whether or not to implement Network Rail's cost allocation methodology to calculate the fixed cost charges.

We will continue to keep you updated.