Reconsidering Induced Demand

Induced demand is no doubt an important concept in transport planning, with wide-ranging implications for the efficacy of certain investments – especially in large road projects. However, it seems that induced demand is brought up all too often as an excuse for the failure of public transport to compete against the car, fitting into a wider story of new road construction eating away at public transport use. Conversely, it is used by some as an argument to justify the reintroduction of otherwise unsustainable long haul country passenger rail services; because …

This post is published in full at Transport Textbook.

The Economics of Electrification Part Two – Cost-Benefit Analysis and Calculating a Net Present Value

Here’s the second part of my discussion of the economics of electrification. You can find part one here.

In order to assess whether electrification of a given line should go ahead, the costs need to be weighed against the benefits through a formal cost-benefit analysis. On top of this, we need to account for the cost of capital and opportunity cost (or what else we could spend the money on). A broadly accepted way of doing this is by calculating the Net present Value (NPV) – the Wikipedia article explains this far better than I can, and is worth reading. Also worth reading is the article on the time value of money – don’t get too worried about it though.

Here’s what the NPV equation looks like, taken from Wikipedia:

\mbox{NPV} = C_0 + \sum_{t=1}^{N} \frac{C_t}{(1+r)^{t}}

If you find the maths intimidating, don’t worry about it – I’m generally terrible at maths so I just use excel to work everything out for me. There’s a link later in this post which allows you to plug in your own numbers and see how changes impact on the viability of a project.

The discount rate and opportunity cost

The discount rate puts money in the future into present value terms. Economists tend to believe that a dollar is worth more to you now than it will be next week – the discount rate measures how much less it will be worth next week. The higher the discount rate, the greater the value placed on the present. In practice though, the discount rate used in these calculations is the cost of capital. The discount rate is also really handy for measuring opportunity cost, so if you can earn 8% by putting that money in the bank, or another project (like using the money to buy more trains) brings in 8% – these figures can be used very effectively as the discount rate and deliver some interesting insights.

Setting the right discount rate is really important – set it too high and worthwhile projects look non-viable; set it too low and non-viable projects look worthwhile. I think a discount rate of somewhere around 7-8% is reasonable for these sort of projects. This article explains very well why setting an appropriate discount rate is necessary.

Most intriguingly, it has been suggested that in reality, politicians face very high effective discount rates – around the 20% mark. With a short electoral cycle, politicians often view the present as much more important than the future. A project with benefits in 20 years (well beyond the current political cycle) is less likely to occur than a pork-barrel which yields political benefits almost immediately. This theory is, in my view, a pretty good explanation of why politicians in Australia are so unlikely to properly support rail.

Some results

So now I’m going to set up a very basic NPV calculation in excel, looking at the potential electrification of the Geelong line. The main assumptions I’m making are below. All of these assumptions have problems, but if anything they favour electrification (with perhaps the exception of the 50 year life of the project).

– The capital works for the project would be in the order of $276 million. This is based on the very optimistic assumption of the project costing half of what Craigieburn cost per km. See part one for details.

– No new expenditure for rollingstock would be required. V/Line are going to have to buy lots more anyway and it makes little difference whether they buy more diesel trains or new electrics and cascade the Vlocitys off the Geelong line.

– Service levels would be held constant

– The life of the project would be 50 years

– The discount rate is 8%

Quantifying costs is not so hard – quantifying benefits is difficult. Now to be clear, I don’t believe that there are any economic benefits to electrifying Geelong while service levels are so low. This diagram from part one explains why. But I’m going to make up some absolute best case benefits for the sake of the exercise. Let’s pretend that that electrification will reduce net maintenance levels such that it cuts 5% out of V/Line’s $342.3 million annual expenditure. That’s $17.1 million. Furthermore, let’s pretend that the ‘spark effect’ exists, and that each of the Geelong line’s 2.57 million annual passengers gets an extra $2 utility per trip. That’s $5.1 million per year.

These are the results when the numbers are put into excel (thanks to this website for showing me how to do it properly). Electrification still doesn’t stack up for Geelong even when the costs are underestimated and the benefits overestimated – the NPV is negative to the tune of $4.4 million!

So that’s that – I don’t think the numbers support Geelong electrification unless there are going to be a lot more services running. I’d highly recommend playing around with the NPV in excel by changing around the discount rate, initial investment, benefits and life of the project. Just for fun, behave like a politician and crank up the discount rate to 20%. You’ll understand why we don’t have more infrastructure with long term benefits!

The Economics of Electrification Part One – the Costs and Benefits

The economics of electrification is an issue which has interested me for some time. So when drwaddles contacted me last week with some interesting information on the issue, I jumped at the the chance to have a look at it on this blog. Unfortunately, I haven’t been able to come up with any hard and fast rule on when a line should be electrified, but hopefully the information here can offer some insights when looking at whether a given line should be electrified.

So in this post – part one of two – I’m going to have a look at some of the costs and benefits of electrification, and then later I’ll set up a basic cost-benefit analysis to show the main factors factors which should inform the decision making process.

Costs

The main costs of electrification are in the construction and maintenance of infrastructure; as well as the need to purchase different rolling stock (or at least locomotives). Stringing up wires can be expensive – the recent Craigieburn electrification cost an exorbitant $115 million for 10km of works (thanks for the tip DB!). Whilst that price tag also included two new stations and re-signalling (as well as goodness knows what else – DoI often like to hide several years worth of operating costs in these numbers), we’re still talking about a fair bit of money. Even if we’re really optimistic and say that the actual electrification (consisting purely of wires, stanchions and substations) cost half that, the per kilometre cost is still $5.75 million.

Put into context, that would see the cost of electrifying 48km Geelong line as far as Marshall around the $276 million mark. Obviously, there are economies of scale for bigger projects and the Craigieburn project was outrageously expensive for what it was, but I’d already halved the per km Craigieburn figure to get $276 million for the Geelong line. To illustrate opportunity cost, it is worth noting that the original Vlocity order (for 38 2 car sets) cost $535 million.

Maintenance of the infrastructure is a crucial cost, but it is often more than offset by reduced maintenance levels required for electric trains. I’ll discuss this issue below.

Benefits

The potential benefits of electrification are fourfold – they consist of better acceleration, lower running costs when a large number of services are provided, the so called ‘spark effect’ and lower carbon emissions (depending on the energy source).

Improved acceleration

Electric trains generally accelerate faster than their diesel counterparts, so for lines with closely spaced stations (like a metropolitan rail system), electrification is often a must for the sake of maintaining a reasonable average speed. However, as station spacing moves further apart – as it does in the country – the benefits of faster acceleration are reduced. Consequently, I’d argue they aren’t a significant factor for a line like Geelong. I should also point out that metropolitan railways also tend to have a high level of service – for the implications of this, see below.

Lower running costs for high frequency services

Amos and Galbraith suggest that while capital costs for electric traction are higher, operating costs can be lower. This is because of lower train maintenance and fuel costs for electric traction. Indeed, Electric and diesel services have very different supply curves. Electric trains have high initial fixed costs (because of the extra infrastructure required), but a low marginal cost. Conversely, diesels have low fixed costs but high marginal costs. These supply curves are represented graphically (and somewhat badly!) below:

supply-curve.jpg

Basically, if fewer than Qx services are provided, diesel trains should run, but if more than Qx services are provided, electric trains should run. Calculating Qx in terms of trains per hour is something I’d love to do, but sadly I don’t have enough data to do it properly. Furthermore, the costs are going to be distorted in favour of electric traction over the longer term, as many of the capital works are a one off (well for 80 years anyway).

On top of this, I haven’t mentioned opportunity cost and the discount rate, so what you see above is a very basic approximation.

The ‘Spark Effect’

The ‘spark effect’ describes the apparently oft occurring phenomenon, in which patronage increases after electrification occurs because passengers like electric trains more. I’m fairly sceptical of this, largely because electrification seldom occurs without a concurrent change in rollingstock and/or service level.

Intuitively, I’d argue that a change in the type of train and how often that train runs are more likely to change passenger behaviour more than whether diesel or electric traction is provided. So in absence of a good sample of lines in which the means of traction was the only thing changed, I’ll rule this out as a definite benefit.

Lower carbon emissions

Electric traction can be better for the environment than diesel traction, although this gets a lot murkier when the electricity is generated from dirty sources like brown coal. I’ve seen a number of studies on this issue (some more dubious than others), and they have varying values for the carbon emissions and disparate average numbers of passengers per service. The basic rule of thumb should be that – if a decent number of passengers are carried – they will both be better than cars, and electric trains should be better than diesels (although this depends on average passenger numbers and the source of power). This is a massive topic in itself, and really deserves it’s own post.

This is not to say electric is always better for the environment – there’s no real envrionmental benefit to electrifying a line like Swan Hill which only carries two trains each way per day. The billions required have a much greater impact on the environment if spent elsewhere – that’s opportunity cost in action.

In part two I’ll set up a basic cost-benefit analysis which will provide a more formal way of weighing up the costs and benefits, as well as accounting for discount rates and opportunity cost.