Revealed: how SA can achieve a functioning rail freight network – Part 2

Do you fancy the idea of a functioning rail freight network in South Africa? ELVIN HARRIS certainly does. He believes that the solution lies in a direct government contribution to financing the network. This is the conclusion of a two-part series on the subject (Part One can be found here). 

In Part One of this series, I explained why South Africa’s rail freight network has crumbled: it’s all down to funding. For the past 30 years, investment in the country’s roads has outpaced investment in rail by almost 10:1. In other words, there has been 10 times more investment into the road network than into the rail network.

I explained that if we wish to avert economic disaster, our only viable option is greater investment in the freight rail network, starting now! But this is no simple undertaking; when new investments are made into freight rail corridors and networks, there are several risks to consider.

Risky business

Firstly, by making “loans” available to Transnet for upgrading, maintaining, and investing in new rail capacity, the State only serves to weaken Transnet’s balance sheet and increase its already high debt burden. This approach by government of trying to “save” a state-owned enterprise (SOE) through limited exposure hasn’t proven effective in the past; SAA is the poster child of how not to rescue an ailing SOE.

Private sector financing, meanwhile, should preferably not be the primary funding mechanism for rail infrastructure. It would be better deployed to railway operations and terminals/consolidation yards. Private sector financing should be leveraged as secondary funders or co-financiers on railway infrastructure to close the funding gap on the back of Transnet and government funding.

Private sector funding alone, or Transnet funding alone – without direct funding injection from government – will make rail freight even less competitive with road freight, as the new investment will have to be fully recovered from customers. Government investment can be treated as a subsidy into economic infrastructure, enabling rail freight to better compete with road freight in pricing to the market by levelling the playing field over time.

Finally, it is probable that the only thing worse than a public monopoly is a private monopoly. The creation of private monopolies on the rail network should be avoided as far as possible.

Potential funding models for reviving freight rail

There have been numerous rail reform exercises undertaken by many countries around the world, as they too have grappled with fixing their railway systems. Very few countries have a railway system entirely funded by the private sector with no support from the State.

The United States Class 1 Railroads has been the best example of private sector-led railway development in the last century. However, even in the US, the Class 1 Railroads are receiving increasing financial support or co-investment from the US government to undertake major network upgrades and remain a competitive modal choice in local and international markets.

The global case file on rail reform initiatives is extensive, and South Africa would do well to take notes. The bottom line is that there is hardly any freight railway system in the world that does not receive financial support from the State in some form.

The Results and Efficiency of Railway Infrastructure Financing within the European Union, a 2015 study commissioned by The Committee on Budgetary Control (CONT) of the European Parliament, made the following key policy findings, amongst others:

• Common railway policy and railway reform began with Directive 1990/440, followed by Directives 2001/12-14 and three railway packages from 2001 to 2004. The EU Commission has prepared a proposal for a fourth railway package which is still under discussion.
• Despite substantial changes having been achieved, the prime political goal as expressed in the White Papers of 2001 and 2011 – to revitalise the railways and substantially increase their market shares – has not yet been achieved. The shares of railway have not changed much in the passenger transport market and have decreased in the freight transport market.

Key findings on infrastructure financing were, inter alia:

• Funding from national budgets contributes more than half of the financial sources for railway infrastructure investment. European co-funding provides an additional 12% on average. The remaining third of the total funding stems from a variety of sources such as loans, equity capital (in the case of large projects), or rail track charges (only for running costs and parts of maintenance/reinvestment costs).
• As rehabilitation of the railway networks is becoming a dominant issue which requires stable financial streams and efficient management of maintenance/reinvestment work, some Member States like Germany have established special funding schemes supported partly by government money and partly by infrastructure management companies and their holding companies. This allows for efficient medium-term planning, scheduling, and implementation of works independent of constraining public budget regulations. It is, however, controlled by private and public auditors on the basis of performance indicators.
• European co-funding can be provided by the Cohesion Fund (CF), European Regional Development Fund (ERDF), Connecting Europe Facility (CEF) (mainly as grants), and European Investment Bank (EIB) (mainly as loans). In the future it could also include funds from the European Fund for Strategic Investments (EFSI) and extended instruments, which can be combined with the above main sources. The role of Trans-European Transport Network (TEN-T) funding through CEF has substantially increased, particularly through the integration of CF funding, which comprises 11.3 out of €26.25 billion for the period 2014 to 2020 (€2.2bn being transferred to EFSI). For railways, a slight growth of financing by the structural funds can be expected.
• The main problem of applying new instruments to railway infrastructure investment is that private investors of a public private partnership (PPP) usually require a revenue stream which can at least finance the private capital invested (amortisation and interest). In such cases, instruments like the Loan Guarantee Instrument for TEN-T projects (LGTT) help to overcome financial difficulties in the start-up phase while they assume that the revenue flows will be sufficient in the following periods. In the case of railways, sufficient revenue flows cannot generally be expected. Therefore PPPs would have to be based on achievement or performance indicators and refinanced by state money.
• PPPs are also, in the first instance, instruments which encourage the efficiency of private business cost control, risk management, and the sanctioning of success or failure. A positive example is provided by the Tours – Bordeaux line on PP3 and the Atlantic CNC. As most railway infrastructure managers claim that they are behaving according to private business rules, conflicts may arise between private project managers of PPP schemes and semi-private infrastructure managers. Such conflicts have to be solved a priori by appropriate contracts and arrangements.

The 2015 European railway performance index: exploring the link between performance and public cost – a report from Boston Consulting Group – probed deeper into the argument that railway infrastructure managers could benefit from receiving the lion’s share of government subsidies.

Throughout Europe, national railway systems use public subsidies to maintain infrastructure and improve passenger and freight operations. Different patterns of investment persist, however: while some countries prioritise either infrastructure managers or train operators in their funding, others choose to divide funds equally between the two.

“Simply put, countries that get the most value from public spending on railway systems also allocate the highest percentage of subsidies to infrastructure managers,” noted Sylvain Duranton, a BCG senior partner and a co-author of the report, in a press release.

Additional insights into government-subsidised railways

• Europe

o German multinational DB Cargo uses track access charges to recover 60% of infrastructure expenditure, including loans and grants. Charges are said to fully cover traffic management costs and maintenance costs.

o Germany’s federal government also finances the construction and replacement of tracks. DB Netz pays the annual depreciation for these tracks to the federal government and raises the necessary funds via access charges from the operators.

• United Kingdom

o Network Rail is a not-for-profit organisation, with most funding coming from a mix of direct grants and borrowing from the UK and Scottish Governments, payments from train and freight operators, and a small amount of income from commercial properties.

• Asia (Indian and Russian Railways)

o India’s central government supports railways in order to expand Indian Railways’ (IRCTC’s) network and invest in capital expenditure. Until recently, this budgetary support from government was the primary source of funds for capital expenditure for the railway, but since 2015-16 most of the capital expenditure has been met through borrowings and external investments. The central government also reimburses the railway for operating losses made on strategic lines and for the operational cost of e-ticketing to IRCTC.

o Government financial support to rail transport companies in Russia – especially to Russian Railways (RZD) as the exclusive public-use rail infrastructure owner – is primarily provided as reimbursement of expenses.

Examples of actual spend

In 2015, the total domestic rail spending by China was US$128 billion. India’s railways are subsidised by around US$5.8 billion, of which around 60% goes to commuter rail and short-haul trips, while in Russia, RZD receives around US$1.5 billion from the government annually.

Current subsidies for Amtrak (passenger rail) are around US$1.4 billion in the US, where the rail freight industry does not receive direct subsidies. The privatised network in Japan requires few subsidies, and the three biggest companies, JR East, JR Central, and JR-West (which account for 60% of the passenger market) receive no state subsidy.

Concluding remarks and recommendations

There are very few railway systems in the world that do not receive financial support directly from the government. Most governments allocate quite considerable financial resources to support their railway systems, including freight rail components, to provide a balanced and efficient transport system to passenger and freight customers. More nuanced research has found that public funds prioritised to network managers (the rail infrastructure component) yield greater benefits over time than subsidies to railway operators.

Given South Africa’s widely publicised dire current situation, it should be a no-brainer that direct government financial support is urgently needed to kick-start the resuscitation of freight rail, to the benefit of the South African economy and the SADC regional economy. Private sector funding will follow on this foundation of increased fixed capital formation in the railways from the State.

Our fear is that if government does not find a way to financially support the freight rail system directly, right now, it will regardless be forced to find money to bail out Transnet and Transnet Freight Rail in the coming years – as it was forced to do with so many other SOEs that are/were “too big to fail”. It would be more prudent to invest funds into the railway system wisely and consciously, rather than haphazardly. The road freight sector and the road networks will, as a consequence, greatly benefit from such targeted government investment in railways. In this scenario, it appears that everyone wins!