FREIGHT RAIL REVIEWPERFORMANCE REVIEW OF REGULATORY REGIME

GOVERNING FREIGHT RAIL INVESTMENT AND PRICING DECISIONS – DRAFT FINDINGS

BASANI BALOYI, 18 FEBRUARY 2014

OUTLINE

• Background to the Research Project• Global Perspective

- Relative performance/common regulatory regime

• South African Perspective– Policy / Regulatory Regime / Transnet Strategy

• Macro-Level study:– Regulatory Regime: investment / competitiveness / pricing

• Unpacking TFR’s pricing model• Micro-level Case Studies

– Regulatory Regime: Investment / Pricing / Access Rules (citrus, autos, and Coalex)

• Where are we now?• Conclusion

RESEARCH BACKGROUNDOBJECTIVES / KEY QUESTIONS / APPROACH

RESEARCH OBJECTIVES

• Review the performance of the current governance of freight rail, with respect to pricing and investment decisions and competitiveness of general freight

• Describe and analyse the outcomes of the regulatory process with reference to pricing, competitiveness and investment in the context of the economic and industrial policy objectives of government

RESEARCH QUESTIONS

• How has SA freight rail performed relative to other freight rail countries?

• What are the common features of a regulatory regime in freight rail and what of the common features does SA regulatory regime possess?

• How has the regulatory regime strategy aligned with economic and industrial policy objectives over time?

RESEARCH QUESTIONS (CONTD.)

• What are the outcomes of the regulatory regime at the macro and micro level measured against investment, pricing and competitiveness within the context of governments economic and industrial policy?

• Evaluate the performance of the regulatory regime in meeting economic and industrial policy objectives at the macro-monitoring level and at the micro-level ?

APPROACH

• Macro-level performance review relied on desktop research particularly Transnet’s annual Reports and stakeholder interviews with Transnet, DPE and DoT

• Micro-level performance review approach is case study based (citrus, coalex, and automotives) and relied on desk top research and interviews with sectors

GLOBAL PERSPECTIVEPERFORMANCE AND REGULATION

GLOBAL MAP

GLOBAL MAP: SIZE OF FREIGHT RAIL BUSINESS

Comparison of Freight Rail Performance

Train Performance Freight Performance

Country Train km (millions)

Tonne/km (millions)

Mt 10 year CARG %

Freight Tonne/km

US 794 4,495,196 1710 0.7 2,254,585

China 1824 4,198,054 2,562,635

Russia 1473 4,043,783 2,127,832

India 1022 1,445,869 922 6.6 625,723

Canada 115 646,824 310 0.8 254,069

SA 60 170,083 182.1 0.2 113,342

Australia 29 101,956 242 5.7 59,649

GLOBAL COMPARISON: FEATURES

Common Features of Regulated Freight Rail Network

• Regulatory Independence• Rules: pricing, investment, services, performance and

access• Monitoring at macro-level: assessing KPIs• Monitored at micro level: Dispute settlement process

designed for regulator to arbitrate complaints • Legislation that gives investigative, enforcement and

decision making powers to monitor performance, design rules and settle disputes.

GLOBAL CASES OF REGULATORY SYSTEMS

Country Ownership Structure Key Features of System

USA Private vertically integrated with four main rail companies

Minimal regulation to encourage commercial decisionsRegulates mergers and acquisition activity Minimal regulation on pricingInconsistent performance monitoringSettle disputes when there are complaints

Canada Private vertically integrated duopoly

Medium regulation but encourages commercial decisionsRegulates pricing, access, serviceSettle disputes when there are complaints

Australia vertically separated private and public

More regulation Regulates pricing, access, service, new investmentMonitors performanceSettles disputes when there are complaints

SOUTH AFRICAN PERSPECTIVEREGULATORY REGIME AND POLICY

SA REGULATORY REGIME: PERFORMANCE BASEDDoT• Develops Transport Policy• Exercises oversight on Safety Regulator• Oversight on Acts that feature rail, most notable ones are

Succession Act ‘89, Railway Purchase and Construction Acts (‘71, ‘75, ‘85)

DPE• Shareholder and quasi-regulator role• Empowered as shareholder by PFMA, Company’s Act, • Regulatory instruments: shareholder compact, revenue

projections and approval of corporate plans• Therefore performance based regulatory regime

SA REGULATORY REGIME INTERPRETATION OF OVERARCHING ECONOMIC AND INDUSTRIAL POLICY

Macroeconomic Policy

Microeconomic Policy

DOT DPE

Phase 1: 1980s-early 2000s

Privatisation Competitive logistics for exportables

Aim: seamless & competitive intermodal transport system, boost general freight

Investments, End competitive market, Interim economic regulator

Privatise to max shareholder value & operational eff

Phase 2: mid 2000s - present

Capex for jobs and growth

Competitive logistics for value added goodsSOE buying power for BEE & industrial development

Max SOE developmental impact through procurement & investment

Less B/S financing to boost investment, esp GFB intermodality

MDS, Gearing, Profitability,

Investment, Vol, Operational eff, service delivery

R 194.4 b

Quantum LeapGearing,

Profitability,Investment, VolOperational eff, Service delivery

R 54.6 b

TurnaroundGearing,

Profitability,Investment

Rev: Vol > Price

R 31.5 b

Financial Stability; Freight focus; Grp Target

GrowthGearing,

Profitability,Investment,

Operational eff, VolRev: Vol > Price

R 34.8 b

GROW BUSINESS: Investments, GFB volumes; integrated planning, Divisional Target

SHAREHOLDER COMPACT NEGOTIATED CORPORATE STRATEGY

TRANSNET (FREIGHT RAIL) STRATEGY

Financing StrategyNo govt guantree

Cash from operationsRest capital market

Key CorridorKey Commodity

Investments in GFB > Coalex and Orex

GFB Volumes growth

Operational Efficiencies

6 corridors selectedCommodities: mainly

bulk, agriculture (grain), automotives & containers

REGULATORY REGIME AT MACRO-LEVEL OUTCOMES AND EVALUATION: INVESTMENT, COMPETITIVENESS AND INVESTMENT

CORPORATE PLANS: INVESTMENT TARGETS

Turnaround Plan Growth Plan Quantum Leap MDS0

20

40

60

80

100

120

140

160

Coal line

Ore line

General Freight

Other

R m

illio

n

Bulk have targeted GRB

ACTUAL INVESTMENTS

2009 2010 20110.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

General FreightCoalIron ore

R bn

Have targeted GFB; however mainly used for sustaining

investments

VOLUME: IRON ORE ON TARGET

2009 2010 2011 20120

10

20

30

40

50

60

Target

Actual

VOLUME: COALEX NOT ON TARGET

2009 2010 2011 201240

50

60

70

80

TargetActual

VOLUME: GFB NOT ON TARGET AND NOT AMBITIOUS

2009 2010 2011 20120

10

20

30

40

50

60

70

80

90

100

TargetLogarithmic (Target)

SERVICE: WAGON TURN AROUND TIME IMPROVEMENT FOR GFB.

Actual Target Actual Target Actual Actual Target Target2010 2011 2012 2013 2014

0

2

4

6

8

10

12

14

16 GFB Coal Iron ore

days

SERVICE: LOCOMOTIVE EFFICIENCY STAGNANT FOR GFB

Actual Target Actual Target Actual Actual Target Target2010 2011 2012 2013 2014

0

10000

20000

30000

40000

50000

60000

GFBCoalIron ore

GTL

000

/loc

omoti

ve/m

onth

TARIFF GROWTH HIGHER THAN VOLUMES GROWTH

2007 2009 2010

-10

-5

0

5

10

15

20

25

Volume growth Target Volume growth Actual

Tariff growth Target Tariff growth Actual

%

TFR’S RISING TARRIFFS FOR INVESTMENT

2008 2009 2010 2011 20120

0.02

0.04

0.06

0.08

0.1

0.12

0.14

0.16

RailRoad

Reve

nue

per t

onne

TARIFF - Revenue per tonne higher than road in 2011 and

2012

MACRO-LEVEL EVALUATION OF REGULATORY REGIME

• GFB volume sluggishness: Regulatory regime has met investment targets and efficiencies but not achieved increased volumes especially in GFB

• Constrained investment environment: biased towards private rate of returns not social rate of return since most investments are sustaining invests which maintains rather than grows current customer base

• Investment strategy vicious circle: increase prices to generate revenue for investment which hampers volume growth in GFB given its current lower service levels.

MACRO-LEVEL EVALUATION OF REGULATORY REGIME

• Regulatory regime constrained: monitoring macro-level performance through KPIs cannot unpack underlying dynamics that explain possible sluggishness in GFB

• Deeper inquiry required at micro level: to unpack the outcomes generated by TFR’s access, service and pricing regime to assess alignment with economic and industrial policy

UNPACKING TFRS PRICING MODEL

DIFFERENTIATED PRICING MODEL

Required Return Coalex Auto CitrusReturn on Asset BaseWACC (risk)DepreciationTaxExpensesCommodity profitabilityCross-subsidisation

ACCESS RULES

• Customer with direct account/key account with TFR

• Submit volume projections to TFR marketing/customer service

• TFR sector teams organise access by identifying slots for the year, negotiate contract and oversee service of contract

• Containers have third party access granted by logistics company with Key Accounts

BIGGER VOLUMES = BETTER PRICES = BETTER ACCESS

• MegaRail: minimum 30 loaded wagons, 5 days a week, annual contract

• Only once slots, locos, crews are allocated for MegaRail is the rest allocated for the pricier AccessRail and FlexiRail

• AccessRail: regular operation, operates trains from other train moves ending at hub

• FlexiRail: irregular, ad hoc for sudden unscheduled demand

Differentiated Pricing Volumes Access

COSTS DUE TO LACK OF STANDARDISATIONDifferentiated Pricing Network technology Costs

COSTS DUE TO COMPLEXITY OF GFB NETWORK

But how are overheads costs and depreciation distributed

across the network?

Differentiated Pricing Network technology Costs

REGULATORY REGIME AT MICRO-LEVEL OUTCOMES AND EVALUATION:TFRS INVESTMENT, PRICING AND ACCESS RULES USING 3 CASE STUDIES

CASE STUDY 1 : COALEXACCOUNTING FOR THE VOLUME GAP

COALEX: SNAPSHOT

Significance to economic and industrial policy• Coalex’s significance to economic/industrial policy is

broadening participation to BEE/junior miners

Market structure• Coal production highly concentrated with 5 producers

controlling 80 % of production based in Mpumalanga

• Monopsomy power

COALEX: SNAPSHOT (CONTD)

Network Access• 100% of mostly higher grade thermal coal is railed on

dedicated Rail line from hub (Ermelo) to Richards Bay Port Terminal using MegaRail Service Plan

• Dedicated line for coalex built in 1970s by Act

• 70 mpta allocated on an annual monthly weekly through contract

COALEX GAP: INVESTMENT DISPUTES

• Coalex line recipient of investments• Growth was facilitated through medium to long term contracts

10 years (ended in 2005) which helped TFR recover risk through guaranteed take or pay volumes

• 9 year dispute over TFR’s investments• Contestation: some majors argue constrained from maximising

port capacity as TFR is under-investing; TFR argues some majors cant fulfill orders due to underinvestment in coal mining

• Not resolving this is blocking potential access to the network if true that coal miners are structurally constrained from fulfilling orders

COALEX GAP: ACCESS DISPUTE

• On-going dispute between TFR and junior miners on the one side and major miners on the other about access onto the rail-port logistics system.

Juniors and TFR: majors blocking access to ports by not increasing Quattro allocation forcing juniors to sell to majors at lower than export price

Majors: juniors cannot even make up their current quota allocation of 4 Mt, we will increase capacity until rail capacity is increased

CASE STUDY 2 : CITRUSACCOUNTING FOR NO VOLUMES ON RAIL

CITRUS EXPORTS: SNAPSHOT

Significance to economic and industrial policy

• NGP targeted rural development and agricultural sector for labour intensive growth

• Industrial Policy targets regional industrialisation

CITRUS EXPORTS: SNAPSHOT

Market structure and dynamics

• Over 1000 citrus growers in Western and Eastern Cape and in Northern Region (Limpopo, Mpumalanga, Zimbabwe and Swaziland)

• Sector employs one statistic 100,000 workers another 400,000 workers

• Northern region produces 800,000 pallets annually

• Logistics cost for Northern region 60% of revenue about 25 % is land freight logistics

• 2005: 80% of Northern region volumes on rail 2013 5 %

CITRUS EXPORTS: INVESTMENT NEEDS

• Historically citrus transported on rail using O type wagons but market dynamics last 5 years moved to container– Need for more reefer containers as 80% of citrus exports

are transported via containers• Deregulation of transport and agricultural boards fragmented

export supply chain– Need for hub in Limpopo to centralise supply chain

CITRUS EXPORTS: INVESTMENT DISPUTE

• Transnet deems citrus not rail friendly due to seasonality and disinvests to focus on iron ore and coal

• Transnet removes citrus from network linking Northern region through Swazi loop to Richards Bay in favour of bulk commodities

• Currently 350 trucks transport citrus to Durban weekly

• Transnet promising investment since Quantum leap

• Industry argues meager investments in containers wasted due to failure of TFR to consult industry to customise containers

Letistele (Limpopo)

average cost per plt 28 standard (2010)

Average cost per plt 26 standard (2010)

Rail R 610 R 640

Road R 643 R 692

Difference R 33 R 52

CITRUS EXPORTS: PRICING DISPUTE

CASE STUDY 3 : AUTOQUASI-REGULATOR AND AUTOS ARRANGEMENTS

AUTO SECTOR: SNAPSHOT

Economic and Industrial Policy

• Sector has received industrial policy support since the 1960s due to linkages/spillovers, technology and employment

Network Access

• Containers and wagons use Durban Corridor from Roslyn recently Maputo

• 90 % CKD on rail containers and 10-30% CBU wagons

AUTO: POTENTIAL FOR INDUSTRIAL POLICY TO SHAPE OUTCOMES

Issues:

• Rail investment was part of package attracting autos sector to Roslyn

• Industry claims Transnet cannot live up to service agreement as it is unreliable

Solutions:

• Industrial policy alignment introduced recent investments in customised wagons through TFR-auto sector design partnership

• Quasi-regulator has been recently involved in the sector through newly est. SOC Automotive Competitive Forum to remove electricity and transport stumbling blocks with Ministerial support

• Projects are targeted towards wagons as containers are complex.

MICRO-LEVEL EVALUATION OF CASES

• Case studies reveal a range of on-going/unresolved disputes in the form of investment, pricing and access that are holding ransom the aim of economic and industrial policy to ensure a competitive and efficient logistics system

• Disputes within coalex in particular is preventing the possible shared use of that infra by other players within the sector or other sectors if investigations by a credible dispute settlement process reveal that certain coal miners cannot fulfill their orders

MICRO-LEVEL EVALUATION OF CASES

• The involvement of quasi-regulator in the auto sector in fast tracking improvements shows the need for a third party as it brings to question whether these arrangements are open to other sectors who have less organising power than autos

• Case studies also reveal that containers, which are most likely to contain value-added goods, are not well prioritised due to system of using unregulated third party accounts

HOW OTHER REGULATORS DEAL WITH DISPUTES?

Australian regulator handling of lack of access/new investment in citrus case solution• Infra owner responds to access seeker within 30 days with

indicative capacity assessment, negotiations for entry begins, if no capacity then infra owner must produce a work programme for expansion

• But 60 % of access seeker industry must sign a contractual agreement with infra owner that they will make use of new investment and that this will be fed into the tariff charged over a particular time frame with penalties for non-delivery

Does citrus have profitability for the tariff, could there be need for a subsidy?

Australia regulator handling of pricing disputes in containers

• Regulator calculates reference pricing which is implemented if investigation view as necessary or

• Negotiations take place within a regulator set max and min rate

• Pricing determined by regulator based on reasonableness & efficiency of network owner forecast, capital expenditure, maintenance & operating costs

HOW OTHER REGULATORS DEAL WITH DISPUTES?

Canadian regulator handling of the coalex-TFR slow contractual agreement• Complaints are forwarded to regulator for arbitration,

complainant has burden of proofCanadian regulator handling of complaints over poor service delivery• Contract must specify the service• If investigation finds breach of contract then application

of penalty

HOW OTHER REGULATORS DEAL WITH DISPUTES?

WHERE ARE WE NOW?

WHAT IS THE END GAME?

DoT- Regulator is NB: price and access- End Game: Privatisation of TFR- Process: White paper Rail Act STER

reporting to Parliament 10 yrs- Interrim process: Interrim regulator,

Rail policy Green Paper

DPE- Regulator is NB: price and access- End Game: No privatisation to align

with Presidence and govt policy- Process: Land Freight Policy creating

intermodal competitive neutrality Regulator

Industry- Regulator is NB: price and access- End Game: Privatisation but ensure at

least 2 companies to ensure competition – Autos; Coal we will run it like in Australia.

TFR- Regulator is NB: price and access- End Game: No privatisation to align with

Presidency and govt policy - Process: Land Policy Freight Policy

creating intermodal competitive neutrality regulator

All stakeholders agree regulator needed, but not how

CONCLUSION

Recap: Project Objectives

• Reviews the performance of the current governance of freight rail with respect to pricing and investment decisions and its impact on volumes and competitiveness of general freight

• Describe and analyse the outcomes of the regulatory process with reference to pricing, competitiveness and investment in the context of the economic and industrial policy objectives of government

Take-Away Points: Macro-level Analysis Revelation

• Macro-level analysis reveals GFB volume underperformance for much of the analysed period: – constrained investment environ sustaining and growing

current customer base rather than expanding and diversifying where possible• reliance on b/s financing means increased tariffs triggering

vicious circle of lower vols from GFB at current service levels

– Focus is on key corridor and key commodities selected based on revenues generated having implication for ‘new’ customer base

Take-Away Points: Micro-level AnalysisRevelations

• Unresolved disputes between TFR and vested interests are blocking possible access to the network for GFB - Major coal miners contract dispute- Major-Junior miners rail-port logistics dispute

• Allocation of resources and access benefits those currently served by network & at times aided by quasi-regulator- sectoral arrangements to serve industrial policy– Coal and autos wagons are served– Citrus not served

Take-Away Points: Micro-level AnalysisRevelations

• Unregulated third party logistics pricing makes containers uncompetitive at current service levels– Citrus

Take-Away: Economic Regulator Role• Economic regulator needed to resolve pricing, access and

investment disputes constraining GFB volumes• Given monopolistic structure regulatory regime should be based

on:– Proactive performance monitoring– Reactive regulated arbitrage model encouraging

commercial decisions over pricing, access and new investment within set out parameters

– Complainant has burden of proof based on certain tests• Fast-track interim regulator before regulator is bound by possible

‘anti-competitive’ long-term contractual regimes• Should there be a formal process for quasi-regulator & sectoral

arrangements that include DTI and EDD for resource allocation towards key sectors, before the setting up of regulator?

THANK YOU

DISCUSSION