FREIGHT RAIL REVIEW

PERFORMANCE 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 TFRs pricing model
Micro-level Case Studies
Regulatory Regime: Investment / Pricing / Access Rules (citrus, autos,
and Coalex)
Where are we now?
Conclusion
RESEARCH BACKGROUND
OBJECTIVES / 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 Transnets 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 PERSPECTIVE
PERFORMANCE AND REGULATION
GLOBAL MAP
GLOBAL MAP: SIZE OF FREIGHT RAIL
BUSINESS
Comparison of Freight Rail Performance

Train Performance Freight Performance

Country Train km Tonne/km Mt 10 year Freight
(millions) (millions) CARG % 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 Minimal regulation to encourage commercial
integrated with four main decisions
rail companies Regulates mergers and acquisition activity
Minimal regulation on pricing
Inconsistent performance monitoring
Settle disputes when there are complaints

Canada Private vertically Medium regulation but encourages commercial

integrated duopoly decisions
Regulates pricing, access, service
Settle disputes when there are complaints
Australia vertically separated More regulation
private and public Regulates pricing, access, service, new investment
Monitors performance
Settles disputes when there are complaints
SOUTH AFRICAN PERSPECTIVE
REGULATORY REGIME AND POLICY
SA REGULATORY REGIME:
PERFORMANCE BASED
DoT
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, Companys 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 Microeconomic DOT DPE
Policy Policy

Phase 1: Privatisation Competitive Aim: seamless Privatise to max

1980s- logistics for & competitive shareholder value &
early exportables intermodal operational ef
2000s transport
system, boost
Phase 2: Capex for jobs Competitive general freight Max SOE
mid and growth logistics for value developmental
2000s - added goods Investments, impact through
present SOE buying End competitive procurement &
power for BEE & market, Interim investment
industrial economic
development regulator Less B/S financing to
boost investment, esp
GFB intermodality
SHAREHOLDER COMPACT NEGOTIATED CORPORATE
STRATEGY
MDS, Gearing,
Profitability,
Quantum Leap Investment, Vol,
Gearing, Operational ef,
Growth Profitability,
Gearing, service delivery
Turnaround Investment, Vol
Profitability, Operational ef,
Gearing, Investment,
Profitability, Service delivery
Operational ef, Vol R 194.4 b
Investment Rev: Vol > Price
Rev: Vol > Price R 54.6 b
R 34.8 b
R 31.5 b

Financial
GROW BUSINESS: Investments, GFB volumes; integrated
Stability; Freight
planning, Divisional Target
focus; Grp Target
TRANSNET (FREIGHT RAIL) STRATEGY

Financing Strategy Key Corridor GFB Volumes

No govt guantree Key Commodity growth
Cash from operations Investments in GFB > Operational
Rest capital market Coalex and Orex Efficiencies

6 corridors selected
Commodities: mainly
bulk, agriculture (grain),
automotives & containers
REGULATORY REGIME AT MACRO-
LEVEL
OUTCOMES AND EVALUATION:
INVESTMENT, COMPETITIVENESS AND INVESTMENT
 CORPORATE PLANS: INVESTMENT
TARGETS
160 Bulk have targeted GRB
140

120
R million

100 Coal line

Ore line
80
General Freight
60
Other
40

20

0
Turnaround Plan Growth Plan Quantum Leap MDS
 ACTUAL INVESTMENTS

Have targeted GFB; however

mainly used for sustaining General Freight
8.0 investments Coal
7.0
Iron ore
6.0
5.0
4.0
R bn

3.0
2.0
1.0
0.0
2009 2010 2011
VOLUME: IRON ORE ON TARGET

60

50

40

30 Target
20 Actual

10

0
2009 2010 2011 2012
VOLUME: COALEX NOT ON TARGET

80

70

60

Target
50
Actual

40
2009 2010 2011 2012
VOLUME: GFB NOT ON TARGET AND NOT
AMBITIOUS

100
90
80
70
60
Target
50
Logarithmi
40
c (Target)
30
20
10
0
2009 2010 2011 2012
SERVICE: WAGON TURN AROUND TIME IMPROVEMENT
FOR GFB.

16
GFB
14 Coal
12 Iron ore
10
days

8
6
4
2
0
 SERVICE: LOCOMOTIVE EFFICIENCY STAGNANT
FOR GFB

60000
GTL 000/locomotive/month

50000 GFB
40000 Coal
30000 Iron ore
20000

10000

0
 TARIFF GROWTH HIGHER THAN VOLUMES
GROWTH

Volume growth Target Volume growth Actual

25 Tarif growth Target Tarif growth Actual
20

15

10
%

0
2007 2009 2010
-5

-10
 TFRS RISING TARRIFFS FOR INVESTMENT

0.16

0.14

0.12
Revenue per tonne

0.1

0.08 TARIFF - Revenue per tonne

0.06 higher than road in 2011 and
0.04
Rail 2012
Road
0.02

0
2008 2009 2010 2011 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 TFRs access, service and pricing regime
to assess alignment with economic and industrial policy
UNPACKING TFRS PRICING
MODEL
DIFFERENTIATED PRICING MODEL

Required Return Coalex Auto Citrus

Return on Asset Base
WACC (risk)
Depreciation
Tax
Expenses
Commodity
profitability
Cross-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

Diferentiated Pricing Volumes 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
COSTS DUE TO LACK OF
STANDARDISATION
Diferentiated Pricing Network technology Costs
 COSTS DUE TO COMPLEXITY OF GFB
NETWORK
Diferentiated Pricing Network technology Costs

But how are overheads costs

and depreciation distributed
across the network?
REGULATORY REGIME AT MICRO-
LEVEL
OUTCOMES AND EVALUATION:
TFRS INVESTMENT, PRICING AND ACCESS RULES USING 3 CASE STUDIES
CASE STUDY 1 : COALEX
ACCOUNTING FOR THE VOLUME GAP
COALEX: SNAPSHOT

Significance to economic and industrial policy

Coalexs 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 TFRs 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 : CITRUS
ACCOUNTING 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
CITRUS EXPORTS: PRICING DISPUTE

Letistele average cost per plt 28 Average cost per plt 26

(Limpopo) standard (2010) standard (2010)

Rail R 610 R 640

Road R 643 R 692

Diference R 33 R 52
CASE STUDY 3 : AUTO
QUASI-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 tarif 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?
HOW OTHER REGULATORS DEAL WITH
DISPUTES?
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 proof
Canadian regulator handling of complaints over poor service
delivery
Contract must specify the service
If investigation finds breach of contract then application
of penalty
WHERE ARE WE NOW?
WHAT IS THE END GAME?
All stakeholders agree regulator needed, but not how
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
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.
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
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
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 Analysis
Revelations
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 Analysis
Revelations
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