freight rail Review performance review of regulatory regime governing freight rail investment and pricing decisions –

1. freight rail Reviewperformance review of regulatory regime governing freight rail investment and pricing decisions – DRAFT FInDINGS BasaniBaloyi, 18 February 2014

2. 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

3. Research BackgroundObjectives / Key Questions / Approach

4. 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

5. 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?

6. 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 ?

7. 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

8. Global PerspectivePerformance and Regulation

9. Global Map

10. Global Map: Size of Freight Rail Business

11. Comparison of Freight Rail Performance

12. 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.

13. Global Cases of Regulatory Systems

14. South African PerspectiveRegulatory Regime and Policy

15. 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, Company’s Act, • Regulatory instruments: shareholder compact, revenue projections and approval of corporate plans • Therefore performance based regulatory regime

16. SA Regulatory Regime interpretation of Overarching Economic and Industrial Policy

17. Shareholder compact negotiated corporate strategy MDS, Gearing, Profitability, Investment, Vol, Operational eff, service delivery Quantum Leap Gearing, Profitability, Investment, Vol Operational eff, Service delivery Growth Gearing, Profitability, Investment, Operational eff, Vol Rev: Vol > Price Turnaround Gearing, Profitability, Investment Rev: Vol > Price R 194.4 b R 54.6 b R 34.8 b R 31.5 b Financial Stability; Freight focus; Grp Target GROW BUSINESS: Investments, GFB volumes; integrated planning, Divisional Target

18. Transnet (Freight Rail) Strategy Financing Strategy No govtguantree Cash from operations Rest capital market GFB Volumes growth Operational Efficiencies Key Corridor Key Commodity Investments in GFB > Coalex and Orex 6 corridors selected Commodities: mainly bulk, agriculture (grain), automotives & containers

19. Regulatory Regime at Macro-Level Outcomes and Evaluation: investment, competitiveness and investment

20. Corporate Plans: Investment targets Bulk have targeted GRB

21. Actual investments Have targeted GFB; however mainly used for sustaining investments

22. Volume: Iron ore on Target

23. Volume: Coalex not on Target

24. Volume: gfb not on target and not ambitious

25. Service: Wagon turn around time improvement for GFB.

26. Service: Locomotive Efficiency stagnant for GFB

27. Tariff Growth higher than volumes growth

28. TFR’s RISING TaRriffS FOR INVESTMENT tariff - Revenue per tonnehigher than road in 2011 and 2012

29. 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.

30. 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

31. Unpacking TFRs pricing model

32. Differentiated Pricing Model

33. 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

34. Bigger Volumes = Better Prices = Better Access Differentiated Pricing  Volumes  Access • MegaRail: minimum 30 loaded wagons, 5 days a week, annual contract • Only once slots, locos, crews are allocated for MegaRailis 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

35. Costs due to Lack of Standardisation Differentiated Pricing  Network technology  Costs

36. Costs due to complexity of GFB network Differentiated Pricing  Network technology  Costs But how are overheads costs and depreciation distributed across the network?

37. Regulatory Regime at Micro-Level Outcomes and evaluation:TFRs Investment, Pricing and Access Rules using 3 Case studies

38. Case Study 1 : CoalexAccounting for the Volume Gap

39. Coalex: Snapshot Significance to economic and industrial policy • Coalex’ssignificance 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

40. 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

41. 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 • 9year 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

42. CoalexGap: 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

43. Case Study 2 : CitrusAccounting for no volumes on Rail

44. 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

45. 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 %

46. 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

47. 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

48. Citrus Exports: Pricing Dispute

49. Case Study 3 : AutoQuasi-regulator and autos arrangements

50. 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