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. Last Updated: 07/27/2016

Rail Freight Privatization Dawdles as Reformers Tussle

VedomostiMore than half of the 20,000 engines that Russian Railways owns are used exclusively for freight haulage, which accounts for more than 70 percent of the state-owned company’s total revenue.

Russia’s rail freight transport system, the third-largest in the world, is waiting for a privatization shift. A lull in reform has set in across Russia’s railroads as a whole, but it has been particularly conspicuous in the already partially liberalized freight sector that still makes up more than 70 percent of total revenue for Russian Railways, or RZD.

Oil and gas pipelines aside, rail freight carries 85 percent of goods in Russia, state-owned monopoly RZD wrote recently in the prospectus for its eurobond launch. Yet the slowdown in Russian industry during the crisis meant that last year, freight turnover on Russian railroads dropped to 2,271.3 billion metric ton-kilometers from 2,423.8 billion in 2008.

Now the Russian government and RZD are in a debate over what the next steps should be for the nascent liberalization of freight transport, as the sector returns to activity thanks to an improvement in the economy. To facilitate the process, the Council for Rail Operators partnership has helped set up a self-regulating organization between RZD and private companies, establishing a number of key groups “to nudge the monopoly toward its conclusion, modernize technological processes and create transparent systems of legal relations,” said Dmitry Korolyov, the council’s executive director.

Reforms of the freight sector first began in earnest in the early 2000s, but at the moment “RZD is seeking to persuade the Russian government to cancel part of its planned market liberalization … If the government accedes to RZD’s wishes, it could undermine the potential midterm prospects of private operators,” analysts at Otkritie wrote in late March. RZD’s desire is that the government will abandon its plans to annul a standard infrastructure tariff that the group still charges Russia’s 2,000 private freight operators; about 30 percent of the tariff covers the use of state-owned locomotives.

RZD says it currently owns about 20,000 locomotives, more than half of which are used exclusively for freight transportation, either by the company or out on lease as part of the tariff deal. Yet a number of the larger private operator companies also have their own locomotives but cannot use them freely. “We own some of our locomotives, too,” said Sergei Stankovin, board member of private operator the Far Eastern Transport Company, “but there’s no coherent system for how we use them — it’s an ad hoc arrangement.”

Liberalization of the operation of locomotives could increase the revenue of GlobalTrans, the biggest private freight operator, by $240 million, Otkritie calculated. The only private operator to have a portion of its stock — 35 percent — listed on the London Stock Exchange, GlobalTrans operates some of its 60 locomotives but leases out the rest, said Mikhail Perestyuk, the company’s investor relations manager.

Despite not yet being able to benefit from such untapped sources of revenue, private operators are still able to make money, and the RZD monopoly is not a major hindrance to the rail freight sector. “The Russian freight market has a bright future,” said Marcus Montenecourt, general director of Transolutions CIS, a rolling stock component manufacturer bought in 2006 by U.S. giant Amsted Rail. “Freight transport is profitable, although it is still only quasi-market oriented,” Montenecourt explained. When costs such as the empty repositioning tariffs that currently “kill everybody” are removed, he said, market conditions for private operators will be better still.

The two major changes required in the current system are the creation of a more transparent tariff policy on goods and a faster approach to privatizing depots and repair services of rolling stock, said Montenecourt, who has worked in Russian rail freight for the past 20 years. Cargo tariffs are currently laid out according to three classes of goods. The highest charges are on Class 3 goods, such as petrochemicals, which provide the greatest margins. RZD itself mostly transports cargo from this category. Repair services for rolling stock are standardized, which means that “you pay for it but don’t necessarily get quality,” Montenecourt said. In 2008 and 2009, RZD divested 16 of its numerous depots across the country, yet these were “not exactly the best depots,” Montenecourt said. "The continuing reform is very important — they have embarked upon it, but they are lagging.”

RZD’s and the government’s possible divergence of short-term aims may lie in the fact that “RZD has gone quite far from the reality of the economy,” explained Stankovin. “We need reforms because there is not enough money to replace existing rolling stock, and the railroads need to support all areas of the economy — this is a question that probably affects all the ministries because of the reliance on infrastructure,” he added.

Indeed, the top job at RZD has long been a coveted position among Russian politicians, with Vladimir Yakunin, the current company president, having previously faced competition for the appointment from Igor Levitin, today’s transport minister, numerous press reports said at the time of Yakunin’s appointment. Levitin himself also previously worked at Severstaltrans, now rebranded as N-Trans, the trading name for the parent of GlobalTrans.

RZD appears not entirely opposed to further privatization and is planning to create a new subsidiary operating company, Freight Two, to divest the remainder of its vast rolling stock assets. This should happen by the end of 2011, Korolyov estimated. RZD already fully owns several freight divisions, including Freight One, which holds more than 200,000 units of rolling stock — about 21 percent of Russia’s total — and is now worth $5 billion, said Salman Babayev, Freight One’s general director. Indecision had reportedly set in over how to structure the proposed public equity sales in the two companies, but Freight One now plans to sell 51 percent of its shares in the fall, Babayev announced, with up to 30 percent of shares issued in an IPO.