1. FREIGHT RAIL REVIEW PERFORMANCE REVIEW OF REGULATORY REGIME GOVERNING FREIGHT RAIL INVESTMENT AND PRICING DECISIONS – DRAFT FINDINGS B ASANI B ALOYI, 18 F EBRUARY 2014

2. O UTLINE 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. R ESEARCH B ACKGROUND OBJECTIVES / KEY QUESTIONS / APPROACH

4. R ESEARCH O BJECTIVES 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. R ESEARCH Q UESTIONS 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. R ESEARCH Q UESTIONS (C ONTD.) 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. A PPROACH 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. G LOBAL P ERSPECTIVE PERFORMANCE AND REGULATION

9. G LOBAL M AP

10. G LOBAL M AP : S IZE OF F REIGHT R AIL B USINESS

11. Comparison of Freight Rail Performance Train PerformanceFreight Performance CountryTrain km (millions) Tonne/km (millions) Mt10 year CARG % Freight Tonne/km US7944,495,19617100.72,254,585 China18244,198,0542,562,635 Russia14734,043,7832,127,832 India10221,445,8699226.6625,723 Canada115646,8243100.8254,069 SA60170,083182.10.2113,342 Australia29101,9562425.759,649

12. G LOBAL C OMPARISON : 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. G LOBAL C ASES OF R EGULATORY S YSTEMS CountryOwnership StructureKey Features of System USAPrivate vertically integrated with four main rail companies Minimal regulation to encourage commercial decisions Regulates mergers and acquisition activity Minimal regulation on pricing Inconsistent performance monitoring Settle disputes when there are complaints CanadaPrivate vertically integrated duopoly Medium regulation but encourages commercial decisions Regulates pricing, access, service Settle disputes when there are complaints Australiavertically separated private and public More regulation Regulates pricing, access, service, new investment Monitors performance Settles disputes when there are complaints

14. S OUTH A FRICAN P ERSPECTIVE REGULATORY REGIME AND POLICY

15. SA R EGULATORY R EGIME : P ERFORMANCE B ASED 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 R EGULATORY R EGIME INTERPRETATION OF O VERARCHING E CONOMIC AND I NDUSTRIAL P OLICY Macroeconomic Policy Microeconomic Policy DOTDPE Phase 1: 1980s- early 2000s PrivatisationCompetitive 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 goods SOE buying power for BEE & industrial development Max SOE developmental impact through procurement & investment Less B/S financing to boost investment, esp GFB intermodality

17. MDS, Gearing, Profitability, Investment, Vol, Operational eff, service delivery R 194.4 b Quantum Leap Gearing, Profitability, Investment, Vol Operational eff, Service delivery Quantum Leap Gearing, Profitability, Investment, Vol Operational eff, Service delivery R 54.6 b Turnaround Gearing, Profitability, Investment Rev: Vol > Price Turnaround Gearing, Profitability, Investment Rev: Vol > Price R 31.5 b Financial Stability; Freight focus; Grp Target Growth Gearing, Profitability, Investment, Operational eff, Vol Rev: Vol > Price Growth Gearing, Profitability, Investment, Operational eff, Vol Rev: Vol > Price R 34.8 b GROW BUSINESS: Investments, GFB volumes; integrated planning, Divisional Target S HAREHOLDER COMPACT NEGOTIATED CORPORATE STRATEGY

18. T RANSNET (F REIGHT R AIL ) S TRATEGY Financing Strategy No govt guantree Cash from operations Rest capital market Financing Strategy No govt guantree Cash from operations Rest capital market Key Corridor Key Commodity Investments in GFB > Coalex and Orex Key Corridor Key Commodity Investments in GFB > Coalex and Orex GFB Volumes growth Operational Efficiencies GFB Volumes growth Operational Efficiencies 6 corridors selected Commodities: mainly bulk, agriculture (grain), automotives & containers 6 corridors selected Commodities: mainly bulk, agriculture (grain), automotives & containers

19. R EGULATORY R EGIME AT M ACRO -L EVEL OUTCOMES AND EVALUATION: INVESTMENT, COMPETITIVENESS AND INVESTMENT

20. C ORPORATE P LANS : I NVESTMENT TARGETS Bulk have targeted GRB

21. A CTUAL INVESTMENTS Have targeted GFB; however mainly used for sustaining investments

22. V OLUME : I RON ORE ON T ARGET

23. V OLUME : C OALEX NOT ON T ARGET

24. V OLUME : GFB NOT ON TARGET AND NOT AMBITIOUS

25. S ERVICE : W AGON TURN AROUND TIME IMPROVEMENT FOR GFB.

26. S ERVICE : L OCOMOTIVE E FFICIENCY STAGNANT FOR GFB

27. T ARIFF G ROWTH HIGHER THAN VOLUMES GROWTH

28. TFR’S RISING TARRIFFS FOR INVESTMENT TARIFF - Revenue per tonne higher than road in 2011 and 2012

29. M ACRO - LEVEL E VALUATION OF R EGULATORY R EGIME 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. M ACRO - LEVEL E VALUATION OF R EGULATORY R EGIME 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. U NPACKING TFR S PRICING MODEL

32. D IFFERENTIATED P RICING M ODEL Required ReturnCoalexAutoCitrus Return on Asset Base WACC (risk) Depreciation Tax Expenses Commodity profitability Cross-subsidisation

33. A CCESS R ULES 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. B IGGER V OLUMES = B ETTER P RICES = B ETTER A CCESS 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

35. C OSTS DUE TO L ACK OF S TANDARDISATION Differentiated Pricing  Network technology  Costs

36. C OSTS DUE TO COMPLEXITY OF GFB NETWORK But how are overheads costs and depreciation distributed across the network? Differentiated Pricing  Network technology  Costs

37. R EGULATORY R EGIME AT M ICRO -L EVEL OUTCOMES AND EVALUATION: TFRS INVESTMENT, PRICING AND ACCESS RULES USING 3 CASE STUDIES

38. C ASE S TUDY 1 : C OALEX A CCOUNTING FOR THE V OLUME G AP

39. C OALEX : S NAPSHOT 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

40. C OALEX : S NAPSHOT (C ONTD ) 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. C OALEX GAP : I NVESTMENT D ISPUTES 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

42. C OALEX G AP : A CCESS D ISPUTE 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. C ASE S TUDY 2 : C ITRUS A CCOUNTING FOR NO VOLUMES ON R AIL

44. C ITRUS E XPORTS : S NAPSHOT Significance to economic and industrial policy NGP targeted rural development and agricultural sector for labour intensive growth Industrial Policy targets regional industrialisation

45. C ITRUS E XPORTS : S NAPSHOT 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. C ITRUS E XPORTS : I NVESTMENT N EEDS 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. C ITRUS E XPORTS : I NVESTMENT D ISPUTE 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. Letistele (Limpopo) average cost per plt 28 standard (2010) Average cost per plt 26 standard (2010) RailR 610R 640 RoadR 643R 692 DifferenceR 33R 52 C ITRUS E XPORTS : P RICING D ISPUTE

49. C ASE S TUDY 3 : A UTO Q UASI - REGULATOR AND AUTOS ARRANGEMENTS

50. A UTO S ECTOR : 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

51. A UTO : P OTENTIAL FOR I NDUSTRIAL P OLICY 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.

52. M ICRO -L EVEL E VALUATION OF C ASES 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

53. M ICRO -L EVEL E VALUATION OF C ASES 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

54. H OW 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?

55. 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 H OW OTHER REGULATORS DEAL WITH DISPUTES ?

56. 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 H OW OTHER REGULATORS DEAL WITH DISPUTES ?

57. W HERE ARE WE NOW ?

58. W HAT 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

59. C ONCLUSION

60. 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

61. 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

62. 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

63. Take-Away Points: Micro-level Analysis Revelations Unregulated third party logistics pricing makes containers uncompetitive at current service levels – Citrus

64. 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?

65. T HANK YOU DISCUSSION