The economic case for rail in inter-capital freight — tackling key impediments AusRAIL 2004 11 November 2004.

The economic case for rail in inter-capital freight — tackling key impediments
AusRAIL 2004 11 November 2004

Port Jackson Partners Limited
ROAD AND RAIL ECONOMICS § While there is a very strong ‘case for rail' emerging, it flies in the face of the long–term trends and there is much scepticism to overcome — in short, rail faces a credibility issue § There are several significant impediments preventing rail achieving its full potential, four of which we will discuss today § Overcoming these impediments requires the industry to work together to drive the reform agenda 11 November 2004 Port Jackson Partners Limited 1

Any good news story for rail flies in the face of a long–term and continuing decline; posing some hard questions TRENDS IN MODAL SHARE — ROAD VERSUS RAIL Percentage share of land freight by net tonne kilometres for inter capital corridors "With no change in relative input costs, and in the absence of a solution to some of rail’s logistic difficulties relative to road, the long-term decline in rail’s share of the freight market is unlikely to change." BTRE, 2003 Actual Forecast 100% Key questions 90% 80% • Is inter-city rail freight in terminal decline, or can it make a significant contribution to the national economy? • If it can make a significant contribution, what in broad terms is required to make this happen? Road 70% 60% 50% 40% Rail 30% 20% 10% 0% 1972 1980 1990 2000 2010 2020 Source: Bureau of Transport and Regional Economics (BTRE), Working Paper 40: Competitive neutrality between road and rail, 1999 11 November 2004 Port Jackson Partners Limited 2

In 1999 the then BTE's view was based in part on the well established phenomenon that all technologies have finite ‘life-cycles’ — and that rail was reaching its ‘technological limits’ and would be replaced by road STYLISED SEQUENTIAL GROWTH OF US TRANSPORT MODES Market saturation (percent) ILLUSTRATIVE 100 80 60 40 20 Canals Railways Roads Air travel 1750 1800 1850 1900 1950 2000 Source: BTRE, Working Paper 40: Competitive neutrality between road and rail, 1999 11 November 2004 Port Jackson Partners Limited 3

However, while recognising that the evidence is mixed, we would argue that it is a bit early to be writing rail's obituary IS RAIL REALLY FINISHED? — THE EVIDENCE IS MIXED On one hand ... ... but on the other hand • Successful trajectories for intermodal freight railways in the US and Canada after industry reform • ‘World Class’ Pilbara railways in Australia • Success of intermodal freight on the East West corridor in Australia • Road is losing share of intermodal freight on the East Coast (North South) 11 November 2004 Port Jackson Partners Limited 4

The US rail industry saw great gains in productivity and volume since it underwent major industry reform (and deregulation) in the 1980s TRENDS IN US RAIL PRODUCTIVITY: 1964–PRESENT Rail KPIs change relative to 1981 base (100) 300 1980: Staggers Act replaces Interstate Commerce Act which prevented: - pricing freedom - horizontal mergers - divestment of assets - confidential contracts Productivity By 1976: 1/3 of Rail co’s bankrupt; maintenance deferred on low density lines; network deteriorates 250 200 ’60s and ’70s: ROI for Rail co’s falls to 2.5% Volume 150 100 Revenue 50 Price 1964 1970 1976: 63 Class I Rail companies 1980 1990 1997: 7 Class I Rail companies 2000 2010: 4 Class I Rail companies? Source: Cambridge Systematics, Freight trends and freight rail, 2002 11 November 2004 Port Jackson Partners Limited 5

The East-West corridor has been the major success story for rail... TREND IN RAIL FREIGHT MARKET SHARE ON THE EAST WEST CORRIDOR Percentage share of land transport Characteristics • Long distances (>1000km) naturally favour rail • High quality, straight track • 1,800m trains with double stacking • Service levels and rail performance are competitive with road 0% 10% 20% 30% 40% 50% 60% 70% 80% 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Eastern states - Perth Source: BTRE Information sheet 22: Freight between Australian capital cities, 2003 11 November 2004 Port Jackson Partners Limited 6

... whereas rail's successes are yet to extend to the North South routes, particularly on the shorter corridors. The general wisdom is that that this reflects the natural distance–economics of rail versus road. . . TREND IN RAIL FREIGHT MARKET SHARE Percentage share of land transport East West characteristics • Long distances (>1000km) naturally favour rail • High quality, straight track • 1,800m trains with double stacking • Service levels and rail performance are competitive with road 80% Eastern states - Perth 70% 60% 50% 40% Mel-Bne North South characteristics • Shorter distances (<1000km for Sydney Brisbane and Melbourne-Sydney) • Speed restrictions; old sleepering • 1,200-1,500m trains and single stacked • Service levels and rail performance are much worse than road 30% 20% Syd-Bne 10% Mel-Syd 0% 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Source: BTRE Information sheet 22: Freight between Australian capital cities, 2003 11 November 2004 Port Jackson Partners Limited 7

. . . and hence the BTRE's observation when you consider most freight moves on the short east coast corridors FREIGHT VOLUMES AND MODAL SHARES ON THE INTERCAPITAL CORRIDORS Current megatons per year Implication for modal share Actual Forecast 20.5 100% 90% 80% Road 70% 60% 50% 40% Rail 30% 4.4 20% 10% 0% North South East West 1972 1980 1990 2000 2010 2020 Source: BTRE Information sheet 22: Freight between Australian capital cities, 2003 11 November 2004 Port Jackson Partners Limited 8

The best place to answer this hard question is to address rail's challenge on the North South WHY DOES RAIL STRUGGLE ON THE EAST COAST - FOUR TOPICS FOR TODAY 1. Performance and service levels are worst on the North South (but there are plans in place to address this) 2. The lack of competitive neutrality in infrastructure access pricing (i.e., heavy vehicles are subsidised) hurts rail more on the shorter routes • Infrastructure cost allocation and recovery are flawed • Externalities are ignored 3. Insufficient "vertical coordination" between above and below rail imposes unnecessarily high costs and inhibits investment 4. ‘Pick up and delivery’ (PUD) costs forms a greater share of the value chain on shorter corridors, but are not being tackled as a ‘strategic imperative’ by the industry 11 November 2004 Port Jackson Partners Limited 10

Rail's current capability on the North South is significantly below East West levels RELATIVE PERFORMANCE CHARACTERISTICS Key Parameter East West Melbourne-Brisbane Average speed 70 kph 55 kph Double stacking Yes No Train length 1,800m 1,500m Tonnes per train 2,600 tonnes* 1,400 tonnes On time performance 70% 45% Service availability 85% 60% * Assumes 60% double stacking Source: Booz Allen & Hamilton/ARTC, Interstate Rail Network Audit, 2001; PJPL analysis 11 November 2004 Port Jackson Partners Limited 11

Significant capital is needed, and is now committed, to overcome the past maintenance deficit on the North South corridor NORTH SOUTH CORRIDOR INVESTMENT PLANS Billion dollars Examples of specific projects 1.1 Cost Newcastle to Brisbane signalling and passing $119m Southern Sydney freight access line $192m Melbourne to Sydney - new loops, resleepering, Murrumbidgee bridge replacement $240m Melbourne to Brisbane - resleepering and bridge strengthening $57m Sydney Brisbane urban freight access $55m Duplication for Wallarobba to Stratford $109m Ease curves Newcastle to Brisbane $158m New TCS Qld border to Acacia Ridge $15m New sleepers Newcastle to Brisbane $113m Wodonga Rail bypass $20m Standardising track Melbourne to Albury-Wodonga $25m ARTC 0.6 Auslink 0.5 Planned investment* * ARTC and Auslink figures only include spending related to the East Coast inter-capital routes Source: Booz Allen & Hamilton/ARTC, Interstate Rail Network Audit, 2001; DoTaRS, Auslink White Paper and factsheets, 2004; ARTC website information on NSW lease; PJPL analysis 11 November 2004 Port Jackson Partners Limited 12

This investment will make a material impact on track performance
This investment will make a material impact on track performance. Recognising there is a lot to be done to achieve this, this is none–the–less a problem with a clear solution Road IMPACT OF ARTC TRACK INVESTMENT ON SERVICE CHARACTERISTICS Rail today Rail improvement Today's performance After investment in track improvements Transit time Reliability* Availability** Transit time Reliability* Availability** hrs % % hrs % % 15 95% 99% 15 95% 99% Syd-Bne 21 50% 25% 17 75% 60% 11 95% 99% 11 95% 99% Mel-Syd 13.5 55% 50% 10.5 75% 75% 33 95% 99% 33 95% 99% Mel-Bne 36 45% 60% 29 75% 85% * Percent of services arriving within 15mins of scheduled time ** Extent to which mode offers services at times the market demands Source: Booz Allen & Hamilton/ARTC, Interstate Rail Network Audit, 2001; Memorandum on ARTC lease of NSW track, June 2004 11 November 2004 Port Jackson Partners Limited Port Jackson Partners Limited Port Jackson Partners Limited 13

The absence of competitive neutrality in access charging is a critical issue with a clear solution, but is proving for more difficult to solve WHY DOES RAIL STRUGGLE ON THE EAST COAST - THREE TOPICS FOR TODAY 1. Performance and service levels are worst on the North South (but there are plans in place to address this) 2. The lack of competitive neutrality in infrastructure access pricing (i.e., heavy vehicles are subsidised) hurts rail more on the shorter routes • Infrastructure cost allocation and recovery are flawed • Externalities are ignored 3. Insufficient "vertical coordination" between above and below rail imposes unnecessarily high costs and inhibits investment 4. ‘Pick up and delivery’ (PUD) costs forms a greater share of the value chain on shorter corridors, but are not being tackled as a ‘strategic imperative’ by the industry 11 November 2004 Port Jackson Partners Limited 14

There are three different methodologies used internationally for estimating road costs and therefore setting road access charges METHODOLOGIES FOR CALCULATING ROAD USE COSTS DESCRIPTION EXAMPLES POSSIBLE IMPACT 1. ‘Equity’ • Allocate all costs between users • May or may not refer to marginal costs as a lower bound for allocations • NRTC approach (i.e. current Australian ‘PAYGO’ regime) • UK NERA approach • US federal studies • EU Commission study • Outcome is heavily dependent on how ‘non-separable’ costs are allocated—by VKT* or PCU*. Current dominant methodology internationally; favours heavy vehicles if non separable costs are allocated by VKTs 2. Engineering • Estimate the marginal cost of road usage, including impact on other road users due to road damage, based on engineering models • ‘Direct’ — uses pavement management system models (e.g. HDM4) to estimate the marginal cost of road use • ‘Indirect’ — uses Newbery's theorem, linking ESALs* to wear • If Marginal cost < Average cost then will reduce costs and will fall short of PAYGO • If Marginal cost = Average cost, then because allocations are made based on ESALs*, it will result in increased heavy vehicle costs 3. Econometric • Use economic models on historical datasets to estimate the impact of traffic on costs • Only works if there are strong datasets (few available now) • VKT*, GVM*, ESAL* are correlated, making estimation of impact difficult • The Link Study (2002) • Li et al. (2001) • Martin (1994) • If successful, likely to result in increased allocation to heavy vehicles BUT currently does not take account of road damage externalities * VKT = Vehicle Kilometre Travelled; PCU = Passenger Car Unit; GVM = Gross Vehicle Mass; ESAL = Equivalent Standard Axle Load Source: Bruzelius N., Measuring the Marginal Cost of Road Use—An International Survey, 2003 11 November 2004 Port Jackson Partners Limited 15

Australia uses the ‘Equity’ method, which attempts to produce a fair allocation of costs between road users and is thus subject to broad interpretation EQUITY OR CLUB APPROACH — BASIC FORMULA HOW ALLOCATED COMMENTS Separable • Allocated based on wear and tear impact – usually ESALs* or GVM* • Many different bases upon which costs are allocated • No damage externalities taken into account in allocating costs Allocated Non-separable • Allocated ‘arbitrarily’ – generally based on VKTs* • French use PCUs* • BTRE** uses PCUs* All costs Non-allocated • Not allocated • Not allocated * VKT = Vehicle Kilometre Travelled; PCU = Passenger Car Unit; GVM = Gross Vehicle Mass; ESAL = Equivalent Standard Axle Load ** Bureau of Transport and Regional Economics Source: NRTC, Updating Heavy Vehicle Charges - Technical Paper, September 1998; BTRE, Working paper 40: Competitive neutrality between road and rail,1999; Team analysis 11 November 2004 Port Jackson Partners Limited 16

Trucks underpay at three levels, they are treated as a car for costing capacity (but take more space), the heavier vehicles (competing with rail) pay less than they should for the damaged caused, and the absence of mass-distance charging favours longer distance shipments COMPARISON OF NRTC AND BTRE HEAVY VEHICLE ROAD COST ALLOCATIONS $ per '000ntk Parameter % of costs Impact from moving from: Allocates all costs to trucks with ~55% going to the heaviest vehicles ESAL* 44% 74% NRTC BTRE Cost for use (damage) Allocates all costs to trucks with ~50% going to the heaviest vehicles GVM** 26% 6% Separable 30% 45% Average heavy truck modelled as being equivalent to 3.5 cars based on 'footprint' $7.8 $11.8 PCU*** 31% 8% Total road expenditure - Opex (e.g. servicing - Capex (e.g. pavement construction) VKT*** 0% 12% Allocated NRTC does not differentiate between cars and trucks for 70% of road costs $9.1 $15.1 GVM 0% 6% All costs $9.4 $15.4 Non-separable PCU 0% 89% Need for road (capacity) 70% 55% $1.3 $3.3 Non-allocated Cars and trucks treated as having equal impact on road costs $0.3 $0.3 VKT 100% 5% * ESAL = Equivalent Standard Axles Loads ** GVM = Gross Vehicle Mass - passenger vehicles are given a value of 0.0 *** PCU = Passenger Car Units - a measure of the space taken up by a vehicle on the road **** VKT = Vehicle Kilometres Travelled Source: NRTC, Updating Heavy Vehicle Charges - Technical Paper, September 1998; BTRE, Working paper 40: Competitive neutrality between road and rail,1999; Team analysis 11 November 2004 Port Jackson Partners Limited 17

Road incurs significantly higher externalities than rail, largely due to accident costs and the effect of greenhouse gases COST OF ‘EXTERNALITIES’—RURAL AREAS Greenhouse Gases $ per '000ntk Accident costs Noise Pollution Air Pollution Congestion Costs* Low Case High Case Difference 10.0 0.8 0.5 8.4 0.8 0.3 6.0 4.6 7.0 3.8 6.7 3.2 1.6 3.0 0.8 0.3 1.4 0.2 1.7 1.1 0.6 0.8 0.6 Road Rail Road Rail Low Case Assumed High Case * Note that increased rail usage will incur road congestion costs around terminals Source: Laird P., Land freight external costs in Queensland, 2002; BTRE, Working paper 40: Competitive neutrality between road and rail,1999; Team analysis 11 November 2004 Port Jackson Partners Limited 18

Changing the methodology used to determine heavy vehicle road use costs, to reflect the latest developments in transport economics, would greatly increased access charges IMPACT OF CHANGES TO THE CURRENT COST ALLOCATION METHODOLOGY $ per '000ntk Var Opex Fixed Opex Higher proportion of costs treated as separable and allocated by mass-distance measures MPM Capex As current NRTC allocation but non-separable expenditure allocated by PCUs rather than VKTs Externalities* 21.1 17.4 6.0 15.1 Implied >100% increase 6.0 6.0 6.5 9.1 5.1 3.9 3.9 3.8 2.5 2.2 2.2 1.0 0.7 0.7 1.3 3.8 2.3 2.3 2.5 NRTC today NRTC (with externalities) NTRC (externalities plus PCU) BTRE * Net charge for the difference in Road/Rail externality costs - based on the mid-range of a number of studies on externality costs for rural areas Source: NRTC, Updating Heavy Vehicle Charges – Technical paper, September 1998; BTRE, Working paper 40: Competitive neutrality between road and rail,1999; Queensland Government Rail Studies, 2002 11 November 2004 Port Jackson Partners Limited 19

Likewise, the issue of vertical coordination is both important and solvable with sufficient goodwill and practical planning within the industry WHY DOES RAIL STRUGGLE ON THE EAST COAST - THREE TOPICS FOR TODAY 1. Performance and service levels are worst on the North South (but there are plans in place to address this) 2. The lack of competitive neutrality in infrastructure access pricing (i.e., heavy vehicles are subsidised) hurts rail more on the shorter routes • Infrastructure cost allocation and recovery are flawed • Externalities are ignored 3. Insufficient "vertical coordination" between above and below rail imposes unnecessarily high costs and inhibits investment 4. ‘Pick up and delivery’ (PUD) costs forms a greater share of the value chain on shorter corridors but are not been tackled as a ‘strategic imperative’ by the industry 11 November 2004 Port Jackson Partners Limited 20

Separating ownership of track and trains has been driven by the desire to create competitive markets within a number of rail industries, however, it is generally recognised this comes with a cost that harms rail's competitiveness against other modes. This impact is most felt on shorter corridors. PERSPECTIVES ON VERTICAL CO-ORDINATION 'The provision of many innovative and market-responsive rail services may require specific investment in infrastructure. It may be difficult and inefficient for any operator to co-ordinate with the infrastructure monopoly, especially if their incentives with respect to investment behaviour are not in harmony.' OECD, Railways: Structure, Regulation and Competition Policy, 1998, pp 'From a technical and operational perspective, railways are considerably more complicated than other network industries in terms of physical planning, coordination, safety, switching and administration'. Canada Transportation Act Review Panel 2001b, p.58 'Technological developments are increasingly focused on the wheel–rail interface for productivity gains In essence, the risk arises that the industry loses the dynamic trade-offs that can be made in wheel and rail decision-making'. BTRE Working paper 109 Rail Infrastructure Pricing, 2003 p. 19 11 November 2004 Port Jackson Partners Limited 21

Four areas have been identified where impaired ‘vertical coordination’ may be unnecessarily harming industry performance FOUR TYPES OF 'VERTICAL COORDINATION' NEED TO BE ADDRESSED Description Example Operational • Operational activities or decision making, including operational negotiation between above and below rail operators. Also extends to safety • Optimising wheel maintenance and rail track grinding to minimise "through-chain" costs • Optimising train speeds and track utilisation to maximise through-chain profits and safety • Minimising time consuming/difficult negotiations over timetabling and access arrangements Capital Investment • Investment delayed waiting both above and below rail sign-off as co-ordinated investment is required • Investment in passing loops • Customer specific sidings Risk Management • Difficulty of installing track monitoring equipment for benefit of above rail • Equipment to monitor condition of bearings would help train operators, and reduce derailments Marketing • Customer acquisition and retention initiatives requiring coordination between above and below rail • Better control over customer offering and customer service • New customer introductory rates to attract them away from road (modal shift requires significant customer investment) 11 November 2004 Port Jackson Partners Limited 22

There are many examples at the operational level that could be quickly addressed without trying to tackle everything at once EXAMPLES OF POTENTIAL AREAS FOR IMPROVED VERTICAL COORDINATION Potential value ($'000 per annum) Example Detailed explanation Key assumptions On track refuelling Providing refuelling facilities on key loops would free up capacity/time in yards 500 On track refuelling saves 1 hour per journey on affected routes - saving crew time, allowing more effective use of yards and improving service reliability etc. Improved sharing of train position data Rail operators use GPS systems to track train movements. This data could be used by train controllers to improve network management 400 Key savings are crew time (e.g. overtime), headcount used in train monitoring activities, service penalties Upgrading of remaining manual signals and points Manual signals require driver to stop train 500 In deciding when to upgrade signals and points the track owner does not account for the fuel saved by not stopping and starting, injuries avoided, time saved, etc. Wheel grinding Improved maintenance of wheels reduces their impact on track wear tbd Cost of frequent wheel grinding is less than the cost of rail grinding/replacement. Whole of rail decisions are not being taken Source: Interviews with Industry operators 11 November 2004 Port Jackson Partners Limited 23

Finally, PUD costs are an "orphan issue" which the industry continues to ignore to its detriment WHY DOES RAIL STRUGGLE ON THE EAST COAST - THREE TOPICS FOR TODAY 1. Performance and service levels are worst on the North South (but there are plans in place to address this) 2. The lack of competitive neutrality in infrastructure access pricing (i.e., heavy vehicles are subsidised) hurts rail more on the shorter routes • Infrastructure cost allocation and recovery are flawed • Externalities are ignored 3. Insufficient "vertical coordination" between above and below rail imposes unnecessarily high costs and inhibits investment 4. ‘Pick up and delivery’ (PUD) costs forms a greater share of the value chain on shorter corridors but are not been tackled as a ‘strategic imperative’ by the industry 11 November 2004 Port Jackson Partners Limited 24

On short corridors PUD costs are a major share of total costs. While an inherent reality in rail economics this needs to be seen as a major challenge rather than an accepted problem outside rail's influence IMPACT OF PUD ON ABOVE RAIL COSTS PUD costs Line haul costs Average PUD costs PUD contribution to total cost $ per '000ntk 14 100% 100% 70% 89% 4 30% 11% Short haul (Melb Syd) Long haul (Syd Perth) Short haul (Melb Syd) Long haul (Syd Perth) Source: Industry data; PJPL analysis 11 November 2004 Port Jackson Partners Limited 25

There seems to be a strong relationship between PUD costs and rail's corridor-by-corridor performance TRENDS IN RAIL MARKET SHARE BY CORRIDOR Short Corridors Long Corridors Percentage share of land transport Percentage share of land transport 80% 80% PUD = 30% PUD = 11% 70% 70% Syd-Perth 60% 60% 50% 50% 40% 40% Mel-Adl 30% 30% Mel-Bne 20% Syd-Bne 20% 10% Mel-Syd 10% 0% 0% 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Source: BTRE, Information sheet 22: Freight between Australian capital cities, 2003 11 November 2004 Port Jackson Partners Limited 26

STRATEGIC LEVERS TO TACKLE PUD Area of opportunity Specific considerations Increase availability of customer sidings/spur lines Works for large customers in specific locations Terminal operations inefficiencies impose unnecessary costs onto PUD economics • Waiting times being the most obvious • Absence of efficient optimal scheduling around different customer requirements Absence of scale/coordination in current 'stand-alone PUD' versus ‘pooled PUD’ imposes costs additional costs everywhere • Too much capital • Sub-optimal movements • Mismatch of customer/train operator needs Strategic terminal location and design • How well do terminals fit customer locations? • Terminals should become like shopping centres— freight forwards co-locate consolidation facilities around the 'anchor tenants (i.e., rail operations) 11 November 2004 Port Jackson Partners Limited 27

The rail industry must not wait for these problems to be solved for it, but must aggressively drive its own agenda; three of the areas raised here are within the industry's direct control A THREE YEAR AGENDA? Challenge Action required Improve rail's service proposition on the East Coast Track owners and train operators must work together to bring rail's pricing and service offering in line with road — through cost reductions, improved track and train management and infrastructure upgrades — just waiting for the investment in track alone is insufficient Establish true competitive neutrality Rail industry must push for a full review of land transport infrastructure pricing arrangements Work is also required to establish the appropriate cost allocation methodology and measures, to better quantify externality costs for road and rail, and develop appropriate charging solutions to deliver these outcomes — mass distance charging is needed Improve vertical coordination Industry needs to establish formal mechanisms to rigorously tackle the interdependent nature of above and below rail operating cost efficiencies and investments— requiring some more innovative ways of cost/benefit/risk sharing than exists today Tackle PUD costs Industry needs to make fundamental changes to how it manages local pick up and delivery logistics to halve costs 11 November 2004 Port Jackson Partners Limited 29

The economic case for rail in inter-capital freight — tackling key impediments AusRAIL 2004 11 November 2004.

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The economic case for rail in inter-capital freight — tackling key impediments AusRAIL 2004 11 November 2004.

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