By Nick Trickett
Judging by their importance to Russia’s economy, one might expect the local rail freight network to be in better shape. Russian Railways (RZhD) transports as much as 85% of Russia’s non-pipeline freight, with its fleet in many cases the only thing linking remote resource deposits, small towns, and sparsely-settled regions to civilization. Unfortunately, however, the system is an abject mess: policymakers have proven remarkably inept at managing the freight market due to a host of structural and cultural legacies, lack of financing, constant shifts in regulation, and top-down decision making.
Recent concerns over potential bread shortages in St Petersburg due to a lack of wagons for domestic grain shipments – a huge issue given the agricultural sector’s importance and high growth as of late – has thrust these problems back into the spotlight. The regulatory concerns that prompted this latest crisis date back to 2013, when RZhD recorded a surplus of 240,000 wagons. Speeds then were down to 11.6 kilometers per hour – their lowest since 1997 – and transportation costs comprised as much as 20% of Russia’s overall total. For comparison, speeds are closer to 45 kilometers per hour in the US and a little higher in Germany and China. Russian policymakers, still hostage to Soviet-era thinking, sensed at the time that the surplus was a problem for the economy, despite the fact that it stood to encourage competition between the private firms which controlled 80% of the freight market. They neglected to consider that what might be bad for a rail freight company could prove good for just about everyone else.
By intervening to control the rail fleet surplus, policymakers hoped to lower the costs of empty runs for cars – when a wagon has no cargo to carry as it returns to its origin. They also used the opportunity to push through reforms that mandated wagons of a certain age be replaced. In other words, dealing with the surplus was a essentially pretext for enriching RZhD and those who might profit from the artificial increase in domestic orders. Yet that style of intervention never works out well in Russia, producing a sort of zombie-stimulus: the sector’s up and walking, but remains unable to think, plan, or invest ahead and devours brains and resources that could be better used.
“…the sector’s up and walking, but remains unable to think, plan, or invest ahead and devours brains and resources that could be better used.”
For example, Customs Union regulations designed to limit lifetime extensions for privately owned locomotives and rolling stock were supposed to go into effect in 2014, but remain delayed because the market simply can’t supply what’s needed per the law. The regulatory shift was designed to inflate demand for domestically- sourced newer wagons with heavier load capacities. That would theoretically allow more freight to move on fewer cars, pull some rolling stock (read: wagons) off the tracks, and possibly increase average speeds if less time was spent at switches or loading and unloading. But that hasn’t happened: train speeds still hover around 12 kilometers an hour. China now looks increasingly likely to pull its subsidy support for transit routes to Europe, a serious blow given the planners’ hopes.
Going into this year, operators’ demand for newer wagons was essentially frozen. Most operators were running loads under 50% of the wagons’ capacity, when they’re only profitable at 50% capacity or higher. Further complicating matters, Kazakhstan then banned newer wagons on its rail network for about four months in 2017 because of fights over the presence of Chinese wagons on Central Asian rail networks – a restriction only lifted in early August. Russia’s United Wagon Company (UWC) seems to have benefitted from the regulatory impasse, but the company’s good news this year belies just how bad the bigger picture looks.
Good News for People Who Like Bad News
UWC’s production is reportedly up 24% through September this year, roughly 13,600 wagons total. But these new cars are mostly replacing older ones since UWC owns one of Russia’s few profitable factories – the Tikhvin Freight Car Plant – taking orders for newer production. In 2012, Russia’s total production peaked at 71,600 rail wagons. It bottomed at 29,900 in 2015 and recovered to 36,600 last year. The Tikhvin plant’s annual capacity is 18,000 wagons per its website. If one of the country’s few profitable producers of newer wagons is operating at two-thirds capacity, the picture is pretty bleak. In short, policymakers can’t simply create demand by demanding something, and since today’s production is geared towards replacement and not growth, there’s likely a bevy of foot-dragging on implementation to squeeze more money out of older models.
Because RZhD doesn’t directly control the local wagon fleet, the regulatory change was Russia’s primary mechanism to deal with the surplus. As a result, write-offs to retire older cars under the change have wracked the market. In August, Russia had an estimated 484,000 gondola cars – open-topped cars for resources like coal. 70,000 gondola cars have been retired since the beginning of 2016. September’s deficit ran at 16,000 cars for the gondola market. Estimates place the reduction of the total fleet regardless of car type at roughly 159,000 wagons since the beginning of 2015, around 13% of the total. Experts at a recent transport forum in Moscow stated that the rail network needs rolling stock reserve that’s 7-10% of the size of the total fleet to stabilize the market. Basically, they need to pull about 100,000 wagons out of a hat.
More is Less
The policy makers that pushed the regulatory change didn’t foresee the effect of reform and counter-sanctions on agricultural production, namely wheat. Since the harvest season began in July, Russia has recorded a 15.7% year-on-year increase in wheat exports, which reached 11.202 million tons as of October 18. Between July and September, wheat exports by train were up nearly 140% and reached 2.36 million tons. The Ministry of Agriculture is about to extend a 3 billion ruble credit to RZhD to finance further exports. Wheat is not lacking in Russia.
It’s perversely fitting that a century after the October Revolution, the mayor of St. Petersburg is again worrying about wheat shipments. Arkady Dvorkovich and RZhD have assured everyone that there will be no shortage, and that he will closely follow complications emerging from the greater stress placed on wheat exports at a time when there’s a systemic lack of wagons. Russia’s Federal Anti-Monopoly Service (FAS) has been pressuring RZhD to rethink its approach to the shortage. In particular, FAS has proposed purchasing a reserve fleet of wagons to cope with peak demand. Policymakers can’t seem to make up their mind as to where the market’s role starts and ends. The large presence of private firms has disrupted attempts to centrally plan.
Last October was the first time in 20 months that demand for new gondola cars exceeded retirements and that indicator has inched up since then. But gondola cars have seen consistent growth in their rental costs from 500 rubles a day in 2014-2015 to 1,500 rubles a day this year. Even if production is outpacing retirements, it’s completely failed to keep pace with the grain and coal markets. Like with grain, coal exports are up. The market will eventually balance out, but there’s no real timeline to predict when that will take place. These regulatory shifts have likely made the situation worse.
Tellingly, Dvorkovich spoke two weeks ago of talks to introduce subsidies for for RZhD’s grain deliveries to ports. Apparently the domestic market is unable to absorb all the grain produced. However, he left out the fact that it has to get to market domestically, and any compensation for export deliveries would further push RZD to focus on external markets to make up for domestic losses. It’s a long tradition in Russia: sell resources and low-value added goods abroad to get currency into the economy.
Boom times for grain and coal are leaner times for domestic consumers. The kaleidoscopic diffraction of reform incentives in the Russian economy due to state control, centralization, old thinking, and power politics take good news and turn it into a problem. The trouble lies in that they make just enough money to stay upright. Meanwhile, geography is cruel. Roads can’t match rail given how simultaneously centralized the economy is and how far-flung resource deposits are. No matter the chatter, RZhD and the rail freight market are set to shamble on.