November 03, 2015

Sluggish commodity prices restricting Australian railfreight

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With lacklustre domestic economic growth and turmoil in the commodities sector resulting in a difficult year for Australian railfreight, Mark Carter reviews the current issues and looks at the key indicators that will shape the industry in 2016 and beyond.

DESPITE the relative doom and gloom, both of Australia's major railfreight operators, Pacific National and Aurizon, delivered strong financial results for the 2014-15 financial year, although these were achieved more through internal business improvement programmes and higher freight rates than any significant growth in volumes.

Traffic volumes at the country's largest railfreight operator, Aurizon, remained relatively flat across its business, but statutory net profit after tax for 2014-15 jumped by 139% to $A 604m ($US 429.2m). This result was achieved on overall revenues of $A 3.78bn, down 1% on 2013-14, with network earnings growth and transformation delivering a 14% improvement in underlying Ebit of $A 970m.

Revenue at transport and logistics group Asciano, parent company of Pacific National (PN), dropped to $A 3.84bn, down 3.9% on the previous year, but statutory net profit after tax rose to $A 359.6m, up 41.4%. Emphasising the importance to the group's overall profitability, the PN rail business contributed revenues of $A 2.24bn which accounted for 62.6% of Asciano's total and 72.1% of Ebitda at $A 846m.

Aus NovA downturn in commodity prices and demand has had ramifications around the globe, including in Australia, although it has yet to have a significant impact on Australian exports of coal and iron-ore in terms of overall volumes, with export totals for both commodities continuing to climb. While iron-ore is largely the preserve of the miners' own integrated rail operations, coal remains the foundation of the two major railfreight operators' traffic despite tonnages appearing to plateau in 2014-15.

Between them Aurizon and PN transported a combined 374 million tonnes of coal during 2014-15. Total coal exported was 392 million tonnes, but given that both operators also transport smaller tonnages for domestic consumption which are included in their totals, this would suggest some 30-40 million tonnes per annum is now carried by the miners' own trains.
Aurizon's total coal haulage task for 2014-15 was 211.2 million tonnes, with 168.2 million tonnes in Queensland, down 1%, and 42.9 million tonnes in the New South Wales (NSW) Hunter Valley, an increase of 6%. PN's figure of 162.8 million tonnes was up by 2.4% on 2013-14, largely on the basis of increased volumes in Queensland where 55 million tonnes was transported during the year. Contracted coal volumes for 2015-16 are 180 million tonnes, with coal contract utilisation 87.5% for 2014-15 in NSW and 89% in Queensland.

"Coal volumes in NSW will be impacted by contracted growth in some contracts and contraction in the haulage task with some existing customers, with a net impact in 2015-16 of negative 200 million net-tonne km," says Asciano CEO Mr John Mullen.

However, according to Aurizon's full year presentation to investors, Australia recorded continued growth in coal exports in 2014-15, with lower exports to China more than offset by increasing volumes to other markets, particularly India. Indeed, in the first six months of 2015, India eclipsed Japan and China as the single largest market for Australian metallurgical coal. Overall metallurgical coal exports grew by 4% for the year to 187 million tonnes while thermal coal exports were up 5% at 205 million tonnes.

Yet Aurizon expects some contraction in 2016. The company says that contracted volumes for the 2016 financial year are forecast to drop by 5 million tonnes to 225 million tonnes and the company announced on October 7 that it would cut costs by a further $A 380m over the next three years including through more than 800 job losses, predominantly in operations, including train crew and maintenance workers. The cuts will help Aurizon reach its target of reducing operating ratio from 74.3% in fiscal 2015 to 70% by 2018, and follows $A 252m of cuts in the past two years, and 3000 jobs losses, mostly of older staff through voluntary redundancies, since 2010.

"Subdued commodity prices resulting in a lower volume and revenue growth outlook for Aurizon in the short to medium term, means that more than ever we need to ramp up our transformation programme," says Mr Lance Hockridge, Aurizon's chief executive. "We need to get leaner, smarter and more efficient in the services we provide our customers who are operating in an extremely tough environment."

This tough environment is reflected in the stance of the seven remaining mining companies involved in the Wiggins Island Coal Export Terminal (Wicet) project. Aurizon built the $A 843m rail loop to deliver coal to the terminal under the pretence that the miners would pay Aurizon back the cost of the project. However, with the market for export coal now in the doldrums, seven of the eight miners which remain solvent argue that they have the right to reduce their financial exposure and are looking to cut a new deal, which Aurizon fears could cost it up to $A 27m per year, or $A 509.5m, for the next two decades. If the dispute is not resolved through arbitration it could end up in the courts.

Intermodal

While coal underpins the major operators' activities, intermodal services are the most visible indicator of their operations across the country.

PN and Aurizon are again experiencing tough times in this area with volumes at the very least static, and sometimes declining in the last three years. Like-for-like comparison between the two is not easy as both use different reporting methods for their financial results, as does the interstate track owner Australian Rail Track Corporation (ARTC).

Aurizon gave very little away in its full year results other than to report intermodal revenue of $A 302m for 2014-15, up by $A 10m on the previous year, but it acknowledges underlying market conditions remain subdued.

PN's intermodal traffic was down 2.4% at 20.94 billion net-tonne km, yet more worryingly, TEUs carried dropped by 4.9% to 771.5 million in 2014-15. In its intermodal results for 2013-14 both measures fell, by 5.1% and 3.2% respectively.

Stories continue to surface in the financial press that one or the other may dispose of their intermodal operations. Nothing concrete has been confirmed and Aurizon, and to a lesser extent PN, continues to invest in capital upgrades to locomotives and rolling stock used on these services.

Aurizon holds a 33% stake in the Sydney Intermodal Terminal Alliance (Simta) which was selected by the federal government to develop and operate the Moorebank intermodal terminal which it feels will strengthen its general freight portfolio and provide a more efficient, long-term solution for Sydney-based intermodal operations.

Looking ahead to PN's intermodal prospects for the coming year, Mullen says that intermodal volumes will reflect activity levels, "in particular with the Western Australian and Queensland economies currently forecast to be relatively flat."

While the east-west routes from Sydney and Melbourne to Perth continue to enjoy a market share in excess of 80%, north-south services remain marginal with no sign of an upturn despite considerable investment in this corridor by ARTC over the last decade.

The proposed $A 8.9bn takeover of Asciano by Canada-based Brookfield Infrastructure is likely to be the major talking point for the next year as Brookfield's plans for the transport, ports and logistics group become clearer.

Speculation is divided with some analysts suggesting that Brookfield is eyeing up PN's lucrative coal operations in the Hunter Valley, while Brookfield Infrastructure's CEO Mr Sam Pollock says combining Asciano's Australian container terminals with Brookfield's existing assets in North America and Europe provide the foundation for a global container operation.

"Asciano's leading above-rail operations, together with our Australian and Brazilian logistics businesses, create a powerful, international rail logistics business," Pollock says.
If the proposal receives Asciano shareholder approval then the deal is expected be completed by mid-December 2015. However, with competition expected to stiffen, Hockridge says Aurizon is watching the regulatory process "very carefully" and had made a submission to the Australian Competition and Consumer Commission.

If one or the other were to divest itself of its intermodal arm then it is quite likely that Genesee & Wyoming, which already has a significant foothold in Australia, will bring some of its newly-acquired intermodal expertise to Australian shores, gained earlier this year through its purchase of Freightliner, Britain.

Infrastructure

After a long period of federal investment in railfreight infrastructure, there is little sign of any funding for new projects. In fact the current administration is canvassing the sale of its 100% stake in the ARTC, which has been the major conduit for much of the previous spending.

A major disappointment over the last few years has been the failure to increase rail's market share on the Mebourne - Sydney - Brisbane axis, despite a $A 3bn investment programme in this corridor, funded and delivered by the federal government and ARTC between 2005 and 2014.

Rail's importance is hard to track on the corridor with little publicly available data and a substantial amount of intrastate freight tonnage ignored when it comes to determining market share, which is estimated to be well below 10%.

Instead the federal government seems to be putting all its faith in the proposed Inland Rail route between Melbourne and Brisbane, despite the failure to lift volumes on the existing north-south corridor.

In September it published its 10-year delivery plan to implement the 1700km line, which would use upgraded existing routes and require 600km of new track.

The project was previously estimated to cost around $A 4bn, but the detailed report puts the cost at a much higher, but more realistic, $A 10bn.

The private sector consortium National Trunk Rail (NTR) has proposed an alternative Inland Rail route and believes its own business case is stronger. Chairman Mr Martin Albrecht said NTR was pleased to see the government had acknowledged there were now options to deliver the project, with previous attention focusing on the ARTC-sanctioned proposal.
Albrecht is urging the government to open up the Inland Rail project to a public-private partnership (PPP), to "drive productivity through innovation to reduce costs to taxpayers and the government."

"NTR would be a strong participant in a PPP process and would deliver an Inland Rail design that is shorter, flatter, straighter and faster, and in less than six years from commencement," he says.

Added to the Inland Rail conundrum is the federal government proposal to sell its 100% stake in ARTC. However, this is fraught with difficulty not least because it is no secret that on the interstate network revenues cannot fund the long-term capital replacement of assets. Potential buyers would have more of an eye for the lucrative Hunter Valley access revenues where this is not an issue, and at least for now record coal volumes continue to run into the Port of Newcastle.

The fact that the bulk of the ARTC network is formed of lines it leases from state governments will also be a major legislative hurdle.

As ARTC is an important part of developing any options for Inland Rail, the Federal Department of Finance recently decided not to proceed with the current tender processes for the previously-announced scoping study into options for the future management, operations and ownership of ARTC. Unfortunately both the possible sale of ARTC and the Inland Rail route proposal are let down by government policy, which will make it difficult to put forward a sound business case for either.

Ausfig1For example, interstate rail traffic is still disadvantaged by inequities in the current road funding model which benefits rail's main competitor.

Commenting on recent federal ministerial changes, Australian Logistics Council CEO Mr Michael Kilgariff said: "With the acknowledgement of the need for a change of thinking on how Australia funds its infrastructure, [we need] national leadership on how we fund and price major infrastructure, including on mooted reforms to the current road funding model."

Proposed changes by the government to the cabotage rule for coastal shipping, allowing greater use of foreign crews and ships, also has the potential to undermine the Inland Rail proposal. As Kilgariff argues, freight cannot fall between the cracks, particularly when it comes to responsibility for major infrastructure projects.

"Planning and investment challenges include ensuring there are effective road and rail links to the ports, protecting future freight corridors, untangling railfreight and passenger rail and supporting the growth of metropolitan intermodal terminals," he says.

With Australia's population continuing to grow - the country's four biggest cities are predicted to expand by an additional 6 million people, or 46%, by 2031 - there needs to be a more consistent approach to transport policy and planning to ensure a healthy future for Australia's railfreight industry. Without this approach, the struggles experienced in the last few years will persist and Australian railfreight will continue to fall short of its potential.

 

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