February 27, 2013

Investment crisis looms in Ukraine

Written by  Vladislav Vorotnikov
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Ukrainian Railways is facing an investment crisis as it lacks the funds to replace its aging assets and the government has so far failed to come to the rescue, as Vladislav Vorotnikov explains.

UKRAINE's rail network is facing a serious crisis in the next few years. Lack of government support in recent years and a consequent failure to invest is beginning to manifest itself in very high levels of depreciation for rolling stock of between 80 and 90%.

The problem has been voiced repeatedly by representatives of the Ukrainian government during the last year, with prime minister Mr Mykola Azarov recently calling for a renewal of the rolling stock fleet. Azarov says that for the railway to continue functioning it is necessary to build and put into operation at least 13,000 rail vehicles during the next five years.

Experts from Ukraine Transport Business news agency estimate that if this does not happen then the current shortage of passenger coaches could get much worse. Excluding commuter trains, Ukrainian Railways (UZ) currently has 4900 passenger coaches available. Without investment, this number will drop to 2600 by 2017. Conversely, passenger demand is estimated at 60 million journeys a year, but with the current fleet it will only be possible to transport 54 million passengers this year, while by 2017 this figure will drop to less than 40 million.

To halt the decline, independent experts estimate that UZ requires an annual investment of Hryvnia 25bn ($US 3bn). This was confirmed recently by the former director general of UZ, Mr Vladimir Kozak, who says the modernisation of the railway requires about Hryvnia 200bn of direct support for the period of 2013-2020. (Kozak, who is now minister of infrastructure, was succeeded on January 28 by Mr Sergei Petrovich Bolobolin).

It is clear that the government needs to provide financial support for UZ in future federal budgets. At the end of 2012 UZ filed a draft capital investment plan for 2013, which would provide funds of Hryvnia 2.7bn for the purchase of passenger coaches. According to UZ these funds would enable it to Ukraine-localpurchase about 200 compartment coaches, 41 coaches with facilities for disabled passengers and seven service coaches.

But the state budget for 2013 does not include one cent for investment in infrastructure or the purchase of passenger coaches. To make matters worse, there is no funding to compensate UZ for transporting disabled passengers, children under the age of seven and some other categories of citizen free-of-charge or with a huge discount, let alone a state programme for rail development, or even any state guarantees to enable UZ to borrow.

The government expects UZ to modernise the railway using a combination of its own funds and money raised elsewhere. However, sources within UZ say that it does not even have the funds to modernise the freight business, which is in a far healthier financial situation than the passenger business. UZ says it needs to purchase 111,000 freight wagons worth about Hryvnia 65bn and more than 2000 freight locomotives worth Hryvnia 68bn by 2020. However, UZ can only afford to invest a maximum of Hryvnia 5bn per year, which precludes any effective modernisation without government support.

UZ estimates freight profitability at 30-40%, so investment in the purchase of freight wagons with a life of 22 years will have a pay off period of seven to eight years. This should make it possible to attract private investment in freight transport which will partly solve UZ's problems.

Conversely, UZ passenger services make an annual loss of about Hryvnia 8bn. The payback time for investment in a passenger coach with a life of 28 years, even when used on profitable services such as business and international trains, is 20-25 years, making it an unattractive proposition for the private sector.

It would be possible to cover the cost of purchasing a passenger coach by adding $US 5 to the price of each ticket, but even that would require a 100% load factor on every trip, and there are only 20 trains - 7% of the total - where it would be possible to achieve such a payback. In general the government should double or treble the price of tickets to make passenger traffic attractive to private investors, but with the low purchasing power of most Ukrainian citizens it is safe to say that this is unlikely to happen in the foreseeable future.

The Ukrainian government had planned to partially solve the investment problem by issuing shares in UZ. This was due to take place in mid-2012, but it has yet to happen because of many bureaucratic difficulties.

Added to this tale of woe, Ukraine's sole producer of passenger coaches - Krukov Wagon Works - only has sufficient capacity to manufacture about 30% of the coaches needed. The rest would therefore have to be imported which would sharply increase the cost. As investment in the domestic production of railway equipment in Ukraine and new plants is not even being considered, the country is simply unable to renew its passenger fleet.

The long-term outlook for both UZ's freight and passenger businesses is pretty bleak unless there a change in government policy, but it needs to come fairly soon before the rot really sets in.

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