April 18, 2017

China-Europe rail freight continues to soar

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China-Europe intermodal freight is a major success story of recent years. Kevin Smith considers the factors driving continuing development and the challenges that trans-Eurasian services face to realise their full potential.

RAIL freight trains rarely generate main stream media attention. Yet the January 18 arrival at DB Cargo’s London Eurohub terminal in Barking, east London, was slightly different.

The 34 TEU-train had travelled more than 12,000km to Britain from Yiwu in eastern China, and was the first-ever freight service to complete the journey. Taking 18 days to pass through eight countries, the train received a VIP welcome, with Chinese lion dancers and TV crews from around the world gathering to mark its arrival.

China europefreightSuch strong interest is due to the potential of trans-Eurasian rail freight to British logistics and forwarding companies. The journey took around half the time of a similar sea voyage, and cost approximately half of the equivalent air freight journey.

“This moment was important to show that we can run the train in less than 18 days to the UK,” said Mr Carsten Pottharst, managing director of InterRail Group, Switzerland, the operator of the service, who added that his company is hopeful of adding more British services in the future. “It depends also on how much freight we can get from the UK to China - if we can get more trains eastbound, then there could be more.”

Pottharst’s optimism reflects recent growth in the China-Europe rail freight market. London is the 15th European city now served by direct trains from China, joining destinations in Germany, Poland, the Netherlands, Belgium, Italy and Spain on a transcontinental network of more than 40 routes. Trains reach Europe using either the southern branch of the Trans-Siberian Railway from northern China, or like the London train, by transiting through western China and Kazakhstan, and joining the Trans-Siberian at Yekaterinburg.

The Barking train was loaded with a mixture of consumer goods and clothing from wholesale suppliers in the Yiwu area. Europe-bound trains also carry high-tech IT products such as laptop computers and mobile phones produced for multinational companies in factories in western China. Indeed, Hewlett Packard is regarded as the pioneer of the very first China-Europe freight train, sending laptops and LCD monitors from Chongqing to Duisburg in 2011.

The speed of the service makes it particularly attractive to these suppliers in order to meet strict sale windows. This is especially advantageous for manufacturers located a long way from the Chinese coast, and carriers and forwarders such as DHL, Geodis, Haltrans, Essers and Wagonborg have responded to this demand, presenting opportunities for companies like InterRail, which conducted its first intermodal rail freight tests in 2012. It began running regular block train services in 2014, growing by more than 250% since.

From its hub in Yiwu, and working in close cooperation with China Railway subsidiaries CRCT and CRIMT, InterRail now serves Duisburg and Madrid twice-weekly, and has instituted a return Madrid - Duisburg - Yiwu service. It also recently conducted a test service to Riga in Latvia.

“The China-Europe and Europe-China services account for approximately a fifth of our total group revenue,” says Mr Hans Reinhard, chairman of InterRail Group. “We expect further growth of at least 150% up to 2020.”

Other prominent operators include Far East Land Bridge (Felb), which is 75% held by Russian Railways (RZD). Felb began operating in 2008 and now provides regular intermodal “Speed” services of 14-18 days using the Trans-Siberian to Malaszewicze, Warsaw, Hamburg, Duisburg and Milan from Suzhou, Changsha, Shenyang and Changchun, with return journeys to Shenyang and Suzhou. It also offers less-than-container-load (LCL) services from Suzhou and Incheon, Korea, and import/export between Suzhou and Guangzhou to Moscow. The company’s logistics network stretches to Qingdao, Beijing, Tianjin, Dalian, Yingkou, Pusan, Tokyo and Kobe.

German Rail (DB) is also heavily involved in trans-continental rail freight. It founded Trans Eurasia Logistics (TEL) with RZD in 2008, which acts as a neutral train operator, handling transport operations, and coordinating purchasing agreements and the railway companies that provide traction along the route. DB Schenker also serves clients and cities across China, delivering to destinations in Germany and Poland.

Higher volumes

This growing network and frequency of service is inevitably translating into higher volumes. DB says that more than 40,000 TEUs were transported between China and Germany in 2016, a record, and that it is expecting this figure to grow to 100,000 by 2020, more than triple the amount carried in 2014. RZD Logistics’ 2016 results reveal a similar trend, with the RZD subsidiary reporting that Chinese-Europe transit trains carried 73,000 TEUs on the Russian network last year.

Yet the recent spike in traffic is not solely driven by organic market growth. Political will from the east, specifically through China’s One Belt, One Road (OBOR) strategy, which was announced in 2013 and formally adopted by president Mr Xi Jinping in 2015, is cited as the primary factor in the recent upsurge in volumes.

The strategy aims to restore the ancient “Silk Road” between China and Europe by encouraging investment in Eurasian transport and logistics networks, including rail, to boost Chinese trade and investment, and economic integration. More than 40 memorandums of understanding and cooperative agreements have been signed with countries along the route since 2013. And according to Mr Wing Chu, a senior economist at Hong Kong Trade Development Council, OBOR is regarded as a long-term plan of cooperation.

“In the next few years we will see China pursue this very heavily both at the government level by working more closely with OBOR countries, but also particularly at a business and enterprise level by increasing trade and investment in OBOR countries,” Chu says. “The railway is an important driver in this macroeconomic development.”

The degree to which China is committed to the strategy’s rail ambitions became evident in June 2016. Eight trans-Eurasian freight trains left eight Chinese cities simultaneously on June 8, heading to destinations across Europe. All were carrying royal blue TEUs with the name of the new service, China Railway (CR) Express stencilled onto each 40 foot unit. The same CR Express containers made the journey to Barking, and companies like InterRail and Felb now have the option to use these containers, their own, or to rent others from elsewhere for their trans-Eurasian rail services. Like the branded containers of shipping companies that are now seen all over the world, the thousands of blue TEUs now in circulation are spreading brand China.

Rail’s role in OBOR is underpinned by subsidies for transcontinental freight services now offered by regional Chinese governments. Indeed, Reinhard and Felb marketing director Mr Leonardo Vender admit that that the New Silk Fund is the main reason why they have been able to grow their respective services by so much and in such a short period of time.

While Chu says the level of subsidies is unclear - some have speculated that they could be covering as much as half of cost - the overall aim is for rail to account for 25% of freight transported from western and inland China to Europe with a long-term goal of making these services profitable. Currently rail accounts for less than 1% of all exports from China.

“By having rail as well as making use of air and sea transport, industries and cities in these regions can now choose how they want to transport their products,” Chu says.

However, to become a truly profitable service, there are a few hurdles that trans-Eurasian rail freight must overcome.

Enhancements

While transit times have certainly improved - some trains from Chengdu to Poland have reportedly completed the journey in 10.5 days - there is still room for enhancements to infrastructure and the logistics process.

Unprecedented investment in China’s rail infrastructure over the last decade means that its major cities are now all well-connected. Rail links with logistics facilities are also improving, while Russia has invested billions of Roubles in recent years to improve capacity and increase line speeds on the Trans-Siberian.

Kazakhstan is also engaged in a $US 2.7bn railway upgrade programme, encompassing 724km of track as well as locomotives and freight wagons, with its president, Mr Nursultan Nazarbayev a long-time backer of restoring the Silk Road.

This is perhaps best reflected in the construction of the Khorgos Gateway project. Situated on the Kazakhstan-Chinese border, the future logistics and industrial hub is billed as the new Dubai, covering a colossal 5470ha. This includes the 129.8ha Khorgos Gateway Inland Container Dock, a gauge-changing station for the trans-Eurasian railway, which has capacity for six trains at one-time, and can process 580,000 TEUs annually.

However, the quality of rail infrastructure in some of the other transit countries outside of the key corridors is not up to this standard, which is holding back progress. While InterRail operates a 14-day service between Yiwun and Tehran, and Turkey is served via the Caspian and Black seas, these are token rather than core services. China Railway’s desire for a third trans-Eurasia connection from Kunming through Myanmar, Bangladesh, India, Pakistan, Iran, Turkey and Europe is also some way off.

As part of OBOR, China is pushing, and largely funding, a vast programme of Eurasian infrastructure investment. The China Investment Bank estimates that 900 OBOR infrastructure projects worth $US 890bn ranging from rail to road, port and pipeline, are planned or underway in 64 countries.

Chinese policy banks such as the China Development Bank and China Ex-Im Bank are expected to provide the lion’s share of the funds. However, China is introducing additional methods to address the inevitable investment gap: the $US 40bn Silk Road Fund was established in January 2014 to support these projects; and the Chinese-driven Asian Infrastructure Investment Bank (AIIB), established in January 2016 with OBOR in mind, has 57 members and is offering a further pool of $US 100bn.

In 2015, this translated into a $US 15bn investment in OBOR initiatives by China, and a corresponding $US 8.2bn investment by individual states. These figures were projected to increase substantially in 2016 and 2017.

Critically, though, it is not just China’s financial muscle which is backing these projects. Increasingly China is turning to international pension funds, insurance companies, sovereign wealth funds and private equity finance to support its plans. Mr Henry Tilman, chairman and CEO of Grisons Peak, a London-based investment bank, told The Financial Times in May 2016 that these institutions are increasingly attracted by long-term returns of 6-8% on some OBOR infrastructure.

State-owned institutions are also keen. IE Singapore, the state-owned trade development board, is partnering with China Construction Bank to finance OBOR projects worth up to $US 22bn. In addition, Chu says that Hong Kong’s financial institutions, the traditional source of Chinese finance, are also watching the OBOR initiative closely.

Many of these investments will be directed at improving logistics processes for rail. Crossing borders, and switching between 1435mm and 1520mm gauge, and back again, remains a major challenge, and an obstacle to reduced transit times.

Vender says that capacity at many border stations in particular is a concern and requires improvement, especially as freight flows continue to increase. Access to the European network is also a problem due to ongoing restrictions on speeds and slots. Similarly, while customs processes at borders have improved significantly in recent years following the advent of the Eurasian Customs Union, which enables the use of a single tracking sheet for individual TEUs - reducing transfer times from anything up to three days previously to a maximum of six hours now - Reinhard feels there is still room for enhancement.

“There could be further improvements on electronic data transfer between railways and operators with the goal of minimising the exchange of paper documentation,” he says. “Secondly, it would make sense to consolidate the trains at CIS inbound borders to enable their full use when it is possible to run longer trains in the CIS. The trains could then be split up into smaller train lengths according to the European maximum length.”

In addition, changes to customs procedures could add a new dimension to what are solely point-to-point services at present. While shipping to lucrative western European markets has driven the early growth, Chu says that only when trains can capture freight from transit countries will the trans-Eurasian railway realise its true potential.

“If we want to see big growth in volumes, then there must be some arrangement to let the trains stop in other countries along the route to load and unload freight,” Chu says. “China is pushing hard to negotiate with other countries that the CR Express operates in to encourage cooperation to enable this to happen and to capture more business.”

Europe - China

There is also a pressing need to boost the transport of goods on return trains from Europe to China.

Despite China being the European Union’s (EU) second largest trading partner after the United States, and one of its largest single sources of exports, Europe’s reliance on cheap Chinese imports meant that in 2016 there was a trade imbalance of $US 174bn.

Nevertheless, China is now Europe’s fastest growing export market and overall trading has increased dramatically in recent years. Following a 37.7% spike between 2010 and 2011, when the value of exports increased to €113.45bn, and a further 20.2% increase between 2011 and 2012 to €136.42bn, growth has continued with exports worth €170.14bn in 2016, on par with the 2015 figure.

This trend is expected to continue, particularly following the passage of a comprehensive EU-China Investment Agreement in November 2013, which eases restrictions on market access and provides a more secure and simpler legal framework.

All of this offers significant potential for rail freight.

Currently European exports to China are concentrated on machinery and equipment, cars, aircraft and chemicals. However, Chu says that strong demand in China, particularly in the west of the country, for high-end European goods such as fashion items and premium frozen food products, could stimulate interest in faster rail shipments. He adds that the Chinese government is taking the unprecedented step of encouraging imports by rail.

Yet this is unlikely to completely satisfy the trade imbalance, and rail must have the flexibility to serve more destinations along the route. Russia is the obvious destination for this. However, since retaliatory economic sanctions to those imposed by the west in 2014 blocked the export of agricultural products to Russia, European carriers have been prevented from tapping into this potentially lucrative market.

Reinhard says InterRail’s Russia - Europe transport has all but been wiped out and transit shipments of some products are now banned. But with Reinhard citing the ample opportunities to encourage more European-based carriers and forwarders to use rail freight to China, it appears the Russian question can be avoided for the time being. “Some European logistics customers are still to fully grasp how they might integrate rail freight services into their internal logistics systems,” he says.

Reinhard adds that InterRail is already active in Central Asia, and he predicts that following expected increases in the price of oil, the economies of these countries will improve, boosting demand for its services.

Vender says Felb has not suffered any restrictions in business from Russia and that it is eyeing further opportunities for growth in Korea and Japan, and “virtually every location along the Trans-Siberian Railway.” He explains that it is the job of the company and forwarders to make the availability and benefits of these services visible to customers. “Further expansion is imminent as we are exploring new options to serve the Nordic countries, France and possibly Spain,” Vender says. “We are not excluding Taiwan and the Philippines, which may one day benefit from our rail services.”

However, with subsidies for westbound services set to end in 2020, both Vender and Reinhard are cautious about prospects beyond this date.
The hope is that trans-Eurasian rail freight offerings will be plentiful and mature enough to become self-sufficient by that point. And with growing enthusiasm in transit countries as they benefit from improvements to infrastructure and related economic growth, there is every chance that this will become the case. China then might be driving the New Silk Road, but it seems that everyone along the route is poised to jump on board.

“We think the era of the rail alternative between China and Europe has just begun,” Vender says.

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