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November 28, 2011

Selling Freight One: what does it mean for Russia?

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Independent Transport Company (ITC) won the battle to secure a 75% minus two shares stake in Russian Railways (RZD) subsidiary Freight One on October 28. Yuri Saakyan, director of the General Institute for Natural Monopolies Research, Russia, considers the history and prospects for Russia’s largest single owner and manager of freight wagons.
OCTOBER's sale of Freight One by RZD to Independent Transport Company (ITC) is the largest transfer of rail assets into private hands since RZD revived its privatisation programme last year.

ITC, part of UCL Holding, which is owned by Russia's richest man Mr Vladimir Lisin, paid Roubles 125.5bn ($US 4.2bn) for the stake, just above the Roubles 125.38bn asking price, beating off competition from three other companies that prequalified for the auction, and the two others that bid: Transoil, which is owned by another oligarch, Mr Gennady Timchenko, and NefteTransServis.

ITC already provides freight transport services for its parent company Novolipetsk Steel (NLMK), one of the four largest steel companies in Russia, and supplies wagons for iron-ore, raw materials, ferrous rolling metal, coke and metallurgical coal traffic.

By purchasing Freight One it has added approximately 21% of Russia's freight rolling stock to its fleet, and according to local media reports, ITC general director Mr Alexander Sapronov said after the auction that ITC would offer RZD Roubles 125.5bn for the remaining 25.5% of Freight One.

The prerequisites for founding Freight One date to the early 2000s, around the same time that independent freight operators were actively being established.
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Charges for these new operators were calculated on a market basis while the charges for similar services provided by RZD remained at fixed tariffs set and regulated by state authorities.

The price discrepancies that subsequently emerged meant that as the business of wagon operators grew, RZD was gradually driven out to the least profitable segments of the market. As a result, RZD was transporting freight at a loss and was not able to compete with independent operators.

The Russian government consequently acted in 2007 by founding a commercial freight operating company affiliated with RZD, which would be free from state regulation. It was named Freight One.

The major goal of the reform was to guarantee the continuing competitiveness and investment attractiveness of freight transport, as well as to raise additional funds for Russia's rolling stock renewal and infrastructure development. As a result, partial exclusion of wagons from government regulation allowed Freight One to renew its rolling stock and to secure strong positions in the rail freight transport market.

Rail transport in Russia is now entering its fourth phase of structural reform, and the need to raise additional funds to fuel this growth is again apparent.

At the beginning of 2011 the state policy document The target model of the freight transportation market up to 2015 was approved which is intended to further develop competition in the railway industry.

As a result of these reforms a number of freight wagon operating companies were established. These companies own wagons (or possess them on another legal basis) and provide consignors and forwarding agents with wagons for loading and transport. However, they do not own locomotives and do not have the rights to provide hauling services for consignors. They do deliver empty wagons to stations, which are specified under contracts with consignors, and maintain wagons, and fix the distance and direction of empty running trains.

Despite some operators being active in the market for 10 years, their legal status is yet to be defined with the legal and regulatory framework significantly behind the reform process. There is still no definition of "operator" in applicable legal rules and the rights and responsibilities of operating companies are still not determined.

At the time it was sold, Freight One had grown into the biggest operating company on the market and one of the largest of RZD's subsidiaries. By the early autumn of 2011 it controlled over 235,000 wagons, including 125,000 open wagons and 66,000 tank wagons. The income of Freight One in 2010 was Euros 2.5bn and its profit reached Euros 470m.

Selling Freight One is a means of raising funds for RZD to spend on infrastructure development, including the eradication of network bottlenecks and to procure new locomotives. However, it should be noted, that funds received will not be enough to cover all of RZD investment projects, so it is likely that RZD will seek additional investment sources in the near future.

The Institute for National Monopolies Research believes that with ITC eager to cover invested assets as soon as possible the sale will result in increases in charges. ITC will also have access to Freight One's lower tariffs which is likely to increase competitive pressure on its rivals if it looks to expand services.

A change of transport logistics and a decline in freight wagon fleet performance is also expected. At present empty wagons belonging to Freight One are dispatched by RZD, which is interested in transport technical efficiency more than in general economic rates, and before the sale, RZD was utilising Freight One to experiment with wagon management techniques in an attempt to improve efficiency. This is unlikely to continue under ITC stewardship.

As ITC attempts to secure the most profitable services, more wagons are likely to spend more time idle so they are available at stations and in regions where high-yielding freight originates. However this might result in the disappearance of many of the socially-important, yet not necessarily profitable, freight services provided by RZD. It could also have a hugely detrimental effect on medium-sized and small businesses operating in Russia if access to railfreight is cut off, and also greatly alter the operating system of the railway.

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