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Knights of the Vine RUSSIA

Cover Story

Russian Railways Resurgent
Text by James Blake
Photos by John Bonar
In an age when international travel and moving cargo conjures up thoughts of vast container ships and cargo aircraft, Russian Railways, (RZD) is about to move into high gear for the redevelopment of the world’s second largest railway system. The money involved is massive; the sheer scale of the restructuring is massive too. Throw in a few Russian- sized bridging, tunnelling and line-laying feats on a network that spans 11 time zones, plus the numbers of wagons and trains that probably only Russians could conceive of, and you have a serious case of ……………………Poezd spotting.

But as RZD prepares to enter the third stage of Russia’s railway restructuring, a 21st century railway boom seems to be in the making, with investors likely to get a look in down the track.

Massive renewal of rolling stock planned

If you think about Russian Railways, you have to think big - real big. The sheer scale of the system is positively staggering. Bridging the Eurasian landmass, covering 11 time zones with more than 85 thousand kilometres of track and employing more than 1.25 million people, Russian Railways last year carried 1.3 billion passengers from one point to another. And just to give the impression that those little old ladies and their bags really do weigh a ton, the statistics tell us the railways carried 1.3 billion tons of cargo as well.

It remains central to the economic performance of Russia, handling 83% of the nation’s freight. If you take a quick look at the commodities base of Russia’s current prosperity, you probably think about oil, metals, coal, and lumber. The only way most of this material can be transported from where it is to where it is needed - reasonably quickly and reliably - is by rail.

In case you didn’t know, Russian Railways is in the midst of a huge restructuring plan. There have been threestages lasting nearly ten years, with the third stage just underway. Stage 3 is planned for completion in 2010, and the targeted completion date is getting close enough for everyone to get a glimpse of what’s ahead, and the results look suitably promising. In the not too distant future, the public will likely be able to buy shares in Russian Railways, and possibly earlier, purchasing shares will be possible of the spun off subsidiaries. But more importantly for Russia, which relies on its national rail system more than any other nation, it is likely that investors will be interested because the restructuring program will produce an organized privatization of what will be an efficient national freight and passenger rail service.

The Background

Along with almost everything else in Russia the railways had a tough time in the 1990’s. With the break-up of the Soviet Union came some radical changes in the industrial market it had served so well; a severe reduction of the volume of traffic, and a rise in competition from road transport. At the same time the cash strapped government cut back on upgrades to rolling stock and track maintenance, let alone any funding of the development of new lines, or the introduction of new technology. In some ways this wasn’t a problem, as reduced volumes lessened the need for new or upgraded carrying capacity. But the downturn in business along with no upgrades in technology or equipment hardly inspired confidence in the future of the industry.

After hitting rock bottom in 1998, when transport volumes were only 38% of what they had been a decade earlier, things began to pick up. Recognizing that the rail system was of strategic importance and that it was certainly not in the national interest to allow it to continue deteriorating, the government initiated a review, which in 2001 came up with a restructuring plan where the rail network would be formed into a rail monopoly, which would be charged with increasing efficiency and investment in rolling stock and track and expanding networks and business. It was also recognized early on that competition would help provide far greater efficiency, so the rail monopoly was told to prepare for the spin off of subsidiaries, with the expectation that competition would push the monopoly into becoming more transparent in its tariff policies and budgeting decisions.

The Creation of RZD

The first phase of restructuring was the creation of the Joint Stock Company ‘RZD’ (Russian Railways) which occurred in October 2003 when the government shunted assets from more than 1000 different railway related organizations into a new governmentowned entity. Nearly all of these entities were formerly part of the Ministry of Communications which retained the policy making and legal oversight functions of the railway system, freeing up the new company, RZD, to function as a corporation. The current President of RZD, Vladimir Yakunin, took the helm shortly afterward. RZD became one of the world’s largest transport companies, handling about 80% of Russia’s trade and 40% of Russia’s passenger transport service.

From the outset RZD faced three key problems. There wasn’t enough investment capacity to do what was needed to improve the railways. There wasn’t enough transparency in the operations of the railways to make informed investment decisions, and it was obvious that a lack of competition meant that the organization wasn’t as efficient or profitable as it might have been. A key factor in the low profitability was that unprofitable passenger operations were subsidized by the more profitable freight operations, but the precise extent was hidden not just by the myriad of organisations which were involved in rail transport, but also by wider social welfare policies including free rail transport for pensioners and the operation of boarding schools for children of railway workers in remote areas.

New stations are going up across the country

The Way Forward – Integrating, Cooperating and Expanding, and a Little Something Called Customer Service

After its creation, the game plan for RZD has been to increase efficiency, increase turnover, and thereby increase capitalization.

A key part of this strategy is to increase the use of Russia’s rail system as a bridge between the booming manufacturing economies of Asia, particularly China, with Europe. The line between Vladivostok and Moscow (and on into Europe) is not just the wish of every rail traveller on the Trans-Siberian, but as a goods conveyor of up to 20 days faster than shipping goods from China or Korea by sea. The trade in goods between Asia and Europe is estimated at more than 600 billion dollars per year and capturing any sizeable portion of this is a positive step in the direction of being able to pay for the investment requirements needed by RZD, which have been estimated as high as 250 billion roubles.

This leads to another challenge for RZD - the need to significantly improve the interoperability between the Russian rail system and the rail systems of its neighbours, including the development of joint logistics handling capacity, and in some cases joint research and development. RZD intends to develop a common economic space between the Russian railways infrastructure and that of the European Union, and last year saw an agreement signed with Finland for increased container shipments between the two countries, and another agreement between RZD and the national rail carriers of Byelorussia, Poland, and Germany on freight traffic cooperation. This was marked by a trial freight run between Berlin and Moscow via Warsaw and Minsk. The last year has also seen the commencement of the fast passenger service between Moscow and Kiev, and in southern Russia the year saw the signing of an agreement between Iran, Azerbaijan and Russia to build a new line between the three nations.

In East Asia it is not just a matter of improving interoperability, but of expanding lines and building new ones requiring large fiscal outlays. By 2010 RZD plans to rebuild and electrify the line from Karymskaya to Zabaikalsk at a cost of some 30 billion roubles and also to complete an infrastructure project between the Kuznetsky Basin and the Far Eastern transport hub for another 46 billion roubles. RZD will outlay another 12 billion roubles on building a new railway to the port of Vanino and a further 20 billion for increasing the capacity of the famous BAM (Baikal- Amur Main Line) which will see the completion of another bridge over the Amur River by 2008 for another 5 billion roubles.

Underlining the wisdom of this investment commitment is the growing trade volumes coming from China and heading west. In the first half of 2006 cargo carried by RZD between Russia and China grew 7.8%. An important part of this growth has been the signing of an agreement between RZD and the Chinese Ministry of Railways on container standardization and the exchange of e-data for freight purposes. It is expected that this will be the precursor of a future coordination of tariff policies, new joint investment projects for railways infrastructure, and the creation of joint logistics companies, which will underpin the future growth in commercial volume.

The other key area of expansion for RZD has been inside Russia into areas where new mineral or ore deposits need railway infrastructure to enable development. It is China and the Chinese market which is highlighting the need. Among the biggest increases in freight volume over the past year, have been in oil and oil products, timber, coal, and iron ore, and the fastest growing consumer of these products is China. The new lines being developed in the Chita region to facilitate the development of coal and iron ore deposits for the Chinese market are a classic example.

All of this expansion will go hand in hand with a customer focus that hasn’t really existed in the railway system of the past. New luxury high speed trains will deliver something passengers might not have too much experience with – customer designed comfort and speed. And for freight handlers, an extensive new range of services, including door-to-door shipments to an expanded range of destinations and consignment tracking using the latest technology.

Modern trains pass the old steam locomotive on display at Vladivostok station

Spinning Off

Currently RZD has created more than 30 subsidiaries for particular parts of its operation, and more are scheduled. These include passenger operations in Yekaterinburg, Vladivostok, Moscow and Krasnoyarsk, the railway manufacturing works ‘Elteza’, and maintenance works in Orenburg, Perm and Moscow. In most cases the spin off of passenger operations see RZD retaining an approximate half share of most operations. Other specialised companies which have been spun off include specialized freight services, particularly for auto transport and timber, as well as this summer’s creation of ‘TransKontainer’. The manufacturing and maintenance operations are still 99% owned by RZD, but spinning them off makes them more accountable to the parent company for controlling costs and more attractive to potential investors when the time comes to offer investors shares in them as separate entities.

In addition to these subsidiaries, there are a large number of associate companies which have been formed and in which RZD maintains a stake. This covers operations not just related to railway transport, such as the commuter operations at Barnaul, Kemerovo, Omsk and Novosibirsk, but activities which one wouldn’t normally associate with one of the world’s largest railway companies. This includes distilleries, sports facilities management and FC Lokomotiv, an investment company, and telecommunications companies in Moscow and Khabarovsk.

The sharing of ownership of the passenger operations has the benefit of regional administrations having a say in what services are provided for railway patrons in their areas. The benefit for RZD in the arrangement is that it enables the cost of the services to be evident to the cities and regions where they operate. It is also expected that regional authorities will take over social facilities currently owned by RZD, including hospitals, schools and recreational facilities for RZD employees.

A big change in the profitability of passenger operations will come from changes to the welfare laws of Russia, resulting in the monetization of benefits given to pensioners. Plus, the reimbursement from the federal budget to service providers such as RZD for the cost of the services they provide. This will enable the company to end the cross subsidization of passenger lines at the expense of freight lines and considerably help RZD’s balance sheet. The cross subsidization will be phased out so as to minimize the impact on those who use the welfare benefits provided.

In addition to the spinning off of subsidiaries and associates, the advent of competition in some key areas has prompted the company to sharpen its act. When permitted in 2004, private operators leapt at the chance to provide their own rolling stock. The government also required that RZD provide non discriminatory tariffs for all operators on the system, and so far they have targeted the high value end of the market, including chemical and oil transport. RZD isn’t intending to vacate the field, but the presence of competition and other alternatives for importers and exporters will guarantee a market focus. Private fleet owners and operators own and lease around 200,000 rail cars, which account for around one third of the country's rolling stock; and this rolling stock carries up to one fourth of all cargo. At the same time, RZD carries most of the low profit cargo such as coal, wood and construction materials.

Lumber is a major cargo for RZD

Finding the Roubles and Spending

RZD is highly regarded by international ratings agencies, with investment grade ratings from Fitch, Standard & Poor’s, and Moody’s. With that sort of respect from the international financial community, it isn’t surprising that it has had no problems whatsoever placing a series of bond issues.

The increases in both freight volumes (11%) and passenger numbers (9%) since the company started have further underlined its sound financial position. Despite this, the company hasn’t the capacity to provide the massive investment resources it needs for its long-term planning. To cover the shortfall in investment funds, it has earmarked the funds from its bond issues, plus monies raised from the spin off of subsidiaries (which are expected to commence issuing stocks in the near future) as well as attracting a syndicated credit worth more than 600 million in late 2005. In addition to the development of new lines there is an outstanding need to conduct major maintenance and upgrading of RZD’s massive fleet of locomotive and rolling stock. Over the ten years 2007-2017 RZD has earmarked 279.63 billion rubles ($10.45 billion) to repair and buy new passenger cars. It plans to buy 12,818 new cars and fully renovate 1,515.

The announcement of a contract with Siemens for 60 high speed trains and 30 years worth of maintenance wipes out last years credit in one fell swoop. The company has also indicated it would look positively at any joint venture proposals, particularly on the development of new technology and rolling stock.

Ready to Spend

At some point in the next few years it is likely that ordinary investors will have the chance to invest in the juiciest morsels being served up by RZD in the form of its subsidiaries going private. It won’t happen overnight but the plans are in the pipeline, and when it does happen it will be handled with a little more caution than some of the privatizations that happened in Russia ten years ago. It may not have the profile of a Rosneft, but it probably won’t generate as much controversy either. Investors will have the chance to get into what will be a solidly run subsidiary of a rail business that has had its future mapped out carefully, and that has good growth prospects. And as the industry turns itself around, the favourite mode of transport for Russians, both as shippers and passengers for the last 150 years will lay the groundwork for the future, underpinning Russia’s continued economic growth and setting both itself and the nation for the long haul.

Siemens to supply HST’s to Russia

Siemens’ Transportation Systems Group (TS) is to initially supply eight Velaro type high-speed trains to Russian Railways (RZD) and also assume responsibility for their maintenance for a period of 30 years. The contract for the trains and the maintenance is worth about EUR 600 million. The corresponding contracts were signed by Siemens and RZD in May 2006.

“This order will give Russia the most modern high-speed trains in the world. At the same time, this contract provides an excellent basis for a long-term partnership between Siemens and RZD in all sectors of rail industry,” said Hans M. Schabert, President of the Transportation Systems Group of Siemens.

Designed to travel at 250 km/h, these new trains are to be used initially on the Moscow–St. Petersburg route. With ten cars and a total length of 250 meters, they will be able to accommodate more than 600 passengers. The trains will be built for the Russian broad-gauge network and, consequently, be approximately 33 cm wider than Germany’s high-speed trains. The design and pproduction work for the Russian high-speed train will be done in Germany. A localization of production activities is also planned. The last trains are due to be delivered by 2010.

The new train is featured on the front cover of Passport

James Blake is a business presenter on Russia Today TV, the English language satellite TV channel launched by RIA-Novosti last year. It is available to Moscow subscribers of NTV Plus and Kosmos TV

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