Competition drives rail freight renaissance

The Australian rail freight business has changed dramatically in recent years, driven by pivotal investment and the restructuring of operations and infrastructure management. The introduction of on-rail competition has facilitated the integration of line-haul train operations into wider logistics businesses

THE PAST decade has been a turbulent time for Australia's rail freight industry. The advent of competition, accompanied by regulatory reform, has driven a series of mergers, divestments and takeovers that have resulted in the emergence of three main inter  -state train operators and a host of supporting players.

Investment in infrastructure, locomotives and rolling stock is encouraging and supporting a modal shift onto rail from road and sea. However, strong price competition from these other modes is keeping freight rates low, making it unlikely that rail operators will be able to pay back the cost of infrastructure works currently being funded by the federal and state governments without putting the rail freight renaissance at risk.

Taking stock

After more than a century of incremental efforts, a coherent national network for freight operations across the different state jurisdictions of Australia finally emerged in the 1990s. At the same time, privatisation, restructuring and other regulatory reforms were bringing substantial change to the market.

The call for a national network aligned with freight movements across internal boundaries intensified in the late 1980s, when losses at the state railways were mounting and freight customers were expressing concern. A single interstate freight operator emerged in the form of National Rail Corp in 1993. Five years later Australian Rail Track Corp was formed, initially managing infrastructure in Victoria, South Australia and part of Western Australia to provide a 'one-stop shop' for movements across state boundaries.

ARTC's remit was broadened in 2004 to include track in New South Wales outside the Sydney commuter network. On the infrastructure side, two investment projects of crucial strategic importance had been undertaken in the 1990s, including conversion of the Melbourne - Adelaide route from 1600 mm to 1435 mm gauge, removing the need for bogie exchange or transhipment of traffic to Western Australia. At last, a network with a uniform gauge linking Australia's major cities had become a reality.

Passing loops on this largely single-track national network were progressively lengthened. This enabled train lengths to rise from around 900 m to at least 1500 m between Melbourne and Perth.

At the same time, Australia was embracing the international trend for rail privatisation. Freight operators NRC and FreightCorp were sold off in 2002, and the rail infrastructure was either privatised or let on long-term lease in Victoria, Tasmania, South Australia and Western Australia. Much was expected from privatisation and, initially, some amazing results were reported.

After almost 130 years of persistently reporting losses when in the public sector, the privatised Tasrail reported an operating profit. But it later transpired that this was only made possible by neglecting infrastructure investment, with the company's subsequent owner demanding public support on the grounds that the business had in fact being making a loss since privatisation.

At present, asset deterioration and the progressive return of contracts and infrastructure to the public sector pose an ongoing policy issue for Australian governments who seek to maintain a viable railway network.

Competition context

In 1995 a National Competition Policy was agreed that included establishing regulatory arrangements to secure third-party access to infrastructure services. It was initially focused on competition in the utilities markets but later expanded to cover railways.

Mandating access to rail infrastructure would, it was hoped, deliver a competitive edge. The policy seeks to provide access to infrastructure that is deemed 'essential' and which could not be replicated easily. There have been major, protracted court cases testing where access must be given and under what terms, particularly with regards to the heavy haul mineral railways in the north of Western Australia.

In that region, mining companies own all the assets of their production chain, including mines, port facilities and the railways that connect them. They are free to choose a train operator, be it in-house or outsourced. Competition policy seeks to reduce costs for new entrants to exploit reserves by enabling them to use the rail networks of the incumbent mining companies. The aim is to encourage competition in mineral extraction rather than in railway operation itself.

Elsewhere, competition policy has tended to follow the European model. State governments have legislated for access to rail infrastructure with the aim of engendering fair competition between train operators, but the federal system has led to an assortment of industry structures and access pricing regimes.

In general terms, vertically-integrated railways have persisted in Queensland, on the intrastate networks in South Australia and Victoria and for commuter operations in Sydney and Adelaide. In New South Wales, Tasmania, Western Australia and on most of the national interstate network vertical separation applies. Most terminals have been excluded from access regimes, and the better train paths have been retained under 'grandfather rights' without the payment of premium access charges.

New entrants

Of the state-owned freight operators in existence when the National Competition Policy was adopted, only Queensland Rail remains intact. It is still an archetypal vertically-integrated railway, although its reach now extends well beyond its home 1067 mm gauge network.

QR and its subsidiaries have bought a range of other businesses, including regional freight operator Northern Rivers Railroad and, in a form of renationalisation, the freight operations of Australian Railroad Group in Western Australia. Acquisitions in the logistics sector include CRT, Golden Bros and Austrans Container Services.

Australia's two major private freight operators are SCT Logistics and Pacific National. SCT was the first private interstate rail freight operator and currently hauls around one-third of east-west traffic. Carrying palletised goods by road and rail, it seeks to maximise payload against tare weight. Bogie covered freight wagons with sliding doors are highly suitable for this traffic, offering more space than containers and accommodating two Australian-sized pallets abreast compared with one in a conventional container. When in 1995 NRC announced that it would no longer operate these wagons, SCT began its own Melbourne - Perth service.

Pacific National has its roots in the Toll freight-forwarding and Patrick stevedoring businesses. In 1996, Toll began a Melbourne - Perth container service and a year later Patrick introduced its own Melbourne - Adelaide landbridge. In both cases, traffic had been captured from NRC.

In 2002 Toll and Patrick were successful in their joint bid for the bundled freight assets of NRC and FreightCorp of New South Wales, which were combined with Toll Rail and some Patrick Rail operations to form Pacific National. PN went on to acquire Freight Australia, a regional operator in Victoria, as well as ATN Access which owned Tasrail and regional grain operations in southeastern Australia.

Further consolidation occurred in 2006 when Toll took over Patrick. To meet competition concerns, Toll agreed to separate its freight-forwarding activity from PN/Patrick infrastructure and earlier this year the combined business was listed on the stock exchange as Asciano.

Several niche train operators have also entered the market, providing regional freight, port shuttle and maintenance services as well as hiring locomotives and crew to larger operators. Such companies include South Spur Rail, El Zorro and Independent Railways of Australia.

The freight market

The potential for effective competition varies across commodities, which fall into four main categories. Agricultural produce such as cereals and cotton is moved for both domestic markets and for export, while raw and finished steel products are carried to a variety of destinations across the country. Non-bulk freight is typically interstate container and palletised goods, with some landbridge traffic between Adelaide and the Port of Melbourne. Bulk flows for export include iron ore in Western Australia and coal in Queensland and New South Wales.

Coal and iron ore traffic is generally profitable, but for other commodities this is only the case because access charges have been set a level well below that needed for the infrastructure owner to recover its costs over the long term.

Effective cost recovery is impeded by modest traffic volumes on most routes and strong competition from other modes. While rail performs well in the non-bulk sector between Melbourne and Perth, with almost two-thirds of the combined rail/road/sea market and train operators recording a profit, ARTC recovers less than half of its long-term costs. Strong road and sea competition prevents the rail infrastructure managers from raising access charges, for fear of customers switching their operations to these other modes.

Emergence of competition

Two forms of competition have emerged. Train operators compete to haul trains, and to provide competing rail freight services. In the case of the former, haulage contracts on vertically-integrated networks owned by coal and iron ore mining companies in South Australia have been awarded by competitive tender for some years now.

It is realistic to assume that QR enjoys competitive advantage for coal haulage on its home network. It has a near-monopoly of 1067 mm gauge operations in Australia and is also the infrastructure manager within Queensland. Mining companies have called for QR to be vertically separated, and from its base of 1435 mm gauge operations PN is now actively pursuing coal haulage business on QR's network. Mining companies are likely to be receptive to changing haulier, with QR being blamed for a recent shortfall in coal deliveries to ports.

But the situation is not completely one-sided. QR has won three haulage contracts from PN in the Hunter Valley coalfields of New South Wales, and now hauls around 15% of coal traffic in this region. The contracts are significant as QR has needed to procure traction and rolling stock to operate on 1435 mm gauge.

There has also been some competition in the grain market. Both ATN Access and Freight Australia were shifting grain in southern New South Wales in competition with PN, until they were taken over by that operator.

On interstate lines, there are three main operators. QR and PN compete on the Cairns - Brisbane and Brisbane - Melbourne routes. SCT and PN have operated for some years between Melbourne and Perth, and in November were joined on this route by QR.

QR's aspirations in the non-bulk market outside Queensland depend on it forging strong links with the logistics sector as long-enjoyed by SCT and PN. Recent developments have made this more imperative. QR began its Brisbane - Sydney - Melbourne intermodal service in 2004, underpinned by business from logistics operator CRT. However, in 2007 CRT lost an important plastics contract to its rival Toll, with the result that PN will now move this freight. QR's intermodal prospects were also undermined this year when PN won a major contract from Linfox, the second-largest rail freight forwarder in the Australian market.

Since commencing Brisbane - Melbourne and Brisbane - Adelaide services, QR has sought to extend its operations to Perth and create a truly national network. This requires a significant traffic base, and explains the logic behind QR's three acquisitions in the logistics sector. However, it is realistic to assume that the modest traffic that has come with these transactions still leaves a significant revenue gap before service viability can be assured.

This bedrock of traffic is something that large freight forwarders and logistics companies tend to possess already. Back in 1995 SCT had adequate business of its own to underpin its fledgling Melbourne - Perth train and was soon expanding its operations. Similarly, Toll, Patrick and (more recently) P&O had large volumes of traffic that could be switched from existing third-party operators to their own trains.

It is worth stressing that these rival services are increasingly coming to resemble the owning logistics businesses rather than traditional train operators vying for line-haul customers. The importance of this trend has been magnified by significant consolidation in the logistics sector, which greatly strengthens the leverage that forwarders have over train operators. Logistics companies choose the mode that gives them the competitive edge. It becomes somewhat incidental whether road or rail is used. Thus, the main battlefield of competition is in end-to-end logistics and not in the simple line haul of a train from one rail terminal to another.

Ancillary markets

Apart from a traffic baseload, would-be train operators also require access to terminals, locomotives, rolling stock and crew. New businesses have emerged to meet these needs. A subsidiary of Chicago Freight Car Leasing is now active in the Australian locomotive and wagon markets, while Momentum Rail provides train crews on a spot-hire basis. Southern & Silverton, Genesee & Wyoming Australia and others provide haulage for other train operators, with GWA supplying crews for SCT trains.

SCT is gearing up to introduce its own locomotives, some new-build and others acquired from PN. The national competition regulator required PN to make available a 'starter kit' for freight train operations by way of compensation for some loss of competition arising out of Toll's acquisition of Patrick. Including locomotives, wagons and train paths, the kit was sold on the open market with SCT named as the successful bidder in early 2007.

Impact of competition

Whilst competition policy was not intended to drive the merging of train operations into wider logistics businesses, it has certainly facilitated this development. Logistics companies have meshed train operations directly into their business models, extracting efficiencies that have revitalised the freight business.

Two approaches are evident. SCT has moved to fully integrate its line-haul train operations with its logistics business. The two other major non-bulk customers, Toll and Linfox, have haulage contracts with PN.

The days of the traditional freight train operator are passing. Whether in the bulk or non-bulk markets, competition policy has reinforced the shift of power from train operators, towards the ever-larger shippers. Even a decade ago, the shift of SCT and Toll business to their own services led to lower volumes and downwards pressure on tariffs, costing NRC A$60m in one year - around 15% of its operating revenue.

These large logistics companies commissioning their own trains can tailor operations to meet the needs of end customers far better than the line-haul provider, enhancing rail's competitiveness. SCT claims that, a year after it commenced its Melbourne - Perth service, the prevailing freight rates had dropped by 30%. Keen pricing is vital to rail on this route, where competition from international shipping is fierce. Although shipping lines are required to obtain government permits to carry domestic container loads, their rates are estimated to be 30% below rail. SCT's expansion from one 600 m train each way per week to at least six trains of 1500 m or longer, taking full advantage of parallel infrastructure enhancements, has won new business to rail rather than simply capturing traffic from other train operators.

But competition comes at a price. It might be assumed that the Melbourne - Perth experience could be replicated between Cairns and Brisbane, where in 2005 Toll shifted its intermodal business from QR to a new PN service. However, this route probably has insufficient traffic for one viable service, let alone competing trains. In this case, essential economies of scale have probably been lost by operating two shorter formations rather than one longer train.

With the consolidation of industry players, the role of the niche train operators is vital to effective competition and service choice. For instance, earlier this year El Zorro won a contract from wheat exporter AWB in southeastern Australia, PN's heartland. Niche operators take on traffic that is of no interest to larger players, ensuring that traffic stays on rail. Patrick Portlink took over a service between an inland terminal at Blayney and Sydney's Port Botany when PN withdrew.

For a time there was on-track competition for grain haulage between Freight Australia, ATN Access and Pacific National. The Australian Wheat Board reported transport cost savings of A$4/tonne. Savings have also been reported in the Hunter Valley coal market, and while QR has retained all its Queensland contracts to date, it has been suggested that competitive tendering has driven down rates.

The large contract to haul steel products in Australia is a good example where other modes - in this case, sea - provide important competitive tension. Were rail felt to be overcharging for this long-term contract, sea freight would be able to provide a practical alternative for most movements. It shows that on-rail competition is not essential when other modes can encourage train operators to be cost-effective.

Future prospects

The iron ore mining companies are unaffected by competition policy, in that they have always been able to choose who will haul their trains on their own tracks. However, they will be adversely affected if their track capacity is forcibly sold to competing companies. In contrast, on Australia's common-carrier railways, competition policy gives the coal mining companies the power to choose who will haul their traffic, generating pressure on haulage rates and service reliability performance.

Efficiency gains from tendering for bulk haulage contracts are likely to be sufficient to ensure that QR and PN continue to provide the necessary competition. Even so, despite high entry costs, the large volumes to be moved mean that it is conceivable that a sufficiently large mining company could start its own train operations. Freightliner of the UK has been reported to be investigating the prospects of entering the coal market, following the recent launch of its first operations in Poland (RG 10.07 p592).

Arguably, competition policy is enabling major non-bulk freight customers - such as logistics companies - to align their businesses more closely with railway line-haul. This policy enabled SCT to pursue its business model based on closed wagons rather than return to road or use the containers that NRC was imposing on it.

But competition in the non-bulk sector is not train operator versus train operator, but logistics company versus logistics company. And this competition would have occurred without the National Competition Policy. The consolidation and growth in the logistics section has increased the power of freight forwarders to provide the make-or-break traffic volumes for train services. And that, presumably, makes train operators more responsive to shippers' needs.

Australia's non-bulk and regional railways operate in a policy cocktail, with gains from investment and national focus mixed with competition policy and ambitious privatisation. This heady mixture has been applied to a physically and financially fragile industry. Mandating third-party access increases investment risk; infrastructure privatisations ignore the fact that most of the network depends on public funding for long-term survival. Without this explicit recognition, railways will not fulfill the role expected from them under wider social policies aimed at protecting the environment, improving transport safety and reducing congestion.

On-track competition requires more capacity and, partly in response to this, ARTC is undertaking very substantial investment. This is particularly the case between Sydney, Melbourne and Brisbane, where further double-tracking and resignalling are now in progress (p775). Given the industry's fragile nature, if these costs are passed on to train operators, it could certainly undermine Australia's rail freight renaissance.

• The largest operator on the standard gauge interstate network, Pacific National has now broken into QR's narrow gauge heartland, moving Toll intermodal traffic to and from Cairns
• Niche players such as Patrick Portlink have taken over flows of no interest to the larger operators and help to ensure an effective level of on-rail competition
• QR National is expanding the state-owned railway onto the standard gauge network, winning contracts to haul coal in NSW's Hunter Valley and buying up train operators elsewhere in Australia