The recent sale of UK operator GB Railfreight to infrastructure fund InfraCapital highlights investors' increasing confidence in the predictability of the European rail freight market after 15 years of progressive liberalisation – much of it forced on unwilling national governments by the European Union.
InfraCapital's decision to invest in this well-run and respected company, also illustrates a fundamental confidence in the stability of the broader UK market.
Rail freight policy seems liberal, sensible, and stable. It is worth noting that a UK that remains within the EU - or which is outside the political structures of the EU, but remains subject to the EU's legal supremacy - (as favoured by the Labour Party, and the Tory rebels) would have limited powers to change this. In other words, Corbyn could bark, but he might not be able to bite.
TIL has been researching the underlying traffics of both UK and EU freight markets – the commodities carried, operator market shares, the paths held and paths used, and the rolling stock deployed. Our preliminary results highlight the exposure of the sector in many countries not to changes in rail regulation, but to secular change in underlying markets.
Within the UK, energy policy has already led to rapid and drastic reductions in coal traffic from over 50 million tonnes carried in 2013/14 to just 10.5 million tonnes in 2018/19..
But our analysis of freight flows within north west Europe indicates the high exposure of freight operators and rolling stock lessors to large changes underway in the maritime, energy and automotive markets, as well as substantial numbers of unused paths. The latter is likely to be a leading indicator of a Eurozone economy facing its third sharp downturn in little more than ten years.
Put simply, EU rail freight operators are – in many cases – heavily dependent on the transport of coal, automotive parts, and finished car traffics, that are likely to be impacted by forthcoming policy upheavals to the way that we generate power, and propel road vehicles.
Electric road vehicles will require entirely different supply chains, and will use far fewer parts [because electric vehicles are fundamentally simpler], and are also likely to have much longer service lives [a side effect of their simplicity and engineering]. Fewer car parts will need to be moved within Northern Europe by rail, and they will move from new origin factories to new destinations. It is not clear that all of the current market-leading European producers will survive the transition from fossil fuel to electric propulsion technology. New market entrants can be expected, and some existing market leaders could lose significant share. The overall volume of finished cars may also fall, if longer vehicle lives and greater use of car sharing changes long established car replacement cycles.
The rapid slowdown in industrial confidence arising from demand challenges is already visible in TIL studies of individual plant-to-port traffic flows, with some rail freight operators holding significant unused capacity in terms of train paths, and reductions in weekly train frequency already underway.
The long distance movement of petroleum fuels – often undertaken by rail – will also be subject to change. China now leads the world in battery technology and production, and this supremacy has coincided with the realisation of the "Belt & Road" initiative into a railway reality.
However, there are significant upsides in the railfreight market. Increasing amounts of maritime traffic is diverting to rail and the volumes moving over very long distances between China and Europe are becoming substantial. This will continue to be a growth area for EU railfreight, as the penalty of off-loading from ship is replaced by the need for regional distribution of commodities that have already arrived in Europe on rail wagons. Containers are travelling much longer distances as the long distance segment transfers from sea to rail, and the distribution by rail becomes relatively more economic. This change will create challenges for operators focused on the North Sea ports of Bremerhaven, Hamburg, Antwerpen and Rotterdam and could be good news for the anaemic cross channel market via the tunnel.
Our surveys have already noted a huge percentage growth in China <> EU rail freight traffic. From a near zero start in 2015, traffic to the Rhein Ruhr terminal in Rheinhausen increased to 3,000 containers per annum in 2017 and based on our October 2019 survey, this figure is running at over 2,000 containers per month . In addition, Chinese containers are now being delivered to other parts of Western Europe with daily flows to Bremerhaven, Nurnberg, Hamburg, Liege (Belgium) and Tilburg (Netherlands).
And it is not only containers that are moving between the two continents, with cars now being moved regularly by the automotive distribution company ARS Altmann on behalf of car manufacturers such as Volvo to / from China.
In other words, rail freight will face not only large changes in the commodities carried, but also in the economic geography of the flows.
We expect these changes to be particularly challenging for Germany and its satellites, which have intensified their use of coal for electricity generation following Chancellor Merkel's overnight decision to shut down Germany's nuclear industry [and simultaneously increase the country's dependence on imported Russian gas and French – nuclear powered – electricity]. Moreover, Germany has an automotive sector in the order of x4 bigger than the UK, which is facing simultaneous challenges arising from the diesel scandal, and the regulatory rush towards electric vehicles: a technology in which Germany has no particular specialist advantage.
Finally, the rapid increase in political concern around local air pollution will also affect the sector. Diesel locomotives have been cheap, and flexible, and the 1930s-derived EMD Class 66 has become widely distributed across the continent as a rugged, practical traction solution for the new generation of commercially-minded rail freight operators. There are plenty of 'heritage' diesels of varying vintages running alongside the EMD 66s.
The emergence of Low Emission Zones [LEZs] in many city regions of the UK and EU, will put such old school technology under pressure: diesels will have to be cleaned up, or replaced with new fleets of flexible electric freight power. Some relatively modern diesel fleets may become prematurely obsolete, or hard to redeploy.
These changes will create large impacts on the owners and users of freight rolling stock. Some wagon types are adaptable for alternative uses at acceptable costs, others not. Investors will therefore need to have a clear view of the market, and the relevance of their portfolios to changing circumstances.
We see big variations in the ability of current rolling stock fleets to weather these changes without spikes in investment. For example KKR-owned European Loco Leasing [ELL] has built up a homogenous fleet of over 140 go-anywhere Siemens class 193 electric locos, that should have very long asset lives and which are being flexibly deployed across a wide range of operators and countries. Other lessors / operators hold large fleets of relatively new diesels, that could be more difficult to re-deploy as air concerns rise to the top of the policy agenda.
Similar issues will arise in wagon fleets, with some lessors holding very large fleets of car-carrying wagons in a market that could become over-supplied.
The lesson is clear. As always, transport is a derived demand, and rolling stock and operator economics will be affected by underlying economic factors. The Eurozone may be simultaneously entering both an economic slowdown and a once in a century change to the way that we generate electricity and power our road vehicles. Consensus in the market is that the Rail Freight market will continue to grow, but it will have to adapt, and investors will need to anticipate how they modify their business models and rolling stock fleets to what lies ahead.
David Leeder, Managing Partner, Transport Investment Limited (TIL)
