Overview of the Russian railway market in February-March 2015
Freight turnover grew in February despite a fall in traffic volume
In February 2015, freight turnover increased by 1.8% year-on-year to 174.3 billion ton-km. The main reason for this growth was an increase in the proportion of freights transported over longer distances (coal, ore and rolled steel) against the backdrop of the falling share of construction materials, which is transported over significantly shorter distances.
In February 2015, traffic volume decreased by 0.9% year-on-year to 92.5 million tons.
There were year-on-year increases in the loading of coal (+ 5.3%), ferrous metals (+ 7.3%), non-ferrous ores (+ 7.1%), ferrous steel scrap (+ 13.5%) and grain and grain mill products (+ 14.9%). The transportation of the following products decreased: petroleum and petroleum products (-1.4%), construction materials (-20.8%), iron and manganese ore (-1.2%), timber (-6.1%), chemical and mineral fertilizers (-4.8%), cement (-5.6%) and coke (-7.4%).
In February 2015, railway’s share in the overall transportation structure, excluding pipeline transport, increased to 89.5%, compared to 88.8% in February 2014. In the same period, the share of road transportation decreased to 8.3% (from 8.7 % in the previous year). There is currently no indication that the model will shift from rail transportation to road transportation.
Coal: transportation continues to grow
In February 2015, Russian Railways’ coal loading grew by 5.3% year-on-year to 25.6 million tons. 53.5 million tons of coal have been delivered by rail since the beginning of the year, a 4.5% increase on the corresponding period of 2014.
Export coal transportation decreased by 1.1% year-on-year and domestic coal transportation increased by 8.4% year-on-year.
The structure of coal exports from Russia is changing. There has been an increase in coal imports from Russia to Japan (+5.5%), Turkey (+39.3%) and Lithuania (7.5 times). EU countries are still increasing their coal supplies (by an average of about 20%) to compensate for falling volumes of Ukrainian coal. There has been a reduction in Russian coal deliveries to Ukraine, China, South Korea, Poland and the UK.
Japan has no plans to reduce its consumption of coal power. In February 2015, energy companies, including Kansai Electric Power Co. and Osaka Gas Co, officially announced plans for building new, large-scale coal-fired power stations. Tokyo Electric Power Co also plans to replace oil power stations with a capacity of six gigawatts with new coal power stations. However, Japan is focused on developing technology to enhance the efficiency of coal energy, which will lead to a reduction in coal consumption in the medium term. The World Bank is delaying the ‘clean coal’ project in Japan due to the environmental degradation that has happened as a result of the country’s low coal prices.
The Asia-Pacific region remains a promising market for Russian coal. According to conservative estimates of the Asian Development Bank, the Asia-Pacific region’s share of total world energy consumption will grow to 51% in 2035 (compared to 34% in 2010). Coal consumption is due to increase by 81% between 2010 and 2035.
In accordance with the ‘Development programme for Russia’s coal industry until 2030’ that was established in 2014, exports to the Asia-Pacific region will increase from 65 million tons in 2014 to 110-160 million tons per year in the next 15 years. Thermal coal will make up 83-115 million tons of these exports, and 27-45 million tons of coking coal will be exported.
Russia is planning to expand its coal capacities. One of the important export projects is the development of the Elegest deposit with a capacity of 15 million tons of coking coal concentrate per year. In addition, last year RT Global Resources (“RT-GR”) and China Shenhua Energy Company signed a cooperation agreement to develop the Ogodzhinsky deposit in the Amur region. This deposit is expected to produce up to 30 million tons of coal by 2019, some of which will be exported to Asia.
EvroSibEnergo also owns export assets. At the beginning of 2014, a subsidiary of this holding, VostSibUgol, created a joint venture with Shenhua, which received a license to develop the Zashulanskoye coal deposit in the Trans-Baikal region. Coal production is expected to begin in 2018, and the surface mine created on this deposit will reach its maximum capacity of six million tons of coal per year in three years’ time. In addition, VostSibUgol holds licenses to develop the North-West Kirbinsk Beysky coal deposits in Khakassia and the Nygdinskaya area in Irkutsk region, the raw materials from which may be exported.
Amid India’s growing presence in the global coal market, SUEK and the Indian company Tata Group agreed to work together in the energy sector in Russia and abroad. Tata Group has assets in all the countries of the Asia-Pacific region. This agreement will help to strengthen the position of SUEK, Russia's largest coal exporting company, in the global market.
Therefore, the consumption potential of Russian coal is supported by the Asia-Pacific countries, Turkey and the EU. In the medium-term, coal transportation from Russia will remain at its current high level, but it will increase over the long-term.
Petroleum and petroleum products: domestic transportation declined, the drop in exports slowed
In February 2015, Russian Railways’ petroleum and petroleum products loading fell by 1.4% year-on-year to 20.6 million tons. Since the start of 2015, 43.2 million tons of petroleum and petroleum products were delivered by rail, which is by 0 5% less than during the same period of 2014.
In February, domestic transportation of petroleum and petroleum products fell by 5.6% year-on-year. The year-on-year fall in exports reduced to 0.5%, compared to 3.7% in January 2015. Exports increased to South Korea (+73.6%), Kazakhstan (+44.4%) and Italy (+3.3%).
One of the factors that influenced the redistribution of freight traffic was the 10% increase in railway tariffs from January 2015. According to the consulting company AT Kearney, unlike the export of petroleum and petroleum products, domestic transportation is highly sensitive to tariff changes. For instance, a 13.4% rate increase last August led to a significant rise in rail transportation costs for oil companies. According to the 2014 annual reports for Rosneft, Gazprom Neft and Novatek, expenses increased by 20%, 7.7%, and 14.4%, respectively.
Another factor contributing to the reduction in domestic oil transportation is the tax maneuver, which came into effect on 1 January 2015. As a result, the customs duty on petroleum and petroleum products decreased, while the Mineral Extraction Tax rate increased. This made Russian oil exports more attractive.
With regard to production volumes, in January-February 2015, oil production in Russia increased by 0.7% year-on-year. According to the January forecast of the Ministry of Economic Development and Trade, oil production in Russia will remain at the level of 2014 and exports will increase by 1.6% year-on-year.
The Ministry of Energy estimates that only production of oil residue will drop this year. Refineries are switching to modern technologies, increasing the production of light oil products and, consequently, reducing production of heavy petroleum products. Oil residue production may reduce by 5%, but its exports may grow from 51 to 53 million tons. As Mikhail Gryaznov, Director of the Department of Oil and Gas Refining at the Ministry of Energy, noted during the National Oil and Gas Forum, by 2020, Russian refineries are predicted to decrease oil residue production from the current 78 million tons to 21 million tons and oil residue exports are expected to decline to 4 million tons.
According to the Energy Minister Alexander Novak, this year's production of diesel oil will remain almost the same as the previous year, although exports will increase by approximately 3 million tons to 46.5 million tons (from 43.4 million tons last year).
The most significant changes may occur in the market of automobile fuel. Its production is expected to increase slightly by 500,000 tons. Exports of automobile fuel are expected to grow by 16% year-on-year to 4.9 million tons. Russian plants plan to increase gasoline exports to 8.7 million tons by 2020.
Therefore, in the medium term, we should expect to continue to see a shift in the distribution of petroleum and petroleum products from the domestic market to export, while maintaining the current high transportation volumes.
Construction materials and cement: the government is stimulating transportation recovery
In February, Russian Railways’ construction materials and cement loading fell by 20.8% and 5.6% year-on-year and amounted to 7.6 million tons and 1.7 million tons, respectively. 14.1 million tons of construction materials and 3.1 million tons of cement have been shipped by rail since the beginning of the year, which is 23.4% and 6.1% less than in 2014.
According to the Ministry of Construction, house building, which accounts for 70% of total building construction in Russia, fell by 10% between January and February 2015. At the same time, during the first two months of 2015, demand for mortgages dropped by nearly 40%. In January 2015, the number of applications for mortgages fell four times compared to January 2014.
The Government has taken measures to support mortgages and housing, which have led to a 30-40% increase in construction volumes in recent years. In early February, officials allocated RUB 20 billion from the budget to subsidize mortgage interest rates. According to a decree of Prime Minister Dmitry Medvedev, the target interest rate of the subsidized programme for purchasing new properties should be 13% while the Central Bank’s key interest rate remains at 14%, which is unfavorable for signing mortgage agreements. The 13% rate is comparable to the level of 2014, when the average mortgage rate was 12.5%.
The road budget will increase by 20% year-on-year in 2015, and the total budget of the Federal Road Agency (Rosavtodor) will exceed RUB 500 billion (compared to RUB 430 billion in 2014). This year, RUB 54 billion will be spent on constructing the Kerch bridge, a transport passage across the Kerch Strait, and RUB 10 billion will be allocated to the regions as subsidies in preparation for the World Cup in 2018. The Kerch bridge project will cost approximately RUB 250 billion.
Therefore, the key drivers of building materials transportation in 2015 are likely to be the construction of sports venues for the FIFA World Cup 2018, the construction of federal facilities, the development of transport infrastructure and the reconstruction of BAM. If the current economic situation remains unchanged, the crisis of the construction industry is expected to exacerbate in the third quarter of 2015.
Iron and manganese ore: the export structure is changing
In February, Russian Railways’ ore loading fell by 1.2% year-on-year to 8.3 million tons. 17.5 million tons of ore have been shipped by rail since the beginning of the year, which is a 1.2% year-on-year increase.
As in the coal segment, there have been significant changes in the structure of ore exports. Exports of Russian ore increased to a number of countries, including Turkey (an increase of over 3.6 times), Slovakia (+34.0%), the UK (over 15 times higher), Czech Republic (+70.9%), Japan (+65.7%) and Italy, which did not import ore from Russia last year. Exports fell to Finland, Ukraine and the Netherlands.
Experts associate the drop in ore supplies to Ukraine with the crisis that Ukraine’s mining and metals sector is currently going through. The Alchevsk Iron and Steel Works, the Donetsk Steel Mill, the Donetsk Metal Works, Donetskstal and Enakievo Steel Works have all shut down. In February, steel production in Ukraine dropped by 16.3% year-on-year due to the business’s negative profitability. World market prices are falling, while production costs are rising, despite the devaluation of the national currency. Currency expenditures of Ukrainian steelmakers currently stand at 70%. The price of electricity and rail transportation rose significantly; the latter has increased by 30% since 31 January 2015 and it is possible that these costs will rise by a further 25%.
Ukrainian steelmakers have repositioned themselves to focus on mineral ore exports, which was previously considered to be a low-margin market segment. These are products with low added value, but with a shorter payback period. As a result, in January-February 2015, ore processing and domestic shipments reduced significantly by 38%, while exports from Ukraine increased by 16%. However, with the March increase in rental payments for iron ore extraction, mining companies’ expenses will grow by 35-40%. This will make exports of ore unprofitable and will lead to Ukrainian producers withdrawing from the world market.
Despite the challenges facing this market, Russia's position on the global market is more stable than those of other exporting countries due to the strong devaluation of the ruble against the US dollar. Therefore, in the medium term iron ore exports from Russia will remain at a high level.
Ferrous metals: exports grew against the backdrop of the falling the ruble
In February, Russian Railways’ ferrous metals loading increased by 7.3% year-on-year to 5.9 million tons. 12.3 million tons of ferrous metals have been shipped by rail since the beginning of the year, an increase of 9.8 % compared to the corresponding period of 2014.
Exports continued to grow to the following countries: Turkey (+21.4%), Spain (8.5 times), Kazakhstan (+32.3%) and India (3.1 times).
Increased demand for Russian rolled metal products resulted from the devaluation of the ruble and the fall in world prices for ferrous metals. Russia has therefore been able to offer a better price, and many importing countries prefer to reduce their own production of rolled metal products and to instead buy them from Russia. In February, Turkey reduced its output by 12.2%, and Spain cut production by 4.4%, while production in Russia increased by 5.6%.
In February, growth of export freight traffic in Russia outstripped that of domestic transportation. Last year, the year-on-year growth rates of export and domestic transportation were relatively equal at 2.5%. In January-February 2015, however, these growth rates were 8.7% and 10.3% for exports and domestic transportation, respectively.
Domestic rolled stock consumption is expected to decline due to low activity in the construction and engineering industries, as well as a slowdown in the development of pipeline and railway transport. At the same time, the devaluation of the ruble has strengthened Russia's position in the global market, which will contribute to the further growth of export cargo.
Grain and grain mill products: exports decreased after duties introduced
In February, Russian Railways’ grain and grain mill products loading grew by 14.9% year-on-year to 1.5 million tons. 3.1 million tons of grain have been shipped by rail since the beginning of 2015, which is a year-on-year increase of 34.8%.
Domestic grain transportation was the main growth driver after expanding by 22.7% year-on-year in February 2015.
At the same time, export shipments decreased by 14.9% year-on-year and through traffic more than halved.
There were also changes to the export structure. Deliveries of wheat to other countries fell by more than 75%, while deliveries of maize and barley grain increased by several times.
Kazakhstan remained one of the most active consumers of Russia grain, more than doubling its deliveries of Russian cereals year-on-year in February 2015. Several factors led to the increased demand for Russian grain including a poor grain harvest in Kazakhstan, a strong harvest in Russia, the devaluation of the ruble, and the fact that grain exports from Russia to Kazakhstan is duty-free.
The Ministry of Agriculture expects a grain harvest of 100 million tons in Russia in 2015.
In the medium term, traffic from Russia to the CIS countries is expected to decrease, although exports to Kazakhstan will remain stable. This will lead to a slight reduction in requirements for rolling stock, because export routes tend to be shorter than domestic ones.
Chemical and mineral fertilizers: transportation declined due to a fall in exports
In February, Russian Railways’ fertilizer loading fell by 4.8% year-on-year to 4.0 million tons. 8.4 million tons of fertilizers have been shipped by rail since the beginning of 2015, which is 2.3% less than during the same period of 2014.
An 8.3% year-on-year drop in export shipments is the main reason for the loading decline. Domestic transportation remained the same as it was in the previous year.
According to the estimates of the international potash manufacturer Uralkali, sales to India and China may temporarily fall this year. The reason for this is the prolonging negotiations between Russia and China, as well as China signing a contract with Belaruskali at a premium of only 3% to last year's price. Other manufacturers expected prices to increase by 8-10%, but now they have to target lower level increases both on the Chinese market and beyond.
Another factor contributing to the reduction in export volumes in 2015 may be falling production at Uralkali in 2015 due to flooding at the Solikamsk-2. Before the incident at the mine, 2.3 million tons of potassium, equating to 20% of total production, were mined annually. The problems experienced at this mine will mean that the company will not be able to equal last year’s record of 12.3 million tons; output will instead remain at 10 million tons.
Farmers and fertilizer producers have been able to reach an agreement. Chemical companies initially offered to fix prices for fertilizers, but then agreed to give farmers a discount of 33% rather than the 20-28% they previously offered. The head of the Federal Antimonopoly Service (FAS) Igor Artemyev later clarified that the discount would mainly be in relation to ammonium nitrate, which has an over 60% share of the domestic market. The size of the discount will also depend on the type of fertilizer and the economic health of the particular manufacturer.
The agreement therefore will support a stable level of domestic fertilizer transportation, while in the medium term, in the absence of entering into contracts with China and India at acceptable prices, exports may decline. Total traffic may be reduced by the amount of lost output resulting from the incident at the Solikamsk-2 mine.
The state will support domestic railcar building
The data on the rolling stock sales made by plants in the CIS is taken from ’Rolling Stock Market’ magazine.
In February 2015, railcar producers in the CIS sold 2.5 ths cars (+31% on the previous month and -54.9% compared to February 2014).
The Ministry of Economic Development believes that it is reasonable to expect the production capacities of Russian railcar manufacturers to halve to 40 ths railcars in the medium term. Some railcar producers support the Ministry’s position. For instance, Vladimir Lisin’s Uralvagonzavod and Freight One offered to close or convert plants where there is excess capacity.
However, the government refused to discuss drastic measures to control the situation in the railcar building sector at a meeting, which Prime Minister Dmitry Medvedev held in Tikhvin. After the meeting, the Minister of Industry and Trade Denis Manturov confirmed that "purposeful solutions for limiting the market are not planned", and that the market will "self-regulate the demand."
At the meeting in Tikhvin, the Russian government suggested that it may direct more than RUB 11 billion worth of funding to the railcar building industry in 2015-2018. In addition, Mr. Manturov said that RUB 2.35 billion will be allocated this year as subsidies for purchasing innovative railcars.
The government is subsidising the purchase of innovative railcars due to their enhanced technical and economic characteristics. According to the operation statistics of innovative railcars equipped with Barber bogies for February 2015, the average freight turnover was 89% higher than the overall network average.
Innovative cars also require less maintenance than standard railcars. According to SUEK, in 2014-2015, the average number of uncoupled maintenance repairs for gondolas equipped with the 18-100 bogie is 1.61 per year. This figure is ten times less for TVSZ’s innovative railcars at 0.06 uncoupled maintenance repairs per year.
The railcar market may achieve a balance in 2015-2016
In February, the non-serviceable rolling stock on Russian Railways’ network grew by 5.1% since January 2015 to 129.8 ths cars, of which 59 ths were gondolas. The main reason for the increase in non-serviceable rolling stock is the fact that at RUB 500-550/day, market leasing rates are below the minimum level that is needed to provide service maintenance to rolling stock. However, a significant proportion of the railcars not currently in operation can be written off in the near future due to the cost of car detention on the railroad infrastructure increasing. From April 1, 2015, cargo shippers, consignees and owners of private tracks will bear financial responsibility for using the railcar infrastructure.
The result of accelerating the write-off of rolling stock should be that the fleet will be balanced by 2015-2016 and that leasing rates for rolling stock should increase. According to the Minister of Industry and Trade Denis Manturov, the target lease rate of old generation gondolas should be RUB 830/day to allow railcars to be repaired in good time and to ensure that payments are made on the loans taken out to purchase them.