Ukrainian Railways can reduce freight tariffs by 20% by optimizing costs

JSC Ukrainian Railways (UZ) has prepared and submitted to the Ministry of Community and Territorial Development a draft Order that provides for an increase in tariffs for rail freight transportation. The Federation of Transport Employers of Ukraine (FTU) categorically does not support this tariff increase, as it will have catastrophic consequences for entire sectors of the Ukrainian economy and budget revenues, and as a result, will negatively affect the defense capability of our country. The Federation appealed to the Prime Minister, the Chairman of the Parliamentary Committee on Economic Development, heads of ministries, the Chairman of the Board of JSC Ukrainian Railways, the Chairman of the State Regulatory Service with a request to reduce freight railway tariffs by 20% from the current level by optimizing UZ’s costs and taking measures to restore and increase the freight base of UZ.

Continuous growth

Ukrainian Railways has sent a draft order to the relevant ministry, according to which tariffs for ore and coal are to be increased by +19%, coke by +12%, and grain cargo by +11% (including an increase for freight and empty flights).

It is important to note that shortly before the Russian invasion, there had already been a series of increases in monopoly tariffs for rail freight transportation, which were formalized by Orders of the Ministry of Infrastructure No. 418 of 11.08.2021 and No. 586 of 29.10.2021. The FRTU believes that there were no sufficient grounds for the adoption of these orders, as the profitability of freight transportation was at a fairly high level – 26% in 2016-2020.

Already in June 2022, in response to the significant decline in freight volumes caused by the outbreak of a full-scale war, the Ministry of Infrastructure was forced to increase railroad transportation tariffs by another 70% for all types of cargo. This increase, which was unprecedented in previous years, was seen by cargo owners as a temporary measure to support UZ, creating expectations of a reduction after the situation at UZ partially recovers and freight volumes increase. As a result of these changes, monopoly tariffs have increased 2.4 times since the beginning of 2021, and the cost of transportation of empty railcars for Class 1 cargo has increased 2.6 times.

The current situation is that Ukrainian Railways’ railroad tariffs in dollars are already 25-60% higher than before the war (2019-2021). In particular, tariffs for the transportation of coal and ore have increased by more than 120%, and for grain by 60% since the beginning of 2019.

Internal problems

The economic rationale for the need to increase tariffs is explained by the need to maintain profitable operations, increase capital investments, etc. However, the actual facts of Ukrainian Railways operating activities indicate the need to restore order in internal processes.

In particular, Ukrainian Railways should address the following issues in its operations:

1. Reach breakeven in passenger transportation. UZ’s main losses are not from freight transportation. In 2023, passenger transportation generated a loss of UAH 15.7 billion, and it is expected to increase to UAH 20 billion in 2024.
2. Controlling cost growth. In the first half of 2023, total expenses amounted to UAH 40 billion, and in the first half of 2024 they will reach UAH 50 billion.
3. Increase labor productivity. In the first quarter of 2024, the labor productivity of Ukrainian Railways employees was 15% lower than in January 2022. In January 2022, UZ planned to increase labor productivity by 20%, but given the decline in traffic, the reserve for increasing labor productivity is more than 25-30%, but nothing is being done to achieve these figures.

Counterarguments

The internal economic factors of Ukrainian Railways that indicate that there is no need to increase freight tariffs are as follows:

1. Freight transportation is profitable. Revenues from freight transportation in 2023 amounted to UAH 74.2 billion (+UAH 11.2 billion compared to 2022), and their profitability was 27%. This is a very high figure. In the first half of this year, the total revenue from freight transportation increased by UAH 6.5 billion to UAH 43 billion compared to the same period in 2023.
2. UZ is quite profitable. The financial result in the first half of 2023 amounted to UAH 4.8 billion, which is UAH 1.7 billion more than in the first half of 2024. This is despite the fact that ports were unblocked in September 2023, and the average monthly traffic volume in the first half of 2024 amounted to 15 million tons per month, which is 27% more than 11.8 million tons per month in the first half of 2023. And UZ plans to make a loss of UAH 2.7 billion by the end of 2024. The question arises, where will the profit of the first half of 2024 go?

In general, the arguments provided by UZ to justify the need for “unification” of rail transportation tariffs do not stand up to any criticism, because in fact, it is not about creating fair economic conditions and paying for the services actually provided by the monopoly in accordance with their volume and real costs (the European principle of “the consumer pays for what he consumes”), but about another non-transparent and voluntary increase in the cost of transportation.

The introduction of a common, equalized tariff for all transportation, which will cover all the costs incurred by UZ, even those related to unprofitable segments of UZ’s activities not related to freight transportation, is nonsense. This approach ignores the difference in real costs between different types of transportation, in particular between route transportation (100% of ore transportation and 15% of grain transportation) and transportation in combined trains (a technology for organizing carload shipments, which is typical for most shipments of grain, scrap metal and oil products).

Looking specifically at cargo, iron ore transportation requires significantly less UZ infrastructure than grain transportation in combined trains. For the transportation of ore, 18 railway stations and 2.3 thousand kilometers of mainline railways are used. For grain transportation in combined trains, more than 379 stations and more than 12 thousand kilometers of tracks (80% of the total length) are used. If we look at the necessary infrastructure for the transportation of 10 million tons of cargo, then 10 million tons of ore (route shipments) require 22 times fewer UZ stations and 5 times less railroad tracks than 10 million tons of grain in combined trains. Sorting stations are not involved in ore transportation, while grain transportation in combined trains requires the constant operation of about 20 sorting stations.

Thus, the unit costs of route transportation are much lower than those of combined trains (in particular, carload transportation), which is why tariffs should be differentiated rather than unified.

Conclusion

The constant increase in tariffs is dangerous both for Ukrainian Railways itself and for the Ukrainian state, as it means that UZ is losing its cargo base and thus the economic basis of its business. Some customers will continue to switch to road transportation, which has been the case for many years due to constant increases in railroad tariffs.

At the level of the entire Ukrainian economy, tariff increases are even more dangerous. Some businesses in key sectors of the economy may close down and not resume operations afterwards. Very disturbing developments have recently been observed in the mining and metals sector (production stoppages), and in the agricultural sector – unprofitable cultivation of key mass crops that make up the bulk of our agricultural exports. In general, the increase in rail freight tariffs has become one of the main reasons why many companies can no longer operate without losses.

For the state, closed enterprises mean the loss of jobs, tax and foreign exchange revenues worth tens or hundreds of billions of hryvnias, and most importantly, in the current environment, the destruction of economic potential to support the Ukrainian Defense Forces, as they are financed by taxes paid by enterprises and their employees.

The way out of the current situation is to reform UZ with the separation of services into separate segments and even legal entities (infrastructure, freight transportation, passenger transportation), and to create the National Commission for Transport Regulation (NCRT), which will develop and implement a methodology for determining the level of economically justified tariffs for certain services in monopolized segments of rail transportation. Segments where competition is possible should be liberalized and conditions for effective competition should be created.

The FRTU believes that by optimizing Ukrainian Railways costs and taking measures to restore and increase the freight base, it is necessary to reduce freight tariffs by 20% of the current level.