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Freight transportation

The industry proposes to reduce tariffs by 15-20% while maintaining the profitability of Ukrainian Railways

Ukrainian Railways (UZ) has returned to the idea of increasing the cost of rail freight transportation – this time in the form of the so-called unification (harmonization) of tariffs. The Cabinet of Ministers is approving a draft document that provides for an increase in the cost of transportation of construction materials by 52%, ore and coal – by 7%, and the return of empty cars by 67%.

At the moment these changes have not been approved yet, but we can say at once that such an increase in the financial burden worsens the economic prospects of key enterprises, especially exporters, and will negatively affect the functioning of the country’s economy and the state as a whole. Industry needs a decrease, not an increase in freight transportation tariffs.

The essence of the problem

Ukrainian Railways submitted a proposal on ‘unification’ of tariffs to the Cabinet of Ministers back in the fall of 2022. This required the adoption of amendments to existing regulations, including the Cabinet of Ministers Resolution No. 605 of 1997. It was not possible to introduce them before the approval of UZ’s financial plan for 2024.

Unification of tariffs for freight transportation of Ukrainian Railways is the establishment of the same tariffs for all types of cargo regardless of the technology and cost of transportation. This approach lacks economic justification, as each service has its own cost price and it cannot be the same for all.

According to Volodymyr Husak, director general of the Federation of Transport Employers (FTE), appealing to the need for “unification” is a substitution of concepts, which Ukrainian Railways uses to mislead government representatives responsible for revising tariffs.

Any transportation specialist understands that, for example, ore and coal are transported in full trains from the loading station to the destination station, so-called routes, and the railroad costs are minimal, the cost of production is minimal and, consequently, the tariff should be minimal. But the same grain requires substantial infrastructure and is often transported by individual wagons or groups of wagons, so the cost of its transportation is higher. Transportation of cargoes that are transported by individual railcars to individual consignees is the most expensive. It sounds clear even for non-professionals.

Despite this, the top management of Ukrainian Railways makes another attempt at “equalization”. What the document provides for:

  1. Increase in tariff for transportation of ore, coal, cement, limestone and minerals (1st class) by 7%;
  2. Increase of tariff for extra-class transportation (crushed stone, sand, slag) – by 52%;
  3. Introduction of a single rate for transportation of empty railcars for each class of cargo. This increase will affect everyone: business, which used UZ railcars for transportation of light oil products, ferrous metals and scrap, after the reform will pay 4% more to UZ for their return, all others – 67% more than now;
  4. Simplification of the tariff system. Instead of 29 basic schemes of UZ tariff rates will remain one, of 15 coefficients for calculations – seven, and the number of fees and charges will be reduced from 33 to 12.
  5. Appearance of coefficients for specific features of transportation (liquid, dangerous goods, container transportation).

That is, tariffs below the level for the 1st class will increase to its level, and tariffs that are higher will remain unchanged. According to the calculations of Ukrainian Railways, the share of the cost of transportation in the cost of most cargoes will increase from 0.4% to 2%. The largest increase will be for crushed stone (40.6%), limestone (15.7%), iron ore (13%) and cement (11%).

The essence of the proposal is that tariffs will increase for all types of cargo. Therefore, what is presented as unification and harmonization provides only another increase in tariffs.

Erroneous arguments of Ukrainian Railways

Ukrainian Railways tries to justify the actual increase in tariffs during the war by the need to ensure the profitability of its activities and the sharp increase in costs in recent months. It remains unclear why exactly a state-owned monopolist enterprise should make a profit, including at the expense of freight carriers and cargo owners.

A survey of experts and market participants showed that the arguments against the tariff increase are more thorough:

1. Setting the same tariffs for different types of cargo does not correspond to the real costs of their transportation.

A simple comparison of the two most massive cargoes ore and coal shows this clearly. Ore transportation requires much less UZ infrastructure than grain in prefabricated trains. According to FTE estimates, for comparable annual transportation volumes, 22 times fewer rail stations and 5 times less track length are needed to support ore removal. In addition, grain transportation requires 20 marshalling stations with hundreds of shunting locomotives, while ore transportation does not require marshalling stations at all.

The question immediately arises: why is a single tariff needed for these and other goods? Perhaps there is a point in dividing the complex transportation service into separate services? For example, formation of a train at a loading station, use of inactive infrastructure, transportation by locomotive depending on the weight of the train. After all, the cost of transporting a ton of cargo on a train, in which a separate locomotive pulls one car, will be significantly different from transportation on a train, where the locomotive pulls 50 cars.

Ukrainian Railways constantly appeals to ‘market conditions’ means it should work on the basis of economically justified costs of providing services. Because in the market of transportation services customers pay an economically justified price for the service they consume. In the market of transportation services, customers do not subsidize the transportation of other goods. This is the basic principle of tariff setting in the European Union.

2. Ukrainian Railways makes profit even without raising tariffs.

The need to ensure profitability of Ukrainian Railways is called one of the main reasons for the need to harmonize tariffs. Indeed, in July-August UZ incurred losses in the amount of UAH 600-700 mln, but for the first half of the year the state-owned company made a profit of UAH 3.1 bln. Obviously, the results for two separate months are not sufficiently indicative. By the way, according to the results of 2023, UZ net profit amounted to UAH 5 billion, although the financial plan included a loss of UAH 20.2 billion (in 2022 the loss amounted to UAH 10.8 billion). Perhaps it is necessary to conduct an audit and look at the reasons for the increase in costs.

3. The growth of railroad tariffs is never accompanied by real changes and improvements in the quality of freight transportation.

The previous increases in freight transportation costs did not achieve the set goals, in particular, the increase in the volume of capital investments. We see that Ukrainian Railways’ capex plan is, at best, fulfilled by 50-60%. For example, UZ’s capex in the first half of the year amounted to only UAH 4.5 billion, which is only 12% of the annual plan of UAH 38 billion. A similar situation was in 2023 – only UAH 19.6 bln of capinvestments out of the planned UAH 50 bln were utilized. That is, the growth of tariffs and the receipt of superprofits by the state monopolist expectedly does not give as a result of the growth of capinvestments, improvement of the quality of services, new terminals and growth of throughput capacity and cargo turnover.

“This is not the first time such an initiative. None of them ended with real reform, but only with banal tariff hikes,” notes Yuriy Ryzhenkov, CEO of Metinvest.

4. Loss of cargo base and transition of part of cargoes to road transportation.

Due to the reduction in the number of tariff schemes and the abolition of classes, UZ may reduce the volume of transportation of certain cargoes, which will go to the segment of road transportation. This will have negative consequences for the entire transport sector, as the increased use of roads requires significant investments in maintaining their normal technical condition.

The difficulties may also affect freight owners-users of Ukrainian Railways services, who have already contracted with buyers. They will have to revise all their agreements and commitments or find funds in their budgets to cover the difference between planned transportation costs and those resulting from unification.

Business suggestions

All experts in the freight market and transport industry say that Ukrainian Railways needs to focus on increasing operational efficiency and cost optimization, improving the quality of transportation, rather than constantly raising tariffs to cover the growth of inefficient costs.

“Ukrainian Railways has an opportunity to gradually reduce freight tariffs by 15% in 2024-2025, while maintaining profitability and profitability. This will help to renew UZ’s competitiveness and expand its freight base by returning freight from the road transportation segment to the railroad,” Kseniya Orinchak, executive director of the National Association of Mining Industry of Ukraine, is confident.

It would seem that it is impossible to talk about reducing tariffs when everything is becoming more expensive, but Ukrainain Railways itself has shown how such an incentive mechanism can work, explains Serhiy Vovk, director of the Center for Transport Strategies. In particular, Ukrainain Railways applied a 30% discount on grain shipments from frontline stations, which resulted in an immediate increase in cargo traffic from there. The use of this incentive became possible because the Cabinet of Ministers covered the difference in UZ’s lost income at the expense of dividends.

Experts argue that the reduction of freight tariffs will help restore the competitiveness of Ukrainian exporters, reduce the financial burden on business and stabilize the Ukrainian economy as a whole.

Instead of raising tariffs and increasing the burden on business, it is important to solve the problems that Ukrzaliznytsia has accumulated over the years: operational inefficiency, corruption in procurement, cross-subsidization of unprofitable passenger transportation, excessive and underutilized repair assets, and large unprofitable underutilized infrastructure.

According to business, a comprehensive reform of freight transportation tariffs should provide for:

  • exclusion of subsidies for unprofitable passenger transportation from the tariff (at the first stage it is necessary to at least calculate this figure);
  • elimination of linkage to the type of cargo, instead of which the tariff will be divided into separate services;
  • realization of the principle that consumers pay for the services they consume.

Business has the right to vote, because as a result of harmonization shippers’ costs may increase by another 10-15%, in addition to the record tariff increase in June 2022. At that time, tariffs went up a lot – the cost of transporting coal, ore and limestone went up by 140%, grain – by 96% and steel – by 70%. No one discussed this with industry and exporters. Today, Ukrainian Railways’ freight tariffs, recalculated in dollars, are already 25-60% higher than in 2019-2021.

For steel sector, the proposed model of harmonization will lead to a 2-fold increase in tariffs for transportation of iron ore (in terms of dollars and compared to 2021). This is in addition to the fact that steel exporters are already facing significant challenges and dim prospects in foreign markets due to falling global iron ore and rolled steel prices.

Prospects for a solution

Ukrainain Railways proposal to harmonize tariffs has already passed the tariff council of the relevant ministry. Currently, the document is at the stage of internal procedures in the Cabinet of Ministers.

The Ukrainian business community was cautiously optimistic that the tariff hike at the beginning of the war would be used to support Ukrainian Railways’ financial situation, which was disastrous at the time. However, there were expectations that tariffs would be reduced after the situation normalized and freight traffic increased. However, this did not happen and now the situation is completely different and the economy and industry are exhausted from working under war conditions.

The need for a fair and transparent freight tariff setting system is overdue. So is the need to create a transportation regulator similar to the NEURC in the energy sector, which would become an arbitrator between the railroad monopoly and cargo owners.

According to FTE estimates, it is precisely because of tariff increases that many companies are operating at a loss. Any increase in the financial burden on key sectors of the economy, which are already on the verge of survival due to high energy and logistics costs, threatens a complete shutdown of key enterprises and could negatively affect the country’s economic security and defense capabilities.