China – Europe rail freight container market has evolved at an explosive pace in the past 10 years, which became possible due to the subsidies and “economically unjustified rates”. This is another example of how “non-market” means help perform the “economic miracle” contrary to classical “economics”. Will the overland container shipping continue to develop rapidly in the foreseeable future? And what should importers from China have in sight planning their business logistics?
From statistical discrepancy to market share
Freight transportation market from the People’s Republic of China to the European continent has always been and still remains sea freight market. Over 90% of cargo going in this direction is transported by sea due to such advantages as low cost and high cargo capacity, which will allow to retain absolute leadership in the foreseeable future.
In the early 2000-s, the volume of rail transportations from China to the European continent was, as they say, “at the level of statistical discrepancy”. According to the data from Eurostat, the share of rail freight transportations (expressed in physical terms) from China to the EU was 0.65% in 2011. The Russian Federation used rail transport more frequently, which is explained by the length and proximity of its territory to China, at the same time the volumes of rail transportation to the Central and Northwestern Federal districts were insignificant.
Over seven years, the share of rail freight transportations from China to the EU increased to 1.37%. Railway transport is still not as competitive as sea shipping market, but the volume of imports by rail from China to Europe has been growing rapidly in recent years.
Compare the following figures to get a general idea of the ratio of sea and railway container imports to Russia: the volume of containers (mainly from China) transshipped at Russian sea ports in 2017 was 1.95 million TEU while the volume of direct rail transportations from China was about 55 thousand TEU.
The development of China – Europe rail freight container market
Rail transportation market from China to Europe is the most dynamic and rapidly developing market in the last 10 years.
According to the China Railway Corporation (CLC), the annual number of container trains in the period from 2011 to 2016 made 17, 42, 80, 308, 815 and 1702 respectively. A great increase took place in 2017 with 3673 trains sent from China to Europe. In 2018, this number increased to 6363 trains, which is 73% more than in 2017.
At the same time, a greater variety of transported goods was created – besides the IT products, which had been the major goods imported from China in containers, the range was expanded by clothes, shoes, hats, automobile spare parts, agricultural products, food, wine, coffee beans, wood, furniture, chemical products, engineering equipment and minor industrial products
As seen from the statistical chart, China-Europe rail freight market can be characterized by growing containerization. This phenomenon has several interrelated reasons:
1) The share of goods appropriate for container transportation from China to Europe is about 80%. More than half of the goods transported to the EU are accounted for machinery, equipment and manufactured goods commodity group, 10-15% for metal products, 5-10% for glass and ceramics, ready-to-use building materials, clothing, shoes and textiles. About a quarter of the cargo volume transported to the Russian Federation is engineering and manufactured products; metal products and building materials constitute 15-20%; and ready-to-use chemical products with chemical raw materials – 10%.
2) The reduction of container freight rates from average $9K per FEU in 2011 to $5.5K per FEU now has increased the demand for the service significantly (see more details on China’s policy for the rates below).
3) Rail freight rates increased as such competitive advantages of railway transportation (over sea shipment) as speed, scheduled delivery and cargo safety have gained more weight. A twofold increase in transportation costs does not affect the cost price of large expensive consignments significantly. This, in its turn, accelerates capital turnover.
4) The increase in the number of routes and container train frequency open new opportunities for the freight sector and attracts more interest of cargo owners.
5) Germany is China’s main contractor receiving over 60% of all containers going in this direction. Almost 100% of goods from China to Germany are transported in containers, including building stone, metallic and non-metallic raw materials, fuel and the like, which is explained by the dominance of container handling technologies in both Chinese and German ports.
The main growth driver
The explosion in demand for rail container transportation from China to Europe was due to a sharp reduction in rates from an average $9K per FEU (equivalent to a 40-foot container) in 2011 to $4.8K per FEU in 2012 and further stabilization at $5.5K per FEU from 2013 till now.
What could happen in China and in transit countries like Russia and Kazakhstan causing the twofold reduction in the rates?
Nothing significant happened in Russia and Kazakhstan, but China decided to do everything in their own way again by granting subsidies to support export rail traffic. These local subsidies were granted only by the related province and city administrations subordinate to central government only for transcontinental export rail routes. Shipments to ports and import rail traffic are not backed.
Each province decides for itself what amount to subside for the support of rail exports. The provinces and cities of Central China, which are far from ports and are geographically closer to Europe, have the major interest in subsidies. The amount of regional subsidies ranges from $1.5K to $7K per FEU. The average amount of subsidies is $3.5-4K per FEU, which reduces the economically justified rates for container transportation from $9-10K to $5-5.5K. In fact, such subsidies reduce Chinese railway charges to zero.
Why do the Chinese do it? And what is the benefit? Recovery of logistics costs increases the merchandise appeal for foreign buyers and supports production in the central provinces of China. At the same time, according to EDB estimates, the average amount of subsidies per FEU is 0.3-0.4% from the value of the transported cargo. The costs are not high as compared with the value of the exported goods and export revenues.
China became attractive for the EU but not for Russia
According to Eurostat, the overall rail freight traffic from China to the EU countries increased by 2.7 times from 350K to 816K tons during 5 years (2013-2017). The growth rates made 33.7% in 2017 over 2016. In 2018, the growth rates of the overall rail freight traffic from China was slightly lower totaling 19.8%, but these are still very high figures.
At the same time, the market volume of container railway transportations from China to the EU saw an explosive increase in this period. According to UNCTAD, container traffic in this direction increased from 2.8K FEU in 2010 to 48.7K FEU in 2016. According to the Ministry of Transport, transit container traffic from China to the EU increased to 164K TEU (82K FEU) in 2017, which is 68% more than in 2016. The trend continued in the first half of 2018.
So Chinese subsidy policy in railway exports worked perfectly for the European market, which is not the case with the Russian Federation…
22.1K FEU were imported from China to Russia by railway via land borders in 2010, which is almost 8 times more than transit to the EU. Imports to the Russian Federation increased to 27.2K FEU in 2011 and were declining until 2015 (to 16.7K FEU) due to the crisis conditions. They increased again to 27.7K FEU in 2016. In 2017, there were no significant changes in the volume of container imports. It is disputable whether there has been any growth, so it would be more precise to say that pre-crisis volumes have recovered.
Why are the growth rates of land container imports to the EU and the Russian Federation so different?
Andrei Lisovsky, Head of Railway Transportation Department, TELS Group: “Such nonsynchronous changes in demand for container rail transportation from China to Russia and Europe can be explained by the following factors:
1) The new spiral of the economic crisis has been suppressing the interest of Russian businesses in rail transport for container imports from China since 2012 due to serious cost reduction priorities. Imports to the EU has been growing against the initially low traffic volumes and high capacity of the European market.
2) Russian businesses do not rush to change the established logistic schemes. If they manage to gain certain profit from two-month sea transportations, why would they need to spend more? European businesses buy more expensive goods, so they are ready to increase the costs for speedy and safe delivery.
3) Accelerated container trains going to the EU have a smaller risk of delay (in fact, only when crossing the borders), while trains to Russia often get stuck at terminals expecting the unload, so the declared speed advantage is lost.”
Thus, the amount of Chinese subsidies reducing the cost of rail container transportation by almost 2 times as compared to the economically justified rates is still insufficient for a significant increase in demand for these services for Russian importers. And since the reduction in the rates is not expected in the next two years, it’s unlikely that there will be a rapid increase in the volume of imports to the Russian Federation.
How will the rates change in the foreseeable future?
Subsidies granted by the authorities of a number of Chinese provinces affect the economics of international container transportation significantly misrepresenting the ratio of real transportation costs and rates. This creates the risks of reducing or even abolishing subsidies, which will immediately increase the cost of the existing railway freight delivery schemes from China.
At the same time, the experts from the Eurasian Development Bank do not predict any changes in the rates in the next two years.
The current rates will ensure explosive growth in export container rail market until 2020. According to the estimates of EDB experts, the volume of China – Europe – China container traffic will be 200-250K FEU by 2020, which is two times more than in 2017. There is no evidence that the Chinese authorities will neglect this effect.
The reduction of rates is not expected until 2020 either as there is no sense in it - the segment is growing rapidly, faster than the problems with the railway capacity along the way are solved. Suppose the rates for railway transportation are reduced for some economically justified reasons, the administration of Chinese provinces is likely to reduce the subsidies to the volumes supporting the existing rates.
It means that the tariffs for container rail transportation from China are likely to remain at the current average level of $5-5.5K per FEU ($4.5-7.5K in different directions) in the next two years. This is about 2 times more than the cost of sea transportations, but several times faster and safer as well as several times cheaper than air freight, which provokes competition for the air cargo market when planning the budgets for logistics with Chinese importers.
China as a “substitute” of Europe
The interest of logistics customers from Russia in import rail transportation schemes from China is still growing, though without explosion. This, first of all, applies to those types of goods the cost price of which is not affected significantly by the increase in logistics costs, and speed of entry to the market matters.
Andrei Lisovsky: “The Chinese industry is already producing good high-tech products, which are not worse than popular world brands in their characteristics but are much cheaper, especially if the brand has not entered the world market. Businesses in the EEU countries are actively buying Chinese equipment for their production needs or for sale. We actually see this in the requests from our customers.
At the same time, importing from China is no longer difficult for anyone. A good logistics provider can resolve the issue legally well even if the Chinese supplier does not have an export license by acting as a consignor or consignee to relieve the customer of transport arrangements or even help obtain the required certificates and shipping documents.”
Based on the customs statistics, the EDB experts say that the cargo cost of $10 per kg arouses the interest of cargo owners in rail transportation from China. There has been a significant increase in the share of industrial consumer goods in recent years. The developing infrastructure of the Silk Road determines a more active use of these transport schemes.
Elena Sazonchik, Marketing Director, TELS Group: “For various reasons, the weakening of the national currency as well as the decrease in wage growth in Russia are expected in the next two years. For example, according to Sberbank of Russia, the exchange rate for the ruble will be at the level of 65-70 Russian rubles per dollar in 2019-2020, the inflation is expected to be 4-5%, and the wages will increase by only 2.5% in Russia in 2019. The decline in the real income will reduce the demand for the imported consumer goods in the mid-price segment, so this might influence the redistribution of import cargo traffic with more interest given for cheaper Chinese goods.
So the main traffic flow will go by sea, while import rail container transportations will grow due to direct trains from China and rail container transshipments at ports.”
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The optimistic projections of the Eurasian Development Bank express the possible increase in subsidies for rail exports from China after 2020. This is explained by the fact that by that time the existing tariffs will no longer ensure the same container export growth rates, and if the Chinese authorities are interested in such growth, it’s likely that they will increase the subsidies and reduce the railway container rates even more. In these conditions, the interest of Russian cargo owners in the Chinese Silk Road might grow significantly.
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P.S. In general, the existing Chinese subsidies for container rail transportation do not seem to be a strong factor in long-term business planning associated with imports from China. Who can grant that the subsidies will not be reduced or redirected for any “Chinese” reason? There is no evidence for such reasons yet, but still…
Marketing Department of TELS Group of Companies
Sources: report №49, 2018, by Eurasian Development Bank, Eurostat, Ministry of Transport of the Russian Federation, RZD-Partner, Kommersant newspaper.