The new economic imperatives of African railways (4)
Social, economic, and environmental approach to railway investments
In making the capital allocation decision on a railway project, cash flow should not be the only consideration. Doing so misses crucial parameters. The social, economic and environmental (SEE) impacts of the project are equally relevant. Assigning monetary values to the SEE benefits allows for a clearer picture and aligns with the classical discounted cashflow approach more robustly. A monetized SEE analysis makes it easier to point out which of the stakeholders in a railway project or concession are better suited for which undertaking.
Some previously unattractive railway concessions or projects might be found to be economically attractive and in line with an investor’s goals when analysed through the SEE prism. Take the case of a commuter railway. Commuter railways reduce travel time in most cities and contribute to urban regeneration. They also increase social equity, as the rich and poor use the same mode of transportation. There are fewer accidents on the road and railways reduce street noise pollution in the cities making them more liveable. So does the reduction of greenhouse gas emissions. An efficient urban rail network helps make cities more productive and healthier, which eventually results in economic growth.
As our exposition in the earlier sections shows, the low traffic density of most African railways limits their profitability prospects. Apart from mineral railways, there is simply not enough passenger traffic and freight volume for most African railways to be considered attractive on a cash flow basis alone (World Bank, 2020). When analysed through the lens of a monetised SEE impact analysis, however, the non-economic benefits of a railway, become more apparent. It also brings to light why governments should bear a significant portion of the financial burden of a railway concession. But a SEE approach also makes it easier to make a case for more accommodative financing terms with international and development financial institutions (IFIs and DFIs), which are increasingly similarly inclined.
Thus, investors must approach the selection of African railway concessions and financing with a SEE mindset. A railway financing request or concession invitation should probably get high marks if such considerations are adopted by the sponsors at the outset. In this event, the project valuation might set out a lesser financial element at the acquisition stage. When this is not the case, the investment decision should be made based on an accurate estimation of the SEE impacts that would ordinarily not be part of the discounted cash flow analysis. Upon agreement with the sponsors on a likely more accommodative valuation thereafter, the concession deal could then be sealed with a mutual understanding of the broader SEE benefits.
In any case, the increasing global environmental, social and governance (ESG) concern means that investors are starting to factor SEE considerations into their investment decisions. It would still be the case, though, that some railway projects would fall below the mark. This should be recognized and necessary accommodation made in the financing agreement should the decision be made to go ahead regardless.
Optimization of railway business model and financial structuring
Railway infrastructure, operations and passenger services require different financing approaches and expertise. Assigning all these three aspects of a railway to a concessionaire, typically a railway management firm has been attributed for failed African railway concessions in the past (AfDB, 2015). Were concessionaires to focus on operations and passenger services, leaving construction, procurement and maintenance to firms with specialist expertise, their cashflows might be positive on a sustained basis, and financing more easily and readily available to them.
The broader socioeconomic imperatives of constructing new African railways, rehabilitating some legacy ones and constructing new LRTs in the continent’s big cities also inform the need for governments to take on the greater financial burden. Even before the environmental advantages of railways gained currency with financiers and other stakeholders, renegotiated concessions bore in mind this realisation. It is simply the case that most of Africa’s railways would barely break even, if at all.
For the current momentum to be sustained, however, African governments must make their propositions very attractive for concessionaires and financiers. The likelihood of success in this regard depends on an optimal cost-benefit assessment of each railway project at the outset. As stated earlier, a costlier SGR would not make economic sense if a cheaper narrow gauge alternative would do. High traffic density mineral railways are almost certainly self-sustaining. Legacy railways, even those with relatively ample freight volumes, are not able to do similarly.
To keep costs low, increase the chances of breaking even and maintain a positive cash flow, the upfront fixed costs of a railway project can be reduced first by making the right choice on the selection of the gauge and then deciding whether to build a new rail line or rehabilitate an old one. Once in operation, periodic maintenance could be done at longer intervals, track renewal only on occasion and replenishment of rolling stock- only if necessary. The long-term potential of a railway concession must also be writ large. It would be all too obvious the likely eventual success of a railway system that connects to a port, airport, and key road interchanges as part of a wider logistics chain, for instance.
Financiers should certainly focus on high volume passenger African markets and freight-focused railways that form part of a logistics chain. But how many of these are available for investment? Only about a quarter of SSA railways have a traffic density of more than 3m net tons. The lesser the traffic density, the greater the likelihood that the state will be required to carry the higher or all of the financial burden, which is already the case for about 75 percent of all SSA railways, according to the World Bank.
The investment or financing decision should be dependent on whether the business model is optimal and fit-for-purpose in regard of the peculiarities of the subject African market. A concessionaire focused on just passenger services can take on- or off-balance sheet financing that is separate from the sovereign owner of the railway. A government could also finance the construction of new railways or the rehabilitation of legacy lines, current and periodic maintenance of assets, as well as the procurement of rolling stock, using an adaptable mix of on- and off-balance sheet financing that leverages on its sovereign credit rating without weighing on the concessionaire’s balance sheet.
An edited version of this article was first published by Nanyang Business School’s NTU-SBF Centre for African Studies, Singapore. References, figures and tables are in the original article. See link viz: https://www.ntu.edu.sg/cas/news-events/news/details/the-new-economic-imperatives-of-african-railways