Friday, October 24, 2008

China's Great Railway Expansion

Chinas Great Railway Expansion

Beijing - Two or three times a year, Cargill's joint-venture fertilizer plant in China's remote Yunnan province has to shut down, usually for weeks at a stretch. That's when there aren't any railcars available for shipping its fertilizer to customers across China. Without railcars, the factory's warehouse fills to overflowing, and production has to halt. "There's a huge demand for shipping, but the railroads can only meet 30% of the demand," says Zhang Hong, sales manager of the plant, which shut down yet again in October.

For decades, China has neglected investment in railroads in favor of building highways. With less than 49,000 miles of rails, China has roughly a third of America's track for an area of similar size. The nation's rails carry a quarter of global train cargo and passenger traffic on only 6% of the world's track, making its system the busiest on the planet. "China's strained railroads have already become a bottleneck for the economy," says Yu Tengqun, secretary of the board of state-owned China Railway Group, which has built two-thirds of China's railroad network since 1949.


China is now undertaking the world's biggest railway expansion since the U.S. laid its transcontinental line in the 1860s. Beijing plans to spend $248 billion through 2020 on 75,000 miles of new track, for both freight and high-speed passenger lines. At that point, China's high-speed passenger network will likely be the biggest on earth.

Despite these colossal ambitions, a nagging question remains: Can anyone make money from all this? Equipment suppliers, such as China South Locomotive & Rolling Stock Corp. and multinationals like Siemens, certainly can. But it's hard to profit from running a railroad on the mainland. Analysts at UBS (UBS) estimate China's Ministry of Railways, which operates the railroads, has a net profit margin of less than one percent on revenues of about $35 billion. The Ministry maintains majority control over all rail lines and sets freight rates for farm products and ticket prices for migrant workers at artificially low levels. It wouldn't comment for this article.

That pricing policy is politically smart but commercially ruinous. Only 16 of China's 26 joint-venture railway companies—each of which involve the Ministry and often local governments as well—are marginally profitable, according to UBS. The rest chug along in the red. In June, China's first private enterprise to invest in a railway project, Guangyu Group, decided to reduce its stake in the Quchang Railway to 19%, from 34%. The company was unwilling to comment.

Pressure on the Ministry of Railways to find the billions needed for all this expansion may eventually force it to loosen its grip on pricing and cede control of at least some of the railroads. "There is a lot of capital now that is very interested in building railroads," says Zhao Jian, a professor at Beijing Jiaotong University who researches railway reforms. Until that happens, China's rail industry will continue to attract more business than it can handle and fewer investors than it needs.

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