To get the economy under way, first we’ll have to break up Transnet

To the relief of almost everyone, Minister of Public Enterprises Pravin Gordhan dismissed the board of Transnet and has appointed an interim board under the leadership of Popo Molefe. The reasons for getting rid of the old board were obvious to anyone who has paid attention to the alarming levels of corruption and abuse of state resources.

Transnet, perhaps even more than Eskom, was stripped of billions by the Guptas and their enablers. The corruption has centred around the 1,064 locomotive and harbour crane deals and IT/systems procurement at the parastatal. As with Eskom, the process of reinstating a semblance of proper governance and rooting out egregious corruption can now commence but also, like Eskom, Transnet’s underlying businesses need to be substantially restructured if South Africa is serious about economic growth.

At a very basic level, what South Africa has to do if it wants to grow is to mine more minerals, grow more agricultural produce, manufacture products and export them as cheaply and efficiently as possible. Likewise, it has to get the products and raw materials that we import to where they are needed as cheaply and efficiently as possible. Transport and logistics are particularly important for South Africa, more so than in other countries.

First, being on the southern tip of Africa, we are further from many of our main export markets than our competitors; and second, although we have a large coastline, in many respects we share many of the disadvantages of other landlocked countries. Gauteng, our main centre of industry and commerce is, inconveniently, 500km from the coast. Most of the largest and most successful cities around the world tend to be port cities or close to a port.

With 2017 gross revenues of about R65.4-billion, just less than half of Eskom’s, it is South Africa’s second largest State-Owned Enterprise (SoE) but employs 55,000 people, even more than Eskom. Unlike many other SoEs with a single focus, Transnet is a sprawling conglomerate of many different businesses linked just by the fact that all of them are basically involved in transporting stuff from one place to another. It is worthwhile looking at each of these businesses on their own.

Transet’s biggest business is freight rail and it generated about R39-billion in Transnet’s 2017 reporting (or about 60% of total group revenues) and it employs about 29,000 (53% of the total) and, with 20,000km of rail, it is one of the largest freight rail companies in the world. Freight rail splits its operations into three subdivisions. The general freight business is primarily about transporting cars and then all goods transported by container and loose bulk materials. The coal line freight is involved in transporting coal to some of Eskom’s power stations and to the (privately operated) coal export terminal at Richards Bay. There is also an ore line which is primarily involved in exporting iron ore out of Saldanha Bay and manganese from the Port of Port Elizabeth (Nelson Mandela Bay).

The Transnet National Ports Authority (TNPA), with revenues of about R10-billion and employing 4,350 people, is the landlord and operator of eight commercial seaports (Richards Bay, Durban, East London, Ngqura, Port Elizabeth, Mossel Bay, Cape Town and Saldanha). It provides port infrastructure and marine services and is in overall management of port activities and the port regulatory function, controlling the provision of port services by its users such as terminal operators including Transnet’s own ports terminals division but also shipping lines, ship agents, cargo owners and clearing and forwarding agents.

Transnet Port Terminals (TPT), with revenues of around R11-billion and employing 7,370 people, is the ports operations business. It handles the container sector, mineral bulk, agricultural bulk sectors. Port Terminal’s major customers include the shipping industry, vehicle manufacturers, agriculture, timber and forest products, the mining industry and exporters of minerals, metals and granite.

Transnet Pipelines, with revenues of R4.3-billion in 2017, owns and operates the country’s strategic pipeline assets transporting liquid products such as crude oil, diesel, petrol and aviation fuels. The liquid fuels network traverses KwaZulu-Natal, Free State, Gauteng, North West and Mpumalanga. The network includes tank farms and a gas pipeline. Transnet pipelines’ network transports 100% of South Africa's bulk petroleum products.

The final division is engineering. It employs about 10,000 people but its revenues are derived principally from Transnet’s other divisions, especially freight rail.

With its strategic advantages, one would expect that freight rail would be a good business, but it isn’t. It isn’t a great business for Transnet and its isn’t for the country either. The recent corruption-riddled procurement of locomotives was part of an effort to increase freight rail’s share of the container market from 79% to 92% but despite its advantages in terms of scale, it is still cheaper to transport by truck.

A National Treasury study (Pieterse, T Farole, M Odendaal & A Steenkamp Enhancing South Africa’s export competitiveness: Reform of the port and rail network) found that while bulk rail was competitive with international peers, general freight is not. General freight tariffs are as much as four to seven times higher than they are in the USA. This has sent more cargo onto the roads, leading to increased congestion, road damage and higher costs for both road commuters and freight.

Professor Jan Havenga, a specialist in transport logistics, calculates that about 79% of South Africa’s transport costs was spent on the country’s road corridors (with 67% were being spent on the two main corridors: N1 Cape Town-Gauteng route and the N3 Durban-Gauteng route) and just 21% was spent on rail. He also estimates that R23-billion goes to waste in the logistics supply chain, making everything in the country 5% more expensive than it otherwise could be. One way of reducing this is to move a good portion of the fast-moving consumer goods sector (which made up 50% of total transport costs) onto rail. However, major inefficiencies at Transnet and a lack of customer focus makes this impossible to get right.

South Africa’s main problem, however, lies in the seaport divisions of Transnet. Transnet’s ports are among the most expensive in the world. Research done by the Ports Regulator of South Africa sets out the inefficiencies and associated costs in its Port Tariffs Benchmarking Report. While charges for bulk commodities are competitive, containers are 182% more expensive and automotives 128% more expensive than other ports. In total, container costs including terminal handling charges are 88% above the global average and South Africa’s main ports (Durban and Cape Town) remain among the most expensive in the sample studied.

There are other costs. A 2010 study says an average ship incurs costs of $35,000/day while waiting for a berth or while in harbour. An OECD report noted that South African ports’ efficiency levels for containers and higher-value cargo are just 50%-70% of similar ports elsewhere. Part of this is low container handling speeds. In 2009, the Durban container terminal achieved an average of 23 units/crane hour, according to Transnet, compared with an international norm of about 35 units. Freight rail’s inability to meet demand has forced customers to resort to road transport, causing congestion at harbours. Once again, in 2010, it was reported that it could take a truck six hours to move in and out of Durban harbour.

High tariffs and inefficiencies are a result of Transnet’s monopolistic structure. According to a 2014 report by Trade and Industrial Policies Strategies (TIPS), entitled Review of regulation in the Ports Sector, at the core of the problem is the inherent conflict of interest between Transnet owning both the landlord company (Transnet National Ports Authority) and the company that is the main user of the ports (Transnet Port Terminals) and that that conflict allowed Transnet to use the excess profit generated by the ports operations to subsidise other operations in the group which led to under-investment in port infrastructure.

There is evidence for the claim in Transnet’s own financials. Freight rail, with 2017 revenues of R39-billion, generates just R1.5-billion of pre-tax profit. Transnet National Ports Authority (the landlord company), with R10.3-billion in 2017 revenues (about a quarter of freight rail’s), generates almost double the pre-tax profit of R2.9-billion. The port terminals are also very profitable. Off revenues of about R11-billion they made a 2017 pre-tax profit of R1.2-billion.

The impact of high port costs and inefficiencies does not just impact on the competitiveness of the country as a whole. Regional economies suffer too. Port users are aware that they have little power and their complaints are not formalised for fear of victimisation. One example is in shipbuilding and repairs. A 2016 study on the sector recorded the decline of the South African ship building industry from the 1980s due to very little private investment and no public investment into new facilities. The last large vessel built in South Africa was built in the mid 1980s after which no large project has been done in the country. As a result, capabilities have been lost. Still, according to another study for the Western Cape government in 2017, ship repair generated over R5.1-billion in revenues. In the Western Cape alone, turnover in this industry in 2011 amounted to R2.5-billion, with about R88-million spent on port fees. Ship fabrication and oil rig repairs contributed about another R1-billion. The sector as a whole employed about 7,000 direct jobs and another 6,000 indirect jobs.

This sector could have been much bigger than it is. Professor Ricardo Hausmann made just this point in his analysis of where the South African economy went wrong after 1994. He pointed out that an effort to set up an oil rig repair industry out of Saldanha Bay showed a lot of promise. South Africa had several competitive advantages but it never really took off due to a lack of co-ordination and interest. He makes the further point that had this project been conceived in China, it would have been a huge industry already. Part of this is the lack of investment in critical facilities like such as dry docks. So, although the shipbuilding and repair industry is a significant contributor and can grow, Transnet seems uninterested in making the investment needed in Cape Town’s three dry docks.

The ship repair sector would jump at the opportunity of making their own investments in these facilities – to modernise and expand them – but they can’t. Instead they have to wait their turn in the queue for them and not complain too loudly when they break down. The knock-on effect is that an industry with potential to grow and employ more people cannot do so.

Another example of a regional economy being held back is in Northern KwaZulu-Natal. The Enterprise Observatory (EOSA) in 2016 noted that Richards Bay harbour has no container facility and all the containers for import and export for the industries in Richards Bay and the mills of northern Natal have to be trucked from Richards Bay to Durban or the other way round. Transnet National Ports Authority maintains that a container terminal in Richards Bay is not warranted since Richards Bay was not earmarked for container handling and should not compete with the port of Durban.

Transnet’s other monopoly, the pipelines business, presents similar problems despite the regulator, Nersa, being enjoined by the Petroleum Pipelines Act to facilitate market entry by private competitors. There have been at least two attempts by private sector companies to do just that.

The first one, the New Multi-Product Pipeline (NMPP), was awarded to Transnet as it was only Transnet that had the ability to cover the construction financing costs from other cash flows. However, once awarded, this project suffered several delays and huge cost escalations and Transnet was able then in 2010 to extract a grant in the form of a 7.5c/l levy on the retail price of fuel in order to generate revenues for a three year/R1.5-billion per annum totalling R4.5-billion paid directly to Transnet.

Another similar problem arose in 2007 when Nersa granted Petroline a licence to build a petroleum pipeline from Maputo to Gauteng, in competition with Transnet’s existing pipelines. Petroline had to abandon the project when it alleged that predatory pricing by Transnet was too low for Petroline to be able to operate profitably. Petroline argued in its submission to Nersa on the 2011 tariff determination that “The regulated cross subsidies presented render it impossible to compete with the state enterprise”. With the subsidy swallowed, Transnet’s pipelines business is excessively profitable. Off revenues of R4.3-billion in 2017, this division’s pre-tax profits amounted to R2.8-billion. Put another way, pre-tax profits amounted to R65% of revenues generated.

It should be clear that Transnet’s various monopolies and its ability to cross-subsidise poorly performing divisions is not serving South Africa well. The main benefit of being a monopoly – the ability to raise cheap capital – no longer exists as Transnet, like other SoEs, is now sub-investment grade. Two recent long-dated bond issues received disappointing interest. Bond investors seem only interested in short-term debt.

It is understood that Transnet is now actively seeking private sector investment despite previous plans having produced significant political opposition. The danger for the country in any partial privatisation is the risk that the government might be tempted to maximise the value of Transnet. The real question is whether the Transnet structure should be allowed to continue to operate as it does in a way that prevents competition from effectively lowering the costs of logistics and transport in South Africa.

Any sustained economic growth in South Africa will need to be based on expanding our exports, maximising our comparative advantages or minimising our (largely geographical) disadvantages. Any privatisation at a corporate level rather than at the level of Transnet’s divisional operations risks baking in the inefficiencies and needlessly high cost base that presents a bottleneck to economic growth. DM