Commentary: Financial Risk Assessment For Alaska-To-Alberta Rail Freight Awaits
Two groups vie for the risk/possible rewards of building a 1,500-mile Alberta, Canada, to the middle of Alaska railroad – primarily to export resources.
This week's rail market view commentary asks, "Where is the deep pro forma assessment?"
In the summer of 2019, Railway Development Corporation A2A negotiated what it called a master agreement of cooperation that together with the Alaska Railroad targets eventual construction of approximately 1,500 miles of new railway line that would link part of Alaska with the Canadian railroads in Alberta province.
This is an institutional agreement. It is not a financial agreement.
Under the terms, the two railroad companies will cooperate in applying for regulatory access permission. The two organizations will also develop a joint operating plan that will specify the track engineering details and the final location for the tracks.
Figure 1 shows the generalized rail route map.
Early estimates cite a capital price tag of approximately $13 billion (C$ 17 billion). But the actual cost is still uncertain.
Three things must happen before construction begins.
First, it appears that there are two railway organizations seeking regulatory permission for the one rail corridor.
A second plan is proposed by the G7G group (Generating for Seven Generations).
Both organizations appear to be relying upon the same pre-feasibility study researched independently by Calgary's Van Horne Institute.
Secondly, there are regulatory hurdles. Both state and provincial authorities and multiple Canadian and U.S. federal regulatory agencies need to review and then issue permits or supportive findings.
Third, the First Nations, indigenous groups and Alaska Native entities – whose traditional lands are crossed by the route – also have a role in approvals and/or denials.
A more detailed project description for this Alaska-to-Alberta rail route might not be publicly released until early in 2020.
Here is what we know now and what's missing.
On the positive side, Sean McCoshen, CEO of A2A Rail, touts that the project "will help assure global investors that obtaining a right-of-way in Alaska is achievable." There is a process underway.
Yet, what is the market outlook?
Future markets for this rail route are only broadly suggested by A2A's current statements.
The actual rail volume that might be moved, by commodity type, isn't yet clear. The focus appears to be on moving crude oil out of Alberta for Pacific Rim nation export. A2A doesn't appear to be too concerned with possible pipeline competition.
In contrast, investors should note that the big American and Canadian railroads are always concerned about the long-term competitive threat of new pipelines eventually being approved by regulators. The fear is that the more efficient pipelines would later divert the crude oil from the railroad routes and tank cars.
In military terms, a pyrrhic victory is a competitive single battle win that in the long run is tantamount to defeat as other variables and subsequent events "decide the war's outcome."
How real is the likelihood of a pipeline market entry? No one is sure.
However, the big Canadian and U.S. railroads are taking prudent measures to not become
over-invested in what might later become "stranded rail assets."
Two other important competitive risks are not yet documented for the A2A corridor proposal.
The first is the strength of distant source competition. The second is land versus sea competition and the modal price differences in setting transport rates.
Source competition will come from distant global markets and even from emerging liquified natural gas (LNG) suppliers. Source competitors can be identified in Australia, Indonesia, the Middle East, Siberia, and even along the Gulf of Mexico in oil- and gas-rich states like Texas.
Some of these competitor commodity providers are located closer to the buyer markets than is the Alberta crude oil to be exported under the A2A concept.
Many of these international energy sources will have the advantage of lower sea transport costs while the Alberta and Alaska resource-origin locations will have to rely on much longer distance of land movement at much higher rail price levels.
How much of a price difference could there be? It could be as much as three to four cents per ton-mile. That is a significant cost delta.
To understand what a rail-competitive price will be, the A2A sponsors will have to first identify what the railroad's engineering specs will be. Is the new Alaska-to-Alberta railroad going to be robust at perhaps 35- to 40-metric ton axle loads for the freight cars? Or just a 30- to 33-metric ton axle loads?
Will unit trains operate with 10,000 to 13,000 net tons per train – or instead be designed and built to a much larger 20,000 or larger tonnage train size? These facts are not yet in evidence.
Figuring all of this out is complex. Change the train's engineering design to a much higher net-to-tare weight option would also mean changing mechanical train equipment set costs.
With so little cost and pricing information, it is difficult to assess the public assertions by many A2A sponsors that the project will be profitable.
The business case "needs to be vetted."
One current assertion is that there would be a steady-state revenue stream in the range of $5 billion annually that would cover both the costs of the train operation and maintenance as well as the capital costs. That was picked up by reporter Elwood Brehmer for the Alaska Journal of Commerce article during November 2019.
The assertion by sponsors is that the A2A corridor will be financed from private sources and from tapping certain sovereign wealth funds.
There is no promised or asked for capital funding or operating subsidy backup from the state of Alaska or the province of Alberta.
This may all prove to be true.
Yet, in a commercial railway project of this size, the financial feasibility for soliciting private investment requires various documented "pro forma" financial statements. Specifically, these pro forma's address the ability of the project – as a business – to cover both operating expenses and capital investment debt service.
An independently estimated pro forma due diligence examines in depth the ability of shipper-paid revenues to cover net operating income after annual operating expenses. The test determines the probability that projected cash flows can also meet taxes plus interest and principle repayment.
Before such rail projects move forward, investors and bankers want to know what the coverage risks are.
What is the role of promised job creation benefits?
Currently, social economic benefits are being touted by supporters. Yes, Alaska and Canadian jobs will be created. However, those community benefits are irrelevant to the investors who will buy the debt and equity. Jobs and state income from economic development gains are seldom used to help pay off the debt, principal, or to cover the negative cash flow from occasional losses in annual income.
To investors those local economics are so-called "soft gains."
A Few Closing Thoughts
There very well could be a set of circumstances whereby a financial outcome based on competitive factors could favor the Alaska to Alberta rail proposal.
The proponents need to demonstrate their case with a solid competitive market report and a series of calculated train operations network study simulations that can feed into pro forma income statements that test the net earnings ability.
Here is what to look for before investing in the project. You will want to look for these plan markers once the next level feasibility reports are published.
A set of multiple customers ready to commit to long-term volume shipments.
A set of two or three diverse commodities that strengthen the railway's market plan.
Calculated rail price terms based upon realistic operating margins for contract prices.
A rail strategy that avoids speculative spot pricing market targets.
Minimum annual volumes in the net 20 million ton range – or higher.
Assess the proposed operating plan. Does it call for about 12 to 15 daily trains in the first start-up years – growing over time to perhaps 40 to 60 daily trains? Some of these will be empty equipment returning unit trains.
Use that data to independently assess revenue charges per ton-mile, rail operating margins and the global ability to match source competitors.
Look for engineering designs that minimizes overbuilding. Constructing a single-track route with remote control frequent passing sidings might well be a more efficient capital infrastructure that matches realistic traffic volume than an entirely double-tracked new railroad line.
Avoid the passenger train promise. Most passenger trains don't cover their full operating and capital costs. Suggesting more passenger trains might dilute the project's cash flow.
As always, contrary opinions and technical approaches are encouraged.
Recommended References For Further Information
The Alaska Journal of Commerce has published multiple articles on the competing company railroad route projects.
Roy Clancy of the University of Calgary has an internet piece regarding studies of moving crude oil as a bitumen mix by rail tank cars. He interviewed Peter Wallis, CEO of the University's Van Horne Institute. The Institute conducted a multiple party two-year pre-feasibility study. Note that the Institute's reported capital cost was in the $27 billion range and higher. The report does acknowledge "substantial risk" in commercial terms. The risk and reward horizon was spread out over 30 to 40 years. It may not have emphasized "stranded rail assets" as a specific risk.
Matt Vickers is one of the partners in the competing G7G organization. He was interviewed in February 2018 by reporter Nelson Bennett from Vancouver. Both the engineering company Aecom and Alberta Energy were cited as study "participants."
See earlier FreightWaves commentary by Darren Prokop (November 5, 2019) ("Is the Alaska Railroad on track to the Lower 48?").
By the way, there are many proposed long rail route projects around the globe. But in fact, if the land routes are much longer than 4,000 miles between major markets, freight logisticians tend to favor high capacity ocean vessels with their much lower unit costs per mile over the waves rather than the land.
Image by David Mark from Pixabay
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