Rail investors journeying to a greener future

A growing number of infrastructure investors are exploring global opportunities in the rail sector amid sustained political support for this mode of transport.

The US and the EU have between them allocated more than $100 billion to upgrade and expand existing rail infrastructure, including track modernisation, electrification and safety enhancements, notes Carlo Maddalena, senior portfolio manager infrastructure at Dutch pension fund investor APG.

“Transitioning from diesel to electric trains will generate environmental benefits and greater energy efficiency as well as cost savings and improved performance.”

Rail is also a key sector for another Dutch pension fund giant, PGGM, not least because of its potential to reduce carbon emissions, says investment director Henry Chung. Even including the environmental impact of diesel-run trains, rail remains the greenest form of transport, he says.

“Rail is less carbon-intensive than all other means of transport and that is the perspective we are starting from. Ultimately, if we could get more people and goods involved in the road-to-rail shift, that would be better for the environment in terms of emissions and for society.”

While rail, road, shipping and aviation combined account for some 25 percent of global carbon dioxide emissions, the share of rail is very low, Chung says. “The biggest contributor is road transport with roughly 75 percent, followed by aviation and shipping. For rail transport, the figure is only 1 percent.”

Europe leads in electrification

The level of electrification of the rail network in Europe varies, with smaller countries such as Belgium and Switzerland leading the trend, but is nevertheless quite high compared to other regions such as North America, says Allard Ruijs, partner and chief investment officer at DIF Capital Partners. “Electrification of the rail sector is not expected to grow much further in Europe as the process will be overtaken by the further development of technologies such as batteries and hydrogen power.”

There is room for expansion and upgrading of rail networks elsewhere in the world, Ruijs adds, pointing to the US and Australia. “The governments there are supportive of measures to improve the use of rail transport but because air travel is very well developed in these countries, passenger rail is less competitive.”

While different business models exist in the rail sector, APG focuses exclusively on the leasing of locomotives and passenger trains through its 50 percent stake in Alpha Trains, a European leasing company of passenger trains and locomotives in which PGGM likewise has a (minority) participation.

In early 2022, Alpha Trains announced the deployment of 31 battery-operated passenger trains in Europe, primarily Germany, which reduce diesel consumption without the need to fully electrify all networks on a certain train route.

Flexible freight solutions

Rail is ‘unquestionably’ more environmentally friendly than road transport and that will only increase, says Viktor Filipan, senior portfolio manager infrastructure at APG. Locomotives are often based on ‘dual mode’ technology which utilises a diesel engine on non-electrified rails while also being able to run solely on electricity on electrified routes, he points out.

“This is a much more flexible solution than a diesel truck. A similarly aged diesel locomotive will transport goods – typically measured per ton-mile – approximately four times more efficiently than a diesel truck on average. Moreover, the asset life of a locomotive or passenger train is typically 35 to 45 years, whereas well-maintained heavy-duty trucks will last 15, maybe 20 years. That means trains are also less wasteful in the production process.”

Amid ongoing efforts towards cleaner, decarbonised rail transport, diesel engines are now gradually being replaced by hydrogen and battery-powered alternatives. Where diesel engines are still used, they are usually operated with hydrogenated vegetable oil which, when mixed with fossil fuels, reduces emissions by circa 90 percent, says Ruijs.

“We need a greater push to make rail the transport mode of choice. Ultimately, road transport needs to be discouraged further, for example through CO2 taxes,” he adds.

Constraints and complexities

While the EU’s decarbonisation and sustainability agenda, coupled with additional taxes on the trucking industry, should make rail transport more attractive, decarbonisation and sustainability are not necessarily the main drivers of investments in rail outside of Europe, according to Filipan.

“A recent government bill in the US to increase the budget for rail investments was driven mainly by a need to improve safety and the general state of existing railways,” Filipan says. “In Asia, investments in rail are typically part of larger economic developments to connect cities for the transport of goods and people.”

A greater sense of urgency as well as budget is required in the US and Europe for the further expansion and electrification of the rail networks, he adds. “The constraints are largely related to the fact that rail projects require strong support across regions and countries, and the many complexities in terms of permitting, costs and political support.”

Compared to Western Europe and the US, Asia is far more advanced in rail transport, says Chung. “Japan is a good example and also China – its rail network is the largest in the world by far.”

That is down partly to Asia’s late mover advantage, but also to how the sector is managed and co-ordinated in this region, Chung notes. While government planning and control are centralised in China, the EU is consensus-driven, with each member state able to exert influence, he adds.

“That creates bottlenecks. In the EU there are differences in signalling and electricity or voltage systems, which makes it hard to harmonise the different systems. But steps are being taken to address that.”

DIF Capital Partners’ investments in rail include Rail First, an Australian rail freight leasing company, and Kinzigtal, a German passenger rail concession which leases state-of-the art electric multiple unit trains. The company typically provides capital to mid-sized companies for the procurement of new, more energy-efficient rolling stock. Ruijs says: “We can help them grow their operations and portfolios – and achieve greater market shares – as well as making them more sustainable.”

Supportive macro-economics

Population and GDP growth worldwide will also translate into more transport movements, Ruijs argues. “Sustainability is a strategy that we seek to promote within all the companies we invest in. Ultimately, this is good for the environment and society, but also for their valuation.”

As for clean technologies, the development of battery-run trains is further advanced than the hydrogen journey, Chung says. “One of the difficulties for using hydrogen is building the infrastructure for fill-up tanks near or at railway stations. The battery proposition is more straightforward because all you need is a charging station, like you do for cars and other road vehicles.”

Chung does not expect a 100 percent phase-out of diesel soon because some of the last-mile rail or shunter activities, for example in ports and terminals, require a lot of power. “We will probably still need diesel for the last-mile activities in 10 to 15 years’ time, unless hydrogen is able to replace it or there is a disruptive battery technology to achieve sufficient energy capacity.”

Rail is a very slow-moving industry, he adds. “It will take some time before the sector is completely green.”

Digitalisation and decarbonisation dominate the landscape

AI offers rail a boost to clean and efficient service delivery.

The acceleration of artificial intelligence capabilities is creating opportunities to improve the way railway companies plan and deliver services. The financial benefits could be huge, according to a recent study by the International Union of Railways and consultancy firm McKinsey. Globally, AI could potentially unlock $13 billion-$22 billion dollars in impact a year for railway companies.

AI is already facilitating improvements in predictive maintenance, inventory management, capacity planning, operational efficiency and risk management, confirms APG’s Viktor Filipan. “In essence, it may allow companies to execute their business activities more efficiently and have a transformative impact on subsectors within the wider rail framework.”

Ultimately AI could also help rail operators to become more competitive with road trucks, adds PGGM’s Henry Chung. “For road trucks it is quite easy to transport goods from one place to another because they do not need a scheduled time slot, but for trains, everything needs to be planned very well in advance. Digitalisation could help there.”

AXA IM Alts’ electric locomotive leasing business is increasingly using AI to optimise operations, says the company’s head of infrastructure, Mark Gilligan. The Paris-based investor acquired the business in 2018 and has grown the all-electric fleet by 40 percent in less than four years, to keep up with customer demand.

“We are continuing to invest in data capture to optimise driver behaviour as well as maintenance cycles. We see the same trend across our entire infrastructure portfolio: decarbonisation, electrification and digitalisation are convergent challenges – and opportunities – in all our assets. This is intentional as we hold the conviction that these themes will dominate 21st century infrastructure,” says Gilligan.

On the passenger side, enhanced ticketing systems, real-time travel information, route optimisation and on-board connectivity can improve the overall customer experience, says Carlo Maddalena at APG. “From an operational perspective, digital technologies help optimise train schedules and improve traffic management while enhanced predictive maintenance leads to more reliable and punctual rail services.”

The largest and most important digitisation project in Europe is the implementation of the European Rail Traffic Management System, the EU’s signalling and speed control system. Once operational, the ERTMS will ensure interoperability of the EU’s national railway systems and make rail transportation across borders far more efficient.

The system also aims to increase the speed of trains, the capacity of rail networks and the safety of rail transport, explains Allard Ruijs at DIF Capital Partners: “It will take time, but greater standardisation of the rail control system will benefit the entire rail system.”