Transportation: Policy and infrastructure changes ahead

Pierre Berton wasn’t an economist, but in telling the early history of Canada he inadvertently revealed how important transportation was to the country.

From the search for the Northwest Passage to the building of the transcontinental railroad, the economic imperative of low-cost reliable transportation links across Canada drove what we now call public-private partnerships to finance the huge cost of national projects.

Then, the idea was to stem the natural development of north-south trade into economic and political annexation by the U.S … today over reliance on the U.S. market is still an issue, now combined with the pull of huge and cash-rich Asian markets hungry for resources. And like 130 years ago, finding the money to build and maintain an enormous transportation infrastructure is an economic and political challenge for investors as well as all three levels of government.

For the metalworking industry, it’s doubly important; we use these routes to get products to market, but the transportation infrastructure itself is also a major consumer of metal products. For our sector, the health of transportation infrastructure is a strong predictor of short to medium term economic growth.

The challenge is familiar: dense population concentrations separated by large distances, with an overall population too small to properly fund major networks. For national rail and road transport, and today shipbuilding as well, public financial support is the only way to minimize investment risk to the point where the private sector can and will share the load.

With much of the world still suffering from recession and a federal government committed to minimal interference with free markets, combined with Canadian taxpayer fatigue, resources are limited, but Ottawa is spending billions to support transportation infrastructure.

For future economic growth, there’s little choice.

Rail: a regulatory tug-of-war

With 48,000 kilometres of track, Canada has one of the largest rail networks in the world. Rail is uniquely efficient at long haul freight carriage and through containerization, is easily integrated into road and seagoing transport systems, yet Canada’s rail system is maintained and developed mainly by the private sector, which invests more than $1.7 billion annually.

According to the Railway Association of Canada, however, a great majority of Canadians (87 per cent) think the government should provide funding for rail. The current political and economic climate favours public-private partnerships and reduced regulation, a strategy supported by the industry but resisted by major shippers whose business models have been built on subsidized freight rates.

While the regulatory climate for major transcontinental carriers is as political now as it was a century ago, private-public financing is the future for line expansion in the resource sector.

Quebec’s “Plan Nord”, for example, will open the northern interior of the province to mineral development through a partnership between the provincial government’s investment arm, the Caisse de Dépot, and CN.

Bulk commodity transport such as minerals and agricultural products are cheapest by rail, and in the case of Northern mineral development, the only cost effective way to get product to market. Asian markets are resource hungry, and with a mature East-West system serving deep water ports on both coasts, there are opportunities for other players to operate profitable lines. Besides the two major players, CN and CP, there are 50 short line railroads in Canada, a significant market for machined and fabricated products.

Compared to other transport sectors, however, the unique regulatory environment outside of rail infrastructure will play a major role in expansion. An example is Bill C-52, the Fair Rail Freight Service Act. C-52 requires a railway company, at the request of a shipper, to make the customer an offer to enter into a contract for service. In effect, the bill forces railroads into contracts with their customers.

The origin of Bill C-52 was lobbying from major shippers and especially the agricultural sector, where the stakes are high. In 2012, Canada’s grain producers exported approximately $17 billion in grain products, as much as 85 per cent of their total sales.

In 2012, Canadian farmers spent over $1 billion to ship grain by rail; a prairie grain shipment travels an average of 1400 kilometres to reach a destination port. The result is an unusual hybrid system where rates and service are essentially government controlled, while new rail infrastructure investment is handled by the private sector, or public-private partnerships.

C-52 is too new to judge its impact on rail system investment, but for short lines and northern resource development, rates and freight tonnage are negotiated over longer terms, reducing investment risk. If the global economy continues to recover, look to Asian market demand to drive more projects like Plan Nord.

Road infrastructure: spending gathers steam

Canada’s road network is the most important element in the national transportation system, and the degradation of this vital infrastructure is a national problem. Repair and remediation, however, is a complex issue, with all three levels of government holding overlapping responsibilities and funding programs.

Federally, the government’s New Building Canada Plan, a component of the Economic Action Plan 2013, targets roads, bridges, subways, commuter rail, and other public infrastructure in cooperation with provinces, territories, and municipalities.

The program differs from traditional federal initiatives by including the private sector. Projects costing over $100 million (which encompasses almost all new-build projects such as border bridges and Toronto’s mass transit expansion) will be passed through a “public-private partnership screen” to determine if funding is better raised with the private sector.

To achieve this, Ottawa has created a Crown corporation called PPP Canada, with an independent Board of Directors reporting through the Minister of Finance to Parliament. Compared to rail and marine transportation, where the Constitution gives the Ottawa control over all but intra-provincial networks, road infrastructure spending is a negotiation between two and often all three levels of government.

The issue is money. The New Building Canada Plan uses a complex funding formula including an indexed $22 billion Gas Tax Fund which gives municipalities considerable flexibility to spend federal funding on local infrastructure priorities and an incremental GST Rebate for Municipalities totaling $10.4 billion.

At the provincial and national level, a new Building Canada Fund offers a $4-billion national infrastructure component and $10-billion provincial-territorial infrastructure component that will support projects of national, regional and local significance across the country in a broader range of categories. An additional $1.25 billion in funding is earmarked for P3 Canada, which will be administered by PPP Canada Inc. While P3 Canada will help determine who can most cost-effectively deliver road infrastructure projects on budget, the power to allocate the projects is still largely locally and provincially-driven.

As the nation urbanizes, the result may be high levels of investment in urban regions like the Greater Toronto Area at the expense of national imperatives such as the Trans-Canada Highway. And as urban population densities drive transport systems away from roads and toward subways and urban rail systems, provincial governments will have fewer incentives to invest in roads that enhance inter-provincial trade, especially where they cross borders far from urban centres.

In practice, Ottawa has the authority to redirect funding at will, but with a national election likely in 2015 and traditional Conservative weakness in major urban ridings, there’s considerable federal incentive to address urban mass transit issues over roads.

Shipbuilding: Defence spending

Shipbuilding is traditionally a highly cyclical “boom-bust” business, and in a Conservative market-driven policy framework, smoothing this business cycle is more important than preserving short term jobs; it’s about ensuring sufficient capacity in domestic yards to prevent reliance on foreign nations for national defence needs.

Defence is a natural “fig leaf” for the Conservatives, allowing them to use DND contracts to effectively subsidize domestic yards while upgrading the nation’s aging naval and patrol fleet.

The core of the program is the National Shipbuilding Procurement Strategy (NSPS) launched in 2010 to design and build both combat and non-combat support vessels in two major shipyards.

Irving Shipbuilding and Vancouver's Seaspan are the prime sites, with the Irving yard cutting metal in 2015. To help prepare Irving for the major project, the government has announced the Halifax Shipyard Modernization Program, a $300 million investment which is estimated to boost Canadian gross domestic product (GDP) by $254 million and create 1,700 full-time jobs across Canada, generating $161 million worth of employment income in the country over the two year period.

The Halifax operation will build Navy combat vessels and Arctic/offshore patrol ships. Major ship procurement is a positive step towards a secure indigenous shipbuilding capacity, but as importantly, the program will separate small vessel contracts and set them aside for competitive bidding from smaller yards.

To ensure fairness in the bidding process, the program uses third party oversight of the process, although CBC has uncovered significant cost overruns during the design phase of the patrol ships planned for the Irving yards.

According to Public Works and Government Services Canada, an independent review by International Marine Consultants Ltd. (IMC) suggests that design cost overruns will be made up by efficiencies in construction, although details have not been released. Both Irving Shipbuilding and Vancouver Shipyards offer on-line registration for suppliers interested in bidding on the projects.

From a metalworking perspective, the non-combat support vessels to be built on the west coast offer more opportunity per dollar spent, as weapons systems represent a large portion of combat vessel costs, while for support vessels, hull and superstructure construction are a larger part of the overall unit cost.

Support vessels are also larger, with proportional demands on plate forming and welding tasks. While Canadian yards are unlikely to wrest control of major shipbuilding tonnage from its Asian and European centre, the Navy/Coast Guard vessels and maintenance/repair will preserve a two-ocean national shipbuilding capability for the foreseeable future.