The Supply Chain Matters blogs provides a further update to our ongoing five-year streaming commentary related to Chinese branded railcars making an opportunistic  market presence among U.S. public transit systems.

Background

Extending back to 2014, the Supply Chain Matters blog has alerted our readers to the potential of Chinese produced subway and railcars appearing among U.S. transit systems. We were one of the few social-media sites highlighting the initial and ongoing presence along with the supply and demand network implications.  Boston CRRC subway railcars

Initially, the Massachusetts Department of Transportation had awarded a contract to China’s state-owned rail equipment manufacturer CNR Corp. for the replacement of 284 modern subway cars to replace existing subway cars that were in excess of 20 years old.  The important headline for this development was the awarded contract cost, namely $567 million, a rather compelling sum for this amount of modern equipment.  It allowed the state authority to procure modern replacement equipment without federal funding. It was a bargain, considering bids from other equipment providers.

The deal broke ground in the presence of a U.S. beachhead for the China state-owned company, including the opening of a new rail car assembly facility near Springfield, Massachusetts. The contract stipulated that 60 percent of equipment manufacturing and supply network would have to take place in the U.S..

In 2016, the Massachusetts based MBTA Control Board voted to authorize as much as $277 million to acquire an additional 134 Red Line subway cars, as an extension of the existing contract with the China based railcar producer. This amended change to the existing contract bypassed standard bidding procedures because the agency indicated that it was seeking to standardize its entire network-wide fleet. The agency had initially considered rebuilding the 184 existing Red Line cars not scheduled to be replaced in the initial CNR contract noted above, but a financial analysis indicated that brand new cars would cost as much as $310,000 less than overhauling the existing ones.

It was at that time that Supply Chain Matters raised initial speculation that the incoming Trump Administration may not be shy in slapping increased tariffs on Chinese parts and components imported into the United States. We wondered aloud what that would mean for overall contract pricing or local manufacturing.

Since the Massachusetts deal, China’s government facilitated the merger of its two major state-owned rail manufacturers which included CNR. The combined China Railroad Rolling Stock Corp. (CRRC Corp. Ltd.) then created a local U.S. subsidiary to administer contract delivery needs involving the U.S.

The state-owned China U.S. subsidiary then landed a major equipment replacement deal with the Chicago Transit Authority, described as a monumental overhaul of the transit authority’s rail car equipment. The deal amounted to a $1.3 billion contract to replace 846 rail cars, about half of the existing subway car fleet — the biggest car purchase in that agency’s history. The CSR Sifang America bid came in at a reported $226 million lower than that of Bombardier Railcar Equipment, the previous manufacturer of Chicago’s railcar fleet. The described new generation of railcars also called for localized final assembly to be performed at a new final assembly manufacturing facility to be located on the Southeast Side of Chicago.

That was followed with contracts to supply new subway cars for both the Philadelphia and Los Angeles subway systems, both at attractive industry pricing, and both requiring forms of local manufacturing presence at the Springfield Massachusetts manufacturing facility.

 

Trade Tensions and Emerging New Factors

In August of 2018, we highlighted a report that the U.S. Congress was considering legislation that could ban the production of Chinese manufactured railcars in the United States. From our lens, that legislation was yet another effect of escalating trade tensions involving the U.S. and China. This legislation reportedly stemmed from concerns from existing U.S. based freight car manufacturers Trinity, and Greenbriar and unnamed others, that CRRC might leverage existing U.S. based subway car manufacturing facilities as a beachhead to expand into freight car market needs, undercutting existing U.S. manufacturers. That legislation did not come to pass.

In December of 2018, the Boston Globe newspaper reported that CRRC was pressing the Trump Administration to exempt it from 25-percent tariffs on a number of components imported from China, including subway car frames, air ducts, and boxes to hold batteries.

There are now a broader twist to these developments.

In the Fall of 2018, the Washington Metropolitan Transit Authority, the transit agency overseeing the Washington DC Metro system-initiated plans to procure 256 modern termed 8000 series subway cars to replace a rapidly aging existing fleet. The full replacement effort can be upwards of 1000 cars in total.

The specifications call for the most advanced technologies in auto train control safety, high definition security cameras and rider comfort. The agency is on record as noting that cost is a major factor because the system has long been hemorrhaging money for quite some time.

One of the bidders is CRRC, which according to reports is expected to be a strong contender for the acquisition contract.

The backdrop of this  saga increasingly relates to the ongoing escalating trade tensions with China and how that intersects with the political tide. Five members of U.S. Congress who represent the DC region expressed fears that foreign adversaries can possibly gain control of subway systems, specifically the DC Metro system. A letter to the agency indicates that while other cities have welcomed investment in foreign manufacturers, there are serious concerns when it can involve activity surrounding the U.S. Capital. Those concerns  related to cyber hacking threats, similar to the perceived Huawei Technologies threat in telecom networks.

For its part, Metro system officials amended the rail car specifications to include provisions for adhering to NIST cyber security standards including the integrity of hardware and software. The specifications reportedly further called for all software code related to equipment to be audited by an independent Department of Defense cleared contractor.

Additionally, there are further calls for federal legislation to address nationwide passenger rail system safeguards related to cyber threats.

In May, Senator Chuck Schumer, Minority Leader of the U.S. Senate called for a security review of any work that CRRC would do for the New York City transit system.

 

Latest Development

Today, The Wall Street Journal reported that the U.S. Congress is now considering final legislation to bar the use of federal funds to acquire both Chinese railcars and buses. The report indicates that advocates argue that such a ban is needed to protect U.S. industry from competition from state-owned subsidized Chinese companies. They further raise the specter of on-board cameras, location trackers and other surveillance gear that could provide surveillance or underlying sabotage threats.  This is a similar national security theme to the Huawei ban.

A U.S. House of Representatives version of an annual defense policy bill now incorporates language blocking public transit agencies from utilizing federal monies to buy railcars procured from a Chinese state-owned controlled or subsidized company, including CRRC Corp. The U.S. Senate version includes similar language but adds busses to the mix, taking special aim at BYD Corp. that assembles electric buses in the U.S..  While BYD in not state-owned, the company reportedly receives subsidies from Chinese government entities.

Lawmakers are expected to now reconcile the two versions for final passage in the coming days.

At this point, there are two CRRC assembly plants in the U.S. with the potential for a third. BYD Corp. has reportedly delivered 340 electric buses to-date to 14 U.S. states from its assembly plant in Lancaster California.

The affected Chinese companies continue to deny that they pose a national security risk or provide an unfair advantage. There are currently no U.S. based manufacturers of public transit railcars in the U.S., have not been for quite some time. As noted, there are two major U.S. manufacturers of freight related railcars. CRRC continues to indicate that it has no plans to manufacture freight cars in the U.S..

 

Supply Chain Matters Perspective

As noted in previous commentary, this ongoing five year set of developments provides a number of themes.

The original theme was severely budget constrained transit agencies operating rather old and repair-prone subway cars had to find a means to replace such equipment with modern technology and safety features at the lowest cost. A state-owned Chinese rail equipment manufacturer seeking to penetrate a rather large, untapped market, was willing to be aggressive in bidding and in establishing a U.S. market foothold, including required local manufacturing presence to conform to a required 60 percent threshold for local component or final assembly manufacturing.

Market success equates to opportunity and value for both the buyer and the seller. Hence, multiple transit agencies elected to go with CRRC. Modern equipment and technology at significantly lower cost- the supply chain sourcing secret sauce. With that came a new mandated U.S. manufacturing and supply network presence, albeit not complete. Overall reliability remains an open question but similar equipment operating in multiple nations at the surface appear to be reliable.

Since the current U.S. Administration took office, trade tensions with China have escalated along with concerns for intellectual property protections and mitigating sophisticated cyber-espionage threats from state-sponsored groups. Along the way, industry or corporate lobbyists add voice and influence to the opportunity of trade conflict favoring certain domestic interests.

The ongoing escalation involves a U.S. market ban along with designated supply constrictions targeting Huawei Technologies.  Passage of the proposed new legislation banning funding for state-owned and subsidized railcars and electric buses will surely add to the ongoing trade tensions, and potential added ramifications.

Combating cyber or other national security threats is an important safeguards, and the backdrop of a Chinese company adds a special political dimension. Chinese state-owned producers of subway cars or buses banned from eligibility for federal funding will force some transit systems to halt current procurement or once again invite bids from other more expensive foreign manufacturers at considerably more cost to agencies and taxpayers. Such procurement would likely be subject to cost impacts of added import tariffs for steel, aluminum or specific proprietary components.

Market opportunity opens a door, while added developments close such doors. Particularly when they include political dimensions.This is not just railcars and buses, but potentially Chinese presence and capability among supply networks across other industries including automotive, industrial machinery and high-tech.

That is the final theme, how politically motivated actions subsume industry market forces. The U.S. presence of CRRC was a market opportunity for public transit agencies and for public transit riders. Concerns related to cyber and other national defense threats are legitimate but can be addressed with adequate design specifications and audit oversight.

Instead, the added political dimensions will subsume a product demand and supply network market opportunity. Regardless, other nations will continue to benefit from China’s railcar or electric bus product and process technologies and efficiencies. U.S. and China trade talks will drag on with added points on contention and lack of trust.

We all get to see where Chinese branded railcars or busses across the U.S. ultimately land, and whether this can be characterized at lost market and supply network opportunity.

 

Bob Ferrari

© Copyright 2019, The Ferrari Consulting and Research Group and the Supply Chain Matters® blog. All rights reserved.