Good, better, best: Railways are advancing their ESG agenda

European rail has a reputation for being safe, smart, and green, and other countries around the world are working to increase passenger and freight rail modal share as this provides a sustainable transport solution. But environmental sustainability is only one part of the sustainability puzzle. Environmental, social, and governance (ESG) criteria play an important role in helping companies and industries become more sustainable. Globally, and across industries, a major part of ESG growth has been driven by the environmental component of ESG and responses to climate change. But other components of ESG, in particular the social dimension, have also been gaining prominence—and ESG considerations are becoming more important in companies’ decision making.¹“Does ESG really matter—and why?,” McKinsey Quarterly, August 10, 2022.

The rail industry has made strides in positioning itself as an environmentally sustainable option, and railway companies are pursuing sustainability agendas, particularly surrounding decarbonizing operations.²“Motorised transport: Train, plane, road or boat—which is greenest?,” European Environment Agency, March 24, 2021. Decarbonization is important, but it is only one element of the wider sustainability agenda that can include ESG criteria.

Individual railway companies could take a holistic approach to ESG and expand their focus on the social and governance aspects—with many leading railways already doing so. Such companies are reaping the benefits, as implementing a comprehensive ESG strategy can help railways form new partnerships, generate additional revenue streams, reduce costs, and increase access to capital.

For example, railway companies could boost their sustainability metrics by coupling environmental actions, such as decarbonization, with social actions, such as digitizing, to improve railway crossing safety and improving diversity and inclusion efforts. Becoming greener could potentially help railways access financing at lower costs through, for instance, green bonds. As employees are increasingly looking to work for companies that share their values, clear ESG commitments can help to attract and retain talent.

This article offers considerations for railway companies to advance their sustainability agendas through developing a comprehensive ESG strategy, addressing all three elements, and highlights best practices of companies that have done so. Such an approach can allow railways to better engage customers and employees, foster meaningful dialogue with governments, investors, and financial institutions, and, ultimately, create value for all stakeholders through advancing all areas of sustainability.

Rail is green, and becoming more so

Rail is well positioned as a more sustainable option than other transport modes as shifting freight and passenger flows from road and air to rail can reduce CO₂ emissions significantly. The transport sector accounts for roughly one quarter of all global emissions, of which less than 1 percent are from rail.³International Energy Agency (IEA) CO₂ emissions statistics. The advantages of rail as a lower-carbon option are evident: for passenger transport, rail produces 14 grams of carbon dioxide equivalent per passenger kilometer, compared to 166 by car and 261 by air travel.⁴International Energy Agency (IEA) CO₂ emissions statistics; “Special report: Global warming of 1.5ºC,” IPCC, 2018. Similarly, for freight transport, rail produces 36 grams of CO₂ per ton kilometer, compared to 96 by long-haul truck and 946 by international aviation.⁵International Energy Agency (IEA) CO₂ emissions statistics; “Special report: Global warming of 1.5ºC,” IPCC, 2018.

Given rail’s potential to reduce traffic congestion and accelerate decarbonization, many European countries have put initiatives in place to increase rail’s modal share and reduce transport CO₂ emissions.⁶“EU invests €5.4bn in sustainable, safe, and efficient transport infrastructure,” European Commission, June 29, 2022. Countries, regions, and individual rail companies are investing in rail infrastructure, expanding the offering through contracting additional train services, replacing diesel trains with those that use hydrogen or alternative fuels, and applying congestion taxes for passenger cars. For example, London implemented a charge system for cars to ease traffic congestion.⁷“A compilation of green economy policies, programs, and initiatives from around the world,” World Resources Institute, February 11, 2011. On a regional level, the European Union plans to increase freight rail’s modal share from 18 to 30 percent by 2030.⁸“30 by 2030: Rail freight strategy to boost modal shift,” Rail Freight Forward; European Commission Mobility Strategy.

Railway companies have also set decarbonization targets such as reducing scope 1 and 2 emissions, reducing energy intensity, and increasing renewable energy share. For example, several leading railways in North America and Europe report that they plan to reduce CO₂ emissions by between 25 and 36 percent, respectively, by 2030.⁹McKinsey analysis. Efforts to achieve this include ensuring that rolling stock is energy efficient, for instance by modernizing fleets, increasing train weight and length, optimizing energy consumption, and sourcing greener steel for new train procurements. Other measures that support decarbonization include electrification of lines; using alternative energy sources such as biofuels; switching to hydrogen or battery-powered trains; and optimizing energy efficiency in railway stations.

Where diesel-powered trains are still in use, many are looking to switch to alternative sources of energy such as biofuels. Although the cost of biofuels is higher than fossil fuels at present and implementing their use may require some modifications to fueling infrastructure, several railways have embarked on pilot projects to do so. While the use of biofuels in trains is not a new phenomenon—for instance the Prignitzer Eisenbahn (PEG) in Germany has been running on pure biofuels since 2006—many railways are joining the trend.¹⁰“Pure biofuels for the Prignitzer railway,” Renewable Carbon News, May 30, 2006. Some railway companies in the United States and Europe are testing new biodiesel blends or pure, renewable hydro-treated vegetable oil (HVO) for their locomotives.¹¹McKinsey analysis.

Hydrogen may become a zero-emission and potentially cost-effective replacement for diesel combustion engines, and hydrogen trains are already being piloted in Europe. Major fuel cell and hydrogen (FCH) manufacturers have a portfolio of more than 100 trains planned for production over the next five years. For instance, 41 of Alstom’s FCH trains were ordered in Germany between 2017 and 2019 and have already entered service this year.¹²“Alstom will supply 41 Coradia Lint regional trains to Bavaria, Germany,” Alstom, March 20, 2019. The contract for these trains includes the maintenance and operation of the hydrogen refueling station, as well as the hydrogen supply. Alstom’s FCH train has also been tested by Austria, France, Poland, and Sweden.

FCH technology will be used in other parts of the world in commercial services, too. In 2019, two of Stadler’s FCH trains were ordered in California, and are due to be operational in 2024.¹³Mykola Zasiadko, “First US hydrogen-powered train will be produced by Stadler,” RailwayTech, November 14, 2019. In China, CRRC has collaborated with a provider of fuel cell solutions to produce hydrogen trams, and CRRC’s first FCH hybrid locomotive rolled off the production line in 2021.¹⁴“China’s first hydrogen fuel cell hybrid locomotive put into operation,” CRRC, November 18, 2021.

Given technological advances, alternative energy sources may surpass diesel by 2030 for new train orders. McKinsey analysis suggests that hydrogen technologies can reach parity with diesel fuel for freight and passenger locomotives by 2030, at which point the costs of FCH could drop by between 15 and 25 percent, compared to diesel.

However, achieving ESG goals in railroads is not limited to decarbonization. Setting specific targets on energy intensity and consumption, improving water and waste management, and prioritizing a circular-economy model can all help railroads achieve their ESG targets.

Railways’ ESG performance varies

While many railway companies have set decarbonization goals, and are taking action to achieve them, ESG performance varies across the industry. We analyzed multiple railways’ ESG performance to gain insight into target setting, gaps in the industry, and best practices across the globe, and to see whether there is a regional element in how different railways set and achieve their sustainability goals.

The analysis is based on metrics that railways and their stakeholders have prioritized and maps the ESG performance of ten railroads from the Australia, Europe, and the United States—based on publicly available information.¹⁵McKinsey analysis based on CDP Climate Change 2020; Refinitiv company data, Refinitiv, October, 2022. Structural and economic differences between railways (for example, the share of freight versus passenger volumes, as well as average price levels) were considered in the comparison.

Common key assessment criteria on the “E” dimension include energy consumption intensity, share of renewable energy, waste, and water consumption intensity—and performance varies widely:

• Energy consumption intensity. Annual scope 1 and 2 emissions intensity ranges from 80 to 1,200 tons of carbon dioxide equivalents (tCO₂e) per million dollars in sales. Apart from technological reasons, the difference in emissions is due to price and cost levels, as well as the split between passenger and freight volumes. To compare like with like, it would make sense to look at passenger and freight businesses separately and exclude commercial factors (for example, comparing CO₂e per million ton-kilometers [tkm] for freight businesses).
  
  Although fewer railways report on this metric, the result is more homogenous with a typical range of 6 to 19 tCO₂e/million tkm. Geography does not seem to play a role here, as leading companies with the lowest figure of 6 tCO₂e/ million tkm were found in Australia, Europe, and North America. Only a few railways report on scope 3 emissions.
  
  If three of the major outliers could reach a median indicator, there could be a CO₂ saving of 16.7 million tons. If all railways analyzed could reach the best performer’s level, there could be a CO₂ saving of 47.6 million tons—equal to up to 60 percent of CO₂ emissions from the railroads we analyzed.
• Water consumption. Annual water consumption intensity ranges from 11 to 250 cubic meters per million dollars in sales. Water savings could reach 10.1 million tons if outliers reach an average indicator, and 21.1 million tons if all railways reach the best performer.
• Waste intensity. In terms of waste intensity, measured in tons per million dollars in sales, figures range from one to 220 tons per year, with most railways reporting below 66 tons.
• Share of renewable energy. Four out of the six railways included in our analysis report that their share of renewable energy in their energy mix is below 2 percent, while one reported a share of 9 percent, and the best performer, 19 percent. However, there are examples of railroads that are on the way to fulfilling their commitment to running on 100 percent renewable energy.

When it comes to social and governance dimensions—such as employee retention, safety, satisfaction, and human rights—many of these metrics are unreported. However, most railways have ambitious gender diversity targets, with the current share of female managers ranging from 20 percent to 40 percent—with 40 percent being the exception.¹⁶McKinsey analysis.

There has been progress in this regard as transparency around ESG performance is increasing within the industry—and many railway companies appear in industry ratings, albeit with room for improvement. Although the exact metrics companies need to focus on will depend on an individual railway, most railways could benefit from greater transparency in disclosing their governance structures and policies. This transparency is appreciated by creditors, investors, and customers. Railway companies could improve this by increasing internal reporting capabilities.

Best performers address ESG holistically

A comprehensive approach to ESG can help companies to create value across all aspects of business. McKinsey research shows that a strong ESG proposition can safeguard a company’s long-term success and lead to better returns. Specifically, ESG links to cash flow in five important ways: facilitating top-line growth; reducing costs; minimizing regulatory and legal interventions; increasing employee productivity; and optimizing investment and capital expenditures.¹⁷“Five ways that ESG creates value,” McKinsey Quarterly, November 14, 2019.

Furthermore, each element of ESG is intertwined and they often overlap. Social criteria overlap with environmental criteria and governance when companies seek to comply with environmental laws and broader concerns about sustainability; and governance is integral to all decision making.

Railway companies that are leading the way in ESG often align and integrate ESG criteria with the company’s overall purpose and business objectives. For example, a major railway company includes environment, safety, people, community, and governance commitments in its overarching vision (see sidebar “How a large North American railway embeds ESG”). The goal of one of the leading EU railways of becoming climate neutral by 2040 informs its approach to ESG commitments, metrics, and actions (see sidebar “A European railway’s decarbonization goal forms the foundation of its ESG strategy”). Both examples showcase how clear ESG strategies are not an add-on to overall strategy, but are an integral part of business, aligned with company goals, commitments, values, and broader sustainable development goals.

Getting ESG right can create value for railways

Once ESG commitments are in place, these can open opportunities for railway companies to form new partnerships, create new products, and generate additional revenue streams. A focus on ESG initiatives could also help companies to reduce costs, attract talent, and access capital. Railways may be benefiting from the decarbonization wave as businesses turn to rail instead of truck as a more sustainable means of transport. Many are accelerating this momentum by proactively forging partnerships and refining their value propositions.

Railways could build on their status as a lower-carbon transport offering to attract additional freight or passenger customers. As part of their broader sustainability goals, they could also partner with suppliers, producers, or shippers across the value chain that seek to reduce their own scope 3 emissions. For instance, EU railways have partnered with European companies looking to reduce their carbon footprint when transporting products.

In one such initiative, a railway worked with an international beverage producer to create a network of dedicated client service stations, thereby moving freight from trucks to rail and reducing carbon emissions by 2,000 tons. In a similar project, a collaboration between a railway and various European car and battery manufacturers created a logistics chain that reduced CO₂ emissions by 11,000 tons. Railways have also worked closely with logistics providers and mail services to increase the portion of mail items that are delivered by rail, and with steel manufacturers to increase the use of rail to transport steel from factories to automotive manufacturers.

In the future, railways can be positioned to capture trucking flows as well as new flows created from the circular economy or generated by the shift to renewables (for example, recycled materials or new materials for renewable energy).

Furthermore, some railway companies are already pioneering new green services or new types of transportation offerings that reduce emissions. For example, several European railways have commissioned a zero-CO₂-emission eco train as a premium service for cargo transportation routes in the European Union. The required power volume for transporting cargo is first calculated and then purchased on the renewables market, thus offsetting any emissions. Railways then reinvest 10 percent of revenues from the eco train into renewable energy production and storage assets. Several leading car brands in Europe have begun to use such green offerings to reduce CO₂ emissions in their supply chains. Similar initiatives include offering electric last-mile delivery as an end-to-end green logistics solution.

Other revenue opportunities arising from a focus on ESG include developing green infrastructure solutions and finding ways to use company resources efficiently and sustainably. For example, railways could put measures in place to make the best use of their tracks, railway terminals, and adjacent areas. They could also create compensatory programs, such as forestry planting initiatives, to offset emissions. Another opportunity stems from using vast spaces of land owned by railways to set up plants for the generation of renewable energy such as solar and wind. One European railway converted 25 hectares of land to a surface solar power plant that generates almost 7,500 MWh electricity a year.

ESG strategies can also help railways to better manage costs, for instance, by reducing energy and water consumption, optimizing wastewater disposal processes, and moving toward a circular economy model that promotes re-use, repair, and recycling of existing materials, instead of the consumption and waste of resources.

Finally, companies with a clear ESG strategy may have increased access to capital markets, with better interest rates, as ESG is a consideration for some investors.

As a first step, railway companies could begin their ESG journey by quantifying the value at stake from associated revenue opportunities, as well as identifying the risks from not taking action. For instance, ESG initiatives could mitigate the risks of infrastructure losses due to climatic events.

Developing a comprehensive ESG strategy

Forward-looking companies approach ESG in a rigorous, strategy-driven, socially attuned way. They make ESG intrinsic to their strategy by defining, implementing, and refining a carefully constructed portfolio of ESG initiatives that connect to the core of what they do. Railway companies could consider the following four actions to develop and implement a comprehensive ESG strategy that can advance all aspects of their sustainability agendas:

1. Map your status. Undertaking a diagnostic and gap analysis is the first step to identifying existing ESG practices and defining how this baseline could evolve in the future. During this process, railway companies could benchmark current ESG targets and performance against peers, incorporate industry guidance on best practices, and prioritize ESG dimensions that are most critical to stakeholders. They could also ensure that ESG objectives are aligned with the overall business strategy, and possibly with national sustainability agendas too. Railway companies that have ESG strategies in place often begin by using their purpose statement or vision as a foundation for choosing ESG dimensions, and link these to any UN Sustainable Development Goals (SDGs) they wish to pursue.
2. Define your contribution. In this phase, it may be beneficial to brainstorm potential sources of ESG distinctiveness and then quantify the value of these opportunities as well as any associated risks that these dimensions could mitigate. Companies could then prioritize key objectives that would lead to the creation of an integrated ESG strategy, including defined commitments, quantified targets and KPIs, and potential flagship initiatives. Several railway companies set timelines and key milestones for specific initiatives, such as reducing emissions by a certain percentage, increasing safety, or achieving diversity milestones or gender parity by a target date.
3. Embed the strategy. The next step involves defining an operating model to embed the strategy across the business and developing an implementation road map. An operating model could include governance guidelines and reporting mechanisms—to management and the board—as well as KPIs across all business areas and processes such as capital allocation, performance management, and talent development. Companies could draft a three- to five-year implementation road map including quick wins and long-term projects, as well as a one-year plan that details priorities, flagship initiatives, milestones, accountabilities, and required resources. Railway companies have also introduced ESG-linked management incentives to improve decision making and ensure that goals and targets are at the forefront, across all aspects of business.
4. Communicate and report. Finally, key ESG themes could be included in all external reporting such as sustainability reports and integrated reports. Railway companies often commit to reporting standards, for instance on SDGs, that help to keep initiatives on track and flag any areas that need attention. Companies could also develop tailored external stakeholder engagement plans to aid potential partnerships, including collaboration with manufacturers or shippers looking to reduce their scope 3 emissions. These plans may also aid investment and increase access to capital markets.

Considering that railways are complex organizations, companies can also put enablers in place to help them develop and embed their ESG strategies. For instance, railways can pay attention to organizational practices and structures that can help to ensure that all aspects of ESG are covered throughout the organization. Often, there is no single point of responsibility for ESG, and multiple departments are responsible for several ESG-related criteria, such as safety, the environment, or the circular economy. A clear structure could help to define roles and responsibilities, and make sure that all the ESG issues in the strategy are being addressed.

Adding the role of a Chief ESG or Sustainability Officer (CSO) could provide a way for railways to orchestrate and drive ESG initiatives across the business. The CSO would be responsible for the company’s sustainability strategy, and reporting, as well as for providing clear and consistent communication on sustainability topics to all external stakeholders. The CSO could also facilitate any culture or change management required, for instance ensuring that ESG is embedded in everyday behavior. The CSO role could be standalone (responsible for leading and ensuring delivery on sustainability initiatives) or could be combined with responsibility for company-wide strategy or innovation.

Finally, railway companies could also set clear methodologies and standards for assessing and reporting ESG metrics for key activities. Clear standards would likely increase transparency and accountability for ESG across the industry.

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Rail is well positioned to build on its ability to accelerate decarbonization efforts, for instance by shifting freight and passenger transport from road and air to rail. Many companies have expanded on this by setting their own decarbonization targets and sustainability goals. Railways could widen their sustainability efforts by focusing on ESG goals—doing so could advance the sustainability agenda and build better relationships with all stakeholders. A clearly defined ESG strategy could also provide opportunities for revenue growth and cost savings.